FORM 10-Q
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
 
FORM 10-Q
(Mark One)
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2008
     
o   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 001-14793
FIRST BANCORP.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
     
Puerto Rico
(State or other jurisdiction of
incorporation or organization)
  66-0561882
(I.R.S. employer
identification number)
     
1519 Ponce de León Avenue, Stop 23   00908
Santurce, Puerto Rico   (Zip Code)
(Address of principal executive offices)    
(787) 729-8200
(Registrant’s telephone number, including area code)
Not applicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large accelerated filer þ    Accelerated filer o    Non-accelerated filer   o
(Do not check if a smaller reporting company)
  Smaller Reporting Company o 
Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act). Yes o No þ
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Common stock: 92,510,506 outstanding as of October 31, 2008.
 
 

 


 

FIRST BANCORP.
INDEX PAGE
         
    PAGE
PART I. FINANCIAL INFORMATION
       
Item 1. Financial Statements:
       
    4  
    5  
    6  
    7  
    8  
    9  
    40  
    89  
    89  
 
       
       
    90  
    90  
    91  
    91  
    92  
    92  
    92  
 
       
       
 EX-3.1
 EX-31.1
 EX-31.2
 EX-32.1
 EX-32.2

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Table of Contents

Forward Looking Statements
     This Form 10-Q contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. When used in this Form 10-Q or future filings by First BanCorp (the “Corporation”) with the Securities and Exchange Commission (“SEC”), in the Corporation’s press releases or in other public or shareholder communications, or in oral statements made with the approval of an authorized executive officer, the word or phrases “would be,” “will allow,” “intends to,” “will likely result,” “are expected to,” “should,” “anticipate” and similar expressions are meant to identify “forward-looking statements.”
     First BanCorp wishes to caution readers not to place undue reliance on any such “forward-looking statements,” which speak only as of the date made, and represent First BanCorp’s expectations of future conditions or results and are not guarantees of future performance. First BanCorp advises readers that various factors could cause actual results to differ materially from those contained in any “forward-looking statement.” Such factors include, but are not limited to, the following:
    risks arising from credit and other risks of the Corporation’s lending and investment activities, including the Corporation’s condo conversion loans from its Miami Corporate Banking operations and the construction loan portfolio in Puerto Rico, which may affect, among other things, the level of non-performing assets, charge-offs and loan loss provision;
 
    an adverse change in the Corporation’s ability to attract new clients and retain existing ones;
 
    changes in general economic conditions in the United States and Puerto Rico, including the interest rate environment, market liquidity, market rates and prices, and disruptions in the U.S. capital markets which may reduce interest margins, impact funding sources and affect demand for the Corporation’s products and services and the value of the Corporation’s assets, including the value of the interest rate swaps that economically hedge the interest rate risk mainly relating to brokered certificates of deposit and medium-term notes as well as other derivative instruments used for protection from interest rate fluctuations;
 
    uncertainty about the effectiveness and impact of the U.S. government’s rescue plan, including the bailout of U.S. government-sponsored housing agencies, on the financial markets in general and on the Corporation’s business, financial condition and results of operations;
 
    uncertainty about the Corporation’s participation in the Troubled Asset Relief Program, if it should decide to apply to issue preferred stock through this program;
 
    changes in the fiscal and monetary policies and regulations of the federal government and including those determined by the Federal Reserve System (FED), the Federal Deposit Insurance Corporation (FDIC), government-sponsored housing agencies and local regulators in Puerto Rico and the U.S. and British Virgin Islands;
 
    risks of not being able to recover all assets pledged to Lehman Brothers Special Financing, Inc.;
 
    changes in the Corporation’s expenses associated with acquisitions and dispositions;
 
    developments in technology;
 
    the impact of Doral Financial Corporation’s and R&G Financial Corporation’s financial condition on the repayment of their outstanding secured loans to the Corporation;
 
    the Corporation’s ability to issue brokered certificates of deposit and fund operations;
 
    risks associated with downgrades in the credit ratings of the Corporation’s securities; and
 
    general competitive factors and industry consolidation.
     The Corporation does not undertake, and specifically disclaims any obligation, to update any of the “forward- looking statements” to reflect occurrences or unanticipated events or circumstances after the date of such statements except as required by the federal securities laws.
     Investors should carefully consider these factors and the risk factors outlined under Item 1A, Risk Factors, of Part II of this Quarterly Report on Form 10-Q, and Item 1A, Risk Factors, in the Corporation’s Annual Report on Form 10-K.

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Table of Contents

FIRST BANCORP
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Unaudited)
                 
(In thousands, except for share information)   September 30, 2008     December 31, 2007  
ASSETS
               
 
               
Cash and due from banks
  $ 151,040     $ 195,809  
 
           
 
               
Money market instruments
    34,998       148,579  
Federal funds sold
    142,436       7,957  
Time deposits with other financial institutions
    116,684       26,600  
 
           
Total money market investments
    294,118       183,136  
 
           
Investment securities available for sale, at fair value:
               
Securities pledged that can be repledged
    2,691,829       789,271  
Other investment securities
    1,325,120       497,015  
 
           
Total investment securities available for sale
    4,016,949       1,286,286  
 
           
Investment securities held to maturity, at amortized cost:
               
Securities pledged that can be repledged
    985,230       2,522,509  
Other investment securities
    748,826       754,574  
 
           
Total investment securities held to maturity, fair value of $1,711,586 (2007 - $3,261,934)
    1,734,056       3,277,083  
 
           
Other equity securities
    60,796       64,908  
 
           
 
               
Loans, net of allowance for loan and lease losses of $261,170 (2007 - $190,168)
    12,419,422       11,588,654  
Loans held for sale, at lower of cost or market
    32,510       20,924  
 
           
Total loans, net
    12,451,932       11,609,578  
 
           
Premises and equipment, net
    172,285       162,635  
Other real estate owned
    40,422       16,116  
Accrued interest receivable on loans and investments
    91,158       107,979  
Due from customers on acceptances
    961       747  
Other assets
    290,723       282,654  
 
           
Total assets
  $ 19,304,440     $ 17,186,931  
 
           
 
               
LIABILITIES
               
 
               
Deposits:
               
Non-interest-bearing deposits
  $ 661,197     $ 621,884  
Interest-bearing deposits (including $1,515,525 and $4,186,563 measured at fair value as of September 30, 2008 and December 31, 2007, respectively)
    12,158,635       10,412,637  
 
           
Total deposits
    12,819,832       11,034,521  
Loans payable
    300,000        
Federal funds purchased and securities sold under agreements to repurchase
    3,326,936       3,094,646  
Advances from the Federal Home Loan Bank (FHLB)
    986,000       1,103,000  
Notes payable (including $12,445 and $14,306 measured at fair value as of September 30, 2008 and December 31, 2007, respectively)
    26,725       30,543  
Other borrowings
    231,890       231,817  
Bank acceptances outstanding
    961       747  
Accounts payable and other liabilities
    170,824       270,011  
 
           
Total liabilities
    17,863,168       15,765,285  
 
           
 
               
Commitments and contingencies (Note 20)
               
 
               
STOCKHOLDERS’ EQUITY
               
Preferred stock, authorized 50,000,000 shares: issued and outstanding 22,004,000 shares at $25 liquidation value per share
    550,100       550,100  
 
           
Common stock, $1 par value, authorized 250,000,000 shares; issued 102,408,306 as of September 30, 2008 (2007 - 102,402,306)
    102,408       102,402  
Less: Treasury stock (at par value)
    (9,898 )     (9,898 )
 
           
Common stock outstanding, 92,510,506 as of September 30, 2008 (2007 - 92,504,506)
    92,510       92,504  
 
           
Additional paid-in capital
    108,326       108,279  
Legal surplus
    286,049       286,049  
Retained earnings
    451,474       409,978  
Accumulated other comprehensive loss, net of tax benefit of $1,086 (2007 - $227)
    (47,187 )     (25,264 )
 
           
Total stockholders’ equity
    1,441,272       1,421,646  
 
           
Total liabilities and stockholders’ equity
  $ 19,304,440     $ 17,186,931  
 
           
The accompanying notes are an integral part of these statements.

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FIRST BANCORP
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
                                 
    Quarter Ended     Nine-Month Period Ended  
    September 30,     September 30,     September 30,     September 30,  
(In thousands, except per share data)   2008     2007     2008     2007  
Interest income:
                               
Loans
  $ 208,241     $ 223,738     $ 626,846     $ 678,288  
Investment securities
    79,077       62,794       211,095       202,138  
Money market investments
    974       9,399       6,046       19,961  
 
                       
Total interest income
    288,292       295,931       843,987       900,387  
 
                       
 
                               
Interest expense:
                               
Deposits
    95,089       143,188       301,053       401,160  
Loans payable
    240             240        
Federal funds purchased and repurchase agreements
    35,790       34,300       98,698       115,460  
Advances from FHLB
    10,018       9,172       30,738       26,370  
Notes payable and other borrowings
    2,534       4,242       9,573       17,718  
 
                       
Total interest expense
    143,671       190,902       440,302       560,708  
 
                       
Net interest income
    144,621       105,029       403,685       339,679  
 
                       
 
                               
Provision for loan and lease losses
    55,319       34,260       142,435       83,802  
 
                       
 
                               
Net interest income after provision for loan and lease losses
    89,302       70,769       261,250       255,877  
 
                       
 
                               
Non-interest income:
                               
Other service charges on loans
    1,612       1,290       4,343       5,499  
Service charges on deposit accounts
    3,170       3,160       9,725       9,536  
Mortgage banking activities
    1,231       1,125       2,354       2,238  
Net (loss) gain on investments and impairments
    (564 )     (3,119 )     14,950       (6,714 )
Net gain on partial extinguishment and recharacterization of a secured commercial loan to a local financial institution
                      2,497  
Rental income
    583       620       1,705       1,953  
Gain on sale of credit card portfolio
                      2,819  
Insurance reimbursements and other agreements related to a contingency settlement
          15,075             15,075  
Other non-interest income
    7,839       5,769       22,176       17,742  
 
                       
Total non-interest income
    13,871       23,920       55,253       50,645  
 
                       
 
                               
Non-interest expenses:
                               
Employees’ compensation and benefits
    35,629       33,995       106,949       103,719  
Occupancy and equipment
    15,647       14,970       46,167       43,848  
Business promotion
    4,083       2,973       13,150       12,767  
Professional fees
    2,724       4,473       12,702       16,478  
Taxes, other than income taxes
    4,242       4,015       12,256       11,249  
Insurance and supervisory fees
    4,213       5,282       12,142       8,773  
Foreclosure-related expenses
    5,626       588       12,054       1,129  
Other non-interest expenses
    10,212       8,656       30,906       29,807  
 
                       
Total non-interest expenses
    82,376       74,952       246,326       227,770  
 
                       
 
                               
Income before income taxes
    20,797       19,737       70,177       78,752  
Income tax benefit (provision)
    3,749       (5,595 )     20,952       (17,983 )
 
                       
 
                               
Net income
  $ 24,546     $ 14,142     $ 91,129     $ 60,769  
 
                       
Net income attributable to common stockholders
  $ 14,477     $ 4,073     $ 60,922     $ 30,562  
 
                       
 
                               
Net income per common share:
                               
Basic
  $ 0.16     $ 0.05     $ 0.66     $ 0.36  
 
                       
Diluted
  $ 0.16     $ 0.05     $ 0.66     $ 0.36  
 
                       
Dividends declared per common share
  $ 0.07     $ 0.07     $ 0.21     $ 0.21  
 
                       
The accompanying notes are an integral part of these statements.

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FIRST BANCORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
                 
    Nine-Month Period Ended  
    September 30,     September 30,  
(In thousands)   2008     2007  
Cash flows from operating activities:
               
Net income
  $ 91,129     $ 60,769  
 
           
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation
    14,188       13,239  
Amortization of core deposit intangible
    2,695       2,477  
Provision for loan and lease losses
    142,435       83,802  
Deferred income tax (benefit) provision
    (23,986 )     12,511  
Stock-based compensation recognized
          2,848  
(Gain) loss on sale of investments, net
    (16,135 )     1,482  
Other-than-temporary impairments on available-for-sale securities
    1,185       5,232  
Derivative instruments and hedging activities (gain) loss
    (31,889 )     6,481  
Net gain on sale of loans and impairments
    (1,635 )     (1,485 )
Net gain on partial extinguishment and recharacterization of a secured commercial loan to a local financial institution
          (2,497 )
Net amortization of premiums and discounts and deferred loan fees and costs
    (956 )     (936 )
Amortization of broker placement fees
    10,935       7,426  
Accretion of basis adjustments on fair value hedges
          (2,061 )
Net accretion of premium and discounts on investment securities
    (8,196 )     (29,550 )
Gain on sale of credit card portfolio
          (2,819 )
Decrease in accrued income tax payable
    (13,429 )     (4,791 )
Decrease in accrued interest receivable
    17,018       6,088  
Decrease in accrued interest payable
    (37,906 )     (26,374 )
Decrease in other assets
    12,716       2,279  
Decrease in other liabilities
    (15,378 )     (97,550 )
 
           
Total adjustments
    51,662       (24,198 )
 
           
Net cash provided by operating activities
    142,791       36,571  
 
           
 
               
Cash flows from investing activities:
               
Principal collected on loans
    2,081,236       2,330,949  
Loans originated
    (2,858,266 )     (2,619,987 )
Purchase of loans
    (373,997 )     (147,848 )
Proceeds from sale of loans
    106,583       97,500  
Proceeds from sale of repossessed assets
    54,127       43,756  
Purchase of servicing assets
    (621 )     (1,614 )
Proceeds from sale of available for sale securities
    389,784       408,285  
Purchase of securities held to maturity
    (99 )     (417,450 )
Purchase of securities available for sale
    (3,368,093 )      
Principal repayments and maturities of securities held to maturity
    1,551,272       392,480  
Principal repayments of securities available for sale
    255,425       163,959  
Additions to premises and equipment
    (21,663 )     (19,294 )
Proceeds from sale of other investment securities
    9,474        
Decrease (increase) in other equity securities
    4,224       (20,520 )
Net cash inflow on acquisition of business
    5,154        
 
           
Net cash (used in) provided by investing activities
    (2,165,460 )     210,216  
 
           
 
               
Cash flows from financing activities:
               
Net increase in deposits
    1,723,172       622,608  
Net increase in loans payable
    300,000        
Net increase (decrease) in federal funds purchased and securities sold under repurchase agreements
    232,290       (1,168,698 )
Net FHLB advances (paid) taken
    (117,000 )     445,000  
Repayments of notes payable and other borrowings
          (150,000 )
Dividends paid
    (49,633 )     (44,981 )
Issuance of common stock
          91,967  
Exercise of stock options
    53        
 
           
Net cash provided by (used in) financing activities
    2,088,882       (204,104 )
 
           
Net increase in cash and cash equivalents
    66,213       42,683  
Cash and cash equivalents at beginning of period
    378,945       568,811  
 
           
Cash and cash equivalents at end of period
  $ 445,158     $ 611,494  
 
           
Cash and cash equivalents include:
               
Cash and due from banks
  $ 151,040     $ 138,037  
Money market instruments
    294,118       473,457  
 
           
 
  $ 445,158     $ 611,494  
 
           
The accompanying notes are an integral part of these statements.

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Table of Contents

FIRST BANCORP
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(Unaudited)
                 
    Nine-Month Period Ended  
(In thousands)   September 30, 2008     September 30, 2007  
Preferred Stock
  $ 550,100     $ 550,100  
 
           
 
               
Common Stock outstanding:
               
Balance at beginning of period
    92,504       83,254  
Issuance of common stock
          9,250  
Common stock issued under stock option plan
    6        
 
           
Balance at end of period
    92,510       92,504  
 
           
 
               
Additional Paid-In-Capital:
               
Balance at beginning of period
    108,279       22,757  
Issuance of common stock
          82,717  
Shares issued under stock option plan
    47        
Stock-based compensation recognized
          2,848  
 
           
Balance at end of period
    108,326       108,322  
 
           
 
               
Legal Surplus
    286,049       276,848  
 
           
 
               
Retained Earnings:
               
Balance at beginning of period
    409,978       326,761  
Net income
    91,129       60,769  
Cash dividends declared on common stock
    (19,426 )     (18,131 )
Cash dividends declared on preferred stock
    (30,207 )     (30,207 )
Cumulative adjustment for accounting change (adoption of FIN 48)
          (2,615 )
Cumulative adjustment for accounting change (adoption of SFAS No. 159)
          91,778  
 
           
Balance at end of period
    451,474       428,355  
 
           
 
               
Accumulated Other Comprehensive Loss, net of tax:
               
Balance at beginning of period
    (25,264 )     (30,167 )
Other comprehensive loss, net of tax
    (21,923 )     (11,776 )
 
           
Balance at end of period
    (47,187 )     (41,943 )
 
           
 
               
Total stockholders’ equity
  $ 1,441,272     $ 1,414,186  
 
           
The accompanying notes are an integral part of these statements.

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FIRST BANCORP
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
                                 
    Quarter Ended     Nine-Month Period Ended  
    September 30,     September 30,     September 30,     September 30,  
(In thousands)   2008     2007     2008     2007  
Net income
  $ 24,546     $ 14,142     $ 91,129     $ 60,769  
 
                       
Other comprehensive gain (loss):
                               
Unrealized gain (loss) on securities:
                               
Unrealized holding gain (loss) arising during the period
    30,773       15,364       (17,306 )     (18,522 )
Less: Reclassification adjustments for net loss (gain) and other-than-temporary impairments included in net income
    696       3,119       (5,476 )     6,714  
Income tax benefit (expense) related to items of other comprehensive income
    109       (173 )     859       32  
 
                       
 
                               
Other comprehensive gain (loss) for the period, net of tax
    31,578       18,310       (21,923 )     (11,776 )
 
                       
 
                               
Total comprehensive income
  $ 56,124     $ 32,452     $ 69,206     $ 48,993  
 
                       
The accompanying notes are an integral part of these statements.

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FIRST BANCORP
PART I — NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1 — BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
     The Consolidated Financial Statements (unaudited) have been prepared in conformity with the accounting policies stated in the Corporation’s Audited Consolidated Financial Statements included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2007. Certain information and note disclosures normally included in the financial statements prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) have been condensed or omitted from these statements pursuant to the rules and regulations of the SEC and, accordingly, these financial statements should be read in conjunction with the Audited Consolidated Financial Statements of the Corporation for the year ended December 31, 2007, included in the Corporation’s 2007 Annual Report on Form 10-K. All adjustments (consisting only of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the statement of financial position, results of operations and cash flows for the interim periods have been reflected. All significant intercompany accounts and transactions have been eliminated in consolidation.
     The results of operations for the quarter and nine-month period ended September 30, 2008 are not necessarily indicative of the results to be expected for the entire year.
Recently issued accounting pronouncements
     On April 30, 2007, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position No. (“FSP”) FIN 39-1 (“FSP FIN 39-1”), which amends FIN 39, “Offsetting of Amounts Related to Certain Contracts.” FSP FIN 39-1 impacts entities that enter into master netting arrangements as part of their derivative transactions by allowing net derivative positions to be offset in the financial statements against the fair value of amounts (or amounts that approximate fair value) recognized for the right to reclaim cash collateral or the obligation to return cash collateral under those arrangements. FSP FIN 39-1 became effective for fiscal years beginning after November 15, 2007. The Corporation analyzed the potential impact of FSP FIN 39-1 on its financial statements. As of September 30, 2008, the Corporation did not apply this pronouncement since FSP FIN 39-1 applies only to cash collateral and all of the collateral received or delivered to counterparties for derivative instruments are investment securities.
     In November 2007, the SEC issued Staff Accounting Bulletin No. (“SAB”) 109, “Written Loan Commitments That Are Accounted For At Fair Value Through Earnings Under Generally Accepted Accounting Principles.” This interpretation expresses the views of the staff regarding written loan commitments that are accounted for at fair value through earnings under GAAP. SAB 109 supersedes SAB 105, “Application of Accounting Principles to Loan Commitments,” which provided the prior views of the staff regarding derivative loan commitments that are accounted for at fair value through earnings pursuant to Statement of Financial Accounting Standards No. (“SFAS”) 133, “Accounting for Derivative Instruments and Hedging Activities.” SAB 109 expresses the current view of the staff that, consistent with the guidance in SFAS 156, “Accounting for Servicing of Financial Assets,” and SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” the expected net future cash flows related to the associated servicing of the loan should be included in the measurement of all written loan commitments that are accounted for at fair value through earnings. SAB 109 became effective for fiscal quarters beginning after December 15, 2007. The adoption of this statement in 2008 did not have an effect on the Corporation’s financial statements.

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     In December 2007, the FASB issued SFAS 160, “Noncontrolling Interests in Consolidated Financial Statements — an amendment of ARB No. 51.” This Statement amends ARB 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. It requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the noncontrolling interest. It also requires disclosure, on the face of the consolidated statement of income, of the amounts of consolidated net income attributable to the parent and to the noncontrolling interest. This Statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008 (that is, January 1, 2009, for entities with calendar year-ends). Earlier adoption is prohibited. The Corporation is currently evaluating the possible effect, if any, of the adoption of this statement on its financial statements, commencing on January 1, 2009.
     In December 2007, the FASB issued SFAS 141R, “Business Combinations.” This Statement retains the fundamental requirements in Statement 141 that the acquisition method of accounting (which Statement 141 called the purchase method) be used for all business combinations and for an acquirer to be identified for each business combination. This Statement defines the acquirer as the entity that obtains control of one or more businesses in the business combination and establishes the acquisition date as the date that the acquirer achieves control. This Statement requires an acquirer to recognize the assets acquired, the liabilities assumed, including contingent liabilities, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions specified in the Statement. This Statement applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. An entity may not apply it before that date. The Corporation is currently evaluating the possible effect, if any, of the adoption of this statement on its financial statements.
     In March 2008, the FASB issued SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133.” This Statement changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about (a) how derivative instruments and related hedged items are accounted for under SFAS 133 and its related interpretations, and (b) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. This Statement is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. Although the Corporation continues to evaluate the disclosure framework dictated by this Statement, most of the required disclosures are included in Note 8 — “Derivative Instruments and Hedging Activities.”
     In May 2008, the FASB issued SFAS 162, “The Hierarchy of Generally Accepted Accounting Principles.” This Statement identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with GAAP. Prior to the issuance of SFAS 162, GAAP hierarchy was defined in the American Institute of Certified Public Accountants (AICPA) Statement on Auditing Standards No. (“SAS”) 69, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.” SFAS 162 provides and direct the GAAP hierarchy to the entities instead of the auditor as provided by SAS 69 because the entities (not their auditors) are responsible for selecting accounting principles for financial statements that are presented in conformity with GAAP. Any effect of applying the provisions of SFAS 162 should be reported as a change in accounting principle in accordance with SFAS 154, “Accounting Changes and Error Corrections.” SFAS 162 is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.” The adoption of SFAS 162 did not impact the Corporation’s current accounting policies or the Corporation’s financial results.

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     In May 2008, the FASB issued FSP APB 14-1 (“FSP—APB 14-1”). FSP-APB 14-1 clarifies that convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) are not addressed by paragraph 12 of APB Opinion No. 14, “Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants.” Additionally, FSP-APB 14-1 specifies that issuers of such instruments should separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. FSP-APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. As of September 30, 2008, the Corporation does not have any convertible debt instrument.
     In May 2008, the FASB issued SFAS 163, “Accounting for Financial Guarantee Insurance Contracts — an interpretation of FASB Statement No. 60.” This Statement requires that an insurance enterprise recognize a claim liability prior to an event of default (insured event) when there is evidence that credit deterioration has occurred in an insured financial obligation. This Statement also clarifies how SFAS 60 applies to financial guarantee insurance contracts, including the recognition and measurement to be used to account for premium revenue and claim liabilities. SFAS 163 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and all interim periods within those fiscal years, except for some disclosures about the insurance enterprise’s risk-management activities. Except for those disclosures, earlier application of SFAS 163 is not permitted. The Corporation is currently evaluating the possible effect, if any, of the adoption of this statement on its financial statements, commencing on January 1, 2009.
     In June 2008, the FASB issued FSP EITF 03-6-1 (“FSP EITF 03-6-1”), “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities.” FSP EITF 03-6-1 applies to entities with outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends. Furthermore, awards with dividends that do not need to be returned to the entity, if the employee forfeits, the award are considered participating securities. Accordingly, under FSP EITF 03-6-1 unvested share-based payment awards that are considered to be participating securities should be included in the computation of EPS pursuant to the two-class method under SFAS 128. FSP EITF 03-6-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those years. Early application is not permitted. The Corporation is currently evaluating this statement in light of the recently approved Omnibus Incentive Plan, however, as of September 30, 2008, there are no outstanding unvested share-based payment awards.
     In September 2008, the FASB issued FSP FAS 133-1 and FIN 45-4 (“FSP FAS 133-1 and FIN 45-4”), “Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161.” FSP FAS 133-1 and FIN 45-4 amends SFAS 133 to require disclosures by sellers of credit derivatives, including credit derivatives embedded in a hybrid instrument. A seller of credit derivatives must disclose information about its credit derivatives and hybrid instruments that have embedded credit derivatives to enable users of financial statements to assess their potential effect on its financial position, financial performance, and cash flows. As of September 30, 2008, the Corporation is not involved in the credit derivatives market. This FSP also amends FASB Interpretation No. (“FIN”) 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” to require an additional disclosure about the current status of the payment/performance risk of a guarantee. Further, this FSP clarifies the FASB’s intent about the effective date of SFAS 161. This FSP clarifies the FASB’s intent that the disclosures required by SFAS 161 should be provided for any reporting period (annual or quarterly interim) beginning after November 15, 2008. The provisions of this FSP that amend SFAS 133 and FIN 45 will be effective for reporting periods (annual or interim) ending after November 15, 2008. The adoption of this pronouncement will not have a significant impact on the Corporation’s financial statements.

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     In October 2008, the FASB issued FSP No. FAS 157-3 (“FSP FAS 157-3”), “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active.” FSP FAS 157-3 clarifies the application of SFAS 157, “Fair Value Measurements,” in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. This FSP became effective on October 10, 2008 and also applies to prior periods for which financial statements have not been issued. The adoption of this pronouncement did not impact the Corporation’s fair value methodologies on its financial assets.
2 — EARNINGS PER COMMON SHARE
        The calculations of earnings per common share for the quarters and nine-month periods ended on September 30, 2008 and 2007 are as follows:
                                 
    Quarter Ended     Nine-Month Period Ended  
    September 30,     September 30,  
    2008     2007     2008     2007  
    (In thousands, except per share data)  
Net Income:
                               
Net income
  $ 24,546     $ 14,142     $ 91,129     $ 60,769  
Less: Preferred stock dividends
    (10,069 )     (10,069 )     (30,207 )     (30,207 )
 
                       
Net income available to common stockholders
  $ 14,477     $ 4,073     $ 60,922     $ 30,562  
 
                       
 
                               
Weighted-Average Shares:
                               
Basic weighted-average common shares outstanding
    92,511       87,075       92,507       84,542  
Average potential common shares
    58       242       116       416  
 
                       
Diluted weighted-average number of common shares outstanding
    92,569       87,317       92,623       84,958  
 
                       
 
                               
Earnings per common share:
                               
Basic
  $ 0.16     $ 0.05     $ 0.66     $ 0.36  
 
                       
Diluted
  $ 0.16     $ 0.05     $ 0.66     $ 0.36  
 
                       
          Potential common shares consist of common stock issuable under the assumed exercise of stock options using the treasury stock method. This method assumes that the potential common shares are issued and the proceeds from the exercise are used to purchase common stock at the exercise date. The difference between the number of potential shares issued and the shares purchased is added as incremental shares to the actual number of shares outstanding to compute diluted earnings per share. Stock options that result in lower potential shares issued than shares purchased under the treasury stock method are not included in the computation of dilutive earnings per share since their inclusion would have an antidilutive effect on earnings per share. For the quarter and nine-month periods ended September 30, 2008, a total of 3,596,300 (2,054,600 for the third quarter of 2007) and 2,020,600 (2,054,600 for the nine month period ended on September 30, 2007) weighted-average outstanding stock options, respectively, were not included in the computation of dilutive earnings per share since their inclusion would have an antidilutive effect on earnings per share.
3 — STOCK OPTION PLAN
          Between 1997 and January 2007, the Corporation had a stock option plan (“the 1997 stock option plan”) covering certain employees. This plan allowed for the granting of up to 8,696,112 options on shares of the Corporation’s common stock to eligible employees. The options granted under the plan could not exceed 20% of the number of common shares outstanding. Each option provides for the purchase of one share of common stock at a price not less than the fair market value of the stock on the date the option was granted. Stock options are fully vested upon issuance. The maximum term to exercise the options is ten years. The stock option plan provides for a proportionate adjustment in the exercise price and the number of shares that can be purchased in the event of a stock dividend, stock split, reclassification of stock, merger or reorganization and certain other issuances and distributions such as stock appreciation rights.

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          Under the 1997 stock option plan, the Compensation Committee had the authority to grant stock appreciation rights at any time subsequent to the grant of an option. Pursuant to stock appreciation rights, the optionee surrenders the right to exercise an option granted under the plan in consideration for payment by the Corporation of an amount equal to the excess of the fair market value of the shares of common stock subject to such option surrendered over the total option price of such shares. Any option surrendered is cancelled by the Corporation and the shares subject to the option are not eligible for further grants under the option plan. During the second quarter of 2008, the Compensation Committee approved the grant of stock appreciation rights to one employee. The employee surrendered the right to exercise 120,000 stock options in the form of stock appreciation rights for a payment of $0.2 million. On January 21, 2007, the 1997 stock option plan expired; all outstanding awards grants under this plan continue in full force and effect, subject to their original terms.
          On April 29, 2008, the Corporation’s stockholders approved the First BanCorp 2008 Omnibus Incentive Plan (the “Omnibus Plan”). The Omnibus Plan provides for equity-based compensation incentives (the “awards”) through the grant of stock options, stock appreciation rights, restricted stock, restricted stock units, performance shares, and other stock-based awards. This plan allows the issuance of up to 3,800,000 shares of common stock, subject to adjustments for stock splits, reorganization and other similar events. The Corporation’s Board of Directors, upon receiving the relevant recommendation of the Compensation Committee, has the power and authority to determine those eligible to receive awards and to establish the terms and conditions of any awards subject to various limits and vesting restrictions that apply to individual and aggregate awards. As of the date of the filing of this Quarterly Report on Form 10-Q, no awards have been granted under the Omnibus Plan.
          The Corporation accounted for stock options using the “modified prospective” method under SFAS 123R, “Share-Based Payment.” There were no stock options granted during the first nine months of 2008. The compensation expense associated with stock options for the nine-month period ended September 30, 2007 was approximately $2.8 million. All employee stock options granted during 2007 were fully vested at the time of grant.
          The activity of stock options during the first nine months of 2008 is set forth below:
                                 
    Nine Month Period Ended  
    September 30, 2008  
                    Weighted-        
            Weighted-     Average     Aggregate  
            Average     Remaining     Intrinsic  
    Number of     Exercise     Contractual     Value (In  
    Options     Price     Term (Years)     thousands)  
Beginning of period
    4,136,910     $ 12.60                  
Options exercised
    (6,000 )     8.85                  
Options cancelled
    (121,000 )     9.03                  
 
                           
End of period outstanding and exercisable
    4,009,910     $ 12.71       6.3     $ 4,231  
 
                       
          The fair value of options granted in 2007, which was estimated using the Black-Scholes option pricing method, and the assumptions used are as follows:
         
    2007
Weighted-average stock price at grant date and exercise price
  $ 9.20  
Stock option estimated fair value
  $ 2.40 - $2.45  
Weighted-average estimated fair value
  $ 2.43  
Expected stock option term (years)
    4.31-4.59  
Expected volatility
    32 %
Expected dividend yield
    3.0 %
Risk-free interest rate
    5.1 %

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          The Corporation uses empirical research data to estimate option exercises and employee termination within the valuation model; separate groups of employees that have similar historical exercise behavior are considered separately for valuation purposes. The expected volatility is based on the historical implied volatility of the Corporation’s common stock at each grant date; otherwise, historical volatilities based upon 260 observations (working days) were obtained from Bloomberg L.P. (“Bloomberg”) and used as inputs in the model. The dividend yield is based on the historical 12-month dividend yield observable at each grant date. The risk-free rate for the period is based on historical zero coupon curves obtained from Bloomberg at the time of grant based on the option’s expected term.
          The options exercised during the first nine months of 2008 did not have any intrinsic value and the cash proceeds from these options were approximately $53,000. No stock options were exercised during 2007.

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4 — INVESTMENT SECURITIES
     Investment Securities Available-for-Sale
          The amortized cost, gross unrealized gains and losses, approximate fair value, weighted-average yield and contractual maturities of investment securities available for sale as of September 30, 2008 and December 31, 2007 were as follows:
                                                                                 
    September 30, 2008     December 31, 2007  
            Gross             Weighted             Gross             Weighted  
    Amortized     Unrealized     Fair     average     Amortized     Unrealized     Fair     average  
    cost     gains     losses     value     yield%     cost     gains     losses     value     yield%  
    (Dollars in thousands)  
U.S. Treasury and Obligations of U.S. Government sponsored agencies:
                                                                               
After 5 to 10 years
  $     $     $     $           $ 6,975     $ 26     $     $ 7,001       6.05  
After 10 years
                                  8,984       47             9,031       6.21  
Puerto Rico Government obligations:
                                                                               
Due within one year
    4,584       51             4,635       6.17                                
After 1 to 5 years
    10,606       60       337       10,329       4.51       13,947       141       347       13,741       4.99  
After 5 to 10 years
    6,292       192       73       6,411       5.80       7,245       247       99       7,393       5.67  
After 10 years
    15,782       24       544       15,262       5.30       3,416       37       66       3,387       5.64  
 
                                                               
United States and Puerto Rico Government obligations
    37,264       327       954       36,637       5.27       40,567       498       512       40,553       5.62  
 
                                                               
Mortgage-backed securities:
                                                                               
FHLMC certificates:
                                                                               
Due within one year
    47                   47       4.99       98       1             99       5.50  
After 1 to 5 years
    234       4             238       7.03       640       20             660       7.01  
After 5 to 10 years
    31       3             34       8.41                                
After 10 years
    1,957,623       2,001       10,826       1,948,798       5.45       158,070       235       111       158,194       5.60  
 
                                                             
 
    1,957,935       2,008       10,826       1,949,117       5.45       158,808       256       111       158,953       5.61  
 
                                                               
GNMA certificates:
                                                                               
Due within one year
    99       1             100       5.88                                
After 1 to 5 years
    216       7             223       6.74       496       8             504       6.48  
After 5 to 10 years
    602       13             615       5.34       708       6       5       709       6.01  
After 10 years
    338,674       692       1,707       337,659       5.38       42,665       582       120       43,127       5.93  
 
                                                               
 
    339,591       713       1,707       338,597       5.38       43,869       596       125       44,340       5.94  
 
                                                               
FNMA certificates:
                                                                               
After 1 to 5 years
    59       5             64       10.01       34       1             35       7.08  
After 5 to 10 years
    260,550       588       272       260,866       4.98       289,125       138       750       288,513       4.93  
After 10 years
    1,315,718       5,547       2,915       1,318,350       5.58       608,942       5,290       582       613,650       5.65  
 
                                                               
 
    1,576,327       6,140       3,187       1,579,280       5.48       898,101       5,429       1,332       902,198       5.42  
 
                                                               
Mortgage pass-through certificates:
                                                                               
After 10 years
    146,941       2       37,217       109,726       5.64       162,082       3       28,407       133,678       6.14  
 
                                                               
 
                                                                               
Mortgage-backed securities
    4,020,794       8,863       52,937       3,976,720       5.46       1,262,860       6,284       29,975       1,239,169       5.55  
 
                                                               
Corporate bonds:
                                                                               
After 5 to 10 years
    1,300             780       520       7.70       1,300             198       1,102       7.70  
After 10 years
    4,411             2,534       1,877       7.97       4,412             1,066       3,346       7.97  
 
                                                               
Corporate bonds
    5,711             3,314       2,397       7.91       5,712             1,264       4,448       7.91  
 
                                                               
 
                                                                               
Equity securities (without contractual maturity)
    1,453             258       1,195       1.94       2,638             522       2,116        
 
                                                               
 
                                                                               
Total investment securities available for sale
  $ 4,065,222     $ 9,190     $ 57,463     $ 4,016,949       5.46     $ 1,311,777     $ 6,782     $ 32,273     $ 1,286,286       5.55  
 
                                                               
          Maturities of mortgage-backed securities are based on contractual terms assuming no prepayments. Expected maturities of investments might differ from contractual maturities because they may be subject to prepayments and/or call options. The weighted-average yield on investment securities held for sale is based on amortized cost and, therefore, does not give effect to changes in fair value. The net unrealized gain or loss on securities available for sale is presented as part of accumulated other comprehensive income.

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          The following tables show the Corporation’s available-for-sale investments’ fair value and gross unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, as of September 30, 2008 and December 31, 2007:
                                                 
    As of September 30, 2008  
    Less than 12 months     12 months or more     Total  
            Unrealized             Unrealized             Unrealized  
    Fair Value     Losses     Fair Value     Losses     Fair Value     Losses  
    (In thousands)  
Debt securities
                                               
 
                                               
Puerto Rico Government obligations
  $ 11,928     $ 418     $ 13,624     $ 536     $ 25,552     $ 954  
Mortgage-backed securities
                                               
FHLMC
    1,766,133       10,785       3,115       41       1,769,248       10,826  
GNMA
    297,689       1,707                   297,689       1,707  
FNMA
    880,477       3,186       21       1       880,498       3,187  
Mortgage pass-through trust certificates
                109,421       37,217       109,421       37,217  
Corporate bonds
                2,397       3,314       2,397       3,314  
Equity securities
    474       258                   474       258  
 
                                   
 
  $ 2,956,701     $ 16,354     $ 128,578     $ 41,109     $ 3,085,279     $ 57,463  
 
                                   
                                                 
    As of December 31, 2007  
    Less than 12 months     12 months or more     Total  
            Unrealized             Unrealized             Unrealized  
    Fair Value     Losses     Fair Value     Losses     Fair Value     Losses  
    (In thousands)  
Debt securities
                                               
Puerto Rico Government obligations
  $     $     $ 13,648     $ 512     $ 13,648     $ 512  
Mortgage-backed securities
                                               
FHLMC
    48,202       40       3,436       71       51,638       111  
GNMA
    625       11       26,887       114       27,512       125  
FNMA
    285,973       274       221,902       1,058       507,875       1,332  
Mortgage pass-through certificates
    133,337       28,407                   133,337       28,407  
Corporate bonds
                4,448       1,264       4,448       1,264  
Equity securities
    1,384       522                   1,384       522  
 
                                   
 
  $ 469,521     $ 29,254     $ 270,321     $ 3,019     $ 739,842     $ 32,273  
 
                                   
          The Corporation’s investment securities portfolio is comprised mainly of (i) fixed-rate mortgage-backed securities issued or guaranteed by FNMA, GNMA or FHLMC and other securities secured by mortgage loans and (ii) U.S. Treasury and agencies securities and obligations of the Puerto Rico Government. Thus, payment of a substantial portion of these instruments is either guaranteed or secured by mortgages together with a guarantee of a U.S. government sponsored entity or by the full faith and credit of the U.S. or Puerto Rico Government. In connection with the placement of FNMA and FHLMC into conservatorship by the U.S. Treasury in September 2008, the Treasury entered into agreements to invest up to approximately $100 billion in each agency to, among other things, protect debt and mortgage-backed securities of the agencies. Principal and interest on these securities are deemed recoverable.
          The unrealized losses in the available-for-sale portfolio as of September 30, 2008 are substantially related to fluctuations in market interest rates and, to some extent, credit spread widening. In the case of private label mortgage-backed securities, the unrealized loss is mainly related to increases in the discount rate used to value such instruments resulting from current lack of liquidity and credit concerns in the U.S. mortgage loan market. However, the underlying mortgages are fixed-rate single family loans with high weighted-average FICO scores (over 700) and moderate loan-to-value ratios (under 80%), as well as a moderate delinquency levels and principal and interest cash flow expectations have not changed to a material degree. Private label

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mortgage-backed securities relates to mortgage loans bought to R&G Financial Corporation (“R&G Financial”). R&G Financial must cover losses up to 10% of the aggregate outstanding balance according to recourse provisions included in the agreements. The Corporation’s investment in equity securities is minimal and none is related to U.S. financial institutions that recently failed in the midst of the current market turmoil. The Corporation’s policy is to review its investment portfolio for possible other-than temporary impairment, at least quarterly. As of September 30, 2008, management has the intent and ability to hold these investments for a reasonable period of time and for a forecasted recovery of fair value up to (or beyond) the cost of these investments; as a result, there is no other-than temporary impairment.
          For the nine-month periods ended on September 30, 2008 and 2007, the Corporation recorded other-than-temporary impairments of approximately $1.2 million and $5.2 million, respectively, on certain equity securities held in its available-for-sale investment portfolio. Management concluded that the declines in value of the securities were other-than-temporary; as such, the cost basis of these securities was written down to the market value as of the date of the analyses and reflected in earnings as a realized loss.
          Total proceeds from the sale of securities available for sale during the nine-month period ended September 30, 2008 amounted to approximately $389.8 million (2007 — $408.3 million). The Corporation realized gross gains of approximately $6.9 million and approximately $0.2 million in gross losses for the first nine months of 2008 (2007 — $0.4 million in gross realized gains and approximately $1.9 million in gross realized losses).
Investment Securities Held to Maturity
     The amortized cost, gross unrealized gains and losses, approximate fair value, weighted-average yield and contractual maturities of investment securities held-to-maturity as of September 30, 2008 and December 31, 2007 were as follows:
                                                                                 
    September 30, 2008     December 31, 2007  
            Gross             Weighted             Gross             Weighted  
    Amortized     Unrealized     Fair     average     Amortized     Unrealized     Fair     average  
    cost     gains     losses     value     yield%     cost     gains     losses     value     yield%  
    (Dollars in thousands)  
U.S. Treasury securities:
                                                                               
Due within 1 year
  $     $     $     $           $ 254,882     $ 369     $ 24     $ 255,227       4.14  
 
                                                                               
Obligations of other U.S. Government sponsored agencies:
                                                                               
After 10 years
    948,904             10,563       938,341       5.77       2,110,265       1,486       2,160       2,109,591       5.82  
Puerto Rico Government obligations:
                                                                               
After 5 to 10 years
    17,765       469       103       18,131       5.85       17,302       541       107       17,736       5.85  
After 10 years
    5,155             195       4,960       5.50       13,920             256       13,664       5.50  
 
                                                               
United States and Puerto Rico Government obligations
    971,824       469       10,861       961,432       5.77       2,396,369       2,396       2,547       2,396,218       5.64  
 
                                                               
 
                                                                               
Mortgage-backed securities:
                                                                               
FHLMC certificates:
                                                                               
After 1 to 5 years
    9,098             123       8,975       3.81                                
After 5 to 10 years
                                  11,274             116       11,158       3.65  
 
                                                                               
FNMA certificates:
                                                                               
After 1 to 5 years
    8,252             94       8,158       3.87                                
After 5 to 10 years
    717,292             11,009       706,283       4.47       69,553             1,067       68,486       4.30  
After 10 years
    25,590             412       25,178       5.31       797,887       61       13,785       784,163       4.42  
 
                                                               
Mortgage-backed securities
    760,232             11,638       748,594       4.48       878,714       61       14,968       863,807       4.40  
 
                                                               
 
                                                                               
Corporate bonds:
                                                                               
After 10 years
    2,000             440       1,560       5.80       2,000             91       1,909       5.80  
 
                                                               
 
                                                                               
Total investment securities held-to-maturity
  $ 1,734,056     $ 469     $ 22,939     $ 1,711,586       5.21     $ 3,277,083     $ 2,457     $ 17,606     $ 3,261,934       5.31  
 
                                                               
          Maturities of mortgage-backed securities are based on contractual terms assuming no prepayments. Expected maturities of investments might differ from contractual maturities because they may be subject to prepayments and/or call options.

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          The following tables show the Corporation’s held-to-maturity investments’ fair value and gross unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, as of September 30, 2008 and December 31, 2007:
                                                 
    As of September 30, 2008  
    Less than 12 months     12 months or more     Total  
            Unrealized             Unrealized             Unrealized  
    Fair Value     Losses     Fair Value     Losses     Fair Value     Losses  
    (In thousands)  
Debt securities
                                               
U.S. Government sponsored agencies
  $ 927,001     $ 10,066     $ 11,340     $ 497     $ 938,341     $ 10,563  
Puerto Rico Government obligations
    4,960       195       4,374       103       9,334       298  
Mortgage-backed securities
                                               
FHLMC
    8,346       104       629       19       8,975       123  
FNMA
    50,052       586       689,567       10,929       739,619       11,515  
Corporate bonds
                1,560       440       1,560       440  
 
                                   
 
  $ 990,359     $ 10,951     $ 707,470     $ 11,988     $ 1,697,829     $ 22,939  
 
                                   
                                                 
    As of December 31, 2007  
    Less than 12 months     12 months or more     Total  
            Unrealized             Unrealized             Unrealized  
    Fair Value     Losses     Fair Value     Losses     Fair Value     Losses  
    (In thousands)  
Debt securities
                                               
U.S. Government sponsored agencies
  $ 616,572     $ 1,568     $ 24,469     $ 592     $ 641,041     $ 2,160  
U.S. Treasury Notes
    24,697       24                   24,697       24  
Puerto Rico Government obligations
    13,664       256       4,200       107       17,864       363  
Mortgage-backed securities
                                               
FHLMC
                11,158       116       11,158       116  
FNMA
                849,341       14,852       849,341       14,852  
Corporate Bonds
    1,909       91                   1,909       91  
 
                                   
 
  $ 656,842     $ 1,939     $ 889,168     $ 15,667     $ 1,546,010     $ 17,606  
 
                                   
          Held-to-maturity securities in an unrealized loss position as of September 30, 2008 are primarily fixed-rate mortgage-backed securities and U.S. agency securities. The vast majority of them are rated the equivalent of AAA by major rating agencies. The unrealized losses in the held-to-maturity portfolio as of September 30, 2008 are substantially related to market interest rate fluctuations and to some extent to credit spread widening. Refer to the “Investment Securities Available-for-Sale” discussion above for additional information regarding concerns about certain government-sponsored agencies due to the troubled U.S. housing and mortgage markets. At this time, the Corporation has the intent and ability to hold these investments until maturity, and principal and interest are deemed recoverable. The impairment is considered temporary.

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5 — OTHER EQUITY SECURITIES
          Institutions that are members of the FHLB system are required to maintain a minimum investment in FHLB stock. Such minimum is calculated as a percentage of aggregate outstanding mortgages, and an additional investment is required that is calculated as a percentage of total FHLB advances, letters of credit, and the collateralized portion of interest-rate swaps outstanding. The stock is capital stock issued at $100 par value. Both stock and cash dividends may be received on FHLB stock.
          As of September 30, 2008 and December 31, 2007, the Corporation had investments in FHLB stock with a book value of $59.2 million and $63.4 million, respectively. The estimated market value of such investments is its redemption value determined by the ultimate recoverability of its par value. Dividend income from FHLB stock for the third quarter and nine-month period ended September 30, 2008 amounted to $1.0 million and $3.2 million, respectively, compared to $0.8 million and $2.0 million, respectively, for the same periods in 2007.
          The Corporation has other equity securities that do not have a readily available fair value. The carrying value of such securities as of September 30, 2008 and December 31, 2007 was $1.6 million. During the first quarter of 2008, the Corporation realized a one-time gain of $9.3 million on the mandatory redemption of part of its investment in VISA, Inc., which completed its initial public offering (IPO) in March 2008.
6 — LOAN PORTFOLIO
          The following is a detail of the loan portfolio:
                 
    As of     As of  
    September 30,     December 31,  
    2008     2007  
    (In thousands)  
Residential real estate loans, mainly secured by first mortgages
  $ 3,438,292     $ 3,143,497  
 
           
 
               
Commercial loans:
               
Construction loans
    1,478,076       1,454,644  
Commercial mortgage loans
    1,422,899       1,279,251  
Commercial loans
    3,602,123       3,231,126  
Loans to local financial institutions collateralized by real estate mortgages
    579,305       624,597  
 
           
Commercial loans
    7,082,403       6,589,618  
 
           
 
               
Finance leases
    371,982       378,556  
 
           
 
               
Consumer loans
    1,787,915       1,667,151  
 
           
 
               
Loans receivable
    12,680,592       11,778,822  
Allowance for loan and lease losses
    (261,170 )     (190,168 )
 
           
Loans receivable, net
    12,419,422       11,588,654  
Loans held for sale
    32,510       20,924  
 
           
Total loans
  $ 12,451,932     $ 11,609,578  
 
           
          The Corporation’s primary lending area is Puerto Rico. The Corporation’s Puerto Rico banking subsidiary (“First Bank” or “the Bank”) also lends in the U.S. and British Virgin Islands markets and in the United States (principally in the state of Florida). Of the total gross loan portfolio, including loans held for sale, of $12.7 billion as of September 30, 2008, approximately 80% has credit risk concentration in Puerto Rico, 12% in the United States (mainly in the state of Florida) and 8% in the Virgin Islands.

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          The Corporation’s largest loan concentration as of September 30, 2008 in the amount of $354.6 million is with one mortgage originator in Puerto Rico, Doral Financial Corporation. Together with the Corporation’s next largest loan concentration of $224.7 million with another mortgage originator in Puerto Rico, R&G Financial, the Corporation’s total loans granted to these mortgage originators amounted to $579.3 million as of September 30, 2008. These commercial loans are secured by individual mortgage loans on residential and commercial real estate.
7 — ALLOWANCE FOR LOAN AND LEASE LOSSES
          The changes in the allowance for loan and lease losses were as follows:
                                 
    Quarter Ended     Nine-Month Period Ended  
    September 30,     September 30,  
    2008     2007     2008     2007  
    (In thousands)  
Balance at beginning of period
  $ 222,272     $ 165,009     $ 190,168     $ 158,296  
Provision for loan and lease losses
    55,319       34,260       142,435       83,802  
Charge-offs
    (27,175 )     (23,173 )     (86,163 )     (68,769 )
Recoveries
    2,417       1,390       6,393       4,157  
Other adjustments (1)
    8,337             8,337        
 
                       
Balance at end of period
  $ 261,170     $ 177,486     $ 261,170     $ 177,486  
 
                       
 
(1)   Carryover of the allowance for loan losses related to a $218 million auto loan portfolio acquired in the third quarter of 2008.
          The allowance for impaired loans is part of the allowance for loan and lease losses. The allowance for impaired loans covers those loans for which management has determined that it is probable that the debtor will be unable to pay all the amounts due in accordance with the contractual terms of the loan agreement, and does not necessarily represent loans for which the Corporation will incur a substantial loss. As of September 30, 2008 and December 31, 2007, impaired loans and their related allowance were as follows:
                 
    As of   As of
    September 30,   December 31,
    2008   2007
    (In thousands)
Impaired loans
  $ 407,348     $ 151,818  
Impaired loans with valuation allowance
    296,351       66,941  
Allowance for impaired loans
    58,963       7,523  
          During the first nine months of 2008, the Corporation identified several commercial and construction loans amounting to $321.5 million that it determined should be classified as impaired, of which $285.0 million have a specific reserve of $57.1 million. Approximately $211.1 million of the $321.5 million commercial and construction loans that were determined to be impaired during 2008 is related to the Miami Corporate Banking operation, mainly condo conversion loans. As of September 30, 2008, approximately $182.2 million, or 73%, of a total portfolio originally disbursed as condo-conversion amounting to $251 million is considered impaired with a specific reserve of $31.4 million.
          Meanwhile, the Corporation’s impaired loans decreased by approximately $64.0 million during the first nine months of 2008 principally as a result of foreclosed loans related to the Miami Corporate Banking operations, with a principal balance of approximately $22.4 million, which had a related impairment reserve of $4.2 million at the time of foreclosure. Also, a loan was sold, related to the Miami operations, that carried a principal balance of approximately $24.1 million with a related impairment reserve of $2.4 million at the time of sale.

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The latter was sold for $22.5 million during the second quarter of 2008. Other decreases in impaired loans may include loans paid in full, loans no longer considered impaired and loans charged-off.
          Interest income in the amount of approximately $14.4 million and $2.7 million was recognized on impaired loans for the nine-month periods ended September 30, 2008 and 2007, respectively. The average recorded investment in impaired loans for the first nine months of 2008 and 2007 was $257.0 million and $101.3 million, respectively.
8 — DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
          One of the market risks facing the Corporation is interest rate risk, which includes the risk that changes in interest rates will result in changes in the value of the Corporation’s assets or liabilities and the risk that net interest income from its loan and investment portfolios will change in response to changes in interest rates. The overall objective of the Corporation’s interest rate risk management activities is to reduce the variability of earnings caused by changes in interest rates.
          The Corporation uses various financial instruments, including derivatives, to manage the interest rate risk related primarily to the values of its brokered certificates of deposit (“CDs”) and medium-term notes.
          The Corporation designates a derivative as a fair value hedge, a cash flow hedge or an economic undesignated hedge when it enters into the derivative contract. As of September 30, 2008, all derivatives held by the Corporation were considered economic undesignated hedges. These undesignated hedges are recorded at fair value with the resulting gain or loss recognized in current earnings.
          The following summarizes most of the derivative activities used by the Corporation in managing interest rate risk:
Interest rate swaps — Interest rate swap agreements generally involve the exchange of fixed and floating-rate interest payment obligations without the exchange of the underlying notional principal amount. Since a substantial portion of the Corporation’s loans, mainly commercial loans, yield variable rates, the interest rate swaps are utilized to convert fixed-rate brokered CDs (liabilities), mainly those with long-term maturities, to a variable rate and mitigate the interest rate risk inherent in these variable rate loans. Similar to unrealized gains and losses arising from changes in fair value, net interest settlements on interest rate swaps are recorded as an adjustment to interest income or interest expense depending on whether an asset or liability is being economically hedged.
Interest rate cap agreements — Interest rate cap agreements provide the right to receive cash if a reference interest rate rises above a contractual rate. The value increases as the reference interest rate rises. The Corporation enters into interest rate cap agreements to protect against rising interest rates. Specifically, the interest rate on certain private label mortgage pass-through securities and certain of the Corporation’s commercial loans to other financial institutions is generally a variable rate limited to the weighted-average coupon of the pass-through certificate or referenced residential mortgage collateral, less a contractual servicing fee.
Indexed options — Indexed options are generally over-the-counter (OTC) contracts that the Corporation enters into in order to receive the appreciation of a specified Stock Index (e.g., Dow Jones Industrial Composite Stock Index) over a specified period in exchange for a premium paid at the contract’s inception. The option period is determined by the contractual maturity of the notes payable tied to the performance of the Stock Index. The credit risk inherent in these options is the risk that the exchange party may not fulfill its obligation.

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          To satisfy the needs of its customers, the Corporation may enter into non-hedging transactions. On these transactions, generally, the Corporation participates as a buyer in one of the agreements and as the seller in the other agreement under the same terms and conditions.
          In addition, the Corporation enters into certain contracts with embedded derivatives that do not require separate accounting as these are clearly and closely related to the economic characteristics of the host contract. When the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract, it is bifurcated, carried at fair value, and designated as a trading or non-hedging derivative instrument.
          The following table summarizes the notional amounts of all derivative instruments as of September 30, 2008 and December 31, 2007:
                 
    Notional Amounts  
    As of     As of  
    September 30,     December 31,  
    2008     2007  
    (In thousands)  
Economic undesignated hedges:
               
 
Interest rate contracts:
               
Interest rate swap agreements used to hedge fixed rate brokered CDs, notes payable and loans
  $ 1,619,010     $ 4,244,473  
Written interest rate cap agreements
    128,052       128,075  
Purchased interest rate cap agreements
    279,247       294,982  
 
               
Equity contracts:
               
Embedded written options on stock index deposits and notes payable
    53,515       53,515  
Purchased options used to manage exposure to the stock market on embedded stock index options
    53,515       53,515  
 
           
 
  $ 2,133,339     $ 4,774,560  
 
           
          The following table summarizes the fair values of derivative instruments and the location in the Statement of Financial Condition as of September 30, 2008 and December 31, 2007:
                                                 
    Asset Derivatives     Liability Derivatives  
            As of     As of             As of     As of  
            September 30,     December 31,             September 30,     December 31,  
    Statement of     2008     2007     Statement of     2008     2007  
    Financial Condition     Fair     Fair     Financial Condition     Fair     Fair  
    Location     Value     Value     Location     Value     Value  
                            (In thousands)                  
Economic undesignated hedges:
                                               
Interest rate contracts:
                                               
Interest rate swap agreements used to hedge fixed rate brokered CDs, notes payable and loans
  Other assets   $ 207     $ 213     Accounts payable and other liabilities   $ 30,281     $ 58,057  
Written interest rate cap agreements
  Other assets               Accounts payable and other liabilities     77       47  
Purchased interest rate cap agreements
  Other assets     4,621       5,149     Accounts payable and other liabilities            
 
                                               
Equity contracts:
                                               
Embedded written options on stock index deposits
  Other assets               Interest-bearing deposits     1,424       4,375  
Embedded written options on stock index notes payable
  Other assets               Notes payable     2,347       4,673  
Purchased options used to manage exposure to the stock market on embedded stock index options
  Other assets     4,059       9,339     Accounts payable and other liabilities            
 
                                       
 
          $ 8,887     $ 14,701             $ 34,129     $ 67,152  
 
                                       

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          The following table summarizes the effect of derivative instruments on the Statement of Income for the quarter and nine-month periods ended on September 30, 2008 and 2007:
                                         
            Unrealized Gain or (Loss)  
    Location of Unrealized Gain or (Loss)     Quarter Ended     Nine-Month Period Ended  
    Recognized in Income on     September 30,     September 30,  
    Derivatives     2008     2007     2008     2007  
                            (In thousands)  
Interest rate contracts:
                                       
Interest rate swap agreements used to hedge fixed-rate:
                                       
Brokered CDs
  Interest expense - Deposits   $ 5,667     $ 61,598     $ 31,219     $ (459 )
Notes payable
  Interest expense - Notes payable and other borrowings     16       168       (98 )     1,222  
Loans
  Interest income - Loans     (136 )     (1,856 )     (96 )     (578 )
Written and purchased interest rate cap agreements — mortgage-backed securities
  Interest income - Investment Securities     (1,416 )     (4,464 )     (559 )     16  
Written and purchased interest rate cap agreements — loans
  Interest income - Loans     (22 )     (130 )     1       (262 )
Equity contracts:
                                       
Embedded written and purchased options on stock index deposits
  Interest expense - Deposits     2       373       (148 )     372  
Embedded written and purchased options on stock index notes payable
  Interest expense - Notes payable and other borrowings     32       190       145       (160 )
Total Unrealized (Loss) Gain on derivatives
          $ 4,143     $ 55,879     $ 30,464     $ 151  
 
                               
          Derivative instruments, such as interest rate swaps, are subject to market risk. The Corporation’s derivatives are mainly composed of interest rate swaps that are used to convert the fixed interest payment on its brokered CDs and medium-term notes to variable payments (receive fixed/pay floating). As is the case with investment securities, the market value of derivative instruments is largely a function of the financial market’s expectations regarding the future direction of interest rates. Accordingly, current market values are not necessarily indicative of the future impact of derivative instruments on earnings. This will depend, for the most part, on the shape of the yield curve as well as the level of interest rates. The unrealized gains and losses in the fair value of derivatives that economically hedge certain callable brokered CDs and medium-term notes are partially offset by unrealized gains and losses on the valuation of such economically hedged liabilities that were elected to be measured at fair value under the provisions of SFAS 159. The Corporation includes the gain or loss on those economically hedged liabilities (brokered CDs and medium-term notes) in the same line item as the offsetting loss or gain on the related derivatives as set forth below:
                                                 
    Quarter ended September 30,
    2008   2007
    Gain   (Loss) Gain   Net Unrealized   Gain   (Loss) Gain   Net Unrealized
(In thousands)   on Derivatives   on SFAS 159 liabilities   Gain   on Derivatives   on SFAS 159 liabilities   (Loss) / Gain
Interest expense — Deposits
  $ 5,669     $ (791 )   $ 4,878     $ 61,971     $ (62,973 )   $ (1,002 )
Interest expense — Notes payable and other borrowings
    48       961       1,009       358       483       841  
                                                 
    Nine-Month Period ended September 30,
    2008   2007
    Gain   (Loss) / Gain   Net Unrealized   (Loss) / Gain   (Loss) Gain   Net Unrealized
    on Derivatives   on SFAS 159 liabilities   Gain   on Derivatives   on SFAS 159 liabilities   (Loss) / Gain
Interest expense — Deposits
  $ 31,071     $ (21,886 )   $ 9,185     $ (87 )   $ (6,575 )   $ (6,662 )
Interest expense — Notes payable and other borrowings
    47       1,860       1,907       1,062       613       1,675  

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          A summary of interest rate swaps as of September 30, 2008 and December 31, 2007 follows:
                 
    As of   As of
    September 30,   December 31,
    2008   2007
    (Dollars in thousands)
Pay fixed/receive floating (generally used to economically hedge variable rate loans):
               
Notional amount
  $ 79,349     $ 80,212  
Weighted-average receive rate at period end
    4.59 %     7.09 %
Weighted-average pay rate at period end
    6.75 %     6.75 %
Floating rates range from 167 to 252 basis points over 3-month LIBOR
               
 
               
Receive fixed/pay floating (generally used to economically hedge fixed-rate brokered CDs and notes payable):
               
Notional amount
  $ 1,539,661     $ 4,164,261  
Weighted-average receive rate at period end
    5.32 %     5.26 %
Weighted-average pay rate at period end
    3.15 %     5.07 %
Floating rates range from 2 basis points to 54 basis points over 3-month LIBOR
               
          During the first nine months of 2008, approximately $2.6 billion of interest rate swaps were called by the counterparties, mainly due to lower 3-month LIBOR. Following the cancellation of the interest rate swaps, the Corporation exercised its call option on approximately $2.5 billion swapped to floating brokered CDs. The Corporation recorded a net unrealized gain of $4.8 million as a result of these transactions resulting from the reversal of the cumulative mark-to-market valuation of the swaps and the brokered CDs called.
          As of September 30, 2008, the Corporation has not entered into any derivative instrument containing credit-risk-related contingent features.

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9 — GOODWILL AND OTHER INTANGIBLES
          Goodwill as of September 30, 2008 amounted to $28.1 million (December 31, 2007 — $28.1 million) and was recognized as part of “Other Assets.” The goodwill resulted primarily from the acquisition of Ponce General Corporation in 2005. No goodwill impairment was recognized during 2008 and 2007. Goodwill and other indefinite life intangibles are reviewed periodically for impairment at least annually. Impairment review will be conducted during the fourth quarter of 2008.
          As of September 30, 2008, the gross carrying amount and accumulated amortization of core deposit intangibles was $45.8 million and $20.9 million, respectively, recognized as part of “Other Assets” in the Consolidated Statements of Financial Condition (December 31, 2007 — $41.2 million and $18.3 million, respectively). The increase in the gross amount from December 2007 relates to the acquisition of the Virgin Islands Community Bank (“VICB”) on January 28, 2008. During the quarters ended September 30, 2008 and 2007, the amortization expense of core deposits amounted to $0.9 million and $0.8 million, respectively. For the nine-month periods ended September 30, 2008 and 2007, the amortization expense of core deposits amounted to $2.6 million and $2.5 million, respectively.
10 — DEPOSITS
          The following table summarizes deposit balances:
                 
    As of     As of  
    September 30,     December 31,  
    2008     2007  
    (In thousands)  
Non-interest bearing checking account deposits
  $ 661,197     $ 621,884  
Savings accounts
    1,353,211       1,036,662  
Interest-bearing checking accounts
    591,820       518,570  
Certificates of deposit
    1,845,731       1,680,344  
 
               
Brokered CDs (includes $1,515,525 and $4,186,563 measured at fair value as of September 30, 2008 and December 31, 2007, respectively)
    8,367,873       7,177,061  
 
           
 
  $ 12,819,832     $ 11,034,521  
 
           
          The interest expense on deposits includes the valuation to market of interest rate swaps that economically hedge brokered CDs, the related interest exchanged, the amortization of broker placement fees related to brokered CDs not elected for the fair value option and changes in fair value of callable brokered CDs elected for the fair value option under SFAS 159 (“SFAS 159 brokered CDs”).
          The following are the components of interest expense on deposits:
                                 
    Quarter ended     Nine-month period ended  
    September 30,     September 30,     September 30,     September 30,  
    2008     2007     2008     2007  
    (In thousands)
Interest expense on deposits
  $ 96,111     $ 139,525     $ 299,303     $ 387,579  
Amortization of broker placement fees (1)
    3,856       2,661       10,935       6,919  
 
                       
Interest expense on deposits excluding net unrealized (gain) loss on derivatives and SFAS 159 brokered CDs
    99,967       142,186       310,238       394,498  
Net unrealized (gain) loss on derivatives and SFAS 159 brokered CDs
    (4,878 )     1,002       (9,185 )     6,662  
 
                       
Total interest expense on deposits
  $ 95,089     $ 143,188     $ 301,053     $ 401,160  
 
                       
 
(1)   Related to brokered CDs not elected for the fair value option under SFAS 159.

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          Total interest expense on deposits includes net cash settlements on interest rate swaps that economically hedge brokered CDs that for the quarter and nine-month period ended September 30, 2008 amounted to net interest realized of $10.3 million and $30.2 million, respectively (2007 — net interest incurred of $3.4 million for the third quarter and $10.8 million for the nine-month period).
11 — LOANS PAYABLE
          As of September 30, 2008 loans payable consist of $300 million in short-term borrowings under the Federal Reserve (FED) Discount Window Program bearing interest at 2.25%. As of September 30, 2008, the Corporation had additional capacity of approximately $180 million on this credit facility based on collateral pledged at the FED, including the haircut reflecting the perceived risk associated with holding the collateral. Haircut refers to the percentage by which an asset’s market value is reduced for the purpose of collateral levels.
12 — FEDERAL FUNDS PURCHASED AND SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
          Federal funds purchased and securities sold under agreements to repurchase (repurchase agreements) consist of the following:
                 
    September 30,     December, 31  
    2008     2007  
    (In thousands)  
Federal funds purchased, interest ranging from 4.50% to 5.12%
  $     $ 161,256  
Repurchase agreements, interest ranging from 2.75% to 5.39% (2007 - 3.26% to 5.67%)
    3,326,936       2,933,390  
 
           
Total
  $ 3,326,936     $ 3,094,646  
 
           
          Repurchase agreements mature as follows:
         
    September 30,  
    2008  
    (In thousands)  
One to thirty days
  $ 339,436  
Over thirty to ninety days
    100,000  
Over ninety days to one year
    100,000  
One to three years
    1,187,500  
Three to five years
    800,000  
Over five years
    800,000  
 
     
Total
  $ 3,326,936  
 
     

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          As of September 30, 2008 and December 31, 2007, the securities underlying such agreements were delivered to the dealers with which the repurchase agreements were transacted.
          Repurchase agreements as of September 30, 2008, grouped by counterparty, were as follows:
                 
(Dollars in thousands)           Weighted-Average  
Counterparty   Amount     Maturity (In Months)  
Morgan Stanley
  $ 580,800       24  
Credit Suisse First Boston
    1,171,136       34  
JP Morgan Chase
    575,000       36  
Barclays Capital
    500,000       39  
UBS Financial Services, Inc.
    100,000       46  
Citigroup Global Markets
    400,000       59  
 
             
 
  $ 3,326,936          
 
             
13 — ADVANCES FROM THE FEDERAL HOME LOAN BANK (FHLB)
          Following is a detail of the advances from the FHLB:
                 
    September 30,     December, 31  
    2008     2007  
    (In thousands)  
Advances from FHLB, tied to 3-month LIBOR, with an average interest rate of 2.85% (2007 - 4.98%)
  $ 400,000     $ 400,000  
Fixed-rate advances from FHLB, with a weighted-average interest rate of 3.98% (2007 - 4.58%)
    586,000       703,000  
 
           
Total
  $ 986,000     $ 1,103,000  
 
           
          Advances from FHLB mature as follows:
         
    September 30,  
    2008  
    (In thousands)  
One to thirty days
  $ 29,000  
Over thirty to ninety days
    400,000  
Over ninety days to one year
    115,000  
One to three years
    211,000  
Three to five years
    231,000  
 
     
Total
  $ 986,000  
 
     
          As of September 30, 2008, the Corporation had additional capacity of approximately $803 million on this credit facility based on collateral pledged at the FHLB, including haircut reflecting the perceived risk associated with holding the collateral.

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14 — NOTES PAYABLE
          Notes payable consist of:
                 
    As of     As of  
    September 30,     December 31,  
    2008     2007  
    (In thousands)  
Callable step-rate notes, bearing step increasing interest from 5.00% to 7.00% (5.50% as of September 30, 2008 and December 31, 2007) maturing on October 18, 2019, measured at fair value under SFAS 159
  $ 12,445     $ 14,306  
 
               
Dow Jones Industrial Average (DJIA) linked principal protected notes:
               
 
               
Series A maturing on February 28, 2012
    6,828       7,845  
 
               
Series B maturing on May 27, 2011
    7,452       8,392  
 
           
 
               
 
  $ 26,725     $ 30,543  
 
           
15 — OTHER BORROWINGS
          Other borrowings consist of:
                 
    As of     As of  
    September 30,     December 31,  
    2008     2007  
    (In thousands)  
Junior subordinated debentures due in 2034, interest-bearing at a floating-rate of 2.75% over 3-month LIBOR (5.57% as of September 30, 2008 and 7.74% as of December 31, 2007)
  $ 103,024     $ 102,951  
 
               
Junior subordinated debentures due in 2034, interest-bearing at a floating-rate of 2.50% over 3-month LIBOR (5.70% as of September 30, 2008 and 7.43% as of December 31, 2007)
    128,866       128,866  
 
           
 
  $ 231,890     $ 231,817  
 
           
16 — INCOME TAXES
          Income tax expense includes Puerto Rico and Virgin Islands income taxes as well as applicable U.S. federal and state taxes. The Corporation is subject to Puerto Rico income tax on its income from all sources. As a Puerto Rico corporation, First BanCorp is treated as a foreign corporation for U.S. income tax purposes and is generally subject to United States income tax only on its income from sources within the United States or income effectively connected with the conduct of a trade or business within the United States. Any such tax paid is creditable, within certain conditions and limitations, against the Corporation’s Puerto Rico tax liability. The Corporation is also subject to U.S. Virgin Islands taxes on its income from sources within this jurisdiction. Any such tax paid is creditable against the Corporation’s Puerto Rico tax liability, subject to certain conditions and limitations.

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          Under the Puerto Rico Internal Revenue Code of 1994, as amended (“PR Code”), First BanCorp is subject to a maximum statutory tax rate of 39%. The PR Code also includes an alternative minimum tax of 22% that applies if the Corporation’s regular income tax liability is less than the alternative minimum tax requirements.
          The Corporation has maintained an effective tax rate lower than the maximum statutory rate mainly by investing in government obligations and mortgage-backed securities exempt from U.S. and Puerto Rico income taxes and doing business through international banking entities (“IBEs”) of the Corporation and the Bank and through the Bank’s subsidiary, FirstBank Overseas Corporation, in which the interest income and gain on sales is exempt from Puerto Rico and U.S. income taxation. The IBEs and FirstBank Overseas Corporation were created under the International Banking Entity Act of Puerto Rico, which provides for total Puerto Rico tax exemption on net income derived by IBEs operating in Puerto Rico. IBEs that operate as a unit of a bank pay income taxes at normal rates to the extent that the IBEs’ net income exceeds 20% of the bank’s total net taxable income.
          For the first nine months of 2008, the Corporation recognized an income tax benefit of $21.0 million compared to an income tax expense of $18.0 million for the same period in 2007. The positive fluctuation on the financial results was mainly due to two non-ordinary transactions: (i) a reversal of $10.6 million of Unrecognized Tax Benefits (“UTBs”) during the second quarter of 2008 for positions taken on income tax returns recorded under the provisions of FIN 48, “Accounting for Uncertainty in Income Taxes,” as explained below, and (ii) the recognition of an income tax benefit of $5.4 million in connection with an agreement entered into with the Puerto Rico Department of Treasury during the first quarter of 2008 that establishes a multi-year allocation schedule for deductibility of the payment of $74.25 million made by the Corporation during 2007 to settle the securities class action suit. Also, the current income tax provision was lower, excluding the reversal of the FIN 48 contingency, due to higher tax-exempt income. A significant portion of the increase in revenues was associated with exempt operations conducted through the international banking entity, FirstBank Overseas Corporation.
          As of September 30, 2008, the Corporation evaluated its ability to realize the deferred tax asset and concluded, based on the evidence available, that it is more likely than not that some of the deferred tax asset will not be realized and, thus, established a valuation allowance of $6.6 million, compared to a valuation allowance of $4.9 million as of December 31, 2007. As of September 30, 2008, the deferred tax asset, net of the valuation allowance of $6.6 million, amounted to approximately $115.0 million compared to $90.1 million, net of the valuation allowance of $4.9 million as of December 31, 2007.
          The Corporation adopted FIN 48 as of January 1, 2007. FIN 48 prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of income tax uncertainties with respect to positions taken or expected to be taken on income tax returns. Under FIN 48, income tax benefits are recognized and measured based upon a two-step model: 1) a tax position must be more likely than not to be sustained based solely on its technical merits in order to be recognized, and 2) the benefit is measured as the largest dollar amount of that position that is more likely than not to be sustained upon settlement. The difference between the benefit recognized in accordance with FIN 48 and the tax benefit claimed on a tax return is referred to as an unrecognized tax benefit.
          As of September 30, 2008, the balance of the Corporation’s UTBs amounted to $15.6 million (excluding accrued interest), all of which would, if recognized, affect the Corporation’s effective tax rate. The Corporation classifies all interest and penalties, if any, related to tax uncertainties as income tax expense. As of September 30, 2008, the Corporation’s accrual for interest that relates to tax uncertainties amounted to $6.4 million. As of September 30, 2008, there is no need to accrue for the payment of penalties. For the nine-month periods ended on September 30, 2008 and 2007, the total amount of interest recognized by the Corporation as part of income tax expense related with tax uncertainties was $1.3 million and $1.7 million, respectively. The amount of UTBs may increase or decrease in the future for various reasons, including changes in the amounts for current tax year positions, the expiration of open income tax returns due to the

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statutes of limitations, changes in management’s judgment about the level of uncertainty, the status of examinations, litigation and legislative activity and the addition or elimination of uncertain tax positions. During the second quarter of 2008, the Corporation reversed UTBs by approximately $7.1 million and accrued interest of $3.5 million as a result of a lapse of the applicable statute of limitations for the 2003 taxable year. For the remaining outstanding UTBs, the Corporation cannot make any reasonably reliable estimate of the timing of future cash flows or changes, if any, associated with such obligations.
     The Corporation’s liability for income taxes includes the liability for UTBs and interest which relate to tax years still subject to review by taxing authorities. Audit periods remain open for review until the statute of limitations has passed. The statute of limitations under the PR Code is 4 years, and under the Virgin Islands and U.S. income tax purposes is 3 years after a tax return is due or filed, whichever is later. The completion of an audit by the taxing authorities or the expiration of the statute of limitations for a given audit period could result in an adjustment to the Corporation’s liability for income taxes. Any such adjustment could be material to results of operations for any given quarterly or annual period based, in part, upon the results of operations for the given period. All tax years subsequent to 2003 remain open to examination under the PR Code and taxable years subsequent to 2004 remain open to examination for Virgin Islands and U.S. income tax purposes.
17 — FAIR VALUE
          Effective January 1, 2007, the Corporation adopted SFAS 157, which provides a framework for measuring fair value under GAAP.
          The Corporation also adopted SFAS 159 effective January 1, 2007. SFAS 159 generally permits the measurement of selected eligible financial instruments at fair value at specified election dates. The Corporation elected to adopt the fair value option for certain of its brokered CDs and medium-term notes (“SFAS 159 liabilities”) on the adoption date.
Fair Value Option
Callable Brokered CDs and Certain Medium-Term Notes
          The Corporation elected the fair value option for certain financial liabilities that were hedged with interest rate swaps that were previously designated for fair value hedge accounting in accordance with SFAS 133. As of September 30, 2008, these liabilities included callable brokered CDs with an aggregate fair value of $1.52 billion and principal balance of $1.53 billion recorded in interest-bearing deposits, and certain medium-term notes with a fair value of $12.4 million and principal balance of $15.4 million recorded in notes payable. Interest paid/accrued on these instruments is recorded as part of interest expense and the accrued interest is part of the fair value of the SFAS 159 liabilities. Electing the fair value option allows the Corporation to eliminate the burden of complying with the requirements for hedge accounting under SFAS 133 (e.g., documentation and effectiveness assessment) without introducing earnings volatility. Interest rate risk on the callable brokered CDs and medium-term notes measured at fair value under SFAS 159 continues to be economically hedged with callable interest rate swaps with the same terms and conditions. The Corporation did not elect the fair value option for the vast majority of other brokered CDs because these are not hedged by derivatives. Effective January 1, 2007, the Corporation discontinued the use of fair value hedge accounting for interest rate swaps that hedged a $150 million medium-term note since the interest rate swaps were no longer effective in offsetting the changes in the fair value of the $150 million medium-term note and, as a consequence, the Corporation did not elect the fair value option for this note either. The Corporation redeemed the $150 million medium-term note during the second quarter of 2007.
          Callable brokered CDs and medium-term notes for which the Corporation has elected the fair value option are priced using observable market data in the institutional markets.

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Fair Value Measurement
          SFAS 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. SFAS 157 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
Level 1   Valuations of Level 1 assets and liabilities are obtained from readily available pricing sources for market transactions involving identical assets or liabilities. Level 1 assets and liabilities include equity securities that are traded in an active exchange market, as well as certain U.S. Treasury and other U.S. government and agency securities that are traded by dealers or brokers in active markets.
Level 2   Valuations of Level 2 assets and liabilities are based on observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets and liabilities include (i) mortgage-backed securities for which the fair value is estimated based on the value of identical or comparable assets, (ii) debt securities with quoted prices that are traded less frequently than exchange-traded instruments and (iii) derivative contracts and financial liabilities (e.g., callable brokered CDs and medium-term notes elected for fair value option under SFAS 159) whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data.
Level 3   Valuations of Level 3 assets and liabilities are based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models for which the determination of fair value requires significant management judgment or estimation.
          The following is a description of the valuation methodologies used for instruments measured at fair value:
Callable Brokered CDs
          The fair value of callable brokered CDs, which are included within deposits, is determined using discounted cash flow analyses over the full term of the CDs. The valuation uses a “Hull-White Interest Rate Tree” approach for the CDs with callable option components, an industry-standard approach for valuing instruments with interest rate call options. The model assumes that the embedded options are exercised economically. The fair value of the CDs is computed using the outstanding principal amount. The discount rates used are based on US dollar LIBOR and swap rates. At-the-money implied swaption volatility term structure (volatility by time to maturity) is used to calibrate the model to current market prices and value the cancellation option in the deposits.
Medium-Term Notes
          The fair value of medium-term notes is determined using a discounted cash flow analysis over the full term of the borrowings. This valuation also uses the “Hull-White Interest Rate Tree” approach to value the option components of the term notes. The model assumes that the embedded options are exercised economically. The fair value of medium-term notes is computed using the notional amount outstanding. The

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discount rates used in the valuations are based on US dollar LIBOR and swap rates. At-the-money implied swaption volatility term structure (volatility by time to maturity) is used to calibrate the model to current market prices and value the cancellation option in the term notes. Effective January 1, 2007, the Corporation updated its methodology to calculate the impact of its own credit standing. The net gain from fair value changes attributable to the Corporation’s own credit to the medium-term notes for which the Corporation has elected the fair value option recorded for the nine-month periods ended September 30, 2008 and 2007 amounted to $1.8 million and $1.6 million, respectively. The cumulative mark-to-market unrealized gain on the medium-term notes since the adoption of SFAS 159 attributed to credit risk amounted to $3.5 million as of September 30, 2008. For the medium-term notes, the credit risk is measured using the difference in yield curves between Swap rates and Treasury rates at a tenor comparable to the time to maturity of the note and option.
Investment Securities
          The fair value of investment securities is the market value based on quoted market prices, when available, or market prices for similar instruments. If listed prices or quotes are not available, fair value is based upon models that use unobservable inputs due to the limited market activity of the instrument (Level 3) as is the case with certain private label mortgage-backed securities held by the Corporation. Unlike U.S. agency mortgage-backed securities, the fair value of these private label securities cannot be readily determined because they are not actively traded in securities markets. Significant information used for fair value determination is proprietary with regard to specific characteristics such as the prepayment model, which follows the amortizing schedule of the underlying loans, which is an unobservable input. Private label mortgage-backed securities are collateralized by fixed-rate mortgages on single-family residential properties in the United States and the market valuation is calculated by discounting the estimated net cash flows over the projected life of the pool of underlying assets using prepayment, default and interest rate assumptions that market participants would commonly use for similar mortgage asset classes that are subject to prepayment, credit and interest rate risk.
Derivative instruments
          The fair value of the derivative instruments is based on observable market parameters and takes into consideration the Corporation’s own credit standing. The “Hull-White Interest Rate Tree” approach is used to value the option components of derivative instruments and the discounting of the cash flows is performed using US dollar LIBOR based discount rates. Certain derivatives with limited market activity are valued using models that consider unobservable market parameters, as is the case with derivative instruments named as “reference caps” (Level 3). Reference caps are used to mainly hedge interest rate risk inherent on private label mortgage-backed securities, thus are tied to the notional amount of the underlying fixed-rate mortgage loans originated in the United States. Significant information used for fair value determination is proprietary with regards to specific characteristics such as the prepayment model which follows the amortizing schedule of the underlying loans, which is an unobservable input. The valuation model uses the Black formula, which is a benchmark standard in financial industry. The Black formula is similar to the Black-Scholes formula for valuing stock options except that the spot price of the underlying is replaced by the forward price. The Black formula uses as inputs the strike price of the cap, forward LIBOR rates, volatility estimates and discount rates to estimate the option value. LIBOR rates and swap rates used in the model are obtained from Bloomberg everyday and build zero coupon curve based on the Bloomberg LIBOR/Swap curve. The discount factor is then calculated from the zero coupon curve. The cap is the sum of all caplets. For each caplet, the rate is reset at the beginning of each reporting period and payments are made at the end of each period. The cash flow of a caplet is then discounted from each payment date.
          Although most of the derivative instruments are fully collateralized, a credit spread is considered for those that are not secured in full. The cumulative mark-to-market effect of credit risk in the valuation of derivative instruments resulted in an unrealized gain of approximately $0.9 million as of September 30, 2008 (an immaterial

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gain of approximately $13,000 relates to the first nine months of 2008). The Corporation compares the valuations obtained with valuations received from counterparties, as an internal control procedure.
          Assets and liabilities measured at fair value on a recurring basis, including financial liabilities for which the Corporation has elected the fair value option, are summarized below:
                                 
    As of September 30, 2008
    Fair Value Measurements Using
                            Assets/ (Liabilities)
(In thousands)   Level 1   Level 2   Level 3   at Fair Value
Callable brokered CDs (1)
  $     $ (1,515,525 )   $     $ (1,515,525 )
Medium-term notes (1)
          (12,445 )           (12,445 )
Securities available for sale (2)
    3,592       3,903,631       109,726       4,016,949  
Derivative instruments (3)
          (29,786 )     4,544       (25,242 )
 
(1)   Amounts represent items for which the Corporation has elected the fair value option under SFAS 159.
 
(2)   Carried at fair value prior to the adoption of SFAS 159.
 
(3)   Derivatives as of September 30, 2008 include derivative assets of $8.9 million and derivative liabilities of $34.1 million, all of which were carried at fair value prior to the adoption of SFAS 159.
                                                 
    Changes in Fair Value for the Quarter Ended     Changes in Fair Values for the Nine-Month Period Ended  
    September 30, 2008, for items Measured at Fair Value Pursuant     September 30, 2008, for items Measured at Fair Value Pursuant  
    to Election of the Fair Value Option     to Election of the Fair Value Option  
                    Total                     Total  
                    Changes in Fair Value                     Changes in Fair Value  
    Unrealized Losses and     Unrealized Gains and     Unrealized (Losses) Gains     Unrealized Losses and     Unrealized Gains and     Unrealized (Losses) Gains  
    Interest Expense included     Interest Expense included     and Interest Expense     Interest Expense included     Interest Expense included     and Interest Expense  
    in Interest Expense     in Interest Expense     included in     in Interest Expense     in Interest Expense     included in  
(In thousands)   on Deposits (1)     on Notes Payable (1)     Current-Period Earnings (1)     on Deposits (1)     on Notes Payable (1)     Current-Period Earnings (1)  
Callable brokered CDs
  $ (22,841 )   $     $ (22,841 )   $ (122,833 )   $     $ (122,833 )
Medium-term notes
          749       749             1,223       1,223  
 
                                   
 
  $ (22,841 )   $ 749     $ (22,092 )   $ (122,833 )   $ 1,223     $ (121,610 )
 
                                   
 
(1)   Changes in fair value for the quarter and nine- month period ended September 30, 2008 include interest expense on callable brokered CDs of $22.1 million, and $100.9 million, respectively, and interest expense on medium-term notes of $0.2 million and $0.6 million, respectively. Interest expense on callable brokered CDs and medium-term notes that have been elected to be carried at fair value under the provisions of SFAS 159 are recorded in interest expense in the Consolidated Statements of Income based on their contractual coupons.
          The table below presents a reconciliation for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the quarter and nine-month period ended September 30, 2008.
Level 3 Instruments Only
                                   
    Total Fair Value Measurements     Total Fair Value Measurements  
    (Quarter ended September 30, 2008)     (Nine-month period ended September 30, 2008)  
(In thousands)   Derivatives (1)     Securities Available For Sale (2)     Derivatives (1)     Securities Available For Sale (2)  
Beginning balance
  $ 5,982     $ 115,190     $ 5,102     $ 133,678  
Total gains or (losses) (realized/unrealized):
                               
Included in earnings
    (1,438 )           (558 )      
Included in other comprehensive income
          (1,203 )           (8,810 )
New instruments acquired
                       
Principal repayments and amortization
          (4,261 )           (15,142 )
Transfers in and/or out of Level 3
                       
 
                       
Ending balance
  $ 4,544     $ 109,726     $ 4,544     $ 109,726  
 
                       
 
(1)   Amounts related to the valuation of interest rate cap agreements which were carried at fair value prior to the adoption of SFAS 159.
 
(2)   Amounts mostly related to certain private label mortgage-backed securities.

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          The table below summarizes changes in unrealized losses recorded in earnings for the quarter and nine-month period ended September 30, 2008 for Level 3 assets and liabilities that are still held as of September 30, 2008.
Level 3 Instruments Only
                 
    Changes in Unrealized (Losses) Gains  
    Quarter Ended     Nine-Month Period Ended  
(In thousands)   September 30, 2008     September 30, 2008  
Changes in unrealized (losses) gains relating to assets still held at reporting
date (1) (2):
               
 
               
Interest income on loans
  $ (22 )   $ 1  
Interest income on investment securities
    (1,416 )     (559 )
 
           
 
  $ (1,438 )   $ (558 )
 
           
 
(1)   Amount represents valuation of interest rate cap agreements which were carried at fair value prior to the adoption of SFAS 159.
 
(2)   Unrealized loss of $1.2 million and of $8.8 million on Level 3 available for sale securities were recognized as part of other comprehensive income for the quarter and nine-month period ended September 30, 2008, respectively.
          Additionally, fair value is used on a non-recurring basis to evaluate certain assets in accordance with GAAP. Adjustments to fair value usually result from the application of lower-of-cost-or-market accounting (e.g., loans held for sale carried at the lower of cost or fair value and repossessed assets) or write-downs of individual assets (e.g., goodwill, loans).
          As of September 30, 2008, impairment or valuation adjustments were recorded for assets recognized at fair value on a non-recurring basis as shown in the following table:
                                             
                                        Losses recorded
                                        for the Nine-
                        Valuation           month period
                        allowance as of   Losses recorded for   ended
                        September 30,   the Quarter ended   September 30,
    Carrying value as of September 30, 2008   2008   September 30, 2008   2008
(In thousands)   Level 1   Level 2   Level 3                        
Loans receivable (1)
  $   $   $ 237,388     $ 58,963     $ 36,707     $ 61,213  
Other Real Estate Owned (2)
            40,422       5,176       2,388       2,892  
 
(1)   Mainly impaired commercial and construction loans. The impairment was generally measured based on the fair value of the collateral in accordance with the provisions of SFAS 114, “Accounting by Creditors for Impairment of a Loan.” The fair values are derived from appraisals that take into consideration prices in observed transactions involving similar assets in similar locations but adjusted for specific characteristics and assumptions of the collateral (e.g. absorption rates), which are not market observable.
 
(2)   The fair value is derived from appraisals that take into consideration prices in observed transactions involving similar assets in similar locations but adjusted for specific characteristics and assumptions of the properties (e.g. absorption rates), which are not market observable. Valuation allowance is based on market valuation adjustments after the transfer from the loan to the Other Real Estate Owned (“OREO”) portfolio.
          During the first nine months of 2008, the Corporation increased its OREO portfolio mainly as a result of the repossession, in settlement of two impaired loans in Miami, of the associated collateral. As of September 30, 2008, the carrying amount of such properties at lower of cost or market was $18.6 million. Total charge-offs recorded during 2008 on these properties amounted to $4.2 million.

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18 — SUPPLEMENTAL CASH FLOW INFORMATION
          Supplemental cash flow information follows:
                 
    Nine-Month Period Ended September 30,
    2008   2007
    (In thousands)
Cash paid for:
               
 
               
Interest on borrowings
  $ 533,281     $ 565,286  
Income tax
    3,262       9,738  
 
               
Non-cash investing and financing activities:
               
 
               
Additions to other real estate owned
    47,046       7,334  
Additions to auto repossessions
    64,885       84,225  
Capitalization of servicing assets
    937       913  
Recharacterization of secured commercial loans as securities collateralized by loans
          183,830  
          On January 28, 2008, the Corporation completed the acquisition of VICB with operations in St. Croix, U.S. Virgin Islands, at a purchase price of $2.5 million. The Corporation acquired cash of approximately $7.7 million from VICB.
19 — SEGMENT INFORMATION
          Based upon the Corporation’s organizational structure and the information provided to the Chief Operating Decision Maker and, to a lesser extent, the Board of Directors, the operating segments are driven primarily by the Corporation’s legal entities. As of September 30, 2008, the Corporation had four reportable segments: Commercial and Corporate Banking; Mortgage Banking; Consumer (Retail) Banking; and Treasury and Investments. There is also an Other category reflecting other legal entities reported separately on an aggregate basis. Management determined the reportable segments based on the internal reporting used to evaluate performance and to assess where to allocate resources. Other factors such as the Corporation’s organizational chart, nature of the products, distribution channels and the economic characteristics of the products were also considered in the determination of the reportable segments.
          The Commercial and Corporate Banking segment consists of the Corporation’s lending and other services for large customers represented by the public sector and specialized and middle-market clients. The Commercial and Corporate Banking segment offers commercial loans, including commercial real estate and construction loans, and other products such as cash management and business management services. The Mortgage Banking segment’s operations consist of the origination, sale and servicing of a variety of residential mortgage loans. The Mortgage Banking segment also acquires and sells mortgages in the secondary markets. In addition, the Mortgage Banking segment includes mortgage loans purchased from other local banks or mortgage brokers. The Consumer (Retail) Banking segment consists of the Corporation’s consumer lending and deposit-taking activities conducted mainly through its branch network and loan centers. The Treasury and Investments segment is responsible for the Corporation’s investment portfolio and treasury functions executed to manage and enhance liquidity. This segment loans funds to the Commercial and Corporate Banking, Mortgage Banking, and Consumer (Retail) Banking segments to finance their lending activities and borrows from those segments. The Consumer (Retail) Banking segment also loans funds to other segments. The interest rates charged or credited by Treasury and Investments and the Consumer (Retail) Banking segments are allocated based on market rates. The difference between the allocated interest income or expense and the Corporation’s actual net interest income from centralized management of funding costs is reported in the Treasury and Investments segment. The Other category is mainly composed of insurance, finance leases and other products.

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     The accounting policies of the business segments are the same as those described in Note 1 of the Corporation’s financial statements for the year ended December 31, 2007 contained in the Corporation’s annual report on Form 10-K.
     The Corporation evaluates the performance of the segments based on net interest income after the estimated provision for loan and lease losses, non-interest income and direct non-interest expenses. The segments are also evaluated based on the average volume of their interest-earning assets less the allowance for loan and lease losses.
     The following table presents information about the reportable segments (in thousands):
                                                 
    Mortgage     Consumer     Commercial and     Treasury and              
    Banking     (Retail) Banking     Corporate     Investments     Other     Total  
For the quarter ended September 30, 2008:
                                               
Interest income
  $ 47,786     $ 45,577     $ 83,226     $ 79,222     $ 32,481     $ 288,292  
Net (charge) credit for transfer of funds
    (36,071 )     16,968       (50,306 )     72,413       (3,004 )      
Interest expense
          (19,027 )           (115,946 )     (8,698 )     (143,671 )
 
                                       
Net interest income
    11,715       43,518       32,920       35,689       20,779       144,621  
 
                                   
Provision for loan and lease losses
    (1,295 )     (8,572 )     (32,694 )           (12,758 )     (55,319 )
Non-interest income (loss)
    1,260       7,779       1,210       (466 )     4,088       13,871  
Direct non-interest expenses
    (5,778 )     (25,643 )     (9,118 )     (1,596 )     (11,255 )     (53,390 )
 
                                   
Segment income (loss)
  $ 5,902     $ 17,082     $ (7,682 )   $ 33,627     $ 854     $ 49,783  
 
                                   
 
                                               
Average earnings assets
  $ 2,998,292     $ 1,902,188     $ 6,092,228     $ 5,944,814     $ 1,401,779     $ 18,339,301  
 
                                               
For the quarter ended September 30, 2007:
                                               
Interest income
  $ 41,335     $ 46,172     $ 104,158     $ 71,388     $ 32,878     $ 295,931  
Net (charge) credit for transfer of funds
    (32,193 )     24,340       (74,318 )     89,581       (7,410 )      
Interest expense
          (20,719 )           (161,721 )     (8,462 )     (190,902 )
 
                                       
Net interest income (loss)
    9,142       49,793       29,840       (752 )     17,006       105,029  
 
                                   
Provision for loan and lease losses
    (738 )     (14,019 )     (11,727 )           (7,776 )     (34,260 )
Non-interest income (loss)
    1,182       5,643       764       (2,977 )     4,233       8,845  
Direct non-interest expenses
    (5,684 )     (24,117 )     (6,254 )     (2,051 )     (12,005 )     (50,111 )
 
                                   
Segment income (loss)
  $ 3,902     $ 17,300     $ 12,623     $ (5,780 )   $ 1,458     $ 29,503  
 
                                   
 
                                               
Average earnings assets
  $ 2,585,239     $ 1,811,466     $ 5,434,273     $ 5,705,114     $ 1,327,513     $ 16,863,605  
                                                 
    Mortgage     Consumer     Commercial and     Treasury and              
    Banking     (Retail) Banking     Corporate     Investments     Other     Total  
For the nine-month period ended September 30, 2008:
                                               
Interest income
  $ 140,346     $ 127,989     $ 262,972     $ 215,094     $ 97,586     $ 843,987  
Net (charge) credit for transfer of funds
    (105,217 )     62,967       (157,582 )     207,522       (7,690 )      
Interest expense
          (57,752 )           (356,621 )     (25,929 )     (440,302 )
 
                                       
Net interest income
    35,129       133,204       105,390       65,995       63,967       403,685  
 
                                   
Provision for loan and lease losses
    (8,263 )     (37,561 )     (65,775 )           (30,836 )     (142,435 )
Non-interest income
    2,489       21,747       3,358       15,268       12,391       55,253  
Direct non-interest expenses
    (18,283 )     (78,758 )     (26,714 )     (5,032 )     (34,094 )     (162,881 )
 
                                   
Segment income
  $ 11,072     $ 38,632     $ 16,259     $ 76,231     $ 11,428     $ 153,622  
 
                                   
 
                                               
Average earnings assets
  $ 2,907,449     $ 1,789,607     $ 5,980,151     $ 5,514,113     $ 1,369,900     $ 17,561,220  
 
                                               
For the nine-month period ended September 30, 2007:
                                               
Interest income
  $ 122,153     $ 139,810     $ 321,236     $ 219,741     $ 97,447     $ 900,387  
Net (charge) credit for transfer of funds
    (92,948 )     78,500       (219,446 )     251,808       (17,914 )      
Interest expense
          (59,803 )           (476,825 )     (24,080 )     (560,708 )
 
                                       
Net interest income (loss)
    29,205       158,507       101,790       (5,276 )     55,453       339,679  
 
                                   
Provision for loan and lease losses
    (1,924 )     (41,706 )     (25,805 )           (14,367 )     (83,802 )
Non-interest income (loss)
    2,336       20,786       2,780       (6,294 )     13,465       33,073  
Net gain on partial extinguishment and recharacterization of secured commercial loan to a local financial institution
                2,497                   2,497  
Direct non-interest expenses
    (16,046 )     (69,568 )     (15,762 )     (6,152 )     (34,740 )     (142,268 )
 
                                   
Segment income (loss)
  $ 13,571     $ 68,019     $ 65,500     $ (17,722 )   $ 19,811     $ 149,179  
 
                                   
 
                                               
Average earnings assets
  $ 2,524,502     $ 1,838,393     $ 5,441,358     $ 5,527,970     $ 1,301,675     $ 16,633,898  

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     The following table presents a reconciliation of the reportable segment financial information to the consolidated totals (in thousands):
                                 
    Quarter Ended     Nine-month Period Ended  
    September 30,     September 30,  
    2008     2007     2008     2007  
Net income:
                               
Total income for segments and other
  $ 49,783     $ 29,503     $ 153,622     $ 149,179  
Other Income
          15,075             15,075  
Other operating expenses
    (28,986 )     (24,841 )     (83,445 )     (85,502 )
 
                       
Income before income taxes
    20,797       19,737       70,177       78,752  
Income tax benefit (expense)
    3,749       (5,595 )     20,952       (17,983 )
 
                       
Total consolidated net income
  $ 24,546     $ 14,142     $ 91,129     $ 60,769  
 
                       
 
                               
Average assets:
                               
Total average earning assets for segments
  $ 18,339,301     $ 16,863,605     $ 17,561,220     $ 16,633,898  
Average non-earning assets
    701,115       708,446       707,336       635,233  
 
                       
Total consolidated average assets
  $ 19,040,416     $ 17,572,051     $ 18,268,556     $ 17,269,131  
 
                       
20 – COMMITMENTS AND CONTINGENCIES
     The Corporation enters into financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments may include commitments to extend credit and commitments to sell mortgage loans at fair value. As of September 30, 2008, commitments to extend credit amounted to approximately $1.7 billion and standby letters of credit amounted to approximately $103.8 million. Commitments to extend credit are agreements to lend to a customer as long as the conditions established in the contract are met. Commitments generally have fixed expiration dates or other termination clauses. For most of the commercial lines of credit, the Corporation has the option to reevaluate the agreement prior to additional disbursements. In the case of credit cards and personal lines of credit, the Corporation can at any time and without cause, cancel the unused credit facility. Generally, the Corporation’s mortgage banking activities do not enter into interest rate lock agreements with its prospective borrowers.
     Lehman Brothers Special Financing, Inc. (“Lehman”) was counterparty to the Corporation on certain interest rate swap agreements. During the third quarter of 2008, Lehman failed to pay the scheduled net cash settlement due to the Corporation, which constitutes an event of default under these interest rate swap agreements. The Corporation terminated all interest rate swaps with Lehman and replaced them with another counterparty under similar terms and conditions. As of September 30, 2008, the Corporation has an unsecured counterparty exposure with Lehman, which filed for bankruptcy on October 3, 2008, of approximately $1.4 million. This exposure has been reserved. Further, the Corporation is in the process of reviewing its options for the recovery of securities pledged under these agreements with Lehman to guarantee the Corporation’s performance thereunder. The market value of the pledged securities as of September 30, 2008 amounted to approximately $63 million. The Corporation believes that the securities pledged as collateral should not be part of the bankruptcy estate. At this early stage in the bankruptcy proceedings the Corporation is not able to determine whether it will succeed in recovering all or a substantial portion of the collateral or its equivalent value.
     As of September 30, 2008, First BanCorp and its subsidiaries were defendants in various legal proceedings arising in the ordinary course of business. Management believes that the final disposition of these matters will not have a material adverse effect on the Corporation’s financial position or results of operations.

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21 — FIRST BANCORP (Holding Company Only) Financial Information
          The following condensed financial information presents the financial position of the Holding Company only as of September 30, 2008 and December 31, 2007 and the results of its operations for the quarters and nine-month periods ended September 30, 2008 and 2007.
                 
    As of     As of  
    September 30,     December 31,  
    2008     2007  
    (In thousands)  
Assets
               
 
               
Cash and due from banks
  $ 52,700     $ 43,519  
Money market investments
    25,236       46,293  
Investment securities available for sale, at market:
               
Mortgage-backed securities
          41,234  
Equity investments
    1,195       2,117  
Other investment securities
    1,550       1,550  
Loans receivable, net
          2,597  
Investment in FirstBank Puerto Rico, at equity
    1,462,136       1,457,899  
Investment in FirstBank Insurance Agency, at equity
    5,088       4,632  
Investment in Ponce General Corporation, at equity
    109,324       106,120  
Investment in PR Finance, at equity
    2,719       2,979  
Accrued interest receivable
          376  
Investment in FBP Statutory Trust I
    3,093       3,093  
Investment in FBP Statutory Trust II
    3,866       3,866  
Other assets
    7,254       1,503  
 
           
Total assets
  $ 1,674,161     $ 1,717,778  
 
           
 
               
Liabilities & Stockholders’ Equity
               
 
               
Liabilities:
               
Other borrowings
  $ 231,890     $ 282,567  
Accounts payable and other liabilities
    999       13,565  
 
           
Total liabilities
    232,889       296,132  
 
           
Stockholders’ equity
    1,441,272       1,421,646  
 
           
Total liabilities and stockholders’ equity
  $ 1,674,161     $ 1,717,778  
 
           

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    Quarter Ended     Nine-month Period Ended  
    September 30,     September 30,     September 30,     September 30,  
    2008     2007     2008     2007  
    (In thousands)     (In thousands)  
Income:
                               
Interest income on investment securities
  $ 282     $ 826     $ 1,072     $ 2,261  
Interest income on other investments
          498       733       515  
Interest income on loans
          80             542  
Dividend from FirstBank Puerto Rico
    20,000       45,017       61,872       68,008  
Dividend from other subsidiaries
    1,500             4,000       1,000  
Other income
    98       142       311       421  
 
                       
 
    21,880       46,563       67,988       72,747  
 
                       
 
                               
Expense:
                               
Notes payable and other borrowings
    3,287       4,747       10,676       14,087  
Interest on funding to subsidiaries
          842       550       2,550  
(Recovery) Provision for loan losses
                (1,398 )     1,320  
Other operating expenses
    497       514       1,531       2,148  
 
                       
 
    3,784       6,103       11,359       20,105  
 
                       
 
                               
Net loss on investments and impairments
    (696 )     (2,370 )     (1,185 )     (5,965 )
 
                       
 
                               
Net loss on partial extinguishment and recharacterization of secured commercial loans to a local financial institution
                      (1,207 )
 
                       
 
                               
Income before income taxes and equity in undistributed earnings (losses) of subsidiaries
    17,400       38,090       55,444       45,470  
 
                               
Income tax benefit (provision)
          1,619       (546 )     4,120  
Equity in undistributed earnings (losses) of subsidiaries
    7,146       (25,567 )     36,231       11,179  
 
                       
 
                               
Net income
  $ 24,546     $ 14,142     $ 91,129     $ 60,769  
 
                       

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (MD&A)
SELECTED FINANCIAL DATA
(In thousands, except for per share and financial ratios)
                                 
    Quarter ended   Nine-month period ended
    September 30,   September 30,   September 30,
    2008   2007   2008   2007
Condensed Income Statements:
                               
Total interest income
  $ 288,292     $ 295,931     $ 843,987     $ 900,387  
Total interest expense
    143,671       190,902       440,302       560,708  
Net interest income
    144,621       105,029       403,685       339,679  
Provision for loan and lease losses
    55,319       34,260       142,435       83,802  
Non-interest income
    13,871       23,920       55,253       50,645  
Non-interest expenses
    82,376       74,952       246,326       227,770  
Income before income taxes
    20,797       19,737       70,177       78,752  
Income tax benefit (provision)
    3,749       (5,595 )     20,952       (17,983 )
Net income
    24,546       14,142       91,129       60,769  
Net income attributable to common stockholders
    14,477       4,073       60,922       30,562  
Per Common Share Results:
                               
Net income per share basic
  $ 0.16     $ 0.05     $ 0.66     $ 0.36  
Net income per share diluted
  $ 0.16     $ 0.05     $ 0.66     $ 0.36  
Cash dividends declared
  $ 0.07     $ 0.07     $ 0.21     $ 0.21  
Average shares outstanding
    92,511       87,075       92,507       84,542  
Average shares outstanding diluted
    92,569       87,317       92,623       84,958  
Book value per common share
  $ 9.63     $ 9.34     $ 9.63     $ 9.34  
Tangible book value per common share
  $ 9.06     $ 8.78     $ 9.06     $ 8.78  
Selected Financial Ratios (In Percent):
                               
Profitability:
                               
Return on Average Assets
    0.52       0.32       0.67       0.47  
Interest Rate Spread (1)
    3.03       2.15       2.87       2.28  
Net Interest Margin (1)
    3.37       2.67       3.25       2.83  
Return on Average Total Equity
    6.98       4.14       8.51       6.28  
Return on Average Common Equity
    6.76       1.99       9.26       5.50  
Average Total Equity to Average Total Assets
    7.39       7.78       7.81       7.47  
Dividend payout ratio
    44.73       159.00       31.89       59.33  
Efficiency ratio (2)
    51.97       58.13       53.67       58.35  
Asset Quality:
                               
Allowance for loan and lease losses to loans receivable
    2.06       1.57       2.06       1.57  
Net charge-offs (annualized) to average loans
    0.79       0.77       0.87       0.77  
Provision for loan and lease losses to net charge-offs
    223.44       157.28       178.56       129.70  
Non-performing assets to total assets
    2.86       2.48       2.86       2.48  
Non-accruing loans to total loans receivable
    3.95       3.58       3.95       3.58  
Allowance to total non-accruing loans
    52.20       43.86       52.20       43.86  
Allowance to total non-accruing loans, excluding residential real estate loans
    103.83       85.24       103.83       85.24  
 
                               
Other Information:
                               
Common Stock Price: End of period
  $ 11.06     $ 9.50     $ 11.06     $ 9.50  
                 
    As of   As of
    September 30,   December 31,
    2008   2007
Balance Sheet Data:
               
Loans and loans held for sale
  $ 12,713,102     $ 11,799,746  
Allowance for loan and lease losses
    261,170       190,168  
Money market and investment securities
    6,105,919       4,811,413  
Intangible Assets
    52,992       51,034  
Deferred tax asset, net
    114,972       90,130  
Total assets
    19,304,440       17,186,931  
Deposits
    12,819,832       11,034,521  
Borrowings
    4,871,551       4,460,006  
Total preferred equity
    550,100       550,100  
Total common equity
    938,359       896,810  
Accumulated other comprehensive loss, net of tax
    (47,187 )     (25,264 )
Total equity
    1,441,272       1,421,646  
 
1-   On a tax equivalent basis (see “Net Interest Income” discussion below).
 
2-   Non-interest expenses to the sum of net interest income and non-interest income. The denominator includes non-recurring income and changes in the fair value of derivative instruments and financial instruments measured at fair value under SFAS 159.

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ECONOMIC AND MARKET ENVIRONMENT
          In recent weeks and months, the volatility and disruptions in the capital and credit markets have reached unprecedented levels. Bankruptcies and forced mergers of major investment banks and commercial banks in the United States, government bailouts of mortgage giants Fannie Mae (“FNMA”) and Freddie Mac (“FHLMC”), government support of the insurance company American International Group and increasing concerns about the ability of other financial institutions to stay capitalized have exacerbated the market disruptions and stress in the credit markets that have affected the economy over the past year. Following a series of market interventions to bail out particular firms, a $700 billion Troubled Asset Relief Program to stimulate economic growth and inspire confidence in the financial markets by the purchase of distressed assets and capitalization of the banking industry was signed into law on October 3, 2008. The legislation also increases the limit on deposit insurance at banks and credit unions and authorizes the Federal Reserve to pay interest on reserves. The credit market has remained tight despite passage of the rescue plan. Banks continue to hold cash to meet their own funding needs, wary of lending either to other banks or to businesses and individuals. The Federal Reserve has taken steps to support market liquidity by lowering the Federal Funds rate and the discount rate, encouraging banks to use their short-term lending windows and determining to provide a facility to increase the availability of commercial paper to eligible issuers. The central banks of Canada, England, Sweden and Switzerland and the European Central Bank have also announced reductions in policy interest rates.
          As is the case with most commercial banks, the lack of liquidity in global credit markets may affect the Corporation’s access to regular and customary sources of funding. Also, the slowing economy and deteriorating housing market in the United States have required increased reserves on the Corporation’s loan portfolio, in particular on the $251 million loans originally disbursed as condo-conversion in the U.S. mainland. However, the Corporation is well capitalized and profitable and maintains sufficient liquidity to operate in a sound and safe manner. The Corporation has taken precautionary steps to enhance its liquidity positions and safeguard the access to credit by, among other things, increasing its borrowing capacity with the Federal Home Loan Bank (FHLB) and the Federal Reserve (FED) through the Discount Window Program, the issuance of additional brokered CDs to increase its liquidity levels and the extension of the maturities of its borrowings to reduce exposure to high levels of market volatility.
          The Corporation has not been active in subprime or adjustable rate mortgage loans (“ARMs”), nor has it been exposed to collateral debt obligations or other types of exotic products that aggravated the current financial crisis in the United States. More than 90% of the Corporation’s outstanding balance in its residential mortgage loan portfolio consists of fixed-rate, fully amortizing, full documentation loans and over 91% of the Corporation’s securities portfolio is invested in U.S. Government and Agency debentures and U.S. government sponsored-agency fixed-rate mortgage-backed securities (mainly FNMA and FHLMC fixed-rate securities). In connection with the placement of FNMA and FHLMC into conservatorship by the U.S. Treasury in September 2008, the Treasury entered into agreements to invest up to approximately $100 billion in each agency to, among other things, protects debt and mortgage-backed securities of the agencies. As of September 30, 2008 the Corporation has $4.3 billion and $0.9 billion in FNMA and FHLMC mortgage-backed securities and debt securities, respectively, representing approximately 85% of the total investment portfolio. The Corporation’s investment in equity securities is minimal and none of its equity securities is related to U.S. financial institutions that recently failed. Also, as part of its credit risk management, the Corporation maintains strict and conservative underwriting guidelines, diversifies the counterparties used and monitors the concentration of risk to limit its counterparty exposure. As of September 30, 2008, the Corporation’s unsecured counterparty exposure to the Lehman Brothers Holdings, Inc. bankruptcy filing is approximately $1.4 million, which has been reserved and relates to interest rate swaps agreements. For more information on current exposure with respect to the Corporation’s derivative instruments and outstanding repurchase agreements by counterparty, management of liquidity risk and current liquidity levels, see the “Risk Management” discussion below and Notes 20 and 12 to the accompanying unaudited consolidated financial statements .

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          The Corporation’s principal market is Puerto Rico. Although affected by the economic situation in the United States, Puerto Rico’s economy has been in a recession since early 2006 due to several local conditions including budget shortfalls, diminished consumer buying power driven by increases in utility costs, gasoline prices, and highway toll charges, the implementation of sales taxes, and periodic impasses between the Executive and the Legislature branches of the government. The above conditions together with a recession looming also in the U.S. mainland and rising food prices will continue to adversely affect the economy in Puerto Rico.
          The Corporation has seen stress in the credit quality of, and worsening trends affecting its construction loan portfolio, in particular condo conversion loans in the U.S. mainland (mainly in the state of Florida) affected by the continuing deterioration in the health of the economy, an oversupply of new homes and declining housing prices in the United States. To a lesser extent, the Corporation also increased its reserves for the residential mortgage and construction loan portfolio from the 2007 level to account for the increased credit risk tied to recessionary conditions in Puerto Rico’s economy. Nevertheless, the Puerto Rico housing market has not seen the dramatic decline in housing prices that is affecting the U.S. mainland but there is a lower demand due to the diminished consumer’s acquisition power. Recent decreases in oil prices should provide a relief to consumers and should immediately impact consumers’ purchasing power positively. In addition, since 2005 the Corporation has taken actions and implemented initiatives designed to strengthen the Corporation’s credit policies as well as loss mitigation initiatives that have begun to have the desired effects as reflected by a decrease in non-performing consumer loans and consumer loans charge-offs and a relative stability in non-performing residential mortgage loans. The degree of the impact of economic conditions on the Corporation’s financial results is dependent upon the duration and severity of the aforementioned conditions. As an example, the credit risk is affected by a deteriorating economy to the extent that the borrowers’ spending capacity is decreased and, as a result, may not be able to make their payments when due. A deteriorating economy could also lead to a decline in real estate values and therefore the reduction of the borrowers’ capacity to refinance loans and increase the Corporation’s exposure to loss upon default. For more information on credit quality, see the “Risk Management — Non-performing Assets and Allowance for Loan and Lease Losses” discussion below.
OVERVIEW OF RESULTS OF OPERATIONS
          This discussion and analysis relates to the accompanying consolidated interim unaudited financial statements of First BanCorp and should be read in conjunction with the interim unaudited financial statements and the notes thereto.
          First BanCorp’s results of operations depend primarily upon its net interest income, which is the difference between the interest income earned on its interest-earning assets, including investment securities and loans, and the interest expense on its interest-bearing liabilities, including deposits and borrowings. Net interest income is affected by various factors, including: the interest rate scenario; the volumes, mix and composition of interest-earning assets and interest-bearing liabilities; and the re-pricing characteristics of these assets and liabilities. The Corporation’s results of operations also depend on the provision for loan and lease losses, non-interest expenses (such as personnel, occupancy and other costs), non-interest income (mainly service charges and fees on loans and deposits and insurance income), the results of its hedging activities, gains (losses) on investments, gains (losses) on sale of loans, and income taxes.
          Net income for the quarter ended September 30, 2008 amounted to $24.5 million or $0.16 per diluted common share, compared to $14.1 million or $0.05 per diluted common share for the quarter ended September 30, 2007. The Corporation’s financial performance for the third quarter of 2008, as compared to the third quarter of 2007, was principally impacted by an increase of $39.6 million in net interest income. By being liability sensitive, (which in general terms means that interest bearing liabilities reprice faster than interest earning assets) the Corporation benefited from lower short-term interest rates on its interest-bearing liabilities as compared to rate

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levels during the third quarter of 2007. This was partially offset by: (i) an increase of $21.1 million in the provision for loan and lease losses due to a higher volume of impaired construction and commercial loans, increases in reserves for potential losses inherent in the loan portfolio associated with weakening economic conditions, and the growth of the Corporation’s total loan portfolio (ii) a decrease of $10.0 million in non-interest income that reflects the impact on the third quarter results of 2007 of income of $15.1 million recorded in connection with an agreement reached with insurance carriers and former executives for indemnity of expenses related to the class action lawsuit brought against the Corporation that was settled in 2007, and (iii) an increase of $7.4 million in non-interest expenses mainly due to higher foreclosure-related expenses. A lower current income tax provision due to higher tax-exempt income resulted in an income tax benefit of $3.7 million for the third quarter of 2008, compared to an income tax expense of $5.6 million recorded for the same period a year ago.
          The highlights and key drivers of the Corporation’s financial results for the quarter ended September 30, 2008 include the following:
    Net interest income for the quarter ended September 30, 2008 was $144.6 million, compared to $105.0 million for the same period in 2007. The net interest spread and margin, on an adjusted tax equivalent basis, for the quarter ended September 30, 2008 were 3.03% and 3.37%, respectively, compared to 2.15% and 2.67%, respectively, for the same period in 2007. The increase in net interest income is mainly associated with a higher interest rate spread and margin due to a decrease in the average cost of funds resulting from lower short-term interest rates and to a lesser extent a higher volume of interest earning assets. The Corporation’s liability sensitive balance sheet position has allowed the Corporation to benefit from lower short-term interest rates as compared to rate levels during the third quarter of 2007. The decrease in funding costs associated with lower short-term interest rates was partially offset by lower loan yields due to the repricing of variable rate construction and commercial loans tied to short-term indexes and the increase in non-accrual loans as compared to 2007 volumes.
 
      Average earning assets for the third quarter of 2008 increased by approximately $1.6 billion as compared to the same period in 2007. Average loans increased by $1.3 billion driven by the growth in internal originations, in particular commercial and residential real estate loans, and to a lesser extent purchases of loans, including the acquisition of a $218 million auto loan portfolio during the third quarter of 2008 that contributed to a wider interest rate spread. In addition, the Corporation purchased approximately $3.2 billion in U.S. government agencies fixed-rate mortgage-backed securities (“MBS”) having an average yield of 5.44% during the first half of 2008, which is higher than the cost of borrowings required to finance the purchase of such assets; thus contributing to a higher net interest income as compared to 2007. Refer to the “Net Interest Income” discussion below for additional information.
 
    For the third quarter of 2008, the Corporation’s provision for loan and lease losses amounted to $55.3 million, compared to $34.3 million for the same period in 2007. Refer to the discussion under the “Risk Management” section below for an analysis of the allowance for loan and lease losses and non-performing assets and related ratios. The increase in the provision for 2008 was primarily due to a higher volume of impaired construction and commercial loans, increases to the reserve factors for potential losses inherent in the loan portfolio associated with the weakening economic conditions in the United States and Puerto Rico, and the overall growth of the loan portfolio.
 
      The Corporation has seen stress in the credit quality of, and worsening trends affecting its construction loan portfolio, in particular condo-conversion loans in the U.S. mainland (mainly in the state of Florida) affected by the continuing deterioration in the health of the economy, an oversupply of new homes and declining housing prices in the United States. The total exposure of the Corporation to loans originally disbursed as condo-conversion loans in the United States is approximately $251 million or 2% of the

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      total loan portfolio. A total of approximately $182.2 million of this condo conversion portfolio is considered impaired under Statement of Financial Accounting Standards No. (“SFAS”) 114, “Accounting by Creditors for Impairment of a Loan,” with a specific reserve of $31.4 million allocated to these impaired loans. With respect to the United States mainland market, the Corporation recorded approximately $16.7 million in additional reserves for impaired loans during the third quarter of 2008, including $9.6 million for a condo-conversion loan in Miami, Florida with an outstanding principal balance of $52.6 million. For the third quarter of 2007, approximately $8.1 million was recorded as a specific reserve for a previously reported impaired relationship tied to the Miami Corporate Banking operations in the U.S. mainland. With respect to the Puerto Rico market, specific reserves of approximately $17.9 million were allocated to commercial and construction loans that were identified as impaired loans during the third quarter of 2008.
 
    For the quarter ended September 30, 2008, the Corporation’s non-interest income amounted to $13.9 million, compared to $23.9 million for the quarter ended September 30, 2007. The financial results for the third quarter of 2007 include an income recognition of $15.1 million in connection with an agreement reached with insurance carriers and former executives for indemnity of expenses related to the class action lawsuit brought against the Corporation that was settled in 2007. Excluding this transaction, non-interest income increased by $5.0 million, as compared to the third quarter of 2007 due to a combination of factors, including lower other-than-temporary impairment charges on equity securities, an increase in point of sale (POS) and ATM interchange fee income, and an increase in fee income from cash management services provided to corporate customers. Refer to the “Non Interest Income” discussion below for additional information.
 
    Non-interest expenses for the third quarter of 2008 amounted to $82.4 million, compared to $75.0 million for the same period in 2007. The increase in non-interest expenses for 2008 was mainly due to an increase of approximately $5.0 million in foreclosure-related expenses, mainly due to a higher inventory of repossessed properties and charges in connection with valuation adjustments and realized losses on the sale of foreclosed properties in Puerto Rico, together with an increase in repairs, legal expenses and management fees paid in connection with foreclosures of properties in the United States (mainly condo conversion projects in the state of Florida). Furthermore, higher non-interest expenses was related to: (i) an increase of $1.6 million in employees’ compensation and benefit expenses due to higher average compensation and related benefits, (ii) an increase of $1.1 million in business promotion expenses to support initiatives directed to increase the Corporation’s deposit base and mortgage loan originations, and (iii) an increase of $1.0 million and $0.7 million in data processing fees and occupancy and equipment expenses, respectively, to support the expansion of the Corporation’s operations. Refer to the “Non Interest Expenses” discussion below for additional information.
 
    For the third quarter of 2008, the Corporation recorded an income tax benefit of $3.7 million, compared to an income tax expense of $5.6 million for the same period in 2007. The fluctuation is mainly related to a lower current income tax provision due to higher tax-exempt income as a significant portion of the increase in revenues was associated with exempt operations conducted through the international banking entity, FirstBank Overseas Corporation.
 
    Total assets as of September 30, 2008 amounted to $19.3 billion, an increase of $2.1 billion compared to total assets as of December 31, 2007. The Corporation’s loan portfolio increased by $913.4 million (before the allowance for loan and lease losses) driven by new originations and the purchase of a $218 million auto loan portfolio during the third quarter of 2008. Also, the increase in total assets is attributable to the purchase of approximately $3.2 billion of U.S. government agency fixed-rate MBS during the first half of 2008 as market conditions presented an opportunity for the Corporation to obtain attractive yields, improve its net interest margin and replace the $1.2 billion of U.S. Agency debentures called by counterparties. The

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      Corporation increased its cash and money market investments by $66.2 million in part as a precautionary measure given the current crisis in the financial markets.
 
    As of September 30, 2008, total liabilities amounted to $17.9 billion, an increase of approximately $2.1 billion as compared to $15.8 billion as of December 31, 2007. The increase in total liabilities was mainly attributable to a higher volume of deposits, as the Corporation has been issuing brokered CDs to finance its lending activities, pay off repurchase agreements issued to finance the purchase of MBS in the first half of 2008, accumulate additional liquidity due to current market volatility and extend the maturity of its borrowings. Total deposits, excluding brokered CDs, increased by $594.5 million from the balance as of December 31, 2007. Refer to “Risk management — Liquidity and Capital Adequacy” discussion below for additional information about the Corporation’s funding sources.
 
    Total loan production, including purchases, for the quarter ended September 30, 2008 was $1.2 billion, compared to $860.3 million for the comparable period in 2007. The increase in loan production during 2008, as compared to the third quarter of 2007, was mainly associated with the purchase of a $218 million auto loan portfolio. In addition, there was an increase of $139.2 million in commercial loan originations.
 
    Total non-performing assets as of September 30, 2008 amounted to $552.9 million compared to $439.3 million as of December 31, 2007. The slowing economy and deteriorating housing market in the United States coupled with recessionary conditions in Puerto Rico’s economy have resulted in higher non-performing balances in most of the Corporation’s loan portfolios. Total non-performing assets in the United States increased by $23.0 million. With regards to the United States portfolio, two condo conversion loans totaling approximately $17.5 million were classified as non-performing during 2008. Also in Florida, two commercial mortgage loans totaling $12.9 million contributed to the increase in non-accrual loans. The balance of non-accruing residential mortgage loans was also adversely affected by deteriorating economic conditions in the United States, which accounted for $9.9 million of the increase in non-accruing residential mortgages as compared to balances as of December 31, 2007.
 
      Partially offsetting the increase in non-performing loans and assets in the United States was the sale, during the first half of 2008, of one impaired condo conversion loan in a single relationship on its Miami Corporate Banking operations portfolio. The loan’s carrying amount was $21.8 million (net of an impairment of $2.4 million), and the loan was sold for $22.5 million. Also, during the first half of 2008, the Corporation added approximately $18.6 million to its other real estate owned (OREO) portfolio, as a result of collateral repossessed in settlement of two other loans in this impaired relationship. As of September 30, 2008, and as a result of the transactions completed during the fourth quarter of 2007 and first half of 2008, there were no outstanding loans associated with this relationship. Refer to “Risk Management — Non-accruing and Non-performing Assets” section below for additional information about non-performing assets in the United States.
 
      In Puerto Rico, non-performing assets increased by $93.0 million from balances as of December 31, 2007 driven by increases in the residential and commercial non-performing loan portfolio. The increase in non-accruing commercial loans is related to continuing adverse economic conditions in Puerto Rico, including the classification as non-accrual of approximately $33.1 million impaired commercial loans identified during 2008. Increases in the Puerto Rico’s non-accruing construction loans portfolio was driven by the classification as non-accrual of a $15.2 million impaired loan extended for land development and construction of a residential housing project in Puerto Rico. The weakening economic conditions in Puerto Rico have also affected the volume of non-performing residential mortgage loans, which increased by $28.2 million; however, the non-performing to total loan ratio for this portfolio remained flat. The relative stability of non-performing residential loans in Puerto Rico reflects, to some extent, the positive impact of loans modified through the loan loss mitigation program that begun in the third quarter of 2007.

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      With respect to the U.S. Virgin Islands, a third party purchased, during the third quarter of 2008, the outstanding debt related to a syndicated commercial loan in the U.S. Virgin Islands on which the Corporation had a participation and that was placed in non-accrual in the second quarter of 2008. The purchase agreement provided a full release of the borrower’s obligation to the participant banks, thus the carrying value of approximately $13.0 million on this participation was taken out of non-accrual during the third quarter of 2008. On September 15, 2008, the Corporation collected approximately $ 6.5 million from this borrower. The remaining balance of approximately $ 6.5 million is due on January 14, 2009.
 
      The non-accruing consumer loan portfolio, mainly composed of Puerto Rico loans, reflects a decrease of $6.0 million from December 31, 2007, principally related to the auto loan portfolio. This portfolio continues to show signs of stability and benefited from changes in underwriting standards implemented in late 2005. The consumer loan portfolio with an average life of approximately four years has been replenished by new originations under revised standards.
 
      Refer to “Risk Management — Non-accruing and Non-performing Assets” section below for additional information.
Critical Accounting Policies and Practices
          The accounting principles of the Corporation and the methods of applying these principles conform with generally accepted accounting principles in the United States and to general practices within the banking industry. The Corporation’s critical accounting policies relate to the 1) allowance for loan and lease losses; 2) other-than-temporary impairments; 3) income taxes; 4) classification and related values of investment securities; 5) valuation of financial instruments; 6) derivative financial instruments; and 7) income recognition on loans. These critical accounting policies involve judgments, estimates and assumptions made by management that affect the recorded assets and liabilities and contingent assets and liabilities disclosed as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from estimates, if different assumptions or conditions prevail. Certain determinations inherently have greater reliance on the use of estimates, assumptions, and judgments and, as such, have a greater possibility of producing results that could be materially different than those originally reported.
          The Corporation’s critical accounting policies are described in the Management Discussion and Analysis of Financial Condition and Results of Operations section of First BanCorp’s 2007 Annual Report on Form 10-K. There have not been any material changes in the Corporation’s critical accounting policies since December 31, 2007.

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Net Interest Income
          Net interest income is the excess of interest earned by First BanCorp on its interest-earning assets over the interest incurred on its interest-bearing liabilities. First BanCorp’s net interest income is subject to interest rate risk due to the re-pricing and maturity mismatch of the Corporation’s assets and liabilities. Net interest income for the quarter and nine-month period ended September 30, 2008 was $144.6 million and $403.7 million, respectively, compared to $105.0 million and $339.7 million, respectively, for the comparable periods in 2007. On an adjusted tax equivalent basis, excluding the changes in the fair value of derivative instruments and unrealized gains and losses on SFAS 159 liabilities, net interest income for the quarter and nine-month period ended September 30, 2008 was $158.2 million and $433.9 million, respectively, compared to $114.9 million and $356.2 million, respectively, for the same periods in 2007.
          Part I of the following table presents average volumes and rates on an adjusted tax equivalent basis and Part II presents, also on an adjusted tax equivalent basis, the extent to which changes in interest rates and changes in volume of interest-related assets and liabilities have affected the Corporation’s net interest income. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (changes in volume multiplied by prior period rates) and, (ii) changes in rate (changes in rate multiplied by prior period volumes). Rate-volume variances (changes in rate multiplied by changes in volume) have been allocated to the changes in volume and rate based upon their respective percentage of the combined totals.
          The net interest income is computed on an adjusted tax equivalent basis (for definition and reconciliation of this non-GAAP measure, refer to discussions below) and excluding: (1) the change in the fair value of derivative instruments and (2) unrealized gains or losses on SFAS 159 liabilities.

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Part I
                                                 
    Average volume     Interest income (1) / expense     Average rate (1)  
    September 30,     September 30,     September 30,     September 30,     September 30,     September 30,  
Quarter ended   2008     2007     2008     2007     2008     2007  
    (Dollars in thousands)                  
Interest-earning assets:
                                               
Money market investments
  $ 178,973     $ 743,628     $ 974     $ 9,418       2.17 %     5.02 %
Government obligations (2)
    1,031,654       2,781,044       18,218       40,694       7.03 %     5.81 %
Mortgage-backed securities
    4,809,138       2,220,250       78,214       27,954       6.47 %     5.00 %
Corporate bonds
    6,103       7,711       143       144       9.32 %     7.41 %
FHLB stock
    69,427       43,919       968       802       5.55 %     7.24 %
Equity securities
    3,692       7,033       18             1.94 %      
 
                                       
Total investments (3)
    6,098,987       5,803,585       98,535       79,012       6.43 %     5.40 %
 
                                       
Residential real estate loans
    3,427,707       2,942,505       54,756       47,093       6.36 %     6.35 %
Construction loans
    1,487,779       1,469,983       20,286       30,070       5.42 %     8.12 %
Commercial loans
    5,477,213       4,767,201       74,164       90,528       5.39 %     7.53 %
Finance leases
    372,404       384,302       7,842       8,350       8.38 %     8.62 %
Consumer loans
    1,800,336       1,713,625       52,142       50,587       11.52 %     11.71 %
 
                                       
Total loans (4) (5)
    12,565,439       11,277,616       209,190       226,628       6.62 %     7.97 %
 
                                       
Total interest-earning assets
  $ 18,664,426     $ 17,081,201     $ 307,725     $ 305,640       6.56 %     7.10 %
 
                                       
 
                                               
Interest-bearing liabilities:
                                               
Brokered CDs
  $ 7,643,238     $ 8,268,728     $ 73,962     $ 107,065       3.85 %     5.14 %
Other interest-bearing deposits
    3,677,632       3,160,418       26,005       35,121       2.81 %     4.41 %
Loans payable
    42,391             240             2.25 %      
Other borrowed funds
    4,296,355       3,183,421       39,333       39,383       3.64 %     4.91 %
FHLB advances
    1,212,121       671,026       10,018       9,172       3.29 %     5.42 %
 
                                       
Total interest-bearing liabilities (6)
  $ 16,871,737     $ 15,283,593     $ 149,558     $ 190,741       3.53 %     4.95 %
 
                                       
Net interest income
                  $ 158,167     $ 114,899                  
 
                                           
Interest rate spread
                                    3.03 %     2.15 %
Net interest margin
                                    3.37 %     2.67 %
                                                 
    Average volume     Interest income (1) / expense     Average rate (1)  
Nine-Month Period Ended September 30,   2008     2007     2008     2007     2008     2007  
    (Dollars in thousands)                  
Interest-earning assets:
                                               
Money market investments
  $ 327,451     $ 526,564     $ 6,046     $ 20,084       2.47 %     5.10 %
Government obligations (2)
    1,532,736       2,715,495       75,929       120,237       6.62 %     5.92 %
Mortgage-backed securities
    3,674,801       2,313,790       170,239       87,222       6.19 %     5.04 %
Corporate bonds
    6,158       7,711       425       369       9.22 %     6.39 %
FHLB stock
    65,998       43,183       3,229       2,004       6.54 %     6.20 %
Equity securities
    4,020       9,244       29       3       0.96 %     0.04 %
 
                                       
Total investments (3)
    5,611,164       5,615,987       255,897       229,919       6.09 %     5.47 %
 
                                       
Residential real estate loans
    3,309,221       2,875,978       160,715       139,461       6.49 %     6.48 %
Construction loans
    1,478,794       1,467,480       64,751       93,286       5.85 %     8.50 %
Commercial loans
    5,360,382       4,759,132       233,065       271,231       5.81 %     7.62 %
Finance leases
    375,460       378,134       24,238       24,929       8.62 %     8.81 %
Consumer loans
    1,689,565       1,741,416       146,677       153,067       11.60 %     11.75 %
 
                                       
Total loans (4) (5)
    12,213,422       11,222,140       629,446       681,974       6.88 %     8.12 %
 
                                       
Total interest-earning assets
  $ 17,824,586     $ 16,838,127     $ 885,343     $ 911,893       6.63 %     7.24 %
 
                                       
 
                                               
Interest-bearing liabilities:
                                               
Brokered CDs
  $ 7,406,242     $ 7,684,093     $ 231,883     $ 306,599       4.18 %     5.33 %
Other interest-bearing deposits
    3,553,985       3,096,184       78,355       87,899       2.94 %     3.80 %
Loans payable
    14,234             240             2.25 %      
Other borrowed funds
    3,898,835       3,553,621       110,178       134,853       3.77 %     5.07 %
FHLB advances
    1,143,851       654,482       30,738       26,370       3.59 %     5.39 %
 
                                       
Total interest-bearing liabilities (6)
  $ 16,017,147     $ 14,988,380     $ 451,394     $ 555,721       3.76 %     4.96 %
 
                                       
Net interest income
                  $ 433,949     $ 356,172                  
 
                                           
Interest rate spread
                                    2.87 %     2.28 %
Net interest margin
                                    3.25 %     2.83 %
 
(1)   On an adjusted tax equivalent basis. The adjusted tax equivalent yield was estimated by dividing the interest rate spread on exempt assets by (1 less Puerto Rico statutory tax rate of 39%) and adding to it the cost of interest-bearing liabilities. When adjusted to a tax equivalent basis, yields on taxable and exempt assets are comparable. Changes in the fair value of derivative and unrealized gains or losses on SFAS 159 liabilities are excluded from interest income and interest expense because the changes in valuation do not affect interest paid or received.
 
(2)   Government obligations include debt issued by government sponsored agencies.
 
(3)   Unrealized gains and losses in available-for-sale securities are excluded from the average volumes.
 
(4)   Average loan balances include the average of non-accruing loans.
 
(5)   Interest income on loans includes $2.5 million and $2.0 million for the third quarter of 2008 and 2007, respectively, and $7.9 million and $9.0 million for the nine-month period ended September 30, 2008 and 2007, respectively, of income from prepayment penalties and late fees related to the Corporation’s loan portfolio.
 
(6)   Unrealized gains and losses on SFAS 159 liabilities are excluded from the average volumes.

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Part II
                                                 
    Quarter ended September 30,     Nine-month period ended September 30,  
    2008 compared to 2007     2008 compared to 2007  
    Increase (decrease)     Increase (decrease)  
    Due to:     Due to:  
    Volume     Rate     Total     Volume     Rate     Total  
    (In thousands)  
Interest income on interest-earning assets:
                                               
Money market investments
  $ (4,825 )   $ (3,619 )   $ (8,444 )   $ (5,934 )   $ (8,104 )   $ (14,038 )
Government obligations
    (28,168 )     5,692       (22,476 )     (55,517 )     11,209       (44,308 )
Mortgage-backed securities
    40,104       10,156       50,260       59,842       23,175       83,017  
Corporate bonds
    (34 )     33       (1 )     (91 )     147       56  
FHLB stock
    407       (241 )     166       1,112       113       1,225  
Equity securities
    (9 )     27       18       (20 )     46       26  
 
                                   
Total investments
    7,475       12,048       19,523       (608 )     26,586       25,978  
 
                                   
Residential real estate loans
    7,623       40       7,663       21,168       86       21,254  
Construction loans
    234       (10,018 )     (9,784 )     678       (29,213 )     (28,535 )
Commercial loans
    11,300       (27,664 )     (16,364 )     30,435       (68,601 )     (38,166 )
Finance leases
    (266 )     (242 )     (508 )     (170 )     (521 )     (691 )
Consumer loans
    2,454       (899 )     1,555       (4,422 )     (1,968 )     (6,390 )
 
                                   
Total loans
    21,345       (38,783 )     (17,438 )     47,689       (100,217 )     (52,528 )
 
                                   
Total interest income
    28,820       (26,735 )     2,085       47,081       (73,631 )     (26,550 )
 
                                   
Interest expense on interest-bearing liabilities:
                                               
Brokered CDs
    (7,667 )     (25,436 )     (33,103 )     (10,724 )     (63,992 )     (74,716 )
Other interest-bearing deposits
    4,614       (13,730 )     (9,116 )     11,737       (21,281 )     (9,544 )
Loans payable
    240             240       240             240  
Other borrowed funds
    11,859       (11,909 )     (50 )     11,550       (36,225 )     (24,675 )
FHLB advances
    5,881       (5,035 )     846       16,481       (12,113 )     4,368  
 
                                   
Total interest expense
    14,927       (56,110 )     (41,183 )     29,284       (133,611 )     (104,327 )
 
                                   
Change in net interest income
  $ 13,893     $ 29,375     $ 43,268     $ 17,797     $ 59,980     $ 77,777  
 
                                   
          A portion of the Corporation’s interest-earning assets, mostly investments in obligations of some U.S. Government agencies and sponsored entities, generate interest that is exempt from income tax, principally in Puerto Rico. Also, interest and gains on sales of investments held by the Corporation’s international banking entities are tax-exempt under the Puerto Rico tax law. To facilitate the comparison of all interest data related to these assets, the interest income has been converted to a taxable equivalent basis. The tax equivalent yield was estimated by dividing the interest rate spread on exempt assets by (1 less the Puerto Rico statutory tax rate of 39.0%) and adding to it the average cost of interest-bearing liabilities. The computation considers the interest expense disallowance required by the Puerto Rico tax law.
          The presentation of net interest income excluding the effects of the changes in the fair value of derivative instruments and unrealized gains or losses on SFAS 159 liabilities provides additional information about the Corporation’s net interest income and facilitates comparability and analysis. The changes in the fair value of the derivative instruments and unrealized gains or losses on SFAS 159 liabilities have no effect on interest due or interest earned on interest-bearing liabilities or interest-earning assets, respectively, or on interest payments exchanged with interest rate swap counterparties.

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          The following table reconciles interest income on an adjusted tax equivalent basis set forth in Part I above to interest income set forth in the Consolidated Statements of Income:
                                 
    Quarter ended September 30,     Nine-month period ended September 30,  
(In thousands)   2008     2007     2008     2007  
Interest income on interest-earning assets on a tax equivalent basis
  $ 307,725     $ 305,640     $ 885,343     $ 911,893  
Less: tax equivalent adjustments
    (17,859 )     (3,259 )     (40,702 )     (10,682 )
Less: net unrealized loss on derivatives
    (1,574 )     (6,450 )     (654 )     (824 )
 
                       
Total interest income
  $ 288,292     $ 295,931     $ 843,987     $ 900,387  
 
                       
          The following table summarizes the components of the changes in fair values of interest rate swaps and interest rate caps, which are included in interest income.
                                 
    Quarter ended September 30,     Nine-month period ended September 30,  
(In thousands)   2008     2007     2008     2007  
Unrealized loss on derivatives (economic undesignated hedges):
                               
Interest rate caps
  $ (1,438 )   $ (4,594 )   $ (558 )   $ (246 )
Interest rate swaps on loans
    (136 )     (1,856 )     (96 )     (578 )
 
                       
Net unrealized loss on derivatives (economic undesignated hedges)
  $ (1,574 )   $ (6,450 )   $ (654 )   $ (824 )
 
                       
          The following table summarizes the components of interest expense for the quarter and nine-month periods ended September 30, 2008 and 2007. As previously stated, the net interest margin analysis excludes the changes in the fair value of derivatives and unrealized gains or losses on SFAS 159 liabilities.
                                 
    Quarter ended September 30,     Nine-month period ended September 30,  
(In thousands)   2008     2007     2008     2007  
Interest expense on interest-bearing liabilities
  $ 155,965     $ 184,652     $ 470,669     $ 537,520  
Net interest (realized) incurred on interest rate swaps
    (10,263 )     3,428       (30,210 )     10,775  
Amortization of placement fees on brokered CDs
    3,856       2,661       10,935       6,919  
Amortization of placement fees on medium-term notes
                      507  
 
                       
Interest expense excluding net unrealized (gain) loss on derivatives (economic undesignated hedges), net unrealized (gain) loss on SFAS 159 liabilities and accretion of basis adjustment
    149,558       190,741       451,394       555,721  
Net unrealized (gain) loss on derivatives (economic undesignated hedges) and SFAS 159 liabilities
    (5,887 )     161       (11,092 )     7,048  
Accretion of basis adjustment
                      (2,061 )
 
                       
Total interest expense
  $ 143,671     $ 190,902     $ 440,302     $ 560,708  
 
                       

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          The following table summarizes the components of the net unrealized gains and losses on derivatives (economic undesignated hedges) and net unrealized gains and losses on SFAS 159 liabilities which are included in interest expense.
                                 
    Quarter ended September 30,     Nine-month period ended September 30,  
(In thousands)   2008     2007     2008     2007  
Unrealized (gain) loss on derivatives (economic undesignated hedges):
                               
Interest rate swaps and other derivatives on brokered CDs
  $ (5,669 )   $ (61,971 )   $ (31,071 )   $ 87  
Interest rate swaps and other derivatives on medium-term notes
    (48 )     (358 )     (47 )     999  
 
                       
Net unrealized (gain) loss on derivatives (economic undesignated hedges)
  $ (5,717 )   $ (62,329 )   $ (31,118 )   $ 1,086  
 
                       
 
                               
Unrealized (gain) loss on SFAS 159 liabilities:
                               
Unrealized loss on brokered CDs
    791       62,973       21,886       6,575  
Unrealized gain on medium-term notes
    (961 )     (483 )     (1,860 )     (613 )
 
                       
Net unrealized (gain) loss on SFAS 159 liabilities
  $ (170 )   $ 62,490     $ 20,026     $ 5,962  
 
                       
 
                               
Net unrealized (gain) loss on derivatives (economic undesignated hedges) and SFAS 159 liabilities
  $ (5,887 )   $ 161     $ (11,092 )   $ 7,048  
 
                       
The following table summarizes the components of the accretion of basis adjustment which are included in interest expense for 2007:
                                 
    Quarter ended September 30,     Nine-month period ended September 30,  
(In thousands)   2008     2007     2008     2007  
Accretion of basis adjustment:
                               
Interest rate swaps on medium-term notes
  $     $     $     $ (2,061 )
 
                       
          Interest income on interest-earning assets primarily represents interest earned on loans receivable and investment securities.
          Interest expense on interest-bearing liabilities primarily represents interest paid on brokered CDs, branch-based deposits, repurchase agreements and notes payable.
          Net interest incurred or realized on interest rate swaps primarily represents net interest exchanged on swaps that economically hedge brokered CDs and medium-term notes.
          The amortization of broker placement fees represents the amortization of fees paid to brokers upon issuance of related financial instruments (i.e., brokered CDs not elected for the fair value option under SFAS 159).
          Unrealized gains or losses on derivatives represent changes in the fair value of derivatives, primarily interest rate swaps, that economically hedge liabilities (i.e., brokered CDs and medium-term notes) or assets (i.e., loans).
          Unrealized gains or losses on SFAS 159 liabilities represent the change in the fair value of liabilities (medium-term notes and brokered CDs), other than the accrual of interests, for which the Corporation elected the fair value option under SFAS 159.
          Effective January 1, 2007, the Corporation discontinued the use of fair value hedge accounting under SFAS 133 for interest rate swaps that hedge the Corporation’s $150 million medium-term note. The Corporation’s decision was based on the determination that the interest rate swaps were no longer effective in offsetting the changes in the fair value of the $150 million medium-term note. The basis adjustment represents the basis differential between the market value and the book value of the $150 million medium-term note recognized at the inception of fair value hedge accounting on April 3, 2006, as well as changes in fair value recognized after the inception until the discontinuance of fair value hedge accounting on January 1, 2007 that

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was amortized or accreted based on the expected maturity of the liability as a yield adjustment. The $150 million medium-term note was redeemed prior to its maturity during the second quarter of 2007.
          Derivative instruments, such as interest rate swaps, are subject to market risk. While the Corporation does have certain trading derivatives to facilitate customer transactions, the Corporation does not utilize derivative instruments for speculative purposes. The Corporation’s derivatives are mainly composed of interest rate swaps that are used to convert the fixed interest payments on its brokered CDs and medium-term notes to variable payments (receive fixed/pay floating). Refer to Note 8 “Derivative Instruments and Hedging Activities” of the accompanying unaudited consolidated financial statements for further details concerning the notional amounts of derivative instruments and additional information. As is the case with investment securities, the market value of derivative instruments is largely a function of the financial market’s expectations regarding the future direction of interest rates. Accordingly, current market values are not necessarily indicative of the future impact of the values of derivative instruments on net interest income. This will depend, for the most part, on the shape of the yield curve as well as the level of interest rates.
          Net interest income increased 38% to $144.6 million for the third quarter of 2008 from $105.0 million in the third quarter of 2007 and by 19% to $403.7 million for the first nine months of 2008 from $339.7 million for the same period a year ago. First BanCorp’s net interest spread and margin, on an adjusted tax equivalent basis, for the quarter and nine-month period ended September 30, 2008 were 3.03% and 3.37% and 2.87% and 3.25%, respectively, compared to 2.15% and 2.67% and 2.28% and 2.83%, respectively, for the same periods in 2007. The increase in net interest income, spread and margin reflects the effect of both changes in interest rates and changes in the mix and volume of the Corporation’s balance sheet. Net interest income benefited from lower short-term interest rates and the Corporation’s liability sensitive balance sheet position. The average rate paid by the Corporation on its interest-bearing liabilities decreased by 142 and 120 basis points during the third quarter and first nine months of 2008 when compared to same periods in 2007, mainly due to lower short-term rates and their effect on the mix of borrowings.
          The Corporation has been extending the duration of its borrowings to reduce exposure to high levels of market volatility. Since the first half of 2008 the Corporation has been replacing swapped-to-floating brokered certificates of deposit (“CDs”) that matured or were called (due to lower short-term rates) with brokered CDs that were not hedged with interest rate swaps; in this way, the Corporation locked-in current lower interest rates for longer periods. The decrease in short-term interest rates resulted in the call by counterparties of approximately $2.6 billion of interest rate swaps used by the Corporation to convert fixed-rate brokered CDs to a floating rate, during the first nine months of 2008 ($167.2 million for the third quarter of 2008). Following the cancellation of these swaps, the Corporation exercised its call option on approximately $2.5 billion swapped-to-floating brokered CDs ($129.2 million for the third quarter of 2008).
          Also, the Corporation has extended the maturity of other funding sources by, among other things, entering into long-term repurchase agreements at lower rates compared to rate levels a year ago. The comparisons against the previous year results reflect improvements in net interest spreads and margins. However, the extension of the maturity of interest bearing liabilities and increasing costs due to the current credit crisis in the U.S. financial markets could increase the Corporation’s current overall cost of funding in the foreseeable future. This possible increase in the cost of funds is expected to be offset by higher and more rational loan pricing in the markets where the Corporation operates.
          A lower overall average cost of funds is also related to the repricing of borrowings as reflected to some extent by net interest settlement income on interest rate swaps of approximately $10.3 million and $30.2 million for the third quarter and first nine months of 2008, respectively, compared to net interest settlement expenses of $3.4 million and $10.8 million, respectively, for the comparable periods in 2007. Meanwhile, interest income was adversely affected by lower yields in the loan portfolio attributable to the re-pricing of variable rate commercial and construction loans tied to short-term indexes and the increase in the balance of non-performing loans.

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          The increase in net interest income was also associated with a higher volume of interest-earning assets, driven by an increase of $1.3 billion in average loans over the third quarter of 2007 and of $991.3 million over the first nine-months of 2007. This increase was driven by the growth in internal originations, in particular commercial and residential real estate loans, and to a lesser extent purchases of loans, including the acquisition of a $218 million auto loan portfolio during the third quarter of 2008 which contributed to a wider interest rate spread. The weighted-average coupon of this portfolio is approximately 10.89%, a significant spread over the average cost of funding.
          For the investments side, the drop in rates in the long end of the yield curve, as compared to previous year rates, adversely affected interest income in the first nine months of 2008 due to the early redemption through call exercises of approximately $1.2 billion of U.S. Agency debentures with an average yield of 5.87% ($18.4 million with an average yield of 5.40% for the third quarter of 2008). In spite of this, and given market opportunities, the Corporation bought U.S. government sponsored agencies MBS amounting to $3.2 billion at an average yield of 5.44% during the first half of 2008, which is significantly higher than the cost of borrowings used to finance the purchase of such assets. Also, the lack of liquidity in the financial markets has caused several call dates go by in 2008 without counterparties actions to exercise call provisions embedded in approximately $949 million of U.S. agency debentures still held by the Corporation as of September 30, 2008. The Corporation has benefited from higher than current market yields on these instruments.
          As shown on the tables above, the results of operations for the third quarter and first nine months of 2008 and 2007 were impacted by changes in the valuation of derivative instruments that economically hedge the Corporation’s brokered CDs and medium-term notes and unrealized gains and losses on SFAS 159 liabilities. The change in the valuation of derivative instruments, net unrealized gains and losses on SFAS 159 liabilities and the basis adjustment (for 2007 results) recorded as part of net interest income resulted in a net gain of $4.3 million and $10.4 million for the third quarter and first nine months of 2008, respectively, compared to a net loss of $6.6 million and $5.8 million, respectively, for the comparable periods in 2007. The results for 2008 include a net gain of $0.5 million for the third quarter and of $4.8 million for the first nine months, resulting from the reversal of the cumulative mark-to-market valuation of swaps and brokered CDs called.
          On an adjusted tax equivalent basis, net interest income, excluding the changes in the fair value of derivative instruments and unrealized gains and losses on SFAS 159 liabilities, increased by $43.3 million, or 38%, and $77.8 million, or 22%, for the third quarter and first nine months of 2008, respectively, compared to the same periods in 2007. The increase in the adjusted tax equivalent net interest income was principally due to an increase in tax-equivalent adjustments and the declining interest rates and changes in the mix and volume of the Corporation’s balance sheet discussed above. The adjusted tax equivalent basis includes an adjustment that increases interest income on tax-exempt securities and loans by an amount which makes tax-exempt income comparable, on a pre-tax basis, to the Corporation’s taxable income. For the third quarter and first nine months of 2008, tax-equivalent adjustments amounted to $17.9 million and $40.7 million, respectively, compared to $3.3 million and $10.7 million, respectively, for the comparable periods in 2007. The increase in tax-equivalent adjustments was mainly related to increases in the interest rate spread on tax-exempt assets due to lower short-term interest rates.
Provision and Allowance for Loan and Lease Losses
          The provision for loan and lease losses is charged to earnings to maintain the allowance for loan and lease losses at a level that the Corporation considers adequate to absorb probable losses inherent in the portfolio. The adequacy of the allowance for loan and lease losses is also based upon a number of additional factors including historical loan and lease loss experience, current economic conditions, the fair value of the underlying collateral

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and the financial condition of the borrowers, and, as such, includes amounts based on judgments and estimates made by the Corporation. Although the Corporation believes that the allowance for loan and lease losses is adequate, factors beyond the Corporation’s control, including factors affecting the economies of Puerto Rico, the United States (principally the state of Florida), the U.S. Virgin Islands and the British Virgin Islands may contribute to delinquencies and defaults, thus necessitating additional reserves.
          For the quarter and nine-month period ended on September 30, 2008, the Corporation provided $55.3 million and $142.4 million, respectively, for loan and lease losses, as compared to $34.3 million and $83.8 million, respectively, for the same periods in 2007.
          Refer to the discussions under “Credit Risk Management” below for an analysis of the allowance for loan and lease losses and non-performing assets and related ratios.
          The increase, as compared to 2007 periods, is mainly attributable to a higher volume of impaired construction and commercial loans, increases to the reserve factors for potential losses inherent in the loan portfolio, and the growth of the Corporation’s total loan portfolio.
          The Corporation has seen stress in the credit quality of, and worsening affecting its construction loan portfolio, in particular condo-conversion loans in the U.S. mainland (mainly in the state of Florida) affected by continuing deterioration in the health of the economy, an oversupply of new homes and declining housing prices in the United States. The total exposure of the Corporation to loans originally disbursed as condo-conversion loans in the United States is approximately $251 million or 2% of the total loan portfolio. A total of approximately $182.2 million of this condo conversion portfolio is considered impaired under SFAS 114 with a specific reserve of $31.4 million allocated to these impaired loans. Specific reserves of $8.1 million were recorded for impaired loans in the United States for the quarter and first nine months of 2007.
          The increase in the provision for loan losses for 2008 was significantly driven by three large impaired loan relationships, two in the United States and one in Puerto Rico, which required significant specific reserves. With respect to the United States mainland market, the Corporation recorded approximately $16.7 million in additional reserves for impaired loans during the third quarter of 2008 ($36.3 million for the first nine months of 2008), including approximately $10.0 million in the third quarter of 2008 ($22.1 million for the first nine months of 2008) for two condo-conversion loans in Miami, Florida with an aggregate outstanding principal balance of $81.7 million. With respect to the Puerto Rico market, specific reserves of approximately $17.9 million were allocated to commercial and construction loans that were identified as impaired loans during the third quarter of 2008 ($24.6 million for those identified during the first nine months of 2008), including a $4.8 million reserve allocated to a loan extended for land development and construction of a mid-rise residential housing project with an outstanding principal of $15.2 million. The construction of a second phase of this mid-rise residential project has been delayed in light of lower than expected demand due to diminished consumer purchasing power and general economic conditions. This loan is in non-accrual status as of September 30, 2008. The construction loan portfolio is affected by the deterioration in the economy because the underlying loans’ repayment capacity is dependent on the ability to attract home-purchasers and maintain housing prices.
          To a lesser extent, the Corporation also increased its reserve factors for the residential mortgage and construction loan portfolio from 2007 level to account for the increased credit risk tied to recessionary conditions in Puerto Rico’s economy. Puerto Rico’s economy has been in a recession for about three years caused by, among other things, increases in utility costs, gasoline prices and highway toll charges, the implementation of sales taxes and periodic impasses between the executive and the legislative branches of the Commonwealth. The above conditions, together with a recession looming also in the U.S. mainland and rising food prices, will continue to adversely affect the economy in Puerto Rico. The Puerto Rico housing market has not seen the dramatic decline in housing prices that is affecting the U.S. mainland, but there is a lower demand due to the diminished consumer purchasing power. Recent decreases in oil prices should provide a relief to consumers and should immediately impact the consumers’ purchasing power positively.

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     Refer to the discussions under “Financial Condition and Operating Analysis — Loan Portfolio” and under “Risk Management — Credit Risk Management” below for additional information concerning the Corporation’s loan portfolio exposure to the geographic areas where the Corporation does business.
Non-Interest Income
                                 
    Quarter Ended     Nine-Month Period Ended  
    September 30,     September 30,     September 30,  
    2008     2007     2008     2007  
    (In thousands)  
Other service charges on loans
  $ 1,612     $ 1,290     $ 4,343     $ 5,499  
Service charges on deposit accounts
    3,170       3,160       9,725       9,536  
Mortgage banking activities
    1,231       1,125       2,354       2,238  
Rental income
    583       620       1,705       1,953  
Insurance income
    2,631       2,681       7,910       8,255  
Other operating income
    5,208       3,088       14,266       9,487  
 
                       
 
                               
Non-interest income before net (loss) gain on investments, insurance reimbursement and other agreements related to a contingency settlement, net gain on partial extinguishment and recharacterization of a secured commercial loan to a local financial institution and gain on sale of credit card portfolio
    14,435       11,964       40,303       36,968  
 
                       
 
                               
Gain on VISA shares and other proceeds
    132             9,474        
Net (loss) gain on sale of investments
          (750 )     6,661       (1,482 )
Impairment on investments
    (696 )     (2,369 )     (1,185 )     (5,232 )
 
                       
Net (loss) gain on investments
    (564 )     (3,119 )     14,950       (6,714 )
Insurance reimbursement and other agreements related to a contingency settlement
          15,075             15,075  
Gain on partial extinguishment and recharacterization of a secured commercial loan to a local financial institution
                      2,497  
Gain on sale of credit card portfolio
                      2,819  
 
                       
 
                               
Total
  $ 13,871     $ 23,920     $ 55,253     $ 50,645  
 
                       
          Non-interest income primarily consists of other service charges on loans; service charges on deposit accounts; commissions derived from various banking, securities and insurance activities; gains and losses on mortgage banking activities; and net gains and losses on investments and impairments.
          Other service charges on loans consist mainly of service charges on credit card-related activities and other non-deferrable fees.
          Service charges on deposit accounts include monthly fees and other fees on deposit accounts.
          Income from mortgage banking activities includes gains on sales of loans and revenues earned for administering residential mortgage loans originated by the Corporation and subsequently sold with servicing retained. In addition, lower-of-cost-or-market valuation adjustments to the Corporation’s residential mortgage loans held for sale and servicing rights portfolio, if any, are recorded as part of mortgage banking activities.

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          Rental income represents income generated by the Corporation’s subsidiary, First Leasing and Rental Corporation, on the rental of various types of motor vehicles.
          Insurance income consists of insurance commissions earned by the Corporation’s subsidiary, FirstBank Insurance Agency, Inc., and the Bank’s subsidiary in the U.S. Virgin Islands, FirstBank Insurance V.I., Inc. These subsidiaries offer a wide variety of insurance business.
          The other operating income category is composed of miscellaneous fees such as debit, credit card and point of sale (POS) interchange fees and check and cash management fees.
          The net gain (loss) on investment securities reflects gains or losses as a result of sales that are consistent with the Corporation’s investment policies as well as other-than-temporary impairment charges on the Corporation’s investment portfolio.
          Non-interest income decreased 42% to $13.9 million for the third quarter of 2008 from $23.9 million for the same period a year ago. The financial results for the third quarter of 2007 included an income recognition of $15.1 million in connection with an agreement reached with insurance carriers and former executives for indemnity of expenses related to the class action lawsuit brought against the Corporation that was settled in 2007. Excluding this transaction, non-interest income increased by $5.0 million as compared to the third quarter of 2007 due to a combination of factors, including lower other-than-temporary impairment charges on equity securities, an increase in point of sale (POS) and ATM interchange fee income, and an increase in fee income from cash management services provided to corporate customers.
          For the third quarter of 2008, other-than-temporary impairment charges on equity securities amounted to $0.7 million, compared to a $2.4 million charge recorded for the same period a year ago. Most of the Corporation’s investment portfolio is comprised of fixed-rate MBS issued or guaranteed by FNMA, FHLMC or GNMA and U.S. agency senior debt obligations. Thus, payment of a substantial portion is secured by mortgages and guaranteed by a U.S. government sponsored entity or backed by the full faith and credit of the U.S. government. In connection with the placement of FNMA and FHLMC into conservatorship by the U.S. Treasury in September 2008, the Treasury entered into agreements to invest up to approximately $100 billion in each agency to, among other things, protects debt and mortgage-backed securities of the agencies. The fluctuation in non-interest income, as compared to the same period in 2007, also reflects the absence of sales of investment securities during the third quarter of 2008 compared to a loss of $0.8 million recorded for the same period of 2007 on the sale of certain low-yielding U.S. Treasury securities and U.S. sponsored agency MBS as part of the repositioning strategy of the investment portfolio.
          POS and ATM interchange fee income increased by approximately $0.7 million, as compared to the third quarter of 2007, based on a change in the calculation of interchange fees charged between financial institutions in Puerto Rico from a fixed fee calculation to a percentage of the sale amount since the latter part of 2007. Fee income from cash management services provided to corporate customers increased by $0.3 million for the third quarter of 2008, as compared to the same period a year ago, positively affected by lower short-term interest rates.
          First BanCorp’s non-interest income for the first nine months of 2008 amounted to $55.3 million, compared to $50.6 million for the same period in 2007. Aside from the items mentioned above, the increase in non-interest income was mainly attributable to a one-time gain of $9.3 million on the sale of part of the Corporation’s investment in VISA, Inc. in connection with VISA’s initial public offering, together with a realized gain of $6.9 million on the sale of approximately $242 million of 5.5% FNMA fixed-rate MBS during the first quarter of 2008. Also, on a comparative basis to the first nine months of 2007, non-interest income was favorably affected by the lower other-than-temporary impairment charges on investment securities that decreased to $1.2 million for the first nine months of 2008 compared to an impairment charge of $5.2 million recorded in the first nine months of 2007. POS and ATM interchange fee income increased by approximately $1.8 million for the first nine months of 2008, as compared to the same period in 2007, and fee income from cash management services increased by $0.75

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million for such period. The impact of these transactions was partially offset, when compared to the first nine months of 2007, by the aforementioned $15.1 million income recognition for reimbursement of expenses related to the class action lawsuit settled in 2007, and gains of $2.8 million on the sale of a credit card portfolio and $2.5 million on the partial extinguishment and re-characterization of a secured commercial loan to a local financial institution that were recognized in the first nine months of 2007.
Non-Interest Expenses
          The following table presents the detail of non-interest expenses for the periods indicated:
                                 
    Quarter Ended     Nine-Month Period Ended  
    September 30,     September 30,     September 30,  
    2008     2007     2008     2007  
    (In thousands)  
Employees’ compensation and benefits
  $ 35,629     $ 33,995     $ 106,949     $ 103,719  
Occupancy and equipment
    15,647       14,970       46,167       43,848  
Deposit insurance premium
    2,967       3,705       7,658       4,389  
Other taxes, insurance and supervisory fees
    5,488       5,592       16,740       15,633  
Professional fees — recurring
    1,900       3,628       10,080       10,373  
Professional fees — non-recurring
    824       845       2,622       6,105  
Servicing and processing fees
    2,685       1,672       7,654       5,047  
Business promotion
    4,083       2,973       13,150       12,767  
Communications
    2,173       1,999       6,696       6,396  
Foreclosure-related expenses
    5,626       588       12,054       1,129  
Other
    5,354       4,984       16,556       18,364  
 
                       
Total
  $ 82,376     $ 74,951     $ 246,326     $ 227,770  
 
                       
          Non-interest expenses increased 10% to $82.4 million for the third quarter of 2008 from $75.0 million for the same period a year ago and by 8% to $246.3 million for the first nine months of 2008 from $227.8 million for the first nine months of 2007. Expenses increased primarily due to higher foreclosure-related expenses, employee compensation and benefits, business promotion, occupancy and equipment expenses and data processing fees partially, offset by a decrease in professional fees.
          Foreclosure-related expenses increased by approximately $5.0 million and $10.9 million for the third quarter and first nine months of 2008, respectively, as compared to the same periods a year ago mainly due to a higher inventory of repossessed properties and charges in connection with valuation adjustments and realized losses on the sale of foreclosed properties in Puerto Rico, together with an increase in repairs, legal expenses, and management fees paid in connection with foreclosures of properties in the United States (mainly condo-conversion projects in the state of Florida).
          Employees’ compensation and benefit expenses increased by $1.6 million and by $3.2 million for the third quarter and first nine months of 2008, respectively, as compared to the same periods a year ago, primarily due to a higher average compensation and related fringe benefits, partially offset by a decrease in expenses related to the fair value of stock options granted to employees. During the first quarter of 2007, the Corporation recorded $2.8 million in stock-based compensation expense; no stock options were granted during 2008. The Corporation’s total headcount has decreased as compared to December 31, 2007 as a result of the voluntary separation program completed earlier in the year and reductions by attrition. These decreases have been partially offset by increases due to the acquisition of the Virgin Islands Community Bank (“VICB”) in the first quarter of 2008 and to reinforcement of audit and credit risk management personnel.
          Business promotion expenses increased by $1.1 million and by $0.4 million for the third quarter and first nine months of 2008, respectively, as compared to the same periods a year ago. The Puerto Rico financial services

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market is highly competitive and requires investment in marketing efforts. The increase in expenses incurred during 2008 supports initiatives directed to increase the Corporation’s deposit base and mortgage loan originations as well as expenses incurred in customer satisfaction and brand awareness studies.
          Occupancy and equipment expenses, including data processing expenses, increased by $1.7 million and $4.9 million for the third quarter and first nine months of 2008, respectively, as compared to the same periods a year ago primarily to support the expansion of the Corporation’s operations as well as increases in utility costs.
          Professional fees decreased by $1.7 million and $3.8 million during the third quarter and first nine months of 2008, respectively, as compared to the same periods a year ago. The decrease was primarily attributable to lower legal, accounting and consulting fees due to, among other things, the conclusion of the process to file all required reports under the federal securities laws and the settlement of legal and regulatory matters.
          For the first nine months of 2008, other expenses decreased by $1.8 million, compared to the first nine months of 2007. The decrease reflects the impact of approximately $3.3 million in costs associated with capital raising efforts recorded in the first half of 2007. This was partially offset by a higher provision for sundry losses and an increase in the amortization of core deposit intangibles, mainly due to the acquisition of VICB in the first quarter of 2008.
          Notwithstanding the above mentioned increases in non-interest expenses, the Corporation’s efficiency ratio for the third quarter and first nine months of 2008 was 51.97% and 53.67%, respectively, compared to 58.13% and 58.35% for the same periods a year ago, as the Corporation has been able to continue the expansion of its operations without incurring substantial additional operating expenses.
Provision for Income Tax
          Income tax expense includes Puerto Rico and Virgin Islands income taxes as well as applicable U.S. federal and state taxes. The Corporation is subject to Puerto Rico income tax on its income from all sources. As a Puerto Rico corporation, First BanCorp is treated as a foreign corporation for U.S. income tax purposes and is generally subject to United States income tax only on its income from sources within the United States or income effectively connected with the conduct of a trade or business within the United States. Any such tax paid is creditable, within certain conditions and limitations, against the Corporation’s Puerto Rico tax liability. The Corporation is also subject to U.S. Virgin Islands taxes on its income from sources within this jurisdiction. Any such tax paid is creditable against the Corporation’s Puerto Rico tax liability, subject to certain conditions and limitations.
          Under the Puerto Rico Internal Revenue Code of 1994, as amended (“PR Code”), First BanCorp is subject to a maximum statutory tax rate of 39%. The PR Code also includes an alternative minimum tax of 22% that applies if the Corporation’s regular income tax liability is less than the alternative minimum tax requirements.
          The Corporation has maintained an effective tax rate lower than the maximum statutory rate mainly by investing in government obligations and mortgage-backed securities exempt from U.S. and Puerto Rico income taxes and doing business through international banking entities (“IBEs”) of the Corporation and the Bank and through the Bank’s subsidiary, FirstBank Overseas Corporation, in which the interest income and gain on sales is exempt from Puerto Rico and U.S. income taxation. The IBEs and FirstBank Overseas Corporation were created under the International Banking Entity Act of Puerto Rico, which provides for total Puerto Rico tax exemption on net income derived by IBEs operating in Puerto Rico. IBEs that operate as a unit of a bank pay income taxes at normal rates to the extent that the IBEs’ net income exceeds 20% of the bank’s total net taxable income.
          For the quarter ended September 30, 2008, the Corporation recorded an income tax benefit of $3.7 million, compared to an income tax expense of $5.6 million recorded for the same period in 2007. The fluctuation is mainly

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related to a lower current income tax provision due to higher tax-exempt income.
          For the first nine months of 2008, the Corporation recognized an income tax benefit of $21.0 million compared to an income tax expense of $18.0 million for the same period in 2007. The positive fluctuation on the financial results was mainly due to two non-ordinary transactions: (i) a reversal of $10.6 million of Unrecognized Tax Benefits (“UTBs”) during the second quarter of 2008 for positions taken on income tax returns recorded under the provisions of FIN 48, “Accounting for Uncertainty in Income Taxes,” as explained below, and (ii) the recognition of an income tax benefit of $5.4 million in connection with an agreement entered into with the Puerto Rico Department of Treasury during the first quarter of 2008 that establishes a multi-year allocation schedule for deductibility of the payment of $74.25 million made by the Corporation during 2007 to settle the securities class action suit. Also, the current income tax provision was lower, excluding the reversal of the FIN 48 contingency, due to higher tax-exempt income. A significant portion of the increase in revenues was associated with exempt operations conducted through the international banking entity, FirstBank Overseas Corporation.
          During the second quarter of 2008, the Corporation reversed UTBs by approximately $7.1 million and accrued interest of $3.5 million as a result of a lapse of the applicable statute of limitations for the 2003 taxable year. The amount of UTBs may increase or decrease in the future for various reasons, including changes in the amounts for current tax year positions, the expiration of open income tax returns due to the statute of limitations, changes in management’s judgment about the level of uncertainty, the status of examinations, litigation and legislative activity and the addition or elimination of uncertain tax positions. For the outstanding UTBs, the Corporation cannot make any reasonably reliable estimate of the timing of future cash flows or changes, if any, associated with such obligations.
          As of September 30, 2008, the Corporation evaluated its ability to realize the deferred tax asset and concluded, based on the evidence available, that it is more likely than not that some of the deferred tax asset will not be realized and, thus, established a valuation allowance of $6.6 million, compared to a valuation allowance of $4.9 million as of December 31, 2007. As of September 30, 2008, the deferred tax asset, net of the valuation allowance of $6.6 million, amounted to approximately $115.0 million compared to $90.1 million, net of the valuation allowance of $4.9 million as of December 31, 2007.
          For additional information relating to income taxes, see Note 16 in the accompanying notes to the unaudited interim consolidated financial statements.

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          FINANCIAL CONDITION AND OPERATING DATA ANALYSIS
Loan Production
          First BanCorp relies primarily on its retail network of branches to originate residential and consumer loans. The Corporation supplements its residential mortgage loan originations with wholesale servicing released mortgage loan purchases from mortgage bankers. The Corporation manages its construction and commercial loan originations through a centralized unit and most of its originations come from existing customers as well as through referrals and direct solicitations. For commercial loan originations, the Corporation also has regional offices to provide services to designated territories.
          Total loan production, including purchases, for the quarter and nine-month period ended September 30, 2008 was $1.2 billion and $3.2 billion, respectively, compared to $860.3 million and $2.8 billion, respectively, for the comparable periods in 2007. The increase in loan production was mainly due to increases in commercial and residential real estate mortgage loan originations and to the purchase of a $218 million auto loan portfolio during the third quarter of 2008.
          The following table details the First BanCorp’s loan production for the periods indicated:
                                 
    Quarter ended September 30,     Nine-month period ended  
(In thousands)   2008     2007     2008     2007  
Residential real estate
  $ 168,808     $ 155,331     $ 560,168     $ 475,032  
Commercial and construction
    603,542       514,733       1,941,416       1,676,614  
Finance leases
    29,131       28,651       87,217       111,796  
Consumer (1)
    374,556       161,605       652,193       504,393  
 
                       
Total loan production
  $ 1,176,037     $ 860,320     $ 3,240,994     $ 2,767,835  
 
                       
 
(1)   Includes the purchase of a $218 million auto loan portfolio during the third quarter of 2008.
          Residential Real Estate Loans
     Residential mortgage loan production for the third quarter and first nine months of 2008 increased by $13.5 million, or 9%, and $85.1 million, or 18%, respectively, compared to the same periods in 2007. These loans are mainly fully amortizing fixed-rate loans. The residential mortgage loan production was favorably affected by recent legislation approved by the Puerto Rico Government (Act 197) which provides credits to lenders and borrowers when individuals purchase certain new or existing homes.
     The incentives are as follows: (a) for a new constructed home that will constitute the individual’s principal residence, a credit equal to 20% of the sales price or $25,000, whichever is lower; (b) for new constructed homes that will not constitute the individual’s principal residence, a credit of 10% of the sales price or $15,000, whichever is lower; and (c) for existing homes, a credit of 10% of the sales price or $10,000, whichever is lower.
     From the homebuyer’s perspective: (1) the individual may benefit from the credit no more than twice; (2) the amount of credit granted will be credited against the principal amount of the mortgage; (3) the individual must acquire the property before December 31, 2008; and (4) for new constructed homes constituting the principal residence and existing homes, the individual must live in it as his or her principal residence for at least three consecutive years. Noncompliance with this requirement will affect only the homebuyer’s credit and not the tax credit granted to the financial institution.

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     From the financial institution’s perspective: (1) the credit may be used against income taxes, including estimated taxes, for years commencing after December 31, 2007 in three installments, subject to certain limitations, between January 1, 2008 and June 30, 2011; (2) the credit may be ceded, sold or otherwise transferred to any other person; and (3) any tax credit not used in a given tax year, as certified by the Secretary of Treasury, may be claimed as a refund.
          Loan originations of the Corporation covered by Act 197 amounted to approximately $18.2 million and $80.9 million for the third quarter and first nine months of 2008, respectively. The increase in residential mortgage loans was also related to higher purchases through the Corporation’s Partners in Business program as explained below, which amounted to $164.5 million for the first nine months of 2008, compared to $147.8 million for the comparable period in 2007.
          Residential real estate loans represent 17% of total loans originated and purchased for the first nine months of 2008. The Corporation’s strategy is to penetrate markets by providing customers with a variety of high quality mortgage products. The Corporation’s residential mortgage loan originations continued to be driven by FirstMortgage, its mortgage loan origination subsidiary. The Corporation continues to commit substantial resources to this operation with the goal of becoming a leading institution in the highly competitive residential mortgage loans market. FirstMortgage supplements its internal direct originations through its retail network with an indirect business strategy. The Corporation’s Partners in Business, a division of FirstMortgage, partners with mortgage brokers and small mortgage bankers in Puerto Rico to purchase ongoing mortgage loan production. FirstMortgage Realty Group focuses on building relationships with realtors by providing resources, office amenities and personnel to assist real estate brokers in building their individual businesses and closing transactions. FirstMortgage’s multi-channel strategy has proven to be effective in capturing business.
          The Corporation has not been active in subprime or adjustable rate mortgage loans (“ARMs”), nor has it been exposed to collateral debt obligations or other types of exotic products that aggravated the current financial crisis in the United States. More than 90% of the Corporation’s outstanding balance in its residential mortgage loan portfolio consists of fixed-rate, fully amortizing, full documentation loans
          Commercial and Construction Loans
          Commercial and construction loan production for the third quarter and first nine months of 2008 increased by $88.8 million, or 17%, and by $264.8 million, or 16%, compared to the same periods in 2007. The increase in commercial and construction loan production was experienced mainly in Puerto Rico. Commercial loan originations in Puerto Rico increased by approximately $382.3 million for the first nine months of 2008, as compared to the same period in 2007. Commercial originations include floor plan lending activities which depends on inventory levels (autos) financed and their turnover. Floor plan originations amounted to approximately $545.1 million for the first nine months of 2008, compared to $528.3 million for the same period a year ago. This was partially offset by lower construction loan originations in the United States, which decreased by $91.4 million for the first nine months of 2008, as compared to the first nine months of 2007 due to the slowdown in the U.S. housing market and the strategic decision by the Corporation to reduce its exposure to condo-conversion loans on its Miami Corporate Banking operations. Also, there was a decrease in construction loan originations in Puerto Rico due to current weakening economic conditions.
          Commercial loan originations come from existing customers as well as through referrals and direct solicitations. The Corporation follows a strategy aimed to cater to customer needs in the commercial loans middle-market segment by building strong relationships and offering financial solutions that meet customers’ unique needs. The Corporation has expanded its distribution network and participation in the commercial loans middle-market segment by focusing on customers with financing needs in amounts up to $5 million. The Corporation has 5 regional offices that provide coverage throughout Puerto Rico. The offices are staffed with

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sales, marketing and credit officers able to provide a high level of personalized service and prompt decision-making.
          Consumer Loans
          Consumer loan originations are principally driven through the Corporation’s retail network. For the third quarter and first nine months of 2008, consumer loan originations increased by $213.0 million and by $147.8 million, compared to the same periods in 2007. The increase was related to the purchase of a $218 million auto loan portfolio from Chrysler Financial Services Caribbean, LLC (“Chrysler”) in July 2008. Aside from this transaction, the consumer loan production decreased for the third quarter and first nine months of 2008 by $5.3 million, or 3%, and by $70.5 million, or 14%, compared to the same periods in 2007, mainly due to adverse economic conditions in Puerto Rico.
          Finance Leases
          For the third quarter of 2008, finance lease originations remained flat as compared to the same period a year ago. For the first nine months of 2008, finance lease originations, which are mostly composed of loans to individuals to finance the acquisition of a motor vehicle, decreased by $24.6 million, or 22%, as compared to the same period in 2007, also affected by adverse economic conditions in Puerto Rico.
Assets
          Total assets as of September 30, 2008 amounted to $19.3 billion, an increase of $2.1 billion compared to total assets as of December 31, 2007. The Corporation’s loan portfolio increased by $913.4 million (before the allowance for loan and lease losses) driven by new originations and the purchase of the $218 million auto loan portfolio during the third quarter of 2008. Also, the increase in total assets is attributable to the purchase of approximately $3.2 billion of U.S. government agency fixed-rate MBS during the first half of 2008 as market conditions presented an opportunity for the Corporation to obtain attractive yields, improve its net interest margin and replace the $1.2 billion of U.S. Agency debentures called by counterparties. The Corporation increased its cash and money market investments by $66.2 million in part as a precautionary measure given the current crisis in the financial markets.
Loan Portfolio
          The composition of the Corporation’s loan portfolio, including loans held for sale, for the periods indicated is as follows:
                 
    September 30,     December 31,  
(In thousands)   2008     2007  
Residential real estate loans
  $ 3,470,802     $ 3,164,421  
 
           
 
               
Commercial loans:
               
Construction loans
    1,478,076       1,454,644  
Commercial real estate loans
    1,422,899       1,279,251  
Commercial loans
    3,602,123       3,231,126  
Loans to local financial institutions collateralized by real estate mortgages
    579,305       624,597  
 
           
Commercial loans
    7,082,403       6,589,618  
 
           
 
               
Finance leases
    371,982       378,556  
 
           
 
               
Consumer and other loans
    1,787,915       1,667,151  
 
           
Total loans
  $ 12,713,102     $ 11,799,746  
 
           

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          As of September 30, 2008, the Corporation’s total loans increased by $913.4 million, when compared with the balance as of December 31, 2007. The increase in the Corporation’s total loans primarily relates to new loans originated, in particular residential real estate and commercial loans and the aforementioned purchase of a $218 million auto loan portfolio.
          Of the total gross loan portfolio of $12.7 billion as of September 30, 2008, approximately 80% has credit risk concentration in Puerto Rico, 12% in the United States (mainly in the state of Florida) and 8% in the Virgin Islands, as shown in the following table.
                                 
    Puerto     Virgin     United        
As of September 30, 2008   Rico     Islands     States (1)     Total  
    (In thousands)  
Residential real estate loans, including loans held for sale
  $ 2,601,167     $ 449,863     $ 419,772     $ 3,470,802  
 
                       
 
                               
Construction loans
    779,028       165,627       533,421       1,478,076  
Commercial real estate loans
    868,188       74,410       480,301       1,422,899  
Commercial loans
    3,428,878       134,434       38,811       3,602,123  
Loans to local financial institutions collateralized by real estate mortgages
    579,305                   579,305  
 
                       
Total commercial loans
    5,655,399       374,471       1,052,533       7,082,403  
 
                               
Finance leases
    371,982                   371,982  
 
                               
Consumer loans
    1,607,679       134,506       45,730       1,787,915  
 
                       
 
                               
Total loans, gross
  $ 10,236,227     $ 958,840     $ 1,518,035     $ 12,713,102  
Allowance for loan and lease losses
    (195,100 )     (9,434 )     (56,636 )     (261,170 )
 
                       
 
  $ 10,041,127     $ 949,406     $ 1,461,399     $ 12,451,932  
 
                       
 
(1)   United States loan portfolio include approximately $251.2 million of loans originally disbursed as condo-conversion loans, for which a reserve of $31.4 million was allocated as of September 30, 2008.
          Residential Real Estate Loans
          As of September 30, 2008, the Corporation’s residential real estate loan portfolio increased by $306.4 million, or 10%, as compared to the balance as of December 31, 2007. The Corporation has diversified its loan portfolio by increasing the concentration of residential real estate loans. More than 90% of the Corporation’s outstanding balance of residential mortgage loan portfolio consists of fixed-rate, fully amortizing, full documentation loans. In accordance with the Corporation’s underwriting guidelines, residential real estate loans are mostly fully documented loans, and the Corporation is not actively involved in the origination of negative amortization loans or adjustable-rate mortgage loans.
          Commercial and Construction Loans
          As of September 30, 2008, the Corporation’s commercial and construction loan portfolio increased by $492.8 million, as compared to the balance as of December 31, 2007. The Corporation has been able to grow its portfolio with new originations from corporate customers as well as commercial real estate and construction loans. A substantial portion of this portfolio is collateralized by real estate. The Corporation’s commercial loans are primarily variable- and adjustable-rate loans.
          The Corporation’s largest loan concentration as of September 30, 2008 in the amount of $354.6 million is with one mortgage originator in Puerto Rico, Doral Financial Corporation. Together with the Corporation’s next largest loan concentration of $224.7 million with another mortgage originator in Puerto Rico, R&G Financial Corporation (“R&G Financial”), the Corporation’s total loans granted to these mortgage originators amounted to $579.3 million as of September 30, 2008. These commercial loans are secured by individual

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mortgage loans on residential and commercial real estate. In December 2005, the Corporation obtained a waiver from the Office of the Commissioner of Financial Institutions of the Commonwealth of Puerto Rico with respect to the statutory limit for individual borrowers (loans-to-one borrower limit). The Corporation has continued working on the reduction of its exposure to both financial institutions.
          The Corporation’s construction lending volume has decreased due to the slowdown in the U.S. housing market and the current economic environment in Puerto Rico. The Corporation has reduced its exposure to condo-conversion loans in its Miami Corporate Banking operations and is closely evaluating market conditions and opportunities in Puerto Rico. Current absorption rates in condo-conversion loans in the United States are low and properties collateralizing some of these condo conversion loans have been formally reverted to rental properties with a future plan for the sale of converted units upon an improvement in the United States real estate market. As of September 30, 2008, approximately $43.3 million of loans originally disbursed as condo-conversion construction loans have been reverted to income-producing loans. Given more conservative underwriting standards of the banks in general and a reduction of market participants in the lending business, the Corporation believes that the rental market will grow and rental properties will hold their values.
          The composition of the Corporation’s construction loan portfolio as of September 30, 2008 by category and geographic location follows:
                                 
    Puerto     Virgin     United        
As of September 30, 2008   Rico     Islands     States     Total  
    (In thousands)  
Loans for residential housing projects:
                               
High-rise (1)
  $ 168,647     $     $ 559     $ 169,206  
Mid-rise (2)
    108,510       4,842       46,564       159,916  
Single-family detach
    105,291       2,376       45,687       153,354  
 
                       
Total for residential housing projects
    382,448       7,218       92,810       482,476  
 
                       
Construction loans to individuals secured by residential properties
    14,680       40,032             54,712  
Condo-conversion loans (3)
                207,835       207,835  
Loans for commercial projects
    184,328       81,044       23,624       288,996  
Bridge and Land loans
    170,753       37,794       209,392       417,939  
Working capital
    31,004                   31,004  
 
                       
Total before net deferred fees and allowance for loan losses
    783,213       166,088       533,661       1,482,962  
Net deferred fees
    (4,185 )     (461 )     (240 )     (4,886 )
 
                       
Total construction loan portfolio, gross
    779,028       165,627       533,421       1,478,076  
Allowance for loan losses
    (22,122 )     (1,292 )     (48,553 )     (71,967 )
 
                       
Total construction loan portfolio, net
  $ 756,906     $ 164,335     $ 484,868     $ 1,406,109  
 
                       
 
(1)   For purposes of the above table, high-rise portfolio is composed of buildings with more than 7 stories, mainly composed of two projects that represent approximately 75% of the Corporation’s total outstanding high-rise residential construction loan portfolio in Puerto Rico.
 
(2)   Mid-rise relates to buildings up to 7 stories.
 
(3)   During the third quarter of 2008, approximately $43.3 million of loans originally disbursed as condo-conversion construction loans have been formally reverted to income-producing loans and included as part of the commercial real estate portfolio.
          The following table presents further information on the Corporation’s construction portfolio as of and for the nine-month period ended September 30, 2008:
         
    (Dollars in thousands)  
Total undisbursed funds under existing commitments
  $ 537,247  
 
     
 
       
Construction loans in non-accrual status
  $ 72,203  
 
     
 
       
Net charge offs — Construction loans (1)
  $ 7,333  
 
     
 
       
Allowance for loan losses — Construction loans
  $ 71,967  
 
     
 
       
Non-performing construction loans to total construction loans
    4.88 %
 
     
 
       
Allowance for loan losses — construction loans to total construction loans
    4.87 %
 
     
 
       
Net charge-offs (annualized) to total average construction loans (1)
    0.66 %
 
     
 
(1)   Includes charge-offs of $6.2 million related to the repossession and sale of impaired loans in the Miami Corporate Banking operations.

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          The following summarizes the construction loans for residential housing projects in Puerto Rico segregated by the estimated selling price of the units:
         
(In thousands)        
Under $300K
  $ 82,187  
$300K-$600k
    162,242  
Over $600k
    138,019  
 
     
 
  $ 382,448  
 
     
          Consumer Loans
          As of September 30, 2008, the Corporation’s consumer loan portfolio increased by $120.8 million, as compared to the portfolio balance as of December 31, 2007. This is mainly the result of the above noted acquisition of a $218 million auto loan portfolio from Chrysler. Excluding this transaction, the consumer loan portfolio decreased by over $90 million since December 31, 2007 mainly due to repayments and charge-offs that on a combined basis more than offset the volume of loan originations during the first nine months of 2008. Nevertheless, the Corporation experienced a decrease in net charge-offs for consumer loans that amounted to $40.8 million for the first nine months of 2008, as compared to $48.1 million for the same period a year ago. The decrease in net charge offs as compared to 2007 is attributable to the changes in underwriting standards implemented in late 2005 and as a consumer loan portfolio with an average life of approximately four years has been replenished by new originations under these revised standards.
          Finance Leases
          As of September 30, 2008, finance leases, which are mostly composed of loans to individuals to finance the acquisition of a motor vehicle, decreased by $6.6 million as compared to the portfolio balance as of December 31, 2007. These leases typically have five-year terms and are collateralized by a security interest in the underlying assets.
Investment Activities
          As part of its strategy to diversify its revenue sources and maximize its net interest income, First BanCorp maintains an investment portfolio that is classified as available-for-sale or held-to-maturity. The Corporation’s investment portfolio, other than short-term money market investments, as of September 30, 2008 amounted to $5.8 billion, an increase of $1.2 billion when compared with the investment portfolio as of December 31, 2007. The increase in investment securities was mainly due to the previously discussed purchase of approximately $3.2 billion of U.S. government sponsored agency fixed-rate MBS during the first half of 2008 as market conditions presented an opportunity for the Corporation to obtain attractive yields, improve its net interest margin and mitigate the impact of $1.2 billion U.S. Agency debentures called by counterparties. The Corporation also sold approximately $242 million of MBS in the first quarter of 2008 as a spike and subsequent contraction in the yield spread during the first quarter provided an opportunity to sell the MBS at a gain.
          Over 91% of the Corporation’s carrying amount in the securities portfolio is invested in U.S. Government and Agency debentures and fixed-rate U.S. government sponsored-agency mortgage-backed securities (mainly FNMA and FHLMC fixed-rate securities). As of September 30, 2008 the Corporation had $4.3 billion and $0.9 billion in FNMA and FHLMC mortgage-backed securities and debt securities, respectively, representing 85% of the total investment portfolio. The Corporation’s investment in equity securities is minimal and none of its equity securities is related to U.S. financial institutions that recently failed.

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The following table presents the carrying value of investments at the indicated dates:
                 
    As of     As of  
    September 30,     December 31,  
(In thousands)   2008     2007  
Money market investments
  $ 294,118     $ 183,136  
 
           
 
               
Investment securities held-to-maturity:
               
U.S. Government and agencies obligations
    948,904       2,365,147  
Puerto Rico Government obligations
    22,920       31,222  
Mortgage-backed securities
    760,232       878,714  
Corporate bonds
    2,000       2,000  
 
           
 
    1,734,056       3,277,083  
 
           
 
               
Investment securities available-for-sale:
               
U.S. Government and agencies obligations
          16,032  
Puerto Rico Government obligations
    36,637       24,521  
Mortgage-backed securities
    3,976,720       1,239,169  
Corporate bonds
    2,397       4,448  
Equity securities
    1,195       2,116  
 
           
 
    4,016,949       1,286,286  
 
           
 
               
Other equity securities
    60,796       64,908  
 
           
Total investments
  $ 6,105,919     $ 4,811,413  
 
           
     Mortgage-backed securities at the indicated dates consist of:
                 
    As of     As of  
    September 30,     December 31,  
(In thousands)   2008     2007  
Held-to-maturity
               
FHLMC certificates
  $ 9,098     $ 11,274  
FNMA certificates
    751,134       867,440  
 
           
 
    760,232       878,714  
 
           
 
               
Available-for-sale
               
FHLMC certificates
    1,949,117       158,953  
GNMA certificates
    338,597       44,340  
FNMA certificates
    1,579,280       902,198  
Mortgage pass-through certificates
    109,726       133,678  
 
           
 
    3,976,720       1,239,169  
 
           
Total mortgage-backed securities
  $ 4,736,952     $ 2,117,883  
 
           

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The carrying values of investment securities classified as available-for-sale and held-to-maturity as of September 30, 2008 by contractual maturity (excluding mortgage-backed securities and equity securities) are shown below:
                 
    Carrying     Weighted  
(Dollars in thousands)   amount     average yield %  
U.S. Government and agencies obligations
  $ 948,904       5.77  
 
           
Due after ten years
    948,904       5.77  
 
           
 
               
Puerto Rico Government obligations
               
Due within one year
    4,635       6.17  
Due after one year through five years
    10,329       4.51  
Due after five years through ten years
    24,176       5.84  
Due after ten years
    20,417       5.35  
 
           
 
    59,557       5.47  
 
           
 
               
Corporate bonds
               
Due after five years through ten years
    520       7.70  
Due after ten years
    3,877       6.85  
 
           
 
    4,397       6.95  
 
           
 
               
Total
    1,012,858       5.76  
 
               
Mortgage-backed securities
    4,736,952       5.30  
Equity securities
    1,195       1.94  
 
           
Total investment securities — available-for-sale and held-to-maturity
  $ 5,751,005       5.38  
 
           
          Net interest income of future periods may be affected by the acceleration in prepayments of mortgage-backed securities. Acceleration in the prepayments of mortgage-backed securities would lower yields on securities purchased at a premium, as the amortization of premiums paid upon acquisition of these securities would accelerate. Conversely, acceleration in the prepayments of mortgage-backed securities would increase yields on securities purchased at a discount, as the amortization of the discount would accelerate. Also, net interest income in future periods might be affected by the Corporation’s investment in callable securities. Approximately $1.2 billion of U.S. Agency debentures with an average yield of 5.87% were called during the first nine months of 2008. However, given market opportunities, the Corporation bought U.S. government sponsored agencies MBS amounting to $3.2 billion at an average yield of 5.44% during the first half of 2008, which is significantly higher than the cost of borrowings used to finance the purchase of such assets. As of September 30, 2008, there are still approximately $0.9 billion in U.S. agency debentures with embedded calls. Lower reinvestment rates and a time lag between calls, prepayments and/or the maturity of investments and actual reinvestment of proceeds into new investments might affect net interest income in the future. These risks are directly linked to future period market interest rate fluctuations. Refer to the “Risk Management” discussion below for further analysis of the effects of changing interest rates on the Corporation’s net interest income and for the interest rate risk management strategies followed by the Corporation. Also refer to Note 4 to the accompanying unaudited consolidated financial statements for additional information regarding the Corporation’s investment portfolio.
RISK MANAGEMENT
          The Corporation has in place a risk management framework to monitor, evaluate and manage the principal risks assumed in conducting its activities. First BanCorp’s business is subject to eight broad categories of risks: (1) liquidity risk, (2) interest rate risk, (3) market risk, (4) credit risk, (5) operational risk, (6) legal and compliance risk, (7) reputation risk, and (8) contingency risk. First BanCorp has adopted policies and procedures designed to identify and manage risks to which the Corporation is exposed, specifically those relating to liquidity risk, interest rate risk, credit risk, and operational risk.

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          The Corporation’s risk management policies are described below as well as in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of First BanCorp’s 2007 Annual Report on Form 10-K.
Liquidity and Capital Adequacy
     Liquidity is the ongoing ability to accommodate liability maturities and deposit withdrawals, fund asset growth and business operations, and meet contractual obligations through unconstrained access to funding at reasonable market rates. Liquidity management involves forecasting funding requirements and maintaining sufficient capacity to meet the needs and accommodate fluctuations in asset and liability levels due to changes in our business operations or unanticipated events.
     The Corporation manages liquidity at two levels. The first is the liquidity of the parent company, which is the holding company that owns the banking and nonbanking subsidiaries. The second is the liquidity of the banking subsidiaries. The Asset and Liability Committee of the Board of Directors is responsible for establishing the Corporation’s liquidity policy as well as approving operating and contingency procedures, and monitoring liquidity on an ongoing basis. The Management’s Investment and Asset Liability Committee of the Corporation (“MIALCO”), using measures of liquidity developed by management, which involve the use of several assumptions, reviews the Corporation’s liquidity position on a monthly basis. The MIALCO oversees liquidity management, interest rate risk and other related matters. The MIALCO, which reports to the Board of Directors’ Asset and Liability Committee, is composed of senior management officers, including the Chief Executive Officer, the Chief Financial Officer, the Chief Operating Officer, the Chief Risk Officer, the Wholesale Banking Executive, the Risk Manager of the Treasury and Investments Division, the Financial Risk Manager and the Treasurer. The Treasury and Investments Division is responsible for planning and executing the Corporation’s funding activities and strategy; monitors liquidity availability on a daily basis and reviews liquidity measures on a weekly basis. The Treasury and Investments Accounting and Operations area of the Comptroller’s Department is responsible for calculating the liquidity measurements used by the Treasury and Investment Division to review the Corporation’s liquidity position.
     In order to ensure adequate liquidity through the full range of potential operating environments and market conditions, the Corporation conducts its liquidity management and business activities in a manner that will preserve and enhance funding stability, flexibility and diversity. Key components of this operating strategy include a strong focus on customer-based funding, maintaining direct relationships with wholesale market funding providers, and maintaining the ability to liquidate certain assets when, and if, requirements warrant.
     The Corporation develops and maintains contingency funding plans for both the parent company and bank liquidity positions. These plans evaluate the Corporation’s liquidity position under various operating circumstances and allow the Corporation to ensure that it will be able to operate through periods of stress when access to normal sources of funding is constrained. The plans project funding requirements during a potential period of stress, specify and quantify sources of liquidity, outline actions and procedures for effectively managing through a difficult period, and define roles and responsibilities. In the Contingency Funding Plan, the Corporation stresses the balance sheet and the liquidity position to critical levels that imply difficulties in getting new funds or even maintaining its current funding position, thereby ensuring the ability to honor its commitments, and establishing liquidity triggers monitored by the MIALCO in order to maintain the ordinary funding of banking business. Three different scenarios are defined in the Contingency Funding Plan: local market event, credit rating downgrade, and a concentration event. They are reviewed and approved annually by the Board of Directors’ Asset and Liability Committee.
     The Corporation maintains a basic surplus (cash, short-term assets minus short-term liabilities, and secured lines of credit) in excess of a 5% self-imposed minimum limit amount over total assets. As of September 30, 2008, the basic surplus ratio of approximately 10.9% included un-pledged assets, FHLB lines of credit, collateral pledged at the FED Discount Window Program, and cash. Un-pledged assets as of September 30,

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2008 are mainly composed of U.S. Agency fixed rate debentures, money market investments and mortgage-backed securities totaling $1.2 billion, which can be sold under agreements to repurchase. The Corporation does not rely on uncommitted inter-bank lines of credit (federal funds lines) to fund its operations; and does not include them in the basic surplus computation. The financial market disruptions that began in 2007, and became exacerbated in 2008, continued to impact the financial services sector and may affect access to regular and customary sources of funding, including repurchase agreements, as counterparties may not be willing to enter into additional agreements in order to protect their liquidity. However, the Corporation has taken direct actions to enhance its liquidity positions and to safeguard the access to credit. Such initiatives include, among other things, the posting of additional collateral and thereby increasing its borrowing capacity with the FHLB and the FED through the Discount Window Program, the issuance of additional brokered CDs to increase its liquidity levels and the extension of its borrowing maturities to reduce exposure to high levels of market volatility. The Corporation understands that current conditions of liquidity and credit limitations could continue to be observed well into 2009. Thus, the Corporation will continue to monitor the different alternatives available under programs announced by the FED and the FDIC such as the Term Auction Facility (TAF) for short-term loans, expansions to qualifying collateral that the government will loan against, including commercial paper, guarantees of new issuances of senior unsecured debts and the issuance of preferred stock under the Troubled-Asset Relief Program (TARP).
     Sources of Funding
     The Corporation utilizes different sources of funding to help ensure that adequate levels of liquidity are available when needed. Diversification of funding sources is of great importance to protect the Corporation’s liquidity from market disruptions. The principal sources of short-term funds are deposits, securities sold under agreements to repurchase, and lines of credit with the FHLB, the FED Discount Window Program, and other unsecured lines established with financial institutions. The Credit Committee of the Board of Directors reviews credit availability on a regular basis. In the past, the Corporation has securitized and sold mortgage loans as a supplementary source of funding. Commercial paper has also provided additional funding as well as long-term funding through the issuance of notes and long-term brokered CDs. The cost of these different alternatives, among other things, is taken into consideration.
     Recent initiatives by the FED to ease the credit crisis have included, among other things, cuts to the discount rate, the availability of the TAF to provide short-term loans to banks and expanding the qualifying collateral it will lend against, to include commercial paper. Meanwhile the FDIC announced a program to strengthen confidence and encourage liquidity in the banking system by guaranteeing newly issued senior unsecured debt of banks, thrifts, and certain holding companies, and by providing full coverage of non-interest bearing deposit transaction accounts, regardless of dollar amount. The FDIC also raise the cap on deposit insurance coverage from $100,000 to $250,000 until December 31, 2009. Additional actions include the announcement of a federal government program to purchase stock in private U.S. financial firms, including banks. These actions made the federal government a viable source of funding in the current environment.
The Corporation’s principal sources of funding are:
Brokered CDs - A large portion of the Corporation’s funding is retail brokered CDs issued by the Bank subsidiary, FirstBank Puerto Rico. Total brokered CDs increased from $7.2 billion at year end 2007 to $8.4 billion at September 30, 2008. The Corporation has been issuing brokered CDs to finance its lending activities, pay off repurchase agreements issued to finance the purchase of MBS in the first half of 2008, accumulate additional liquidity due to current market volatility, and extend the maturity of its borrowings.
In the event that the Corporation’s Bank subsidiary falls below the ratios of a well-capitalized institution, it faces the risk of not being able to replace funding through this source. The Bank currently complies and exceeds the minimum requirements of ratios for a “well-capitalized” institution and does not foresee falling below required levels to issue brokered deposits. The average term to maturity of the retail brokered CDs

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outstanding as of September 30, 2008 is approximately 3 years. Approximately 28% of the principal value of these certificates is callable at the Corporation’s option.
          The use of brokered CDs has been particularly important for the growth of the Corporation. The Corporation encounters intense competition in attracting and retaining regular retail deposits in Puerto Rico. The brokered CDs market is very competitive and liquid, and the Corporation has been able to obtain substantial amounts of funding in short periods of time. This strategy enhances the Corporation’s liquidity position, since the brokered CDs are insured by the FDIC up to regulatory limits and can be obtained faster compared to regular retail deposits. Demand for brokered CDs has recently increased as a result of the move by investors from riskier investments, such as equities, to federally guaranteed instruments such as brokered CDs and the recent increase in FDIC deposit insurance from $100,000 t