First BanCorp.
Annual Report 2003

Plain-text annual report

We dedicate this Annual Report to agility, strength and focus, elements that take us through the road of success and lead to excellent performance. This masterpiece, created by renowned Puerto Rican artist Carlos Dávila Rinaldi, portrays the essence of our vision, the path which we travel day by day, with the focus and commitment nec- essary to help us excel in the financial field. Agility, strength and focus, combined, make First BanCorp a leader in the financial indus- try. They are the most important elements in the leadership role we perform. They convey our ability to adapt, change and lead, and to satisfy customers in this constantly chang- ing market. TABLE OF CONTENTS 01 Financial Highlights 04 Selected Financial Data 08 Offices 10 Corporate Structure 11 Business Profile 13 President’s Letter 17 Economy 18 Board of Directors 20 First BanCorp Officers 25 Financial Review 90 Stockholders’ Information FINANCIAL HIGHLIGHTS In thousands (except for per share results) OPERATING RESULTS: Net interest income Provision for loan losses Other income Other operating expenses Income tax provision Net income Per common share: Net income - basic Net income - diluted WEIGHTED AVERAGE COMMON SHARES: Basic Diluted AT YEAR END: Assets Loans Allowance for loan losses Investments Deposits Borrowings Capital 2003 2002 $ $ 292,210 55,916 118,710 163,994 38,672 152,338 3.04 2.98 39,994 40,983 $ 12,667,910 7,044,518 126,378 5,366,205 6,765,107 4,646,115 1,089,569 $ $ $ 266,850 62,302 58,492 132,756 22,327 107,956 2.04 2.01 39,901 40,553 9,643,852 5,637,851 111,911 3,728,669 5,482,918 3,249,355 798,424 FIRST BANCORP PAGE 1 MARKET PRICE PER COMMON SHARE (end of year) $39.55 $13.83 $15.75 $22.60 $19.00 DILUTED EARNINGS PER COMMON SHARE $2.98 $1.32 $1.47 $2.01 $1.73 1999 2000 2001 2002 2003 1999 2000 2001 2002 2003 $185.7 $190.8 $236.1 $266.9 $292.2 NET INTEREST INCOME (in millions) 1.49 1.28 1.28 1.23 1.46 RETURN ON ASSETS (in percent) 1999 2000 2001 2002 2003 1999 2000 2001 2002 2003 RETURN ON COMMON EQUITY (in percent) COMMON STOCKHOLDERS’ EQUITY (in millions) 24.68 27.81 22.13 21.90 25.20 $539.5 $437.9 $334.4 $269.5 $204.9 1999 2000 2001 2002 2003 1999 2000 2001 2002 2003 PAGE 2 2003 ANNUAL REPORT FIRST BANCORP PAGE 3 SELECTED FINANCIAL DATA Since the current management took over in 1991, the Bank has transformed itself from First Federal Savings Bank, a small Savings and Loan institution with $1.9 billion in assets, into First BanCorp, a $12.7 billion financial holding company with a wide array of opera- tions. The table on the following pages shows the long-term growth of this Corporation. From 1991 to 2003 the company reported consistent growth without restat- ing earnings. Over this thirteen year period earnings multiplied as net income grew more than 15 times from $10 million to $152 million, and per share earn- ings multiplied almost 20 times from $0.15 to $2.98 (diluted). Book value per common share grew 15 times from $0.90 to $13.48. The efficiency ratio improved dramatically from 63.69% to 39.91%. The growth shown in this table has involved great changes at all levels of the organization. The Corporation has adopted new technologies and entered into new businesses while at the same time growing its traditional operations. All this has created substantial value for the First BanCorp’s shareholders while providing more and better services to its clients. PAGE 4 2003 ANNUAL REPORT FIRST BANCORP PAGE 5 SELECTED FINANCIAL DATA (In thousands except for per share and financial ratios results) 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 Condensed Income Statements: Year ended Total interest income Total interest expense Net interest income Provision for loan losses Other income Other operating expenses Unusual item - SAIF assessment Income before income tax provision, extraordinary item and cumulative effect of accounting change Provision for income tax Income before extraordinary item and cumulative effect of accounting change Extraordinary item Cumulative effect of accounting change Net income Per Common Share Results (1): Year ended Income before extraordinary item and $ 536,681 244,471 292,210 55,916 118,710 163,994 $ 540,033 273,184 266,850 62,302 58,492 132,756 $ 516,256 280,201 236,055 61,030 52,980 120,855 $ 463,388 272,615 190,773 45,719 50,032 113,049 $ 369,063 183,330 185,733 47,961 32,862 101,271 191,010 38,672 130,283 22,327 107,150 20,134 82,037 14,761 69,363 7,288 $ $ 321,298 155,130 166,168 76,000 58,240 91,798 $ 285,160 130,429 154,731 55,676 39,866 83,268 56,610 4,798 55,653 8,125 256,523 113,027 143,496 31,582 29,614 82,498 9,115 49,915 12,281 $ 208,488 96,838 111,650 30,894 48,268 65,628 $ 180,309 76,674 103,635 17,674 18,169 60,760 $ 159,433 72,413 87,020 18,669 17,123 56,994 $ 158,993 85,986 73,007 13,596 13,563 54,745 $ 63,396 14,295 43,370 12,385 30,985 (429) 18,229 2,879 15,350 (870) 28,480 6,525 21,955 6,840 28,795 171,789 109,942 61,847 16,444 18,895 51,423 12,875 1,420 11,455 (1,400) 152,338 107,956 87,016 67,276 62,075 51,812 47,528 37,634 49,101 152,338 107,956 (1,015) 86,001 67,276 62,075 51,812 47,528 37,634 49,101 30,556 14,480 10,055 cumulative effect of accounting change diluted $ 2.98 $ 2.01 $ 1.76 $ 1.47 $ 1.32 $ 1.16 $ 1.05 $ 0.81 Extraordinary item Cumulative effect of accounting change Net income per common share diluted Net income per common share basic Cash dividends declared Average shares outstanding Average shares outstanding diluted Balance Sheet Data: End of year Loans and loans held for sale Allowance for possible loan losses Investments Total assets Deposits Borrowings Total common equity Total equity Book value per common share (1) Regulatory Capital Ratios (In Percent): End of year Total capital to risk weighted assets Tier 1 capital to risk weighted assets Tier 1 capital to average assets Selected Financial Ratios (In Percent): Year ended Net income to average total assets Interest rate spread (2) Net interest income to average earning assets (2) Yield on average earning assets (2) Cost on average interest bearing liabilities Net income to average total equity Net income to average common equity Average total equity to average total assets Dividend payout ratio Efficiency ratio (3) Offices: $ 2.98 3.04 $ $ 0.44 39,994 40,983 $ 2.01 2.04 $ $ 0.40 39,901 40,553 $ $ $ (0.03) 1.73 1.74 0.35 39,851 40,144 $ $ $ 1.47 1.48 0.29 40,415 40,718 $ 1.32 $ 1.33 $ 0.24 43,412 43,799 $ 7,044,518 126,378 5,366,205 12,667,910 6,765,107 4,646,115 539,469 1,089,569 13.48 $ 5,637,851 111,911 3,728,669 9,643,852 5,482,918 3,249,355 437,924 798,424 10.96 $ 4,308,780 91,060 3,715,999 8,197,518 4,098,554 3,425,236 334,419 602,919 8.39 $ 3,498,198 76,919 2,233,216 5,919,657 3,345,984 2,069,484 269,461 434,461 6.80 $ 2,745,368 71,784 1,811,164 4,721,568 2,565,422 1,803,729 204,902 294,902 4.87 15.22 13.65 8.35 1.46 2.93 3.24 5.66 2.73 17.06 25.20 8.56 14.43 39.91 13.75 11.90 7.35 1.23 3.20 3.56 6.77 3.57 14.90 21.90 8.28 19.58 40.81 14.50 12.16 7.49 1.28 3.64 4.08 8.42 4.78 16.20 22.13 7.92 19.91 41.81 14.43 11.23 7.28 1.28 3.38 3.91 9.21 5.83 21.21 27.81 6.05 19.72 46.95 16.16 11.64 7.47 1.49 4.29 4.85 9.29 5.00 21.06 24.68 7.07 17.96 46.33 $ 1.16 1.17 $ $ 0.20 44,379 44,787 $ 1.05 $ 1.05 $ 0.16 45,054 45,306 $ $ $ 0.81 0.81 0.13 46,191 46,428 $ $ $ $ 1.05 $ $ $ 1.05 1.07 0.05 45,888 46,677 0.67 (0.01) 0.66 0.68 N/A 44,966 46,289 $ 2,120,054 67,854 1,800,489 4,017,352 1,775,045 1,930,488 270,368 270,368 6.11 $ 1,959,301 57,712 1,276,900 3,327,436 1,594,635 1,461,581 236,379 236,379 5.29 $ 1,896,074 55,254 830,980 2,822,147 1,703,926 889,668 191,142 191,142 4.21 $ 1,556,606 55,009 785,747 2,432,816 1,518,367 700,609 171,202 171,202 3.67 $ 1,501,273 37,413 595,555 2,174,692 1,493,445 538,080 120,015 120,015 2.66 $ 0.42 $ $ 0.14 0.56 0.63 N/A 43,983 49,419 $ 1,237,928 30,453 603,373 1,913,902 1,398,247 400,977 92,785 92,785 2.09 $ $ $ 0.25 (0.02) $ 0.17 (0.03) 0.23 0.27 N/A 42,876 51,098 $ 0.15 $ 0.17 N/A 42,876 49,856 $ 1,182,409 30,474 636,781 1,888,754 1,359,448 415,257 50,194 88,622 1.17 $ 1,264,380 29,001 564,431 1,898,399 1,396,066 408,414 38,410 74,146 0.90 17.39 11.55 6.59 1.48 4.76 5.27 9.83 5.07 20.54 20.54 7.22 17.12 40.91 17.26 11.07 7.44 1.63 5.30 5.83 10.45 5.15 22.30 22.30 7.32 15.14 42.79 15.25 9.32 6.65 1.48 5.46 6.03 10.63 5.17 20.49 20.49 7.23 16.32 47.66 16.17 9.93 6.82 2.22 5.07 5.59 10.12 5.05 33.19 33.19 6.68 5.06 41.04 9.76 8.50 5.74 1.53 5.23 5.65 9.63 4.40 29.07 29.07 5.27 N/A 49.88 9.05 7.79 4.70 1.53 4.73 5.10 9.10 4.37 30.36 39.68 5.05 N/A 54.73 9.32 8.06 4.60 0.78 3.66 4.04 8.80 5.14 17.70 26.37 4.38 N/A 63.24 7.08 5.75 3.74 0.53 3.19 3.39 9.41 6.22 14.38 20.20 3.67 N/A 63.69 Number of full service branches 54 54 48 48 48 40 36 36 36 32 33 33 33 1-Amounts presented were recalculated, when applicable, to retroactively consider the effect of common stock splits. 2-Ratios for 1993 and thereafter were computed on a taxable equivalent basis. 3-Other operating expenses to the sum of net interest income and other income. PAGE 6 2003 ANNUAL REPORT FIRST BANCORP PAGE 7 OFFICES PUERTO RICO 54 BRANCH 28 MONEY EXPRESS 09 FIRST LEASING & RENTAL CORP. 12 FIRSTBANK INSURANCE 21 FIRST MORTGAGE 03 FIRST EXPRESS 02 FIRST TRADE 01 FIRST BANK INSURANCE V.I. VIRGIN ISLANDS TORTOLA ST. THOMAS ST. JOHN BARBADOS ST. CROIX FIRST MORTGAGE Puerto Rico Branches 1 Aguada 3 Bayamón 2 Caguas 4 Carolina 1 Cayey 1 Dorado 1 Guaynabo 1 Humacao 1 Manatí 1 Mayagüez 1 Ponce 4 San Juan 21 FIRSTBANK INSURANCE AGENCY Puerto Rico Branches 1 Bayamón 1 Carolina 1 Dorado 9 San Juan 12 FIRSTBANK INSURANCE AGENCY VI USVI Branches 1 St. Thomas FIRST EXPRESS USVI Branches 2 St. Thomas 1 St. Croix 3 FIRST TRADE USVI & Barbados Branches 1 St. Thomas 1 Barbados 2 FIRSTBANK PUERTO RICO Puerto Rico Branches 1 Aguada 1 Aguas Buenas 1 Arecibo 1 Barranquitas 4 Bayamón 1 Cabo Rojo 4 Caguas 5 Carolina 1 Cayey 1 Dorado 1 Guayama 2 Guaynabo 1 Humacao 1 Manatí 2 Mayagüez Ponce 1 11 San Juan 1 Toa Baja 1 San Sebastián 1 Yauco USVI Branches 7 St. Thomas 1 St. John 3 St. Croix BVI Branches Tortola 1 54 MONEY EXPRESS Puerto Rico Branches 1 Aguadilla 1 Arecibo 1 Barranquitas 3 Bayamón 2 Caguas 2 Carolina 1 Cayey 1 Dorado 1 Fajardo 1 Guayama 1 Humacao Isabela 1 1 Manatí 1 Mayagüez 1 Ponce 1 Rio Grande 1 San Sebastián 4 San Juan 1 Toa Baja 1 Vega Baja 1 Yauco 28 FIRST LEASING & RENTAL CORP Puerto Rico Branches 1 Barceloneta 1 Caguas 1 Cayey 1 Mayagüez 1 Ponce 2 San Juan Toa Baja 2 9 PAGE 8 2003 ANNUAL REPORT FIRST BANCORP PAGE 9 CORPORATE STRUCTURE BUSINESS PROFILE First BanCorp (“the Corporation”) is a publicly owned, Puerto Rico-chartered financial holding company that is subject to regulation, supervi- sion and examination by the Federal Reserve Board. First BanCorp operates two direct sub- sidiaries: FirstBank Puerto Rico (“FirstBank or the Bank”) and FirstBank Insurance Agency, Inc. FirstBank is a Puerto Rico-chartered commercial bank, and FirstBank Insurance Agency is a Puerto Rico-chartered insurance agency. FirstBank is subject to supervision, examination and regula- tion by the Office of the Commissioner of Financial Institutions of the Commonwealth of Puerto Rico and the Federal Deposit Insurance Corporation, which insures its deposits through the Savings Association Insurance Fund. The Virgin Islands’ operations of FirstBank are sub- ject to regulation and examination by the United States Virgin Islands Banking Board and by the Islands Financial Services British Virgin Commission. FirstBank Insurance Agency is sub- ject to supervision, examination and regulation by the Office of the Insurance Commissioner of the Commonwealth of Puerto Rico. First BanCorp in the banking is engaged business and provides a wide range of financial services for retail and institutional clients. First BanCorp had total assets of approximately $12.7 billion, total deposits of approximately $6.8 billion and total stockholder’s equity of approxi- mately $1.1 billion at December 31, 2003. Based on total assets, First BanCorp is the second largest, locally-owned bank holding company headquartered in the Commonwealth of Puerto PAGE 10 2003 ANNUAL REPORT FIRST BANCORP PAGE 11 Rico and the second largest depository institu- tion in Puerto Rico. FirstBank conducts its business through its main offices located in San Juan, Puerto Rico, forty- two full service banking branches in Puerto Rico and twelve branches in the United States Virgin Islands (USVI) and British Virgin Islands (BVI). FirstBank has three subsidiaries with operations in Puerto Rico, First Leasing and Rental Corporation, a vehicle leasing and daily rental company with nine offices in Puerto Rico, First Federal Finance Corp. (d/b/a Money Express La Financiera), a finance company with twenty- eight offices in Puerto Rico and First Mortgage, Inc., a residential mortgage loan origination company with twenty-one offices in FirstBank branches. FirstBank has three subsidiaries with operations outside of Puerto Rico, FirstBank Insurance Agency VI, Inc., an insurance agency with one office that sells insurance products in the USVI, First Trade, Inc., which provides for- eign sales corporation management services with an office in the USVI and an office in Barbados, and First Express, a small loans com- pany with three offices in the USVI. First Mortgage, Inc. started operations specializ- ing in the origination of residential mortgage loans and related services in September 2003. First Express started operations in the USVI in November 2003 and concentrates primarily in the origination of small loans in the Virgin Islands. PRESIDENT’S LETTER Ángel Álvarez-Pérez Chairman President Chief Executive Officer TO OUR STOCKHOLDERS: On behalf of the Board of Directors and Officers of First BanCorp, I am pleased to submit our annual report for 2003, another excellent year. In 2003 First BanCorp earned $152.3 million, repre- senting $3.04 per common share basic (or $2.98 on a diluted basis). Excluding an after tax gain on the sale of a large part of the credit card portfolio which occurred in 2003, earnings totaled $133.5 million, which is $2.57 per common share (basic or $2.52 per com- mon share diluted). This represents an increase of $25.5 million as compared to 2002, when the Corporation earned $108 million. Growth in 2003 First BanCorp grew substantially in 2003, and net interest income expanded by 9.5% or $25.4 mil- lion to $292.2 million. This growth was a key fac- tor in our outstanding performance. We achieved these results in spite of the narrow margins, which have accompanied the current environ- ment of low interest rates. Assets rose 31.4% from $9.6 billion at year-end 2002 to $12.7 billion at the end of 2003. Net loans increased 25% to $7.0 billion, due mostly to increases in commercial and residential mort- gage lending. Deposits increased 23% to $6.8 bil- lion. First BanCorp is the second largest commer- cial bank in Puerto Rico. PAGE 12 2003 ANNUAL REPORT FIRST BANCORP PAGE 13 Along with the growth in loans and deposits, FirstBank, the Corporation’s bank subsidiary, continues to broaden and deepen its operations in Puerto Rico. In late 2003, First Mortgage, Inc., a new subsidiary specializing in the origination of mortgage loans started operations from twenty-one offices in FirstBank branches. In addi- tion, we have started an institutional banking section with the goal of working more closely with large private and governmental entities. In 2004, the Bank will open five new branches in Puerto Rico. This wider distribution of services will help the organization reach clients in all areas of the Island. In the Virgin Islands, FirstBank has opened two new branches and relocated a third to a new, modern facility. A newly formed subsidiary, First Express, is providing consumer finance service to our Virgin Islands clients. In addition, during 2003, FirstBank entered into an agreement with a major international brokerage house to provide financial and investment services in the US Virgin Islands. Strategic Alliances In 2003, FirstBank entered into a business alliance with MBNA Corporation, one of the world’s largest credit card issuers. FirstBank and MBNA together will be able to offer a wider selection of credit card services to consumers in Puerto Rico. In 2000, FirstBank entered into an agreement with a major international brokerage house to provide financial and investment services in its branches. At year-end, their FirstBank branch offices had approximately $300 million in assets under management. Since 2000, First BanCorp has a continuing arrangement with Goldman Sachs under which we provide consulting servic- es for local bond issues. For our clients, these strategic alliances are bringing more and better services. For FirstBank, the changes permit us to limit growth in operat- ing expenses while earning additional income from fees and commissions for the services we provide. Other Competitive Advantages Another key to our success is careful, prudent control of costs. For several years, we have been investing in state of the art technology to improve service to our clients and increase effi- ciency while adding more personnel and facili- ties, especially in the Virgin Islands. These investments led operating costs to increase from $133 million in 2002 to $164 million in 2003. Still, the Corporation’s efficiency ratio was 39.91% (43.15% excluding the sale of a credit card port- folio) in line with the 40.81% in 2002. This ratio is better than the average when compared to other financial institutions in the banking business. The quality of our loan portfolio was another fac- tor which contributed to the Corporation’s record profits last year. Starting in 1998, we have been improving loan underwriting, introducing tighter approval procedures and improving computer systems. These efforts have resulted in an improvement in asset quality. During 2003, First BanCorp wrote off $41.4 million of loans on a net basis (0.66% of the portfolio) compared with $41.5 million (0.87% of the portfolio) in 2002. Loan loss reserves reached $126.4 million at the end of 2003 compared with $111.9 million for 2002. By December 31, 2003 the reserve cover- age ratio (allowance for loan losses as a percent- age of non-performing loans) had risen to 147.8% compared with 121.9% at the end of 2002. Maintaining good asset quality has been one of the most important ingredients of our success. We also rely heavily on our employees and the quality of service they provide to our clients. All units of First BanCorp are in the midst of a con- tinuing program to improve service quality in all areas of our operations. Marketing surveys have shown the positive results of these efforts. Strengthening the Corporation’s Capital Base For First BanCorp to be able to continue growing and taking advantage of new opportunities, a sound capital base is necessary. In September 2003, First BanCorp issued $189.6 million in per- petual preferred stock. Due to strong demand, the offering became the largest single preferred stock issue ever completed in Puerto Rico. This new capital, plus retained earnings for the year, allowed consolidated equity capital to reach $1,089.6 million at year-end compared with $798.4 million at the end of 2002. Funding the Corporation’s Growth During 2003, FirstBank also launched a new deposit product, the Cuenta Perfecta (Perfect Account), which is highly competitive with accounts offered at other banks in Puerto Rico. This account has no monthly service charges for the first two years, pays interest, requires no minimum balance, and includes many free serv- ices such as ATM access and internet banking. Management is confident that this account will prove successful. Community Service and Corporate Image First BanCorp began operations in 1948 as “First Federal Savings Bank” and for many years was the leading Savings and Loan institution on the Island. Even after converting to a commercial bank in 1994, the Bank specialized in consumer lending for many years and still maintains strong ties with the Puerto Rican community, helping a number of charitable organizations. First BanCorp is lending $10 million to help finance a massive urban renewal project in PAGE 14 2003 ANNUAL REPORT FIRST BANCORP PAGE 15 2003, the dividend payout ratio was 14.43%. Officers and directors of First BanCorp own approximately 10 percent of its shares. This shows their confidence in First BanCorp’s future and their commitment to keep its fundamentals sound. As First BanCorp begins another year of growth and service to Puerto Rico and the Virgin Islands, we are confident that our Corporation is stronger and better positioned than ever. We have a truly outstanding group of employees, officers, and directors. I am confident that we can meet the challenges ahead, and that we will provide better service than ever to our clients, while benefiting employees and stockholders in the years to come. Ángel Álvarez-Pérez Chairman President Chief Executive Officer Santurce, where our home offices are located. Bank officials have taken a leading role in organ- izing this project, which involves five local banks and the Puerto Rico Housing Finance Authority. FirstBank’s latest advertising campaign features gymnasts demonstrating the same agility that characterizes our staff. The Bank continues to work on exceeding customer’s expectations. Enhancing Shareholder Value The efforts of Management and employees have paid off in strong earnings growth. In 2003, the Corporation experienced a return on common equity of 25.20% (21.31% excluding the gain on the sale of a credit card portfolio) compared with 21.90% in the previous year. The return on assets was 1.46% (1.28% excluding the credit card sale) compared with 1.23% in 2002. Our stock price reflected these strong results, increasing from $22.60 on December 31, 2002 to $39.55 at the end of 2003. Our shareholders experienced a total return of 77.54% on their investment during that year. Investors who held First BanCorp stock over the ten-year period from year-end 1993 to year-end 2003 received a cumulative total return of 1,133%, equivalent to an annualized return of 28.54%. The Corporation has traditionally followed a con- servative dividend policy, in the belief that we can better serve our shareholders by reinvesting most of our profits in our growing business. In ECONOMY The island of Puerto Rico is a U.S. commonwealth with a population of 3.8 million, located in the Caribbean approximately 1,600 miles southeast of New York. Puerto Rico grew moderately over most of the 1990’s, but its growth has paused recently due to the U.S. recession. Real GNP fell by 0.2% in the 2002 fiscal year, then grew by 1.9% in fiscal year 2003 according to the Puerto Rico Planning Board. This agency forecasts real growth of 2.9% in fiscal year 2004, led by manufacturing exports and government financed construction projects. Puerto Rico’s economic performance is a natural result of its increasing integration into the U.S. economy. Puerto Ricans are U.S. citizens and serve in the United States armed forces. The Island uses U.S. currency and forms part of the U.S. financial system. Federal courts enforce U.S. laws here. Since Puerto Rico falls within the U.S. for purposes of customs and migration, there is full mobility of funds, people and goods between Puerto Rico and the U.S. mainland. Puerto Rico’s banks are subject to the same Federal laws, regu- lations and supervision as other U.S. financial institutions. The Federal Deposit Insurance Corporation insures the deposits of Puerto Rico chartered commercial banks, including FirstBank, the banking subsidiary of First BanCorp. Manufacturing is the backbone of Puerto Rico’s economy, and many multinational corporations have substantial operations here. The Island’s pharmaceutical industry is especially strong. In recent years, however, a reduction of tax incen- tives combined with intense wage competition from other areas and the U.S. recession have been reducing island manufacturing employment. Still, Puerto Rico is becoming somewhat less depend- ent on manufacturing than it was in the early post- war period, as its economy has been diversifying with substantial investments in tourism, retail trade, services, banking and transportation. PAGE 16 2003 ANNUAL REPORT FIRST BANCORP PAGE 17 BOARD OF DIRECTORS 01 01 02 03 04 05 06 07 08 09 Ángel Álvarez-Pérez Chairman of the Board of Directors Annie Astor-Carbonell Sharee Ann Umpierre-Catinchi Richard Reiss-Huyke José Teixidor-Méndez José Julián Álvarez-Bracero Jorge L. Díaz Irizarry José L. Ferrer-Canals Juan Acosta-Reboyras 02 03 04 05 06 07 08 09 PAGE 18 2003 ANNUAL REPORT FIRST BANCORP PAGE 19 FIRST BANCORP OFFICERS 01 02 03 04 05 06 07 Fernando L.Batlle Luis M. Beauchamp Aurelio Alemán Annie Astor-Carbonell Angel Alvarez-Pérez Randolfo Rivera Josianne M. Rosselló 08 09 10 11 12 13 14 Miguel Mejías Carmen G. Szendrey-Ramos Cassan A. Pancham Aida M. García Luis M. Cabrera Laura Villarino Dacio A. Pasarell 01 02 03 04 05 06 07 08 09 10 11 12 13 14 PAGE 20 2003 ANNUAL REPORT FIRST BANCORP PAGE 21 PRESIDENT Ángel Álvarez-Pérez Chief Executive Officer SENIOR EXECUTIVE VICE PRESIDENTS Annie Astor-Carbonell Chief Financial Officer Luis M. Beauchamp Wholesale Banking Executive and Chief Lending Officer EXECUTIVE VICE PRESIDENTS Aurelio Alemán Consumer Banking Executive Fernando L. Batlle Retail and Mortgage Banking Executive Dacio A. Pasarell Operations and Technology Executive Randolfo Rivera Commercial Banking Executive FIRST SENIOR VICE PRESIDENT Emilio Martinó Credit Risk Management Denise Segarra Branch Banking Cassan A. Pancham Eastern Caribbean Region Executive SENIOR VICE PRESIDENTS José H. Aponte Commercial Mortgage Lending Miguel Babilonia Consumer Risk Management Luis M. Cabrera Treasury and Investments Salvador Calaf Government and Institutional Banking James E. Crites Regional Credit Officer Eastern Caribbean Region Aida M. García Human Resources Miguel Mejías Information Systems Carmen Nigaglioni Middle Market and Asset Based Financing John Ortiz Consumer Products and Credit Cards Jorge Rendón Facilities Management Luis Sueiro Commercial Wholesale Operations Carmen G. Szendrey-Ramos General Counsel and Secretary of the Board of Directors Laura Villarino Controller Haydeé Rivera Sales & Distribution Operations Julio Rivera Construction Lending Nayda Rivera General Auditor Carmen Rocafort Corporate and Structured Finance Josianne M. Rosselló Marketing and Public Relations Michael García Consumer Collection Demetrio Santiago Auto Wholesale Fernando Iglesias Special Loans Roger Lay Internal Audit Héctor Santiago Auto Business and Operations Ingrid Schmidt Mortgage Banking VICE PRESIDENTS Alexis Aguiar Structured Finance William Álvarez Indirect Business and Merchants José Alvelo Information Systems Deidre Elías Compliance Manager Eastern Caribbean Region Laura Escalante Compliance Officer Mayra Gascot Information Systems Vivian Arteaga Commercial Department José Gómez Mortgage Servicing and Operations Sylvia Astor Middle Market Department Marga Avilés Consumer Loans Operations Beverly Bachetti VIP Customer Group María Benabe Consumer Collections Javier Cabrera Investments Department Ana Colón Centralized Accounting María Conor-Freeman Lending and Client Group Eastern Caribbean Region Lenitzia Delgado Corporate Services David González Corporate Business Development Nelson González Structured Finance Paul Gourieux Consumer Credit Manager Eastern Caribbean Region Tessa Hugh Finance and Risk Manager Eastern Caribbean Region Carol Jackson Human Resources Manager Eastern Caribbean Region Felipe Lebrón Structured Finance Ariane Lewis Branch Banking Manager Eastern Caribbean Region John E. Lewis System & Programming Manager Eastern Caribbean Region Francisco Pascual Commercial Department Dionisio Ramírez Construction Lending Gilberto López Middle Market Migdalia Rivera Middle Market Marcelo López Regional Manager Sales & Distribution Pedro J. López Systems and Procedures & Document Retention Manager John McDonald Commercial Department Eastern Caribbean Region José Negrón Auto Lot José Nevárez Information Systems Luis Orengo Commercial Wholesale Eduardo Ortiz Auto Wholesale María Cristina Oruña Customer Relationship Management & Service Quality Sandra Rivera Consumer Collections Belinda Rodríguez Remote Sales José L. Rodríguez Information Systems Pedro Romero Assistant Controller Katherine Rullán Consumer Lending Elizabeth Sánchez Marine Finance Roberto Sánchez Consumer Loans Credit Risk José J. Santiago Commercial Wholesale Ramón Santiago Asset Based Unit Miguel Santín Structured Finance Osvaldo Padilla Corporate Services Carmen Torres Branch Manager Reynaldo Padilla Auto Finance Ralph Torres Regional Manager Sales & Distribution PAGE 22 2003 ANNUAL REPORT FIRST BANCORP PAGE 23 FINANCIAL REVIEW FIRST FEDERAL FINANCE CORPORATION DBA MONEY EXPRESS “LA FINANCIERA” FIRSTBANK INSURANCE AGENCY, INC. Ángel Álvarez-Pérez Chief Executive Officer FIRST TRADE INC. FIRST MORTGAGE, INC. Ángel Álvarez-Pérez Chief Executive Officer Ángel Álvarez-Pérez Chief Executive Officer Ángel Álvarez-Pérez Chief Executive Officer Aurelio Alemán President and Chief Operating Officer Carlos Power Senior Vice President and General Manager FIRST LEASING AND RENTAL CORPORATION Ángel Álvarez-Pérez Chief Executive Officer Aurelio Alemán President and Chief Operating Officer Agustín Dávila General Manager Aurelio Alemán President and Chief Operating Officer Víctor Santiago Vice President and General Manager FIRSTBANK INSURANCE AGENCY V.I., INC. Ángel Álvarez-Pérez Chief Executive Officer Fernando L. Batlle President and Chief Operating Officer Cassan A. Pancham First Senior Vice President Fernando L. Batlle President and Chief Operating Officer Cassan A. Pancham First Senior Vice President Fernando L. Batlle President and Chief Operating Officer Ingrid Schmidt Senior Vice President and General Manager Pamela Clarke Manager Carmen Fernández Vice President FIRST EXPRESS, INC. Juanita Marrero Vice President Ángel Álvarez-Pérez Chief Executive Officer Ricardo Negrón Vice President Fernando L. Batlle President and Chief Operating Officer Cassan A. Pancham First Senior Vice President PAGE 24 2003 ANNUAL REPORT FIRST BANCORP PAGE 25 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This discussion and analysis relates to the accompa- nying consolidated financial statements of First BanCorp (the Corporation) and should be read in con- junction with the financial statements and the notes thereto. Information in the notes referred to in this discussion and analysis is hereby incorporated by ref- erence herein. The use of terms such as “see”, “refer to”, “included in” or “explained in” shall be deemed to incorporate by reference into this discussion and analysis the information to which reference is made. Forward Looking Statements When used in this report and in other filings by First BanCorp with the Securities and Exchange Commission, in the Corporation’s press releases or other public or shareholder communication, or in oral statements made with the approval of an authorized executive officer, the words or phrases “will be”, “will determine”, “will allow”, “intends to”, “will likely result”, “are expected to”, “will continue”, “is antici- pated”, “estimated”, “project”, “believe”, “should” or similar expressions are intended to identify “forward looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. The future results of the Corporation could be affected by subsequent events and could differ materially from those expressed in forward-looking statements. If future events and actual performance differ from the Corporation’s assumptions, the actual results could vary significantly from the performance projected in the forward-looking statements. The Corporation wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made and are based on management’s current expectations, and to advise readers that various factors, including regional and national economic conditions, substan- tial changes in levels of market interest rates, credit and other risks of lending and investment activities, competitive, regulatory legislative changes and accounting pronouncements, could affect the Corporation’s financial performance and could cause the Corporation’s actual results for future periods to differ materially from those anticipated or projected. The Corporation does not undertake, and specifically disclaims any obligation, to update any forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements. factors, and OVERVIEW First BanCorp is the financial holding company of FirstBank (“FirstBank or the Bank”), the second largest commercial bank in Puerto Rico. Headquartered in San Juan, Puerto Rico, First BanCorp had $12.7 billion in assets at December 31, 2003 and operates full-serv- ice banking branches in Puerto Rico and in the U.S. Virgin Islands (USVI) and British Virgin Islands (BVI). In addition, the holding company owns an insurance agency and the Bank through its wholly-owned sub- sidiaries, operates offices in Puerto Rico specializing in residential mortgage loans originations, small person- al loans, finance leases and vehicle rental, and sub- sidiaries in the USVI and Barbados specializing in insurance agency services, small personal loans and foreign sales corporation management. Financial Highlights Although the long-awaited economic recovery did not materialize in fiscal year 2003, First BanCorp grew sub- stantially and improved its financial performance. The Corporation recorded earnings of $152,338,342 or $3.04 per common share basic and $2.98 per common share diluted, compared to $107,956,351 or $2.04 per common share basic and $2.01 per common share diluted for 2002, and $86,001,444 or $1.74 per com- mon share basic and $1.73 per common share diluted for 2001. For 2003 as compared to 2002, net income increased by $44,381,991 or $0.97 per common share diluted, and for 2002 as compared to 2001, by $21,954,907 or $0.28 per common share diluted. Assets rose 31% from $9.6 billion at year-end 2002 to $12.7 billion at the end of 2003. Deposits increased 23% to $6.8 billion. Net loans increased 25% to $6.9 billion, mostly due to increases of $341 million in com- mercial loans and $1,024 million in residential real estate loans. Consumer loans and finance leases grew by $40 million. In spite of increases in the loan portfo- lio and the economic slowdown, net charge offs as a percentage of average loans were at their lowest in a decade, mainly attributed to prior year’s efforts that improved loan underwriting and implemented tighter approval procedures, and to the change in the overall risk profile of the loan portfolio. The Corporation’s earnings increase is mainly the result of a significant growth in average earning assets of approximately $1,571 million together with lower cost of funding, gains on sales of investments securi- ties and a gain realized on the sale of a large part of the Corporation’s credit card portfolio, net of increases in operating expenses resulting mainly from the expansion in the Virgin Islands. As low interest rates have persisted, the key source of revenue generation for the Corporation, the net interest margin, has come under considerable downward pressure. The net inter- est margin declined over the past two years, from 4.08 percent for the year 2001 and 3.56 percent in 2002 to 3.24 percent for 2003. Since the Corporation’s lending operations have continued to grow, especially com- mercial and residential mortgages, the interest increases due to volume have exceeded interest spread contractions. The Bank is now a more diversi- fied institution after several years of focusing on the origination of commercial loans and residential mort- gage loans. A substantial amount of the Corporation’s assets have variable interest rates. The majority of commercial loans have loans and mortgage adjustable rates; as a result the Corporation is asset sensitive. Any increase in current interest rates should result in increases in net interest margin, conversely, any decrease in current interest rates should result in decreases in the net interest margin. During 2003, the Corporation completed its investment securities port- folio restructuring which reduced its sensitivity to ris- ing interest rates. The restructuring resulted in both, a growth in the investment portfolio and increases in interest income from investments during the last half of the year. The 2003 provision for loan losses of $55.9 million was down $6.4 million from 2002. The decrease results from lower charge-offs relative to the size of the loan portfolios and diversification into secured lending areas such as residential and commercial mortgage loans, as well as stable delinquencies, especially in the Bank’s consumer loan portfolios. Gains on the sale of investments securities of $34.9 million mainly resulted from sales of mortgage- backed securities made when the 10 year Treasury note rate reached a low level during the first quarter of 2003 partially offset by other-than-temporary impair- ments of $5.8 million. Also during the fourth quarter, the Corporation reached an agreement with MBNA Corporation, the world’s largest independent credit card lender, for the sale of approximately $114 million of a large portion of credit card loans, which resulted in a gain of approximately $31 million before tax. This sale was made after a thorough evaluation of credit card loans opportunities in an alliance with MBNA. Under the alliance, which will benefit both companies, the Bank will provide full support to MBNA in the orig- ination of credit card loans in Puerto Rico, and share in the revenues from this new business. An important factor in the Corporation’s strategy is prudent control of costs. For several years the Corporation has been investing in state of the art tech- nology to improve service to its clients and increase efficiency. This approach continues at the Corporation as substantial investments have been made in upgrad- ing the performance, capacity and speed of existing technology and adapting new ones during 2002 and 2003. The Corporation has maintained a better than average efficiency ratio of approximately 40%, when compared to other financial institutions in the banking business. The increase in operating expenses of $31 million from $132.8 million in 2002 to $164.0 million in 2003 is mainly attributed to the full year cost of JP Morgan Chase Virgin Islands operations acquired in October 2002, which represented $19.4 million of the increase. The additional costs from the Virgin Islands operations are more than compensated by the increases in income attributable to this operation. Also increases in operating expenses are the result of the Corporation’s continuous investment in technology to provide the latest in delivery channels to its commercial and con- sumer lending business and to the general growth in the subsidiary Bank’s operations, which required increases in salaries, occupancy and technology expenses. Operating expenses also increased due to significant expenditures on an advertising campaign to support the introduction of First Mortgage Inc., the new subsidiary specializing in mortgage loans origina- tions; a campaign to introduce a new deposit product, namely the “Cuenta Perfecta”, targeted at the retail segment, and a new image campaign for the sub- sidiary Bank operations. Return on average assets was 1.46% for 2003, and 1.23% for 2002 and 1.28% for 2001. Return on average equity was 17.06% for 2003, 14.90% for 2002 and 16.20% for 2001. Return on average common equity was 25.20% for 2003, 21.90% for 2002 and 22.13% for 2001. In September 2003, the Corporation issued $189.6 mil- lion of the Corporation’s “Series E Perpetual Preferred Stock”. This issuance will support the Corporation’s continuous growth and search for new business opportunities. During 2003 First BanCorp expanded its operations through the establishment of First Mortgage Inc., a subsidiary specializing in the origina- tion of residential mortgage loans and related servic- es. Since November 2003, a newly formed subsidiary, First Express Inc., is providing consumer finance serv- ice to Virgin Islands clients. As aforementioned, the Corporation’s subsidiary Bank entered into a long-term strategic marketing alliance with MBNA Corporation. As part of the alliance, FirstBank became an MBNA Financial Institution Partner in Puerto Rico and is the only Puerto Rico based financial institution whose credit cards are issued by MBNA. The following table provides a reconciliation of finan- cial information, as reported under accounting princi- ples generally accepted in the United States of America (GAAP), to information excluding the after tax effect of the gain on sale of the credit card loans to MBNA. Management believes this presentation is useful to investors as it provides information exclud- ing the effect of the gain on this sale. PAGE 26 2003 ANNUAL REPORT FIRST BANCORP PAGE 27 Under GAAP as reported Effect of the after tax gain on the sale of a large part of the subsidiary bank’s credit card loans Excluding effect stated above First BanCorp Year ended December 31, 2003 Earnings for Year Basic EPS Diluted EPS ROA ROCE Efficiency Ratio $ 152,338,342 $ 3.04 $ 2.98 1.46% 25.20% 39.91% (18,840,065) $ 133,498,277 (0.47) 2.57 $ (0.46) $ 2.52 (0.18%) 1.28% (3.89%) 21.31% 3.24% 43.15% Critical Accounting Policies and Practices the The accounting and reporting policies of its subsidiaries conform with Corporation and accounting principles generally accepted in the United States of America. A summary of accounting policies and recently issued accounting pronouncements is included in Note 2 to the Corporation’s financial state- ments. The reported amounts are based on judg- ments, estimates and assumptions made by Management that affect the recorded assets and liabil- ities and contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates, if dif- ferent assumptions or conditions prevail. Investments Classification and Valuation The Corporation classifies its investments in debt and equity securities into trading, held to maturity and available for sale securities at the time of purchase. The available for sale securities are carried at fair value, with unrealized holding gains and losses, net of deferred tax effects, reported in other comprehensive income as a separate component of stockholders’ equity. The fair values of these securities were calcu- lated based on quoted market prices and dealer quotes. Changes in the assumptions used in calculat- ing the fair values such as interest rates, estimated prepayment rates for such securities subject to prepay- ment risk and discount rates could affect the reported valuations. Held to maturity, securities are accounted for at amortized cost. Trading securities, if any, are reported at fair value with unrealized gains and losses included in earnings. For 2003 and 2002, the Corporation did not hold investment securities for trading purposes. An impairment charge Evaluation for Other-than-temporary Impairment on Available for Sale and Held to Maturity Securities The Corporation evaluates its investment securities for impairment. the Consolidated Statements of Income is recognized when the decline in the fair value of investments below their cost basis is judged to be other-than-tem- porary. The Corporation considers various factors in determining whether it should recognize an impair- ment charge, including, but not limited to the length of time and extent to which the fair value has been less in than its cost basis, and the Corporation’s intent and ability to hold the investment for a period of time suf- ficient to allow for any anticipated recovery in market value. For debt securities, the Corporation also consid- ers, among other factors, the investees repayment ability on its bond obligations and its cash and capital generation ability. At December 31, 2003, the Corporation did not hold any investment securities with significant unrealized losses sustained for more than one year. The Corporation’s accounting policy for other-than-temporary impairment is included in Note 2 of the Corporation’s financial statements. See Note 8 of the Corporation’s financial statements, which dis- closes amounts of impairment charges recognized during 2003 and other related quantitative and qualita- tive information. Allowance for Loan Losses The Corporation maintains the allowance for loan loss- es at a level that Management considers adequate to absorb losses inherent in the loan portfolio. The ade- quacy of the allowance for loan losses is reviewed on a quarterly basis as part of the continuing evaluation of the quality of the assets. Groups of small balance, homogeneous loans are collectively evaluated for impairment. The portfolios of residential mortgage loans, consumer loans, auto loans and finance leases are considered homogeneous and are evaluated col- lectively for impairment. In determining probable loss- es for each category of homogeneous pools of loans, Management uses historical information about loan losses over several periods of time that reflect varying economic conditions and adjusts such historical data based on the current conditions, considering informa- tion and trends on charge-offs, non-accrual loans, risk characteristics relevant to the particular loan category and delinquencies. The Corporation measures impair- ment individually for those commercial and real estate loans with a principal balance exceeding $1 million. An allowance for impaired loans is established based on the present value of expected future cash flows or the fair value of the collateral, if the loan is collateral dependent. Accordingly, the measurement of impair- ment for involves assumptions by Management as to the amount and timing of cash flows to be recovered and of appropri- ate discount rates. When the loans are collateral dependent, Management generally obtains an inde- loans evaluated individually bilities; and the re-pricing characteristics of these assets and liabilities. The Corporation’s results of operations also depend on the provision for loan loss- es, operating expenses (such as personnel, occupancy and other costs), other income (mainly service charges and fees on loans), gains on sale of investments and loans and income taxes. Net Interest Income Net interest income increased to $292 million for 2003 from $267 million in 2002 and $236 million in 2001. The increase in net interest income for the year 2003 was mainly driven by volume increases of $1,571 mil- lion in the Corporation’s average earning assets, spe- cially commercial and residential real estate loans. The following table includes a detailed analysis of net interest income. Part I presents average volumes and rates on a tax equivalent basis and Part II presents 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 earning assets and interest bearing liabilities, information is provided on changes attribut- able to changes in volume (changes in volume multi- plied by old rates), and changes in rate (changes in rate multiplied by old volumes). Rate-volume vari- ances (changes in rate multiplied by changes in vol- ume) have been allocated to the changes in volume and changes in rate based upon their respective per- centage of the combined totals. pendent appraisal. Those appraisals also involve esti- mates of future cash flows and appropriate discount rates or adjustments to comparable properties in determining fair values. The Corporation’s primary lending area is Puerto Rico. The Corporation’s subsidiary Bank also lends in the U.S. and British Virgin Islands markets. At December 31, 2003, there is no significant concentration of cred- it risk in any specific industry. Income Taxes The Corporation is routinely subject to examinations from governmental taxing authorities. Such examina- tions may result in challenges to the tax return treat- ment applied by the Corporation to specific transac- tions. Management believes that the assumptions and judgment used to record tax-related assets or liabili- ties have been appropriate. There are currently no open income tax investigations. Should tax laws change or the tax authorities assumptions differ from Management’s assumptions, the result and adjust- ments required could have a material effect on the Corporation’s results of operation. Information regarding income taxes is included in Note 23 of the Corporation’s financial statements. Accounting Pronouncements During 2003, the Financial Accounting Standards Board (FASB) issued several accounting pronounce- ments, namely FASB Interpretation (FIN) No. 46R, Consolidation of Variable Interests Entities, an Interpretation of ARB 51, Statement of Financial Accounting Standard (SFAS) No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, SFAS No. 150, Accounting for Certain Instruments with Characteristics of both Liabilities and Equity and the Accounting Standards Executive Committee Statement of Position (SOP) No. 03-3 Accounting for Certain Loans or Debt Securities Acquired in a Transfer. The adoption of these pro- nouncements did not have a significant impact on the Corporation’s financial statements. Refer to Note 2 of the Corporation’s financial statements for a summary of the major provisions of these pronouncements. The Corporation’s results of operation could be affect- ed by the effect of new accounting pronouncements issued in the future. RESULTS OF OPERATIONS The Corporation’s results of operations depend prima- rily on its net interest income, which is the difference between the interest income earned on interest earn- ing assets, including investment securities and loans, and the interest expense on interest bearing liabilities, including deposits and borrowings. Net interest income is affected by various factors including the interest rate scenario, the volumes, mix and composi- tion of interest earning assets and interest bearing lia- PAGE 28 2003 ANNUAL REPORT FIRST BANCORP PAGE 29 Part I Year ended December 31, Average volume 2002 2003 2001 Interest income (1) / expense 2002 2001 2003 Average rate (1) 2002 2001 2003 (Dollars in thousands) Earning assets: Money market investments Government obligations Mortgage backed securities Corporate bonds FHLB stock Total investments Consumer loans Residential real estate loans Construction loans Commercial loans Finance leases Total loans (2) Total earning assets Interest bearing liabilities: Interest bearing checking accounts Savings accounts Certificate accounts Interest bearing deposits Other borrowed funds FHLB advances Total interest bearing liabilities Net interest income Interest rate spread Net interest margin $ 60,522 $ 46,517 $ 4,494 $ 999 $ 455,866 $ 850,516 2,257,617 181,063 40,447 3,785,509 1,198,964 2,286,809 314,588 2,340,744 150,832 6,291,937 1,236,281 2,144,236 259,840 32,586 3,733,465 1,048,283 1,283,710 223,627 2,080,892 136,851 4,773,363 588,932 1,711,980 247,094 21,841 2,616,364 1,036,637 869,374 219,890 1,584,910 127,872 3,838,683 48,912 116,778 7,792 1,206 179,182 152,937 107,777 14,824 101,293 14,670 391,501 56,130 147,779 15,493 1,635 222,036 142,612 74,411 11,726 110,315 14,659 353,723 65,496 17,323 119,867 14,661 357,397 $10,077,446 $ 8,506,828 $ 6,455,047 $ 570,683 $ 575,759 $ 543,445 0.99% 1.65% 3.17% 1,476 5.75% 4.54% 6.11% 35,955 5.17% 6.89% 7.37% 126,098 4.30% 5.96% 8.59% 21,230 2.98% 5.02% 5.90% 1,289 186,048 4.73% 5.95% 7.11% 140,050 12.76% 13.60% 13.51% 4.71% 5.80% 7.53% 4.71% 5.24% 7.88% 4.33% 5.30% 7.56% 9.73% 10.71% 11.47% 6.22% 7.41% 9.31% 5.66% 6.77% 8.42% $ 259,447 $ 922,887 4,158,111 5,340,445 2,965,714 633,692 215,462 $ 186,111 $ 609,324 3,622,918 4,447,704 2,868,212 339,477 436,595 2,859,181 3,481,887 2,125,022 256,354 3,426 $ 5,146 $ 11,849 97,266 112,541 112,512 19,418 14,603 113,486 133,235 123,925 16,024 5,926 12,954 141,878 160,758 106,858 12,585 1.32% 2.39% 3.18% 1.28% 2.40% 2.97% 2.34% 3.13% 4.96% 2.11% 3.00% 4.62% 3.79% 4.32% 5.03% 3.06% 4.72% 4.91% $ 8,939,851 $ 7,655,393 $ 5,863,263 $ 244,471 $ 273,184 $ 280,201 $ 326,212 $ 302,575 $ 263,244 2.73% 3.57% 4.78% 2.93% 3.20% 3.64% 3.24% 3.56% 4.08% (1) On a tax equivalent basis. The tax equivalent yield was computed dividing the interest rate spread on exempt assets by (1- 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 tax- able and exempt assets are comparative. (2) Non-accruing loans are included in the average balances. Part II Earning assets: Money market investments Government obligations Mortgage backed securities Corporate bonds FHLB stock Total investments Consumer loans Residential real estate loans Construction loans Commercial loans Finance leases Total loans Total interest income Interest bearing liabilities: Deposits Other borrowed funds FHLB advances Total interest expense Change in net interest income 2003 compared to 2002 Increase (decrease) Due to: Rate Total Volume 2002 compared to 2001 Increase (decrease) Due to: Rate Total Volume (In thousands) $ $ 5,212 (19,856) 6,839 (4,015) 314 (11,506) 19,860 52,710 4,528 12,511 1,429 91,038 79,532 (1,717) $ 12,638 (37,840) (3,686) (743) (31,348) (9,535) (19,345) (1,430) (21,533) (1,416) (53,259) (84,607) 22,778 3,956 11,452 38,186 $ 41,346 $ (43,472) (15,369) (8,058) (66,899) (17,708) $ 3,495 (7,218) (31,001) (7,701) (429) (42,854) 10,325 33,365 3,098 (9,022) 13 37,779 (5,075) (20,694) (11,413) 3,394 (28,713) 23,638 $ $ $ (815) $ 338 34,457 30,815 928 587 67,125 1,580 27,616 245 31,903 993 62,337 129,462 36,762 34,742 4,002 75,506 53,956 $ (14,282) (9,134) (6,665) (241) (31,137) 982 (18,701) (5,842) (41,455) (995) (66,011) (97,148) (64,285) (17,675) (563) (82,523) (14,625) (477) 20,175 21,681 (5,737) 346 35,988 2,562 8,915 (5,597) (9,552) (2) (3,674) 32,314 (27,523) 17,067 3,439 (7,017) 39,331 $ Total interest income includes tax equivalent adjust- ments of $34 million, $36 million and $27 million for 2003, 2002, and 2001, respectively. On a tax equiva- lent basis, net interest income increased to $326 mil- lion for 2003 from $303 million for 2002, and $263 mil- lion for 2001. The interest rate spread and net interest margin amounted to 2.93% and 3.24%, respectively, for 2003, as compared to 3.20% and 3.56%, respective- ly, for 2002 and to 3.64% and 4.08%, respectively, for 2001. 2003 compared to 2002 On a tax equivalent basis, interest income decreased by $5.1 million for 2003 as compared to 2002. The tax equivalent yield on earning assets was 5.66% for 2003 as compared to 6.77% for 2002. The decrease in inter- est income as compared to the same period last year is mainly attributed to the interest rate sensitivity of a substantial part of the Corporation’s assets which resulted in further interest yield decreases in 2003, given the low interest rate scenario that has persisted during the last few years. Significant variances due to rate were noted specifically on the Corporation’s mort- gage-backed securities and commercial loans. The variance due to rate on the mortgage-backed securi- ties is attributed to accelerated prepayments and sub- sequent replacement with lower yield securities and the variances on commercial loans is mainly attributed to the re-pricing of loans which rates are variable. The variances due to rate were partially offset by sig- nificant volume increases in the Corporation’s lending operations. As shown in Part I, the Corporation expe- rienced continuous growth of its loan portfolios. Average loans increased by $1,519 million compared to 2002. Residential real estate loans and commercial loans, accounted for the largest growth in the portfo- lio, with average volumes rising $1,003 million and $260 million, respectively. The Corporation’s Bank subsidiary is now a more commercial base institution after several years of working on a strategy to reduce the loan portfolio risk and achieve a diversified asset base. For the loan portfolio, the growth in average volume represented a positive increase of $91 million in interest income due to volume. The negative $53 million decrease in interest income due to rate, men- tioned earlier, is mainly attributed to the floating rate characteristics of a substantial portion of the Corporation’s portfolio and to the origination of new loans in a lower rate environment. At December 31, 2003, approximately 75% of the commercial, 60% of the residential mortgage and 90% of the construction portfolios have floating rates. Average investment securities increased by $52 mil- lion. During 2003, the Corporation restructured its investments portfolio. Prepayments on mortgaged backed securities and repayments on callable securi- ties accelerated when compared to recent historical experience, also substantial profits were realized on the sale of investment securities early in 2003. A sub- stantial amount from the proceeds of accelerated pre- payments on mortgage-backed securities, prepay- ments on callable securities and proceeds from sales of securities were maintained in money market instru- ments for a substantial part of 2003, which explains the increase in the average volume of the money mar- ket instruments and the decrease in the average vol- ume of other components, such as government obli- gations, when compared to 2002. The majority of the proceeds mentioned above were reinvested in the third quarter of 2003 when the Corporation reentered the longer-term investment market and at the same time grew its investments portfolio by purchasing approximately $2 billion of 15 year FNMA mortgage- backed securities. For such reasons, interest income from investments was affected during a period which extended from the first quarter to the third quarter of 2003, when the restructuring was completed. The income Corporation’s Bank subsidiary increased after the reinvestment of the prepayments and sales proceeds during the third quarter of 2003. The tax equivalent average yield on investment secu- rities was 4.73% in 2003 and 5.95% in 2002. The decrease in the average yield on investments, as com- pared to 2002, is primarily a result of a 172 basis point decrease in the yield earned on mortgage-backed securities given the acceleration of prepayments on these securities, which in turn accelerated the amorti- zation of premiums paid upon the acquisition of such investments. interest On the liabilities side the Corporation benefited from a low interest rate environment, as the cost of funds decreased when short term liabilities re-priced and new short-term (i.e. deposits and repurchase agree- ments) and long-term (i.e. long-term repurchase agreements and other advances) liabilities were origi- nated at lower rates. Interest expense decreased by $29 million for 2003 as compared to 2002. This was the result of the decrease in the average rates of inter- est bearing liabilities, which generated a positive rate variance of $67 million, that was partially offset by increases in the average volume of liabilities to sup- port the Corporation’s growth. In summary, on a rate/volume basis the Corporation’s net interest income (on tax equivalent basis) increased by approximately $23.6 million, as a result of a posi- tive volume variance of $41.3 million, net of a negative rate variance of $17.7 million. The net interest margin declined from 3.56 percent for the year 2002 to 3.24 percent for 2003. The Corporation’s lending operations have continued to grow, especially commercial and residential mortgages, and these volume increases have exceeded interest spreads contractions resulting in an increase of tax equivalent net interest income as compared to 2002. PAGE 30 2003 ANNUAL REPORT FIRST BANCORP PAGE 31 was partially offset by increases in the average vol- ume of liabilities to support the Corporation’s growth. The allowance activity for 2003, and previous four years was as follows: Provision for Loan Losses During 2003, the Corporation provided $55.9 million for loan losses, as compared to $62.3 million in 2002 and $61 million in 2001. The decrease in the provision is mainly attributed to lower charge offs as a result of diversification into secured lending areas such as res- idential and commercial mortgage loans. Net charge offs amounted to $41.4 million for 2003, $41.5 million for 2002, and of $47.0 million for 2001. The ratio of net charge offs to average loans outstanding has improved to 0.66% as compared to 0.87% and 1.22% for 2002 and 2001, respectively. The charge offs ratio is at the lowest level in more than ten years, in spite of the economic slowdown. The improvement when compared to recent historical data is attributed to improvements in the Corporation’s underwriting stan- dards, credit administration policies and an effective risk management infrastructure. Year ended December 31, 2003 2002 2001 (Dollars in thousands) 2000 1999 Allowance for loan losses, beginning of year Provision for loan losses Loans charged off: Residential real state Commercial and Construction Finance leases Consumer Recoveries Net charge offs Other adjustments (1) Allowance for loan losses, end of year Allowance for loan losses to year end total loans and loans held for sale Net charge offs to average loans outstanding during the period $ 111,911 55,916 $ 91,060 62,302 $ 76,919 61,030 $ 71,784 45,719 $ 67,854 47,960 (475) (6,488) (2,424) (38,745) 6,683 (41,449) (555) (4,643) (2,532) (41,261) 7,540 (41,451) $ 126,378 $111,911 (192) (9,523) (2,316) (42,349) 7,391 (46,989) 100 $ 91,060 (3,463) (2,145) (46,223) 9,807 (42,024) 1,440 $ 76,919 (825) (793) (52,047) 9,048 (44,617) 587 $ 71,784 1.79% 1.99% 2.11% 2.20% 2.61% 0.66% 0.87% 1.22% 1.36% 1.90% (1) Other adjustments mainly consist of the carrying allowance of the loan portfolios acquired. The Corporation maintains the allowance for loan losses at a level that Management considers adequate to absorb losses inherent in the loan portfolio. The adequacy of the allowance for loan losses is reviewed on a quarterly basis as part of the continuing evalua- tion of the quality of the assets. This evaluation is based upon a number of factors, including the follow- ing: historical loan loss experience, projected loan losses, loan portfolio composition, current economic conditions, changes in underwriting process, fair value of the underlying collateral, financial condition of the borrowers, and, as such, includes amounts based on judgments and estimates made by Management. The increase in the allowance is most- ly attributable to the growth of the commercial loan portfolio in the year 2003, together with the seasoning of this same portfolio, which has been growing signif- icantly since 1998. The allowance for loan losses on commercial and real estate loans over $1 million is determined based on the present value of expected future cash flows or the fair value of the collateral, if the loan is collateral dependent. 2002 compared to 2001 On a tax equivalent basis interest income increased by $32 million for 2002 as compared to 2001. On a tax equivalent basis the yield on earning assets was 6.77% for 2002 as compared to 8.42% for 2001. The increase in interest income resulted from the growth in the average volume of interest earning assets of $2,052 million in 2002, partially offset by lower yields due to lower market rates. The economic slowdown led the Federal Reserve Bank to cut the federal funds rate sev- eral times during 2001 and 2002 to 1.25%, its lowest level since 1962, which resulted in a lower average cost of fund (3.57% for the year ended 2002 versus 4.78% for the year ended 2001). On a rate/volume basis, the increase of $39 million in net interest income (on a tax equivalent basis) resulted from of a positive volume variance of $54 million, net of a nega- tive rate variance of $15 million. The negative rate variance was mainly due to the high level of variable rate assets, and the acceleration of prepayments on the Corporation’s mortgage-backed securities. As shown in Part I, the Corporation continued to expe- rience growth in its loan portfolio during 2002. Total average loans increased by $935 million as compared to 2001. Residential real estate loans and commercial loans, accounted for the largest growth in the portfo- lio, with average volumes rising $414 million and $496 million, respectively. The growth in the commercial and residential real estate portfolios resulted mainly from the Corporation’s ongoing strategy of maintain- ing a diversified asset base. For the loan portfolio, the growth in average volume represented an increase of $62 million in interest income due to volume. The $66 million decrease in interest income due to rate is mainly attributed to the floating rate characteristics of a portion of the Corporation’s portfolio and to the orig- ination of new loans in a lower rate environment. At December 31, 2002, approximately 75% of the com- mercial, 49% of the residential mortgage and 88% of the construction portfolios had floating rates. Average investment securities increased by $1,117 million. The average yield on investment securities was 5.95% in 2002 and 7.11% in 2001, on a tax equiv- alent basis. The portfolio of investment securities con- tributed $67 million on the interest income increase due to volume partially offset by a decrease of $31 mil- lion in interest income due to rate. The yield on gov- ernment obligations had a negative variance of 157 basis points declining from 6.11% in 2001 to 4.54% in 2002. The yield on mortgage-backed securities also had a negative variance as it decreased 48 basis points from 7.37% in 2001 to 6.89% in 2002. Interest expense decreased by $7 million for 2002 as compared to 2001. This was the result of the decrease in the average rates of interest bearing liabilities which generated a positive rate variance of $83 million, that PAGE 32 2003 ANNUAL REPORT FIRST BANCORP PAGE 33 2003 2002 (In thousands) 2001 $ $ 20,617 9,527 3,014 2,224 1,526 4,258 703 10,481 52,350 40,617 (5,761) 34,856 30,885 619 118,710 $ 21,441 9,200 3,540 2,285 1,081 2,269 705 10,032 50,553 48,873 (36,872) 12,001 $ 19,632 9,213 1,562 2,293 1,511 700 669 7,794 43,374 9,606 9,606 (4,062) 58,492 $ $ 52,980 Other Income The following table presents the composition of other income. Year ended December 31, Other fees on loans Service charges on deposit accounts Mortgage banking activities Rental income Other commissions and fees Insurance income Dividends on equity securities Other operating income Other income before net gain on sale of investments, gain on sale of credit cards portfolio and derivatives gain (loss) Gain on sale of investments Impairment on investments Gain on sale of investments, net Gain on sale of credit cards portfolio Derivatives gain (loss) Total Other income primarily consists of fees on loans, serv- ice charges on deposit accounts, commissions derived from various banking activities, securities and insur- ance activities, net gain on sale of investments, and derivatives gain (loss). Other income for 2003 includes a gain on the sale of a large part of the Corporation’s credit card portfolio. The portfolio sold approximated $114 million. This sale is further explained in the overview section of this document. Other fees on loans consist mainly of credit card fees and late charges collected on loans. Service charges on deposit accounts includes month- ly fees on deposit accounts and fees on returned and paid check services, which represent an important and stable source of other income for the Corporation. Mortgage banking activities income includes gains on sale of loans and the servicing fees on residential mortgage loans originated by the Corporation and subsequently securitized or sold. Gains on sale of loans amounted to approximately $2.9 million in 2003 (2002-$3.4 million, 2001-$1.2 million). The Corporation’s subsidiary, First Leasing and Rental Corporation, generates income on the rental of vari- ous types of motor vehicles. This source of income has averaged approximately $2.2 million in the past three years. Insurance income consists of commissions earned by the Corporation’s subsidiary FirstBank Insurance Agency, Inc., and the Bank’s subsidiary in the U.S.V.I, FirstBank Insurance V.I., Inc. Other commissions and fees income is the result of an agreement with Goldman, Sachs & Co. to participate in bond issues by the Government Development Bank for Puerto Rico, and an agreement with a internation- al brokerage house doing business in Puerto Rico to offer brokerage services in selected branches. The other operating income category is composed of miscellaneous fees such as check fees and rental of safe deposit boxes. Other operating income also includes earned discounts on tax credits purchased and utilized against income tax payments, and other fees generated on the portfolio of commercial loans. The net gain on the sale of investment securities reflects gains or losses as a result of sales that are con- sistent with the Corporation’s investment policies and strategy as well as other-than-temporary impairment charges on portfolio securities. Refer to Note 8 to the financial statements for further discussion on invest- ment activities and other-than-temporary impairment charges. As explained in Note 27 of the Corporation’s financial statements, the derivatives gain for 2003 consists mainly of an unrealized gain of $1.1 million due to the valuation to fair value of a portfolio of swaps that does not qualify for hedge accounting under GAAP. Other Operating Expenses Other operating expenses amounted to approximately $164 million for 2003 as compared to $132.8 million for 2002 and $120.9 million for 2001. The following table presents the components of other operating expenses. Year ended December 31, Salaries and benefits Occupancy and equipment Deposit insurance premium Other taxes, insurance and supervisory fees Professional and service fees Business promotion Communications Expense of daily rental vehicles Other Total 2003 2002 (In thousands) 2001 $ $ 75,213 36,394 806 10,329 9,402 12,415 6,959 1,642 10,834 163,994 $ $ 59,432 29,015 746 8,915 7,685 9,304 5,854 1,588 10,217 132,756 $ 54,703 24,992 645 7,804 7,931 7,506 5,395 1,578 10,300 $ 120,854 PAGE 34 2003 ANNUAL REPORT FIRST BANCORP PAGE 35 Management’s goal is to limit expenditures to those that directly contribute to increase the efficiency, serv- ice quality and profitability of the Corporation. This control over other operating expenses has been an important factor contributing to the increase in earn- ings in recent years. The Corporation’s efficiency ratio, which is the ratio of other operating expenses to the sum of net interest income and other income, remained in line with prior years at 39.91% for 2003 as compared to 40.81% and 41.81% for 2002 and 2001, respectively. The Corporation has maintained a better than average efficiency ratio when compared to other financial institutions in the banking business, while it has provided the latest in delivery channels for its commercial and consumer financial products and services. The increase in operating expenses for 2003 is mainly attributed to the full year cost of JP Morgan Chase Virgin Islands operations acquired in October 2002, which represented approximately $19.4 million of the $31 million increase as compared to 2002. The addi- tional costs from the Virgin Islands operations are more than compensated by the increases in income attributable to this operation. Also increases in oper- ating expenses are the result of the Corporation’s con- tinuous investment in technology to provide the latest in delivery channels to its commercial and consumer lending business and to the general growth in the sub- sidiary Bank’s operations, which required increases in salaries, occupancy and technology expenses. Operating expenses also increased due to significant expenditures on an advertising campaign to support the introduction of First Mortgage Inc., the new sub- sidiary specializing in mortgage loans originations; a campaign to introduce a new deposit product, namely the “Cuenta Perfecta”, targeted at the retail segment, and a new image campaign for the subsidiary Bank operations. Income Tax Expense The provision for income tax amounted to $39 million (or 20% of pre-tax earnings) for 2003 as compared to $22 million (or 17% of pre-tax earnings) in 2002, and $20 million (or 19% of pre-tax earnings) in 2001. The increase in the effective tax rate, when compared to 2002, is mainly due to an increase in total average tax- able assets, specifically commercial and residential mortgage loans, as a percentage of total average assets and the increase in other taxable income includ- ing the gain on sale of credit card loans to MBNA. The Corporation has maintained an effective tax rate lower than the statutory rate of 39% mainly by investing in government obligations and mortgage-backed securi- ties exempt from U.S. and Puerto Rico income tax combined with gains on sale of investments held by the international banking divisions (IBE’s) of the Corporation and the Bank. These divisions were creat- ed under the International Banking Entity Act of Puerto Rico, which provides for total Puerto Rico tax exemp- tion on net income derived by the IBE’s operating in Puerto Rico. On January 8, 2004, the Governor of Puerto Rico approved an amendment the International Banking Center Regulatory Act; which imposes income tax at statutory rates on the IBE’s net income that exceeds 20% of the Bank’s total net tax- able income plus the net income generated by the IBE. The amendment, which applies only to IBE’s that oper- ate as a unit of a bank, is effective for fiscal years beginning after June 30, 2003. The amendment pro- vides for a transitional period during which the limita- tion for 2004 will be 40%, 30% in 2005 and finally 20% in 2006 and thereon. Management estimates that the financial impact of the amendment is not likely to be material to the Corporation. For additional informa- tion relating to income taxes, see Note 23 of the Corporation’s financial statements. to FINANCIAL CONDITION The following table presents an average balance sheet of the Corporation for the following years: December 31, Assets Interest earning assets: Money market investments Government obligations Mortgage backed securities Corporate bonds FHLB stock Total investments Commercial loans Consumer loans Residential real estate loans Construction loans Finance leases Total loans Total interest earning assets Equity securities Total non-earning assets (1) Total assets Liabilities and stockholders’ equity Interest bearing liabilities: Interest bearing checking accounts Savings accounts Certificate accounts Interest bearing deposits Other borrowed funds FHLB advances Total interest bearing liabilities Total non-interest bearing liabilities Total liabilities Stockholders’ equity Total liabilities and stockholders’ equity 2003 2002 (In thousands) 2001 $ 455,866 850,516 2,257,617 181,063 40,447 3,785,509 2,340,744 1,198,964 2,286,809 314,588 150,832 6,291,937 10,077,446 34,029 318,787 $10,430,262 $ 259,447 922,887 4,158,111 5,340,445 2,965,714 633,692 8,939,851 597,651 9,537,502 892,760 $10,430,262 $ 60,522 1,236,281 2,144,236 259,840 32,586 3,733,465 2,080,892 1,048,283 1,283,710 223,627 136,851 4,773,363 8,506,828 52,703 188,691 $ 8,748,222 $ 215,462 609,324 3,622,918 4,447,704 2,868,212 339,477 7,655,393 368,315 8,023,708 724,514 $ 8,748,222 $ 46,517 588,932 1,711,980 247,094 21,841 2,616,364 1,584,910 1,036,637 869,374 219,890 127,872 3,838,683 6,455,047 48,122 198,233 $ 6,701,402 $ 186,111 436,595 2,859,181 3,481,887 2,125,022 256,354 5,863,263 307,237 6,170,500 530,902 $ 6,701,402 (1) Includes the allowance for loan losses and the valuation on investments securities available for sale. PAGE 36 2003 ANNUAL REPORT FIRST BANCORP PAGE 37 Assets The Corporation’s total assets at December 31, 2003 amounted to $12.7 billion, $3.1 billion over the $9.6 billion at December 31, 2002, mainly due to the growth in the Corporation’s loan portfolio during 2003 and growth of the investments portfolio in the last half of 2003. The following table presents the composition of the loan portfolio including loans held for sale at year-end for each of the last five years. December 31, 2003 % of Total 2002 % of Total 2001 % of Total 2000 % of Total 1999 % of Total (Dollars in thousands) Residential real estate loans Commercial real estate loans Construction loans Commercial loans Total commercial Finance leases Consumer loans Total $ 2,879,011 41 $1,854,068 33 $1,011,908 23 $ 746,792 21 $ 473,563 17 889,156 328,175 1,615,304 2,832,635 161,283 1,171,589 13 4 23 40 2 17 $ 7,044,518 100 14 813,513 5 259,053 25 1,418,792 44 2,491,358 3 143,412 20 1,149,012 $5,637,850 100 688,922 219,396 1,238,173 2,146,491 127,935 1,022,445 $4,308,779 16 5 29 50 3 24 438,321 203,955 947,709 1,589,985 122,883 1,038,538 100 $3,498,198 13 6 27 46 3 30 100 371,643 132,068 655,417 1,159,128 85,692 1,026,985 $2,745,368 14 5 24 43 3 37 100 Total loans receivable increased by $1,407 million in 2003 when compared with 2002. The Corporation is a balanced and diversified institution. As shown on the table above the loan portfolio is comprised of com- mercial (40%), residential real estate (41%), and con- sumer and finance leases (19%). This diversification has been achieved after several years of management efforts towards this goal. For 2003, the Corporation achieved significant increases of $341 million in the commercial loan portfolio and of $1,025 million in res- idential real estate loans. A significant portion of this increase is related to purchases of residential real estate loans from mortgage bankers in Puerto Rico, which yield a variable rate to the Bank. Finance leas- es, which are mostly composed of loans to individuals to finance the acquisition of an auto, increased by $18 million, and consumer loans increased by $23 million in 2003. The Corporation’s investment portfolio at December 31, 2003 amounted to $5.4 billion, an increase of $1.6 billion when compared with the investment portfolio of $3.7 billion at December 31, 2002. During 2003, the Corporation restructured its investments portfolio, which enabled it to record substantial profits on the securities sold, while at the same time gave it the opportunity to reinvest in 15 year FNMA mortgage- backed securities with more attractive yields and shorter maturities. Mortgage-backed securities repre- sent a substantial balance of the Corporation’s portfo- lio and are subject to prepayment risk. The restructur- ing of the portfolio during 2003 resulted mainly from the fact that during the year prepayments on mort- gage-backed securities accelerated when compared to recent historical experience. For a detail of invest- ments available for sale and held to maturity classified by maturity date refer to Note 8 to the Corporation’s financial statements. The composition and estimated tax equivalent weight- ed average interest and dividend yields of the Corporation’s earning assets at December 31, 2003 were as follows: Money market investments Federal Funds Government obligations Mortgage backed securities FHLB of N.Y. stock Corporate bonds Equity securities Total investments Consumer loans Residential real estate loans Construction loans Commercial and commercial real estate loans Finance leases Total loans (1) Total earning assets (1) Excludes the reserve for loan losses. Non-performing Assets Total non-performing assets are the sum of non-accru- ing loans and investments, other real estate owned and other repossessed properties. Non-accruing loans and investments are loans and investments as to which interest is no longer being recognized. When loans and investments fall into non-accruing status, all previously accrued and uncollected interest is charged against interest income. At December 31, 2003, total non-performing assets amounted to approximately $101 million (0.80% of total assets) as compared to $105 million (1.09% of total assets) at December 31, 2002 and $79 million (0.96% of total assets) at December 31, 2001. The decrease as compared to 2002 results from stable loan delinquencies during 2003 notwithstanding economic conditions. Non-performing loans decreased both in dollar amount and as a percentage of the portfolios when compared to 2002. The increase in dollar amount in 2002 when compared to 2001 is mostly composed of secured real estate loans and is mainly attributed to the Corporation’s general growth of these portfolios and to the acquisition of JP Morgan Chase’s Virgin Islands operations in October 2002. The Corporation’s allowance for loan losses to non-per- forming loans was 147.77% at December 31, 2003 as compared to 121.95% and 124.74% at December 31, 2002 and 2001, respectively. PAGE 38 2003 ANNUAL REPORT FIRST BANCORP PAGE 39 Amount (In thousands) $ 705,940 265,000 1,135,932 3,057,746 45,650 93,617 62,319 5,366,204 1,171,590 2,879,010 328,175 2,504,460 161,283 7,044,518 $ 12,410,722 Tax Equivalent Weighted Average Rate 1.12% 0.72% 5.73% 5.62% 1.45% 4.79% 0.73% 4.70% 12.27% 4.23% 4.89% 4.17% 10.14% 5.71% 5.27% The following table presents non-performing assets at the dates indicated. December 31, 2003 2002 2001 2000 (Dollars in thousands) 1999 Non-accruing loans: Residential real estate Commercial, commercial real estate and construction Finance leases Consumer Other real estate owned Other repossessed property Investment securities Total non-performing assets Past due loans Non-performing assets to total assets Non-performing loans to total loans Allowance for loan losses Allowance to total non-performing loans Non-accruing Loans $ 26,327 $ 23,018 $ 18,540 $ 15,977 $ 8,633 38,304 3,181 17,713 85,525 4,617 6,879 3,750 $ 100,771 23,493 $ 0.80% 1.21% $ 126,378 147.77% 47,705 2,049 18,993 91,765 2,938 6,222 3,750 $ 104,675 $ 24,435 1.09% 1.63% $ 111,911 121.95% 29,378 2,469 22,611 72,998 1,456 4,596 31,913 2,032 17,794 67,716 2,981 3,374 17,975 2,482 24,726 53,816 517 3,112 $ $ $ 79,050 27,497 0.96% 1.69% 91,060 124.74% $ 74,071 $ 16,358 1.25% 1.94% $ 76,919 113.59% $ 57,445 $ 13,781 1.22% 1.96% $ 71,784 133.39% At December 31, 2003, loans in which the accrual of interest income had been discontinued amounted to $85,525,000 (2002 - $91,765,000; 2001 - $72,998,000). If these loans had been accruing interest, the additional interest income realized would have been approxi- - mately $6,631,000 $5,735,000). There are no material commitments to lend additional funds to borrowers whose loans were in non-accruing status at these dates. - $5,833,000; 2001 (2002 Residential Real Estate Loans - The Corporation clas- sifies all real estate loans delinquent 90 days or more in non-accruing status. Even though these loans are in non-accruing status, Management considers, based on the value of the underlying collateral, the loan to value ratios and historical experience, that no material losses will be incurred in this portfolio. Non-accruing real estate loans amounted to $26 million (0.92% of total residential real estate loans) at December 31, 2003, as compared to $23 million (1.25% of total resi- dential real estate loans) and $19 million (1.83% of total residential real estate loans) at December 31, 2002 and 2001, respectively. The increase as com- pared to 2002 is mainly attributed to the general growth of this portfolio. Commercial Loans - The Corporation places commer- cial loans (including commercial real estate and con- struction loans) 90 days delinquent as to principal and interest in non-accruing status. The risk exposure of this portfolio is diversified as to individual borrowers and industries among other factors. In addition, a Past due consumer loans include personal lines of credit and credit card loans delinquent 90 days up to 179 days and personal loans (including small loans) delinquent 90 days up to 119 days. Sources of Funds The Corporation’s principal funding sources are branch-based deposits, retail brokered deposits, insti- tutional deposits, federal funds purchased, securities sold under agreements to repurchase, and FHLB advances. As of December 31, 2003, total liabilities amounted to $11,578 million, an increase of $2,733 million as com- pared to $8,845 million as of December 31, 2002. The net increase in total liabilities was mainly due to: (1) an increase of $1,282 million in total deposits, includ- ing $1,167 million in retail brokered certificates of deposit, (2) an increase of $857 million in federal funds and securities sold under agreements to repur- chase, (3) an increase of $540 million in advances from FHLB, (4) and an increase of approximately $54 million in accounts payable and other liabilities. The Corporation maintains unsecured standby lines of credit with other banks. At December 31, 2003 the Corporation’s total unused lines of credit with these banks amounted to approximately $95 million. At December 31, 2003, the Corporation had an available line of credit with the FHLB guaranteed with excess collateral, in the amount of approximately $83 million. During the latter part of the fourth quarter of 2003, the Corporation agreed to enter into various repurchase agreements with an aggregate amount of $400 million and a settlement date in 2004 with the purpose of lock- ing interest rates (range from 3.30% to 3.35%). The term of the agreements is for approximately ten years, however, the counterparty has an option to terminate the agreement after four (4) years. The fair value of these contracts at December 31, 2003 is not signifi- cant. large portion is secured with real estate collateral. Non-accruing commercial loans amounted to $38 mil- lion (1.35% of total commercial loans) at December 31, 2003 as compared to $48 million (1.91% of total com- mercial loans) and $29 million (1.37% of total commer- cial loans) at December 31, 2002 and 2001, respective- ly. The decrease as compared to 2002 results mainly from a significant non-accruing construction loan of $9.1 million at December 31, 2002, which at December 31, 2003 was out of non-accrual status since it was paid-off and to a lesser extend reduced by charge-offs. At December 31, 2003 there were seven non-accruing commercial loans over $1 million, for a total of $13.4 million. Finance Leases - Finance leases are classified as non- accruing when they are delinquent 90 days or more. Non-accruing finance leases amounted to $3 million (1.97% of total finance leases) at December 31, 2003 as compared to $2 million at December 31, 2002 and 2001 (1.43% and 1.93%, respectively, of total finance leases). Consumer Loans - Consumer loans are classified as non-accruing when they are delinquent 90 days in auto, boat and home equity reserve loans, 120 days in personal loans (including small loans) and 180 days in credit cards and personal lines of credit. Non-accruing consumer loans amounted to $18 mil- lion (1.51% of the total consumer loan portfolio) at December 31, 2003, $19 million (1.65% of the total con- sumer loan portfolio) at December 31, 2002 and $23 million (2.21% of the total consumer loan portfolio) at December 31, 2001. Other Real Estate Owned (OREO) OREO acquired in settlement of loans is carried at the lower of cost (carrying value of the loan) or fair value less estimated cost to sell off the real estate at the date of acquisition (estimated realizable value). Other Repossessed Property The other repossessed property category includes repossessed boats and autos acquired in settlement of loans. Repossessed boats are recorded at the lower of cost or estimated fair value. Repossessed autos are recorded at the principal balance of the loans less an estimated loss on the disposition based on historical experience. Investment securities This category presents investment securities reclassi- fied to non-accruing status, at their carrying amount. Past Due Loans Past due loans are accruing commercial and consumer loans, which are contractually delinquent 90 days or more. Past due commercial loans are current as to interest but delinquent in the payment of principal. PAGE 40 2003 ANNUAL REPORT FIRST BANCORP PAGE 41 2003 2002 (Dollars in thousands) 2001 $ 985,062 286,607 4,944,517 6,216,186 548,921 $ 6,765,107 $ 921,103 230,743 3,883,996 5,035,842 447,076 $ 5,482,918 $ 469,452 205,760 3,183,491 3,858,703 239,851 $ 4,098,554 2.11% 3.00% 4.62% $ 5,340,445 $ 4,447,704 $ 3,481,887 $ 520,902 $ 257,454 $ 233,254 Deposits Total deposits amounted to $6,765 million at December 31, 2003, as compared to $5,483 million and $4,099 million at December 31, 2002 and 2001, respec- tively. The following table presents the composition of total deposits. December 31, Savings accounts Interest bearing checking accounts Certificates of deposit Interest bearing deposits Non-interest bearing deposits Total Weighted average rate during the period on interest bearing deposits Interest bearing deposits: Average balance outstanding Non-interest bearing deposits: Average balance outstanding Total deposits are composed of branch-based deposits, brokered deposits and to a lesser extent of institutional deposits. Institutional deposits include among other certificates issued to agencies of the Government of Puerto Rico and to Governments in the Virgin Islands. Total deposits increased by approximately $1.3 billion at December 31, 2003 when compared to December 31, 2002 mainly due to an increase of approximately $1.2 billion in brokered certificates of deposits. Retail brokered certificates of deposits, which are cer- tificates sold through brokers represent 56% of the Corporation’s deposits at December 31, 2003. The total U.S. market for this source of funding approxi- mates $300 billion. The brokered certificates of deposit market is a very competitive and liquid market in which the Corporation has been able to obtain sub- stantial amounts of funding in short periods of time. Further, the Corporation’s liquidity position, as this type of deposit is unsecured. this strategy has also enhanced At December 31, 2003, approximately 75% of retail brokered certificates of deposit held by the Corporation are callable, but only at Corporation’s option. At December 31, 2003, the average remaining maturity of callable and fixed term brokered certifi- cates approximated 14.28 years (2002-12 years) and 1.12 years (2002-2.54 years), respectively. interest rate swap agreements where it agrees to pay variable-rates of interest as a hedge against changes in the fair value of fixed-rate brokered certificates of deposit. This swap strategy, which converts fixed rate brokered certificates of deposit in to variable instru- ments, provides an effective way to fund the variable rate commercial loan portfolio and the variable rate purchased residential real estate portfolio. The interest swap agreements are callable, only at the counter party’s option. Borrowings At December 31, 2003 total borrowings amounted to $4,646 million as compared to $3,249 million and $3,425 million at December 31, 2002 and 2001, respec- tively. December 31, Federal funds purchased and securities sold under agreements to repurchase Advances from FHLB Subordinated notes Total 2003 2002 (Dollars in thousands) 2001 $ 3,650,297 913,000 82,818 $ 4,646,115 $ 2,793,540 373,000 82,815 $ 3,249,355 $ 2,997,174 343,700 84,362 $ 3,425,236 Weighted average rate during the period 3.66% 4.36% 5.02% The Corporation uses federal funds purchased, repur- chase agreements, advances from FHLB, and notes payable as additional funding sources. Federal funds purchased and securities sold under agreements to repurchase (repurchase agreements) at December 31, 2003 amounted to $3,650 million or 79% of total bor- rowings. Repurchase agreements had a total weight- ed average cost of 3.05% at December 31, 2003. For more information on borrowings please refer to Notes 17 through 20 of the Corporation’s financial state- ments. The composition and estimated weighted average interest rates of liabilities at December 31, 2003, were as follows: interest bearing Interest bearing deposits Borrowed funds Amount (In thousands) $ 6,216,186 4,646,115 $ 10,862,301 Weighted Average Rate 1.82% 2.88% 2.27% fully explained As more the Corporation’s financial statements, as part of the asset and liability management, the Corporation enters into in Note 27 to PAGE 42 2003 ANNUAL REPORT FIRST BANCORP PAGE 43 Contractual Obligations and Commitments The following table presents a detail of the maturities of long-term contractual debt obligations, operating leases, certificates of deposits, commitments to pur- chase mortgage loans and commitments to extend credit: Contractual Obligations: Certificates of Deposit Federal funds purchased and securities sold under agreements to repurchase Advances from FHLB Subordinated Notes Operating Leases Other contractual obligations Total Contractual Obligations Commitments to Purchase Mortgage Loans Other Commitments: Lines of Credit Standby Letters of Credit Other Commercial Commitments Total Commercial Commitments Contractual Obligations and Commitments (In thousands) Total Less than 1 year 1-3 years 4-5 years After 5 years $ 4,944,517 $1,435,023 $ 507,371 $ 212,196 $2,789,927 50,000 82,818 7,104 2,272 $ 649,565 650,000 29,000 1,268,460 244,000 5,153 600 $ 896,949 7,272 $4,309,659 1,731,837 590,000 3,650,297 913,000 82,818 25,035 5,390 5,506 2,518 $ 9,621,057 $3,764,884 $ 575,000 $ 575,000 $ 202,235 $ 202,235 29,207 732,182 $ 963,624 $ 963,624 29,207 732,182 The Corporation has obligations and commitments to make future payments under contracts, such as debt and lease agreements, and under other commitments to purchase loans and to extend credit. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition estab- lished in the contract. Other contractual obligations result mainly from contracts for rent and maintenance of equipment. Since certain commitments are expect- ed to expire without being drawn upon, the total com- mitment amount does not necessarily represent future cash requirements. 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. Capital During 2003, the Corporation increased its total capital from $798 million at December 31, 2002 to $1,090 mil- lion at December 31, 2003. Total capital increased by $291 million mainly due to earnings of $152 million, the issuance of 7,584,000 shares of preferred stock with net proceeds of $183 million, the issuance of 72,750 shares of common stock through the exercise of stock options with proceeds of $1.1 million, a posi- tive fluctuation in the valuation of securities available for sale, and valuation of fair value hedges of $2.6 mil- lion, net of cash dividends of approximately $48 mil- lion. The Corporation’s objective is to maintain a solid cap- ital position above the “well capitalized” classification regulations. The under federal banking the Corporation continues to exceed the well capitalized guidelines. To be in a “well capitalized” position, an institution should have: (i) a leverage ratio (Tier 1 cap- ital to average assets) of 5% or greater; (ii) a total risk based capital ratio of 10% or greater; and (iii) a Tier 1 risk-based capital ratio of 6% or greater. At December 31, 2003 the Corporation had a leverage ratio of 8.35%; a total risk based capital ratio of 15.22%; and a Tier 1 risk-based capital ratio of 13.65%. Dividends In 2003, 2002 and 2001 the Corporation declared four quarterly cash dividends of $0.11, $0.10 and $0.09 per common share outstanding, respectively, for an annu- al dividend of $0.44, $0.40 and $0.35, respectively. Total cash dividends paid on common shares amount- ed to $17.6 million for 2003 (or a 14.43% dividend pay- out ratio), $16 million for 2002 (or a 19.58% dividend payout ratio) and $14 million for 2001 (or a 19.91% div- idend payout ratio). Dividends declared on preferred stock amounted to $30.4 million in 2003, $26 million in 2002, and $17 million in 2001. The increase in divi- dends on preferred stocks resulted from the issuance of preferred stock of $189.6 million in 2003, $92 million in 2002 and $103.5 million in 2001. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK First BanCorp manages its asset/liability position in order to limit the effects of changes in interest rates on net interest income, subject to other goals of Management and within guidelines set forth by the Board of Directors. The day-to-day management of interest rate risk, as well as liquidity management and other related mat- ters, is assigned to the Asset Liability Management and Investment Committee of FirstBank (ALCO). The ALCO is composed of the following officers: President and CEO, the Senior Executive Vice President and Chief Financial Officer, the Senior Executive Vice President and Chief Lending Officer, the Executive Vice President for Retail and Mortgage Banking, the Senior Vice President of Treasury and Investments and the Economist. The ALCO meets on a weekly basis. The Economist also acts as secretary, keeping minutes of all meetings. An Investment Committee for First BanCorp also monitors the investment portfolio of the Holding Company, including an equity securities port- folio, which amounted to a fair value of $62.3 million at December 31, 2003. This Committee meets weekly and has the same membership as the ALCO Committee described previously. Committee meetings focus on, among other things, current and expected conditions in world financial markets, competition and prevailing rates in the local deposit market, reviews of liquidity, unrealized gains and losses in securities, recent or proposed changes to the investment portfolio, alternative funding sources and their costs, hedging and the possible pur- chase of derivatives, such as swaps and caps, and any tax or regulatory issues which may be pertinent to these areas. The ALCO approves funding decisions in light of the Corporation’s overall growth strategies and objectives. On a quarterly basis the ALCO performs a comprehensive asset/liability review, examining the measures of interest rate risk described below togeth- er with other matters such as liquidity and capital. The Corporation uses simulations to measure the effects of changing interest rates on net interest income. These measures are carried out over a one year time horizon, assuming gradual upward interest rate movements of 200 basis points and downward movements of 75 basis points. Simulations are car- ried out in two ways: (1) using a balance sheet which is assumed to be at the same levels existing on the simulation date, and (2) using a balance sheet which has growth patterns and strategies similar to those which have occurred in the recent past. The balance sheet is divided into groups of similar assets and liabilities in order to simplify the process of carrying out these projections. As interest rates rise or fall, these simulations incorporate expected future lending rates, current and expected future funding sources and cost, the possible exercise of options, changes in prepayment rates, and other factors which may be important in determining the future growth of net interest income. All computations are done on a tax equivalent basis, including the effects of the changing cost of funds on the tax-exempt spreads of certain investments. The projections are carried out for First BanCorp on a fully consolidated basis. These simulations are highly complex, and they use many simplifying assumptions that are intended to reflect the general behavior of the Corporation over the period in question, but there can be no assurance that actual events will parallel these assumptions in all cases. For this reason, the results of these simulations are only approximations of the true sensitivity of net interest income to changes in market interest rates. Assuming a no growth balance sheet as of December 31, 2003, tax equivalent net interest income projected for 2004 would rise by $15.6 million (3.8%) under a ris- ing rate scenario and would decrease by $7.4 million (1.8%) under falling rates. As of December 31, 2003, the same simulations were also carried out assuming that the Corporation would grow. The growing balance sheet simulations indicate that tax equivalent net interest income projected for 2003, would rise by $16.2 million (3.7%) under a rising rate scenario and would decrease by $8.3 million (1.9%) with falling rates. PAGE 44 2003 ANNUAL REPORT FIRST BANCORP PAGE 45 Concentration Risk The Corporation conducts its operations in a geo- graphically concentrated area, as its main market is Puerto Rico. However, the Corporation continues diversifying its geographical risk as evidenced by recent acquisitions in the Virgin Islands. Puerto Rico’s economy is generally similar to U.S. economy and its economic performance is a natural result of its increasing integration into the U.S. economy. At December 31, 2003, there is no significant concentra- tion of credit risk in any specific industry. SELECTED QUARTERLY FINANCIAL DATA Financial data showing results of the 2003 and 2002 quarters is presented below. In the opinion of Management, all adjustments necessary for a fair presentation have been included: Interest income Net interest income Provision for loan losses Net income Earnings per common share-basic Earnings per common share-diluted Interest income Net interest income Provision for loan losses Net income Earnings per common share-basic Earnings per common share-diluted March 31 June 30 Sept. 30 Dec. 31 (In thousands, except for per share results) 2003 $ 132,919 72,437 16,564 36,428 0.74 0.73 $ $ $ 122,825 63,903 12,600 29,271 0.56 0.55 $ $ $ 133,618 71,896 12,600 31,684 0.62 0.61 $ $ $ 147,319 83,974 14,152 54,955 $ 1.12 $ 1.09 March 31 June 30 Sept. 30 Dec. 31 (In thousands, except for per share results) 2002 $ 136,716 69,271 19,801 25,650 0.49 0.49 $ $ $ 136,348 68,523 14,501 26,979 0.51 0.50 $ $ $ 129,606 60,338 14,000 27,357 0.52 0.51 $ $ $ 137,364 68,717 14,001 27,971 0.53 0.52 $ $ The simulation for the year 2003 assuming a no growth balance sheet as of December 31, 2002, con- cluded that under a rising rate scenario net interest income would have risen by $27.8 million (8.23%) and that under a falling rate scenario would have decreased by $1.5 million (0.5%). As of December 31, 2002, the same simulations were also carried assuming that Corporation was going to grow. The growing balance sheet simulation indicat- ed that the tax equivalent net interest income for 2003 would have risen by $27.0 million (7.70%) under a ris- ing interest rate scenario and decreased by $0.8 mil- lion (0.2%) with falling rates. The Corporation compared 2003 projections with actu- al results. In the growth scenario, which is more real- istic, the Bank projected taxable equivalent net interest income of $350.1 million under flat rates for 2003. In reality, taxable equivalent net interest income was $326.2 million. The most important reason for this dif- ference was that the projections did not include either higher than expected prepayments on mortgage- backed securities or changes which Management made in the investment portfolio after the projection was made, both of which were due to the low interest rate environment which prevailed during much of 2003. These changes generally led to smaller spreads than anticipated in the initial projection. Partially off- setting the effect of smaller spreads was a more rapid growth of the investment portfolio than the original projection had anticipated. Liquidity Liquidity refers to the level of cash and eligible invest- ments to meet loan and investment commitments, potential deposit outflows and debt repayments. The Asset Liability Management and Investment Committee, using measures of liquidity developed by Management, which involves the use of several assumptions, reviews the Corporation’s liquidity posi- tion on a weekly basis. The Corporation utilizes different sources of funding to help ensure that adequate levels of liquidity are avail- able when needed. Diversification of funding sources is of great importance as it protects the Corporation’s liquidity from market disruptions. The principal sources of short-term funds are loan repayments, deposits, securities sold under agreements to repur- chase, and lines of credit with the FHLB and other unsecured lines established with financial institutions. The Investment Committee reviews credit availability on a regular basis. In the past, the Corporation has securitized and sold auto and mortgage loans as sup- plementary sources of funding. Commercial paper has also provided additional funding, as well as long- term funding through the issuance of notes and long- term brokered certificates of deposit. The cost of these different alternatives, among other things, is taken into consideration. The Corporation’s principal uses of funds are the origination of loans and the repayment of maturing deposit accounts and borrowings. A large portion of the Corporation’s funding repre- sents retail brokered certificates of deposit. In the event that the Corporation falls under the ratios of a well-capitalized institution, it faces the risk of not being able to replace this source of funding. The Corporation currently complies with the minimum requirements of ratios for a “well capitalized” institu- tion and does not foresee falling below required levels to issue brokered deposits. In addition, the average life of the retail brokered certificates of deposit was approximately 11 years at December 31, 2003. Approximately 75% of these certificates are callable, but only at the Corporation’s option. Certificates of deposit with denominations of $100,000 or higher amounted to approximately $4.5 billion at December 31, 2003 of which approximately $3.8 billion were brokered certificates of deposit. The following table presents a maturity summary of brokered certificates of deposits at December 31, 2003: Less than one year Over one year to five years Over five years to ten years Over ten years Total Total (In thousands) $ $ 535,886 488,073 332,225 2,457,098 3,813,282 The Corporation’s liquidity plan contemplates alterna- tive sources of funding that could provide significant amounts of funding at reasonable cost. The alterna- tive sources of funding include, among others, FHLB advances, lines of credits from other banks, which amounted to $95 million at December 31, 2003, sale of commercial loans participations, securitization of auto loans and commercial paper. Impact of Inflation and Changing Prices The financial statements and related data presented herein have been prepared in conformity with accounting principles generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of his- torical dollars without considering changes in the rela- tive purchasing power of money over time due to infla- tion. Unlike most industrial companies, substantially all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a greater impact on a financial institution’s performance than the effects of general levels of inflation. Interest rate movements are not necessarily correlated with changes in the prices of goods and services. PAGE 46 2003 ANNUAL REPORT FIRST BANCORP PAGE 47 Market Prices and Stock Data The Corporation’s common stock is traded in the New York Stock Exchange (NYSE) under the symbol FBP. On December 31, 2003, there were 617 holders of record of the Corporation’s common stock. The following table sets forth the high and low prices of the Corporation’s common stock for the periods indicated as reported by the NYSE. Quarter ended High Low Last 2003: December September June March 2002: December September June March 2001: December September June March $ $ $ 40.32 31.98 31.68 28.00 26.38 27.61 25.13 19.80 20.00 20.00 17.99 17.42 $ $ $ 31.24 28.35 27.45 22.71 22.08 22.82 19.13 18.43 17.07 16.00 15.32 13.00 $ $ $ 39.55 30.75 27.45 26.98 22.60 25.41 25.13 19.27 19.00 17.24 17.99 17.27 PAGE 48 2003 ANNUAL REPORT FIRST BANCORP PAGE 49 LETTER TO STOCKHOLDERS FINANCIAL STATEMENTS PAGE 50 2003 ANNUAL REPORT PricewaterhouseCoopers LLP 254 Munoz Rivera Avenue BBVA Tower, 9th Floor Hato Rey PR 00918 Telephone (787) 754 9090 Facsimile (787) 766 1094 Report of Independent Auditors To the Board of Directors and Stockholders of First BanCorp In our opinion, the accompanying consolidated statements of financial condition and the related consolidated statements of income, comprehensive income, changes in stockholders' equity, and cash flows present fairly, in all material respects, the financial position of First BanCorp and its subsidiaries at December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. As discussed in Note 27 to the accompanying consolidated financial statements, in 2001 the Company adopted the Statement of Financial Accounting Standards No. 133, "Accounting for Certain Derivative Instruments and Certain Hedging Activities," as amended, which effect was accounted for as a cumulative effect of a change in accounting principle. PricewaterhouseCoopers LLP San Juan, Puerto Rico March 1, 2004 CERTIFIED PUBLIC ACCOUNTANTS (OF PUERTO RICO) License No. 216 Expires Dec. 1, 2004 Stamp 1935638 of the P.R. Society of Certified Public Accountants has been affixed to the file copy of this report FIRST BANCORP Consolidated Statements of Financial Condition FIRST BANCORP Consolidated Statements of Income Assets Cash and due from banks Money market instruments, including $222,992,538 pledged that can be repledged for 2002 Federal funds sold and securities purchased under agreements to resell Total money market investments Investment securities available for sale, at market: Securities pledged that can be repledged Other investment securities Total investment securities available for sale Investment securities held to maturity, at cost: Securities pledged that can be repledged Other investment securities Total investment securities held to maturity Federal Home Loan Bank (FHLB) stock Loans, net of allowance for loan losses of $126,378,484 (2002 - $111,911,470) Loans held for sale, at lower of cost or market Total loans, net Other real estate owned Premises and equipment, net Accrued interest receivable Due from customers on acceptances Other assets Total assets Liabilities & Stockholders’ Equity Liabilities: Non-interest bearing deposits Interest bearing deposits Federal funds purchased and securities sold under agreements to repurchase Advances from FHLB Bank acceptances outstanding Accounts payable and other liabilities Subordinated notes Commitments and contingencies Stockholders’ equity: Preferred Stock, authorized 50,000,000 shares; issued and outstanding 22,004,000 shares at $25 liquidation value per share (2002 - 14,420,000 shares) Common stock, $1 par value, authorized 250,000,000 shares; issued 44,948,185 shares (2002 - 44,875,435 shares) Less: Treasury Stock (at par value) Common stock outstanding Additional paid-in capital Capital reserve Legal surplus Retained earnings Accumulated other comprehensive income, net of tax of $613,081 (2002 - $11,127,054) Total liabilities and stockholders’ equity The accompanying notes are an integral part of these statements. December 31, 2003 December 31, 2002 $ 89,304,520 $ 108,305,943 705,939,823 251,659,553 265,000,000 970,939,823 990,408,046 228,729,507 1,219,137,553 2,687,039,595 443,437,738 3,130,477,333 45,650,000 6,906,289,028 11,850,639 6,918,139,667 4,616,888 85,269,402 41,508,434 286,611 162,580,138 $12,667,910,369 22,000,000 273,659,553 2,379,786,252 336,987,292 2,716,773,544 541,047,654 161,558,730 702,606,384 35,629,500 5,515,185,610 10,753,585 5,525,939,195 2,938,249 87,595,569 39,282,010 304,346 150,818,003 $ 9,643,852,296 $ 548,920,960 6,216,186,213 $ 447,076,347 5,035,841,381 3,650,297,211 913,000,000 286,611 166,831,871 11,495,522,866 82,818,437 11,578,341,303 2,793,539,832 373,000,000 304,346 112,851,285 8,762,613,191 82,815,105 8,845,428,296 550,100,000 360,500,000 44,948,185 (4,920,900) 40,027,285 268,855 80,000,000 163,106,509 220,038,308 44,875,435 (4,920,900) 39,954,535 70,000,000 149,345,178 145,243,124 36,028,109 1,089,569,066 $12,667,910,369 33,381,163 798,424,000 $ 9,643,852,296 Interest income: Loans Investment securities Short-term investments Dividends on FHLB stock Total interest income Interest expense: Deposits Federal funds purchased and repurchase agreements Notes payable Advances from FHLB Total interest expense Net interest income Provision for loan losses Net interest income after provision for loan losses Other income: Other fees on loans Service charges on deposit accounts Mortgage banking activities Net gain on sale of investments Rental income Derivatives gain (loss) Gain on sale of credit cards portfolio Other operating income Total other income Other operating expenses: Employees’ compensation and benefits Occupancy and equipment Business promotion Taxes, other than income taxes Insurance and supervisory fees Other Total other operating expenses Income before income tax provision and cumulative effect of accounting change Income tax provision Income before cumulative effect of accounting change Cumulative effect of accounting change, net of tax Net income Net income available to common stockholders Net income per common share basic: Income before cumulative effect of accounting change Cumulative effect of accounting change Earnings per common share basic Net income per common share diluted: Income before cumulative effect of accounting change Cumulative effect of accounting change Earnings per common share diluted Dividends declared per common share The accompanying notes are an integral part of these statements. 2003 Year ended December 31, 2002 2001 $389,721,772 140,977,049 4,775,947 1,206,378 536,681,146 $ 351,838,718 185,561,056 998,710 1,634,899 540,033,383 $ 353,777,585 159,713,664 1,475,521 1,289,125 516,255,895 112,540,796 105,856,415 6,655,888 19,418,432 244,471,531 292,209,615 133,234,567 117,127,270 6,797,889 16,023,967 273,183,693 266,849,690 160,758,451 97,952,979 8,904,611 12,585,108 280,201,149 236,054,746 55,915,598 62,301,996 61,030,000 236,294,017 204,547,694 175,024,746 20,617,491 9,526,946 3,013,840 34,856,273 2,223,734 619,473 30,885,353 16,967,078 118,710,188 75,213,081 36,394,322 12,414,820 7,404,729 3,729,860 28,836,736 163,993,548 21,440,852 9,200,327 3,540,034 12,000,487 2,285,021 (4,061,988) 14,087,218 58,491,951 59,432,111 29,015,200 9,304,277 6,857,010 2,803,905 25,343,669 132,756,172 19,631,741 9,213,436 1,562,158 9,606,314 2,292,541 10,673,633 52,979,823 54,702,977 24,991,540 7,506,040 5,973,897 2,475,411 25,204,513 120,854,378 191,010,657 130,283,473 107,150,191 38,672,315 152,338,342 22,327,122 107,956,351 20,133,858 87,016,333 (1,014,889) $152,338,342 $121,979,479 $ 107,956,351 $ 81,550,077 $ 86,001,444 $ 69,493,246 $ $ $ $ $ 3.04 3.04 2.98 2.98 0.44 $ $ $ $ $ 2.04 2.04 2.01 2.01 0.40 $ $ $ $ $ 1.77 (0.03) 1.74 1.76 (0.03) 1.73 0.35 PAGE 52 2003 ANNUAL REPORT FIRST BANCORP PAGE 53 FIRST BANCORP Consolidated Statements of Cash Flows FIRST BANCORP Consolidated Statements of Changes in Stockholders’ Equity Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation Amortization of core deposit intangible Provision for loan losses Deferred income tax benefit Gain on sale of investments, net Unrealized derivatives (gain) loss Net gain on sale of loans Amortization of deferred net loan (fees) cost Net originations of loans held for sale Gain on sale of credit cards portfolio Increase in accrued income tax payable Increase in accrued interest receivable Increase (decrease) in accrued interest payable Decrease in other assets (Decrease) increase in other liabilities Total adjustments Net cash provided by operating activities Cash flows from investing activities: Principal collected on loans Loans originated Purchase of loans Proceeds from sale of loans Proceeds from sale of investments securities Purchase of securities held to maturity Purchase of securities available for sale Principal repayments and maturities of securities held to maturity Principal repayments of securities available for sale Additions to premises and equipment Cash received for net liabilities assumed on acquisition of business Purchase of FHLB stock Net cash used in investing activities Cash flows from financing activities: Net increase in deposits Net increase (decrease) in federal funds purchased and securities sold under repurchase agreements FHLB advances taken Payments of notes payable Dividends Exercise of stock options Issuance of preferred stock Treasury stock acquired Net cash provided by financing activities Net increase in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period Cash and cash equivalents include: Cash and due from banks Money market investments 2003 Year ended December 31, 2002 2001 Preferred stock Common stock Additional paid-in capital Capital reserve Legal surplus Retained comprehensive income (loss) earnings Accumulated other $ 152,338,342 $ 107,956,351 $ 86,001,444 December 31, 2000 $165,000,000 $ 26,424,152 $16,567,516 $50,000,000 $126,792,514 $ 69,275,152 $(19,598,785) 13,761,331 2,396,620 55,915,598 (6,786,958) (34,856,273) (619,473) (2,917,364) (785,047) (36,873,320) (30,885,353) 10,393,838 (2,226,424) 12,518,655 7,131,161 (6,570,908) (20,403,917) 131,934,425 11,710,016 1,165,488 62,301,996 (8,610,812) (12,000,487) 4,522,925 (3,416,222) (1,544,375) (40,264,215) 3,434,149 (141,451) (1,364,672) 39,671,318 27,974,273 83,437,931 191,394,282 9,844,282 919,261 61,030,000 (5,402,000) (9,606,314) (1,282,845) 522,685 (4,629,562) 11,306,695 (9,661,332) 4,841,187 22,893,906 (9,395,151) 71,380,812 157,382,256 1,758,334,538 (2,064,719,667) (1,361,125,878) 264,126,724 1,439,718,183 (11,840,435,784) (1,464,811,333) 635,765,469 (903,166,444) (734,531,121) 83,862,533 2,242,654,071 (17,031,372,741) (10,336,516,102) 897,831,839 (1,334,581,873) (481,200,701) 42,343,060 847,716,293 (254,818,754) (12,462,323,482) 9,412,564,835 1,549,299,968 (11,435,164) 16,613,061,948 8,816,493,581 (14,412,317) 74,529,997 10,377,705,993 (13,912,556) (10,020,500) (2,328,504,078) 73,357,625 (12,738,900) (567,542,398) (4,354,100) (2,311,064,284) 1,343,294,310 790,122,398 764,012,251 Net income Other comprehensive income Issuance of preferred stock Addition to legal surplus Addition to capital reserve Treasury stock acquired Stock options exercised Cash dividends: Common stock Preferred stock December 31, 2001 Net income Other comprehensive income Issuance of preferred stock Addition to legal surplus Addition to capital reserve Stock options exercised Common stock split on September 30, 2002 Cash dividends: Common stock Preferred stock December 31, 2002 Net income Other comprehensive income Issuance of preferred stock Addition to legal surplus Addition to capital reserve Stock options exercised Cash dividends: Common stock Preferred stock December 31, 2003 103,500,000 (3,430,750) 10,000,000 10,000,000 (86,200) 234,000 (43,100) 1,121,211 268,500,000 26,571,952 14,214,877 60,000,000 136,792,514 86,001,444 (10,000,000) (10,000,000) (1,800,385) (13,835,100) (16,508,198) 103,132,913 107,956,351 13,305,431 (6,293,354) 39,674,517 92,000,000 (3,094,000) 64,500 1,276,343 10,000,000 12,552,664 (12,552,664) (10,000,000) 13,318,083 (12,397,220) (920,863) 360,500,000 39,954,535 - 70,000,000 149,345,178 189,600,000 (778,352) 72,750 1,047,207 10,000,000 13,761,331 (15,966,339) (26,406,274) 145,243,124 33,381,163 2,646,946 152,338,342 (5,823,109) (13,761,331) (10,000,000) (17,599,855) (30,358,863) $550,100,000 $ 40,027,285 $ 268,855 $80,000,000 $163,106,509 $ 220,038,308 $ 36,028,109 855,394,412 540,000,000 (47,958,718) 1,119,957 182,998,539 2,874,848,500 678,278,847 381,965,496 $ 1,060,244,343 $ 89,304,520 970,939,823 $ 1,060,244,343 $ $ $ (202,096,134) 29,300,000 (1,550,000) (42,372,613) 1,340,843 88,906,000 663,650,494 287,502,378 94,463,118 381,965,496 108,305,943 273,659,553 381,965,496 1,134,888,478 276,700,000 (62,000,000) (30,343,298) 1,355,211 100,069,250 (1,929,685) 2,182,752,207 29,070,179 65,392,939 94,463,118 59,898,550 34,564,568 94,463,118 $ $ $ The accompanying notes are an integral part of these statements. The accompanying notes are an integral part of these statements. PAGE 54 2003 ANNUAL REPORT FIRST BANCORP PAGE 55 FIRST BANCORP Consolidated Statements of Comprehensive Income 2003 Year ended December 31, 2002 2001 Net income $ 152,338,342 $ 107,956,351 $ 86,001,444 Other comprehensive income: Unrealized gains on securities: Unrealized holding gains arising during the period Less: Reclassification adjustment for gains included in net income Unrealized gain (loss) on fair value hedge of available for sale securities attributable to credit risk Cumulative effect of accounting change Income tax benefit (expense) related to items of other comprehensive income Other comprehensive income for the period, net of tax 26,570,827 65,157,017 27,280,982 (34,856,273) (12,000,487) (9,606,314) 418,419 (257,174) 10,513,973 2,646,946 (13,224,839) 39,674,517 (1,260,094) 1,326,000 (4,435,143) 13,305,431 Total comprehensive income $ 154,985,288 $ 147,630,868 $ 99,306,875 The accompanying notes are an integral part of these statements. FIRST BANCORP Notes to Consolidated Financial Statements NOTE 1 - NATURE OF BUSINESS First BanCorp (the Corporation) is a financial holding company offering a full range of financial services through its wholly-owned bank subsidiary, FirstBank Puerto Rico (FirstBank or the Bank). First BanCorp also offers insurance services through its wholly-owned insurance subsidiary, FirstBank Insurance Agency. The Corporation is subject to the Federal Bank Holding Company Act and its insurance subsidiary is subject to the supervision, examination and regulation of the Office of the Insurance Commissioner of the Commonwealth of Puerto Rico. FirstBank is a commercial bank chartered under the laws of the Commonwealth of Puerto Rico. Its main office is located in San Juan, Puerto Rico, and it has 42 full-service banking branches in Puerto Rico and 12 in the U.S. Virgin Islands (USVI) and British Virgin Islands (BVI). The Bank, through wholly-owned subsidiaries, operates 58 offices in Puerto Rico specializing in resi- dential mortgage loan originations, small personal loans, finance leases, and vehicle rental, one office that sells insurance in the U.S. Virgin Islands, and two offices, one in the U.S. Virgin Islands and one in Barbados specializing in foreign sales corporation management and three offices specializing in the orig- ination of small loans in the USVI. The Bank offers bro- kerage services in selected branches through an alliance with an international brokerage house doing business in Puerto Rico. The Bank is subject to the supervision, examination and regulation of the Office of the Commissioner of Financial Institutions of the Commonwealth of Puerto Rico and the Federal Deposit Insurance Corporation (FDIC), which insures the U.S. and USVI. deposits through the Savings Association Insurance Fund (SAIF). The Virgin Islands operations of FirstBank are regulated by the Virgin Islands Banking Board (for the USVI) and by the British Virgin Islands Financial Services Commission (for the BVI). In September 2003, First Mortgage Inc., a wholly- owned subsidiary of FirstBank started operations spe- cializing in the origination of residential mortgage loans and related services. In November 2003, First Express Inc., a wholly-owned subsidiary of FirstBank, started operations in the USVI specializing in the orig- ination of small personal loans. NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) which require management to make esti- mates and assumptions that affect the reported amounts of assets and liabilities and disclosure of con- tingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. These estimates are based on information available as of the date of the consolidated financial statements. Therefore, actu- al results could differ from those estimates. For purposes of comparability, certain prior period amounts have been reclassified to conform with the 2003 presentation. Following is a description of the more significant accounting policies followed by the Corporation: Principles of consolidation The consolidated financial statements include the accounts of the Corporation and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Statements of cash flows For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks and short-term money market instruments with original maturities of 90 days or less. Securities purchased under agreements to resell The Corporation purchases securities under agree- ments to resell the same securities. The counterparty retains control over the securities acquired, according- ly, amounts advanced under these agreements repre- sent short-term loans and are reflected as assets in the statements of financial condition. The Corporation monitors the market value of the underlying securities as compared to the related receivable, including accrued interest, and requests additional collateral where deemed appropriate. Investment securities The Corporation classifies its investments in debt and equity securities into one of three categories: Held to maturity - Securities which the entity has the positive intent and ability to hold to maturity. These securities are carried at amortized cost. Trading - Securities that are bought and held principal- ly for the purpose of selling them in the near term. These securities are carried at fair value, with unreal- ized gains and losses reported in earnings. At December 31, 2003 and 2002 the Corporation did not hold investment securities for trading purposes. Available for sale - Securities not classified as trading or as held to maturity. These securities are carried at fair value, with unrealized holding gains and losses, net of deferred tax, reported in other comprehensive income as a separate component of stockholder’s equity. PAGE 56 2003 ANNUAL REPORT FIRST BANCORP PAGE 57 Premiums and discounts are amortized as an adjust- ment to interest income on investments over the life of the related securities using a method that approxi- mates the interest method. Realized gains and losses related to investment securities are determined using the specific identification method and are reported in Other Income as net gains on the sale of investments. Evaluation of other-than-temporary impairment on available for sale and held to maturity securities The Corporation evaluates for impairment its debt and equity securities when their market value has remained below cost for six months or more, or earli- er if other factors indicative of potential impairment exist. Investments are considered to be impaired when a decline in fair value is judged to be other-than- temporary. The Corporation employs a systematic methodology that considers all available places evi- dence in evaluating a potential impairment of its investments. The impairment analysis of the fixed income invest- ments places special emphasis on the analysis of the cash position of the company, its cash and capital gen- eration capacity, which could increase or diminish the company’s ability to repay its bond obligations. The Corporation also considers its intent and ability to hold the fixed income securities. If Management believes, based on the analysis, that the company will not be able to service its debt and pay its obligations on a timely manner, the security is written down to Management’s estimate of net realizable value. For securities written down to its estimate net realizable value, any accrued and uncollected interest is also reversed. Interest income is then recognized if collect- ed. The equity securities impairment analyses are per- formed and reviewed on an ongoing basis based on the latest financial information and any supporting research report made by a major brokerage house. These analyses are very subjective and based, among other things, on relevant financial data such as capital- ization, cash flow, liquidity, systematic risk, and debt outstanding. Management also considers the industry trends, the historical performance of the stock, as well as the Corporation’s intent to hold the security for an extended period. If Management believes there is a low probability of recovering book value in a reason- able time frame, then an impairment will be recorded by writing the security down to market value. An impairment charge is generally recognized when an equity security has remained significantly below cost (over twenty percent 20%) for a period of twelve month. Loans held for sale Loans held for sale are stated at the lower of cost or market. The amount by which cost exceeds market value in the aggregate portfolio of loans held for sale, if any, is accounted for as a valuation allowance with changes therein included in the determination of net income. Loans and allowance for loan losses Loans are stated at their outstanding balance less unearned interest and net deferred loan origination fees and costs. Unearned interest on certain personal and auto loans is recognized as income under a method, which approximates the interest method. Loans on which the recognition of interest income has been discontinued are designated as non-accruing. When loans are placed on non-accruing status, any accrued but uncollected interest income is reversed and charged against interest income. Consumer loans are classified as non-accruing when they are delin- quent: 90 days or more for auto, boat and home equi- ty reserve loans; 120 days or more for personal loans; and 180 days or more for credit cards and personal lines of credit. Commercial and mortgage loans are classified as non-accruing when they are delinquent 90 days or more. This policy is also applied to all impaired loans based upon an evaluation of the risk characteristics of said loans, loss experience, econom- ic conditions and other pertinent factors. Loan losses are charged and recoveries are credited to the allowance for loan losses. The Corporation has defined impaired loans as loans with interest and/or principal past due 90 days or more and other specific loans for which, based on current information and events, it is probable that the debtor will be unable to pay all amounts due according to the contractual terms of the loan agreement. The Corporation measures impairment individually for those commercial and real estate loans with a princi- pal balance exceeding $1 million. An allowance for impaired loans is established based on the present value of expected future cash flows or the fair value of the collateral, if the loan is collateral dependent. Groups of small balance, homogeneous loans are col- lectively evaluated for impairment considering among other factors, historical charge-off experience, existing economic conditions and risk characteristics relevant to the particular loan category. The portfolios of resi- dential mortgage loans, consumer loans, auto loans and finance leases are considered homogeneous and are evaluated collectively for impairment. Loan fees and costs Loan fees and costs incurred in the origination of loans are deferred and amortized using the interest method or under a method that approximates the interest method over the life of the loans as an adjust- ment to interest income. When a loan is paid off or sold, any unamortized net deferred fee (cost) is credit- ed (charged) to income. Servicing assets The Corporation recognizes as separate assets the rights to service loans for others, whether those serv- icing assets are originated or purchased. The total cost of the loans to be sold with servicing assets retained is allocated to the servicing assets and the loans (without the servicing asset), based on their rel- ative fair values. Servicing assets are amortized in proportion to and over the period of estimated net servicing income. Loan servicing fees, which are based on a percentage of the principal balances of the loans serviced, are credited to income as loan pay- ments are collected. To estimate the fair value of servicing assets the Corporation considers the present value of expected future cash flows associated with the servicing assets. For purposes of measuring impairment of servicing assets, the Corporation stratifies such assets based on predominant risk characteristics of underlying loans. The amount of impairment recognized, if any, is the amount by which the servicing asset exceeds its esti- mated fair value. Impairment, if any, is charged against servicing income. Other real estate owned Other real estate owned, acquired in settlement of loans, is recorded at the lower of cost (carrying value of the loan) or fair value minus estimated cost to sell the real estate. Gains or losses resulting from the sale of these properties and losses recognized on the peri- odic reevaluations of these properties are credited or charged to net cost (gain) of operations and disposi- tion of other real estate owned. The cost of maintain- ing and operating these properties is expensed as incurred. Premises and equipment Premises and equipment are carried at cost, less accu- mulated depreciation. Depreciation is provided on the straight-line method over the estimated useful lives of the individual assets. Depreciation of leasehold improvements is computed on the straight-line method over the terms of the leases or estimated use- ful lives of the improvements, whichever is shorter. Costs of maintenance and repairs, which do not improve or extend the life of the respective assets are expensed as incurred. Costs of renewals and better- ments are capitalized. When assets are sold or dis- posed of, their cost and related accumulated deprecia- tion are removed from the accounts and any gain or loss is reflected in earnings. Securities sold under agreements to repurchase The Corporation sells securities under agreements to repurchase the same or similar securities. Generally, similar securities are securities from the same issuer, with identical form and type, similar maturity, identical contractual interest rates, similar assets as collateral and the same aggregate unpaid principal amount. The Corporation retains control over the securities sold under these agreements, accordingly, these agreements are considered financing transactions and the securities underlying the agreements remain in the asset accounts. The counter party to certain agree- ments may have the right to repledge the collateral by contract or custom. Such assets are presented sepa- rately in the statements of financial condition as secu- rities pledged to creditors that can be repledged. the transactions affect Accounting for income taxes Deferred taxes arise because certain transactions affect the determination of income for financial report- ing purposes in periods different from the period in income. which Deferred taxes have been recorded based upon the Puerto Rico enacted tax rates. Current tax expense has been provided based upon the estimated tax lia- bility incurred for tax return purposes. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be real- ized. taxable Treasury stock The Corporation accounts for treasury stock at par value. Under this method, the treasury stock account is increased by the par value of each share of common stock reacquired. Any excess paid per share over the par value is debited to additional paid-in capital for the amount per share that it was originally credited. Any remaining excess is charged to retained earnings. Stock option plan The Corporation has a stock-based employee compen- sation plan, which is described more fully in Note 5. The Corporation accounts for the plan under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and relat- ed Interpretations. No stock based employee compen- sation cost is reflected in net income, as all options granted under the plan had an exercise price equal to the market value of the underlying common stock on the date of the grant. Options granted are not subject to vesting requirements. The table below illustrates the effect on net income and earnings per share if the Corporation had applied the fair value recognition pro- visions of Financial Accounting Standards Board (FASB) Statement No. 123, Accounting for Stock Based Compensation, to stock-based employee compensa- tion granted in year 2003 and 2002 (no options were granted during 2001). PAGE 58 2003 ANNUAL REPORT FIRST BANCORP PAGE 59 Year ended December 31, 2003 2002 (In thousands, except per share data) $ 152,338 $ 107,956 2,897 149,441 3.04 2.98 2.98 2.91 $ $ $ $ $ 2,215 105,741 2.04 1.99 2.01 1.96 $ $ $ $ $ Proforma net income and earnings per common share Net income As reported Deduct: Stock-based employee compensation expense determined under fair value method Pro forma Earnings per common share-basic: As reported Pro forma Earnings per common share-diluted: As reported Pro forma Management uses the Black-Scholes option pricing model for the computation of the estimated fair value of each option granted to buy shares of the Corporation’s common stock. The fair value of each option granted during 2003 and 2002 (no options were granted during 2001) was estimated using the follow- ing assumptions: expected weighted dividend yield of 1.72% (2003) and 1.85% (2002); expected life of 3.29 years; weighted expected volatility of 45.94% (2003) and 31.76% (2002); and weighted risk-free interest rate of 2.09% (2003) and 3.66% (2002). The weighted esti- mated fair value of the options granted was $7.94 (2003) and $4.08 (2002) per option. Comprehensive income Comprehensive income includes net income and sev- eral other items that current accounting standards require to be recognized outside of net income, prima- rily the unrealized gain (loss) on securities available for sale, net of estimated tax effect, and the change in fair value attributable to credit risk on securities hedged with interest rate swaps. Derivative instruments On January 1, 2001, the Corporation adopted the Statement of Financial Accounting Standards (SFAS) No. 133 “Accounting for Derivatives Instruments and Hedging Activities”, as amended. All derivatives are recognized in the statement of financial position at fair value. Changes in the fair value of derivative instru- ments are accounted for as current income or other comprehensive income, depending on their intended use and designation. For transactions that qualify for hedge accounting, SFAS No. 133 provides for a match- ing of the timing of gain or loss recognition on the hedging instrument with the recognition in earnings of (a) the changes in the fair value of the hedged asset or liability, that are attributable to the hedged risk (fair value hedges) or (b) the effect of the exposure to the variability of cash flows from the hedged asset or lia- bility (cash flows hedges). Note 27 describes in more detail the hedging transactions entered into by the Corporation. Earnings per common share Earnings per share-basic is calculated by dividing income available to common stockholders by the weighted average number of outstanding common shares. The computation of earnings per share-dilut- ed is similar to the computation of earnings per share- basic except that the weighted average common shares are increased to include the number of addi- tional common shares that would have been outstand- ing if the dilutive potential common shares had been issued. Stock options outstanding under the Corporation’s stock option plan are considered in the earnings per share-diluted by application of the treas- ury stock method, which assumes that proceeds for the exercise of options are used to repurchase com- mon stock in the open market. Any stock splits or stock dividends are retroactively recognized in all peri- ods presented in financial statements. Acquisition of business Business combinations are accounted using the pur- chase method of accounting. Assets acquired and lia- bilities assumed are recorded at estimated fair values at the date of acquisition. After initial recognition, any resulting intangible assets are accounted for as fol- lows: • Definite life intangibles are amortized over their esti- mated life, generally on a straight line basis and are reviewed periodically for impairment. • Goodwill and other indefinite life intangibles are not amortized but are reviewed periodically for impair- ment. Recently issued accounting pronouncements During 2003 the Financial Accounting Standards Board (FASB) issued the following financial account- ing pronouncements: In December 2003, the FASB published a revision to its Interpretation No. 46 (FIN 46) to clarify some of the provisions of FIN 46 and to exempt certain entities from its requirements. FIN 46, as revised, applies to variable interest entities that are commonly referred to as special-purpose entities for periods ending after December 15, 2003 and for all other types of variable interest entities for periods ending after March 15, 2004. It requires the consolidation of a variable inter- est entity (as defined) by its primary beneficiary. Primary beneficiaries are those companies that are subject to a majority of the risk of loss or entitled to receive a majority of the variable interest entity’s resid- ual returns, or both. The adoption of FIN 46 did not have any effect on the Corporation’s financial state- ments. SFAS 149 - Amendment of Statement 133 on Derivative Instruments and Hedging Activities. This Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other con- tracts (collectively referred to as derivatives) and for hedging activities under FASB Statement No. 133. This Statement is effective for contracts entered into or modified after June 30, 2003, except for contracts which relate to forward purchases or sales of when- issued securities or other securities that do not yet exist, for which in the Statement should be applied to both existing contracts and new contracts entered into after June 30, 2003. The adoption of this standard did not have an impact on the Corporation’s financial posi- tion or results of operations. SFAS 150 - Accounting For Certain Financial Instruments with Characteristics of both Liabilities and Equity - Issued on May 15, 2003, this Statement estab- lishes standards for how an entity classifies and meas- ures certain financial instruments with characteristics of both liabilities and equity. It requires that an entity classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of this standard did not have an impact on the Corporation’s financial position or results of oper- ations. In November 2003, the Accounting Standards Executive Committee issued the Statement of Position (SOP) No. 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer.” This statement addresses accounting for differences between con- tractual cash flows and cash flows expected to be col- lected from an investor’s initial investment in loans or debt securities (loans) acquired in a transfer if those differences are attributable, at least in part, to credit quality. This SOP does not apply to loans originated by the entity. This SOP prohibits “carrying over” or cre- ation of valuation allowances in the initial accounting of all loans acquired in a transfer that are within the scope of this SOP. The prohibition of the valuation allowance carry-over applies to the purchase of an individual loan, a pool of loans, a group of loans, and loans acquired in a purchase business combination. This SOP is effective for loans acquired in fiscal years beginning after December 15, 2004. Management believes that the adoption of this statement will not have a material effect on the Corporation’s consolidat- ed financial statements. PAGE 60 2003 ANNUAL REPORT FIRST BANCORP PAGE 61 NOTE 3 - STOCKHOLDERS’ EQUITY Common stock The Corporation has 250,000,000 shares of authorized common stock with a par value of $1 per share. At December 31, 2003, there were 44,948,185 (2002- 44,875,435) shares issued and 40,027,285 (2002- 39,954,535 shares outstanding). The Corporation issued 72,750, 96,750 and 351,000 shares of common stock during 2003, 2002 and 2001, respectively, as part of the exercise of stock options under the Corporation’s stock option plan. The 2002 and the 2001 number of shares issued was adjusted for the September 30, 2002 stock split. Stock repurchase plan and treasury stock The Corporation has a stock repurchase program under which, from time to time, it repurchases shares of common stock in the open market and holds them as treasury stock. No shares of common stock were repurchased during 2003 and 2002 by the Corporation. From the total amount of common stock repurchased, 4,920,900 shares were held as treasury stock at December 31, 2003 and 2002 and were available for general corporate purposes. issued 7,584,000 shares of Preferred stock The Corporation has 50,000,000 shares of authorized non-cumulative and non-convertible preferred stock with a par value of $25, redeemable at the Corporation’s option subject to certain terms. This stock may be issued in series and the shares of each series shall have such rights and preferences as shall be fixed by the Board of Directors when authorizing the issuance of that particular series. During 2003, the Corporation the Corporation’s “Series E Preferred Stock”, (3,680,000 shares in 2002; 4,140,000 shares in 2001; 3,000,000 shares in 2000 and 3,600,000 shares in 1999). The liq- uidation value per share is $25. Annual dividends of $1.75 per share (issuance of 2003), $1.8125 per share (issuance of 2002), $1.85 per share (issuance of 2001), $2.0875 per share (issuance of 2000) and 1.78125 per share (issuance of 1999), are payable monthly, if declared by the Board of Directors. During the year, dividends declared on preferred stock amounted to $30,358,863 (2002 - $26,406,274; 2001 - $16,508,198). Capital reserve The capital reserve account was established to comply with certain regulatory requirements of the Office of the Commissioner of Financial Institutions of the Commonwealth of Puerto Rico related to the issuance of subordinated notes by FirstBank in 1995. An amount equal to 10% of the principal of the notes is set aside each year from retained earnings until the reserve equals the total principal amount. At the notes repayment date the balance in capital reserve is to be transferred to the legal surplus account or retained earnings after the approval of the Commissioner of Financial Institutions of the Commonwealth of Puerto Rico. Legal surplus The Banking Act of the Commonwealth of Puerto Rico requires that a minimum of 10% of FirstBank’s net income for the year be transferred to legal surplus, until such surplus equals the total of paid in capital on common and preferred stock. Amounts transferred to the legal surplus account from the retained earnings account are not available for distribution to the stock- holders. NOTE 4 - REGULATORY CAPITAL REQUIREMENTS The Corporation is subject to various regulatory capi- tal requirements imposed by the federal banking agencies. Failure to meet minimum capital require- ments can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Corporation’s financial statements. Under capital ade- quacy guidelines and the regulatory framework for prompt corrective action, the Corporation must meet specific capital guidelines that involve quantitative measures of the Corporation’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Corporation’s capital amounts and classification are also subject to qualitative judgment by the regulators about compo- nents, risk weightings and other factors. Capital standards established by regulations require the Corporation to maintain minimum amounts and ratios of Tier 1 capital to total average assets (leverage ratio) and ratios of Tier 1 and total capital to risk- weighted assets, as defined in the regulations. The total amount of risk-weighted assets is computed by applying risk-weighting factors to the Corporation’s assets and certain off-balance sheet items, which vary from 0% to 100% depending on the nature of the asset. At December 31, 2003 and 2002, the most recent noti- fication from FDIC, categorized the Corporation as a well-capitalized institution under the regulatory frame- work for prompt corrective action. To be categorized as well as capitalized, the Corporation must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following table. Management believes that there are no conditions or events since that date that have changed that classifi- cation. The Corporation’s and its banking subsidiary’s regula- tory capital positions were as follows: Actual Amount Ratio Regulatory requirement For capital adequacy purposes Ratio Amount (Dollars in thousands) To be well capitalized Amount Ratio At December 31, 2003 Total Capital (to Risk Weighted Assets) First Bancorp FirstBank $ 1,103,798 $ 974,208 15.22% $ 580,090 13.49% $ 577,872 Tier I Capital (to Risk Weighted Assets) First Bancorp FirstBank $ 989,853 $ 867,025 13.65% $ 290,045 12.00% $ 288,936 Tier Capital (to Average Assets) First Bancorp FirstBank $ 989,853 $ 867,025 8.35% $ 355,713 7.38% $ 352,631 At December 31, 2002 Total Capital (to Risk Weighted Assets) First Bancorp FirstBank $ 816,946 $ 739,996 13.75% $ 475,155 12.50% $ 473,617 Tier I Capital (to Risk Weighted Assets) First Bancorp FirstBank $ 707,083 $ 632,487 11.90% $ 237,578 10.68% $ 236,809 Tier Capital (to Average Assets) First Bancorp FirstBank NOTE 5 - STOCK OPTION PLAN $ 707,083 $ 632,487 7.35% $ 288,628 6.62% $ 286,801 8% 8% 4% 4% 3% 3% 8% 8% 4% 4% 3% 3% $ 725,113 $ 722,340 10% 10% $ 435,068 $ 433,404 $ 592,855 $ 587,718 6% 6% 5% 5% $ 593,944 $ 592,022 10% 10% $ 356,366 $ 355,213 $ 481,046 $ 478,002 6% 6% 5% 5% The Corporation has a stock option plan covering certain employees. The options granted under the plan cannot exceed 20% of the number of common shares outstanding. Each option provides for the purchase of one share of com- mon stock at a price not less than the fair market value of the stock on the date the option is granted. Stock options are fully vested upon issuance. The maximum term to exer- cise 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 issuance and distribu- tions. PAGE 62 2003 ANNUAL REPORT FIRST BANCORP PAGE 63 Following is a summary of the activity related to stock options: At December 31, 2000 Exercised Canceled At December 31, 2001 Granted Exercised At December 31, 2002 Granted Exercised At December 31, 2003 The exercise price of the options outstanding at December 31, 2003, ranges from $10.42 to $29.55 and the weighted average remaining contractual life is approximately six years. Following is additional information concerning the stock options outstanding at December 31, 2003. Numbers of Options Exercise Price per Option 300,000 65,000 60,000 18,000 259,500 3,000 261,000 428,500 514,500 20,000 357,000 5,000 2,291,500 $ $ $ $ $ $ $ $ $ $ $ $ 10.42 12.79 18.06 17.71 17.33 17.29 13.08 14.88 18.69 25.99 25.63 29.55 Number of Options Weighted Average Exercise Price per Option 1,907,250 (351,000) (3,000) 1,553,250 542,750 (96,750) 1,999,250 365,000 (72,750) 2,291,500 $ 12.24 $ 3.86 $ 18.92 $ 14.12 $ 18.96 $ 13.86 $ 15.44 $ 25.68 $ 15.43 $ 17.08 Contractual Maturity November 2007 February 2008 May 2008 June 2008 November 2008 February 2009 November 2009 December 2010 February 2012 October 2012 February 2013 May 2013 NOTE 6 - EARNINGS PER COMMON SHARE The calculations of earnings per common share for the years ended December 31, 2003, 2002 and 2001 follow: 2003 Year ended December 31, 2002 (In thousands, except per share data) 2001 Net income Less: Preferred stock dividend Net income-attributable to common stockholders $ 152,338 (30,359) $ 121,979 $ 107,956 (26,406) 81,550 $ $ $ 86,001 (16,508) 69,493 Earnings per common share-basic: Net income - available to common stockholders Weighted average common shares outstanding Earnings per common share-basic $ 121,979 39,994 3.04 $ $ $ 81,550 39,901 2.04 $ $ 69,493 39,851 1.74 $ 121,979 $ 81,550 $ 69,493 39,994 989 40,983 2.98 $ 39,901 652 40,553 2.01 $ 39,851 293 40,144 1.73 $ Earnings per common share-diluted: Net income - available to common stockholders Weighted average common shares and share equivalents: Average common shares outstanding Common stock equivalents - Options Total Earnings per common share-diluted Stock options outstanding, under the Corporation’s stock option plan for officers, are common stock equivalents and, therefore, considered in the compu- tation of earnings per common share diluted. Common stock equivalents were computed using the treasury stock method. For the year ended December 31, 2003, all options outstanding were included in the computation of outstanding shares. In 2002, 20,000 stock options (2001-10,500) were not included in the computation of outstanding shares because they were antidilutive. NOTE 7-CASH AND DUE FROM BANKS The Corporation is required by law to maintain mini- mum average reserve balances. The amount of those average reserve balances for the week ended December 31, 2003 was approximately $104,000,000 at (2002 - $93,000,000). PAGE 64 2003 ANNUAL REPORT FIRST BANCORP PAGE 65 Obligations of U.S. Government Agencies: After 1 to 5 years After 5 to 10 years After 10 years Puerto Rico Government Obligations: After 5 to 10 years After 10 years United States and Puerto Rico Government Obligations Mortgage-backed Securities: FHLMC certificates: After 1 to 5 years After 5 to 10 years After 10 years GNMA certificates: After 5 to 10 years After 10 years FNMA certificates: Within 1 year After 1 to 5 years After 5 to 10 years After 10 years Mortgage pass through certificates: After 10 years Mortgage-backed Securities Corporate Bonds: Within 1 year After 1 to 5 years After 5 to 10 years Corporate bonds Equity securities (without contractual maturity) Total Investment Securities Available for Sale NOTE 8 - INVESTMENT SECURITIES Investment Securities Available For Sale The amortized cost, gross unrealized gains and losses, approximate market value, weighted average yield and contractual maturities of investment securities available for sale at December 31, 2003 and 2002 were as follows: December 31, 2003 Amortized cost Gross Unrealized gains losses Weighted Market average Amortized yield% value cost Investments Held to Maturity The amortized cost, gross unrealized gains and losses, approximate market value, weighted average yield and contractual maturities of investment securities held to maturity at December 31, 2003 and 2002 were as follows: December 31, 2003 Gross Unrealized gains losses Amortized cost December 31, 2002 Gross Unrealized gains losses Weighted Market average yield% value Market value Weighted average Amortized yield% cost (Dollars in thousands) December 31, 2002 Gross Unrealized gains losses Weighted Market average yield% value (Dollars in thousands) $ 500 $ 750 15,568 $ 7,546 8,612 5.81 5.99 4,999 5,679 3 17 480 375 401 $ 503 767 16,048 3.87 5.60 7.69 5,374 6,080 6.27 6.30 $ 16,158 5.90 $ 27,496 $ 1,276 $ 28,772 7.02 $ $ $ 354 459 813 112 312 193 617 $ $ $ 7,192 8,153 15,345 2,217 4,596 3,863 10,676 2,536 169,220 171,756 $ 2,329 4,908 4,056 11,293 6.52 $ 7.60 6.89 7.12 1,458 $ 8,211 6,347 16,016 133 3,836 3,969 $152 152 2,669 172,904 175,573 6.42 5.19 5.21 3,608 524,278 527,886 2 565 885,521 886,088 43 13,155 13,198 2 608 898,676 899,286 6.96 8.24 4.80 4.80 29 5 764 1,916,460 1,917,258 82 613 358 1,053 170 9,439 9,609 53 39,523 39,576 $ 1,540 8,824 6,705 17,069 3,778 533,717 537,495 29 5 817 1,955,983 1,956,834 6.47 7.42 6.86 7.11 6.41 5.11 5.12 6.33 7.68 7.66 4.93 4.93 U.S. Treasury Securities: Due within 1 year Obligations of other U.S. Government Agencies: Due within 1 year After 1 to 5 years After 10 years Puerto Rico Government Obligations: After 1 to 5 years After 10 years United States and Puerto Rico Government obligations Mortgage-backed securities: FHLMC certificates After 1 to 5 years After 5 to 10 years FNMA certificates: After 5 to 10 years After 10 years Mortgage-backed securities: Corporate bonds: Due within 1 year After 1 to 5 years Corporate bonds Total Investment Securities $ 11,318 $ 7 $ 11,311 0.90 14,979 500 1,083,337 $ 144 163 1 17,225 14,816 1.05 499 3.02 1,066,256 4.45 $628,820 $ 3,307 $ 59 $632,068 7.85 5,000 4,641 175 648 5,175 5.00 5,289 6.50 5,000 4,354 113 586 5,113 4,940 5.00 6.50 $ 1,119,775 $ 967 $ 17,396 $ 1,103,346 4.38 $638,174 $ 4,006 $ 59 $642,121 7.82 $ 35,005 $ 830 $ 34,175 3.65 29,491 1,906,359 $ 162 $ 1,970,855 $ 162 94 16,464 $ 17,388 29,397 3.81 1,890,057 4.04 $ 1,953,629 4.03 $ $ 39,847 $ 72 39,847 $ 72 $ $ 39,919 2.69 39,919 2.69 $ 25,000 39,432 $ 64,432 $ 609 $ 609 $ 25,000 38,823 $ 63,823 3.05 2.95 2.98 732 7 739 7.27 1,175 32 1,207 7.23 Held to Maturity $ 3,130,477 $1,201 $ 34,784 $ 3,096,894 4.14 $702,606 $ 4,006 $ 668 $705,944 7.38 $ 1,069,252 $17,791 $152 $1,086,891 4.89 $2,462,335 $ 50,270 $2,512,605 4.99 45,000 3,750 48,750 $ 1,395 3,625 $ 5,020 $ 979 $ $ 46,395 7,375 $ 53,770 4.51 7.67 4.75 $ 143,966 $ 85,711 57,276 36 1,244 445 1,725 $10,865 1,084 $11,949 $ 1,015 7.87 76,090 6.16 6.94 56,637 6.48 $ 133,742 48,051 $14,464 $196 $ 62,319 0.73 $ 36,951 $ 10,006 $ 5,302 $ 41,655 1.72 $ $ $ $ 1,181,398 $38,088 $348 $1,219,138 4.76 $2,670,748 $ 63,277 $17,251 $2,716,774 5.04 Maturities for mortgage-backed securities are based upon contractual terms assuming no repayments. Expected maturities of investments might differ from contractual maturities because they may be subject to prepayments and/or call options. The weighted aver- age yield on investment securities held for sale is based on amortized cost; therefore, it does not give effect to changes in fair value. Expected maturities of investments might differ from contractual maturities because they may be subject to prepayments and/or call options. Rates in the corpo- rate bonds classified as held to maturity are floating. Investment Activities The net unrealized gains or losses on available for sale securities are presented in accumulated other com- prehensive income. During the first quarter of 2003, the Corporation reduced its deferred tax liability on the unrealized gains on available for sale securities to reflect current Puerto Rico tax statutes, which provide for tax exemp- tion on the gain on sale of investments held by the Corporation’s international banking divisions. This tax benefit is reflected in Other Comprehensive Income. PAGE 66 2003 ANNUAL REPORT FIRST BANCORP PAGE 67 During 2003, the Corporation replaced and grew its investments portfolio. In the first quarter of 2003, the Corporation’s bank subsidiary sold $700 million of its 15-year 5.5% coupon and 30 year 6.5% mortgage- backed securities portfolio, to take advantage of a market opportunity, which arose when the 10-year treasury notes rate reached 3.56%. Also during 2003, prepayments on mortgage-backed securities and repayments on callable securities accelerated when compared to recent historical experience. A substan- tial amount of the proceeds from both the aforemen- tioned sales and accelerated prepayments of mort- gage-backed securities was maintained in money mar- ket instruments, awaiting an opportunity to reenter the longer-term investment market. For such reasons, interest income was affected during this waiting peri- od, which included the first half of 2003 and the first part of the third quarter of 2003. During the months of July and August of 2003, with the increase in the 10- year treasury note rates, the Corporation’s Bank sub- sidiary reinvested proceeds from sales and prepay- ments and grew its portfolio by purchasing $2.0 billion in 15-year 5% coupon FNMA securities. For this rea- son, the Corporation’s Bank subsidiary investment interest income increased since August 2003 after the mortgage-backed securities purchases. The restruc- turing of the investment’s portfolio, briefly discussed above, enabled the Corporation to record substantial profits on securities sold, while at the same time gave the Corporation the opportunity to reinvest in mort- gage-backed securities with more attractive yields and shorter maturities. During 2003, Management’s impairment analyses on its debt and equity securities portfolios concluded that other-than-temporary impairments had occurred in certain investments. As a result the Corporation rec- ognized impairment charges against the net gain on sale of investments category of Other Income of approximately $5.8 million in corporate bonds and equity securities. Management determined that except for the impairments on these bonds and stocks, there are no other-than-temporary impairments on the rest of the bonds and equity securities portfolio. As of December 31, 2003, the Corporation did not hold any investments securities with significant unrealized losses sustained for more than one year. The invest- ment securities with unrealized losses as of December 31, 2003 are mainly mortgage-backed securities and obligations of U.S. government agencies for which the Corporation has the intent and ability to hold to matu- rity and, as such, have been classified as securities held-to-maturity on the Corporation’s consolidated financial statements. Specifically, at December 31, 2003, the most significant unrealized losses were reflected in U.S. government agencies obligations held-to-maturity with an amortized cost of approxi- mately $850 million and unrealized losses of approxi- mately $17 million, and Federal National Mortgage Association (FNMA) mortgage-backed securities held- to-maturity with an amortized cost of approximately $1,834 million and unrealized losses of approximately $16 million. Both, the U.S. government agencies obli- gations and the FNMA mortgage-backed securities were purchased during 2003. The unrealized losses on these securities result substantially from interest rate fluctuations, and, because of Management’s intention to hold them until maturity, are expected to recover in full. Further, Management does not con- sider that such securities have been impaired, since it is considered that the interest and principal on these securities will be repaid when due based on several factors such as credit quality and the fact that the prin- cipal and interest on substantially all of the securities with an unrealized loss position are guaranteed by government sponsored agencies such as FNMA, GNMA, FHLB, and FHLMC, and in the case of the mort- gage-backed securities, also by residential real estate collateral. Total proceeds from the sale of securities during the year period ended December 31, 2003 amounted to $1,440 million (2002 - $2,243 million). The Corporation realized gross gains of $43.8 million (2002 - $49.7 mil- lion, 2001 - $13.6 million), and gross realized losses and other-than-temporary impairments of $8.9 million (2002 - $37.7 million, 2001 - $4 million). NOTE 9 - FEDERAL HOME LOAN BANK (FHLB) STOCK 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 percent- age of total FHLB advances, letters of credit, and the collateralized portion of interest-rate swaps outstand- ing. The stock is capital stock issued at $100 par. Both stock and cash dividends may be received on FHLB stock. At December 31, 2003 and 2002, there were invest- ments in FHLB stock with book value of $45,650,000 and $35,629,500, respectively. The estimated market value of such investments is its redemption value determined by the ultimate recoverability of its par value. In September 2003, the FHLB of New York announced the suspension of dividends on its out- standing common stock for the third quarter of 2003. At that time, Management’s impairment analyses con- cluded that no other-than-temporary impairments had occurred on these securities. In January 2004, the FHLB declared dividends on its outstanding common stock for the fourth quarter of 2003. NOTE 10 - INTEREST AND DIVIDEND ON INVESTMENTS A detail of interest and FHLB dividend income on investments follows: Mortgage Backed Securities: Taxable Exempt Other Investment Securities: Taxable Exempt NOTE 11 - LOANS RECEIVABLE The following is a detail of the loan portfolio: Residential real estate loans, mainly secured by first mortgages Deferred net loan fees Residential real estate loans Commercial loans: Construction loans Commercial loans Commercial mortgages Commercial loans Finance leases Consumer and other loans: Personal Personal lines of credit Auto Boat Credit card Home equity reserve loans Unearned interest Consumer and other loans Loans receivable Allowance for loan losses Loans receivable, net Loans held for sale Total loans 2003 Year ended December 31, 2002 (In thousands) 2001 $ $ $ $ 1,305 94,358 95,663 2,307 48,989 51,296 $ $ $ $ 3,765 117,338 121,103 3,079 64,013 67,092 $ $ $ $ 2,666 106,571 109,237 2,639 50,602 53,241 December 31, 2003 December 31, 2002 (In thousands) $ 2,871,222 (4,062) 2,867,160 $ 1,846,561 (3,247) 1,843,314 328,175 1,615,304 889,156 2,832,635 161,283 410,572 11,906 665,484 59,385 58,568 4,552 (38,878) 1,171,589 7,032,667 (126,378) 6,906,289 11,851 6,918,140 $ 259,053 1,418,792 813,513 2,491,358 143,412 413,931 10,401 565,478 53,017 164,172 4,566 (62,553) 1,149,012 5,627,096 (111,911) 5,515,185 10,754 5,525,939 $ PAGE 68 2003 ANNUAL REPORT FIRST BANK PAGE 69 Decrease in credit cards loans portfolio is attributed to the sale of approximately $114 million to MBNA Corporation in the last quarter of 2003; the sale gener- ated a gain of approximately $31 million. The sale was made pursuant to a long term strategic marketing alliance with MBNA, whereas FirstBank and MBNA together will be able to offer a wider selection of cred- it card services to consumers in Puerto Rico. The Corporation’s primary lending area is Puerto Rico. The Corporation’s subsidiary Bank also lends in the U.S. and British Virgin Islands markets. At December 31, 2003 and 2002 there is no significant concentration of credit risk in any specific industry on the loan port- folio. At December 31, 2003, loans in which the accrual of interest income had been discontinued amounted to $85,525,000 (2002 - $91,765,000; 2001 - $72,998,000). If these loans had been accruing interest, the additional interest income realized would have been approxi- mately $6,631,000 - $5,735,000). There are no material commitments to lend additional funds to borrowers whose loans were in non-accruing status at these dates. - $5,833,000; 2001 (2002 At December 31, 2003, the Corporation was servicing residential mortgage loans owned by others aggregat- ing approximately $266,155,000 (2002 - $196,748,000; 2001 - $160,583,000). Various loans secured by first mortgages were assigned as collateral for certificates of deposit, indi- vidual retirement accounts, advances from the Federal Home Loan Bank, and unused lines of credit. The mortgage loans pledged as collateral amounted to $1,325,384,220 and $778,829,294 at December 31, 2003 and 2002, respectively. NOTE 12 - ALLOWANCE FOR LOAN LOSSES The changes in the allowance for loan losses were as follows: Balance at beginning of year Provision charged to income Losses charged against the allowance Recoveries credited to the allowance Other adjustments Balance at end of year 2003 Year ended December 31, 2002 (In thousands) $ 111,911 55,916 (48,132) 6,683 $ 91,060 62,302 (48,991) 7,540 $ 126,378 $ 111,911 $ $ 2001 76,919 61,030 (54,380) 7,391 100 91,060 At December 31, 2003, $75 million ($27 million at December 31, 2002) in commercial, real estate, and construction loans over $1,000,000 were considered impaired with an allowance of $14.8 million ($5.9 mil- lion at December 31, 2002). For 2003, $12.6 million of the allowance on impaired loans was established based on the fair value of the collateral and $2.2 mil- lion was established based on the present value of expected future cash flows. The total allowance for impaired loans as of December 31, 2002 was estab- lished based on the fair value of collateral. The allowance for impaired loans is part of the allowances for loan losses. The increase in loans considered impaired is mainly in loans with real estate collateral. These loans represent loans for which management has determined that is probable that the debtor will be unable to pay all the amounts due, according to the contractual terms of the loan agreement, and do not necessarily represent loans for which the Corporation will incur a substantial loss. The average recorded investment in impaired loans amounted to $45 million for 2003 (2002 - $18.9 million). Interest income in the amount of approximately $2,922,000 was recognized on impaired loans in 2003 (2002 – $803,000; 2001 – $377,000). NOTE 13 - RELATED PARTY TRANSACTIONS The Corporation granted loans to its directors, execu- tive officers and to certain related individuals or enti- ties in the ordinary course of business. The move- ment and balance of these loans were as follows: Balance at December 31, 2001 New loans Payments Balance at December 31, 2002 New loans Payments Other changes Balance at December 31, 2003 Amount (In thousands) $ $ $ 34,663 48,784 (1,943) 81,504 12,236 (2,338) (37,115) 54,287 These loans do not involve more than normal risk of collectivity and present terms no more favorable than those that would have been obtained if transactions had been with unrelated parties. The amounts report- ed as other changes include changes in the status of those who are considered related parties. PAGE 70 2003 ANNUAL REPORT FIRST BANCORP PAGE 71 NOTE 14 - PREMISES AND EQUIPMENT Premises and equipment are stated at cost less accu- mulated depreciation as follows: Land Buildings and improvements Leasehold improvements Furniture and equipment Accumulated depreciation Projects in progress Total premises and equipment, net NOTE 15 - INTANGIBLE ASSETS At December 31, 2003, the Corporation has a core deposit intangible with a carrying amount of $18,410,919 (2002 - $20,807,539) included in the Other Assets category. The straight-line amortization expense for the year ended December 31, 2003 amounted to approximately $2,400,000. The estimat- ed aggregate amortization expense for each of the five succeeding fiscal years will be approximately $2,400,000. Management has reviewed the core deposits intangible assets concluding that no impair- ment exists and that the useful life of ten years used to amortize them is the best estimate of the economic benefit period. NOTE 16 - DEPOSITS AND RELATED INTEREST Deposits and related interest consist of the following: Type of account and interest rate: Savings accounts – 1.00% to 1.45% (2002 – 1.25% to 2.25%) Interest bearing checking accounts – 1.00% to 1.35% (2002 – 1.15% to 2.00%) Non-interest bearing checking accounts Certificate of deposit – 0.75% to 7.85% (2002 – 1.00% to 7.85%) Useful life in years December 31, 2003 2002 (In thousands) 10-40 1-15 3-10 $ $ 8,303 51,476 22,107 70,093 151,979 (72,315) 79,664 5,605 85,269 $ $ 8,203 41,918 20,436 94,675 165,232 (87,083) 78,149 9,447 87,596 2003 December 31, (In thousands) 2002 $ 985,062 $ 921,103 286,607 548,921 4,944,517 $ 6,765,107 230,743 447,076 3,883,996 $ 5,482,918 The weighted average interest rate on total deposits at December 31, 2003 and 2002 was 1.82% and 2.58%, respectively. At December 31, 2003, the aggregate amount of over- drafts in demand deposits that were reclassified as loans amounted to $14,809,498 (2002 - $7,281,895). The following table presents a summary of certificates of deposits with a remaining term of more than one year at December 31, 2003: Over one year to two years Over two years to three years Over three years to four years Over four years to five years Over five years Total Total (In thousands) $ 183,730 323,641 98,294 113,902 2,789,928 $ 3,509,495 At December 31, 2003 certificates of deposit (CD’s) in denominations of $100,000 or higher amounted to $4,508,865,618 (2002 - $3,379,748,775) including bro- kered certificates of deposit of $3,813,218,000 (2002 - $2,645,909,222) at a weighted average rate of 1.90%, after hedging (2002 – 2.64%). See Note 27 for a description of the program used to hedge the fair value of the brokered certificates of deposit. At December 31, 2003, deposit accounts issued to gov- ernment agencies with a carrying value of $378,861,589 (2002 - $220,869,357) were collateralized by securities with a carrying value of $422,369,034 (2002 - $259,433,606) and estimated market value of $423,913,988 (2002 - $263,467,485), by mortgage loans with a carrying value of $2,416,677 and estimated mar- ket value of $3,010,938 in 2002, there were no mort- gages as collateral as of December 31, 2003, and by municipal obligations with a carrying value and esti- - mated market value of $32,850,000 $27,810,000). (2002 A table showing interest expense on deposits follows: Savings Interest bearing checking accounts Certificates of deposit Total 2003 Year ended December 31, 2002 (In thousands) 2001 $ $ 11,849 3,426 97,266 112,541 $ $ 15,096 4,763 113,376 133,235 $ $ 12,954 5,296 142,508 160,758 PAGE 72 2003 ANNUAL REPORT FIRST BANCORP PAGE 73 NOTE 17 - 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: 2003 December 31, (In thousands) 2002 Federal funds purchased, interest rate 1.28% Repurchase agreements, interest ranging from 0.88% to 5.39% (2002 - 1.00% to 5.37%) Accrued interest payable Total $ 155,000 3,484,472 10,825 3,650,297 $ $ 2,784,078 9,462 $ 2,793,540 The weighted average interest rates of federal funds purchased and repurchase agreements at December 31, 2003 and 2002 was 3.13% and 3.82%, respectively. Federal funds purchased and repurchase agreements mature as follows: One to thirty days Over thirty to ninety days Over ninety days to one year Over one year Total 2003 December 31, (In thousands) 2002 $ $ 664,573 899,939 156,500 1,918,460 3,639,472 $ 708,924 194 2,074,960 $ 2,784,078 The following securities were sold under agreements to repurchase: Underlying securities U.S. Treasury Securities and obligations of other U.S. Government Agencies Mortgage backed securities Corporate bonds Total Accrued interest receivable Underlying securities U.S. Treasury Securities and obligations of other U.S. Government Agencies P.R. Government Securities Mortgage backed securities Corporate bonds Total Accrued interest receivable December 31, 2003 Amortized cost of underlying securities Approximate Weighted average market value interest of underlying rate securites Balance of borrowing (In thousands) $ 788,517 2,836,204 37,370 $ 3,662,091 $ 13,321 Amortized cost of underlying securities $ 718,886 290 2,248,037 130,525 $ 3,097,738 $ 12,257 $ 750,273 2,698,642 35,557 $ 3,484,472 $ 773,954 2,835,237 37,442 $ 3,646,633 4.06% 4.84% 2.69% December 31, 2002 Approximate Weighted average market value interest of underlying rate securites Balance of borrowing (In thousands) $ 646,095 260 2,020,414 117,309 $ 2,784,078 $ 721,216 324 2,293,031 130,523 $ 3,145,094 5.70% 6.48% 5.67% 5.20% The maximum aggregate balance outstanding at any month-end during 2003 was $3,985,306,843 (2002 - $3,342,284,753). The average balance during 2003 was - $2,784,701,323). $2,881,937,413 approximately (2002 At December 31, 2003 and 2002, the securities under- lying such agreements were delivered to, and are being held by the dealers with which the repurchase agreements were transacted, except for transactions where the Corporation has agreed to repurchase sim- ilar but not identical securities. PAGE 74 2003 ANNUAL REPORT FIRST BANCORP PAGE 75 NOTE 18 - ADVANCES FROM THE FEDERAL HOME LOAN BANK (FHLB) Following is a detail of the advances from the FHLB: Maturity Interest rate 2003 2002 December 31, January 13, 2003 January 2, 2004 January 5, 2004 January 7, 2004 January 7, 2004 January 23, 2004 August 16, 2005 October 9, 2008 October 16, 2008 February 28, 2011 March 21, 2011 1.44% 1.08% 1.11% 1.15% 1.05% 1.18% 6.30% 5.10% 5.09% 4.50% 4.42% (In thousands) $ 50,000 $ $ 50,000 60,000 80,000 200,000 200,000 50,000 14,000 15,000 79,000 165,000 913,000 50,000 14,000 15,000 79,000 165,000 373,000 $ Advances are received from the FHLB under an Advances, Collateral Pledge and Security Agreement (the Collateral Agreement). Under the Collateral Agreement, the Corporation is required to maintain a minimum amount of qualifying mortgage collateral with a market value at least 110% of the outstanding advances. At December 31, 2003, specific mortgage loans with an estimated value of $994,306,442 (2002 - $553,144,554), as computed by Federal Home Loan Bank for collateral purposes, were pledged to the FHLB as part of the Collateral Agreement. The carry- ing value of such loans at December 31, 2003 amount- ed to $1,304,868,690 (2002 - $776,412,617). In addi- tion, securities with an approximated market value of $2,109,236 (2002 - $26,587,830) and a carrying value of $2,200,795 (2002 - $29,149,623) were pledged to the FHLB. NOTE 19 - SUBORDINATED NOTES in (2002 repurchased was $82,818,437 On December 20, 1995, the Corporation issued 7.63% subordinated capital notes the amount of $100,000,000 maturing in 2005. The notes were issued at a discount. At December 31, 2003 the out- standing balance net of the unamortized discount and notes - $82,815,105). Interest on the notes is payable semian- nually and at maturity. The notes represent unsecured obligations of the Corporation ranking subordinate in right of payment to all existing and future senior debt including the claims of depositors and other general creditors. The notes may not be redeemed prior to their maturity. At December 31, 2003, the Corporation has transferred to capital reserves from the retained earnings account $80,000,000 as a result of the requirement explained in Note 3 - “Stockholders’ Equity.” NOTE 20 - UNUSED LINES OF CREDIT these banks amounted The Corporation maintains unsecured standby lines of credit with other banks. At December 31, 2003 and 2002, the Corporation’s total unused lines of credit to approximately with $95,000,000 and $180,000,000, respectively. At December 31, 2003, the Corporation has an available line of credit with the FHLB guaranteed with excess collateral, the amount of approximately $83,415,678. in NOTE 21 - EMPLOYEES’ BENEFIT PLAN FirstBank provides contributory retirement plans pur- suant to Section 1165(e) of the Puerto Rico Internal Revenue Code for Puerto Rico employees and Section 401(K) of the U.S. Internal Revenue Code for U.S.V.I. employees. All employees are eligible to participate in the Plan after one year of service. Under the provi- sions of the Plan, the Bank contributes a quarter of the first 4% of each participant’s compensation. Participants are permitted to contribute up to 10% of their annual compensation, limited to $8,000 per year ($12,000 for U.S.V.I. employees). Additional contribu- tions to the Plan are voluntarily made by the Bank as determined by its Board of Directors. The Bank had a total plan expense of $1,235,230; $861,478 and $845,227 during 2003, 2002 and 2001, respectively. NOTE 22 - OTHER EXPENSES A detail of other expenses follows: Professional and service fees Communications Revenue earning equipment Supplies and printing Other Total NOTE 23 - INCOME TAXES The Corporation is subject to Puerto Rico income tax on its income from all sources. For United States income tax purposes, the Corporation is treated as a foreign corporation. Accordingly, it is generally sub- ject to United States income tax only on its income from sources within the United States or income effec- tively connected with the conduct of a trade or busi- ness within the United States. Any United States income tax paid by the Corporation is creditable, with- in certain conditions and limitations, as a foreign tax 2003 Year ended December 31, 2002 (In thousands) 2001 $ $ 9,402 6,959 1,642 2,034 8,800 28,837 $ $ 7,685 5,865 1,588 1,963 8,243 25,344 $ $ 7,461 5,395 1,578 1,282 9,489 25,205 PAGE 76 2003 ANNUAL REPORT FIRST BANCORP PAGE 77 credit against its Puerto Rico tax liability. In addition, certain interest including interest on U.S. Treasury and agency securities is not taxable in the U.S. under port- folio interest exception applicable to certain foreign corporations. The Corporation is also subject to B.V.I. and U.S.V.I taxes on its income from sources within these jurisdictions. However, any tax paid, subject to certain conditions and limitations, is creditable as a foreign tax credit against its P.R. tax liabilities. The provision for income taxes was as follows: Current Deferred Total Income tax expense applicable to income before pro- vision for income tax differs from the amount comput- ed by applying the Puerto Rico statutory rate of 39% as follows: 2003 Year ended December 31, 2002 (In thousands) 2001 $ $ 45,459 (6,787) 38,672 $ $ 30,938 (8,611) 22,327 $ $ 25,536 (5,402) 20,134 2003 % of pre-tax Income Amount Year ended December 31, 2002 2001 % of pre-tax Income % of pre-tax Income Amount Amount (Dollars in thousands) Computed income tax at statutory rate Benefit of net exempt income Other-net Total income tax provision $ 74,494 (37,766) 1,944 $ 38,672 39 (20) 1 20 $ 50,811 (31,819) 3,335 $ 22,327 39 (24) 2 17 $ 41,789 (24,442) 2,787 $ 20,134 39 (23) 3 19 The components of the deferred tax asset and liability were as follows: Deferred tax asset: Allowance for loan losses Unrealized loss on fair value hedges attributable to credit risk Other Deferred tax asset Deferred tax liability: Unrealized gain on available for sale securities Other Deferred tax liability 2003 December 31, (In thousands) 2002 $ $ $ 49,288 7,647 56,935 (613) (16) (629) $ $ $ 43,645 379 6,584 50,608 (11,506) (98) (11,604) No valuation allowance was considered necessary for the deferred tax asset. Deferred tax assets and liabili- ties are presented net in the statement of financial condition under Other Assets. The tax effect of the unrealized holding gain or loss for securities available for sale, outside the Corporation’s international banking entities, was computed based on a 25% capital gain tax rate, and is included in accu- mulated other comprehensive income as a part of stockholders’ equity. The Puerto Rico Treasury Department conducted an investigation of the Bank’s income tax returns for the years 1995, 1997, 1998 and 1999 and certain tax posi- tions for the years 2000, 2001 and 2002. On July 2003, the Bank and the Puerto Rico Tax Department reached an agreement whereby the investigations of the afore- mentioned tax returns and tax positions were closed. The agreement did not have a material impact on the Corporation’s results of operations. NOTE 24 - COMMITMENTS through the year 2021. At December 31, 2003 certain premises are leased with terms expiring The Corporation has the option to renew or extend certain leases from two to ten years beyond the original term. Some of these leases require the payment of insur- ance, increases in property taxes and other incidental costs. At December 31, 2003, the obligation under var- ious leases follows: Year 2004 2005 2006 2007 2008 2009 and later years Total Amount (In thousands) $ $ 5,506 3,845 3,259 2,944 2,209 7,272 25,035 Rental expense included in occupancy and equipment expense was $5,378,802 in 2003 (2002 - $4,509,798; 2001 - $4,240,437). PAGE 78 2003 ANNUAL REPORT FIRST BANCORP PAGE 79 NOTE 25 - FAIR VALUE OF FINANCIAL INSTRUMENTS The information about the estimated fair values of financial instruments required by accounting princi- ples generally accepted in the United States of America, is presented hereunder. The disclosure requirements exclude certain financial instruments and all non-financial instruments. Accordingly, the aggregate fair value amounts presented do not repre- sent Management’s estimate of the underlying value of the Corporation. A summary table of estimated fair values and carrying values of financial instruments at December 31, 2003 and 2002 follows: December 31, 2003 2002 Estimated fair value Carrying value Estimated fair value Carrying value (In thousands) $1,060,244 4,316,032 45,650 $ 1,060,244 4,349,615 45,650 $ 381,965 3,422,718 35,630 $ 381,965 3,419,380 35,630 6,912,047 864 6,918,140 864 5,527,122 27,022 5,525,939 27,022 6,769,147 6,765,107 5,499,998 5,482,918 3,806,685 933,017 88,725 43,243 3,650,297 913,000 82,818 43,243 2,966,580 399,941 89,084 9,739 2,793,540 373,000 82,815 9,739 Assets: Cash and due from banks and money market instruments Investment securities FHLB stock Loans receivable, including loans held for sale – net Interest rate swaps, included in other assets Liabilities: Deposits Federal funds purchased and securities sold under agreements to repurchase Advances from FHLB Subordinated notes Interest rate swaps, included in other liabilities The estimated fair values are subjective in nature and involve uncertainties and matters of significant judg- ment and, therefore, cannot be determined with preci- sion. Changes in the underlying assumptions used in calculating the fair values could significantly affect the results. In addition, the fair value estimates are based on outstanding balances without attempting to esti- mate the value of anticipated future business. Therefore, the estimated fair values may materially differ from the values that could actually be realized on a sale. The estimated fair values were calculated using cer- tain facts and assumptions, which vary depending on the specific financial instrument, as follows: Cash and due from banks and money market instruments The carrying amounts of cash and due from banks and money market instruments are reasonable estimates of their fair values. and savings deposits that bear a low or zero rate of interest and do not fluctuate in response to changes in interest rates. Federal funds and securities sold under agreements to repurchase Federal funds purchased and some repurchase agree- ments reprice at least quarterly, and their outstanding balances are estimated to be their fair values. Where longer commitments are involved, fair values are esti- mated using indications from brokers of the cost of unwinding the transactions as of December 31, 2003. Advances from FHLB and subordinated notes The fair values of advances from FHLB with fixed maturities are determined using discounted cash flow analysis over the full term of the borrowings, or using indications from brokers of the fair value of similar transactions. The cash flows assumed no early repay- ment of the borrowings. Discount rates are based on the LIBOR yield curve. The fair value of subordinated notes is based on indications of market prices. Interest rate swaps The fair values of the interest rate swaps were provid- ed by the counter party. Investment securities The fair values of investment securities are the market values based on quoted market prices and dealer quotes. FHLB stock Investments in FHLB stock are valued at their redemp- tion values. Loans receivable, including loans held for sale - net The fair value of all loans was estimated using dis- counted present values. Loans were classified by type, such as commercial, residential mortgage, cred- it card and automobile. These asset categories were further segmented into fixed and adjustable rate cate- gories and by accruing and non-accruing groups. Performing floating rate loans were valued at book if they reprice at least once every three months, as were performing credit lines. The fair value of fixed rate performing loans was calculated by discounting expected cash flows through the estimated maturity date. Recent prepayment experience was assumed to continue for mortgage loans, auto loans and personal loans. Other loans assumed little or no prepayment. the Prepayment estimates were based on Corporation’s historical data for similar loans. Discount rates were based on the Treasury Yield Curve at the date of the analysis, with an adjustment, which reflects the risk and other costs inherent in the loan category. Non-accruing loans covered by a specific loan loss allowance were viewed as immediate losses and were valued at zero. Other non-accruing loans were arbi- trarily assumed to be repaid after one year. Presumably this would occur either because loan is repaid, collateral has been sold to satisfy the loan or because general reserves are applied to it. The princi- pal of non-accruing loans not covered by specific reserves was discounted for one year at the going rate for similar new loans. Deposits The estimated fair values of demand deposits and sav- ings accounts, which are the deposits with no defined maturities, equal the amount payable on demand at the reporting date. For deposits with stated maturi- ties, but that reprice at least quarterly, the fair values are also estimated to be the amount on books at the reporting date. The fair values of fixed rate deposits with stated matu- rities, are based on the present value of the future cash flows expected to be paid on deposits. The cash flows are based on contractual maturities; no early repay- ments are assumed. Discount rates are based on the LIBOR yield curve. The estimated fair values of total deposits exclude the fair value of core deposit intangi- bles, which represent the value of the customer rela- tionship measured by the values of demand deposits PAGE 80 2003 ANNUAL REPORT FIRST BANCORP PAGE 81 NOTE 26 - SUPPLEMENTAL CASH FLOW INFORMATION Supplemental cash flow information follows: 2003 Year ended December 31, 2002 (In thousands) 2001 Cash paid for: Interest Income tax Non-cash investing and financing activities: Additions to other real estate owned $ 231,953 23,027 $ 274,548 15,799 $ 275,360 12,535 3,473 3,338 1,797 2003 December 31, (In thousands) 2002 $ 165,139 181,293 20,942 472,532 94,511 29,207 $ 208,925 307,492 14,859 439,996 80,448 30,313 NOTE 27 - FINANCIAL INSTRUMENTS WITH OFF- BALANCE SHEET RISK, COMMITMENTS TO EXTEND CREDIT AND STANDBY LETTERS OF CREDIT The following table presents a detail of commitments to extend credit and standby letters of credit: Financial instruments whose contract amounts represent credit risk: Commitments to extend credit: To originate loans Unused credit card lines Unused personal lines of credit Commercial lines of credit Commercial letters of credit Standby letters of credit The Corporation’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument on commitments to extend credit and standby letters of credit is represented by the contrac- tual amount of those instruments. Management uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Commitments to extend credit are agreements to lend to a customer, as long as there is no violation of any condition established in the contract. These commit- ments generally expire within one year. Since certain commitments are expected to expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. 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. The amount of collateral, obtained if deemed necessary by the Corporation upon extension of credit, is based on Management’s credit evaluation of the borrower. Rates charged on the loans that are finally disbursed, are the rates being offered at the time the loans are closed, therefore, no fee is charged on these commitments. The fee is the amount which is used as the estimate of the fair value of commitments. In general, commercial and standby letters of credit are issued to facilitate foreign and domestic trade transactions. Normally, commercial and standby let- ters of credit are short-term commitments used to finance commercial contracts for the shipment of goods. The collateral for these letters of credit include cash or available commercial lines of credit. The fair value of commercial and standby letters of credit is based on the fees currently charged for such agree- ments, which at December 31, 2003 is not significant. Interest rate risk management The operations of the Corporation are subject to inter- est rate fluctuations to the extent that interest-earning assets and interest-bearing liabilities mature or reprice at different times or in different amounts. As part of the interest rate risk management, the Corporation has entered into a series of interest rate swap agreements. Under the interest rate swaps, the Corporation agrees with other parties to exchange, at specified intervals, the difference between fixed-rate and floating-rate interest amounts calculated by reference to an agreed notional principal amount. Net interest settlements on interest rate swaps are recorded as an adjustment to interest expense on deposit accounts, interest income on investment accounts or derivatives gain (loss) in the case of interest rate swaps that do not qualify for hedge accounting. The following table indicates the types of swaps used: Pay-fixed and receive-variable swaps: Balance at December 31, 2001 New Contracts Balance at December 31, 2002 New contracts Balance at December 31, 2003 Receive-fixed and pay variable swaps: Balance at December 31, 2001 Expired contracts New contracts Balance at December 31, 2002 Expired contracts New contracts Balance at December 31, 2003 Notional amount (In thousands) $ $ $ $ $ $ 58,165 20,000 78,165 12,000 90,165 1,495,000 (1,193,681) 1,656,590 1,957,909 (1,170,879) 2,085,342 2,872,372 PAGE 82 2003 ANNUAL REPORT FIRST BANCORP PAGE 83 other segments. The Treasury and Investment seg- ment sells funds to the Retail and Commercial Corporate segments to finance their lending activities and purchases funds gathered by those segments. The interest rates charged or credited by Investment and Treasury is based on market rates. Interest rate swap agreements under which the Corporation agrees to pay variable rates of interest are considered to be a hedge against changes in the fair value of the Corporation fixed-rate brokered certifi- cates of deposit. The interest rate swap agreements are reflected at fair value in the Corporation’s consoli- dated statement of financial condition and the related portion of fixed-rate debt being hedged is reflected at an amount equal to the sum of its carrying value plus an adjustment representing the change in fair value of the debt obligations attributable to the interest rate risk being hedged. The hedge relationship is estimat- ed to be 100 percent effective; therefore, there is no impact on the statement of income nor on comprehen- sive income, because the gain or loss on the swap agreements will completely offset the loss or gain on the certificates of deposit. The Corporation, in order to achieve 100% effectiveness, incorporates in the hedge of fixed-rate brokered CD’s the right to lower a specif- ic notional amount for a stated period of time which is different from stated maturity, in the case of cancella- tions prior to maturity. The net effect of this account- ing treatment is that the interest expense on the hedged certificates of deposit generally reflects vari- able interest rates. Interest rate swap agreements under which the Corporation agrees to pay fixed rates of interest are considered to be a hedge against changes in the fair value attributable to market interest rates of fixed rate available for sale corporate bonds. Accordingly, the interest rate swap agreements and the securities being hedged are reflected at fair value in the Corporation’s consolidated statement of financial condition. The adjustment of the hedged item’s carrying amount attributable to the hedged risk is recorded in earnings in order to offset the gain or loss on the hedging instrument. The change in the fair value of the securi- ty attributable to credit risk is recorded in other com- prehensive income. The hedge relationship is estimat- ed to be 100 percent effective; therefore, there is no impact on the statement of income, because the gain or loss on the interest rate swap reflects the full amount of the gain or loss on the hedged item attrib- utable to the hedged risk. The net effect of this accounting treatment is that the interest of the fixed- rate securities being hedged generally reflects variable interest rates. During the year ended on December 31, 2002, the Corporation sold certain corporate bonds to which interest rate swap agreements with an aggre- gate notional principal balance of $53.2 million were attributable. Therefore, these swaps no longer qualify for hedge accounting, and an unrealized gain of $619,473 for 2003 was recorded to reflect changes in the fair value and net interest settlements of these derivatives as part of derivative gain in the Other Income section of the statement of income. Interest rate swaps with an aggregate notional princi- pal balance of $25 million had an unrealized loss of $1,098,849 (2002 - $1,517,268 unrealized loss), attribut- able to credit risk, which was recorded in accumulated comprehensive income net of income tax. Pay-fixed swaps at December 31, 2003 had a fixed weighted average rate payment of 6.53% (2002 – 6.53%) and a floating weighted average rate receiving of 3.15% (2002 – 3.53%). Receive-fixed swaps at December 31, 2003, have a floating weighted average rate payment of 1.21% (2002 – 1.58%) and a fixed weighted average rate receiving of 5.28% (2002 – 5.60%). Floating rates on pay fixed swaps range from 175 to 240 basis points over LIBOR and from minus 3 basis points to 6 basis points over LIBOR rate on receive fixed swaps. For swap transactions, the amounts potentially subject to credit loss are the net streams of payments under the agreements and not the notional principal amounts used to express the volume of the swaps. At December 31, 2003, the Corporation had total net receivable of $18,881,644 (2002 - $12,147,354) related to the swap transactions. The Corporation controls the credit risk of its interest rate swap agreements through approvals, limits, and monitoring procedures. The Corporation does not anticipate non-performance by the counter parties. The Corporation has a policy of diversifying swap counter parties to reduce the risk that any counter party will fail. As part of the swap transactions, the Corporation is required to pledge col- lateral in the form of deposits in banks or securities. The book value and aggregate market value of securi- ties pledged as collateral for interest rate swaps at December 31, 2003 was approximately $137 million and $135 million, respectively (2002 - $42.1 million and $42.9 million, respectively). The final maturity of the swaps at December 31, 2003 ranged from one month through twenty five years (2002 - from one year through nineteen years). Interest rate swaps with an aggregate notional princi- pal balance of $2,962,536,500 (2002-$2,036,074,000) had a gross unrealized gain of approximately $864,391 (2002 - $27,021,907) and gross unrealized loss of $43,242,808 (2002 - $9,738,638), which are included in the Other Assets category and Other Liabilities catego- ry, respectively. Interest rate protection agreements (Caps) To satisfy the needs of its customers, the Corporation may enter into non-hedging activities. In June 2003, the Corporation entered into two interest rate cap agreements based on a notional amount of $25 million each. Under the agreements, which are structured with the same terms and conditions, the Corporation participates as a buyer in one of the agreements and as the seller in the other agreement. At December 31, 2003, the Corporation included $205,066 and $205,066 in Other Assets and Other Liabilities, respectively, per- taining to the fair value of these contracts. Also, from time to time, the Corporation uses interest rate protection agreements (Caps) to limit its exposure to rising interest rates on its deposits. Under these agreements, the Corporation pays an up front premi- um or fee for the right to receive cash flow payments in excess of the predetermined cap rate; thus, effec- tively capping its interest rate cost for the duration of the agreement. There were no caps agreements of this type outstanding at December 31, 2003. On January 1, 2001 a loss of approximately $1.3 mil- lion was recognized in the statement of income as a cumulative effect of the adoption of SFAS No. 133, as a result of unamortized premium paid for caps of $1.5 million less an estimated fair market value of $200,000. Prior to the implementation of SFAS No. 133, the premium was amortized as an adjustment to interest expense on borrowings. NOTE 28 - SEGMENT INFORMATION The Corporation has four reportable segments: Retail Banking, Treasury and Investments, Commercial Corporate Banking and other. Management deter- mined 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 prod- ucts, distribution channels and the economic charac- teristics of the products, were also considered in the determination of the reportable segments. The Retail Banking segment is composed of the Corporation’s branches and loan centers together with the retail products of deposits and consumer loans. Consumer loans include loans such as personal, resi- dential real estate, auto, credit card and small loans. Finance leases are also included in Retail banking. The Commercial Corporate segment is composed of commercial loans including commercial real estate and construction loans. The Treasury and Investment segment is responsible for the Corporation investment portfolio and treasury functions. The Other Income segment is mainly composed of insurance and other products. The accounting policies of the segments are the same as those described in Note 2 - “Summary of Significant Accounting Policies.” The Corporation evaluates the performance of the seg- ments based on net interest income after the estimat- ed provision for loan losses, other income and direct operating expenses. The segments are also evaluated based on the average volume of its earning assets less the allowance for loan losses. The only intersegment transaction is the net transfer of funds by the Treasury and Investment segment and PAGE 84 2003 ANNUAL REPORT FIRST BANCORP PAGE 85 The following table presents information about the reportable segments: Retail Business Treasury and Commercial Corporate Investments (In thousands) Other Total For theYear Ended December 31, 2003 Interest Income Net (charge) credit for transfer of funds Interest Expenses Net interest income Provision for Loan Losses Other Income Direct Operating Expenses Segment Income Average Earnings Assets For the Year Ended December 31, 2002 Interest Income Net (charge) credit for transfer of funds Interest Expenses Net interest income Provision for Loan Losses Other Income Direct Operating Expenses Segment Income Average Earnings Assets For the Year Ended December 31, 2001 Interest Income Net (charge) credit for transfer of funds Interest Expenses Net interest income Provision for Loan Losses Other Income Direct Operating Expenses Segment Income Average Earnings Assets $ 273,678 (39,972) (46,178) 187,528 (32,523) 69,224 (88,733) $ 135,496 $ 3,573,736 $ 146,959 66,064 (198,294) 14,729 36,179 (2,452) 48,456 $ $ 3,817,982 $ 116,044 (26,092) 89,952 (23,393) 6,232 (7,388) 65,403 $ $2,594,551 $ 230,141 (46,552) (58,835) 124,754 (43,090) 39,352 (74,357) 46,659 $ $ $ 2,410,548 $ 188,194 97,360 (214,349) 71,205 8,643 (2,227) 77,621 $ 3,746,245 $ 121,698 (50,808) 70,890 (19,212) 5,080 (6,439) $ 50,319 $2,258,025 $ 217,021 (21,043) (71,410) 124,568 (44,541) 35,384 (69,198) $ 46,213 $ 1,970,768 $ 162,478 102,123 (208,791) 55,810 10,211 (1,844) $ 64,177 $ 2,627,205 $136,757 (81,081) 55,676 (16,489) 4,440 (5,664) $ 37,963 $1,781,314 7,076 (1,622) 5,454 $ 536,681 (244,472) 292,209 (55,916) 118,711 (100,195) $ 254,809 $9,986,269 $ 540,033 (273,184) 266,849 (62,302) 58,492 (83,720) 4,720 $ 179,319 $8,414,818 5,417 (697) $ 516,256 (280,201) 236,055 (61,030) 52,980 (77,069) $ 150,936 $6,379,287 2,945 (362) 2,583 $ $ $ $ $ $ The following table presents a reconciliation of the reportable segment financial information to the con- solidated totals: Net Income: Total income for segments Other Operating Expenses Income Taxes Income before cumulative effect of accounting change Cumulative effect of accounting change Total consolidated net income Average assets: Total average earning assets for segments Average non earning assets Total consolidated average assets 2003 Year ended December 31, 2002 (In thousands) 2001 $ $ $ 254,809 (63,799) (38,672) 152,338 152,338 $ $ $ 179,319 (49,036) (22,327) 107,956 107,956 $ $ $ 150,936 (43,786) (20,134) 87,016 (1,015) 86,001 $ 9,986,269 443,993 $ 10,430,262 $ 8,414,818 333,404 $ 8,748,222 $ 6,379,287 322,115 $ 6,701,402 NOTE 29 - LITIGATION The Corporation is a defendant in a number of legal proceedings arising in the normal course of business. Management believes, based on the opinion of legal counsel, that the final disposition of these matters will not have a material adverse effect on the Corporation’s financial position or results of opera- tions. NOTE 30 - FIRST BANCORP (HOLDING COMPANY ONLY) FINANCIAL INFORMATION The following condensed financial information pres- ents the financial position of the Holding Company only at December 31, 2003 and 2002, and the results of its operations and its cash flows for the years ended on December 31, 2003, 2002 and 2001. Statements of Financial Condition Assets: Cash and due from banks Money market instruments Investment securities available for sale, at market value: Other investments Total investment securities available for sale Investment securities held to maturity, at cost: United States Government obligations Total investment securities held to maturity Loans receivable Investment in FirstBank Puerto Rico, at equity Investment in FirstBank Insurance Agency, at equity Other assets Total assets Liabilities and Stockholders’ Equity: Accounts payable and other liabilities Stockholders’ equity Contingencies and commitments Total liabilities and stockholders’ equity $ $ $ $ 2003 December 31, (In thousands) 2002 17,808 51,371 62,319 62,319 - - 5,542 948,644 3,175 829 1,089,688 119 1,089,569 $ $ $ 26,276 300 42,674 42,674 5,700 5,700 6,000 718,480 1,445 726 801,601 3,177 798,424 1,089,688 $ 801,601 PAGE 86 2003 ANNUAL REPORT FIRST BANCORP PAGE 87 Statements of Income Statement of Cash Flows Income: Interest income on investment securities Interest income on other investments Interest income on loans Dividend from FirstBank Other income Expenses: Interest expense Other operating expenses Gain (loss) on sale of investments, net Income before income taxes and equity in undistributed earnings of subsidiaries Income taxes Equity in undistributed earnings of subsidiaries Net income Other comprehensive income, net of tax Comprehensive income The principal source of income for the Holding Company consists of the earnings of FirstBank. 2003 Year ended December 31, 2002 (In thousands) 2001 $ 221 114 273 48,640 676 49,924 17 640 657 12,406 61,673 472 91,137 152,338 2,647 $ 154,985 $ $ 351 248 5,269 38,855 705 45,428 2 709 711 (22,321) 22,396 2,250 87,810 107,956 39,675 147,631 $ 658 250 306 30,316 668 32,198 559 559 1,093 32,732 170 53,439 86,001 13,306 $ 99,307 Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed earnings of subsidiaries Net loss (gain) on sale of investments securities Net (increase) decrease in other assets Net increase (decrease) in other liabilities Total adjustments 2003 Year ended December 31, 2002 (In thousands) 2001 $ 152,338 $ 107,956 $ 86,001 (91,137) (12,406) 333 (2,121) (105,331) (87,810) 22,321 (175) 2,069 (63,595) (53,439) (1,093) (75) (186) (54,793) Net cash provided by operating activities 47,007 44,361 31,208 Cash flows from investing activities: Capital contribution to subsidiaries Loans originated Purchases of securities available for sale Sales and maturity of securities held to maturity and available for sale Other investing activities Net cash used in investing activities Cash flows from financing activities: Net decrease in other borrowings Proceeds from issuance on preferred stock Exercise of stock options Cash dividends paid Treasury stock acquired Net cash provided by financing activities (150,000) (62,569) 71,549 456 (140,564) (88,000) (88,000) (1,235,145) 1,240,079 87,685 (83,381) 182,999 1,120 (47,959) 88,906 1,341 (42,373) 136,160 47,874 Net increase in cash Cash and cash equivalents at the beginning of the year Cash and cash equivalents at the end of the year Cash and cash equivalents include: Cash and due from banks Money market instruments 42,603 26,576 69,179 17,808 51,371 69,179 $ $ $ 8,854 17,722 26,576 26,276 300 26,576 $ $ $ $ $ $ (80,305) (5,682) (24,203) 10,227 (99,963) 100,069 1,355 (30,343) (1,930) 69,151 396 17,326 17,722 17,422 300 17,722 PAGE 88 2003 ANNUAL REPORT FIRST BANCORP PAGE 89 STOCKHOLDERS’ INFORMATION Independent Certified Public Accountants PriceWaterhouseCoopers LLP Annual Meeting: The annual meeting of stockholders will be held on April 29, 2004, at 2:00 p.m., at the main office of the Corporation, located at 1519 Ponce de León Avenue, Santurce, Puerto Rico. Telephone (787) 729-8200 Internet: http//www.firstbankpr.com Additional Information and Form 10-K: Additional financial information about First BanCorp may be requested to Mrs. Laura Villarino, Senior Vice President and Controller, PO Box 9146, Santurce, Puerto Rico 00908. First BanCorp’s filings with the Securities and Exchange Commission (SEC) may be accessed in the website maintained by the SEC at site http://www.sec.gov. http://www.firstbankpr.com, First BanCorp section, Company Filings link. our web and at Transfer Agent and Registrar: The Bank of New York 1-800-524-4458 Address Shareholder Inquiries To: Shareholder Relations Department PO Box 11258 Church Street Station New York, NY 10286 E-mail Address: shareowners@bankofny.com The Bank of New York’s Stock Transfer Website: http://www.stockbny.com Send Certificates for Transfer and Address Changes To: Receive and Deliver Department PO Box 11002 Church Street Station New York, NY 10286 PAGE 90 2003 ANNUAL REPORT 

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