Popular Inc
Annual Report 2007

Plain-text annual report

Popular, Inc. 2007 Annual Report Informe Anual 1 2 5 6 8 17 Letter to Shareholders Popular, Inc. At-a-Glance Institutional Values 25-Year Historical Financial Summary Board of Directors / Corporate Leadership Circle / Our Creed / Our People / Corporate Information Financial Review and Supplementary Information 9 10 13 14 16 Carta a los Accionistas Un Vistazo a Popular, Inc. Valores Institucionales Resumen Financiero Histórico – 25 Años Junta de Directores / Círculo de Liderato Corporativo / Nuestro Credo / Nuestra Gente / Información Corporativa Popular, Inc. is a full service financial institution based in Popular Inc. es un proveedor de servicios financieros completos Puerto Rico with operations in Puerto Rico, the United States, con operaciones en Puerto Rico, Estados Unidos, el Caribe y the Caribbean and Latin America. As the leading financial América Latina. Como institución financiera líder en Puerto institution in Puerto Rico, with over 300 branches and offices, Rico, con más de 300 sucursales y oficinas, la Corporación the Corporation offers retail and commercial banking services ofrece servicios bancarios comerciales y a individuos a través de through its franchise, Banco Popular de Puerto Rico, as well su franquicia, Banco Popular de Puerto Rico, así como servicios as auto and equipment leasing and financing, mortgage loans, de arrendamiento y financiamiento de vehículos y equipo, consumer lending, investment banking, broker/dealer and préstamos hipotecarios, financiamiento individual, corretaje insurance services through specialized subsidiaries. In the y banca de inversión y seguros a través de subsidiarias United States, the Corporation operates Banco Popular North especializadas. En los Estados Unidos, la Corporación opera America, including its wholly-owned subsidiary E-LOAN, and Banco Popular North America, incluyendo su subsidiaria Popular Financial Holdings. Banco Popular North America, E-LOAN y Popular Financial Holdings. Banco Popular North a community bank, provides a wide range of financial services and products and operates branches in New York, California, America, un banco comunitario, provee una amplia gama de servicios y productos financieros y opera sucursales en Nueva Illinois, New Jersey, Florida and Texas. E-LOAN offers online York, California, Illinois, Nueva Jersey, Florida y Texas. E-LOAN consumer direct lending, while Popular Financial Holdings is provee financiamiento en línea directo al consumidor, mientras dedicated to mortgage servicing. The Corporation, through its que Popular Financial Holdings se dedica a préstamos transaction processing company, EVERTEC, continues to use hipotecarios manejados a terceros. La Corporación, a través its expertise in technology as a competitive advantage in its de su compañía de procesamiento de transacciones financieras expansion throughout the United States, the Caribbean and EVERTEC, continúa usando su experiencia en tecnología como Latin America, as well as internally servicing many of the una ventaja competitiva para su expansión en Estados Unidos, Corporation’s subsidiaries’ system infrastructures and el Caribe y América Latina, y prestando internamente servicios transactional processing businesses. The Corporation is a las infraestructuras de sistemas así como procesamiento a las exporting its 114 years of experience through these regions subsidiarias de la Corporación. La Corporación está exportando while continuing its commitment to meeting the needs of retail sus 114 años de experiencia a estas regiones mientras continúa and business clients through innovation, and to fostering su compromiso con satisfacer las necesidades de clientes growth in the communities it serves. individuales y comerciales por medio de la innovación, y con fomentar el crecimiento en las comunidades donde sirve. Popular, Inc. 2007 Annual Report 1 Decisions we made during 2007 were extremely difficult, but will place us in a better position moving forward. Letter 2007 to Shareholders Popular’s financial performance in 2007 was significantly influenced by the negative impact of the mortgage industry downturn in the results of our non-banking opera- tions in the United States and by actions we undertook to address that situation. These decisions, while extremely difficult, place us in a better position going forward as we focus on our core banking franchise in the mainland. In Puerto Rico, our finan- cial services business continued delivering strong results, despite an economic recession and deteriorating credit quality. EVERTEC, our processing business, showed steady earnings growth and made progress on several strategic fronts. Popular reported a net loss of $64.5 million for 2007, compared with a net income of $357.7 million in 2006. Basic and diluted net loss per common share for the year was $0.27, compared with a net income per common share of $1.24 for 2006. These losses represented a negative return on assets (ROA) of 0.14% and a negative return on common equity (ROE) of 2.08%, compared to 0.74% and 9.73% in 2006, respectively. Our results for 2007 were negatively affected by (i) a $274.9 million increase in the provision for loan losses in 2007 as compared to 2006, driven by the slowdown in the United States housing sector and weak economic conditions in Puerto Rico; (ii) a $90.1 million pre-tax loss related to the recharacterization of several on-balance sheet securitizations at Popular Financial Holdings (PFH); (iii) a reduction of $85.1 million in the fair value of residual interests recognized by PFH in previous securitizations; 2 Popular, Inc. At-a-Glance Letter to Shareholders, continued Banco Popular de Puerto Rico > Approximately 1.4 million clients > 204 branches and 111 offices throughout Puerto Rico and the Virgin Islands > 6,442 FTEs as of 12/31/07 > 615 ATMs and 28,000 POS throughout Puerto Rico and the Virgin Islands > #1 market share in Total Deposits (34.9% - 9/30/07) and Total Loans (23.0% - 9/30/07) > $27.1 billion in assets, $16.6 billion in loans and $18.8 billion in deposits as of 12/31/07 Banco Popular North America > 147 branches throughout six states (Florida, California, New York, New Jersey, Texas, and Illinois) > 24 leasing offices with a presence in 15 states > 2,923 FTEs as of 12/31/07 > 5th SBA lender in the United States in terms of dollars of loans > E-LOAN held $1.5 billion in deposits and originated $3.6 billion in loans during 2007 > $13.4 billion in assets, $10.3 billion in loans and $9.8 billion in total deposits as of 12/31/07 EVERTEC > 11 offices throughout the United States and Latin America serving 15 countries > 1,765 FTEs as of 12/31/07 > Processed over 1 billion transactions in 2007, of which more than 535 million corresponded to the ATH® Network > 4,944 ATMs and over 100,500 POS throughout the United States and Latin America Popular Financial Holdings > 135 offices in 16 states as of 12/31/07 > Total originations amounted to $3.4 billion in 2007 > Mortgage portfolio serviced for others of $9.4 billion as of 12/31/07 > 930 FTEs as of 12/31/07 > $3.9 billion in assets and $3.3 billion in loans secondary market. In the case of Banco Popular North America (BPNA), we embarked on a process to focus our resources to improve the profitability of our retail franchise. Popular Financial Holdings PFH recorded a net loss of $269.4 million in 2007. These results reflect the deterioration of the sub-prime mortgage business as well as charges related to some of the initiatives we undertook during the year. In January of 2007, we adopted a restructuring plan for PFH which included the decisions to exit the whole- sale sub-prime origination business, to consolidate support functions with its sister United States banking entity, Banco Popular North America, and to focus on profitable businesses. As a result of the restructuring plan and the decision to exit the wholesale sub-prime business, we completed the recharacterization of certain on-balance sheet securitizations that allowed us to recognize these transactions as sales. Consequently, we removed approxi- mately $3.2 billion in mortgage loans and $3.1 billion in related liabilities from our balance sheet. The impact of the recharacterization was a pre-tax loss of $90.1 million. The removal of these mortgage assets from our books improves capital and credit quality ratios and reduces the amount of sub-prime mortgages on our books. Most of PFH’s remaining portfolio amounting to approximately $1.5 billion and $287 million of bond certificates associated with on-balance sheet securiti- zations will be presented at market value based on FAS 159 (Fair Value Option for Financial Assets and Financial (iv) $16.6 million in restructuring charges at PFH; and (v) $231.9 million in restructuring and impairment charges at E-LOAN. These negative variances were partially offset by a pre-tax gain of $118.7 million stemming from the sale of the Corporation’s shares of common stock of Telecomunicaciones de Puerto Rico, Inc. (TELPRI) in March of 2007. Our stock price fell 41% during 2007, closing the year at $10.60. We are extremely disappointed with our financial results as well as the perform- ance of our stock. We recognize these results are unacceptable and have begun a process to realign our operations in the United States to take them to acceptable profitability levels. United States At Popular Financial Holdings (PFH), our mainland United States sub-prime lending operation, we reduced the size of the business and took measures to lessen our exposure to the sub-prime mortgage market. At E-LOAN, we adapted the business model and right-sized our infrastructure to reflect a market with significantly lower volumes, higher delinquencies and a practically illiquid Popular, Inc. 2007 Annual Report 3 Liabilities). The adoption of FAS 159, which will be implemented on January 1st, will result in a negative pre-tax adjustment that could range between $280 million and $300 million that will have no impact in the income statement since it will be deducted from retained earnings. At the time of the January 2007 restructuring, we decided to continue the operations of Equity One and its subsidiaries, which are dedicated to origi- nating and servicing consumer finance loans through a network of over 130 offices. However, given increasing funding costs stemming from the disruption in the capital markets that began in the summer of 2007, we became convinced that it would become progressively more diffi- cult to generate an adequate return on the capital invested at Equity One. In January 2008, we announced the signing of an agreement to sell certain assets of Equity One to American General Financial, a member of the American International Group (AIG). As part of the agreement, American General acquired a significant portion of Equity One’s mortgage loan and consumer loan portfolio approximating $1.4 billion as well as 24 of Equity One’s branches. We will be closing the remain- ing branches. The transaction which closed on March 1st, 2008, resulted in restructuring charges of $19.5 million, most of which will be recorded in the first quarter, and generated a pre-tax gain of approximately $50 million. The combined effect of the aforemen- tioned initiatives is a reduction of PFH’s mortgage loans held-in portfolio from $6.9 billion in the beginning of 2007 to approximately $1.3 billion as of December 2007, of which $1 billion is sub-prime compared to a sub-prime portfolio amounting to $4.6 billion as of December 2006. Also, these initiatives enable us to present a clearer picture of Popular’s real exposure in this business. Banco Popular North America Banco Popular North America (BPNA), which includes E-LOAN as a subsidiary, reported a net loss of $195.4 million in 2007. This loss was driven by a net loss of $245.7 million at E-LOAN. BPNA’s banking operations generated a net income of $50.5 million, which, even though positive, was 50% below 2006. BPNA’s results were adversely affected by increased credit costs and lower net inter- est income. BPNA’s provision totaled $77.8 million, 106% higher than in 2006, due to the higher non-performing assets in the construction loan and mortgage portfolios. Net interest income was $14.5 million below 2006 levels due to tighter margins. Given the challenges we face, we took action to focus and prioritize resources. In October 2007, we announced the sale of six of our Houston, Texas branches to Prosperity Bank. Prosperity Bank paid a premium of 10.10% for approximately $125 million in deposits, and purchased certain loans and assets attributable to the branches. We will focus our efforts on improving the performance of the branch network we have built in the United States to enhance the value of our retail franchise. E-LOAN incurred a net loss of $245.7 million in 2007, which includes restructuring charges of $20.1 million and goodwill and trademark impairment charges amounting to $211.8 million. We will focus our efforts to enhance the value of our retail franchise. E-LOAN’s business continued to be severely impacted by market conditions during 2007. A general decline in mortgage origination volume, significant increases in delinquencies and foreclo- sures and reduced liquidity in the secondary markets prompted us to restructure E-LOAN. In November 2007, we adopted a restructuring plan that substantially reduced marketing and personnel expenses and focused E-LOAN in the origination of agency conforming first mortgage loans. This plan resulted in restructuring charges of $20.1 million in the fourth quarter of 2007 and is expected to reduce operating expenses by $77 million in 2008. Given the changes to the business model and the challenging environment faced by the mortgage industry in the United States, we conducted an assess- ment of the value of E-LOAN’s recorded goodwill and trademark. The review resulted in the recognition of an impair- ment. This charge was a non-cash transaction and did not impact Popular’s liquidity or regulatory capital ratios. E-LOAN continues to be an important element for Popular given its technology platform, the wide geographic reach of its products, its ability to raise deposits for the Corporation and its widely known and respected brand. 4 Letter to Shareholders, continued Puerto Rico Our financial services operations in Puerto Rico, which consist of Banco Popular de Puerto Rico and other special- ized subsidiaries, performed very well in 2007 despite an economy in recession, deteriorating credit quality and aggressive competition. These results confirm our capacity not only to withstand these nega- tive forces, but to strengthen our position even in the most challenging of times. Net income for the Puerto Rico circle totaled $327.3 million, $28.6 million lower than in 2006. Financial results were impacted by deterioration in credit quality, which translated in a provision for loan losses of $243.7 million, 73% higher than the previous year. Net charge-offs rose by 69%, reaching $191 million, mostly in the commercial, credit card and personal loan portfolios. Throughout the year, we focused on proactively managing credit quality by tightening underwriting standards, anticipating possible losses, increasing spreads and improving collection efforts. Notwithstanding our careful approach in the credit arena, we were able to defend and increase our market share across the board. Market share gains get tougher every year, considering we are already the top player in seven out of the nine key product categories we closely track. During 2007, we improved our position in eight out of the nine categories, accounting for 23% of total loans and 35% of total deposits in the market. We will continue to focus on profitable market growth to further solidify our leadership position in Puerto Rico. In addition to growing our existing business, we strengthened our franchise with the acquisition of Citibank’s local retail business and Smith Barney’s local retail brokerage operations. The retail business acquisition included 17 branches (seven of which were consolidated), approximately $1 billion in deposits, mostly core deposits, and over $220 million in loans. Including these deposits, Popular’s market share rose to approxi- mately 38%. We welcomed over 200 new colleagues and a solid client base which offers great potential to cross-sell additional Popular products. The local securities business is highly concentrated, with 60% of assets under management (AUM) controlled by the top two players. The Smith Barney transaction strengthens our sales force and provides additional business volume ($1.2 billion in AUM), significantly closing the gap between Popular Securities and the second player. Improving cost efficiency remained one of Banco Popular’s priorities in 2007. Expenses were 4.7% higher than in 2006, in great part due to costs related to the conversion of Citibank’s retail and brokerage operations. However, even though these costs were not in the origi- nal budget, total expenses for the year were below budget due to disciplined spending in other areas. As a result of our cost efficiency efforts throughout the last three years, we have improved our efficiency ratio from 55.8% in 2005 to 52.9% in 2007. We expect the tough economic scenario to persist well into 2008, but as we proved in 2007, discipline, a focus on execution and a strong franchise can not only get us through the toughest times, it can make us emerge even stronger than before. As we proved in 2007, discipline and focus on execution can make us emerge stronger. EVERTEC EVERTEC, our processing unit with oper- ations in Puerto Rico, the Caribbean and Latin America, increased revenues, net income and transaction volume in 2007 despite a recession in its main market, Puerto Rico, and increased competition from larger processing companies across all regions. EVERTEC’s net income in 2007 reached $31.3 million, an increase of 20% over 2006. These results were driven by good revenue growth, mainly from clients other than Popular companies, combined with tight expense management. In addition to solid financial results, EVERTEC made important progress in several of its key strategic areas, such as enhancing the competitiveness of the ATH® Network. For over 20 years, ATH® has been the preferred, as well as the most secure and cost effective payment method for Puerto Ricans. During 2007, the ATH® network processed over 535 million transactions through 4,944 ATMs and 100,500 POS terminals. In recent years, ATH® has experienced increased competition from Visa and MasterCard due to the rise in signature debit cards. In response to this challenge, the ATH® Network in Puerto Rico updated its price structure to give greater financial Popular, Inc. 2007 Annual Report 5 Institutional Values Social Commitment We are committed to work actively in promoting the social and economic well-being of the communities we serve. Customer We achieve satisfaction for our customers and earn their loyalty by adding value to each interaction. Our relationship with the customer takes precedence over any particular transaction. Integrity We are guided by the highest standards of ethics, integrity and morality. Our customers’ trust is of utmost importance to our institution. Excellence We believe there is only one way to do things: the right way. Innovation We foster a constant search for new solutions as a strategy to enhance our competitive advantage. Our People We strive to attract, develop, compensate and retain the most qualified people in a work environment characterized by discipline and affection. Shareholder Value Our goal is to produce high and consistent financial returns for our shareholders, based on a long-term view. incentives to member banks while remaining the lowest-cost alternative for merchants. These changes will solidify and protect the ATH® brand and foster long-term growth of the business. In Puerto Rico, we added several financial institutions to our client roster as well as expanded the services offered to existing clients. EVERTEC now processes approximately 75% of all checks and electronic interchange in Puerto Rico. We expanded our workforce management business with the acquisition of SENSE, a software development company that provides solutions for human resources, payroll, and time and attendance. The health systems business acquired a port- folio of medical providers and increased the number of processed transactions by approximately 20%. EVERTEC Latin America had an excellent year, signifi- cantly increasing revenues and adding important customers in the region, despite the entry of international proces- sors resulting from the acquisition of local banks by large international players. EVERTEC’s results and strategic accomplishments during 2007 corroborate the strategy we laid out four years ago of leveraging our existing infrastructure to generate additional revenues and further diversify our sources of income. Moving Forward Throughout this challenging year, the guidance and support of our Board of Directors has been very significant and greatly appreciated. I would like to recog- nize José B. Carrión (Pepe) for his service in the Banco Popular and Popular, Inc. Boards. For seven years, this organization greatly benefited from his counsel and insight. Pepe retired in 2007 upon reaching the mandatory retirement age. At the same time, we are extremely pleased to welcome Michael Masin to our Board of Directors. I know that Michael’s vast experience as part of the management and the Boards of some of the top corporations in the United States will be of great value to Popular. Also, after serving Popular for 30 years, our Executive Vice President in charge of People, Communications and Planning, Tere Loubriel will retire in March. Tere held a wide variety of positions through- out the years, all of them with the same level of dedication and commitment to excellence. We will miss her tremendously and wish her the best. Eduardo Negrón, our Deputy Chief Legal Officer for seven years, will direct the People and Communications area going forward. In retrospect, 2007 was definitely one of the most challenging years that our Corporation has faced to date. Unprecedented conditions and turmoil in the financial services industry have put our organization to the test. Our people responded as they always have, focusing their attention and energy to define and execute what was necessary to tackle the issues at hand. Now, more than ever, we are confident about our ability to go forward and return Popular to the growth and profitability levels that have characterized this organization’s history. Richard L. Carrión Chairman, President and Chief Executive Officer 6 25-Year Historical Financial Summary (Dollars in millions, except per share data) Selected Financial Information Net Interest Income Non-Interest Income Operating Expenses Net Income Assets Net Loans Deposits Stockholders’ Equity Market Capitalization Return on Assets (ROA) Return on Equity (ROE) Per Common Share1 Net Income – Basic Net Income – Diluted Dividends (Declared) Book Value Market Price Assets by Geographical Area Puerto Rico United States Caribbean and Latin America Total Traditional Delivery System Banking Branches Puerto Rico Virgin Islands United States Subtotal Non-Banking Offices Popular Financial Holdings Popular Cash Express Popular Finance Popular Auto Popular Leasing, U.S.A. Popular Mortgage Popular Securities Popular Insurance Popular Insurance Agency U.S.A. Popular Insurance, V.I. EVERTEC Subtotal Total Electronic Delivery System ATMs2 Owned and Driven Puerto Rico Caribbean United States Subtotal Driven Puerto Rico Caribbean Subtotal Total Transactions (in millions) Electronic Transactions3 Items Processed Employees (full-time equivalent) 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 $ $ $ $ $ 144.9 19.6 127.3 26.8 2,974.1 1,075.7 2,347.5 182.2 119.3 0.95% 15.86% 0.19 0.19 0.06 1.24 0.83 94% 5% 1% 100% 112 3 6 121 $ $ $ $ $ 156.8 19.0 137.2 29.8 3,526.7 1,373.9 2,870.7 203.5 159.8 0.94% 15.83% 0.21 0.21 0.06 1.38 1.11 91% 8% 1% 100% 113 3 9 125 $ $ $ $ $ 174.9 26.8 156.0 32.9 4,141.7 1,715.7 3,365.3 226.4 216.0 0.89% 15.59% 0.23 0.23 0.07 1.54 1.50 92% 7% 1% 100% 115 3 9 127 $ $ $ $ $ 184.2 41.4 168.4 38.3 4,531.8 2,271.0 3,820.2 283.1 304.0 0.88% 15.12% 0.25 0.25 0.08 1.73 2.00 92% 7% 1% 100% 124 3 9 136 121 125 127 136 113 113 51 51 164 30 30 30 0.6 102.1 3,832 78 78 6 6 84 4.4 110.3 4,110 94 94 36 36 130 7.0 123.8 4,314 $ $ $ $ $ 207.7 41.0 185.7 38.3 5,389.6 2,768.5 4,491.6 308.2 260.0 0.76% 13.09% 0.24 0.24 0.09 1.89 1.67 94% 5% 1% 100% $ $ $ $ $ 232.5 54.9 195.6 47.4 5,706.5 3,096.3 4,715.8 341.9 355.0 0.85% 14.87% 0.30 0.30 0.09 2.10 2.22 93% 6% 1% 100% $ $ $ $ $ 260.9 63.3 212.4 56.3 5,972.7 3,320.6 4,926.3 383.0 430.1 0.99% 15.87% 0.35 0.35 0.10 2.35 2.69 92% 6% 2% 100% $ $ $ $ $ 284.2 70.9 229.6 63.4 8,983.6 5,373.3 7,422.7 588.9 479.1 1.09% 15.55% 0.40 0.40 0.10 2.46 2.00 89% 9% 2% 100% $ $ $ $ $ 407.8 131.8 345.7 64.6 8,780.3 5,195.6 7,207.1 631.8 579.0 0.72% 10.57% 0.27 0.27 0.10 2.63 2.41 87% 11% 2% 100% $ $ $ $ $ 440.2 124.5 366.9 85.1 10,002.3 5,252.1 8,038.7 752.1 987.8 0.89% 12.72% 0.35 0.35 0.10 2.88 3.78 87% 10% 3% 100% $ $ $ $ $ 492.1 125.2 412.3 109.4 11,513.4 6,346.9 8,522.7 834.2 1,014.7 1.02% 13.80% 0.42 0.42 0.12 3.19 3.88 79% 16% 5% 100% 126 3 9 138 14 14 152 136 3 139 55 55 194 126 3 10 139 17 17 156 153 3 156 68 68 224 128 3 10 141 18 4 22 163 151 3 154 65 65 219 173 3 24 200 26 9 35 235 211 3 214 54 54 268 161 3 24 188 27 26 9 62 250 206 3 209 73 73 282 162 3 30 195 41 26 9 76 271 211 3 6 220 81 81 301 165 8 32 205 58 26 8 92 297 234 8 11 253 86 86 339 8.3 134.0 4,400 12.7 139.1 4,699 14.9 159.8 5,131 16.1 161.9 5,213 18.0 164.0 7,023 23.9 166.1 7,006 28.6 170.4 7,024 33.2 171.8 7,533 1 Per common share data adjusted for stock splits. 2 Does not include host-to-host ATMs (2,186 in 2007) which are neither owned nor driven, but are part of the ATH® Network. 3 From 1981 to 2003, electronic transactions include ACH, Direct Payment, TelePago, Internet Banking and ATH® Network transactions in Puerto Rico. Since 2004, these numbers were adjusted to include ATH® Network transactions in the Dominican Republic, Costa Rica, El Salvador and United States, health care transactions, wire transfers, and other electronic payment transactions in addition to those previously stated. Popular, Inc. 2007 Annual Report 7 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 $ $ $ $ $ $ $ $ $ $ 535.5 141.3 447.8 124.7 12,778.4 7,781.3 9,012.4 1,002.4 923.7 1.02% 13.80% 0.46 0.46 0.13 3.44 3.52 76% 20% 4% 100% $ 584.2 173.3 486.8 146.4 15,675.5 8,677.5 9,876.7 1,141.7 $ 1,276.8 $ 681.3 205.5 541.9 185.2 16,764.1 9,779.0 10,763.3 1,262.5 $ 2,230.5 $ 784.0 247.6 636.9 209.6 19,300.5 11,376.6 11,749.6 1,503.1 $ 3,350.3 1.04% 14.22% 1.14% 16.17% 1.14% 15.83% $ $ $ 0.53 0.53 0.15 3.96 4.85 75% 21% 4% 100% $ $ $ 0.67 0.67 0.18 4.40 8.44 $ $ $ 0.75 0.75 0.20 5.19 12.38 74% 22% 4% 100% 74% 23% 3% 100% 166 8 34 208 73 28 10 111 319 262 8 26 296 88 88 384 166 8 40 214 91 31 9 3 134 348 281 8 38 327 120 120 447 178 8 44 230 102 39 8 3 1 153 383 327 9 53 389 162 97 259 648 201 8 63 272 117 44 10 7 3 2 183 455 391 17 71 479 170 192 362 841 43.0 174.5 7,606 56.6 175.0 7,815 78.0 173.7 7,996 111.2 171.9 8,854 $ $ $ $ $ 873.0 291.2 720.4 232.3 23,160.4 13,078.8 13,672.2 1,709.1 4,611.7 $ 953.7 372.9 837.5 257.6 25,460.5 14,907.8 14,173.7 1,661.0 $ 3,790.2 1.14% 15.41% 1.08% 15.45% 0.83 0.83 0.25 5.93 17.00 71% 25% 4% 100% 198 8 89 295 128 51 48 10 8 11 2 258 553 421 59 94 574 187 265 452 1,026 130.5 170.9 10,549 $ $ $ 0.92 0.92 0.30 5.76 13.97 71% 25% 4% 100% 199 8 91 298 137 102 47 12 10 13 2 4 327 625 442 68 99 609 102 851 953 1,562 159.4 171.0 11,501 982.8 464.1 876.4 276.1 28,057.1 16,057.1 14,804.9 1,993.6 3,578.1 $ 1,056.8 491.8 926.2 304.5 30,744.7 18,168.6 16,370.0 2,272.8 $ 3,965.4 $ 1,160.2 543.8 1,029.0 351.9 33,660.4 19,582.1 17,614.7 2,410.9 $ 4,476.4 $ 1,284.7 626.0 1,113.1 470.9 36,434.7 22,602.2 18,097.8 2,754.4 $ 5,960.2 $ 1,375.5 608.8 1,171.0 489.9 44,401.6 28,742.3 20,593.2 3,104.6 $ 7,685.6 $ 1,424.2 785.3 1,328.2 540.7 48,623.7 31,710.2 22,638.0 3,449.2 $ 5,836.5 $ 1,427.9 809.5 1,485.1 357.7 47,404.0 32,736.9 24,438.3 3,620.3 $ 5,003.4 $ $ 1,449.4 694.3 1,704.6 -64.5 44,411.4 29,911.0 28,334.4 3,581.9 2,968.3 1.04% 15.00% 1.09% 14.84% 1.11% 16.29% 1.36% 19.30% 1.23% 17.60% 1.17% 17.12% 0.74% 9.73% -0.14% -2.08% 0.99 0.99 0.32 6.96 13.16 72% 26% 2% 100% 199 8 95 302 136 132 61 12 11 21 3 2 4 382 684 478 37 109 624 118 920 1,038 1,662 199.5 160.2 10,651 $ $ $ 1.09 1.09 0.38 7.97 14.54 $ $ $ 1.31 1.31 0.40 9.10 16.90 $ $ $ 1.74 1.74 0.51 9.66 22.43 $ $ $ 1.79 1.79 0.62 10.95 28.83 $ $ $ 1.98 1.97 0.64 11.82 21.15 $ $ $ 1.24 1.24 0.64 12.32 17.95 -$ -$ $ 0.27 0.27 0.64 12.12 10.60 68% 30% 2% 100% 66% 32% 2% 100% 62% 36% 2% 100% 55% 43% 2% 100% 53% 45% 2% 100% 52% 45% 3% 100% 196 8 96 300 149 154 55 20 13 25 4 2 1 4 427 727 524 39 118 681 155 823 978 1,659 206.0 149.9 11,334 195 8 96 299 153 195 36 18 13 29 7 2 1 1 5 460 759 539 53 131 723 174 926 1,100 1,823 236.6 145.3 11,037 193 8 97 298 181 129 43 18 11 32 8 2 1 1 5 431 729 557 57 129 743 176 1,110 1,286 2,029 255.7 138.5 11,474 192 8 128 328 183 114 43 18 15 30 9 2 1 1 7 423 751 568 59 163 790 167 1,216 1,383 2,173 568.5 133.9 12,139 194 8 136 338 213 4 49 17 14 33 12 2 1 1 8 354 692 583 61 181 825 212 1,726 1,938 2,763 625.9 140.3 13,210 191 8 142 341 159 52 15 11 32 12 2 1 1 12 297 638 605 65 192 862 226 1,360 1,586 2,448 690.2 150.0 12,508 59% 38% 3% 100% 196 8 147 351 135 51 12 24 32 13 2 1 1 11 282 633 615 69 187 871 433 1,454 1,887 2,758 772.7 175.2 12,303 8 Board of Directors Richard L. Carrión Chairman, President, Chief Executive Officer, Popular, Inc. Juan J. Bermúdez Partner, Bermúdez & Longo, S.E. María Luisa Ferré President, Grupo Ferré Rangel Michael Masin Senior Partner, O’Melvany & Myers Manuel Morales Jr. President, Parkview Realty, Inc. Francisco M. Rexach Jr. President, Capital Assets, Inc. Frederic V. Salerno Investor William J. Teuber Jr. Vice Chairman, EMC Corporation José R. Vizcarrondo President and Chief Executive Officer Desarrollos Metropolitanos, S.E. Samuel T. Céspedes, Esq. Secretary of the Board of Directors, Popular, Inc. Corporate Leadership Circle Richard L. Carrión Chairman, President, Chief Executive Officer, Popular, Inc. David H. Chafey Jr. Senior Executive Vice President, Popular, Inc. President, Banco Popular de Puerto Rico Roberto R. Herencia Executive Vice President, Popular, Inc. President, Banco Popular North America Amílcar Jordán, Esq. Executive Vice President, Risk Management, Popular, Inc. Jorge A. Junquera Senior Executive Vice President, Chief Financial Officer, Popular, Inc. Tere Loubriel Executive Vice President, People, Communications and Planning, Popular, Inc. Brunilda Santos de Álvarez, Esq. Executive Vice President, Chief Legal Officer, Popular, Inc. Félix M. Villamil Executive Vice President, Popular, Inc. President, EVERTEC, Inc. Our Creed Banco Popular is a local institution dedicating its efforts exclusively to the enhancement of the social and economic conditions in Puerto Rico and inspired by the most sound principles and fundamental practices of good banking. Banco Popular pledges its efforts and resources to the development of a banking service for Puerto Rico within strict commercial practices and so efficient that it could meet the requirement of the most progressive community of the world. These words, written in 1928 by Don Rafael Carrión Pacheco, Executive Vice President and President (1927–1956), embody the philosophy of Popular, Inc. Our People The men and women who work for our institution, from the highest executive to the employees who handle the most routine tasks, feel a special pride in serving our customers with care and dedication. All of them feel the personal satisfaction of belonging to the “Banco Popular Family,” which fosters affection and understanding among its members, and which at the same time firmly complies with the highest ethical and moral standards of behavior. These words by Don Rafael Carrión Jr., President and Chairman of the Board (1956–1991), were written in 1988 to commemorate the 95th anniversary of Banco Popular de Puerto Rico, and reflect our commitment to human resources. Corporate Information Independent Registered Public Accounting Firm PricewaterhouseCoopers LLP Annual Meeting The 2008 Annual Stockholders’ Meeting of Popular, Inc. will be held on Friday, April 25, at 9:00 a.m. at Centro Europa Building in San Juan, Puerto Rico. Additional Information The Annual Report to the Securities and Exchange Commission on Form 10-K and any other financial information may also be viewed by visiting our website: www.popular.com Popular, Inc. 2007 Informe Anual 9 Decisiones tomadas durante el 2007 fueron muy difíciles, pero nos colocarán en mejor posición para ir hacia adelante. Carta a 2007 los Accionistas La ejecutoria financiera de Popular en el año 2007 se vio significativamente influida por el impacto negativo del deterioro de la industria hipotecaria en los resultados de nuestras operaciones no bancarias en los Estados Unidos, y por las acciones que tomamos para hacerle frente a esta situación. Aunque fueron extremadamente difíciles, estas decisiones nos posicionan mejor para salir adelante, mientras nos enfocamos en nuestra franquicia bancaria en los Estados Unidos continentales. Nuestros servicios financieros en Puerto Rico continua- ron rindiendo resultados sólidos, a pesar de la recesión económica y del deterioro en la calidad de crédito. EVERTEC, nuestra compañía de procesamiento, reflejó un crecimiento consistente en ganancias y realizó avances en varios frentes estratégicos. Popular registró una pérdida neta de $64.5 millones en el 2007, en comparación con un ingreso neto de $357.7 millones en el 2006. La pérdida neta por acción común básica y diluida en el año fue $0.27, comparado con $1.24 de ingreso neto por acción en el 2006. Estas pérdidas representaron un rendimiento negativo de activos (ROA) de un 0.14% y un rendimiento negativo sobre capital (ROE) de 2.08%, comparado con un rendimiento positivo de 0.74% y un 9.73%, respectivamente en el 2006. Nuestros resultados del 2007 se vieron afectados negativamente por (i) un aumento en la provisión para pérdidas en préstamos de $274.9 millones en el 2007 comparado con el 2006, que fue impulsado por la contracción en el sector de la vivienda en los Estados Unidos, así como la débil situación económica en Puerto Rico, (ii) una pérdida antes de contribución sobre ingresos de $90.1 millones asociada con la recaracterización de varias titulizaciones en el estado de situación de Popular Financial Holdings (PFH), (iii) una 10 Un Vistazo a Popular, Inc. Carta a los Accionistas, continuación Banco Popular de Puerto Rico > Aproximadamente 1.4 millones de clientes > 204 sucursales y 111 oficinas a través de Puerto Rico e Islas Vírgenes > 6,442 empleados (equivalente a tiempo completo) al 31/12/07 > 615 cajeros automáticos y 28,000 termina- les de punto de venta a través de Puerto Rico e Islas Vírgenes > Primer lugar en participación de mercado en total de depósitos (34.9% - 30/09/07) y volumen de préstamos (23.0% - 30/09/07) > $27,100 millones en activos, $16,600 millones en préstamos y $18,800 millones en depósitos al 31/12/07 Banco Popular North America > 147 sucursales a través de seis estados (Florida, California, Nueva York, Nueva Jersey, Texas, e Illinois) > 24 oficinas de arrendamiento con presencia en 15 estados > 2,923 empleados (equivalente a tiempo completo) al 31/12/07 > Como prestamista de SBA, ocupa la quinta posición en los Estados Unidos en términos de volumen de préstamos en dólares > E-LOAN tuvo $1,500 millones en depósitos y alcanzó $3,600 millones en originaciones en 2007 > $13,400 millones en activos, $10,300 millones en préstamos y $9,800 millones en depósitos al 31/12/07 EVERTEC > 11 oficinas a través de los Estados Unidos y Latinoamérica, sirviendo a 15 países > 1,765 empleados (equivalente a tiempo completo) al 31/12/07 > Procesó más de 1,000 millones de transacciones en 2007, de las cuales más de 535 millones correspondieron a la Red ATH® > 4,944 cajeros automáticos y más de 100,500 terminales de punto de venta a través de los Estados Unidos y Latinoamérica Popular Financial Holdings > 135 oficinas in 16 estados al 31/12/07 > El total de originaciones alcanzó $3,400 millones en 2007 > Al 31/12/07, la cartera de préstamos hipotecarios manejados a terceros ascendió a $9,400 millones > 930 empleados (equivalente a tiempo completo) al 31/12/07 > $3,900 millones en activos y $3,300 millones en préstamos mercado con volúmenes notablemente más bajos, mayores niveles de morosidad, y un mercado secundario prácticamente sin liquidez. En el caso de Banco Popular North America (BPNA), hemos emprendido un proceso de enfocar nuestros recursos para mejorar la rentabilidad de nuestra franquicia de banca individual. Popular Financial Holdings Popular Financial Holdings (PFH) registró una pérdida neta de $269.4 millones en el 2007. Estos resultados reflejan el deterioro del negocio de hipotecas de alto riesgo, así como cargos asociados con algunas de las iniciativas que llevamos a cabo durante el año. En enero del 2007, adoptamos un plan de reestructuración para PFH que incluyó las decisiones de salir del negocio mayorista de originación de hipotecas de alto riesgo, consolidar las funciones de apoyo con Banco Popular North America, su entidad bancaria afiliada en los Estados Unidos, y enfocarnos en negocios rentables. Como resultado del plan de reestructura- ción y de la decisión de salir del negocio de hipotecas de alto riesgo, completamos la recaracterización de ciertas titulizaciones en el estado de situación que nos permitieron reconocer estas transacciones como ventas. Por consiguiente, removimos aproximada- mente $3,200 millones en préstamos hipotecarios, y $3,100 millones en pasivos relacionados de nuestro estado de situación. El impacto de la recaracterización fue una pérdida antes de contribución sobre ingre- sos de $90.1 millones. La eliminación de estos activos hipotecarios de nuestros libros mejora las métricas de capital y de calidad de crédito, y también reduce la cantidad de hipotecas de alto riesgo en nuestros libros. La mayor parte de la cartera restante de PFH, la cual totaliza aproximadamente $1,500 millones al igual que $287 millones en certificados de bonos asociados con las titulizaciones en el estado de situación se presentarán al valor del mercado en base a FAS 159 (Fair Value Option for Financial Assets and Financial Liabilities). La adop- ción de FAS 159, que se implementará el reducción de $85.1 millones en el justo valor de intereses residuales reconocidos por PFH en titulizaciones previas, (iv) $16.6 millones en costos por reestructuración en PFH y (v) $231.9 millones en cargos por reestructuración y menoscabo de algunos activos en E-LOAN. Estas variaciones nega- tivas fueron compensadas en parte por una ganancia antes de contribución sobre ingre- sos de $118.7 millones proveniente de la venta en marzo del 2007 de las acciones comunes de Telecomunicaciones de Puerto Rico, Inc. (TELPRI) que tenía la Corporación. El precio de nuestra acción bajó en un 41% durante el 2007 a $10.60 al cierre del año. Estamos extremadamente decepciona- dos con nuestros resultados financieros, así como con el rendimiento de nuestra acción. Reconocemos que estos resultados son inaceptables, y hemos comenzado un proceso dirigido a realinear nuestras opera- ciones en los Estados Unidos, con el fin de llevarlas a niveles aceptables de rentabilidad. Estados Unidos En Popular Financial Holdings (PFH), nuestra operación de préstamos de alto riesgo en los Estados Unidos, reducimos el tamaño del negocio y tomamos medidas para aminorar nuestro riesgo en el mercado de hipotecas de alto riesgo. En E-LOAN, adaptamos el modelo de negocio y ajusta- mos nuestra infraestructura al tamaño adecuado para reflejar la realidad de un Popular, Inc. 2007 Informe Anual 11 Enfocaremos nuestros esfuerzos en realzar el valor de nuestra franquicia de banca individual. como la reducción de liquidez en los mercados secundarios, nos instaron a rees- tructurar E-LOAN. En noviembre del 2007, adoptamos un plan de reestructuración que redujo sustancialmente los gastos de merca- deo y personal, a la vez que enfocó a E-LOAN en la originación de préstamos de primeras hipotecas que cumplen con las pautas de las agencias federales. Este plan se tradujo en cargos de $20.1 millones por concepto de reestructuración durante el cuarto trimestre del 2007, y se espera que reduzca los gastos de operaciones en $77 millones en el 2008. En vista de los cambios realizados al modelo de negocios y del ambiente de desafíos que encara la industria hipotecaria en los Estados Unidos, realizamos una valoración de la plusvalía y del poder de la marca E-LOAN. La valoración demostró un deterioro de plusvalía. Esta transacción se realizó sin que mediara efectivo, y por tanto no impactó la liquidez de Popular ni las métricas de capital requeridas por las agen- cias reguladoras. E-LOAN sigue siendo un elemento importante para Popular, dada su plata- forma tecnológica, el amplio alcance geográfico de sus productos, su capacidad de aumentar el nivel de depósitos de la Corporación, así como el valor de su marca, que es ampliamente reconocida y respetada. 1ro de enero, se traducirá en un ajuste negativo de entre aproximadamente $280 y $300 millones antes de contribuciones sobre ingresos y no tendrá impacto en el estado de ingresos y gastos, puesto que se deducirá del balance de las ganancias acumuladas. Al momento de la reestructuración de enero del 2007, decidimos continuar las operaciones de Equity One y sus subsidia- rias, las cuales se dedican a originar y dar servicio a préstamos de consumo a través de una red de más de 130 oficinas. No obstante, en vista del aumento en los costos de fondos debido a cambios en los merca- dos capitales que comenzaron en el verano del 2007, nos convencimos de que sería progresivamente más difícil generar un rendimiento adecuado sobre el capital invertido en Equity One. En enero del 2008, anunciamos la firma de un acuerdo para vender ciertos activos de Equity One a American General Financial, miembro de American International Group (AIG). Como parte del acuerdo, American General adquirió una parte significativa de la cartera de préstamos hipotecarios y de consumo de aproximadamente $1,400 millones, así como 24 sucursales de Equity One. Cerraremos las sucursales restantes. Esta transacción cerró en marzo primero del 2008, y resultó en cargos por concepto de reestructuración de $19.5 millones, la mayor parte de los cuales se registrarán en el primer trimestre, y generaron una ganan- cia antes de contribuciones sobre ingresos de aproximadamente $50 millones. El efecto combinado de las iniciativas mencionadas anteriormente es una reduc- ción en la cartera de préstamos de PFH, de $6,900 millones al comienzo del 2007, a aproximadamente $1,300 millones a diciembre del 2007, de los cuales $1,000 millones son préstamos de alto riesgo, comparado con $4,600 millones a diciem- bre del 2006. Estas iniciativas nos permiten presentar un cuadro más claro de nuestro riesgo en este negocio. Banco Popular North America Banco Popular North America (BPNA), que incluye E-LOAN como subsidiaria, registró una pérdida neta de $195.4 millones en el 2007. Esta pérdida fue impulsada por una pérdida neta de $245.7 millones en E-LOAN. Las operaciones bancarias de BPNA generaron un ingreso neto de $50.5 millones, lo cual aunque positivo, fue un 50% más bajo que en el 2006. Los resultados de BPNA se vieron afectados adversamente por el aumento en los costos de crédito e ingre- sos por concepto de interés más bajos. La provisión para pérdida de préstamos de BPNA alcanzó un total de $77.8 millones, la cual es 106% más alta que en el 2006, debido a una cantidad mayor de activos no acumulativos en las carteras de préstamos hipotecarios y de construcción. El ingreso neto por intereses fue de $14.5 millones, menos que el del 2006, debido a márgenes más estrechos. En vista de los retos a los cuales nos enfrentamos, tomamos acción para enfocar y priorizar nuestros recursos. En octubre del 2007 anunciamos la venta de seis de nuestras sucursales en Houston, Texas a Prosperity Bank. Prosperity Bank pagó una prima de 10.10% para obtener aproxi- madamente $125 millones en depósitos y también adquirió ciertos préstamos y activos atribuibles a las sucursales. Enfocaremos nuestros esfuerzos en mejorar la ejecutoria de la red de sucursales que hemos formado en los Estados Unidos para aumentar el valor de nuestra franquicia de banca individual. E-LOAN incurrió en una pérdida neta de $245.7 millones en el 2007, que incluye los cargos de $20.1 millones por reestructu- ración, al igual que cargos por deterioro de plusvalía y del poder de la marca ascendien- tes a $211.8 millones. El negocio de E-LOAN continuó reci- biendo el impacto severo de las condiciones del mercado en el 2007. Una disminución general en el volumen de originación de hipotecas, aumentos significativos en los niveles de morosidad y ejecuciones, así 12 Carta a los Accionistas, continuación Puerto Rico Nuestras operaciones de servicios financie- ros en Puerto Rico, compuestas por Banco Popular de Puerto Rico y otras subsidiarias especializadas, se desempeñaron muy bien en el 2007, a pesar del escenario de rece- sión, el deterioro de la calidad de crédito, y la competencia tan reñida. Estos resultados confirman nuestra capacidad de no sola- mente resistir estas fuerzas negativas, sino también de fortalecer nuestra posición aun en las épocas marcadas por los más formi- dables retos. El ingreso neto en el círculo de Puerto Rico alcanzó un total de $327.3 millones, $28.6 millones menos que en el 2006. Los resultados financieros recibieron el impacto del deterioro en la calidad de crédito, que resultó en una provisión para pérdidas en préstamos de $243.7 millones, la cual es 73% más alta que en el año anterior. Las pérdidas netas en préstamos aumentaron en un 69%, alcanzando la cifra de $191 millones, mayormente en las carteras de préstamos comerciales, personales y de tarjetas de crédito. A través del año nos enfocamos en manejar proactivamente la calidad de crédito, siendo más estrictos con los estándares de suscripción, anticipando posibles pérdidas, aumentando los márgenes y mejorando los esfuerzos de cobro. A pesar de nuestro enfoque cauteloso en el área de crédito, pudimos defender y aumentar nuestra participación general de mercado. El obtener mayor participación de mercado resulta más difícil cada año, considerando que somos el jugador princi- pal en siete de nueve categorías de producto claves que seguimos de cerca. Durante el 2007 mejoramos nuestra posición en ocho de nueve categorías, abarcando el 23% del total de préstamos y el 35% del total de depósitos en el mercado. Continuaremos haciendo hincapié en la expansión rentable del mercado, para solidificar más nuestra posición de liderazgo en Puerto Rico. Además de ampliar nuestro negocio exis- tente, fortalecimos nuestra franquicia con la adquisición del negocio de banca individual a nivel local de Citibank y las operaciones locales de corretaje de Smith Barney. La adquisición del negocio de banca individual incluyó 17 sucursales (de las cuales siete fueron consolidadas), aproximadamente $1,000 millones en depósitos, mayormente depósitos básicos, y más de $220 millones en préstamos. Al incluir estos depósitos, la participación de mercado de Popular aumentó a aproximadamente un 38%. Le dimos la bienvenida a más de 200 nuevos compañeros, así como a una sólida base de clientes que representa un gran potencial para la venta cruzada de productos adicio- nales de Popular. El negocio local de valores se encuentra sumamente concentrado, con el 60% de los activos bajo manejo (AUM) controlado por las dos entidades principales del mercado. La transacción de Smith Barney fortalece nuestra fuerza de ventas y provee volumen adicional de negocios ($1,200 millones en AUM), lo cual cierra significativamente la brecha existente entre Popular Securities y la segunda entidad que compite en el mismo mercado. El mejoramiento de la rentabilidad continuó siendo una de las prioridades de Banco Popular en el 2007. Los gastos fueron 4.7% más altos que en el 2006, en gran parte debido a los costos relacionados con la conversión de las operaciones de banca individual y de corretaje de Citibank. Sin embargo, aun cuando estos costos no estaban contemplados en el presupuesto original, los gastos totales del año estuvieron por debajo del presupuesto debido a la disciplina ejercida en los gastos de otras áreas. Como resultado de nuestros esfuerzos realizados a través de los pasados tres años, hemos mejorado nuestra métrica de eficien- cia de un 55.8% en el 2005 a un 52.9% en el 2007. Anticipamos que el difícil escenario económico actual persistirá hasta bien entrado el 2008. No obstante, tal y como lo probamos en el 2007, la disciplina, el enfoque en la ejecución, y la solidez de nuestra franquicia, pueden no solamente Tal y como lo probamos en el 2007, la disciplina y el enfoque en la ejecución pueden fortalecernos aún más. hacernos sobrellevar los tiempos más difíciles, sino que pueden hacernos surgir aún mas fuertes que antes. EVERTEC EVERTEC, nuestra unidad de procesa- miento con operaciones en Puerto Rico, el Caribe y Latinoamérica, aumentó sus ingresos, su ingreso neto y su volumen de transacciones en el 2007, a pesar de la recesión económica en Puerto Rico, que es su mercado principal, y de la creciente competencia de otras compañías de procesa- miento más grandes establecidas a través de todas las regiones. En ingreso neto de EVERTEC en el 2007 alcanzó $31.3 millones, lo que representa un aumento de un 20% sobre el 2006. Estos resultados fueron impulsados por un crecimiento bueno en los ingresos prove- niente principalmente de clientes fuera de las compañías Popular, combinado con un manejo más estricto de los gastos. Además de sus sólidos resultados finan- cieros, EVERTEC realizó un importante progreso en varias de sus áreas estratégicas claves, tales como aumentar la competitivi- dad de la Red ATH®. Por más de 20 años, ATH® ha sido el método de pago preferido, así como el más seguro y menos costoso para los puertorriqueños. Durante el 2007, la red ATH® procesó más de 535 millones de transacciones a través de 4,944 cajeros automáticos y 100,500 terminales de punto de venta. En años recientes, ATH® ha expe- rimentado niveles de competencia en aumento por parte de Visa y MasterCard Popular, Inc. 2007 Informe Anual 13 Valores Institucionales Compromiso Social Estamos comprometidos a traba- jar activamente para promover el bienestar social y económico de las comunidades que servimos. Cliente Logramos la satisfacción y lealtad de nuestros clientes añadiéndole valor a cada interacción. La relación con nuestro cliente está por encima de una transacción particular. Integridad Nos desempeñamos bajo las normas más estrictas de ética, integridad y moral. La confianza que nuestros clientes nos depositan es lo más importante. Excelencia Creemos que sólo hay una forma de hacer las cosas: bien hechas. Innovación Fomentamos la búsqueda incesante de nuevas soluciones como estrategia para realzar nuestra ventaja competitiva. Nuestra Gente Nos esforzamos por atraer, desarrollar, recompensar y retener al mejor talento dentro de un ambiente de trabajo que se caracteriza por el cariño y la disciplina. Rendimiento Nuestra meta es obtener resultados financieros altos y consistentes para nuestros accionistas fundamentados en una visión a largo plazo. debido al alza de tarjetas de débito con firma. Como respuesta a este cambio, la Red ATH® en Puerto Rico actualizó su estructura de precios para brindar mayores incentivos financieros a sus miembros bancarios, a la vez que se mantiene como la alternativa de más bajo costo para los comerciantes. Estos cambios solidificarán y protegerán el poder de la marca ATH® y fomentarán el creci- miento del negocio a largo plazo. En Puerto Rico, añadimos varias institu- ciones financieras a nuestra lista de clientes y ampliamos los servicios que se ofrecen a los clientes existentes. EVERTEC ahora procesa aproximadamente el 75% de todos los cheques e intercambios electrónicos en Puerto Rico. Expandimos nuestro negocio de manejo de fuerza laboral con la adquisi- ción de SENSE, una compañía de desarrollo de software que brinda soluciones a las áreas de recursos humanos, procesamiento de nómina, horario y asistencia. El negocio de sistemas de salud adquirió una cartera de proveedores médicos y aumentó el número de transacciones procesadas en aproximada- mente un 20%. EVERTEC Latinoamérica tuvo un año excelente, aumentando nota- blemente los ingresos y añadiendo clientes importantes en la región, a pesar de la entrada de compañías internacionales de procesamiento, como consecuencia de la adquisición de bancos locales por parte de grandes entidades internacionales. Los resultados y logros estratégicos de EVERTEC durante el 2007 corroboran la estrategia que establecimos hace cuatro años apalancando nuestra infraestructura para generar ingresos adicionales y diversificar más nuestras fuentes de ingreso. Hacia adelante La guía y el apoyo de nuestra Junta de Directores durante este año, caracterizado por tantos retos, ha sido muy significativa y absolutamente apreciada. Quisiera expresar un reconocimiento especial a José B. Carrión (Pepe) por su servicio en las Juntas de Banco Popular y Popular, Inc. Durante siete años esta organización se benefició enormemente de su asesoría e intelecto. Pepe se retiró en el 2007 al llegar a la edad de jubilación obligatoria. A la misma vez, nos sentimos extremadamente complacidos de darle la bienvenida a nuestra Junta de Directores a Michael Masin. Sé que la vasta experiencia de Michael como parte de la gerencia y de las Juntas de algunas de las principales corporaciones en los Estados Unidos, será de gran valor a Popular. Igualmente, luego de servir a Popular por espacio de 30 años, Tere Loubriel, nuestra Vicepresidenta Ejecutiva a cargo de Gente, Comunicaciones y Planificación, se retirará en Marzo. Tere ocupó una amplia variedad de cargos a través de los años, todos ellos con el mismo nivel de dedica- ción y compromiso con la excelencia. La vamos a echar muchísimo de menos y le deseamos lo mejor. Eduardo Negrón, nuestro Principal Oficial Legal Auxiliar durante siete años, va a dirigir y llevar hacia adelante las áreas de Gente y Comunicaciones. En retrospectiva, el 2007 fue definitiva- mente uno de los años de más desafíos a los cuales nuestra Corporación se ha enfrentado hasta la fecha. Las condiciones sin precedentes y la turbulencia en la industria de servicios financieros han puesto a prueba nuestra organización. Nuestra gente respondió como siempre lo ha hecho, enfocando su atención y energías en definir y llevar a cabo lo que era necesario hacer para afrontar los retos. Ahora más que en cualquier otro momento, nos sentimos seguros de nuestra capacidad de ir hacia adelante y volver a colocar a Popular en los niveles de crecimiento y rentabilidad que han caracterizado la historia de esta organización. Richard L. Carrión Presidente de la Junta de Directores Presidente, Principal Oficial Ejecutivo 14 Resumen Financiero Histórico – 25 Años (Dólares en millones, excepto información por acción) 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 Información Financiera Seleccionada Ingreso Neto por Intereses Ingreso Operacional Gastos Operacionales Ingreso Neto Activos Préstamos Netos Depósitos Capital de Accionistas Valor Agregado en el Mercado Rendimiento de Activos (ROA) Rendimiento de Capital (ROE) Por Acción Común1 Ingreso Neto – Básico Ingreso Neto – Diluido Dividendos (Declarados) Valor en los Libros Precio en el Mercado Activos por Área Geográfica Puerto Rico Estados Unidos Caribe y Latinoamérica Total Sistema de Distribución Tradicional Sucursales Bancarias Puerto Rico Islas Vírgenes Estados Unidos Subtotal Oficinas No Bancarias Popular Financial Holdings Popular Cash Express Popular Finance Popular Auto Popular Leasing, U.S.A. Popular Mortgage Popular Securities Popular Insurance Popular Insurance Agency U.S.A. Popular Insurance, V.I. EVERTEC Subtotal Total Sistema de Distribución Electrónico Cajeros Automáticos2 Propios y Administrados Puerto Rico Caribe Estados Unidos Subtotal Administrados Puerto Rico Caribe Subtotal Total Transacciones (en millones) Transacciones Electrónicas3 Efectos Procesados Empleados (equivalente a tiempo completo) $ $ $ $ $ 144.9 19.6 127.3 26.8 2,974.1 1,075.7 2,347.5 182.2 119.3 0.95% 15.86% 0.19 0.19 0.06 1.24 0.83 94% 5% 1% 100% 112 3 6 121 $ $ $ $ $ 156.8 19.0 137.2 29.8 3,526.7 1,373.9 2,870.7 203.5 159.8 0.94% 15.83% 0.21 0.21 0.06 1.38 1.11 91% 8% 1% 100% 113 3 9 125 $ $ $ $ $ 174.9 26.8 156.0 32.9 4,141.7 1,715.7 3,365.3 226.4 216.0 0.89% 15.59% 0.23 0.23 0.07 1.54 1.50 92% 7% 1% 100% 115 3 9 127 $ $ $ $ $ 184.2 41.4 168.4 38.3 4,531.8 2,271.0 3,820.2 283.1 304.0 0.88% 15.12% 0.25 0.25 0.08 1.73 2.00 92% 7% 1% 100% 124 3 9 136 121 125 127 136 113 113 51 51 164 30 30 30 0.6 102.1 3,832 78 78 6 6 84 4.4 110.3 4,110 94 94 36 36 130 7.0 123.8 4,314 $ $ $ $ $ 207.7 41.0 185.7 38.3 5,389.6 2,768.5 4,491.6 308.2 260.0 0.76% 13.09% 0.24 0.24 0.09 1.89 1.67 94% 5% 1% 100% $ $ $ $ $ 232.5 54.9 195.6 47.4 5,706.5 3,096.3 4,715.8 341.9 355.0 0.85% 14.87% 0.30 0.30 0.09 2.10 2.22 93% 6% 1% 100% $ $ $ $ $ 260.9 63.3 212.4 56.3 5,972.7 3,320.6 4,926.3 383.0 430.1 0.99% 15.87% 0.35 0.35 0.10 2.35 2.69 92% 6% 2% 100% $ $ $ $ $ 284.2 70.9 229.6 63.4 8,983.6 5,373.3 7,422.7 588.9 479.1 1.09% 15.55% 0.40 0.40 0.10 2.46 2.00 89% 9% 2% 100% $ $ $ $ $ 407.8 131.8 345.7 64.6 8,780.3 5,195.6 7,207.1 631.8 579.0 0.72% 10.57% 0.27 0.27 0.10 2.63 2.41 87% 11% 2% 100% $ $ $ $ $ 440.2 124.5 366.9 85.1 10,002.3 5,252.1 8,038.7 752.1 987.8 0.89% 12.72% 0.35 0.35 0.10 2.88 3.78 87% 10% 3% 100% $ $ $ $ $ 492.1 125.2 412.3 109.4 11,513.4 6,346.9 8,522.7 834.2 1,014.7 1.02% 13.80% 0.42 0.42 0.12 3.19 3.88 79% 16% 5% 100% 126 3 9 138 14 14 152 136 3 139 55 55 194 126 3 10 139 17 17 156 153 3 156 68 68 224 128 3 10 141 18 4 22 163 151 3 154 65 65 219 173 3 24 200 26 9 35 235 211 3 214 54 54 268 161 3 24 188 27 26 9 62 250 206 3 209 73 73 282 162 3 30 195 41 26 9 76 271 211 3 6 220 81 81 301 165 8 32 205 58 26 8 92 297 234 8 11 253 86 86 339 8.3 134.0 4,400 12.7 139.1 4,699 14.9 159.8 5,131 16.1 161.9 5,213 18.0 164.0 7,023 23.9 166.1 7,006 28.6 170.4 7,024 33.2 171.8 7,533 1 Datos ajustados por las divisiones en acciones. 2 No incluyen cajeros automáticos que están conectados a la Red ATH® (2,186 en el 2007) pero que son administrados por otras instituciones financieras. 3 Desde el 1981 al 2003, transacciones electrónicas incluyen transacciones ACH, Pago Directo, TelePago, Banca por Internet y transacciones por la Red ATH® en Puerto Rico. Desde 2004, estos números incluyen el total de transacciones por la Red ATH® en República Dominicana, Costa Rica, El Salvador y Estados Unidos, transacciones de facturación médica, transferencias cablegráficas y otros pagos electrónicos además de lo previamente señalado. Popular, Inc. 2007 Informe Anual 15 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 $ $ $ $ $ $ $ $ $ $ 535.5 141.3 447.8 124.7 12,778.4 7,781.3 9,012.4 1,002.4 923.7 1.02% 13.80% 0.46 0.46 0.13 3.44 3.52 76% 20% 4% 100% $ 584.2 173.3 486.8 146.4 15,675.5 8,677.5 9,876.7 1,141.7 $ 1,276.8 $ 681.3 205.5 541.9 185.2 16,764.1 9,779.0 10,763.3 1,262.5 $ 2,230.5 $ 784.0 247.6 636.9 209.6 19,300.5 11,376.6 11,749.6 1,503.1 $ 3,350.3 1.04% 14.22% 1.14% 16.17% 1.14% 15.83% $ $ $ 0.53 0.53 0.15 3.96 4.85 75% 21% 4% 100% $ $ $ 0.67 0.67 0.18 4.40 8.44 $ $ $ 0.75 0.75 0.20 5.19 12.38 74% 22% 4% 100% 74% 23% 3% 100% 166 8 34 208 73 28 10 111 319 262 8 26 296 88 88 384 166 8 40 214 91 31 9 3 134 348 281 8 38 327 120 120 447 178 8 44 230 102 39 8 3 1 153 383 327 9 53 389 162 97 259 648 201 8 63 272 117 44 10 7 3 2 183 455 391 17 71 479 170 192 362 841 43.0 174.5 7,606 56.6 175.0 7,815 78.0 173.7 7,996 111.2 171.9 8,854 $ $ $ $ $ 873.0 291.2 720.4 232.3 23,160.4 13,078.8 13,672.2 1,709.1 4,611.7 $ 953.7 372.9 837.5 257.6 25,460.5 14,907.8 14,173.7 1,661.0 $ 3,790.2 1.14% 15.41% 1.08% 15.45% 0.83 0.83 0.25 5.93 17.00 71% 25% 4% 100% 198 8 89 295 128 51 48 10 8 11 2 258 553 421 59 94 574 187 265 452 1,026 130.5 170.9 10,549 $ $ $ 0.92 0.92 0.30 5.76 13.97 71% 25% 4% 100% 199 8 91 298 137 102 47 12 10 13 2 4 327 625 442 68 99 609 102 851 953 1,562 159.4 171.0 11,501 982.8 464.1 876.4 276.1 28,057.1 16,057.1 14,804.9 1,993.6 3,578.1 $ 1,056.8 491.8 926.2 304.5 30,744.7 18,168.6 16,370.0 2,272.8 $ 3,965.4 $ 1,160.2 543.8 1,029.0 351.9 33,660.4 19,582.1 17,614.7 2,410.9 $ 4,476.4 $ 1,284.7 626.0 1,113.1 470.9 36,434.7 22,602.2 18,097.8 2,754.4 $ 5,960.2 $ 1,375.5 608.8 1,171.0 489.9 44,401.6 28,742.3 20,593.2 3,104.6 $ 7,685.6 $ 1,424.2 785.3 1,328.2 540.7 48,623.7 31,710.2 22,638.0 3,449.2 $ 5,836.5 $ 1,427.9 809.5 1,485.1 357.7 47,404.0 32,736.9 24,438.3 3,620.3 $ 5,003.4 $ $ 1,449.4 694.3 1,704.6 -64.5 44,411.4 29,911.0 28,334.4 3,581.9 2,968.3 1.04% 15.00% 1.09% 14.84% 1.11% 16.29% 1.36% 19.30% 1.23% 17.60% 1.17% 17.12% 0.74% 9.73% -0.14% -2.08% 0.99 0.99 0.32 6.96 13.16 72% 26% 2% 100% 199 8 95 302 136 132 61 12 11 21 3 2 4 382 684 478 37 109 624 118 920 1,038 1,662 199.5 160.2 10,651 $ $ $ 1.09 1.09 0.38 7.97 14.54 $ $ $ 1.31 1.31 0.40 9.10 16.90 $ $ $ 1.74 1.74 0.51 9.66 22.43 $ $ $ 1.79 1.79 0.62 10.95 28.83 $ $ $ 1.98 1.97 0.64 11.82 21.15 $ $ $ 1.24 1.24 0.64 12.32 17.95 -$ -$ $ 0.27 0.27 0.64 12.12 10.60 68% 30% 2% 100% 66% 32% 2% 100% 62% 36% 2% 100% 55% 43% 2% 100% 53% 45% 2% 100% 52% 45% 3% 100% 196 8 96 300 149 154 55 20 13 25 4 2 1 4 427 727 524 39 118 681 155 823 978 1,659 206.0 149.9 11,334 195 8 96 299 153 195 36 18 13 29 7 2 1 1 5 460 759 539 53 131 723 174 926 1,100 1,823 236.6 145.3 11,037 193 8 97 298 181 129 43 18 11 32 8 2 1 1 5 431 729 557 57 129 743 176 1,110 1,286 2,029 255.7 138.5 11,474 192 8 128 328 183 114 43 18 15 30 9 2 1 1 7 423 751 568 59 163 790 167 1,216 1,383 2,173 568.5 133.9 12,139 194 8 136 338 213 4 49 17 14 33 12 2 1 1 8 354 692 583 61 181 825 212 1,726 1,938 2,763 625.9 140.3 13,210 191 8 142 341 159 52 15 11 32 12 2 1 1 12 297 638 605 65 192 862 226 1,360 1,586 2,448 690.2 150.0 12,508 59% 38% 3% 100% 196 8 147 351 135 51 12 24 32 13 2 1 1 11 282 633 615 69 187 871 433 1,454 1,887 2,758 772.7 175.2 12,303 16 Junta de Directores Richard L. Carrión Presidente de la Junta de Directores Presidente, Principal Oficial Ejecutivo, Popular, Inc. Juan J. Bermúdez Socio, Bermúdez & Longo, S.E. María Luisa Ferré Presidenta, Grupo Ferré Rangel Michael Masin Senior Partner, O’Melvany & Myers Manuel Morales, Jr. Presidente, Parkview Realty, Inc. Francisco M. Rexach, Jr. Presidente, Capital Assets, Inc. Frederic V. Salerno Inversionista William J. Teuber, Jr. Vicepresidente de la Junta de Directores, EMC Corporation José R. Vizcarrondo Presidente y Principal Oficial Ejecutivo, Desarrollos Metropolitanos, S.E. Lcdo. Samuel T. Céspedes Secretario de la Junta de Directores, Popular, Inc. Círculo de Liderato Corporativo Richard L. Carrión Presidente de la Junta de Directores Presidente, Principal Oficial Ejecutivo, Popular, Inc. David H. Chafey, Jr. Primer Vicepresidente Ejecutivo, Popular, Inc. Presidente, Banco Popular de Puerto Rico Roberto R. Herencia Vicepresidente Ejecutivo, Popular, Inc. Presidente, Banco Popular North America Lcdo. Amílcar Jordán Vicepresidente Ejecutivo, Manejo de Riesgo, Popular, Inc. Jorge A. Junquera Primer Vicepresidente Ejecutivo, Principal Oficial Financiero, Popular, Inc. Tere Loubriel Vicepresidenta Ejecutiva, Gente, Comunicaciones y Planificación, Popular, Inc. Lcda. Brunilda Santos de Álvarez Vicepresidenta Ejecutiva, Principal Oficial Legal, Popular, Inc. Félix M. Villamil Vicepresidente Ejecutivo, Popular, Inc. Presidente, EVERTEC, Inc. Nuestro Credo El Banco Popular es una institución genuinamente nativa dedicada exclusivamente a trabajar por el bienestar social y económico de Puerto Rico e inspirada en los principios más sanos y fundamentales de una buena práctica bancaria. El Popular tiene empeñados sus esfuerzos y voluntad al desarrollo de un servicio bancario para Puerto Rico dentro de normas estrictamente comerciales tan eficiente como pueda requerir la comunidad más progresista del mundo. Estas palabras, escritas en 1928 por don Rafael Carrión Pacheco, Vicepresidente Ejecutivo y Presidente (1927-1956), representan el pensamiento que rige a Popular, Inc. en todos sus mercados. Nuestra Gente Los hombres y mujeres que laboran para nuestra institución, desde los más altos ejecutivos hasta los empleados que llevan a cabo las tareas más rutinarias, sienten un orgullo especial al servir a nuestra clientela con esmero y dedica- ción. Todos sienten la íntima satisfacción de pertenecer a la Gran “Familia del Banco Popular”, en la que se fomenta el cariño y la comprensión entre todos sus miembros, y en la que a la vez se cumple firmemente con las más estrictas reglas de conducta y de moral. Estas palabras fueron escritas en 1988 por don Rafael Carrión, Jr., Presidente y Presidente de la Junta de Directores, (1956- 1991), con motivo del 95 aniversario del Banco Popular de Puerto Rico y son muestra de nuestro compromiso con nuestros recursos humanos. Información Corporativo Firma Registrada de Contabilidad Pública Independiente PricewaterhouseCoopers LLP Reunión Anual La reunión anual de accionistas del 2007 de Popular, Inc. se celebrará el viernes, 25 de abril, a las 9:00 a.m. en el Edificio Centro Europa en San Juan, Puerto Rico. Información Adicional El Informe Anual en la Forma 10-K radicado con la Comisión de Valores e Intercambio e información financiera adicional están disponibles visitando nuestra página de Internet: www.popular.com Financial Review and Supplementary Information Management’s Discussion and Analysis of Financial Condition and Results of Operations Statistical Summaries Financial Statements Management’s Report to Stockholders Report of Independent Registered Public Accounting Firm Consolidated Statements of Condition as of December 31, 2007 and 2006 Consolidated Statements of Operations for the years ended December 31, 2007, 2006 and 2005 Consolidated Statements of Cash Flows for the years ended December 31, 2007, 2006 and 2005 Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2007, 2006 and 2005 Consolidated Statements of Comprehensive Income for the years ended December 31, 2007, 2006 and 2005 Notes to Consolidated Financial Statements 3 68 73 74 76 77 78 79 80 81 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements Overview Significant U.S. Strategic Events Events Subsequent to Year-End 2007 Critical Accounting Policies / Estimates Statement of Operations Analysis Net Interest Income Provision for Loan Losses Non-Interest Income Operating Expenses Income Tax Expense Fourth Quarter Results Reportable Segment Results Statement of Condition Analysis Assets Deposits, Borrowings and Other Liabilities Stockholders’ Equity Off-Balance Sheet Financing Entities Risk Management Market Risk Liquidity Risk Credit Risk Management and Loan Quality Operational Risk Management Loss Mitigation for Securitized Mortgage Loans Recently Issued Accounting Pronouncements and Interpretations Glossary of Selected Financial Terms Statistical Summaries Statements of Condition Statements of Operations Average Balance Sheet and Summary of Net Interest Income Quarterly Financial Data 3 3 8 10 11 19 21 21 26 28 28 29 32 34 35 36 36 36 43 50 60 60 62 65 68 69 70 72 2007 Annual Report 3 2007 2007 Popular, Inc. 2007 2007 Management’’’’’s Discussion and Analysis of Financial Condition and Results of Operations The following management’s discussion and analysis (“MD&A”) provides you with information management believes necessary for understanding the financial performance of Popular, Inc. and its subsidiaries (the “Corporation” or “Popular”). All accompanying tables, consolidated financial statements and corresponding notes included in this “Financial Review and Supplementary Information - 2007 Annual Report” (“the report”) should be considered an integral part of this MD&A. FFFFF O R W A R D L O O K I N G S S S S S T A T E M E N T S O R W A R D----- L O O K I N G T A T E M E N T S T A T E M E N T S L O O K I N G L O O K I N G O R W A R D O R W A R D T A T E M E N T S T A T E M E N T S L O O K I N G O R W A R D The information included in this report may contain certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These include descriptions of products or services, plans or objectives for future operations, and forecast of revenues, earnings, cash flows, or other measures of economic performance. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. Forward-looking statements are not guarantees of future performance and, by their nature, involve certain risks, uncertainties, estimates and assumptions by management that are difficult to predict. Various factors, some of which are beyond the Corporation’s control, could cause actual results to differ materially from those expressed in, or implied by, such forward- looking statements. Factors that might cause such a difference include, but are not limited to, the rate of growth in the economy, as well as general business and economic conditions; changes in interest rates, as well as the magnitude of such changes; the fiscal and monetary policies of the federal government and its agencies; the relative strength or weakness of the consumer and commercial credit sectors and of the real estate markets; the performance of the stock and bond markets; competition in the financial services industry; possible legislative, tax or regulatory changes; and difficulties in combining the operations of acquired entities. All forward-looking statements are based upon information available to the Corporation as of the date of this report. Management assumes no obligation to update or revise any such forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements. OOOOO V E R V I E W V E R V I E W V E R V I E W V E R V I E W V E R V I E W The Corporation is a financial holding company, which is subject to the supervision and regulation of the Board of Governors of the Federal Reserve System. Since its foundation more than a century ago, Popular has evolved from a commercial bank based in Puerto Rico to a diverse financial services company with operations in Puerto Rico, the United States, the Caribbean and Latin America. The Corporation ranked 30th among the top 50 bank holding companies based on total assets as per information gathered and disclosed by the Federal Reserve System as of December 31, 2007. The Corporation operates four principal businesses or operating segments: Banco Popular de Puerto Rico, Banco Popular North America, Popular Financial Holdings and EVERTEC. As the leading financial institution in Puerto Rico, the Corporation offers retail and commercial banking services through its principal banking subsidiary, Banco Popular de Puerto Rico (“BPPR”), as well as auto and equipment leasing and financing, mortgage loans, consumer lending, investment banking, broker-dealer and insurance services through specialized subsidiaries. In the United States, the Corporation operates Banco Popular North America (“BPNA”), including its wholly-owned subsidiary E-LOAN, and Popular Financial Holdings (“PFH”). BPNA is a community bank providing a broad range of financial services and products to the communities it serves. BPNA operates branches in New York, California, Illinois, New Jersey, Florida and Texas. E-LOAN offers online consumer direct lending and provides an online platform to raise deposits for BPNA. PFH, after certain restructuring events discussed later in this MD&A, is currently exiting the loan origination business, but still carries a maturing loan portfolio that approximated $3.3 billion at December 31, 2007, of which a carrying amount of $1.4 billion was classified as held-for-sale. Also, PFH continues to service for others over $9.4 billion in mortgage loans. The Corporation, through its transaction processing company, EVERTEC, continues to use its expertise in technology as a competitive advantage in its expansion throughout the United States, the Caribbean and Latin America, as well as internally servicing many of the Corporation's subsidiaries’ system infrastructures and transactional processing businesses. Note 32 to the consolidated financial statements, as well as the Reportable Segments section in this MD&A, present further information about the Corporation’s business segments. Popular, Inc.’s financial performance for the year ended December 31, 2007 reflected a net loss of $64.5 million, compared with net income of $357.7 million for 2006. The reduction in the Corporation’s results of operations continued to reflect the impact of unprecedented adverse market conditions, particularly on Popular’s U.S. mainland operations. Net losses in the Corporation’s U.S. operations, which include the reportable segments of Banco Popular North America and PFH, amounted to $467.8 million for the year ended December 31, 2007, compared to net income of $5.0 million in 2006. The year 2007 was marked by very important decisions with respect to Popular’s U.S. operations, which had a significant impact in the financial results for the year, including: • the implementation of various restructuring plans, resulting in the recognition of significant associated costs, which approximated $36.7 million, and of non-cash impairment losses related to E-LOAN’s goodwill and trademark approximating $211.8 million, and 4 Table A Table A Table A Table A Table A Components of Net (Loss) Income as a Percentage of Average Total Assets Net interest income Provision for loan losses Sales and valuation adjustments of investment securities (Loss) gain on sale of loans and valuation adjustments on loans held-for-sale Trading (losses) gains Other non-interest income Operating expenses Net (loss) income before tax and cumulative effect of accounting change Income tax Cumulative effect of accounting change, net of tax Net (loss) income 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 3 . 0 8 % 3 . 0 8 % 3 . 0 8 % 3 . 0 8 % 3 . 0 8 % ( 1 . 1 9 ) ( 1 . 1 9 ) ( 1 . 1 9 ) ( 1 . 1 9 ) ( 1 . 1 9 ) 0 . 1 2 0 . 1 2 0 . 1 2 0 . 1 2 0 . 1 2 ( 0 . 0 8 ) ( 0 . 0 8 ) ( 0 . 0 8 ) ( 0 . 0 8 ) ( 0 . 0 8 ) ( 0 . 0 1 ) ( 0 . 0 1 ) ( 0 . 0 1 ) ( 0 . 0 1 ) ( 0 . 0 1 ) 1 . 4 4 1 . 4 4 1 . 4 4 1 . 4 4 1 . 4 4 3 . 3 6 3 . 3 6 3 . 3 6 3 . 3 6 3 . 3 6 ( 3 . 6 2 ) ( 3 . 6 2 ) ( 3 . 6 2 ) ( 3 . 6 2 ) ( 3 . 6 2 ) ( 0 . 2 6 ) ( 0 . 2 6 ) ( 0 . 2 6 ) ( 0 . 2 6 ) ( 0 . 2 6 ) 0 . 1 2 0 . 1 2 0 . 1 2 0 . 1 2 0 . 1 2 - ( 0 . 1 4 % ) ( 0 . 1 4 % ) ( 0 . 1 4 % ) ( 0 . 1 4 % ) ( 0 . 1 4 % ) For the Year 2006 2.96% (0.60) 0.01 0.24 0.07 1.36 4.04 (3.08) 0.96 (0.22) - 0.74% 2005 3.07% (0.42) 0.11 0.18 0.06 1.34 4.34 (2.86) 1.48 (0.32) 0.01 1.17% 2004 3.45% (0.45) 0.04 0.11 - 1.38 4.53 (2.94) 2003 3.71% (0.57) 0.21 0.15 (0.03) 1.48 4.95 (3.21) 1.59 (0.36) - 1.23% 1.74 (0.38) - 1.36% • the loan recharacterization transaction of the majority of the on-balance sheet securitizations at PFH which resulted in a net pre-tax loss of approximately $90.1 million. These U.S. strategic events are explained in detail in the Significant U.S. Strategic Events section of this MD&A and are integral to the understanding of the 2007 financial results. The Corporation’s operations in Puerto Rico continued to perform well despite a difficult economic environment, which presents credit challenges and has led to a recessionary cycle. Solidifying Popular’s presence in the Puerto Rico market and sustaining the Corporation’s confidence in this market, in 2007, the Corporation completed the acquisition of Citibank’s retail banking operations in Puerto Rico, which added 17 branches to BPPR’s retail branch network prior to branch closing due to synergies, and contributed approximately $1 billion in deposits and $220 million in loans. Also, Popular Securities, a subsidiary within the Banco Popular de Puerto Rico reportable segment, strengthened its brokerage sales force and increased its assets under its management by acquiring Smith Barney’s retail brokerage operations in Puerto Rico. Both of these acquisitions took place in the latter part of the fourth quarter of 2007. The Corporation recorded $147 million in goodwill and other intangibles related to these two acquisitions. Information on the analysis of financial results for the Puerto Rico, including EVERTEC, and U.S. operations is provided in the Reportable Segments section of this MD&A. Table A presents a five-year summary of the components of net (loss) income as a percentage of average total assets. Table B presents the changes in net (loss) income applicable to common stock and (losses) earnings per common share for the last three years. In addition, Table C provides selected financial data for the past 10 years. A glossary of selected financial terms has been included at the end of this MD&A. Financial results for the year ended December 31, 2007 were principally impacted by the following items (on a pre-tax basis), compared to the year 2006: • A $274.9 million increase in the provision for loan losses, which was mostly influenced by a slowdown in the housing sector, principally in the U.S. mainland, and weak economic conditions in Puerto Rico and the U.S. mainland that impacted the commercial and consumer sectors and has resulted in higher delinquencies. Refer to the Credit Risk Management and Loan Quality section of this MD&A for a more detailed analysis of the allowance for loan losses, net charge-offs, non-performing assets and credit quality statistics. • A decrease of $115.2 million in non-interest income, mostly driven by loss on sale of loans that includes the impact of the PFH loan recharacterization transaction described in detail in the Significant U.S. Strategic Events section in this MD&A and unfavorable valuation adjustments on loans held-for-sale due to illiquidity in certain markets and higher credit loss expectations which impacted price margins. Also, the decrease in non-interest income was the result of reductions in value in the residual interests of PFH. These unfavorable variances were partially offset by higher gains on sale of equity securities by the Corporation’s holding company and higher service fees. 2007 Annual Report 5 2007 2007 Popular, Inc. 2007 2007 Table B Table B Table B Table B Table B Changes in Net (Loss) Income Applicable to Common Stock and (Losses) Earnings per Common Share (In thousands, except per common share amounts) D o l l a r s D o l l a r s D o l l a r s D o l l a r s D o l l a r s Per share Per share Per share Per share Per share Dollars Per share Dollars Per share 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2006 2005 $ 3 4 5 , 7 6 3 $ 3 4 5 , 7 6 3 $ 3 4 5 , 7 6 3 $ 3 4 5 , 7 6 3 $ 3 4 5 , 7 6 3 $ 1 . 2 4 $ 1 . 2 4 $ 1 . 2 4 $ 1 . 2 4 $ 1 . 2 4 $528,789 $1.98 $477,995 $1.79 Net income applicable to common stock for prior year Increase (decrease) from changes in: Net interest income Provision for loan losses Sales and valuation adjustments of investment securities Trading account Sales of loans and valuation adjustments on loans held-for-sale Other non-interest income Impairment losses on long-lived assets* Goodwill and trademark impairment losses* Amortization of intangibles All other operating expenses Income tax Cumulative effect of accounting change 2 1 , 4 8 0 2 1 , 4 8 0 2 1 , 4 8 0 2 1 , 4 8 0 2 1 , 4 8 0 ( 2 7 4 , 8 9 0 ) ( 2 7 4 , 8 9 0 ) ( 2 7 4 , 8 9 0 ) ( 2 7 4 , 8 9 0 ) ( 2 7 4 , 8 9 0 ) 0 . 0 8 0 . 0 8 0 . 0 8 0 . 0 8 0 . 0 8 ( 0 . 9 9 ) ( 0 . 9 9 ) ( 0 . 9 9 ) ( 0 . 9 9 ) ( 0 . 9 9 ) 3,703 (92,488) 5 0 , 8 0 0 5 0 , 8 0 0 5 0 , 8 0 0 5 0 , 8 0 0 5 0 , 8 0 0 ( 3 7 , 7 5 2 ) ( 3 7 , 7 5 2 ) ( 3 7 , 7 5 2 ) ( 3 7 , 7 5 2 ) ( 3 7 , 7 5 2 ) 0 . 1 8 0 . 1 8 0 . 1 8 0 . 1 8 0 . 1 8 ( 0 . 1 4 ) ( 0 . 1 4 ) ( 0 . 1 4 ) ( 0 . 1 4 ) ( 0 . 1 4 ) (47,754) 5,237 ( 1 5 6 , 3 9 1 ) ( 1 5 6 , 3 9 1 ) ( 1 5 6 , 3 9 1 ) ( 1 5 6 , 3 9 1 ) ( 1 5 6 , 3 9 1 ) 2 8 , 1 7 4 2 8 , 1 7 4 2 8 , 1 7 4 2 8 , 1 7 4 2 8 , 1 7 4 ( 5 , 1 1 2 ) ( 5 , 1 1 2 ) ( 5 , 1 1 2 ) ( 5 , 1 1 2 ) ( 5 , 1 1 2 ) ( 1 9 7 , 5 1 2 ) ( 1 9 7 , 5 1 2 ) ( 1 9 7 , 5 1 2 ) ( 1 9 7 , 5 1 2 ) ( 1 9 7 , 5 1 2 ) 1 , 9 3 3 1 , 9 3 3 1 , 9 3 3 1 , 9 3 3 1 , 9 3 3 ( 1 8 , 7 8 7 ) ( 1 8 , 7 8 7 ) ( 1 8 , 7 8 7 ) ( 1 8 , 7 8 7 ) ( 1 8 , 7 8 7 ) 1 6 5 , 8 8 8 1 6 5 , 8 8 8 1 6 5 , 8 8 8 1 6 5 , 8 8 8 1 6 5 , 8 8 8 ----- ( 0 . 5 6 ) ( 0 . 5 6 ) ( 0 . 5 6 ) ( 0 . 5 6 ) ( 0 . 5 6 ) 0 . 1 0 0 . 1 0 0 . 1 0 0 . 1 0 0 . 1 0 ( 0 . 0 2 ) ( 0 . 0 2 ) ( 0 . 0 2 ) ( 0 . 0 2 ) ( 0 . 0 2 ) ( 0 . 7 1 ) ( 0 . 7 1 ) ( 0 . 7 1 ) ( 0 . 7 1 ) ( 0 . 7 1 ) 0 . 0 1 0 . 0 1 0 . 0 1 0 . 0 1 0 . 0 1 ( 0 . 0 6 ) ( 0 . 0 6 ) ( 0 . 0 6 ) ( 0 . 0 6 ) ( 0 . 0 6 ) 0 . 6 0 0 . 6 0 0 . 6 0 0 . 6 0 0 . 6 0 ----- 34,124 32,603 (7,232) (14,239) (2,798) (132,604) 42,029 (3,607) 0.01 (0.35) (0.18) 0.02 0.13 0.12 (0.03) (0.05) (0.01) (0.50) 0.16 (0.01) 1.29 (0.05) 48,696 (16,615) 0.18 (0.06) 36,859 30,210 39,129 70,306 - - (1,735) (155,453) (4,210) 3,607 528,789 - 0.14 0.11 0.15 0.27 - - (0.01) (0.58) (0.01) 0.01 1.99 (0.01) Net (loss) income before preferred stock dividends and change in average common shares Change in average common shares** ( 7 6 , 4 0 6 ) ( 7 6 , 4 0 6 ) ( 7 6 , 4 0 6 ) ( 7 6 , 4 0 6 ) ( 7 6 , 4 0 6 ) ----- ( 0 . 2 7 ) ( 0 . 2 7 ) ( 0 . 2 7 ) ( 0 . 2 7 ) ( 0 . 2 7 ) ----- 345,763 - Net (loss) income applicable to common stock ( $ 7 6 , 4 0 6 ) ( $ 7 6 , 4 0 6 ) ( $ 7 6 , 4 0 6 ) ( $ 7 6 , 4 0 6 ) ( $ 7 6 , 4 0 6 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) $345,763 $1.24 $528,789 $1.98 *Associated with the PFH Restructuring Plan, PFH Branch Network Restructuring Plan, and E-LOAN Restructuring Plan. **Reflects the effect of the shares repurchased, plus the shares issued through the Dividend Reinvestment Plan and the subscription rights offering, and the effect of stock options exercised in the years presented. • Higher operating expenses by $219.5 million, which includes restructuring charges that are detailed in the Significant U.S. Strategic Events section in this MD&A. The above unfavorable variances were partially offset by: • Higher net interest income by $21.5 million. For further information refer to the Net Interest Income and Market Risk sections of this MD&A. • Income tax benefit of $59.0 million in 2007, compared to income tax expense of $106.9 million in 2006. Refer to the Income Tax section of this MD&A for additional information. Total assets at December 31, 2007 amounted to $44.4 billion, or $3.0 billion lower than total assets at the same date in the previous year. Total earning assets at December 31, 2007 decreased by $2.8 billion, or 6%, compared with December 31, 2006. As of December 31, 2007, loans, the primary interest- earning asset category for the Corporation, totaled $29.9 billion, reflecting a decline of $2.8 billion, or 9%, from December 31, 2006. As explained in the Significant U.S. Strategic Events section of this MD&A, the loan recharacterization transaction and the PFH Restructuring Plan contributed substantially to the reduction in total loans. For more detailed information on lending activities, refer to the Statement of Condition Analysis and Credit Risk Management and Loan Quality sections of this MD&A. Investment and trading securities, the second largest component of interest- earning assets, accounted for $0.6 billion of the decline in total assets from December 31, 2006. Assets at December 31, 2007 were funded principally through deposits, primarily time deposits. Deposits supported approximately 64% of the asset base, while borrowings, other liabilities and stockholders’ equity accounted for approximately 36%. As of December 31, 2006, 52% of total assets were funded through deposits, while borrowings, other liabilities and stockhoders' equity accounted for 48%. In the third quarter of 2007, the Corporation increased its reliance on brokered certificates of deposit, as a result of expected reduced availability of non-deposit funding. Beginning in the third quarter of 2007, 6 T a b l e C T a b l e C T a b l e C T a b l e C T a b l e C Selected Financial Data (Dollars in thousands, except per share data) CONDENSED INCOME STATEMENTS Interest income Interest expense Net interest income Provision for loan losses Net gain (loss) on sale and valuation adjustment of investment securities Trading account (loss) profit (Loss) gain on sale of loans and valuation adjustments on loans held-for-sale Other non-interest income Operating expenses Income tax (benefit) expense Net (gain) loss of minority interest Cumulative effect of accounting change, net of tax Net (loss) income Net (loss) income applicable to common stock PER COMMON SHARE DATA* Net (loss) income: Basic before cumulative effect of accounting change Diluted before cumulative effect of accounting change Basic after cumulative effect of accounting change Diluted after cumulative effect of accounting change Dividends declared Book value Market price Outstanding shares: Average - basic Average - diluted End of period AVERAGE BALANCES Net loans** Earning assets Total assets Deposits Borrowings Total stockholders’ equity PERIOD END BALANCES Net loans** Allowance for loan losses Earning assets Total assets Deposits Borrowings Total stockholders’ equity SELECTED RATIOS 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2006 2005 $ 3 , 1 2 8 , 1 7 1 $ 3 , 1 2 8 , 1 7 1 $ 3 , 1 2 8 , 1 7 1 $ 3 , 1 2 8 , 1 7 1 $ 3 , 1 2 8 , 1 7 1 1 , 6 7 8 , 7 8 1 1 , 6 7 8 , 7 8 1 1 , 6 7 8 , 7 8 1 1 , 6 7 8 , 7 8 1 1 , 6 7 8 , 7 8 1 1 , 4 4 9 , 3 9 0 1 , 4 4 9 , 3 9 0 1 , 4 4 9 , 3 9 0 1 , 4 4 9 , 3 9 0 1 , 4 4 9 , 3 9 0 5 6 2 , 6 5 0 5 6 2 , 6 5 0 5 6 2 , 6 5 0 5 6 2 , 6 5 0 5 6 2 , 6 5 0 5 5 , 1 5 9 5 5 , 1 5 9 5 5 , 1 5 9 5 5 , 1 5 9 5 5 , 1 5 9 ( 2 , 4 6 4 ) ( 2 , 4 6 4 ) ( 2 , 4 6 4 ) ( 2 , 4 6 4 ) ( 2 , 4 6 4 ) ( 3 8 , 9 7 0 ) ( 3 8 , 9 7 0 ) ( 3 8 , 9 7 0 ) ( 3 8 , 9 7 0 ) ( 3 8 , 9 7 0 ) 6 8 0 , 5 9 1 6 8 0 , 5 9 1 6 8 0 , 5 9 1 6 8 0 , 5 9 1 6 8 0 , 5 9 1 1 , 7 0 4 , 5 5 1 1 , 7 0 4 , 5 5 1 1 , 7 0 4 , 5 5 1 1 , 7 0 4 , 5 5 1 1 , 7 0 4 , 5 5 1 ( 5 9 , 0 0 2 ) ( 5 9 , 0 0 2 ) ( 5 9 , 0 0 2 ) ( 5 9 , 0 0 2 ) ( 5 9 , 0 0 2 ) - - ( $ 6 4 , 4 9 3 ) ( $ 6 4 , 4 9 3 ) ( $ 6 4 , 4 9 3 ) ( $ 6 4 , 4 9 3 ) ( $ 6 4 , 4 9 3 ) ( $ 7 6 , 4 0 6 ) ( $ 7 6 , 4 0 6 ) ( $ 7 6 , 4 0 6 ) ( $ 7 6 , 4 0 6 ) ( $ 7 6 , 4 0 6 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( 0 . 2 7 ) ( 0 . 2 7 ) ( 0 . 2 7 ) ( 0 . 2 7 ) ( 0 . 2 7 ) ( 0 . 2 7 ) ( 0 . 2 7 ) ( 0 . 2 7 ) ( 0 . 2 7 ) ( 0 . 2 7 ) ( 0 . 2 7 ) ( 0 . 2 7 ) ( 0 . 2 7 ) ( 0 . 2 7 ) ( 0 . 2 7 ) 0 . 6 4 0 . 6 4 0 . 6 4 0 . 6 4 0 . 6 4 1 2 . 1 2 1 2 . 1 2 1 2 . 1 2 1 2 . 1 2 1 2 . 1 2 1 0 . 6 0 1 0 . 6 0 1 0 . 6 0 1 0 . 6 0 1 0 . 6 0 $3,064,441 1,636,531 1,427,910 287,760 4,359 35,288 117,421 652,417 1,485,073 106,886 - - $357,676 $345,763 $1.24 1.24 1.24 1.24 0.64 12.32 17.95 $2,665,859 1,241,652 1,424,207 195,272 52,113 30,051 83,297 619,814 1,328,200 148,915 - 3,607 $540,702 $528,789 $1.97 1.96 1.98 1.97 0.64 11.82 21.15 2 7 9 , 4 9 4 , 1 5 0 2 7 9 , 4 9 4 , 1 5 0 2 7 9 , 4 9 4 , 1 5 0 2 7 9 , 4 9 4 , 1 5 0 2 7 9 , 4 9 4 , 1 5 0 2 7 9 , 4 9 4 , 1 5 0 2 7 9 , 4 9 4 , 1 5 0 2 7 9 , 4 9 4 , 1 5 0 2 7 9 , 4 9 4 , 1 5 0 2 7 9 , 4 9 4 , 1 5 0 2 8 0 , 0 2 9 , 2 1 5 2 8 0 , 0 2 9 , 2 1 5 2 8 0 , 0 2 9 , 2 1 5 2 8 0 , 0 2 9 , 2 1 5 2 8 0 , 0 2 9 , 2 1 5 278,468,552 278,703,924 278,741,547 267,334,606 267,839,018 275,955,391 $ 3 2 , 7 4 9 , 9 9 3 $ 3 2 , 7 4 9 , 9 9 3 $ 3 2 , 7 4 9 , 9 9 3 $ 3 2 , 7 4 9 , 9 9 3 $ 3 2 , 7 4 9 , 9 9 3 4 3 , 7 8 9 , 6 9 3 4 3 , 7 8 9 , 6 9 3 4 3 , 7 8 9 , 6 9 3 4 3 , 7 8 9 , 6 9 3 4 3 , 7 8 9 , 6 9 3 4 7 , 1 0 4 , 9 3 5 4 7 , 1 0 4 , 9 3 5 4 7 , 1 0 4 , 9 3 5 4 7 , 1 0 4 , 9 3 5 4 7 , 1 0 4 , 9 3 5 2 5 , 5 6 9 , 1 0 0 2 5 , 5 6 9 , 1 0 0 2 5 , 5 6 9 , 1 0 0 2 5 , 5 6 9 , 1 0 0 2 5 , 5 6 9 , 1 0 0 1 6 , 8 6 6 , 7 5 4 1 6 , 8 6 6 , 7 5 4 1 6 , 8 6 6 , 7 5 4 1 6 , 8 6 6 , 7 5 4 1 6 , 8 6 6 , 7 5 4 3 , 8 6 1 , 4 2 6 3 , 8 6 1 , 4 2 6 3 , 8 6 1 , 4 2 6 3 , 8 6 1 , 4 2 6 3 , 8 6 1 , 4 2 6 $ 2 9 , 9 1 1 , 0 0 2 $ 2 9 , 9 1 1 , 0 0 2 $ 2 9 , 9 1 1 , 0 0 2 $ 2 9 , 9 1 1 , 0 0 2 $ 2 9 , 9 1 1 , 0 0 2 5 4 8 , 8 3 2 5 4 8 , 8 3 2 5 4 8 , 8 3 2 5 4 8 , 8 3 2 5 4 8 , 8 3 2 4 0 , 9 0 1 , 8 5 4 4 0 , 9 0 1 , 8 5 4 4 0 , 9 0 1 , 8 5 4 4 0 , 9 0 1 , 8 5 4 4 0 , 9 0 1 , 8 5 4 4 4 , 4 1 1 , 4 3 7 4 4 , 4 1 1 , 4 3 7 4 4 , 4 1 1 , 4 3 7 4 4 , 4 1 1 , 4 3 7 4 4 , 4 1 1 , 4 3 7 2 8 , 3 3 4 , 4 7 8 2 8 , 3 3 4 , 4 7 8 2 8 , 3 3 4 , 4 7 8 2 8 , 3 3 4 , 4 7 8 2 8 , 3 3 4 , 4 7 8 1 1 , 5 6 0 , 5 9 6 1 1 , 5 6 0 , 5 9 6 1 1 , 5 6 0 , 5 9 6 1 1 , 5 6 0 , 5 9 6 1 1 , 5 6 0 , 5 9 6 3 , 5 8 1 , 8 8 2 3 , 5 8 1 , 8 8 2 3 , 5 8 1 , 8 8 2 3 , 5 8 1 , 8 8 2 3 , 5 8 1 , 8 8 2 $32,078,716 44,930,391 48,294,566 23,264,132 20,545,546 3,741,273 $32,736,939 522,232 43,660,568 47,403,987 24,438,331 18,533,816 3,620,306 $29,730,913 43,245,684 46,362,329 22,253,069 20,091,520 3,274,808 $31,710,207 461,707 45,167,761 48,623,668 22,638,005 21,296,299 3,449,247 Net interest yield (taxable equivalent basis) Return on average total assets Return on average common stockholders’ equity Dividend payout ratio to common stockholders Efficiency ratio Overhead ratio Tier I capital to risk-adjusted assets Total capital to risk-adjusted assets 3.59% 1.17 17.12 32.31 62.30 38.12 11.17 12.44 * Per share data is based on the average number of shares outstanding during the periods, except for the book value and market price which are based on the information 3 . 5 2 % 3 . 5 2 % 3 . 5 2 % 3 . 5 2 % 3 . 5 2 % ( 0 . 1 4 ) ( 0 . 1 4 ) ( 0 . 1 4 ) ( 0 . 1 4 ) ( 0 . 1 4 ) ( 2 . 0 8 ) ( 2 . 0 8 ) ( 2 . 0 8 ) ( 2 . 0 8 ) ( 2 . 0 8 ) ( 2 3 3 . 8 9 ) ( 2 3 3 . 8 9 ) ( 2 3 3 . 8 9 ) ( 2 3 3 . 8 9 ) ( 2 3 3 . 8 9 ) 8 1 . 9 9 8 1 . 9 9 8 1 . 9 9 8 1 . 9 9 8 1 . 9 9 6 9 . 7 0 6 9 . 7 0 6 9 . 7 0 6 9 . 7 0 6 9 . 7 0 1 0 . 1 2 1 0 . 1 2 1 0 . 1 2 1 0 . 1 2 1 0 . 1 2 1 1 . 3 8 1 1 . 3 8 1 1 . 3 8 1 1 . 3 8 1 1 . 3 8 3.44% 0.74 9.73 51.02 67.16 47.31 10.61 11.86 at the end of the periods. All per share data have been adjusted to reflect two stock splits effected in the form of dividends on July 8, 2004 and July 1, 1998. ** Includes loans held-for-sale. 2007 Annual Report 7 2007 2007 Popular, Inc. 2007 2007 2004 2003 2002 Year ended December 31, 2001 2000 1999 1998 $2,216,265 840,754 1,375,511 178,657 15,254 (159) 44,168 549,508 1,171,012 144,705 - - $489,908 $477,995 $1.79 1.79 1.79 1.79 0.62 10.95 28.83 $2,034,238 749,550 1,284,688 195,939 71,094 (10,214) 53,572 511,558 1,113,083 130,326 (435) - $470,915 $460,996 $1.74 1.74 1.74 1.74 0.51 9.66 22.43 $2,023,797 863,553 1,160,244 205,570 (3,342) (804) 52,077 495,832 1,029,002 117,255 (248) - $351,932 $349,422 $1.31 1.31 1.31 1.31 0.40 9.10 16.90 $2,095,862 1,039,105 1,056,757 213,250 27 (1,781) 45,633 447,937 926,209 105,280 18 686 $304,538 $296,188 $1.09 1.09 1.09 1.09 0.38 7.97 14.54 $2,150,157 1,167,396 982,761 194,640 11,201 1,991 39,673 411,195 876,433 100,797 1,152 - $276,103 $267,753 $0.99 0.99 0.99 0.99 0.32 6.96 13.16 $1,851,670 897,932 953,738 148,948 638 (1,582) 34,890 338,970 837,482 85,120 2,454 - $257,558 $249,208 $0.92 0.92 0.92 0.92 0.30 5.76 13.97 $1,651,703 778,691 873,012 137,213 8,933 3,653 23,036 255,624 720,354 74,671 328 - $232,348 $223,998 $0.83 0.83 0.83 0.83 0.25 5.93 17.00 266,302,105 266,674,856 266,582,103 265,481,840 265,595,832 265,783,892 267,830,164 267,830,550 264,878,094 272,476,576 272,476,938 272,724,728 271,814,952 271,814,952 271,997,234 271,171,268 271,171,268 271,308,584 271,064,172 271,064,172 271,274,654 $25,143,559 37,621,648 39,898,775 19,409,055 16,954,909 2,903,137 $28,742,261 437,081 41,812,475 44,401,576 20,593,160 19,882,202 3,104,621 $20,730,041 32,781,355 34,674,761 17,757,968 13,835,437 2,545,113 $22,602,192 408,542 34,451,748 36,434,715 18,097,828 14,949,236 2,754,417 $18,729,220 30,194,914 31,822,390 16,984,646 12,190,076 2,150,386 $19,582,119 372,797 31,899,765 33,660,352 17,614,740 12,955,966 2,410,879 $17,045,257 26,414,204 27,957,107 15,575,791 9,805,000 2,096,534 $18,168,551 336,632 29,139,288 30,744,676 16,370,042 11,588,221 2,272,818 $15,801,887 24,893,366 26,569,755 14,508,482 9,674,547 1,884,525 $16,057,085 290,653 26,339,431 28,057,051 14,804,907 10,785,239 1,993,644 $13,901,290 22,244,959 23,806,372 13,791,338 7,825,855 1,712,792 $14,907,754 292,010 23,754,620 25,460,539 14,173,715 9,154,468 1,660,986 $11,930,621 19,261,949 20,432,382 12,270,101 6,268,921 1,553,258 $13,078,795 267,249 21,591,950 23,160,357 13,672,214 7,297,742 1,709,113 3.95% 1.23 17.60 32.85 59.86 40.88 11.82 13.21 4.28% 1.36 19.30 27.05 60.51 37.91 12.43 13.93 4.19% 1.11 16.29 30.76 60.42 41.82 9.85 11.52 4.33% 1.09 14.84 33.10 59.81 41.11 9.96 11.74 4.23% 1.04 15.00 32.47 61.45 41.96 10.44 12.37 4.65% 1.08 15.45 31.56 63.16 48.71 10.17 12.29 4.91% 1.14 15.41 28.42 62.35 49.15 10.82 13.14 8 the U.S. credit markets were marked by unprecedented instability and disruption, making even routine asset sale and funding activities much more challenging for financial institutions. Credit spreads widened significantly and rapidly as many investors allocated their funds to only the highest-quality financial assets such as U.S. government securities. The result of these actions by market participants made it more difficult for corporate borrowers to raise financing in the capital markets. In light of this scenario, the Corporation determined at that time to substitute overnight borrowings with longer term funding. Furthermore, the increase in deposits was the result of the acquisition of the Citibank retail branches in Puerto Rico in the fourth quarter of 2007, which contributed with approximately $1 billion in deposits, principally in time deposits and savings accounts. For additional data on funding sources refer to the Statement of Condition Analysis and Liquidity Risk sections of this MD&A. Stockholders’ equity at December 31, 2007 showed a reduction of $38 million, compared to December 31, 2006. The impact of the net loss for the year 2007 and the dividend payouts was partially offset by the net impact of unrealized gains in the valuation of available-for-sale securities at year-end 2007 of $21 million, compared to unrealized losses of $155 million in year-end 2006. The Corporation’s common stock declined 41% in market value in 2007 closing at $10.60. The Corporation’s market capitalization at December 31, 2007 was $3.0 billion, compared with $5.0 billion at December 31, 2006. The shares of the Corporation’s common and preferred stock are traded on the National Association of Securities Dealers Automated Quotations (“NASDAQ”) system under the symbols BPOP and BPOPO, respectively. Table J shows the Corporation’s common stock performance on a quarterly basis during the last five years, including market prices and cash dividends declared. The Corporation, like other financial institutions, is subject to a number of risks, many of which are outside of management’s control, though efforts are made to manage those risks while optimizing returns. Among the risks assumed are (1) market risk, which is the risk that changes in market rates and prices will adversely affect the Corporation’s financial condition or results of operations, (2) liquidity risk, which is the risk that the Corporation will have insufficient cash or access to cash to meet operating needs and financial obligations, (3) credit risk, which is the risk that loan customers or other counterparties will be unable to perform their contractual obligations, and (4) operational risk, which is the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events. These four risks are covered in greater detail throughout this MD&A. In addition, the Corporation is subject to legal, compliance and reputational risks, among others. As a financial services company, the Corporation’s earnings are significantly affected by general business and economic conditions. Lending and deposit activities and fee income generation are influenced by the level of business spending and investment, consumer income, spending and savings, capital market activities, competition, customer preferences, interest rate conditions and prevailing market rates on competing products. The Corporation continuously monitors general business and economic conditions, industry-related indicators and trends, competition, interest rate volatility, credit quality indicators, loan and deposit demand, operational and systems efficiencies, revenue enhancements and changes in the regulation of financial services companies. The Corporation operates in a highly regulated environment and may be adversely affected by changes in federal and local laws and regulations. Also, competition with other financial institutions could adversely affect its profitability. The description of the Corporation’s business and risk factors contained in Item 1 and 1A of its Form 10-K for the year ended December 31, 2007, while not all inclusive, discusses additional information about the business of the Corporation and the material risk factors that, in addition to the other information in this report, readers should consider. Further discussion of operating results, financial condition and business risks is presented in the narrative and tables included herein. Significant U.S. Strategic Events Significant U.S. Strategic Events Significant U.S. Strategic Events Significant U.S. Strategic Events Significant U.S. Strategic Events The following significant U.S. initiatives were adopted to improve the Corporation’s balance sheet, profitability and liquidity. Certain of these events occurred in 2007, while others are expected to be effected in early 2008. PFH Restructuring Plan In January 2007, the Corporation adopted a Restructuring and Integration Plan at PFH, the holding company of Equity One (the “PFH Restructuring Plan”). The PFH Restructuring Plan called for PFH to exit the wholesale subprime mortgage loan origination business during early first quarter of 2007 and to shut-down the wholesale broker, retail and call center business divisions. Also, the plan included consolidating PFH support functions with its sister U.S. banking entity, Banco Popular North America, creating a single integrated North American financial services unit. At that time, Popular decided to continue the operations of Equity One and its subsidiaries (“Equity One”), with over 130 consumer services branches, principally dedicated to direct subprime loan origination, consumer finance and mortgage servicing. The PFH Restructuring Plan resulted in restructuring costs amounting to approximately $14.7 million in 2007, primarily in severance and lease termination charges. In 2006, the Corporation recognized $7.2 million in impairment of long-lived assets and $14.2 million in the impairment of PFH’s goodwill as a result of 2007 Annual Report 9 2007 2007 Popular, Inc. 2007 2007 the PFH Restructuring Plan. Refer to the Operating Expenses section in this MD&A for a breakdown of these costs by major categories. Exiting these origination channels also impacted financial results by reducing new loan volumes and, thus, had an impact on revenues generated by the sale of loans. Refer to the Events Subsequent to Year-End 2007 section of this MD&A for additional steps taken by management with respect to PFH’s operations in 2008, which resulted in a second restructuring plan, namely the PFH Branch Network Restructuring Plan. E-LOAN Restructuring Plan In November 2007, the Board of Directors of Popular adopted a restructuring plan for its Internet financial services subsidiary E- LOAN (the “E-LOAN Restructuring Plan”). Considering E-LOAN’s operating losses in light of current market conditions and other factors, the Board of Directors approved a substantial reduction of marketing and personnel costs at E-LOAN and changes in E-LOAN’s business model to align it with revenue expectations. The changes include concentrating marketing investment toward the Internet and the origination of first mortgage loans that qualify for sale to government sponsored entities (“GSEs”). Also, as a result of escalating credit costs in the current economic environment and lower liquidity in the secondary markets for mortgage related products, in December 2007, the Corporation determined to hold back the origination by E-LOAN of home equity lines of credit, closed-end second lien mortgage loans and auto loans. The E-LOAN Restructuring Plan continues to promote the Internet deposit gathering initiative with BPNA. As part of the E-LOAN Restructuring Plan, the Corporation evaluated the value of E-LOAN’s recorded goodwill and trademark by considering the changes in E-LOAN’s business model and the unprecedented conditions in the mortgage loan business. The E- LOAN Restructuring Plan resulted in charges recorded in the fourth quarter of 2007 amounting to $231.9 million, which included $211.8 million in non-cash impairment losses related to its goodwill and trademark intangible assets. Refer to the Operating Expenses section in this MD&A for a breakdown of these costs by major categories. The cost-control plan initiative and changes in loan origination strategies incorporated as part of the plan will result in the elimination of over 400 positions between the fourth quarter of 2007 and first quarter of 2008. As a result of the E-LOAN Restructuring Plan, operating expenses are expected to be reduced by approximately $77 million for 2008. E-LOAN’s estimated net losses for the year ended December 31, 2008 are expected to decline by $15 million, resulting principally from the reduction in operating expenses, partially offset by the related tax impact and by lower volume of loan originations in certain business channels that are impacted by this plan. Recharacterization of Certain On-Balance Sheet Securitizations as Sales under FASB Statement No. 140 From 2001 through 2006, the Corporation conducted 21 mortgage loan securitizations that were sales for legal purposes but did not qualify for sale accounting treatment at the time of inception because the securitization trusts did not meet the criteria for qualifying special purpose entities (“QSPEs”) contained in SFAS No. 140 “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities”. As a result, the transfers of the mortgage loans pursuant to these securitizations were initially accounted for as secured borrowings with the mortgage loans continuing to be reflected as assets on the Corporation’s consolidated statement of financial condition with appropriate footnote disclosure indicating that the mortgage loans were, for legal purposes, sold to the securitization trusts. As part of the Corporation’s strategy of exiting the subprime business at PFH, on December 19, 2007, PFH and the trustee for each of the related securitization trusts amended the provisions of the related pooling and servicing agreements to delete the discretionary provisions that prevented the transactions from qualifying for sale treatment. These changes in the primary discretionary provisions included: • deleting the provision that grants the servicer “sole discretion” to have the right to purchase for its own account or for resale from the trust fund any loan which is 91 days or more delinquent; • deleting the provision that grants the servicer (PFH) “sole discretion” to sell loans with respect to which it believes default is imminent; • deleting the provision that grants the servicer “sole discretion” to determine whether an immediate sale of a real estate owned (“REO”) property or continued management of such REO property is in the best interest of the certificateholders; and • deleting the provision that grants the residual holder (PFH) to direct the trustee to acquire derivatives post closing. The Corporation obtained a legal opinion, which among other considerations, indicated that each amendment (a) is authorized or permitted under the pooling and servicing agreement related to such amendment, and (b) will not adversely affect in any material respect the interests of any certificateholders covered by the related pooling and servicing agreement. The amendments to the pooling and servicing agreement allowed the Corporation to recognize 16 out of the 21 transactions as sales under SFAS No. 140. When accounting for the transfers as sales, the Corporation (i) reclassified the loans as held-for-sale with the corresponding lower of cost or market adjustment as of the date of the transfer, (ii) removed from the Corporation’s books 10 approximately $3.2 billion in mortgage loans and $3.1 billion in related liabilities representing secured borrowings, (iii) recognized assets referred to as residual interests, which represent the fair value of residual interest certificates that were issued by the securitization trusts and retained by PFH, and (iv) recognized mortgage servicing rights, which represent the fair value of PFH’s right to continue to service the mortgage loans transferred to the securitization trusts. As part of the recharacterization, the Corporation recognized residual interests of $38 million and MSRs of $18 million. The Corporation had previously recorded MSRs in several of these securitization transactions, which amounted to $18 million at December 31, 2007. The net impact of the recharacterization transaction was a pre-tax loss of $90.1 million, which is included in the caption “(Loss) gain on sale of loans and valuation adjustments on loans held-for-sale” in the consolidated statement of operations. Because the loans in these trusts continued to be reflected as assets on the Corporation’s consolidated financial statements prior to effecting the loan recharacterization transaction, the Corporation was required to record charge-offs and make provision for inherent loan losses relating to such loans in accordance with FASB Statement No. 5, “Accounting for Contingencies.” This loan recharacterization transaction as sale on the Corporation’s financial statements reflects management’s current strategy of exiting the subprime mortgage origination business of PFH. It also provides investors a better portrayal of the legal rights and obligations related to these transactions and will allow them to better assess their economic impact on the Corporation’s financial condition. The removal of the mortgage assets from Popular’s books had a favorable impact on its capital ratios and reduced the amount of subprime mortgages in the Corporation’s books. The loan recharacterization transaction contributed with a reduction in non-performing mortgage loans of approximately $316 million, when compared to December 31, 2006. Events Subsequent To Year-End 2007 Events Subsequent To Year-End 2007 Events Subsequent To Year-End 2007 Events Subsequent To Year-End 2007 Events Subsequent To Year-End 2007 Sale of BPNA’s Retail Bank Branches in Houston On January 10, 2008, the Corporation completed the sale of six branches of BPNA in Houston, Texas to Prosperity Bank. Prosperity Bank paid a premium of 10.10% for approximately $126 million in deposits, as well as purchased certain loans and other assets attributable to the branches. Prosperity retained all branch-based employees. BPNA continues to operate its mortgage business based in Houston as well as its franchise and small business lending activities in Texas. BPNA will also continue to maintain a retail branch in Arlington, Texas. PFH Branch Network Restructuring Plan Given the unprecedented disruption in the capital markets since the summer of 2007 and its impact on funding, Popular’s management concluded that it would be difficult to generate an adequate return on the capital invested at Equity One’s consumer service branches. In January 2008, the Corporation signed an Asset Purchase Agreement (the “Agreement”) to sell certain assets of Equity One, the U.S. mainland consumer finance operations of Popular Financial Holdings, to American General Finance, Inc., a member of American International Group. The closing of the Agreement with effective date of March 1, 2008 resulted in the sale of a significant portion of Equity One’s mortgage loan and consumer loan portfolio approximating $1.4 billion. This portfolio was reclassified by the Corporation from loans held-in-portfolio to loans held-for-sale in December 2007. American General Finance, Inc. will hire certain Equity One’s consumer services employees and will retain certain branch locations. Equity One will close all remaining consumer branches. Workforce reductions at Equity One will result in the loss of employment for those employees at the consumer services branches not hired by American General Finance, Inc., as well as for other related support functions. This strategic initiative resulted in the adoption of an additional restructuring plan at PFH (the “PFH Branch Network Restructuring Plan”) during the first quarter of 2008. It is anticipated that this restructuring plan (the “PFH Branch Network Restructuring Plan”) will result in estimated combined charges for the Corporation of approximately $19.5 million, of which $1.9 million in impairment charges related to long-lived assets, primarily leasehold improvements, furniture and equipment, were recognized on December 31, 2007, and the remainder is expected to be substantially incurred in the first quarter of 2008. Adoption of Statement of Financial Accounting Standards No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”) The Corporation adopted the provisions of SFAS No. 159 in January 2008. Management elected the fair value option for approximately $287 million of loans and $287 million of bond certificates associated to PFH’s on-balance sheet securitizations that were outstanding at December 31, 2007 (transactions excluded from the recharacterization transaction described in Note 23 to the consolidated financial statements). These loans serve as collateral for the bond certificates. Due to accounting constraints, the Corporation is unable to recharacterize these loan securitizations as sales. Additionally, the Corporation elected the fair value option for approximately $1.2 billion of whole loans held-in-portfolio by PFH. These whole loans consist principally of mortgage loans, including second-liens, that were originated through the exited business of PFH and home equity lines of credit that had been originated by E-LOAN prior to the 2007 U.S. reorganization. Due to their subprime characteristics and current market disruptions, these loans are being held-in-portfolio as 2007 Annual Report 11 2007 2007 Popular, Inc. 2007 2007 potential buyers have withdrawn from the market given heightened concerns over credit quality of borrowers and continued deterioration in the housing markets. Management understands that accounting for these loans at fair value provides a more relevant and transparent measurement of the realizable value of the assets and differentiates the PFH portfolio from that loan portfolio that the Corporation will continue to originate through other channels outside PFH. The measurement of the bond certificates at fair value reflects the actual liability of the Corporation after considering the credit risk to be borne by the certificateholders on the on-balance sheet securitization. Management understands that the adoption of the fair value option for the financial assets and liabilities selected better reflects the inherent risks of these instruments and reflects the intention of the Corporation to discontinue most of the businesses previously conducted at PFH. As a result of the adoption of SFAS No. 159, the Corporation expects to recognize a negative pre-tax adjustment that could range between $280 million and $300 million ($158 million and $169 million after-tax) due to the transitional adjustment for electing the fair value option on existing instruments at adoption. That amount represents the difference between the fair value and the carrying value of the loans at date of adoption. This negative adjustment would not impact earnings but instead be reflected as a reduction of beginning retained earnings as of January 1, 2008. Subsequent increases or decreases in the fair value of the assets and liabilities accounted under SFAS No. 159 provisions will be recorded as valuation adjustments through earnings in the consolidated statement of operations. The fair value adjustments disclosed here are only estimates as management is in the process of validating the methodologies used to value the assets and liabilities and the results of such valuations. Also, management continues to evaluate the impact that SFAS No. 159 will have on the consolidated financial statements, including disclosures. CCCCCRITICAL OLICIES / E / E / E / E / E STIMATES CCOUNTING P P P P P OLICIES RITICAL A A A A ACCOUNTING STIMATES STIMATES OLICIES OLICIES CCOUNTING CCOUNTING RITICAL RITICAL STIMATES STIMATES OLICIES CCOUNTING RITICAL The accounting and reporting policies followed by the Corporation and its subsidiaries conform with generally accepted accounting principles ( “GAAP”) in the United States of America and general practices within the financial services industry. The Corporation’s significant accounting policies are described in detail in Note 1 to the consolidated financial statements and should be read in conjunction with this section. Critical accounting policies require management to make estimates and assumptions, which involve significant judgment about the effect of matters that are inherently uncertain and that involve a high degree of subjectivity. These estimates are made under facts and circumstances at a point in time and changes in those facts and circumstances could produce actual results that differ from those estimates. The following MD&A section is a summary of what management considers the Corporation’s critical accounting policies / estimates. Securities’ Classification and Related Values Securities’ Classification and Related Values Securities’ Classification and Related Values Securities’ Classification and Related Values Securities’ Classification and Related Values Management determines the appropriate classification of debt and equity securities at the time of purchase. Debt securities are classified as held-to-maturity ( “HTM”) when the Corporation has the intent and ability to hold the securities to maturity. HTM securities are reported on the Corporation’s financial statements at amortized cost. Debt and equity securities classified as trading securities are reported at fair value, with unrealized gains and losses included in earnings. Debt and equity securities not classified as HTM or trading, except for equity or other securities which do not have readily available fair values, are classified as available-for-sale ( “AFS”). Securities AFS are reported at fair value, with unrealized gains and losses excluded from earnings and reported net of taxes in accumulated other comprehensive income (a component of stockholders’ equity). At December 31, 2007, unrealized net gains on the AFS securities, net of taxes, amounted to $21 million. Investments in equity or other securities that do not have publicly and readily determinable fair values are classified as other investment securities in the statement of condition and carried at the lower of cost or realizable value. The assessment of fair value applies to certain of the Corporation’s assets and liabilities, including the trading and investment portfolios. Fair values are volatile and are affected by factors such as market interest rates, technical factors affecting supply and demand, prepayment speeds and discount rates. Fair values for most of the Corporation’s trading and investment securities, including publicly-traded equity securities, are based on quoted market prices. If quoted market prices are not readily available, fair values are based on quoted prices of similar instruments. For information on the determination of the fair value of interest-only strips derived from securitization transactions, refer to the critical accounting policy described under the section Retained Interests on Transfers of Financial Assets - Subprime Mortgage Loan Securitizations, in this MD&A. Significant changes in factors such as interest and prepayment rates could affect the value of the trading, AFS and HTM securities and cause the Corporation to recognize other-than-temporary impairments, thereby adversely affecting results of operations. Management assesses the fair value of its portfolio at least on a quarterly basis. Factors considered include for example, the nature of the investment, severity and duration of possible impairments, industry reports, sector credit ratings, economic environment, creditworthiness of the issuers and any guarantees, and the ability to hold the security until maturity or recovery. Any impairment that is considered other-than-temporary is recorded directly in the statement of operations. 12 Notwithstanding the judgment required in determining the fair value of the Corporation’s assets and liabilities, management believes that its estimates of fair value are reasonable given the process of obtaining external prices, periodic reviews of internal models and the consistent application of methodologies from period to period. Loans and Allowance for Loan Losses Loans and Allowance for Loan Losses Loans and Allowance for Loan Losses Loans and Allowance for Loan Losses Loans and Allowance for Loan Losses Interest on loans is accrued and recorded as interest income based upon the principal amount outstanding. Recognition of interest income on commercial and construction loans, lease financing, conventional mortgage loans and closed-end consumer loans is discontinued when loans are 90 days or more in arrears on payments of principal or interest, or when other factors indicate that the collection of principal and interest is doubtful. Income is generally recognized on open-end (revolving credit) consumer loans until the loans are charged-off. Closed-end consumer loans and leases are charged-off when payments are 120 days in arrears. In the case of the Corporation’s non-bank consumer and mortgage lending subsidiaries, however, closed-end consumer loans, including second mortgages, are charged-off when payments are 180 days delinquent. Open-end (revolving credit) consumer loans are charged-off when payments are 180 days in arrears. One of the most critical and complex accounting estimates is associated with the determination of the allowance for loan losses. The provision for loan losses charged to current operations is based on this determination. The methodology used to establish the allowance for loan losses is based on SFAS No. 114 “Accounting by Creditors for Impairment of a Loan” (as amended by SFAS No. 118) and SFAS No. 5 “Accounting for Contingencies.” Under SFAS No. 114, the Corporation has defined as impaired loans those commercial loans that amount to $250,000 or more and with interest and /or principal 90 days or more past due. Also, specific commercial loans over $500,000 are deemed impaired when, based on current information and events, management considers that it is probable that the debtor will be unable to pay all amounts due according to the contractual terms of the loan agreement. An allowance for loan impairment is recognized to the extent that the carrying value of an impaired commercial loan exceeds the present value of the expected future cash flows discounted at the loan’s effective rate, the observable market price of the loan, if available, or the fair value of the collateral if the loan is collateral dependent. The allowance for impaired commercial loans is part of the Corporation’s overall allowance for loan losses. SFAS No. 5 provides for the recognition of a loss allowance for groups of homogeneous loans. To determine the allowance for loan losses under SFAS No. 5, the Corporation applies a historic loss and volatility factor to specific loan balances segregated by loan type and legal entity. For subprime mortgage loans, the allowance for loan losses is established to cover at least one year of projected losses which are inherent in these portfolios. The Corporation’s management evaluates the adequacy of the allowance for loan losses on a monthly basis following a systematic methodology in order to provide for known and inherent risks in the loan portfolio. In developing its assessment of the adequacy of the allowance for loan losses, the Corporation must rely on estimates and exercise judgment regarding matters where the ultimate outcome is unknown, such as economic developments affecting specific customers, industries or markets. Other factors that can affect management’s estimates are the years of historical data to include when estimating losses, the level of volatility of losses in a specific portfolio, changes in underwriting standards, financial accounting standards and loan impairment measurement, among others. Changes in the financial condition of individual borrowers, in economic conditions, in historical loss experience and in the condition of the various markets in which collateral may be sold, may all affect the required level of the allowance for loan losses. Consequently, the business, financial condition, liquidity, capital and results of operations could also be affected. A discussion about the process used to estimate the allowance for loan losses is presented in the Credit Risk Management and Loan Quality section of this MD&A. Retained Interests on Transfers of Financial Assets Retained Interests on Transfers of Financial Assets Retained Interests on Transfers of Financial Assets Retained Interests on Transfers of Financial Assets Retained Interests on Transfers of Financial Assets - Subprime Mortgage Loan Securitizations - Subprime Mortgage Loan Securitizations - Subprime Mortgage Loan Securitizations - Subprime Mortgage Loan Securitizations - Subprime Mortgage Loan Securitizations In subprime mortgage loan securitizations, the Corporation combines the subprime mortgage loans that are originated or purchased in pools to serve as collateral for asset-backed securities that are issued and sold to the public. In connection with PFH’s securitization transactions, the Corporation is party to pooling and servicing agreements in which the Corporation transfers (on a servicing retained basis) certain of the Corporation’s loans to a special purpose entity, which in turn transfers the loans to a securitization trust vehicle. In order to determine the proper accounting treatment for each securitization transaction, management evaluates whether or not the Corporation retained or surrendered control over the transferred assets by reference to the conditions set forth in SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities - a replacement of FASB Statement No. 125.” All terms of these transactions are evaluated against the conditions set forth in this statement, including among the principal factors the isolation of transferred assets from the transferor, transferee’s right to pledge or exchange the transferred assets, and entitlement and obligation to repurchase or redeem the assets. When the transfer of subprime mortgage loans is executed in a manner such that the Corporation surrenders control over the collateral and meets all required sale criteria of SFAS No. 140, the transfer is accounted for as a sale to the extent that consideration other than beneficial interests is received in exchange (“off-balance sheet securitizations”). In accordance with SFAS No. 140, a gain or loss on the sale is recognized based on the carrying amount of the financial assets involved in the transfer, allocated between the assets transferred and the retained interests based on their relative fair value at the date of transfer. In a loan securitization accounted for as a sale of assets, the Corporation normally retains the right to service the underlying mortgage loans and also retains the residual interest certificates. The estimated fair value of the securitization components is considered a critical accounting estimate as the valuation assumptions used regarding economic conditions and the make-up of the collateral, including interest rates, principal payments, prepayments and loan defaults, are highly uncertain and require a high degree of judgment. During 2007, the Corporation conducted one off-balance sheet asset securitization that involved the transfer of mortgage loans to a qualifying special purpose entity (“QSPE”), which in turn transferred these assets and their titles to different trusts. Approximately $461 million in adjustable (“ARM”) and fixed-rate loans were securitized and sold by PFH during 2007 as part of this off-balance sheet asset securitization and PFH realized a gain on sale of approximately $13.5 million. As part of this transaction, the Corporation initially recognized MSRs of $8 million and residual interests of $5 million. Also, in December 2007, the Corporation completed the recharacterization of certain on-balance sheet securitizations that allowed the Corporation to recognize t h e t r a n s a c t i o n s a s s a l e s u n d e r S F A S N o . 1 4 0 . T h i s recharacterization was described in the Significant U.S. Strategic Events section of this MD&A. When the Corporation transfers financial assets and the transfer fails any one of the SFAS No. 140 sales criteria, the Corporation is not permitted to derecognize the transferred financial assets and the transaction is accounted for as a secured borrowing. In these cases, the assets remain on the Corporation’s financial statements and a liability is recorded for the related asset-backed securities (“on-balance sheet securitizations”). The loans transferred to the trusts are included on the consolidated statement of condition as pledged loans held-in-portfolio. During 2007, PFH did not execute any on-balance sheet securitization. The recorded residual interests and MSRs resulting from the subprime mortgage loan securitizations are subject to the valuation techniques described below since quoted market prices for these types of assets are not readily available because these assets are not actively traded. 2007 Annual Report 13 2007 2007 Popular, Inc. 2007 2007 R e s i d u a l i n t e r e s t s R e s i d u a l i n t e r e s t s R e s i d u a l i n t e r e s t s R e s i d u a l i n t e r e s t s R e s i d u a l i n t e r e s t s Under SFAS No. 140, residual interests retained in securitizations or other financial assets that can contractually be prepaid or otherwise settled in such a way that the holder would not recover substantially all of its investment shall be subsequently measured like investments in debt securities classified as available-for-sale or trading under SFAS No. 115. Residual interests retained as part of off-balance sheet securitizations of subprime mortgage loans prior to 2006 have been classified as investment securities available-for-sale and are presented at fair value in the consolidated statements of condition. PFH’s residual interests classified as available-for-sale as of December 31, 2007 amounted to $5 million. Commencing in January 2006 and as permitted by accounting guidance, the residual interests derived from newly-issued PFH’s off-balance sheet securitizations and from the recharacterization were accounted for as trading securities. Trading securities are marked-to-market with changes in value reflected in current period earnings (favorable and unfavorable value changes) as opposed to available-for-sale securities in which the changes in value are recorded as unrealized gains (losses) through equity, unless unfavorable changes are considered other-than temporary. Residual interests from PFH’s securitizations and recharacterization accounted for as trading securities amounted to $40 million at December 31, 2007. Management’s determination to prospectively classify the residual interests as trading securities was driven by accounting considerations and not by intent to actively trade these assets. Illiquidity in the subprime markets had a direct impact on the value and liquidity of the Corporation’s residual interests as will be described below. Given market conditions, management does not anticipate selling these residual interests in the near term unless an opportunity arises as part of strategic initiatives. The cash flows the Corporation receives on residual interests are dependent on the interest rate environment, default and prepayment experience of the borrowers of the underlying mortgage loan collateral and the interest spread between the coupon on the underlying loans and the cost of financing, considering overcollateralization, which is designed to protect the primary security holder from credit loss on the underlying loans. As payments are received, they are applied to the cost basis of the residual interest. Each period, the accretable yield for each residual interest is evaluated and, to the extent there has been a change in the estimated cash flows, it is adjusted and applied prospectively. The accretable yield is recorded as interest income with a corresponding increase to the cost basis of the residual interest. The Corporation reviews the residual interests for potential impairment on a quarterly basis and records impairment in accordance with SFAS No. 115 and EITF 99-20 “Recognition of 14 Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets” ("EITF 99- 20"). Management’s basis in determining when these securities must be written down to fair value due to other-than-temporary impairment is based on EITF 99-20. Whenever the current fair value of the residual interests classified as available-for-sale is lower than its current amortized cost, management evaluates if an impairment charge for the deficiency is required to be taken through earnings. If there has been an adverse change in estimated cash flows (considering both the timing and amount of flows), then the residual interest security is written-down to fair value, which becomes the new amortized cost basis. The Corporation recognized other-than-temporary impairment losses on these residual interests of $45.4 million for the year ended December 31, 2007 that are classified as part of net gain (loss) on sale and valuation adjustment of investment securities in the consolidated statements of operations. During 2007, all declines in fair value in residual interests classified as available-for-sale were considered other-than-temporary. The fair value determinations for residual interests classified as trading securities are also performed on a quarterly basis. Any valuation adjustment related to these particular residual interests is reflected in earnings as it occurs and is recorded as part of trading account (loss) profit in the consolidated statements of operations. The Corporation recognized trading losses on these residual interests of $39.7 million for the year ended December 31, 2007. The fair value of the residual interests for each securitization is determined by using a third-party cash flow valuation model to calculate the present value of projected future cash flows. However, all economic assumptions are internally developed and provided to the third-party (the internal-based valuation). The assumptions, which are highly uncertain and require a high degree of judgment, include primarily market discount rates, anticipated prepayment speeds, delinquency and loss rates. The assumptions used are drawn from a combination of internal and external data sources. The principal assumptions and their sources are summarized below: • Prepayment rates on loan collateral are estimated by product types (adjustable and fixed rate mortgages) by analyzing internal loan collateral prepayment performance and prepayment data obtained from research reports and publications provided by industry participants. • Discount rates are determined based on the inherent risk associated with the specific cash flow stream and rates of return observed in the capital markets for instruments with similar cash flow characteristics. • Future interest rates are projected from a forward yield curve obtained from nationally recognized market data service providers, such as Bloomberg. • Credit losses are estimated by utilizing an industry standard predictive credit performance model and allocated over the expected life of the collateral by utilizing a default curve developed by a nationally recognized credit rating agency. Credit losses are determined for the major product types (adjustable and fixed rate mortgages) in the collateral pool being securitized and are calibrated by analyzing actual loss experience realized by the Corporation to that projected by the model for the same type of collateral. These assumptions are periodically refined as data is updated, accumulated and analyzed, tools utilized for analysis become more sophisticated and market conditions change. This is based on the same framework utilized to determine the initial assumptions used to calculate fair value. Any measurement of the fair value of residual interests is limited by the existing conditions and the assumptions utilized as of a particular point in time. Those same assumptions may not be appropriate if applied at a different point in time. A third-party valuation of the residual interests, in which all economic assumptions are determined by this third-party (the external-based valuation), is obtained on a quarterly basis in connection with the preparation of the financial statements, and is used by management as a benchmark to evaluate the adequacy of the cash flow model and the reasonableness of the assumptions and fair value estimates developed internally for the internal-based valuation. The external-based valuations are analyzed and assumptions are evaluated and incorporated in the internal-based valuation model when deemed necessary and agreed by management. The Corporation requires that internally determined assumptions be documented and validated quarterly, and that significant deviations in assumptions when compared with outside sources be investigated and substantiated with factual data. In 2007, the subprime mortgage market has continued to experience (1) deteriorating credit performance trends, particularly in loans originated in 2005, 2006 and 2007, (2) unprecedented turmoil with subprime lenders due to increases in losses, bankruptcies and liquidity problems, (3) lower levels of housing activity and home price appreciation, and (4) a general tightening of credit standards that may adversely affect subprime borrowers when trying to refinance their mortgages. Furthermore, since the third quarter of 2007, the U.S. credit markets have been affected by unprecedented instability and disruption, making even routine asset sales much more challenging. Credit spreads have widened significantly and rapidly, as many investors have allocated their funds to only the highest-quality financial assets such as U.S. government securities. 2007 Annual Report 15 2007 2007 Popular, Inc. 2007 2007 These factors led to an increase in cash flow uncertainty for investors in subprime mortgage securities thereby causing risk premiums to increase. Given the increase in risk premiums, along with lower liquidity for subprime mortgage securities observed in the market, in the first quarter of 2007, the Corporation changed the discount rate utilized to discount projected residual cash flows from 17% at the end of the fourth quarter in 2006 to 25% at March 31, 2007. Market liquidity deteriorated further during the third quarter of 2007, as evidenced by wider spreads on subordinated interests in newly issued asset-backed security transactions. As a result of the incremental market disruptions, management increased again the discount rate utilized in the valuation of the residual interests to 30% in the third quarter of 2007 and to 40% in the fourth quarter of 2007. For the reasons described below, the prepayment assumption for fixed-rate loans was changed to 20.7% HEP (“home equity prepayment curve”) by December 31, 2007 from the 28% HEP utilized at the same date in the previous year. The HEP model assumes that prepayment speeds increase evenly over the seasoning ramp of 12 months. The revised HEP reflects a decrease in the long-term projected prepayment rates for the fixed-rate mortgage collateral influenced by factors such as decreases in home prices, slowdown in the purchases and sales of both new and existing homes, and interest rates behavior, which impact refinance activity. With respect to credit losses, reduction in home prices, declining demand for housing units leading to rising inventories, housing affordability challenges and a general tightening of underwriting standards are expected to lead to higher future cumulative credit losses. Based on an analysis by management of PFH’s historical collateral performance, risk model estimates and rating agency loss coverage levels, the cumulative credit loss assumptions were also changed, worsening throughout all quarters of 2007. The cumulative credit loss estimates range between 3.35% and 11.03% as of December 31, 2007, compared to 1.28% and 3.19% basis points at December 31, 2006. The increase reflects current conditions in the housing and credit markets and higher delinquencies in 2005 through 2007 vintages. Refinements to assumptions, as well as model mechanics, are typical in the on-going modeling process. As such, enhancements to the estimation process are to be expected in the normal assumption development process. Management believes that the value of the Corporation’s residual interests as of December 31, 2007 is reasonable, but no assurance can be provided that future changes in interest rates, prepayments and loss experience, or changes in the market discount rate will not require additional write-downs. Refer to Note 23 to the consolidated financial statements for information on the key economic assumptions used in measuring the fair value of the residual interests at the dates of the securitizations and as of the end of 2007. Also, such note provides a sensitivity analysis based on immediate changes to the most critical assumptions used in determining the fair value at December 31, 2007. Mortgage Servicing Rights Mortgage Servicing Rights Mortgage Servicing Rights Mortgage Servicing Rights Mortgage Servicing Rights The Corporation accounts for mortgage servicing rights (“MSRs”) at fair value. The fair value of servicing rights is estimated by using a cash flow valuation model which calculates the present value of estimated future net servicing cash flows, taking into consideration actual and expected loan prepayment rates, discount rates, servicing costs, and other economic factors, which are determined based on current market conditions. Similar to the residual interests, the Corporation estimates fair value of MSRs using a third-party valuation model that calculates the present value of projected future cash flows in which all economic assumptions are determined by the Corporation. The valuation of MSRs requires the Corporation to make estimates of numerous market assumptions, such as interest rates, prepayment assumptions, servicing costs, discount rates, and the payment performance of the underlying loans. These MSRs are valued using a static interest rate simulation. Economic assumptions are reviewed for reasonableness on a quarterly basis and adjusted as necessary to reflect current and anticipated market conditions. Thus, any measurement of the fair value of MSRs is limited by the existing conditions and the assumptions utilized as of a particular point in time. Those same assumptions may not be appropriate if applied at a different point in time. Third-party valuations of the fair value of the subprime mortgage loans’ MSRs, in which all economic assumptions are determined by the third party, are obtained on a quarterly basis, and are used by management only as a benchmark to evaluate the reasonableness of the fair value estimates made internally. These external-based valuations are analyzed and assumptions are evaluated and incorporated in the internal-based valuation model when validated and agreed upon by management. The Corporation requires that internally determined assumptions be documented and validated quarterly, and that significant deviations in assumptions when compared with outside sources be investigated and substantiated with factual data. Refer to Note 22 to the consolidated financial statements for information on the impact of the adoption of SFAS No. 156 and other information on the Corporation’s MSRs. Refer to Note 23 to the consolidated financial statements for information on the key economic assumptions used in measuring the fair value of the MRSs recorded by PFH and BPPR at the dates of the securitizations, recharacterization or sales and as of December 31, 2007. Also, Note 23 provides a sensitivity analysis based on immediate 16 changes to the most critical assumptions used in determining the fair value at December 31, 2007. Income Taxes Income Taxes Income Taxes Income Taxes Income Taxes The calculation of our periodic income taxes is complex and requires the use of estimates and judgments. The Corporation has recorded two accruals for income taxes: (1) the net estimated amount currently due or to be received from taxing jurisdictions, including any reserve for potential examination issues, and (2) a deferred income tax that represents the estimated impact of temporary differences between how the Corporation recognizes assets and liabilities under GAAP, and how such assets and liabilities are recognized under the tax code. Differences in the actual outcome of these future tax consequences could impact the Corporation’s financial position or its results of operations. In estimating taxes, management assesses the relative merits and risks of the appropriate tax treatment of transactions taking into consideration statutory, judicial and regulatory guidance. Valuation allowances are established, when necessary, to reduce the deferred tax assets to the amount expected to be realized. The net deferred tax asset at December 31, 2007 amounted to $520 million of which $215 million was related to timing differences in the recognition of the provision for loan losses under GAAP and actual charge offs under the tax code, and $175 million was related to net operating losses carryforward in the U.S. operations. The realization of the deferred tax asset related to the net operating loss carryforward of the Corporation’s U.S. operations is dependent upon the existence of, or generation of, taxable income prior to their expiration term of 20 years. Based on the information available as of December 31, 2007, the Corporation expects to fully realize the net deferred tax asset. Refer to Note 27 to the consolidated financial statements for the Corporation’s net deferred tax assets and valuation allowance requirements at December 31, 2007. Changes in the Corporation’s estimates can occur due to changes in tax rates, new business strategies, newly enacted guidance, and resolution of issues with taxing authorities regarding previously taken tax positions. Such changes could affect the amount of accrued taxes. The current income tax payable for 2007 has been paid during the year in accordance with estimate tax payments rules. Any remaining payment will not have any significant impact on liquidity and capital resources. SFAS No. 109, “Accounting for Income Taxes,” requires the recognition of income taxes on the unremitted earnings of subsidiaries, unless these can be remitted on a tax-free basis or are permanently invested. The Corporation’s U.S. subsidiaries (which are considered foreign under Puerto Rico income tax law) have never remitted retained earnings. The Corporation considers the reinvestment of such earnings permanent. The Corporation’s subsidiaries in the United States file a consolidated return. As of December 31, 2007, the Corporation had no current or accumulated earnings and profits on its combined U.S. subsidiaries’ operations and, accordingly, the recognition of a deferred tax liability was not considered necessary. During the first quarter of 2007, the Corporation adopted Financial Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement 109” (FIN 48), which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Under the accounting guidance, a tax benefit from an uncertain position may be recognized only if it is “more likely than not” that the position is sustainable based on its technical merits. The tax benefit of a qualifying position is the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with a taxing authority having full knowledge of all relevant information. Based on management’s assessment, there was no impact on retained earnings as of January 1, 2007 due to the initial application of the provisions of FIN 48 since the Corporation did not recognize any change in the liability for unrecognized tax benefits. The amount of unrecognized tax benefits, including accrued interest, as of December 31, 2007 amounted to $22.2 million. Refer to Note 27 to the consolidated financial statements for further information on the impact of FIN 48. The amount of unrecognized tax benefits may increase or decrease in the future for various reasons including adding amounts for current tax year positions, expiration of open income tax returns due to the statutes of limitation, changes in management’s judgment about the level of uncertainty, status of examinations, litigation and legislative activity and the addition or elimination of uncertain tax positions. Although the outcome of tax audits is uncertain, the Corporation believes that adequate amounts of tax, interest and penalties have been provided for any adjustments that are expected to result from open years. The Corporation does not anticipate a significant change to the total amount of unrecognized tax benefits within the next 12 months. From time to time, the Corporation is audited by various federal, state and local authorities regarding income tax matters. The audits are in various stages of completion; however, no outcome for a particular audit can be determined with certainty prior to the conclusion of the audit, appeal and, in some cases, litigation process. Although management believes its approach to determining the appropriate tax treatment is supportable and in accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes,” and FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” it is possible that the final tax authority will take a tax position that is different than that which is reflected in the Corporation’s income tax provision and other tax reserves. As each audit is conducted, adjustments, if any, are appropriately recorded in the consolidated 2007 Annual Report 17 2007 2007 Popular, Inc. 2007 2007 financial statement in the period determined. Such differences could have an adverse effect on our income tax provision or benefit, or other tax reserves, in the reporting period in which such determination is made and, consequently, on our results of operations, financial position and/or cash flows for such period. Goodwill and Other Intangible Assets Goodwill and Other Intangible Assets Goodwill and Other Intangible Assets Goodwill and Other Intangible Assets Goodwill and Other Intangible Assets The Corporation’s goodwill and other identifiable intangible assets having an indefinite useful life are tested for impairment based on the requirements of SFAS No. 142, “Goodwill and Other Intangible Assets.” Intangibles with indefinite lives are evaluated for impairment at least annually and on a more frequent basis if events or circumstances indicate impairment could have taken place. Such events could include, among others, a significant adverse change in the business climate, an adverse action by a regulator, an unanticipated change in the competitive environment and a decision to change the operations or dispose of a reporting unit. As of December 31, 2007, goodwill totaled $631 million, while other intangibles with indefinite useful lives, mostly associated with E-LOAN’s trademark, amounted to $17 million. Refer to Notes 1 and 12 to the consolidated financial statements for further information on goodwill and other intangible assets. Note 12 to the consolidated financial statements provides an allocation of goodwill by business segment. During 2007, the Corporation performed the annual goodwill impairment evaluation for the entire organization. The reporting units utilized for this evaluation were those that are one level below the business segments identified in Note 12 to the consolidated financial statements. The impairment evaluation is performed in two steps. The first step of the goodwill evaluation process is to determine if potential impairment exists in any of the Corporation’s reporting units, and is performed by comparing the fair value of the reporting units with their carrying amount, including goodwill. If required from the results of this step, a second step measures the amount of any impairment loss. The second step process estimates the fair value of the unit’s individual assets and liabilities in the same manner as if a purchase of the reporting unit was taking place. If the implied fair value of goodwill calculated in step two is less than the carrying amount of goodwill for the reporting unit, an impairment is indicated and the carrying value of goodwill is written down to the calculated value. In determining the fair value of a reporting unit, the Corporation generally uses a combination of methods, including market price multiples of comparable companies and the discounted cash flow analysis. The computations require management to make estimates and assumptions. Critical assumptions that are used as part of these evaluations include: • selection of comparable publicly traded companies, based on nature of business, location and size; • selection of comparable acquisition transactions; • the discount rate applied to future earnings, based on an estimate of the cost of equity; • the potential future earnings of the reporting unit; • market growth and new business assumptions; • the relative weight given to the valuations derived by the different valuation methods. For purposes of the market comparable approach, valuations were determined by calculating average price multiples of relevant revenue drivers from a group of companies that are comparable to the reporting unit being analyzed and applying those price multiples to the revenue drivers of the reporting unit. While the market price multiple is not an assumption, a presumption that it provides an indicator of the value of the reporting unit is inherent in the valuation. The determination of the market comparables also involves a degree of judgment. For purposes of the discounted cash flows approach, the valuation is based on estimated future cash flows. The Corporation uses its internal Asset Liability Management Committee (ALCO) forecasts to estimate future cash flows. The cost of equity used to discount the cash flows was calculated using the Ibbotson Build- Up Method and ranged from 10.88% to 18.62%. As indicated in the Significant U.S. Strategic Events section of this MD&A, management made a decision during the fourth quarter of 2007 to restructure the operations of E-LOAN. As a result, management updated the valuation test of E-LOAN’s goodwill during the fourth quarter of 2007 to consider the new business developments at that subsidiary. As a result of this impairment analysis, the Corporation recorded goodwill impairment losses of $164.4 million associated with the operations of E-LOAN. The annual goodwill impairment evaluation performed for the other reporting units resulted in no impairment of goodwill or other intangible assets with indefinite lives. The goodwill impairment evaluation process requires the Corporation to make estimates and assumptions with regard to the fair value of the reporting units. Actual values may differ significantly from these estimates. Such differences could result in future impairment of goodwill that would, in turn, negatively impact the Corporation’s results of operations and the reporting units where the goodwill is recorded. However, had our estimated fair value calculated for all units evaluated using the market comparable approach been approximately 10% lower, there would still be no indication of impairment for any of the Corporation’s reporting units. 18 The valuation of the E-LOAN trademark was performed using a valuation approach called the “relief-from-royalty” method. The basis of the “relief-from-royalty” method is that, by virtue of having ownership of the trademarks and trade names, Popular is relieved from having to pay a royalty, usually expressed as a percentage of revenue, for the use of trademarks and trade names. The main estimates involved in the valuation of this intangible asset included the determination of: • an appropriate royalty rate; • the revenue projections that benefit from the use of this intangible; • the after-tax royalty savings derived from the ownership of the intangible; and • the discount rate to apply to the projected benefits to arrive at the present value of this intangible. Since estimates are an integral part of this trademark impairment analysis, changes in these estimates could have a significant impact on the calculated fair value. Based on the impairment evaluation test completed as of December 31, 2007, the Corporation recorded impairment losses of $47.4 million associated with E-LOAN’s trademark. Pension and Postretirement Benefit Obligations Pension and Postretirement Benefit Obligations Pension and Postretirement Benefit Obligations Pension and Postretirement Benefit Obligations Pension and Postretirement Benefit Obligations The Corporation provides pension and restoration benefit plans for certain employees of various subsidiaries. The Corporation also provides certain health care benefits for retired employees of BPPR. The benefit costs and obligations of these plans are impacted by the use of subjective assumptions, which can materially affect recorded amounts, including expected returns on plan assets, discount rates, rates of compensation increase and health care trend rates. Management applies judgment in the determination of these factors, which normally undergo evaluation against industry assumptions and the actual experience of the Corporation. The Corporation uses an independent actuarial firm for assistance in the determination of the pension and postretirement benefit costs and obligations. Detailed information on the plans and related valuation assumptions are included in Note 24 to the consolidated financial statements. The Corporation periodically reviews its assumption for long- term expected return on pension plan assets in the Banco Popular de Puerto Rico Retirement Plan, which is the Corporation’s largest pension plan with a market value of assets of $516.5 million at December 31, 2007. The expected return on plan assets is determined by considering a total fund return estimate based on a weighted average of estimated returns for each asset class in the plan. Asset class returns are estimated using current and projected economic and market factors such as real rates of return, inflation, credit spreads, equity risk premiums and excess return expectations. As part of the review, the Corporation’s independent consulting actuaries performed an analysis of expected returns based on the plan’s asset allocation at January 1, 2008. This analysis is validated by the Corporation and used to develop expected rates of return. This forecast reflects the actuarial firm’s view of expected long-term rates of return for each significant asset class or economic indicator; for example, 9.0% for large / mid-cap stocks, 5.3% for fixed income, and 2.7% inflation at January 1, 2008. A range of expected investment returns is developed, and this range relies both on forecasts and on broad-market historical benchmarks for expected returns, correlations, and volatilities for each asset class. As a consequence of recent reviews, the Corporation left unchanged its expected return on plan assets for year 2008 at 8.0%, similar to the expected rate assumed in 2006 and 2007. Pension expense for the Banco Popular de Puerto Rico Retirement Plan in 2007 amounted to $0.6 million. This included a credit of $41.4 million reflecting the expected return on assets. Pension expense is sensitive to changes in the expected return on assets. For example, decreasing the expected rate of return for 2008 from 8.00% to 7.50% would increase the projected 2008 expense for the Banco Popular de Puerto Rico Retirement Plan by approximately $2.5 million. On December 31, 2006, the Corporation adopted SFAS No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R)”, and commenced to account for the underfunded status of the Corporation’s pension and postretirement benefit plans as a liability, with an offset, net of tax, in accumulated other comprehensive income. The determination of the fair value of pension plan obligations involves judgment, and any changes in those estimates could impact the Corporation’s consolidated statement of financial condition. The valuation of pension plan obligations is discussed above. Management believes that the fair value estimates of the pension plan assets are reasonable given that the plan assets are managed, in the most part, by the fiduciary division of BPPR, which is subject to periodic audit verifications. Also, the composition of the plan assets, as disclosed in Note 24 of the consolidated financial statements, is primarily in equity and debt securities, which have readily determinable quoted market prices. The Corporation uses the Citigroup Yield Curve to discount the expected program cash flows as a guide in the selection of the discount rate, as well as the Citigroup Pension Liability Index. The Corporation decided to use a discount rate of 6.40% to determine the benefit obligation at December 31, 2007, compared with 5.75% at December 31, 2006. 2007 Annual Report 19 2007 2007 Popular, Inc. 2007 2007 A 40 basis point decrease in the assumed discount rate of 6.40% as of the beginning of 2008 would increase the projected 2008 expense for the Banco Popular de Puerto Rico Retirement Plan by approximately $2.0 million. The change would not affect the minimum required contribution to the Plan. The Corporation also provides a postretirement health care benefit plan for certain employees of BPPR. This plan was unfunded (no assets were held by the plan) at December 31, 2007. The Corporation had an accrual for postretirement benefit costs of $126 million at December 31, 2007. Assumed health care trend rates may have significant effects on the amounts reported for the health care plan. Note 24 to the consolidated financial statements provides information on the assumed rates considered by the Corporation and on the sensitivity that a one-percentage point change in the assumed rate may have in the cost components and postretirement benefit obligation of the Corporation. SSSSS TATEMENT PERATIONS A A A A A NALYSIS TATEMENT OFOFOFOFOF O O O O O PERATIONS NALYSIS NALYSIS PERATIONS PERATIONS TATEMENT TATEMENT NALYSIS NALYSIS PERATIONS TATEMENT Net Interest Income Net Interest Income Net Interest Income Net Interest Income Net Interest Income Net interest income is the Corporation’s primary source of earnings representing 68% of total revenues (defined as net interest income plus non-interest income) for 2007, compared to 64% in 2006. It is defined as the difference between the revenue generated on interest earning assets less the interest cost of funding those assets. Various factors may cause the net interest income to fluctuate from period to period, which may include interest rate volatility, the shape of the yield curve, changes in volume and mix of earning assets and interest bearing liabilities, repricing characteristics of assets and liabilities, and derivative transactions, among others. Interest earning assets include investment securities and loans that are exempt from income tax, principally in Puerto Rico. The main sources of tax-exempt interest income are investments in obligations of some U.S. Government agencies and sponsored entities of the Puerto Rico Commonwealth and its agencies, and assets held by the Corporation’s international banking entities, which are tax-exempt under Puerto Rico laws. To facilitate the comparison of all interest data related to these assets, the interest income has been converted to a taxable equivalent basis, using the applicable statutory income tax rates. The marginal tax rate for the Puerto Rico subsidiaries in 2007 was 39%, compared to 43.5% for BPPR and 41.5% for the other Puerto Rico subsidiaries in 2006. The marginal tax rate was 41.5% for all the Puerto Rico subsidiaries in 2005. The decrease in the marginal tax rate was responsible for the majority of the reduction in the taxable equivalent benefit between 2006 and 2007, as shown in Table D. The taxable equivalent computation considers the interest expense disallowance required by the Puerto Rico tax law, also affected by the mentioned decrease in tax rate. Average outstanding securities balances are based on amortized cost excluding any unrealized gains or losses on securities available-for-sale. Non-accrual loans have been included in the respective average loans and leases categories. Loan fees collected and costs incurred in the origination of loans are deferred and amortized over the term of the loan as an adjustment to interest yield. Interest income for the year ended December 31, 2007 included an unfavorable impact of $8.4 million, consisting principally of amortization of net loan origination costs (net of origination fees) and amortization of net premiums on loans purchased, partially offset by prepayment penalties and late payment charges. These amounts approximated unfavorable impacts of $18 million and $42 million, respectively, for the years ended December 31, 2006 and 2005. The reduction in the unfavorable impact for 2007, compared with 2006 and 2005, was mainly the result of a lower balance of premium amortized related to mortgage loans purchased by PFH, mainly in years prior to 2006, due to reduced loan prepayments and to the direct impact of the maturity run-off of the purchased mortgage loan portfolio. In 2007, management continued its strategy to improve the net interest margin by not reinvesting maturities of securities; focusing on growing the commercial and consumer loan portfolio; and reducing the level of residential mortgage loans (mainly through a reduction of volume at PFH). These strategies assisted in increasing the yield on earning assets and reduced the Corporation’s dependence on wholesale funding, while the purchase of the Citibank retail network in Puerto Rico provided a more stable funding source. However, even though the Corporation showed improvement in its margin, the year 2007 presented various challenges: Internet- based deposits carry a higher rate than deposits from branches due to the competitive nature of this business channel, the liquidity crisis that took place in the second half of 2007 lead the Corporation to enter into certain financing agreements which may delay the expected benefit of reduced market interest rates, and competitive pressures that resulted in increases in the cost of interest bearing deposits, and that affected the volume and spreads of consumer and mortgage loans in the Puerto Rico subsidiaries. During 2006, the Federal Reserve (“FED”) raised the federal funds target rate 100 basis points, increasing this rate from 4.25% on December 31, 2005 to 5.25% by June 30, 2006 and remaining at that rate as of December 31, 2006. In 2007, the FED reduced the federal funds rate 50 basis points in September 2007, 25 basis points in October 2007 and 25 basis points in December 2007, reaching 4.25% at December 31, 2007. As a result of financial markets remaining under considerable stress, further credit tightening throughout 2007 for some businesses and households, the housing sector contracting and some labor markets softening, among other considerations, the FED announced these interest rate cuts in 2007. 20 The average key index rates for the years 2005 through 2007 were as follows: Prime rate Fed funds rate 3-month LIBOR 3-month Treasury Bill 10-year Treasury FNMA 30-year 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2006 2005 8 . 0 5 % 8 . 0 5 % 8 . 0 5 % 8 . 0 5 % 8 . 0 5 % 5 . 0 5 5 . 0 5 5 . 0 5 5 . 0 5 5 . 0 5 5 . 3 0 5 . 3 0 5 . 3 0 5 . 3 0 5 . 3 0 4 . 4 6 4 . 4 6 4 . 4 6 4 . 4 6 4 . 4 6 4 . 6 3 4 . 6 3 4 . 6 3 4 . 6 3 4 . 6 3 6 . 2 4 6 . 2 4 6 . 2 4 6 . 2 4 6 . 2 4 7.96% 4.96 5.20 4.84 4.79 6.32 6.19% 3.20 3.57 3.20 4.28 5.72 Table D presents the different components of the Corporation’s net interest income, on a taxable equivalent basis, for the year ended December 31, 2007, as compared with the same period in 2006, segregated by major categories of interest earning assets and interest bearing liabilities. The decrease in average earning assets for the year ended December 31, 2007, compared with the previous year, was principally due to the Corporation’s decision not to reinvest maturities of securities, mainly U.S. Government agencies, as well as selling low yielding mortgage loans in the second half of 2006. These strategies, in addition to the growth in the commercial and consumer loan portfolios and the reduction experienced in the Corporation’s U.S. subprime mortgage loan originations, contributed to a change in the mix of earning assets and funding sources. Refer to the Statement of Condition Analysis section of this MD&A for additional information on factors that contributed to the fluctuation in major earning assets categories. The Corporation’s funding sources also experienced a change in its mix, which contributed to the variance attributable to the change in volume shown in Table D. The decline in low yielding assets, an increase in the Corporation’s deposit base, and liquidity measures taken in the second half of 2007 in response to market disruptions, resulted in reduced levels of borrowed money. The E-LOAN Internet deposit gathering initiative, launched in the latter part of 2006, as well as increases in non-Internet certificates of deposit, including brokered CDs and money market accounts, coupled with the deposits derived from the acquisition of Citibank’s retail branches in Puerto Rico, contributed also to the reduction in borrowed money. The increase in the net interest margin for the year ended December 31, 2007, compared with the previous year, was partly attributed to the following factors: • The yield for commercial loans increased, when compared to 2006, in part due to a high proportion of these loans with floating rates. As of December 31, 2007, approximately 63% of the portfolio of commercial and construction loans had floating or adjustable interest rates. For the majority of 2007, rates remained higher than 2006. In addition, due to the timing of the rate resets, certain adjustable rate portfolios have not had the complete impact of the decrease in market rates that occurred in the last quarter of 2007. • The yield of residential mortgage loans increased, when compared to 2006, mainly as a result of a decrease in the premium amortization for secured mortgage loans due to a slowdown in the prepayment activity in the U.S. market, as well as the direct impact of the maturity run-off of the purchased mortgage portfolio. • The yield of consumer loans increased, when compared to 2006, mainly as a result of higher rates for the Puerto Rico consumer loan portfolio, and a higher volume and rate of credit cards. The yield of the credit card portfolio increased by 39 basis points. Partially offsetting the above mentioned favorable variances were the following negative impacts: • Increased cost of interest bearing deposits as a result of a higher proportion of Internet-based deposits raised through the E-LOAN platform and higher rates for money markets and time deposits. The overall increase in the Corporation’s cost of deposits was also affected by the lagged impact of the FED’s rate increase in 2006 and competitive pressures. • Higher cost of short-term borrowings primarily as a result of the tightening performed by the FED during 2006 and higher funding costs in response to the market disruptions in the second half of 2007. • Increase in the cost of long-term debt, in part due to secured debt with floating rates derived from on-balance sheet mortgage loan securitizations that were outstanding for most of the year prior the loan recharacterization transaction that took effect in late December 2007. • Unfavorable impact of mark-to-market adjustment related to derivative instruments that were associated with borrowed funds. The Corporation recognized $15.9 million in derivative losses for the year ended December 31, 2007, compared with derivative losses of $8.2 million in 2006, which are included as funding costs on borrowed funds. Most of these derivatives are economically hedging long- term debt. The decline in the fair value of the derivative instruments was influenced by disruptions in the financial markets during the third quarter of 2007 and the reduction in interest rates by the FED in the second half of 2007. As part of its asset / liability management strategies, the Corporation has entered into some activities with derivative financial instruments to protect its exposure to market risk. Refer to the Market Risk – Derivatives section of this MD&A and Note 30 to the audited consolidated financial statements for additional information regarding the Corporation’s involvement in derivative activities. 2007 Annual Report 21 2007 2007 Popular, Inc. 2007 2007 As shown in Table D, the decrease in net interest income on a taxable equivalent basis from 2005 to 2006 was mainly the result of a lower taxable equivalent adjustment and lower net interest margin, partially offset by an increase in average earning assets. The decrease in the net interest margin for the year ended December 31, 2006, compared with 2005, was partly attributed to a higher average cost of interest bearing liabilities, principally due to the tightening in monetary policy by the FED. During 2006, the FED raised the federal funds target rate from 4.25% on December 31, 2005 to 5.25% by June 30, 2006 and remaining at that rate as of December 31, 2006. Also, there was an increase in the cost of long-term debt resulting primarily from secured debt with floating rates derived from mortgage loan on-balance sheet securitization transactions by PFH and higher cost of interest bearing deposits. Partially offsetting these unfavorable variances were higher yields in commercial, mortgage and consumer loans. Contributors to the increase in loan yields for 2006 included the favorable impact of rising rates in collateralized mortgage obligations and commercial loans with floating rates, a decline in premium amortization on mortgage loans purchased due to a slowdown in the prepayment activity in the U.S. market, as well as a decrease in the amount of mortgage loans purchased as part of PFH’s operations. Also contributing to this variance were the impact of sales of low yielding mortgage loans during the third quarter of 2006 and maturities of low yielding securities during 2006, mainly agency securities. The decrease in the taxable equivalent adjustment from 2005 to 2006, as shown in Table D, was mainly the result of a higher cost of funds, partially offset by the increase in exempt interest income and a greater benefit derived from a higher statutory rate in 2006, when compared to 2005, as mentioned above. Puerto Rico tax law requires that an interest expense be assigned to the exempt interest income in order to calculate a net benefit. The interest expense is determined by applying the ratio of exempt assets to total assets to the Corporation’s total interest expense in Puerto Rico. To the extent that the cost of funds increases at a faster pace than the yield of earning assets, the net benefit will be reduced. The cost of funds increased in part due to the FED's tightening in monetary policy, which increased the federal funds target rate by 100 basis points during 2006. Average tax-exempt earning assets approximated $8.9 billion in 2007, of which 83% represented tax-exempt investment securities, compared with $9.7 billion and 87% in 2006, and $10.0 billion and 88% in 2005. Provision for Loan Losses Provision for Loan Losses Provision for Loan Losses Provision for Loan Losses Provision for Loan Losses The Corporation’s provision for loan losses for the year ended December 31, 2007 increased by $274.9 million, compared with 2006, and exceeded net charge-offs by $139.6 million. This increase was mainly attributed to higher net charge-offs by $193.4 million, mainly in the mortgage, consumer, and commercial loan portfolios, which reflect the continued credit problems in the U.S. mainland subprime mortgage market, as well as higher delinquencies in U.S. and Puerto Rico, due in part by the slowdown in the economy. Also, the increase reflects probable losses inherent in the loan portfolio, as a result of current economic conditions and deteriorating market trends, primarily in the mortgage and commercial loan sectors. The net charge-offs to average loans held-in-portfolio ratio deteriorated, increasing to 1.31% in 2007, from 0.74% in 2006 and 0.62% in 2005. The provision for loan losses for the year ended December 31, 2006 increased by $92.5 million, or 47%, and exceeded net- charge offs by $58 million compared with 2005. This increase was mainly attributed to the growth in the loan portfolio and higher net charge-offs, mainly in the consumer loan portfolio in Puerto Rico. Also, the increase reflected probable losses inherent in the loan portfolio as a result of economic conditions and deteriorating market trends in 2006, primarily in the subprime mortgage loan sectors and in the commercial portfolio, evidenced by an increase in non-performing assets from 2005 to 2006. Refer to the Credit Risk Management and Loan Quality section for a detailed analysis of non-performing assets, allowance for loan losses and selected loan losses statistics. Also, refer to Table G and Note 9 to the consolidated financial statements for the composition of the loan portfolio. N o n - I n t e r e s t I n c o m e N o n - I n t e r e s t I n c o m e N o n - I n t e r e s t I n c o m e N o n - I n t e r e s t I n c o m e N o n - I n t e r e s t I n c o m e Refer to Table E for a breakdown on non-interest income by major categories for the past five years. Non-interest income accounted for 32% of total revenues in 2007, while it represented 36% of total revenues in the years 2006 and 2005. Non-interest income for the year ended December 31, 2007, compared with the previous year, was mostly impacted by: • Higher other service fees, which are detailed by category in Table E. (cid:132) The favorable variance in credit card fees was due to higher merchant fees resulting from higher volume of purchases and late payment fees due to greater volume of credit card accounts billed at a higher average rate pursuant to a change in contract terms. (cid:132) The increase in debit card fees was mostly due to the change in the automatic teller machines’ interchange fees from a fixed rate to a variable rate, as well as higher transactional volume. Also, the increase is associated to higher surcharge revenues from non-BPPR users of the ATM terminals. (cid:132) The increase in mortgage servicing fees was related to higher servicing fees due to the growth in the portfolio of loans serviced for others, which rose by approximately 22 T a b l e D T a b l e D T a b l e D T a b l e D T a b l e D Net Interest Income - Taxable Equivalent Basis (Dollars in millions) Year ended December 31, Average Volume 2006 Variance 2007 2007 2007 2007 2007 Average Yields / Costs 2007 2007 2007 2007 2007 2006 Variance 5 . 1 7 % 5 . 1 7 % 5 . 1 7 % 5.56% 5 . 1 7 % 5 . 1 7 % (0.39%) Money market investments $514 $514 $514 $514 $514 9 , 8 5 4 9 , 8 5 4 9 , 8 5 4 9 , 8 5 4 9 , 8 5 4 6 7 26 7 26 7 26 7 26 7 2 $564 11,774 513 ($50) (1,920) 159 1 1 , 0 4 0 1 1 , 0 4 0 1 1 , 0 4 0 1 1 , 0 4 0 1 1 , 0 4 0 12,851 (1,811) 1 5 , 0 8 2 1 5 , 0 8 2 1 5 , 0 8 2 1 5 , 0 8 2 1 5 , 0 8 2 1 , 1 7 8 1 , 1 7 8 1 , 1 7 8 1 , 1 7 8 1 , 1 7 8 1 0 , 9 5 4 1 0 , 9 5 4 1 0 , 9 5 4 1 0 , 9 5 4 1 0 , 9 5 4 5 , 5 3 6 5 , 5 3 6 5 , 5 3 6 5 , 5 3 6 5 , 5 3 6 3 2 , 7 5 0 3 2 , 7 5 0 3 2 , 7 5 0 3 2 , 7 5 0 3 2 , 7 5 0 13,613 1,283 12,113 5,070 32,079 1,469 (105) (1,159) 466 671 5 . 1 9 5 . 1 9 5 . 1 9 5 . 1 9 5 . 1 9 6 . 4 4 6 . 4 4 6 . 4 4 6 . 4 4 6 . 4 4 5 . 2 6 5 . 2 6 5 . 2 6 5 . 2 6 5 . 2 6 7 . 7 2 7 . 7 2 7 . 7 2 7 . 7 2 7 . 7 2 7 . 8 9 7 . 8 9 7 . 8 9 7 . 8 9 7 . 8 9 7 . 1 2 7 . 1 2 7 . 1 2 7 . 1 2 7 . 1 2 1 0 . 8 2 1 0 . 8 2 1 0 . 8 2 1 0 . 8 2 1 0 . 8 2 8 . 0 5 8 . 0 5 8 . 0 5 8 . 0 5 8 . 0 5 5.14 6.63 5.22 7.63 7.57 6.93 10.53 7.82 0.05 (0.19) 0.04 0.09 0.32 0.19 0.29 0.23 Investment securities Trading securities Loans: (In thousands) Interest Variance Attributable to 2007 2007 2007 2007 2007 2006 Variance Rate Volume $ 2 6 , 5 6 5 $ 2 6 , 5 6 5 $ 2 6 , 5 6 5 $ 2 6 , 5 6 5 $ 2 6 , 5 6 5 5 1 1 , 2 0 8 5 1 1 , 2 0 8 5 1 1 , 2 0 8 5 1 1 , 2 0 8 5 1 1 , 2 0 8 4 3 , 3 0 6 4 3 , 3 0 6 4 3 , 3 0 6 4 3 , 3 0 6 4 3 , 3 0 6 $31,382 605,588 34,004 ($4,817) ($1,824) ($2,993) (94,380) 5,061 (99,441) 9,302 (992) 10,294 5 8 1 , 0 7 9 5 8 1 , 0 7 9 5 8 1 , 0 7 9 5 8 1 , 0 7 9 5 8 1 , 0 7 9 670,974 (89,895) 2,245 (92,140) 1 , 1 6 4 , 9 1 8 1 , 1 6 4 , 9 1 8 1 , 1 6 4 , 9 1 8 Commercial and construction 1 , 1 6 4 , 9 1 8 1 , 1 6 4 , 9 1 8 1,038,497 126,421 11,693 114,728 Leasing Mortgage Consumer 9 2 , 9 4 0 9 2 , 9 4 0 9 2 , 9 4 0 9 2 , 9 4 0 9 2 , 9 4 0 7 8 0 , 0 1 2 7 8 0 , 0 1 2 7 8 0 , 0 1 2 7 8 0 , 0 1 2 7 8 0 , 0 1 2 5 9 9 , 0 8 5 5 9 9 , 0 8 5 5 9 9 , 0 8 5 5 9 9 , 0 8 5 5 9 9 , 0 8 5 97,166 839,515 533,692 (4,226) 3,950 (8,176) (59,503) 22,472 (81,975) 65,393 9,047 47,162 56,346 80,923 2 , 6 3 6 , 9 5 5 2 , 6 3 6 , 9 5 5 2 , 6 3 6 , 9 5 5 2 , 6 3 6 , 9 5 5 2 , 6 3 6 , 9 5 5 2,508,870 128,085 $ 4 3 , 7 9 0 $ 4 3 , 7 9 0 $ 4 3 , 7 9 0 $ 4 3 , 7 9 0 $ 4 3 , 7 9 0 $44,930 ($1,140) 7 . 3 5 % 7 . 3 5 % 7 . 3 5 % 7.08% 7 . 3 5 % 7 . 3 5 % 0.27% Total earning assets Interest bearing deposits: $ 3 , 2 1 8 , 0 3 4 $ 3 , 2 1 8 , 0 3 4 $ 3 , 2 1 8 , 0 3 4 $3,179,844 $ 3 , 2 1 8 , 0 3 4 $ 3 , 2 1 8 , 0 3 4 $38,190 $49,407 ($11,217) $ 4 , 4 2 9 $ 4 , 4 2 9 $ 4 , 4 2 9 $ 4 , 4 2 9 $ 4 , 4 2 9 5 , 6 9 8 5 , 6 9 8 5 , 6 9 8 5 , 6 9 8 5 , 6 9 8 1 1 , 3 9 9 1 1 , 3 9 9 1 1 , 3 9 9 1 1 , 3 9 9 1 1 , 3 9 9 2 1 , 5 2 6 2 1 , 5 2 6 2 1 , 5 2 6 2 1 , 5 2 6 2 1 , 5 2 6 8 , 6 8 5 8 , 6 8 5 8 , 6 8 5 8 , 6 8 5 8 , 6 8 5 8 , 1 8 1 8 , 1 8 1 8 , 1 8 1 8 , 1 8 1 8 , 1 8 1 $3,878 5,440 9,977 19,295 10,677 9,868 $551 258 1,422 2,231 (1,992) (1,687) 2 . 6 0 % 2 . 6 0 % 2 . 6 0 % 2.06% 2 . 6 0 % 2 . 6 0 % 0.54% NOW and money market* $ 1 1 5 , 0 4 7 $ 1 1 5 , 0 4 7 $ 1 1 5 , 0 4 7 $ 1 1 5 , 0 4 7 $ 1 1 5 , 0 4 7 $79,820 $35,227 $17,963 $17,264 1 . 9 6 1 . 9 6 1 . 9 6 1 . 9 6 1 . 9 6 4 . 7 3 4 . 7 3 4 . 7 3 4 . 7 3 4 . 7 3 3 . 5 6 3 . 5 6 3 . 5 6 3 . 5 6 3 . 5 6 5 . 1 6 5 . 1 6 5 . 1 6 5 . 1 6 5 . 1 6 5 . 6 8 5 . 6 8 5 . 6 8 5 . 6 8 5 . 6 8 1.43 4.24 3.01 4.86 5.45 0.53 0.49 0.55 0.30 0.23 Savings Time deposits Short-term borrowings Medium and long-term debt Total interest bearing 1 1 1 , 8 7 7 1 1 1 , 8 7 7 1 1 1 , 8 7 7 1 1 1 , 8 7 7 1 1 1 , 8 7 7 77,611 34,266 5 3 8 , 8 6 9 5 3 8 , 8 6 9 5 3 8 , 8 6 9 5 3 8 , 8 6 9 5 3 8 , 8 6 9 422,663 116,206 7 6 5 , 7 9 3 7 6 5 , 7 9 3 7 6 5 , 7 9 3 7 6 5 , 7 9 3 7 6 5 , 7 9 3 4 4 8 , 1 7 2 4 4 8 , 1 7 2 4 4 8 , 1 7 2 4 4 8 , 1 7 2 4 4 8 , 1 7 2 4 6 4 , 8 1 6 4 6 4 , 8 1 6 4 6 4 , 8 1 6 4 6 4 , 8 1 6 4 6 4 , 8 1 6 580,094 518,960 537,477 185,699 (70,788) (72,661) 4,513 46,221 68,697 30,623 19,458 29,753 69,985 117,002 (101,411) (92,119) 3 8 , 3 9 2 3 8 , 3 9 2 3 8 , 3 9 2 3 8 , 3 9 2 3 8 , 3 9 2 39,840 (1,448) 4 . 3 7 4 . 3 7 4 . 3 7 4 . 3 7 4 . 3 7 4.11 0.26 liabilities 1 , 6 7 8 , 7 8 1 1 , 6 7 8 , 7 8 1 1 , 6 7 8 , 7 8 1 1 , 6 7 8 , 7 8 1 1 , 6 7 8 , 7 8 1 1,636,531 42,250 118,778 (76,528) 4 , 0 4 3 4 , 0 4 3 4 , 0 4 3 4 , 0 4 3 4 , 0 4 3 1 , 3 5 5 1 , 3 5 5 1 , 3 5 5 1 , 3 5 5 1 , 3 5 5 3,970 1,120 73 235 $ 4 3 , 7 9 0 $ 4 3 , 7 9 0 $ 4 3 , 7 9 0 $ 4 3 , 7 9 0 $ 4 3 , 7 9 0 $44,930 ($1,140) 3 . 8 3 % 3 . 8 3 % 3 . 8 3 % 3.64% 3 . 8 3 % 3 . 8 3 % 3 . 5 2 % 3 . 5 2 % 3 . 5 2 % 3.44% 3 . 5 2 % 3 . 5 2 % 0.19% 0.08% Non-interest bearing demand deposits Other sources of funds Net interest margin Net interest income on 2 . 9 8 % 2 . 9 8 % 2 . 9 8 % 2.97% 2 . 9 8 % 2 . 9 8 % 0.01% Net interest spread a taxable equivalent basis 1 , 5 3 9 , 2 5 3 1 , 5 3 9 , 2 5 3 1 , 5 3 9 , 2 5 3 1 , 5 3 9 , 2 5 3 1 , 5 3 9 , 2 5 3 1,543,313 (4,060) ($69,371) $65,311 Taxable equivalent adjustment 8 9 , 8 6 3 8 9 , 8 6 3 8 9 , 8 6 3 8 9 , 8 6 3 8 9 , 8 6 3 115,403 (25,540) Net interest income $ 1 , 4 4 9 , 3 9 0 $ 1 , 4 4 9 , 3 9 0 $ 1 , 4 4 9 , 3 9 0 $1,427,910 $ 1 , 4 4 9 , 3 9 0 $ 1 , 4 4 9 , 3 9 0 $21,480 Notes: The changes that are not due solely to volume or rate are allocated to volume and rate based on the proportion of the change in each category. *Includes interest bearing demand deposits corresponding to certain government entities in Puerto Rico. $7.2 billion from December 31, 2006 to December 31, 2007 as well as, higher late payment fees derived from the serviced portfolio as a result of increased delinquencies primarily associated with the U.S. mainland. Also, the positive variance was impacted by the adoption of SFAS No. 156, in which the Corporation elected fair value measurement and, as a result, the residential mortgage servicing rights are no longer amortized in proportion to and over the period of estimated net servicing income. Refer to Note 22 to the consolidated financial statements for detailed information on the adoption of SFAS No. 156. Any fair value adjustment of MSRs is recorded in “other service fees” in the consolidated statements of operations together with 2007 Annual Report 23 2007 2007 Popular, Inc. 2007 2007 (In thousands) Interest Variance Attributable to 2006 2005 Variance Rate Volume $31,382 605,588 34,004 $33,319 ($1,937) $8,592 ($10,529) 591,089 14,499 38,049 (23,550) 32,427 1,577 (123) 1,700 670,974 656,835 14,139 46,518 (32,379) Average Volume 2005 Variance Average Yields / Costs 2005 2006 Variance (Dollars in millions) 2006 $564 11,774 513 12,851 13,613 1,283 12,113 5,070 32,079 $797 12,230 488 13,515 11,815 1,303 12,238 4,375 29,731 $44,930 $43,246 $3,878 5,440 9,977 19,295 10,677 9,868 $3,732 5,677 8,776 18,185 10,327 9,764 ($233) (456) 25 (664) 1,798 (20) (125) 695 2,348 $1,684 $146 (237) 1,201 1,110 350 104 5.56% 4.18% 1.38% Money market investments 5.14 6.63 5.22 7.63 7.57 6.93 10.53 7.82 4.83 6.65 4.86 6.73 7.57 6.53 10.12 7.18 0.31 (0.02) 0.36 0.90 - 0.40 0.41 0.64 Investment securities Trading securities Loans: Leasing Mortgage Consumer 7.08% 6.46% 0.62% Total earning assets Interest bearing deposits: Commercial and construction 1,038,497 794,899 243,598 113,981 129,617 97,166 839,515 533,692 98,618 (1,452) 799,332 442,662 40,183 91,030 60 48,421 16,012 (1,512) (8,238) 75,018 2,508,870 2,135,511 373,359 178,474 194,885 $3,179,844 $2,792,346 $387,498 $224,992 $162,506 2.06% 1.49% 0.57% NOW and money market* $79,820 $55,645 $24,175 $20,257 $3,918 1.43 4.24 3.01 4.86 5.45 1.23 3.48 2.37 3.38 4.73 0.20 0.76 0.64 1.48 0.72 Savings Time deposits Short-term borrowings Medium and long-term debt Total interest bearing 77,611 422,663 580,094 518,960 537,477 69,940 7,671 305,228 117,435 430,813 349,203 149,281 169,757 9,953 72,341 102,551 162,016 461,636 75,841 73,812 (2,282) 45,094 46,730 7,741 2,029 39,840 38,276 1,564 4.11 3.24 0.87 liabilities 1,636,531 1,241,652 394,879 338,379 56,500 3,970 1,120 4,069 901 (99) 219 $44,930 $43,246 $1,684 3.64% 3.44% 2.87% 3.59% 0.77% (0.15%) Non-interest bearing demand deposits Other sources of funds Net interest margin Net interest income on 2.97% 3.22% (0.25%) Net interest spread a taxable equivalent basis 1,543,313 1,550,694 (7,381) ($113,387) $106,006 Taxable equivalent adjustment 115,403 126,487 (11,084) Net interest income $1,427,910 $1,424,207 $3,703 the loan servicing fees charged to third-parties on the serviced portfolio. These favorable variances were partially offset by lower prepayment fees on loans serviced due to a slowdown in prepayments. (cid:132) Other fees decreased mainly as a result of lower brokered loan fees on services provided to mortgage brokers on the origination of loans for their portfolio. This reduction in servicing fees was a result of the discontinuation of PFH’s broker-origination channel as part of the PFH Restructuring Plan. • Favorable variance in the net gain on sale and valuation adjustments of investment securities, which consisted of: 24 (In thousands) Net gain on sale of investment securities Valuation adjustments of investment securities Total Year ended December 31, 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2006 $ Variance $ 1 2 0 , 3 2 8 $ 1 2 0 , 3 2 8 $ 1 2 0 , 3 2 8 $ 1 2 0 , 3 2 8 $ 1 2 0 , 3 2 8 $22,233 $98,095 • Unfavorable variance in gain on sales of loans and negative adjustments in the valuation of loans held-for-sale, particularly mortgage loans, were as follows: ( 6 5 , 1 6 9 ) ( 6 5 , 1 6 9 ) ( 6 5 , 1 6 9 ) ( 6 5 , 1 6 9 ) ( 6 5 , 1 6 9 ) $ 5 5 , 1 5 9 $ 5 5 , 1 5 9 $ 5 5 , 1 5 9 $ 5 5 , 1 5 9 $ 5 5 , 1 5 9 (17,874) $4,359 (47,295) $50,800 (In thousands) Year ended December 31, 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2006 $ Variance The favorable variance in the net gain on sale of investment securities for the year ended December 31, 2007, compared with the same period in 2006, was mainly due to $118.7 million in gains from the sale of the Corporation ’s interest in Telecomunicaciones de Puerto Rico, Inc. (“TELPRI”) during the first quarter of 2007. The gain on sale of investment securities in 2006 included gains of $13.6 million from the sale of marketable equity securities and FNMA securities. The unfavorable variance in valuation adjustments of investment securities, considered other-than-temporary, included a negative valuation adjustment of $45.4 million in PFH’s residual interests classified as available-for-sale and $19.5 million in certain equity securities for 2007. During 2006, the negative valuation adjustments were mostly associated to $17.8 million of PFH’s residual interests. For information on the conditions that impacted PFH’s residual interests during 2007 and 2006, refer to the Critical Accounting Policies / Estimates section of this MD&A. • Unfavorable variance in trading account (loss) profit, which consisted of: (In thousands) Mark-to-market of PFH'S residual interests Other trading account profit Total Year ended December 31, 2006 $ Variance 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 ( $ 3 9 , 6 6 1 ) ( $ 3 9 , 6 6 1 ) ( $ 3 9 , 6 6 1 ) ( $ 3 9 , 6 6 1 ) ( $ 3 9 , 6 6 1 ) ($971) ($38,690) 3 7 , 1 9 7 3 7 , 1 9 7 3 7 , 1 9 7 3 7 , 1 9 7 3 7 , 1 9 7 ( $ 2 , 4 6 4 ) ( $ 2 , 4 6 4 ) ( $ 2 , 4 6 4 ) ( $ 2 , 4 6 4 ) ( $ 2 , 4 6 4 ) 938 36,259 $35,288 ($37,752) PFH’s residual interests classified as trading securities were also unfavorably impacted by credit and market events in the U.S. subprime market during 2007 as described previously in this MD&A. Loss on sale of loans related to loan recharacterization by PFH ( $ 9 0 , 1 4 4 ) ( $ 9 0 , 1 4 4 ) ( $ 9 0 , 1 4 4 ) ( $ 9 0 , 1 4 4 ) ( $ 9 0 , 1 4 4 ) - ($90,144) Gain on sales of loans, excluding loan recharacterization Lower of cost or market valuation adjustment on loans held-for-sale Total 7 6 , 5 6 4 7 6 , 5 6 4 7 6 , 5 6 4 7 6 , 5 6 4 7 6 , 5 6 4 $117,421 (40,857) ( 2 5 , 3 9 0 ) ( 2 5 , 3 9 0 ) ( 2 5 , 3 9 0 ) ( 2 5 , 3 9 0 ) ( 2 5 , 3 9 0 ) ( $ 3 8 , 9 7 0 ) ( $ 3 8 , 9 7 0 ) ( $ 3 8 , 9 7 0 ) ( $ 3 8 , 9 7 0 ) ( $ 3 8 , 9 7 0 ) - (25,390) $117,421 ($156,391) The negative variance associated to the loss on the loan recharacterization transaction by PFH was explained in the Significant U.S. Strategic Events section of this MD&A. Excluding the PFH loan recharacterization transaction, the decrease in gain on sales of loans for 2007, compared to 2006, was principally due to lower volume of loans originated at PFH due to exiting the wholesale subprime mortgage business, coupled with lower origination volume at E-LOAN due to market conditions and the lack of liquidity in the private secondary markets. There were also lower gains on sale of SBA loans by the Corporation’s U.S. banking subsidiary. The decrease was partially offset by the fact that during 2006, BPPR realized a $20.1 million loss on the bulk sale of mortgage loans, and there were no similar losses during 2007. The unfavorable lower of cost or market valuation adjustment on loans held-for-sale resulted principally from the deterioration in the U.S. subprime mortgage market and lack of liquidity in the private secondary markets experienced during the second half of 2007, which negatively impacted price margins, coupled with credit deterioration. For the year ended December 31, 2006, non-interest income increased $24.2 million, or 3%, compared with 2005. There were higher gains on sale of loans by $34.1 million mainly due to E- LOAN’s production, as this subsidiary was acquired in the fourth quarter of 2005, partially offset by losses in the Puerto Rico operations that resulted from the bulk sale of approximately $0.6 billion of mortgage loans to a U.S. financial institution during 2006 and lower sales volumes and price margins due to the slowdown in the housing market. Other operating income rose by $34.9 million during 2006, when compared to the previous year, due to higher revenues from E-LOAN related in part to mortgage loan closing services and business referral fees, higher dividend income derived from the Corporation’s investment in TELPRI, higher income derived from securitization related invested funds, 2007 Annual Report 25 2007 2007 Popular, Inc. 2007 2007 T a b l e E T a b l e E T a b l e E T a b l e E T a b l e E Non-Interest Income (Dollars in thousands) 2007 2007 2007 2007 2007 2006 2005 2004 2003 Five-Year C.G.R.* Service charges on deposit accounts $ 1 9 6 , 0 7 2 $ 1 9 6 , 0 7 2 $ 1 9 6 , 0 7 2 $ 1 9 6 , 0 7 2 $ 1 9 6 , 0 7 2 $190,079 $181,749 $165,241 $161,839 4.45% Year ended December 31, Other service fees: Credit card fees and discounts Debit card fees Insurance fees Processing fees Sale and administration of 1 0 2 , 1 7 6 1 0 2 , 1 7 6 1 0 2 , 1 7 6 1 0 2 , 1 7 6 1 0 2 , 1 7 6 7 6 , 5 7 3 7 6 , 5 7 3 7 6 , 5 7 3 7 6 , 5 7 3 7 6 , 5 7 3 5 5 , 8 2 4 5 5 , 8 2 4 5 5 , 8 2 4 5 5 , 8 2 4 5 5 , 8 2 4 4 7 , 4 7 6 4 7 , 4 7 6 4 7 , 4 7 6 4 7 , 4 7 6 4 7 , 4 7 6 89,827 61,643 53,889 44,050 82,062 52,675 50,734 42,773 69,702 51,256 38,924 40,169 60,432 45,811 29,855 40,003 11.53 12.52 18.02 5.37 investment products 3 0 , 4 5 3 3 0 , 4 5 3 3 0 , 4 5 3 3 0 , 4 5 3 3 0 , 4 5 3 27,873 28,419 22,386 21,174 7.12 Mortgage servicing fees, net of amortization and fair value adjustments Trust fees Check cashing fees Other fees 1 1 , 7 0 8 1 1 , 7 0 8 1 1 , 7 0 8 1 1 , 7 0 8 1 1 , 7 0 8 1 1 , 1 5 7 1 1 , 1 5 7 1 1 , 1 5 7 1 1 , 1 5 7 1 1 , 1 5 7 3 8 73 8 73 8 73 8 73 8 7 2 7 , 5 0 3 2 7 , 5 0 3 2 7 , 5 0 3 2 7 , 5 0 3 2 7 , 5 0 3 (2,750) 9,316 737 36,290 6,226 8,290 17,122 43,200 7,412 8,872 21,680 35,150 6,853 7,830 24,420 48,014 Total other service fees 3 6 3 , 2 5 7 3 6 3 , 2 5 7 3 6 3 , 2 5 7 3 6 3 , 2 5 7 3 6 3 , 2 5 7 320,875 331,501 295,551 284,392 (0.36) 4.23 (55.07) (6.99) 6.45 Net gain on sale and valuation adjustments of investment securities Trading account (loss) profit (Loss) gain on sale of loans and valuation adjustments on loans held-for-sale Other operating income Total non-interest income * C.G.R. refers to compound growth rate. 5 5 , 1 5 9 5 5 , 1 5 9 5 5 , 1 5 9 5 5 , 1 5 9 5 5 , 1 5 9 ( 2 , 4 6 4 ) ( 2 , 4 6 4 ) ( 2 , 4 6 4 ) ( 2 , 4 6 4 ) ( 2 , 4 6 4 ) 4,359 35,288 52,113 30,051 15,254 (159) 71,094 (10,214) - 25.11 ( 3 8 , 9 7 0 ) ( 3 8 , 9 7 0 ) ( 3 8 , 9 7 0 ) ( 3 8 , 9 7 0 ) ( 3 8 , 9 7 0 ) 1 2 1 , 2 6 2 1 2 1 , 2 6 2 1 2 1 , 2 6 2 1 2 1 , 2 6 2 1 2 1 , 2 6 2 117,421 141,463 83,297 106,564 44,168 88,716 53,572 65,327 - 10.89 $ 6 9 4 , 3 1 6 $ 6 9 4 , 3 1 6 $ 6 9 4 , 3 1 6 $ 6 9 4 , 3 1 6 $ 6 9 4 , 3 1 6 $809,485 $785,275 $608,771 $626,010 5.01% and higher revenues from services on the structuring of bond issues, among others. These favorable variances were partially offset by a decrease of $47.8 million in net gains on sale and unfavorable valuation adjustments of other-than-temporary impairments of investment securities available-for-sale, principally residual interests of PFH. Additionally, there were lower check cashing fees and other fees as a result of the lack of revenue originally produced by the Corporation’s check cashing operations in the U.S., which were sold during the fourth quarter of 2005. 26 Operating Expenses Operating Expenses Operating Expenses Operating Expenses Operating Expenses Refer to Table F for the detail of operating expenses by major categories along with various related ratios for the last five years. Operating expenses totaled $1.7 billion for the year ended December 31, 2007, an increase of $219.5 million, or 15%, compared with the same period in 2006. Included in operating expenses for 2007 are approximately $248.5 million in impairment charges and costs associated to the PFH Restructuring Plan, E- LOAN Restructuring Plan and PFH Branch Network Restructuring Plan described previously in this MD&A. In 2006, there were $21.4 million in impairment charges associated with the PFH Restructuring Plan. The table below segregates these 2007 costs by categories within operating expenses. PFH E-LOAN PFH Branch Restructuring Restructuring Network Restructuring (in millions) Plan Plan Plan Total - - - - - $4.6 $7.8 $14.7 $12.4 4.5 0.3 1.8 0.3 4.2 0.4 0.4 - 8.7 0.7 2.2 0.3 Personnel costs (1) Net occupancy expenses (2) Equipment expenses Professional fees (3) Other operating expenses Total restructuring expenses Impairment of long-lived assets (4) Impairment of trademark and goodwill (5) Total restructuring and impairment charges (1) Severance, stay bonuses, related taxes and other employee benefits (2) Lease terminations (3) Outplacement services and professional services contract termination (4) Impairment of leasehold improvements, equipment and intangible assets with definitive lives (5) Goodwill impairment of $164.4 million and trademark impairment of $47.4 million $248.5 $231.9 $24.3 211.8 211.8 $14.7 12.4 10.5 $9.6 $1.9 1.9 - - - - Isolating the impact of the different charges associated to the restructuring plans named above, operating expenses increased (decreased) from 2006 to 2007 as follows: (in millions) 2007 Charges 2007, excluding related to charges related to excluding restructuring impairment plans restructuring plans 2006, charges Variance $12.4 8.7 0.7 - 2.2 - - - $655.8 114.9 126.8 50.1 147.7 66.9 115.4 17.4 $668.7 116.7 135.9 44.5 141.5 68.3 130.0 17.7 $668.2 123.6 127.5 50.1 149.9 66.9 115.4 17.4 ($12.9) (1.8) (9.1) 5.6 6.2 (1.4) (14.6) (0.3) Personnel costs Net occupancy expenses Equipment expenses Other taxes Professional fees Communications Business promotion Printing and supplies Impairment losses on long-lived assets (1) Other operating expenses Impact of change in fiscal period Goodwill and trademark - impairment losses (1) (2.0) Amortization of intangibles Total ($7.4) (1) For comparative purposes, this table excludes $7.2 million in impairment of long-lived assets and $14.2 million in goodwill impairment losses taken in 2006 that were associated to the PFH Restructuring Plan. - 12.4 $1,463.5 211.8 10.4 $1,704.6 - 10.4 $1,456.1 211.8 - $248.5 (0.1) 150.8 12.3 151.1 - 118.1 (0.1) 32.7 12.4 0.3 (9.7) 9.7 - - - Excluding the severance costs associated with the restructuring plans, the decrease in personnel costs for 2007, compared to 2006, was principally the result of lower headcount resulting from the PFH Restructuring Plan which took effect in early 2007. The PFH reportable segment’s personnel expenses, excluding $7.8 million related to the PFH Restructuring Plan, decreased by $37.1 million during 2007, compared to the previous year. PFH was impacted by a reduction in headcount as described below. The reduction in the PFH reportable segment’s personnel costs was partly offset by increases in the Corporation’s other reportable segments, including the Puerto Rico and U.S. mainland operations. These increases were mostly associated to the impact of merit increases across the Corporation’s subsidiaries, increased headcount, higher commissions on certain businesses, medical insurance costs and savings plan expenses, among other factors, coupled with lower cost deferrals due to a lower volume of loan originations. At December 31, 2007, the Corporation’s full-time equivalent employees (“FTEs”) were 12,303, compared with 12,508 at December 31, 2006. Other operating expenses categories reflecting greater variances in 2007 compared to 2006, excluding the impact of the restructuring plans, are described below. • Equipment expenses declined mostly as a result of lower electronic equipment depreciation, maintenance and repair 2007 Annual Report 27 2007 2007 Popular, Inc. 2007 2007 T a b l e F T a b l e F T a b l e F T a b l e F T a b l e F Operating Expenses (Dollars in thousands) 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2006 2005 2004 2003 Salaries $ 5 1 9 , 5 2 3 $ 5 1 9 , 5 2 3 $ 5 1 9 , 5 2 3 $ 5 1 9 , 5 2 3 $ 5 1 9 , 5 2 3 Pension, profit sharing and other benefits 1 4 8 , 6 6 6 1 4 8 , 6 6 6 1 4 8 , 6 6 6 1 4 8 , 6 6 6 1 4 8 , 6 6 6 $517,178 151,493 $474,636 148,053 $427,870 143,148 $388,527 137,917 Year ended December 31, Total personnel costs Net occupancy expenses Equipment expenses Other taxes Professional fees Communications Business promotion Printing and supplies Impairment losses on long-lived assets Other operating expenses: Credit card processing, volume and interchange expenses Transportation and travel All other* Goodwill and trademark impairment losses Amortization of intangibles Subtotal Total 6 6 8 , 1 8 9 6 6 8 , 1 8 9 6 6 8 , 1 8 9 6 6 8 , 1 8 9 6 6 8 , 1 8 9 1 2 3 , 6 2 1 1 2 3 , 6 2 1 1 2 3 , 6 2 1 1 2 3 , 6 2 1 1 2 3 , 6 2 1 1 2 7 , 4 7 2 1 2 7 , 4 7 2 1 2 7 , 4 7 2 1 2 7 , 4 7 2 1 2 7 , 4 7 2 5 0 , 1 1 1 5 0 , 1 1 1 5 0 , 1 1 1 5 0 , 1 1 1 5 0 , 1 1 1 1 4 9 , 8 5 4 1 4 9 , 8 5 4 1 4 9 , 8 5 4 1 4 9 , 8 5 4 1 4 9 , 8 5 4 6 6 , 8 7 7 6 6 , 8 7 7 6 6 , 8 7 7 6 6 , 8 7 7 6 6 , 8 7 7 1 1 5 , 3 8 8 1 1 5 , 3 8 8 1 1 5 , 3 8 8 1 1 5 , 3 8 8 1 1 5 , 3 8 8 1 7 , 4 3 8 1 7 , 4 3 8 1 7 , 4 3 8 1 7 , 4 3 8 1 7 , 4 3 8 1 2 , 3 4 4 1 2 , 3 4 4 1 2 , 3 4 4 1 2 , 3 4 4 1 2 , 3 4 4 4 1 , 6 9 5 4 1 , 6 9 5 4 1 , 6 9 5 4 1 , 6 9 5 4 1 , 6 9 5 1 6 , 1 4 2 1 6 , 1 4 2 1 6 , 1 4 2 1 6 , 1 4 2 1 6 , 1 4 2 9 3 , 2 2 5 9 3 , 2 2 5 9 3 , 2 2 5 9 3 , 2 2 5 9 3 , 2 2 5 2 1 1 , 7 5 0 2 1 1 , 7 5 0 2 1 1 , 7 5 0 2 1 1 , 7 5 0 2 1 1 , 7 5 0 1 0 , 4 4 5 1 0 , 4 4 5 1 0 , 4 4 5 1 0 , 4 4 5 1 0 , 4 4 5 1 , 0 3 6 , 3 6 2 1 , 0 3 6 , 3 6 2 1 , 0 3 6 , 3 6 2 1 , 0 3 6 , 3 6 2 1 , 0 3 6 , 3 6 2 668,671 116,742 135,877 44,543 141,534 68,283 129,965 17,741 7,232 30,707 18,064 79,098 14,239 12,377 816,402 622,689 108,386 124,276 39,197 119,281 63,395 100,434 18,378 - 29,700 19,426 73,459 - 9,579 571,018 89,821 108,823 40,260 95,084 60,965 75,708 17,938 - 26,965 14,968 61,618 - 7,844 526,444 83,630 104,821 37,904 82,325 58,038 73,277 19,111 - 23,869 13,811 82,009 - 7,844 705,511 599,994 586,639 Five-Year C.G.R. 7.50% 3.24 6.45 9.51 5.16 6.17 12.10 4.41 13.43 (2.63) - 18.25 3.04 7.62 - 2.79 13.92 $ 1 , 7 0 4 , 5 5 1 $ 1 , 7 0 4 , 5 5 1 $ 1 , 7 0 4 , 5 5 1 $ 1 , 7 0 4 , 5 5 1 $ 1 , 7 0 4 , 5 5 1 $1,485,073 $1,328,200 $1,171,012 $1,113,083 10.62% Efficiency ratio** Personnel costs to average assets Operating expenses to average assets Employees (full-time equivalent) Assets per employee (in millions) 8 1 . 9 9 % 8 1 . 9 9 % 8 1 . 9 9 % 8 1 . 9 9 % 8 1 . 9 9 % 1 . 4 2 1 . 4 2 1 . 4 2 1 . 4 2 1 . 4 2 3 . 6 2 3 . 6 2 3 . 6 2 3 . 6 2 3 . 6 2 1 2 , 3 0 3 1 2 , 3 0 3 1 2 , 3 0 3 1 2 , 3 0 3 1 2 , 3 0 3 $ 3 . 6 1 $ 3 . 6 1 $ 3 . 6 1 $ 3 . 6 1 $ 3 . 6 1 67.16% 1.38 3.08 12,508 $3.79 62.30% 1.34 2.86 13,210 $3.68 59.86% 1.43 2.94 12,139 $3.66 60.51% 1.52 3.21 11,474 $3.18 * Includes insurance, sundry losses, FDIC assessment and other real estate expenses, among others. ** Non-interest expense divided by net interest income plus recurring non-interest income. expenses, and software package amortization, as well as lower equipment requirements due to the streamlining of PFH’s operations. • Other taxes increased mainly associated to higher municipal license taxes, personal property taxes, examination banking fees and the new sales tax implemented in Puerto Rico in the later part of 2006. • Professional fees also increased principally due to higher business strategy consulting, computer service fees, credit collection, imaging services and programming services, among others. • Business promotion expenses experienced a reduction mainly as a result of cost control measures on marketing expenditures on the U.S. mainland operations, primarily at E-LOAN, and lower expenditures at PFH due to the streamlining of operations in 2007. These reductions were partially offset by higher costs related to the loyalty reward program in the Puerto Rico operations. • Other operating expenses rose primarily as a result of higher other real estate expenses associated with the increased administrative and foreclosure costs resulting from a higher number of repossessed units and additional write downs in the collateral value of repossessed real estate properties in the U.S. mainland. The increase in other operating expenses is also due to higher credit card processing and interchange expenses, primarily due to higher volume of transactions at a higher average rate. 28 • Impact of change in fiscal period of certain subsidiaries represents a net loss for the month of December 2005 in those subsidiaries that changed their fiscal year in 2006, as described in the Corporation’s 2006 Annual Report. The efficiency ratio measures how much of a company’s revenue is used to pay operating expenses. As stated in the Glossary of Selected Financial Terms included in this 2007 Annual Report, in determining the efficiency ratio, the Corporation includes recurring non-interest income items, thus isolating income items that may be considered volatile in nature. Management believes that the exclusion of those items would permit greater comparability for analytical purposes. Amounts within non-interest income not considered recurring in nature by the Corporation amounted to $64.6 million during the year ended December 31, 2007, compared with $26.0 million in the same period of the previous year. Non-recurring gains during 2007 corresponded principally to net gains on sale and valuation adjustments of investment securities available-for-sale, whereas 2006 was mainly impacted by gains on the sale of real estate properties. The efficiency ratio was mainly unfavorably impacted by the impairment losses that resulted from the evaluation of the goodwill and trademark of E-LOAN and the restructuring charges related to the three restructuring plans previously discussed. For the year 2006, total operating expenses increased $156.9 million, or 12%, from 2005, mainly resulting from E-LOAN’s operations, which had only impacted 2005 results since its acquisition in November 2005. E-LOAN’s share of the increase in operating expenses for 2006, compared to 2005, was approximately $133 million. Popular Cash Express ("PCE"), sold in late 2005, contributed with a reduction of $28 million in operating expenses for 2006, which represented the subsidiary’s costs for the year 2005. Isolating the above impact in operating expenses from E-LOAN and PCE, the Corporation’s operating expenses for the year ended December 31, 2006 increased $52 million, or 4%, compared with the previous year. For the year ended December 31, 2006, personnel costs increased by $46.0 million, or 7%, compared with 2005. E-LOAN contributed with $46.4 million of this increase, while PCE contributed with a reduction of $10.1 million. The increase was mainly attributed to higher salaries and related taxes, bonuses, health insurance costs and savings plan expenses, partially offset by lower incentive compensation, training costs and profit sharing. All other operating expenses for the year 2006, excluding personnel costs, increased by $110.9 million, or 16%, compared with 2005. E-LOAN contributed with approximately $86.1 million of this increase, mostly in business promotion and professional fees. PCE represented a reduction of approximately $17.6 million, principally in net occupancy expenses. Excluding the impact of E-LOAN and PCE, the most significant variances were goodwill impairment losses during 2006 of $14.2 million at PFH, higher net occupancy expenses by $11.1 million resulting from business expansion in the U.S. mainland, the impact of a change in this fiscal year of certain of the Corporation’s subsidiaries amounting to a pre-tax loss of $9.7 million, and higher equipment expenses by $8.8 million driven by software maintenance and systems technology investments to support business processes. These variances were partially offset by a reduction of $14.9 million in business promotion expenses, excluding E-LOAN and PCE operations, resulting from lower expenses related to the loyalty rewards program as a result of a lower cost structure and changes in the redemption requirements, and by cost control measures. Income Tax Expense Income Tax Expense Income Tax Expense Income Tax Expense Income Tax Expense Income tax benefit for the year ended December 31, 2007 was $59.0 million, compared with an income tax expense of $106.9 million for 2006. This variance was primarily due to the pre-tax losses for 2007, in the Corporation’s U.S. operations, and to higher income subject to a preferential tax rate on capital gains in Puerto Rico when compared to 2006. In addition, income tax expense in the Puerto Rico operations decreased due to the expiration of the transitory provision that increased the statutory tax rate for Puerto Rico corporations in 2006, as described earlier in the Net Interest Income section of this MD&A. The impact of these changes was partially offset by lower net tax-exempt interest income and by the reversal of several tax positions during 2006 upon the completion of various federal and Puerto Rico tax audits. Income tax expense for the year ended December 31, 2006 was $106.9 million, compared with $148.9 million in 2005, a decrease of $42.0 million, or 28%. This decline was primarily due to lower pre-tax earnings, partially offset by a decrease in net tax-exempt interest income and by lower income subject to a preferential tax rate on capital gains in Puerto Rico. In addition, income tax expense reflected a change in the statutory tax rate from 41.5% to 43.5% in BPPR effective in 2006 and there was lower reversal of certain tax positions during 2006 as compared to 2005. Refer to Note 27 to the consolidated financial statements for additional information on income taxes. Fourth Quarter Results Fourth Quarter Results Fourth Quarter Results Fourth Quarter Results Fourth Quarter Results Refer to the Statistical Summary 2006-2007 Quarterly Financial Data presented in this MD&A. Net interest margin, on a taxable equivalent basis, was 3.53% for the fourth quarter of 2007, compared to 3.52% in the same period of 2006. Net interest income, on a taxable equivalent basis, declined by $3.1 million, or less than 1%, compared with the fourth quarter of 2006. The reduction was principally due to a lower taxable equivalent adjustment, as a result of the lower marginal tax rate in 2007 of 39%, which was discussed in the Net 2007 Annual Report 29 2007 2007 Popular, Inc. 2007 2007 Interest Income section of this MD&A. The average volume of earning assets declined by $0.4 billion, primarily due to a $0.9 billion net reduction in money markets and securities, offset in part by an increase in average loans of $0.5 billion, mainly commercial and consumer loans, reduced in part by a lower average volume of mortgage loans. Earning assets were funded principally through interest bearing deposits, which on average rose by $3.0 billion, and non-interest bearing sources of funds, which rose on average by $0.3 billion. Borrowed funds decreased $3.7 billion. Refer to the Statement of Condition and Liquidity sections of this MD&A for explanations on changes in the mix of earning assets and funding sources. The provision for loan losses for the fourth quarter of 2007 increased by $94.8 million, compared with the same quarter in 2006, principally due to higher net charge-offs and to higher delinquencies, a trend exhibited throughout the year due to weak economic conditions. The net charge-offs to average loans held- in-portfolio ratio deteriorated, increasing to 1.75% in the fourth quarter of 2007, from 0.93% for the same quarter in 2006. Net charge-offs for the quarter ended December 31, 2007 were $141.5 million, compared with $73.4 million in the same quarter of the previous year. The increase was experienced in mortgage loans by $37.2 million, consumer loans by $16.7 million and commercial loans by $16.1 million. The increase in net charge-offs on mortgage loans primarily reflects the continued credit problems in the U.S. mainland subprime mortgage market. Increases in net charge-offs in the commercial loan and consumer loan portfolios are principally due to higher delinquencies in Puerto Rico resulting from the slowdown in the economy. The commercial loan sector in the Corporation’s U.S. mainland operations also experienced higher charge-offs. Non-interest income amounted to $71.8 million for the quarter ended December 31, 2007, compared with $205.3 million for the same quarter in 2006. This decline was mostly the result of the $90.1 million pre-t ax l oss re sul ti ng f ro m t he lo an recharacterization transaction by PFH, and to higher losses on the valuation of PFH’s residual interest by $15.0 million for the fourth quarter of 2007, compared to the same period in 2006. Also, there were lower gains on the sale of real estate property in the fourth quarter of 2007 by approximately $10.5 million, compared to the same quarter in the previous year. These unfavorable variances were partially offset by higher other service fees that included debit and credit card fees, offset in part by an unfavorable change in the fair value of mortgage servicing rights during the fourth quarter of 2007 due to market conditions, including changes in delinquency curves and increased servicing costs. Operating expenses for the fourth quarter of 2007 totaled $621.2 million, representing an increase of $242.3 million, compared with the same quarter in 2006. This increase was principally driven by $211.8 million in impairment losses related to E- LOAN’s goodwill and trademark, and to $20.1 million in other charges taken in the fourth quarter of 2007 associated to the E- LOAN Restructuring Plan. The fourth quarter of 2006 included $21.4 million in impairment charges related to goodwill and long- lived assets on the PFH Restructuring Plan. Other factors impacting the increase in other operating expenses for the fourth quarter of 2007, when compared to the same quarter in 2006, included higher salaries in part due to merit increases, additional headcount from the Puerto Rico acquisitions, lower expense deferrals due to lower loan origination volumes, higher other real estate expenses and credit collection expenses, partially offset by lower equipment and business promotion expenses, among other factors. Income tax benefit amounted to $95.5 million in the fourth quarter of 2007, compared to income tax expense of $18.8 million in the same quarter of 2006. The main factors impacting this variance were the operating losses recorded in the U.S. operations primarily as a result of the loan recharacterization and the restructuring plans. RRRRR E P O R T A B L E E G M E N T R R R R R E S U L T S E P O R T A B L E S S S S S E G M E N T E S U L T S E S U L T S E G M E N T E G M E N T E P O R T A B L E E P O R T A B L E E S U L T S E S U L T S E G M E N T E P O R T A B L E The Corporation’s reportable segments for managerial reporting purposes consist of Banco Popular de Puerto Rico, EVERTEC, Banco Popular North America, and PFH. Also, a Corporate group supports the reportable segments. For managerial reporting purposes, the costs incurred by the Corporate group are not allocated to the four reportable segments. Prior to the fourth quarter of 2007, all U.S. operations were in a single segment referred to as Popular North America. Given the events and strategic moves commenced by management in the fourth quarter of 2007 with respect to selling or discontinuing PFH’s loan origination branch operations, including the prospective sale of a significant portion of its branch portfolio during the first quarter of 2008 and the sale or closure of its consumer branch network, management determined that the Popular North America (U.S. operations) would no longer be evaluated as a single reportable segment. As a result, commencing in the fourth quarter of 2007, the Corporation’s Popular North America reportable segment was segregated in two segments: Banco Popular North America, which includes the operations of E-LOAN; and PFH. As a result of further disruptions in the subprime market, liquidity constraints with respect to financing the operations of PFH and further loan credit deterioration, the Corporation determined to exit this business and allow the existing loan portfolio that cannot be sold due to lack of market or to legal constraints (i.e. for the on-balance sheet securitization not recharacterized) to mature. As indicated in the Events Subsequent to Year-End 2007 section of this MD&A, management opted to 30 account for a substantial portion of PFH’s maturing loans held- in-portfolio at fair value commencing on January 1, 2008. PFH will continue to operate its loan servicing unit. For a more complete description of the Corporation’s reportable segments, including additional financial information and the underlying management accounting process, refer to Note 32 to the consolidated financial statements. The Corporate group had a net income of $44.2 million in 2007, compared with a net loss of $28.8 million in 2006 and a net income of $9.0 million in 2005. In 2007, the Corporation’s holding companies within the Corporate group realized net gains on the sale and valuation adjustment of investment securities, mainly marketable equity securities, approximating $95.5 million, mainly due to a gain on the sale of TELPRI shares in the first quarter of 2007, while in 2006 these gains amounted to $13.9 million. Highlights on the earnings results for the reportable segments are discussed below. Banco Popular de Puerto Rico Banco Popular de Puerto Rico Banco Popular de Puerto Rico Banco Popular de Puerto Rico Banco Popular de Puerto Rico The Corporation’s core operations in Puerto Rico continued to perform well during 2007 despite a difficult economic environment which presented credit challenges, aggressive competition and an economy experiencing a greater slowdown than in the previous year. As indicated earlier, Banco Popular de Puerto Rico grew its retail banking business by acquiring Citibank’s retail banking operations, which added 17 branches prior to branch closings due to synergies. Also, Popular Securities, a subsidiary within the Banco Popular de Puerto Rico reportable segment, strengthened its brokerage sales force and assets under management by acquiring Smith Barney’s retail brokerage operations in Puerto Rico. Both of these acquisitions took place in the latter part of the fourth quarter of 2007. Banco Popular de Puerto Rico reportable segment reported net income of $327.3 million in 2007, a decrease of $28.6 million, or 8%, when compared with the previous year. Net income amounted to $355.9 million for 2006 and $398.7 million for 2005. The main factors that contributed to the variance 2007 compared to 2006 included: • Higher net interest income by $42.9 million, or 5%, primarily related to the commercial banking business; • Higher provision for loan losses by $102.6 million, or 73%, primarily associated with higher net charge-offs mainly in the consumer and commercial loan portfolios due to higher delinquencies resulting from the slowdown in the economy. The provision for loan losses represented 127% of net charge-offs for 2007, compared with 124% in 2006. The net charge-offs to average loans held-in-portfolio for the Banco Popular de Puerto Rico operations was 1.22% for the year ended December 31, 2007, compared with 0.77% in the previous year. The ratio of allowance for loan losses to loans held-in-portfolio for the Banco Popular de Puerto Rico reportable segment was 2.31% at December 31, 2007, compared with 2.09% at December 31, 2006; • Higher non-interest income by $53.6 million, or 12%, mainly due to higher other service fees by $42.0 million, primarily in debit and credit card fees and mortgage servicing fees. Also, there was a favorable variance in the caption of gains on sale of loans by $16.4 million because of a $20.1 million loss on the bulk sale of mortgage loans in the third quarter of 2006; • Higher operating expenses by $34.1 million, or 5%, primarily associated with higher professional fees, personnel costs, business promotion, other operating taxes and other operating expenses, which include credit card processing and interchange expenses. Despite the 5% increase in operating costs, this reportable segment managed costs through disciplined spending during 2007; • Lower income tax expense by $11.7 million, or 9%, primarily due to lower taxable income in 2007 than in the previous year. E V E R T E C E V E R T E C E V E R T E C E V E R T E C E V E R T E C EVERTEC is the Corporation’s reportable segment dedicated to processing and technology outsourcing services, servicing customers in Puerto Rico, the Caribbean, Central America and the U.S. mainland. EVERTEC provides support internally to the Corporation’s subsidiaries, as well as to third parties. EVERTEC increased transaction volume, revenues and net income during 2007 in spite of a recession in its main market, Puerto Rico, and in spite of increased competition from larger competitors across all regions it serves. During 2007, EVERTEC focused on leveraging its existing product offering to achieve strong revenue growth, enhancing competitiveness of the automated teller machine network, continuously improving quality levels, and continuing to develop its technology infrastructure. For the year ended December 31, 2007, net income for the reportable segment of EVERTEC totaled $31.3 million, an increase of $5.3 million, or 20%, compared with $26.0 million for 2006. Net income amounted to $24.7 million for 2005. Factors that contributed to the variance in results for 2007 when compared to 2006 included: • Lower net interest loss by $1.1 million, or 57%, primarily due to increased revenues from funds invested in securities; • Higher non-interest income by $12.4 million, or 5%, mostly as a result of higher electronic transactions processing fees related to point of sale and the automated teller machine network, other item processing fees associated with cash depot services and payment 2007 Annual Report 31 2007 2007 Popular, Inc. 2007 2007 processing, and an increase in IT consulting services, among others; • Higher operating expenses by $5.7 million, or 3%, primarily due to higher personnel costs, including impact of merit increases, higher headcount, commissions and medical costs, among other factors, and professional services primarily in programming services. These variances were partially offset by lower equipment expenses due to lower software package expenses and lower depreciation of electronic equipment. • Higher income tax expense by $2.5 million, or 17%, primarily due to higher taxable income in 2007 compared to the previous year. Banco Popular North America Banco Popular North America Banco Popular North America Banco Popular North America Banco Popular North America For the year ended December 31, 2007, the reportable segment of Banco Popular North America, which includes the operations of E-LOAN, had a net loss of $195.4 million, compared to net income of $67.5 million for 2006 and $97.6 million for 2005. E-LOAN’s net loss for the year ended December 31, 2007 amounted to $245.7 million, compared to net losses of $33.0 million in 2006 and $1.6 million in 2005. E-LOAN was acquired by the Corporation in the fourth quarter of 2005. The main factors that contributed to the variance in results for 2007 as compared to results a year earlier for the Banco Popular North America reportable segment included: • Lower net interest income by $9.4 million, or less than 3%; • Higher provision for loan losses by $49.0 million, or 105%, primarily due to higher net charge-offs in the mortgage and commercial loan portfolios. The provision for loan losses represented 166% of net charge-offs for 2007, compared with 116% of net charge-offs in 2006. The net charge-offs to average loans held-in-portfolio for the Banco Popular North America operations was 0.62% for the year ended December 31, 2007, compared with 0.45% in the previous year. The ratio of allowance for loan losses to loans held-in-portfolio for the Banco Popular North America reportable segment was 1.26% at December 31, 2007, compared with 1.00% at December 31, 2006. The increase in the allowance for loan losses reflects potential losses inherent in the loan portfolio as a result of current economic conditions and deteriorating market trends, primarily in the subprime mortgage loan sector and in the commercial portfolio, evidenced by an increase in non-performing assets. Refer to the Overview of Mortgage Loan Exposure section in the Credit Risk Management and Loan Quality area of this MD&A for further information on the Corporation’s subprime mortgage loan exposure. • Lower non-interest income by $32.6 million, or 15%, mainly due to an unfavorable variance in the caption of gain on sale of loans and valuation adjustments on loans held-for-sale by $25.7 million mainly due to lower loan volume originated and sold by E-LOAN, lower price margins due to market conditions, reduced gains on sale of SBA loans by BPNA due to lower volume, and unfavorable lower of cost or market adjustments on mortgage loans held-for-sale due to less liquidity in the secondary markets. Also, contributing to the unfavorable variance in non- interest income for this reportable segment were lower gains on the sale of real estate properties by $10.4 million. These unfavorable variances were partially offset by higher service charges on deposits by $5.3 million; • Higher operating expenses by $238.7 million, or 53%, mainly due to the $211.8 million impairment losses related to E-LOAN’s goodwill and trademark. Also included in the increase for 2007 are the $9.6 million of restructuring charges and $10.5 million in impairment losses on long- lived assets as a result of the E-LOAN restructuring plan. Other increases in personnel costs, net occupancy and equipment expenses were partially offset by lower business promotion expenses; and • Income tax benefit of $29.5 million in 2007, compared to income tax expense of $37.3 million in 2006. The variance is mainly attributed to higher losses in the operations of E- LOAN, as well as lower taxable income at BPNA. P o p u l a r F i n a n c i a l H o l d i n g s P o p u l a r F i n a n c i a l H o l d i n g s P o p u l a r F i n a n c i a l H o l d i n g s P o p u l a r F i n a n c i a l H o l d i n g s P o p u l a r F i n a n c i a l H o l d i n g s For the year ended December 31, 2007, net loss for the reportable segment of Popular Financial Holdings totaled $269.4 million, compared to a net loss of $61.7 million for 2006. Net income amounted to $10.5 million for 2005. The main factors that contributed to this variance in results for 2007 compared to 2006 included: • Lower net interest income by $32.9 million, or 19%, mostly the result of margin compression, including the impact of higher cost of funds, and a reduction in earning assets due to the downsizing of the operation that took effect in 2007; • Higher provision for loan losses by $121.2 million, or 121%, primarily due to higher net charge-offs in the mortgage loan portfolio due to the continued credit problems in the U.S. mainland subprime mortgage market. The provision for loan losses represented 129% of net charge- offs for 2007, compared with 131% of net charge-offs in 2006. The net charge-offs to average loans held-in-portfolio for the Popular Financial Holdings operations was 2.36% for the year ended December 31, 2007, compared with 0.99% for the year ended December 31, 2006. The ratio of allowance 32 for loan losses to loans held-in-portfolio for the Popular Financial Holdings reportable segment was 2.41% at December 31, 2007, compared with 1.46% at December 31, 2006; • Non-interest losses of $179.4 million in 2007, compared to non-interest income of $39.0 million in 2006. The variance was mainly due to the $90.1 million unfavorable impact of PFH’s loan recharacterization transaction, lower gains on the sale of loans resulting because of lower volume of loans originated and sold as a result of the exiting of the wholesale subprime mortgage business during 2007, and lower price margins. Also, the reduction in non-interest income includes the impact of the unfavorable valuation adjustments of PFH’s residual interests of $85.1 million in 2007, compared with $18.7 million in 2006; • Lower operating expenses by $47.0 million, or 23%, mainly due to the impact of the downsizing of PFH’s operations during 2007 and the fact that the year 2006 included $14.2 million in goodwill impairment losses and $7.2 million in impairment losses on long-lived assets. This was in part offset by $16.6 million in restructuring charges and impairment losses on long-lived assets taken in 2007 as part of the PFH Restructuring Plan and PFH Branch Network Restructuring Plan described in the Operating Expenses section of this MD&A; and • Income tax benefit of $150.5 million in 2007, compared to $32.8 million in 2006, mostly due to higher operating losses. ONDITION A A A A A NALYSIS TATEMENT O FO FO FO FO F C C C C C ONDITION SSSSS TATEMENT NALYSIS NALYSIS ONDITION ONDITION TATEMENT TATEMENT NALYSIS NALYSIS ONDITION TATEMENT A s s e t s A s s e t s A s s e t s A s s e t s A s s e t s Refer to the consolidated financial statements included in this Annual Report for the Corporation’s consolidated statements of condition as of December 31, 2007 and 2006. Also, refer to the Statistical Summary 2003-2007 in this MD&A for condensed statements of condition for the past five years. Earning assets at calendar year-end 2007 totaled $40.9 billion, a decrease of 6%, when compared to $43.7 billion at December 31, 2006. This decline was principally due to the strategic decisions made with respect to PFH’s reportable segment, which included exiting the wholesale subprime mortgage origination business since early 2007 and a reduction in loans of approximately $3.2 billion that resulted from the loan recharacterization transaction discussed earlier, offset in part by growth in other loan portfolio categories. The portfolio of investment securities, including trading and other securities, totaled $10.0 billion at December 31, 2007, compared with $10.6 billion at December 31, 2006, a decrease of 6%. Notes 6 and 7 to the consolidated financial statements provide additional information of the Corporation’s available-for-sale and held-to-maturity investment portfolios. Also, refer to the Market Risk section of this MD&A, which includes a table with the breakdown of the trading portfolio by major types of securities at December 31, 2007. The decline in the Corporation’s investment securities portfolio was mainly associated with the determination of not replacing securities that were maturing, in part because the interest spread was not favorable, and also as part of the Corporation’s strategy to deleverage the balance sheet and reduce lower yielding assets. A breakdown of the Corporation’s loan portfolio, the principal category of earning assets, is presented in Table G. The main challenge during 2007 for the Corporation’s commercial business sector was maintaining portfolio growth while curtailing delinquency. Commercial loans increased by $1.1 billion, or 8%, from December 31, 2006 to the same date in 2007, and included growth in commercial mortgage, participations, franchise, SBA and construction loans, among others. Commercial construction loans, which are included as part of commercial loans in Table G, totaled $1.9 billion at December 31, 2007, an increase of 37%, compared with $1.4 billion at December 31, 2006. The growth in the construction loan sector was focused on experienced developers, small condos, and the social interest market. The decrease in the lease financing portfolio from December 31, 2006 to the end of 2007 was mostly reflected in the Puerto Rico operations, whose leasing portfolio decreased by approximately $74 million, or 8%, compared to December 31, 2006. As in the prior year, the Corporation’s lease financing subsidiary in Puerto Rico (“the Island”) was impacted by strong competition and slowdown in the Island’s economy. The Banco Popular North America reportable segment also reflected a decline in its lease financing portfolio, including the runoff of underperforming lease financings. Mortgage loans at December 31, 2007 decreased by $4.3 billion, or 36%, from December 31, 2006. The PFH reportable segment’s mortgage loan portfolio was reduced by $4.5 billion. This decline at PFH was principally the result of the aforementioned strategies, which included exiting the wholesale mortgage loan origination channel and completing the loan recharacterization transaction. The latter strategy of converting on-balance sheet securitizations to sale transactions resulted in the removal of approximately $3.2 billion in mortgage loans from the Corporation’s books. Also, PFH completed one new off-balance sheet securitization transaction in 2007 involving approximately $461 million in unpaid principal balance of mortgage loans. The reduction in mortgage loans by PFH was partially offset by increases in the Banco Popular de Puerto Rico reportable segment. Despite the slowdown in the housing market, Popular Mortgage in Puerto Rico increased its loan production due to successful sales efforts and market share gained from past major competitors. Also, the Banco Popular North America reportable segment was impacted 2007 Annual Report 33 2007 2007 Popular, Inc. 2007 2007 T a b l e G T a b l e G T a b l e G T a b l e G T a b l e G Loans Ending Balances (including Loans Held-for-Sale) (Dollars in thousands) Commercial* Lease financing Mortgage** Consumer Total 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 $ 1 5 , 6 2 7 , 1 6 3 $ 1 5 , 6 2 7 , 1 6 3 $ 1 5 , 6 2 7 , 1 6 3 $ 1 5 , 6 2 7 , 1 6 3 $ 1 5 , 6 2 7 , 1 6 3 1 , 1 6 4 , 4 3 9 1 , 1 6 4 , 4 3 9 1 , 1 6 4 , 4 3 9 1 , 1 6 4 , 4 3 9 1 , 1 6 4 , 4 3 9 7 , 4 3 4 , 8 0 0 7 , 4 3 4 , 8 0 0 7 , 4 3 4 , 8 0 0 7 , 4 3 4 , 8 0 0 7 , 4 3 4 , 8 0 0 5 , 6 8 4 , 6 0 0 5 , 6 8 4 , 6 0 0 5 , 6 8 4 , 6 0 0 5 , 6 8 4 , 6 0 0 5 , 6 8 4 , 6 0 0 $ 2 9 , 9 1 1 , 0 0 2 $ 2 9 , 9 1 1 , 0 0 2 $ 2 9 , 9 1 1 , 0 0 2 $ 2 9 , 9 1 1 , 0 0 2 $ 2 9 , 9 1 1 , 0 0 2 2006 $14,536,837 1,226,490 11,695,156 5,278,456 $32,736,939 2005 $12,757,886 1,308,091 12,872,452 4,771,778 $31,710,207 2004 $10,897,747 1,164,606 12,641,329 4,038,579 $28,742,261 2003 $8,571,165 1,053,821 9,708,536 3,268,670 $22,602,192 Five-Year C.G.R. 13.96% 5.60 (0.09) 12.90 8.84% As of December 31, *Includes commercial construction. **Includes residential construction. by growth in non-conventional mortgages. Refer to the Overview of Mortgage Loan Exposure section in the Credit Risk Management and Loan Quality area of this MD&A for further information on the Corporation’s mortgage loan exposure. A breakdown of the Corporation’s consumer loan portfolio at December 31, 2007 and 2006 follows: (In thousands) 2007 2007 2007 2007 2007 2006 Change % Change Personal Credit cards Auto Other Total $ 3 , 2 7 6 , 6 7 5 $ 3 , 2 7 6 , 6 7 5 $ 3 , 2 7 6 , 6 7 5 $ 3 , 2 7 6 , 6 7 5 $ 3 , 2 7 6 , 6 7 5 1 , 1 2 8 , 1 3 7 1 , 1 2 8 , 1 3 7 1 , 1 2 8 , 1 3 7 1 , 1 2 8 , 1 3 7 1 , 1 2 8 , 1 3 7 1 , 0 4 0 , 7 4 3 1 , 0 4 0 , 7 4 3 1 , 0 4 0 , 7 4 3 1 , 0 4 0 , 7 4 3 1 , 0 4 0 , 7 4 3 2 3 9 , 0 4 5 2 3 9 , 0 4 5 2 3 9 , 0 4 5 2 3 9 , 0 4 5 2 3 9 , 0 4 5 $ 5 , 6 8 4 , 6 0 0 $ 5 , 6 8 4 , 6 0 0 $ 5 , 6 8 4 , 6 0 0 $ 5 , 6 8 4 , 6 0 0 $ 5 , 6 8 4 , 6 0 0 $2,457,619 1,032,546 1,570,308 217,983 $5,278,456 $819,056 95,591 (529,565) 21,062 $406,144 33% 9 (34) 10 8% The increase in personal loans from December 31, 2006 to December 31, 2007 was principally attributed to higher volume of home equity lines of credit in the Banco Popular North America operations, particularly from loan originations by E-LOAN. Also, the increase in personal loans was associated to the Citibank acquisition in Puerto Rico, which contributed with over $180 million in personal loans at acquisition date. Credit cards also increased from December 31, 2006 to the same date in 2007, principally in the Banco Popular de Puerto Rico reportable segment, whose credit card portfolio grew 8% from the end of 2006, mostly as a result of higher sales volume, new credit cards launched, effective mailing campaigns that included convenience checks, and volume generated for benefits derived from the loyalty rewards program, among other factors. Banco Popular North America also contributed with a newly originated credit card portfolio of approximately $12 million, as a result of initiating the credit cards issuance business during 2007. Auto loans decreased from the end of 2006 to the same date in 2007 by $530 million, or 34%. There was a decline in the auto loan portfolio of the Banco Popular North America reportable segment by approximately $508 million. BPNA’s auto loan portfolio continues to runoff because of management’s decision to cease auto loan originations through dealer channels. Furthermore, the Corporation completed a sale of over $275 million in auto loans to a third-party buyer in December 2007, which had been originated by E-LOAN. Also contributing to the reduction in the Corporation’s auto loan portfolio was the economic slowdown in the Puerto Rico market, which reduced automobile sales and decreased the size of the overall auto loan market. The “other” category of consumer loans includes marine loans and revolving lines of credit. The increase in this category is principally due to reserve lines of credit by approximately $16 million from the Citibank portfolio acquired. Despite the growth in the consumer lending business, this business in Puerto Rico was negatively impacted by the economic downturn in the Island which has led to a deterioration of credit quality, as evidenced by the increase in consumer loan charge-offs, depicted later in the Credit Risk Management and Loan Quality section of this MD&A. Servicing assets increased $32 million, or 19%, from December 31, 2006 to the same date in 2007. Refer to Note 22 to the consolidated financial statements for further information on the composition and accounting for servicing assets. The growth in servicing rights was mainly due to purchased mortgage servicing rights in the PFH operations, mortgage servicing rights derived from the off-balance sheet securitization executed by PFH in 2007 and the loan recharacterization transaction, and from sales and securitizations of originated loans by the Puerto Rico operations. Also, the increase was due in part to the adoption of SFAS No. 156 during 2007, pursuant to which the Corporation elected to account for residential mortgage servicing rights at fair value. These favorable impacts were offset in part by reductions in the servicing rights value, as a result of maturity run-off of the serviced portfolio. 34 The following table provides a breakdown of the principal categories that comprise the caption of “Other assets” in the consolidated statements of condition as of December 31, 2007 and 2006. of a total of $63.8 million prior to the impairment charge. Refer to Note 12 to the consolidated financial statements for further information on goodwill and the composition of other intangible assets by reportable business segments. (In thousands) Net deferred tax assets Bank-owned life insurance program Prepaid expenses Securitization advances and 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 $525,369 $525,369 $525,369 $525,369 $525,369 2006 Change $359,433 $165,936 2 1 5 , 1 7 1 2 1 5 , 1 7 1 2 1 5 , 1 7 1 2 1 5 , 1 7 1 2 1 5 , 1 7 1 1 8 8 , 2 3 7 1 8 8 , 2 3 7 1 8 8 , 2 3 7 1 8 8 , 2 3 7 1 8 8 , 2 3 7 206,331 168,717 8,840 19,520 related assets 1 6 8 , 5 9 9 1 6 8 , 5 9 9 1 6 8 , 5 9 9 1 6 8 , 5 9 9 1 6 8 , 5 9 9 181,387 (12,788) Investments under the equity method Derivative assets Others Total 8 9 , 8 7 0 8 9 , 8 7 0 8 9 , 8 7 0 8 9 , 8 7 0 8 9 , 8 7 0 7 6 , 9 5 8 7 6 , 9 5 8 7 6 , 9 5 8 7 6 , 9 5 8 7 6 , 9 5 8 1 9 2 , 7 9 0 1 9 2 , 7 9 0 1 9 2 , 7 9 0 1 9 2 , 7 9 0 1 9 2 , 7 9 0 $ 1 , 4 5 6 , 9 9 4 $ 1 , 4 5 6 , 9 9 4 $ 1 , 4 5 6 , 9 9 4 $ 1 , 4 5 6 , 9 9 4 $ 1 , 4 5 6 , 9 9 4 66,794 23,076 21,545 55,413 408,816 (216,026) $10,103 $1,446,891 Explanations for the most significant variances in other assets follow: • The decrease in “others” was mainly due to trade receivables of $232 million outstanding at December 31, 2006 for mortgage-backed securities sold prior to year-end, with settlement date in January 2007. • The increase in net deferred tax assets was mostly associated with PFH due to the impact of the loss on the loan recharacterization transaction and on the valuation of PFH’s residual interests since these losses were recognized for tax purposes in a different period causing a timing difference. Also, the increase is due to the net operating loss carryforwards in certain tax jurisdictions and to the reversal of a deferred tax liability due to the impairment of E-LOAN’s trademark. Transactions that were treated as on-balance sheet securitizations for accounting purposes were treated as sales for tax purposes since inception. Refer to Note 27 to the consolidated financial statements for the composition of deferred tax assets as of December 31, 2007, compared to the results at December 31, 2006. Goodwill and other intangible assets at December 31, 2007 reflected a decline of $75 million, or 10%, when compared to December 31, 2006. This reduction was principally the result of the aforementioned write-down in E-LOAN’s goodwill and trademark for $211.8 million, partially offset by recorded goodwill and core deposit intangibles of $126 million and $21 million, respectively, that are related to the Citibank retail business acquisition and Smith Barney's retail brokerage operations by the Banco Popular de Puerto Rico reportable segment in late 2007. After recording the estimated impairment charge, the full amount of E-LOAN’s goodwill of $164.4 million was eliminated while the balance in trademark remains at approximately $16.4 million, out Deposits, Borrowings and Other Liabilities Deposits, Borrowings and Other Liabilities Deposits, Borrowings and Other Liabilities Deposits, Borrowings and Other Liabilities Deposits, Borrowings and Other Liabilities The composition of the Corporation’s financing to total assets at December 31, 2007 and 2006 was as follows: (Dollars in millions) 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2006 % increase (decrease) % of total assets 2006 from 2006 to 2007 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 $ 4 , 5 1 1 $ 4 , 5 1 1 $ 4 , 5 1 1 $ 4 , 5 1 1 $ 4 , 5 1 1 1 5 , 5 5 3 1 5 , 5 5 3 1 5 , 5 5 3 1 5 , 5 5 3 1 5 , 5 5 3 Non-interest bearing deposits Interest-bearing core deposits Other interest-bearing deposits Federal funds and repurchase agreements 5 , 4 3 7 5 , 4 3 7 5 , 4 3 7 5 , 4 3 7 5 , 4 3 7 Other short-term borrowings Notes payable Others Stockholders’ equity 8 , 2 7 1 8 , 2 7 1 8 , 2 7 1 8 , 2 7 1 8 , 2 7 1 1 , 5 0 2 1 , 5 0 2 1 , 5 0 2 1 , 5 0 2 1 , 5 0 2 3 , 5 8 2 3 , 5 8 2 3 , 5 8 2 3 , 5 8 2 3 , 5 8 2 4 , 6 2 1 4 , 6 2 1 4 , 6 2 1 4 , 6 2 1 4 , 6 2 1 9 3 49 3 49 3 49 3 49 3 4 $4,222 14,923 5,293 5,762 4,034 8,737 813 3,620 6.8% 1 0 . 2 % 1 0 . 2 % 1 0 . 2 % 1 0 . 2 % 1 0 . 2 % 8.9% 4.2 56.3 (5.6) (62.8) (47.1) 14.9 (1.1) 3 5 . 0 3 5 . 0 3 5 . 0 3 5 . 0 3 5 . 0 31.5 1 8 . 6 1 8 . 6 1 8 . 6 1 8 . 6 1 8 . 6 11.2 1 2 . 2 1 2 . 2 1 2 . 2 1 2 . 2 1 2 . 2 12.2 3 . 43 . 43 . 43 . 43 . 4 1 0 . 4 1 0 . 4 1 0 . 4 1 0 . 4 1 0 . 4 2 . 12 . 12 . 12 . 12 . 1 8 . 18 . 18 . 18 . 18 . 1 8.5 18.4 1.7 7.6 The Corporation’s deposits by categories for 2007 and previous years are presented in Table H. Total deposits increased $3.9 billion, or 16%, from the end of 2006 to December 31, 2007. The acquisition of the Citibank retail branches in Puerto Rico in the fourth quarter of 2007 contributed with approximately $1 billion in deposits, principally in time deposits and savings accounts. Time deposits totaled $13.4 billion at December 31, 2007. When compared to December 31, 2006, this category increased by $3.1 billion, or 30%. Brokered certificates of deposit reflected a significant increase of $2.3 billion. The increase in brokered certificates of deposit is directly related to the Corporation’s decision to substitute short-term borrowings with deposits as a result of continued instability in the global financial and capital markets during the second half of 2007. Refer to the Liquidity Risk section later in this MD&A for further information on the Corporation’s banking subsidiaries and holding companies liquidity position. Also, the increase in time deposits from December 31, 2006 to December 31, 2007 was due to time deposits from the Citibank retail branch acquisition, competitive interest rate campaigns by BPPR focused on certificates of deposit to individuals, growth in IRA deposits and increased volume of time deposits gathered through the E-LOAN Internet platform, among other factors. At December 31, 2007, $791 million in time deposits were gathered through the E-LOAN on-line platform, an increase of $365 million, or 86%, when compared to December 31, 2006. 2007 Annual Report 35 2007 2007 Popular, Inc. 2007 2007 Table H Table H Table H Table H Table H Deposits Ending Balances As of December 31, (Dollars in thousands) Demand deposits* Savings, NOW and money market deposits Time deposits Total 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 $ 5 , 1 1 5 , 8 7 5 $ 5 , 1 1 5 , 8 7 5 $ 5 , 1 1 5 , 8 7 5 $ 5 , 1 1 5 , 8 7 5 $ 5 , 1 1 5 , 8 7 5 2006 $4,910,848 2005 $4,415,972 2004 $4,173,268 2003 $3,726,707 9 , 8 0 4 , 6 0 5 9 , 8 0 4 , 6 0 5 9 , 8 0 4 , 6 0 5 9 , 8 0 4 , 6 0 5 9 , 8 0 4 , 6 0 5 1 3 , 4 1 3 , 9 9 8 1 3 , 4 1 3 , 9 9 8 1 3 , 4 1 3 , 9 9 8 1 3 , 4 1 3 , 9 9 8 1 3 , 4 1 3 , 9 9 8 $ 2 8 , 3 3 4 , 4 7 8 $ 2 8 , 3 3 4 , 4 7 8 $ 2 8 , 3 3 4 , 4 7 8 $ 2 8 , 3 3 4 , 4 7 8 $ 2 8 , 3 3 4 , 4 7 8 9,200,732 10,326,751 $24,438,331 8,800,047 9,421,986 $22,638,005 8,865,831 7,554,061 $20,593,160 7,839,291 6,531,830 $18,097,828 *Includes interest and non-interest bearing demand deposits. Five-Year C.G.R. 8.72% 5.19 15.12 9.97% Savings, NOW and money market deposits increased 7%, when compared to December 31, 2006. This growth was mainly derived from the acquisition of the Citibank branches in Puerto Rico. Borrowed funds totaled $11.6 billion at December 31, 2007, a decrease of $7 billion, or 38%, compared to December 31, 2006. This decline was principally due to the loan recharacterization transaction discussed earlier, which reduced the balance of securitized debt in the form of bond certificates to investors by approximately $3.1 billion. Also, the Corporation placed greater reliance on deposits. Several strategies were put in place by the Corporation’s banking subsidiaries to mitigate the impact of current market conditions on liquidity risk. Among the strategies implemented was the utilization of unpledged liquid assets to raise financing in the repo markets, the proceeds of which were also used to pay off unsecured borrowings. Furthermore, the reduction in borrowed funds was also impacted by the strategy to deleverage the balance sheet and not reinvest proceeds obtained from maturing securities. Refer to Notes 14 through 18 to the consolidated financial statements for additional information on the Corporation’s borrowings at December 31, 2007 and 2006. Also, refer to the Liquidity Risk section of this MD&A for additional information on the Corporation’s funding sources at December 31, 2007. S t o c k h o l d e r s ’ E q u i t y S t o c k h o l d e r s ’ E q u i t y S t o c k h o l d e r s ’ E q u i t y S t o c k h o l d e r s ’ E q u i t y S t o c k h o l d e r s ’ E q u i t y Total stockholders’ equity at December 31, 2007 and December 31, 2006 was $3.6 billion. The reduction in stockholders’ equity due to the net loss for the year 2007 and to the dividend payouts was partially offset by the net impact of unrealized gains in the valuation of available-for-sale securities at year-end 2007 of $21 million, compared to unrealized losses of $155 million in year- end 2006. Refer to the consolidated statements of condition and of stockholders’ equity included in the accompanying consolidated financial statements for further information on its composition. Also, the disclosures of accumulated other comprehensive income (loss), an integral component of stockholders’ equity, are included in the consolidated statements of comprehensive income. The Corporation offers a dividend reinvestment and stock purchase plan for its stockholders that allows them to reinvest their quarterly dividends in shares of common stock at a 5% discount from the average market price at the time of the issuance, as well as purchase shares of common stock directly from the Corporation by making optional cash payments at prevailing market prices. During 2007, $20.2 million in additional capital was issued under the plan, compared to $16.5 million in 2006. The Corporation continues to exceed the well-capitalized guidelines under the federal banking regulations. At December 31, 2007 and 2006, BPPR, BPNA and Banco Popular, National Association (“BP, N.A.”) were all well-capitalized. Table I presents the Corporation’s capital adequacy information for the years 2003 to 2007. Note 21 to the consolidated financial statements presents further information on the Corporation’s regulatory capital requirements. Included within surplus in stockholders’ equity at December 31, 2007 was $374 million corresponding to a statutory reserve fund applicable exclusively to Puerto Rico banking institutions. This statutory reserve fund totaled $346 million at December 31, 2006. The Banking Act of the Commonwealth of Puerto Rico requires that a minimum of 10% of BPPR’s net income for the year be transferred to a statutory reserve account until such statutory reserve equals the total of paid-in capital on common and preferred stock. During 2007, $28 million were transferred to the statutory reserve. Any losses incurred by a bank must first be charged to retained earnings and then to the reserve fund. Amounts credited to the reserve fund may not be used to pay dividends without the prior consent of the Puerto Rico’s Commissioner of Financial Institutions. The failure to maintain sufficient statutory reserves would preclude BPPR from paying dividends. At December 31, 2007 and 2006, BPPR was in compliance with the statutory reserve requirement. The more relevant capital requirements applicable to the Corporation are the federal banking agencies capital requirements included in Table I. 36 T a b l e I T a b l e I T a b l e I T a b l e I T a b l e I Capital Adequacy Data (Dollars in thousands) Risk-based capital: Tier I capital Supplementary (Tier II) capital Total capital Risk-weighted assets: Balance sheet items Off-balance sheet items Total risk-weighted assets Ratios: 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2006 2005 2004 2003 As of December 31, $ 3 , 3 6 1 , 1 3 2 $ 3 , 3 6 1 , 1 3 2 $ 3 , 3 6 1 , 1 3 2 $ 3 , 3 6 1 , 1 3 2 $ 3 , 3 6 1 , 1 3 2 4 1 7 , 1 3 2 4 1 7 , 1 3 2 4 1 7 , 1 3 2 4 1 7 , 1 3 2 4 1 7 , 1 3 2 $ 3 , 7 7 8 , 2 6 4 $ 3 , 7 7 8 , 2 6 4 $ 3 , 7 7 8 , 2 6 4 $ 3 , 7 7 8 , 2 6 4 $ 3 , 7 7 8 , 2 6 4 $3,727,860 441,591 $4,169,451 $3,540,270 403,355 $3,943,625 $3,316,009 389,638 $3,705,647 $2,834,599 341,840 $3,176,439 $ 3 0 , 2 9 4 , 4 1 8 $ 3 0 , 2 9 4 , 4 1 8 $ 3 0 , 2 9 4 , 4 1 8 $ 3 0 , 2 9 4 , 4 1 8 $ 3 0 , 2 9 4 , 4 1 8 2 , 9 1 5 , 3 4 5 2 , 9 1 5 , 3 4 5 2 , 9 1 5 , 3 4 5 2 , 9 1 5 , 3 4 5 2 , 9 1 5 , 3 4 5 $ 3 3 , 2 0 9 , 7 6 3 $ 3 3 , 2 0 9 , 7 6 3 $ 3 3 , 2 0 9 , 7 6 3 $ 3 3 , 2 0 9 , 7 6 3 $ 3 3 , 2 0 9 , 7 6 3 $32,519,457 2,623,264 $35,142,721 $29,557,342 2,141,922 $31,699,264 $26,561,212 1,495,948 $28,057,160 $21,384,288 1,411,402 $22,795,690 Tier I capital (minimum required - 4.00%) Total capital (minimum required - 8.00%) Leverage ratio* Equity to assets Tangible equity to assets Equity to loans Internal capital generation rate 1 0 . 1 2 % 1 0 . 1 2 % 1 0 . 1 2 % 1 0 . 1 2 % 1 0 . 1 2 % 1 1 . 3 8 1 1 . 3 8 1 1 . 3 8 1 1 . 3 8 1 1 . 3 8 7 . 3 3 7 . 3 3 7 . 3 3 7 . 3 3 7 . 3 3 8 . 2 0 8 . 2 0 8 . 2 0 8 . 2 0 8 . 2 0 6 . 6 4 6 . 6 4 6 . 6 4 6 . 6 4 6 . 6 4 1 1 . 7 9 1 1 . 7 9 1 1 . 7 9 1 1 . 7 9 1 1 . 7 9 ( 6 . 6 1 ) ( 6 . 6 1 ) ( 6 . 6 1 ) ( 6 . 6 1 ) ( 6 . 6 1 ) 10.61% 11.86 8.05 7.75 6.25 11.66 4.48 11.17% 12.44 7.47 7.06 5.86 11.01 10.93 11.82% 13.21 7.78 7.28 6.59 11.55 10.82 12.43% 13.93 8.00 7.34 6.76 12.28 12.84 * All banks are required to have a minimum Tier I leverage ratio of 3% or 4% of adjusted quarterly average assets, depending on the bank's classification. The average tangible equity amounted to $3.1 billion and $3.0 billion for the years ended December 31, 2007 and 2006, respectively. Total tangible equity was $2.9 billion at December 31, 2007 and $2.8 billion at the end of 2006. The average tangible equity to average tangible assets ratio for 2007 was 6.64%, compared with 6.25% in 2006. I N A N C I N G E E E E E N T I T I E S A L A N C E S S S S S H E E TH E E TH E E TH E E TH E E T F F F F F I N A N C I N G OOOOO F FF FF FF FF F-B-B-B-B-B A L A N C E N T I T I E S N T I T I E S I N A N C I N G I N A N C I N G A L A N C E A L A N C E N T I T I E S N T I T I E S I N A N C I N G A L A N C E The Corporation, through certain subsidiaries of PFH, conducted a program of asset securitizations that involved the transfer of mortgage loans to a special purpose entity depositor, which in turn transferred those mortgage loans to different securitization trusts, thus isolating those loans from the Corporation’s assets. The securitization trusts that constituted “qualified special purpose entities” (“QSPEs”) under the provisions of SFAS No. 140 and are associated with securitizations that qualified for sale accounting under SFAS No. 140 are not consolidated in the Corporation’s financial statements. The investors in these off- balance sheet securitizations have no recourse to the Corporation’s assets or revenues. The Corporation’s creditors have no recourse to any assets or revenues of the special purpose entity depositor, or the securitization trust funds. As of December 31, 2007 and 2006, the Corporation had mortgage loans of approximately $5.4 billion and $2.3 billion, respectively, in securitization transactions that qualified for off-balance sheet treatment. These transactions had liabilities in the form of debt securities payable to investors from the assets inside each securitization trust of approximately $5.1 billion and $2.3 billion at the end of 2007 and 2006, respectively. The Corporation retained servicing responsibilities and certain subordinated interests in these securitizations in the form of residual interests. Their value is subject to credit, prepayment and interest rate risks on the transferred financial assets. The servicing rights and residual interests retained by the Corporation are recorded in the statement of condition as of December 31, 2007 at fair value. Refer to the Significant U.S. Strategic Events and Critical Accounting Policies / Estimates sections in this MD&A for further information. RRRRR I S KI S KI S KI S KI S K M M M M M A N A G E M E N T A N A G E M E N T A N A G E M E N T A N A G E M E N T A N A G E M E N T Risk identification and monitoring are key elements in overall risk management. The Corporation’s primary risk exposures are market, liquidity, credit and operational risks, all of which are discussed in the following sections. Market Risk Market Risk Market Risk Market Risk Market Risk Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments or other assets due to changes in interest rates, currency exchange rates or equity prices. The financial results and capital levels of Popular, Inc. are constantly exposed to market risk. It is a primary responsibility of the Corporation’s Board of Directors (“the Board”) and management to ensure that the level of market risk assumed throughout all of the subsidiaries of Popular as well as on a consolidated basis, is within policy guidelines approved by the Board. The Board delegates the monitoring of this risk to the Board’s Risk Management Committee, and its management to the Market Risk 2007 Annual Report 37 2007 2007 Popular, Inc. 2007 2007 Committee (“the Committee”) of Popular, Inc., which is composed of certain executive officers, and senior officers from the business, treasury and finance areas. The Committee’s primary goal is to ensure that the market risk assumed by the Corporation remains within the parameters of the Board’s policies. Interest Rate Risk Interest Rate Risk Interest Rate Risk Interest Rate Risk Interest Rate Risk Interest rate risk represents the exposure of the Corporation’s profitability or market value to changes in interest rates. Management considers interest rate risk (IRR) a predominant market risk in terms of its potential impact on earnings. The Corporation is subject to various categories of interest rate risk, including: • Repricing or Term Structure Risk – this risk arises due to mismatches in the timing of rate changes and cash flows from the Corporation’s assets and liabilities. For example, if assets reprice or mature at a faster pace than liabilities and interest rates are generally declining, earnings could initially decline. • Basis Risk – this risk involves changes in the spread relationship of the different rates that impact the Corporation’s balance sheet. This type of risk is present when assets and liabilities have similar repricing frequencies but are tied to different market interest rate indexes. • Yield Curve Risk - short-term and long-term market interest rates may change by different amounts; for example, the shape of the yield curve may affect new loan yields and funding costs differently. • Options Risk – changes in interest rates may shorten or lengthen the maturities of assets and liabilities. For example, prepayments, which tend to increase when market rates decline, may accelerate maturities for mortgage related products. In addition, call options in the Corporation’s investment portfolios may be exercised in a declining rate. Conversely, the opposite would occur in a rising interest rate scenario. In addition to the risks detailed above, interest rates may have an indirect impact on loan demand, credit losses, loan origination volume, the value of the Corporation’s investment securities holdings, including residual interests, gains and losses on sales of securities and loans, the value of mortgage servicing rights, and other sources of earnings. In limiting interest rate risk to an acceptable level, management may alter the mix of floating and fixed rate assets and liabilities, change pricing schedules, adjust maturities through sales and purchases of investment securities, and enter into derivative contracts, among other alternatives. The Corporation maintains a formal asset and liability management process to quantify, monitor and control interest rate risk and to assist management in maintaining stability in the net interest income under varying interest rate environments. The Committee implements the market risk policies approved by the Board as well as the risk management strategies reviewed and adopted in Committee meetings. The Committee measures and monitors the level of short and long-term IRR assumed by the Corporation and its subsidiaries. It uses simulation analysis and static gap estimates for measuring short-term IRR. Duration analysis is used to quantify the level of long-term IRR assumed, and focuses on the estimated economic value of the Corporation, that is, the difference between the estimated market value of financial assets less the estimated value of financial liabilities. Due to the importance of critical assumptions in measuring market risk, the risk models incorporate third-party developed data for critical assumptions such as prepayment speeds on mortgage- related products, estimates on the duration of the Corporation’s deposits and interest rate scenarios. Static gap analysis measures the volume of assets and liabilities maturing or repricing at a future point in time. The repricing volumes typically include adjustments for anticipated future asset prepayments and for differences in sensitivity to market rates. The volume of assets and liabilities repricing during future periods, particularly within one year, is used as one short-term indicator of IRR. Table K presents the static gap estimate for the Corporation as of December 31, 2007. These static measurements do not reflect the results of any projected activity and are best used as early indicators of potential interest rate exposures. They do not incorporate possible action that could be taken to manage the Corporation’s IRR. The interest rate sensitivity gap is defined as the difference between earning assets and interest bearing liabilities maturing or repricing within a given time period. At December 31, 2007, the Corporation’s one-year cumulative positive gap was $3.3 billion or 8.12% of total earning assets. Net interest income simulation analysis performed by legal entity and on a consolidated basis is another tool used by the Corporation in estimating the potential change in future earnings resulting from hypothetical changes in interest rates. Sensitivity analysis is calculated on a monthly basis using a simulation model, which incorporates actual balance sheet figures detailed by maturity and interest yields or costs, the expected balance sheet dynamics, reinvestments, and other non-interest related data. Simulations are processed using various interest rate scenarios to estimate how sensitive future net interest income is to changes in interest rates. The asset and liability management group also performs validation procedures on various assumptions used as part of the sensitivity analysis. Simulation analyses are based on many assumptions, including relative levels of market interest rates, interest rate spreads, loan prepayments and deposit decay. Thus, they should not be relied 38 T a b l e J T a b l e J T a b l e J T a b l e J T a b l e J Common Stock Performance Market Price High Low Cash Dividends Declared Per Share Book Value Per Share Dividend Payout Ratio Dividend Yield * Price/ Earnings Ratio Market/ Book Ratio ( 2 3 3 . 8 9 % ) ( 2 3 3 . 8 9 % ) $ 1 2 . 1 2 $ 1 2 . 1 2 ( 2 3 3 . 8 9 % ) $ 1 2 . 1 2 ( 2 3 3 . 8 9 % ) ( 2 3 3 . 8 9 % ) $ 1 2 . 1 2 $ 1 2 . 1 2 ( 3 9 . 2 6 x ) ( 3 9 . 2 6 x ) 4 . 3 8 % 4 . 3 8 % ( 3 9 . 2 6 x ) 4 . 3 8 % ( 3 9 . 2 6 x ) ( 3 9 . 2 6 x ) 4 . 3 8 % 4 . 3 8 % 8 7 . 4 6 % 8 7 . 4 6 % 8 7 . 4 6 % 8 7 . 4 6 % 8 7 . 4 6 % $12$12$12$12$121/2 16161616161/6 17171717171/2 1 91 91 91 91 9 $192/3 201/8 22 211/5 $24 271/2 252/3 28 $287/8 261/3 22 24 $237/9 203/5 202/5 171/2 $8$8$8$8$82/3 11111111113/8 15151515155/6 15151515155/6 $ 0 . 1 6 $ 0 . 1 6 $ 0 . 1 6 $ 0 . 1 6 $ 0 . 1 6 0 . 1 6 0 . 1 6 0 . 1 6 0 . 1 6 0 . 1 6 0 . 1 6 0 . 1 6 0 . 1 6 0 . 1 6 0 . 1 6 0 . 1 6 0 . 1 6 0 . 1 6 0 . 1 6 0 . 1 6 $172/9 172/5 181/2 191/2 $201/9 242/9 23 234/5 $241/2 211/2 20 211/2 $198/9 181/3 17 16 $0.16 0.16 0.16 0.16 $0.16 0.16 0.16 0.16 $0.16 0.16 0.16 0.14 $0.14 0.13 0.14 0.10 12.32 51.02 3.26 14.48 145.70 11.82 32.31 2.60 10.68 178.93 10.95 32.85 2.50 16.11 263.29 9.66 27.05 2.45 12.93 232.14 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 4th4th4th4th4th quarter quarter quarter quarter quarter 3rd3rd3rd3rd3rd quarter quarter quarter quarter quarter 2 n d2 n d2 n d2 n d2 n d quarter quarter quarter quarter quarter 1st1st1st1st1st quarter quarter quarter quarter quarter 2006 4th quarter 3rd quarter 2nd quarter 1st quarter 2005 4th quarter 3rd quarter 2nd quarter 1st quarter 2004 4th quarter 3rd quarter 2nd quarter 1st quarter 2003 4th quarter 3rd quarter 2nd quarter 1st quarter * Based on the average high and low market price for the four quarters. Note: All per share data has been adjusted to reflect the two-for-one stock split effected in the form of a dividend on July 8, 2004. upon as indicative of actual results. Further, the estimates do not contemplate actions that management could take to respond to changes in interest rates. By their nature, these forward-looking computations are only estimates and may be different from what may actually occur in the future. Based on the results of the simulation analyses as of December 31, 2007, the Corporation’s net interest income for the next twelve months is estimated to increase by $50.4 million in a hypothetical 200 basis points parallel rising rate scenario, and the change for the same period, utilizing a similar size declining rate scenario, is an estimated decrease of $44.3 million. Both hypothetical rate scenarios consider the gradual change to be achieved during a twelve-month period from the prevailing rates at December 31, 2007. The Corporation’s loan and investment portfolios are subject to prepayment risk, which results from the ability of a third party to repay debt obligations prior to maturity. At December 31, 2007 and 2006, net discount associated with loans acquired represented less than 1% of the total loan portfolio, while net premiums associated with portfolios of AFS and HTM securities approximated 2% of these investment securities portfolios. Prepayment risk also could have a significant impact on the duration of mortgage-backed securities and collateralized mortgage obligations, since prepayments could shorten the 2007 Annual Report 39 2007 2007 Popular, Inc. 2007 2007 Table K Table K Table K Table K Table K Interest Rate Sensitivity (Dollars in thousands) Assets: Money market investments Investment and trading securities Loans Other assets Total Liabilities and stockholders’ equity: Savings, NOW, money market and other interest bearing demand accounts Other time deposits Federal funds purchased and assets sold under agreements to repurchase Other short-term borrowings Notes payable Non-interest bearing deposits Other non-interest bearing liabilities and minority interest Stockholders’ equity Total Interest rate swaps Interest rate sensitive gap Cumulative interest rate sensitive gap Cumulative interest rate sensitive gap to earning assets As of December 31, 2007 By Repricing Dates After three months but within six months After six months but within nine months After nine months but within one year After one year Non-interest bearing funds $399 204,831 1,447,674 $394 499,261 1,495,593 $998,672 1,017,525 $100 5,575,921 12,776,804 0-30 days $871,747 1,837,550 10,700,337 Within 31-90 days $134,072 867,905 2,473,069 13,409,634 3,475,046 1,652,904 1,995,248 2,016,197 18,352,825 2,054,835 2,069,485 2,704,165 1,201,067 736,410 13,595 3,109,235 1,306,568 120,100 85,827 2,450,131 1,231,682 1,027,080 8,341,261 3,526,385 1,426,532 180,812 549,453 43,060 605,763 2,600,839 $3,509,583 3,509,583 4,510,789 Total $1,006,712 9,984,140 29,911,002 3,509,583 44,411,437 10,409,691 13,413,998 5,437,265 1,501,979 4,621,352 4,510,789 $8,765,962 385,315 5,028,987 $4,635,325 $3,180,396 $1,274,742 $1,632,843 $15,895,017 189,925 (970,354) (105,641) (1,633,133) (4,728) 715,778 (204,401) 178,953 (260,470) 2,197,338 5,028,987 4,058,633 2,425,500 3,141,278 3,320,231 5,517,569 12.30% 9.92% 5.93% 7.68% 8.12% 13.49% 934,481 3,581,882 $9,027,152 934,481 3,581,882 $44,411,437 weighted average life of these portfolios. Table L, which presents the maturity distribution of earning assets, takes into consideration prepayment assumptions, as determined by management, based on the expected interest rate scenario. Duration analysis measures longer-term IRR, in particular the duration of the market value of equity. It expresses in general terms the sensitivity of the market value of equity to changes in interest rates. The estimated market value of equity is obtained from the market value of the cash flows from the Corporation’s financial assets and liabilities, which are primarily payments of interest and repayments of principal. Thus, the market value of equity incorporates all expected future cash flows from net interest income as well as principal repayments, whereas other measures of IRR focus primarily on short-term net interest income. The duration of the market value of portfolio equity (“MVPE”) is a measure of its riskiness. The MVPE is equal to the estimated market value of the Corporation’s assets minus the estimated market value of the liabilities. The duration of MVPE is equal to the product of the market value of assets times its duration, minus the product of the market value of liabilities times its duration, divided by the market value of equity. In general, the longer the duration of MVPE, the more sensitive is its market value to changes in interest rates. Duration measures the expected length of a financial asset or liability. In particular, it equals the weighted average maturity of the present value of all the cash flows of a financial asset or liability where the weights are equal to the present value of each cash flow. The present value of cash flows occurring in the future is the estimated market value as of a certain date. The sensitivity of the market value of a financial asset or liability to changes in interest rates is primarily a function of its duration. In general terms, the longer the duration of an asset or liability, the greater is the sensitivity of its market value to interest rate changes. Since duration measures the term of a financial asset or liability, it is usually expressed in terms of years or months. 40 Duration of equity is evaluated by management on a monthly basis. The duration of equity at December 31, 2007 was in compliance with the Corporation’s established MVPE policy limits in a most likely interest rate scenario. T r a d i n g T r a d i n g T r a d i n g T r a d i n g T r a d i n g The Corporation’s trading activities are another source of market risk and are subject to policies and risk guidelines approved by the Board of Directors to manage such risks. Most of the Corporation’s trading activities are limited to mortgage banking activities and the market-making activities of the Corporation’s broker-dealer business. In anticipation of customer demand, the Corporation carries an inventory of capital market instruments and maintains market liquidity by quoting bid and offer prices to and trading with other market makers and clients. Positions are also taken in interest rate sensitive instruments, based on expectations of future market conditions. These activities constitute the proprietary trading business and are conducted by the Corporation to provide customers with securities inventory and liquidity. Also, as indicated in the Critical Accounting Policies / Estimates in this MD&A, the Corporation had $40 million in residual interests derived from PFH’s off-balance sheet securitization transactions classified as trading securities. Trading instruments are recognized at market value, with changes resulting from fluctuations in market prices, interest rates or exchange rates reported in current period income. Further information on the Corporation’s risk management and trading activities is included in Note 30 to the consolidated financial statements. In the opinion of management, the size and composition of the trading portfolio does not represent a potentially significant source of market risk for the Corporation. At December 31, 2007, the trading portfolio of the Corporation amounted to $768 million and represented 2% of total assets, compared with $382 million and 1% a year earlier. Mortgage- backed securities represented 90% of the trading portfolio at the end of 2007, compared with 55% in 2006. The mortgage-backed securities are investment grade securities, all of which are rated AAA by at least one of the three major rating agencies at December 31, 2007. A significant portion of the trading portfolio is hedged against market risk by positions that offset the risk assumed. This portfolio was composed of the following at December 31, 2007: (Dollars in thousands) Amount Average Yield* Weighted Mortgage-backed securities Commercial paper U.S. Treasury and agencies Puerto Rico and U.S. Government obligations Interest-only strips Other *Not on a taxable equivalent basis. $687,754 6,331 273 14,097 42,312 17,188 $767,955 6.32% 5.69 3.13 5.63 14.92 4.47 6.73% At December 31, 2007, the trading portfolio of the Corporation had an estimated duration of 4.0 years and a one-month value at risk (VAR) of approximately $3.6 million, assuming a confidence level of 95%. VAR is a key measure of market risk for the Corporation. VAR represents the maximum amount that the Corporation can expect to lose with 95% confidence within one month in the course of its risk taking activities. Its purpose is to describe the amount of capital needed to absorb potential losses from adverse market volatility. There are numerous assumptions and estimates associated with VAR modeling, and actual results could differ from these assumptions and estimates. The Corporation enters into forward contracts to sell mortgage- backed securities with terms lasting less than a month which are accounted for as trading derivatives. These contracts are recognized at fair value with changes directly reported in current period income. Refer to the Derivatives section that follows in this MD&A for additional information. At December 31, 2007, the fair value of these forward contracts was not significant. The Corporation does not participate in any trading activities involving commodity contracts. D e r i v a t i v e s D e r i v a t i v e s D e r i v a t i v e s D e r i v a t i v e s D e r i v a t i v e s Derivatives are used by the Corporation to protect against changes in net interest income and cash flows as part of its overall interest rate risk management strategy. Derivative instruments that the Corporation may use include, among others, interest rate swaps and caps, index options, and forward contracts. The Corporation does not use highly leveraged derivative instruments in its interest rate risk management strategy. The Corporation also enters into foreign exchange contracts and interest rate swaps and caps for the benefit of commercial customers. The Corporation economically hedges its exposure related to these commercial customer derivatives by entering into offsetting third-party contracts with approved, reputable counterparties with substantially matching terms and currencies. Refer to Note 30 to the consolidated financial statements for further information on 2007 Annual Report 41 2007 2007 Popular, Inc. 2007 2007 the Corporation’s involvement in derivative instruments and hedging activities. specified price or yield. These securities are hedging a forecasted transaction and thus qualify for cash flow hedge accounting. The Corporation’s derivatives activities are entered primarily to offset the impact of market volatility on the economic value of assets or liabilities. The net effect on the market value of potential changes in interest rates of derivatives and other financial instruments is analyzed. The effectiveness of these hedges is monitored to ascertain that the Corporation is reducing market risk as expected. Derivatives transactions are generally executed with instruments with a high correlation to the hedged asset or liability. The underlying index or instrument of the derivatives used by the Corporation is selected based on its similarity to the asset or liability being hedged. As a result of interest rate fluctuations, hedged fixed and variable interest rate assets and liabilities will appreciate or depreciate in fair value. The effect of this unrealized appreciation or depreciation is expected to be substantially offset by the Corporation’s gains or losses on the derivative instruments that are linked to these hedged assets and liabilities. Management will assess if circumstances warrant liquidating or replacing the derivatives position in the hypothetical event that high correlation is reduced. Based on the Corporation’s derivative instruments outstanding at December 31, 2007, it is not anticipated that such a scenario would have a material impact on the Corporation’s financial condition or results of operations. Certain derivative contracts also present credit risk because the counterparties may not meet the terms of the contract. If a counterparty fails to perform, the Corporation’s credit risk is equal to the net fair value of the derivative contract. The Corporation minimizes credit risk through approvals, limits and monitoring procedures. The Corporation deals exclusively with counterparties that have high quality credit ratings. Further, as applicable under the terms of the master arrangements, the Corporation may obtain collateral, where appropriate, to reduce risk. The Corporation has not incurred losses from counterparty nonperformance on derivatives. Credit risk related to derivatives is not considered significant at December 31, 2007. Cash Flow Hedges In a cash flow hedging strategy, the Corporation manages the variability of cash payments due to interest rate fluctuations by the effective use of derivatives linked to hedged assets and liabilities. The notional amount of derivatives designated as cash flow hedges as of December 31, 2007 amounted to $343 million. The cash flow hedges outstanding related to forward contracts or “to be announced” (“TBA”) mortgage-backed securities that are sold and bought for future settlement to hedge the sale of mortgage- backed securities and loans prior to securitization, had a notional amount of $143 million at December 31, 2007. The seller agrees to deliver on a specified future date, a specified instrument, at a In conjunction with the issuance of medium-term notes, the Corporation entered into interest rate swaps to convert floating rate debt to fixed rate debt with the objective of minimizing the exposure to changes in cash flows due to higher interest rates. At December 31, 2007, these contracts had a notional amount of $200 million. Refer to Note 30 to the consolidated financial statements for additional quantitative information on these derivative contracts. Fair Value Hedges The Corporation did not have any outstanding derivatives designated as fair value hedges at December 31, 2007. Trading and Non-Hedging Derivative Activities The Corporation takes derivatives positions based on market expectations or to benefit from price differentials between financial instruments and markets. However, these derivatives instruments are mostly utilized to economically hedge a related asset or liability. Also, to a lesser extent, the Corporation may also enter into various derivatives to provide these types of products to customers. These types of free-standing derivatives are carried at fair value with changes in fair value recorded as part of the results of operations for the period. Following is a description of the most significant of the Corporation’s derivative activities that do not qualify for hedge accounting as defined in SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities” (as amended). Refer to Note 30 to the consolidated financial statements for additional quantitative and qualitative information on these derivative instruments. During 2006 and most of 2007, the Corporation had interest rate caps in conjunction with a series of securitizations of mortgage loans in order to limit the interest rate payable to the security holders. These contracts were designated as non-hedging derivatives and were marked-to-market, thus impacting earnings. However, at the end of 2007, these caps were no longer required to be consolidated by the Corporation as a result of the recharacterization transaction described in the Significant U.S. Strategic Events section of this MD&A since they pertained to the bond certificates issued by the trust. During 2007, the Corporation recognized an increase in interest expense of $3.1 million due to unfavorable changes in fair value associated with interest rate caps, compared to $8.2 million in additional interest expense for 2006. At December 31, 2007, the Corporation also had outstanding $2.0 billion in notional amount of interest rate swap agreements with a negative fair value (liability) of $4.0 million, which were 42 not designated as accounting hedges, some of which had offsetting positions. The agreements seek various strategies, including among others: • utilizing the instruments in the Corporation’s capacity as an intermediary on behalf of its customers; • economically hedging the cost of short-term borrowings; • economically hedging the payments on the bond certificates offered as part of an on-balance sheet securitization; • economically converting to a fixed-rate the cost of funding a portion of the auto loans held-in-portfolio; and • economically hedging the changes in fair value of loans acquired and originated prior to securitization. For the year ended December 31, 2007, the impact of the mark-to-market of interest rate swaps not designated as accounting hedges was a net decrease in earnings of approximately $11.6 million, primarily in the interest expense category of the statement of operations, compared with an earnings reduction of approximately $1.8 million in 2006 mainly in the trading profit (loss) category of the income statement. Some of the strategies for which the derivatives held by the Corporation were utilized are not expected to be employed by the Corporation in the near term or are not expected to have a significant impact during 2008. The Corporation cancelled all swaps related to the auto loans because a substantial amount of that loan portfolio was sold in December 2007. Additionally, the Corporation is no longer entering into swaps to economically hedge changes in the fair value of loans prior to securitization because that strategy was related to the operations of PFH that were exited in 2007. The Corporation has $200 million remaining in swaps that are economically hedging the cost of short-term borrowing. These swaps will mature in December 2008. Additionally, at December 31, 2007, the Corporation continued to hold an interest swap with a notional amount of $185 million that is associated with hedging the payments of bond certificates offered as part of one on-balance sheet securitization that remained outstanding at year- end 2007 because it did not qualify for recharacterization as a result of the existence of the derivative instrument. The Corporation will account for the related bond certificate at fair value upon adoption of SFAS No. 159 in 2008. The Corporation also enters into interest rate lock commitments (“IRLCs”) in connection with one of its subsidiary’s mortgage banking activities to fund mortgage loans at interest rates previously agreed (locked) by both the Corporation with the customer for specified periods of time. When the borrower locks its interest rate, the Corporation effectively extends a put option to the customer, whereby the customer is not obligated to enter into the loan agreement but the Corporation must honor the interest rate for the specified time period. The Corporation is exposed to interest rate risk during the period of the IRLC through the sale of the underlying loan due to changes in interest rates. These IRLCs are recognized at fair value with changes in fair value recorded in the consolidated statement of operations. Outstanding IRLCs expose the Corporation to the risk that the price of the loans associated with the commitments might decline from inception of the rate lock to funding of the loan due to increases in mortgage interest rates. To protect against this risk, the Corporation utilizes forward loan sales commitments to economically hedge the risk of potential changes in the value of the loans that would result from the commitments. The Corporation expects that the changes in the fair value of these derivative instruments will offset changes in the fair value of the IRLCs. At December 31, 2007, the Corporation had outstanding IRLCs with a notional amount of $149 million and a negative fair value (liability) of $128 thousand. Additionally, at December 31, 2007, the Corporation had forward contracts with a notional amount of $693 million and a negative fair value (liability) of $3.2 million not designated as accounting hedges. These forward contracts are considered derivatives under SFAS No. 133 and are recorded at fair value. Subsequent changes in the value of these forward contracts are recorded in the statement of operations. These forward contracts are principally used to economically hedge the changes in fair value of mortgage loans held-for-sale and mortgage pipeline through both mandatory and best efforts forward sale agreements. These forward contracts are entered into in order to optimize the gain on sales of loans and / or mortgage-backed securities. For the year ended December 31, 2007, the impact of the mark-to- market of the forward contracts not designated as accounting hedges was a reduction to earnings of $11.2 million, which was included in the categories of trading account profit and gain on sale of loans in the consolidated statement of operations. In 2006, the unfavorable impact to earnings was $1.9 million. Furthermore, the Corporation has over-the-counter option contracts which are utilized in order to limit the Corporation’s exposure on customer deposits whose returns are tied to the S&P 500 or to certain other equity securities or commodity indexes. The Corporation, through its Puerto Rico banking subsidiary, BPPR, offers certificates of deposit with returns linked to these indexes to its retail customers, principally in connection with IRA accounts, and certificates of deposit sold through its broker- dealer subsidiary. At December 31, 2007, these deposits amounted to $187 million, or less than 1% of the Corporation’s total deposits. In these certificates, the customer’s principal is guaranteed by BPPR and insured by the FDIC to the maximum extent permitted by law. The instruments pay a return based on the increase of these indexes, as applicable, during the term of the instrument. Accordingly, this product gives customers the opportunity to invest in a product that protects the principal 2007 Annual Report 43 2007 2007 Popular, Inc. 2007 2007 invested but allows the customer the potential to earn a return based on the performance of the indexes. other operating income in the consolidated statements of operations. The risk of issuing certificates of deposit with returns tied to the applicable indexes is hedged by BPPR. BPPR purchases index options from financial institutions with strong credit standings, whose return is designed to match the return payable on the certificates of deposit issued. By hedging the risk in this manner, the effective cost of the deposits raised by this product is fixed. The contracts have a maturity and an index equal to the terms of the pool of client’s deposits they are economically hedging. The purchased option contracts are initially accounted for at cost (i.e., amount of premium paid) and recorded as a derivative asset. The derivative asset is marked-to-market on a monthly basis with changes in fair value charged to earnings. The deposits are hybrid instruments containing embedded options that must be bifurcated in accordance with SFAS No. 133. The initial value of the embedded option (component of the deposit contract that pays a return based on changes in the applicable indexes) is bifurcated from the related certificate of deposit and is initially recorded as a derivative liability and a corresponding discount on the certificate of deposit is recorded. Subsequently, the discount on the deposit is accreted and included as part of interest expense while the bifurcated option is marked-to-market with changes in fair value charged to earnings. The purchased option contracts are marked-to-market on a quarterly basis. The purchased index options are used to economically hedge the bifurcated embedded option. These option contracts do not qualify for hedge accounting in accordance with the provisions of SFAS No. 133 and therefore cannot be designated as accounting hedges. At December 31, 2007, the notional amount of the index options on deposits approximated $211 million with a fair value of $46 million (asset) while the embedded options had a notional value of $187 million with a fair value of $44 million (liability). Refer to Note 30 to the consolidated financial statements for a description of other non-hedging derivative activities utilized by the Corporation during 2007 and 2006. F o r e i g n E x c h a n g e F o r e i g n E x c h a n g e F o r e i g n E x c h a n g e F o r e i g n E x c h a n g e F o r e i g n E x c h a n g e The Corporation conducts business in certain Latin American markets through several of its processing and information technology services and products subsidiaries. Also, it holds interests in Consorcio de Tarjetas Dominicanas, S.A. (“CONTADO”) and Centro Financiero BHD, S.A. (“BHD”) in the Dominican Republic. Although not significant, some of these businesses are conducted in the country’s foreign currency. The resulting foreign currency translation adjustment, from operations for which the functional currency is other than the U.S. dollar, is reported in accumulated other comprehensive loss in the consolidated statements of condition, except for highly- inflationary environments in which the effects are included in During the year ended December 31, 2006, approximately $0.8 million in net remeasurement gains on the investments held by the Corporation in the Dominican Republic were reflected in other operating income instead of accumulated other comprehensive loss. In 2007, the Corporation ceased to consider the Dominican Republic as a “highly inflationary economy” and as such, the foreign currency translation adjustment was reported as part of other comprehensive loss. Refer to the consolidated statement of comprehensive income in the financial statements for related amounts corresponding to the year 2007. At December 31, 2007, the Corporation had approximately $35 million in an unfavorable foreign currency translation adjustment as part of accumulated other comprehensive loss, compared to unfavorable adjustments of $37 million at December 31, 2006 and $36 million at December 31, 2005. Liquidity Risk Liquidity Risk Liquidity Risk Liquidity Risk Liquidity Risk For a financial institution, liquidity risk may arise whenever the institution cannot generate enough cash from either assets or liabilities to meet its obligations when they become due, without incurring unacceptable losses. Cash requirements for a financial institution are primarily made up of deposit withdrawals, contractual loan funding, the repayment of borrowings as they mature and the ability to fund new and existing investments as opportunities arise. An institution’s liquidity may be pressured if, for example, its credit rating is downgraded, it experiences a sudden and unexpected substantial cash outflow, or some other event causes counterparties to avoid exposure to the institution. An institution is also exposed to liquidity risk if markets on which it depends are subject to loss of liquidity. The objective of effective liquidity management is to ensure that the Corporation remains sufficiently liquid to meet all of its financial obligations, finance expected future growth and maintain a reasonable safety margin for cash commitments under both normal operating conditions and under unpredictable circumstances of industry or market stress. To achieve this objective, the Board of Directors, through the Risk Management Committee, is responsible for approving policies regarding liquidity risk management as well as approving operating and contingency procedures, and supervising their implementation. Liquidity is managed at the level of the holding companies that own the banking and non-banking subsidiaries. Also, it is managed at the level of the banking and non-banking subsidiaries. The Corporation’s Corporate Treasurer is responsible for implementing the policies and procedures approved by the Risk Management Committee and for monitoring the liquidity position on an ongoing basis. 44 The Corporation has established policies and procedures to assist it in remaining sufficiently liquid to meet all of its financial obligations, finance expected future growth and maintain a reasonable safety margin for cash commitments under both normal operating conditions and unsettled market environments. including its terms, is included in Notes 14 through 18 to the consolidated financial statements. Also, the consolidated statements of cash flows in the accompanying consolidated financial statements provide information on the Corporation’s cash inflows and outflows. Liquidity, Funding and Capital Resources Liquidity, Funding and Capital Resources Liquidity, Funding and Capital Resources Liquidity, Funding and Capital Resources Liquidity, Funding and Capital Resources The U.S. credit markets have been marked by unprecedented instability and disruption since the beginning of the third quarter of 2007, making most funding activities much more challenging for financial institutions. Credit spreads have widened significantly and rapidly, as many investors allocated their funds to only the highest-quality financial assets such as U.S. government securities. The result of these actions by market participants made it more difficult for corporate borrowers to raise financing in the credit markets and reduced the value of most financial assets except the highest-quality obligations. Several sectors have been significantly impacted, including the money markets, the corporate debt market and more recently, the municipal securities and student loan markets. A primary catalyst of the market disruptions has been an abrupt shift by investors away from non-government securities into U.S. Government obligations, and the unwillingness to assume many types of risk. The Corporation has historically financed a portion of its business in the money and corporate bond markets, both of which have been affected by financial market developments since the beginning of the third quarter of 2007. As it became more challenging to raise financing in the capital markets, the Corporation’s management took actions to reduce the use of borrowings to finance its businesses and thus ensure access to stable sources of liquidity. These actions, which are explained below, included, for example, replacing short-term unsecured borrowings with deposits and increasing secured lines of credit. The Corporation’s liquidity position is closely monitored on an ongoing basis. Management believes that its current sources of liquidity are adequate to meet the funding needs in the normal course of business. Sources of liquidity include both those available to the banking affiliates and to a lesser extent, those expected to be available with third party providers. The former include access to stable base of core deposits and secured sources of credit. The latter include credit lines and anticipated debt offerings in the capital markets. In addition to these, asset sales can be a source of liquidity to the Corporation. Even if some of these alternatives may not be available temporarily, it is expected that in the normal course of business, our funding sources are adequate. The following sections provide further information on the Corporation’s major funding activities and needs, as well as the risks involved in these activities. A more detailed description of the Corporation’s borrowings and available lines of credit, B a n k i n g S u b s i d i a r i e s B a n k i n g S u b s i d i a r i e s B a n k i n g S u b s i d i a r i e s B a n k i n g S u b s i d i a r i e s B a n k i n g S u b s i d i a r i e s Primary sources of funding for the Corporation’s banking subsidiaries (BPPR, BPNA and BP,N.A., or “the banking subsidiaries”) include retail and commercial deposits, purchased funds, institutional borrowings, and to a lesser extent, loan sales. The principal uses of funds for the banking subsidiaries include loan and investment portfolio growth, repayment of obligations as they become due, dividend payments to the holding company, and operational needs. In addition, the Corporation’s banking subsidiaries maintain borrowing facilities with the Federal Home Loan Banks ("FHLB") and at the discount window of the Federal Reserve Bank of New York ("FED"), and have a considerable amount of collateral that can be used to raise funds under these facilities. Borrowings from the FHLB or the FED discount window require the Corporation to post securities or whole loans as collateral. The banking subsidiaries must maintain their FHLB memberships to continue accessing this source of funding. To mitigate exposure to funding risk for the banking subsidiaries in the current environment, concrete steps have been taken by management to reduce the need to access the money markets for financing, including relying more on deposits than borrowings. Deposits Deposits are a key source of funding as they tend to be less volatile than institutional borrowings and their cost is less sensitive to changes in market rates. Core deposits are generated from a large base of consumer, corporate and institutional customers. Total deposits at the Corporation increased from $24.4 billion at December 31, 2006 to $28.3 billion at December 31, 2007, an increase of $3.9 billion or 16%. As indicated previously in this MD&A, the growth in deposits was impacted by the acquisition of the Citibank retail branches in Puerto Rico and by measures taken in the fourth quarter of 2007 to raise brokered certificates of deposit in the U.S. national CD market. Core deposits have historically provided the Corporation with a sizable source of relatively stable and low-cost funds. As indicated in the glossary, for purposes of defining core deposits, the Corporation excludes brokered certificates of deposits with denominations under $100,000. Core deposits totaled $20.1 billion, or 71% of total deposits, at December 31, 2007, compared to $19.1 billion and 78% at December 31, 2006. Core deposits financed 49% of the Corporation’s earning assets at December 31, 2007 compared to 44% at December 31, 2006. Certificates of deposit with denominations of $100,000 and over at December 31, 2007 totaled $5.3 billion, or 19% of total deposits. Their distribution by maturity was as follows: (In thousands) 3 months or less 3 to 6 months 6 to 12 months Over 12 months $2,839,025 859,462 664,980 914,223 $5,277,690 The Corporation had $3.1 billion in brokered certificates of deposit at December 31, 2007, which represented 11% of its total deposits, compared to $866 million and 4% at December 31, 2006. Approximately 2% of the brokered certificates of deposit outstanding at December 31, 2007 are callable, but only at the option of the Corporation. Brokered certificates of deposit, which are typically sold through an intermediary to small retail investors, provide access to longer-term funds that are available in the market area and provide the ability to raise additional funds without pressuring retail deposit pricing. In the event that any of the Corporation’s banking subsidiaries fall under the regulatory capital ratios of a well-capitalized institution, that banking subsidiary faces the risk of not being able to raise brokered deposits. Each of the Corporation's banking subsidiaries were considered well-capitalized at December 31, 2007. One of the strategies followed by management in response to the unprecedented market disruptions described above, was the utilization of brokered certificates of deposit to replace uncommitted lines of credit. Average deposits for the year ended December 31, 2007 represented 58% of average earning assets, compared with 52% and 51% for the years ended December 31, 2006 and 2005, respectively. Table M summarizes average deposits for the past five years. The Corporation’s ability to compete successfully in the marketplace for deposits depends on various factors, including pricing, service, convenience and financial stability as reflected by operating results and credit ratings (by nationally recognized credit rating agencies). Although a downgrade in the credit rating of the Corporation may impact its ability to raise deposits or the rate it is required to pay on such deposits, management does not believe that the impact should be material. Deposits at all of the Corporation’s banking subsidiaries are federally insured and this is expected to mitigate the effect of a downgrade in credit ratings. 2007 Annual Report 45 2007 2007 Popular, Inc. 2007 2007 Borrowings Liquidity on the liability side is also generated through the ability to obtain wholesale funding through a variety of sources, including advances from FHLB, federal funds purchased, repurchase agreements whereby investment securities and loans are pledged as collateral, and advances under lines of credit with correspondent banks, among other sources. Borrowings at the banking subsidiaries, excluding intercompany balances between the three entities, amounted to $6.2 billion at December 31, 2007, compared with $8.1 billion at December 31, 2006. The use of borrowings was decreased substantially at the banking subsidiaries during 2007. Management decided to eliminate the use of unsecured short-term borrowings, primarily by raising deposits. Another strategy implemented by management during the second half of 2007 included the utilization of unpledged liquid assets to raise financing in the repo markets, the proceeds of which were also used to pay off unsecured borrowings. Short- term unsecured borrowings at the banking subsidiaries excluding intercompany balances between the three entities were reduced from $3.8 billion at December 31, 2006 to $626 million at December 31, 2007, which represents a decrease of $3.2 billion or 84%. Outstanding repurchase agreements at the banking subsidiaries, also excluding the intercompany balances between the three entities, were $3.8 billion at December 31, 2007, an increase of $384 million or 11%, when compared to December 31, 2006. The Corporation’s banking subsidiaries have the ability to borrow funds from the FHLB at competitive prices. At December 31, 2007, the banking subsidiaries had short-term and long-term credit facilities authorized with the FHLB aggregating $2.6 billion based on assets pledged with the FHLB at that date. Outstanding borrowings under these credit facilities totaled $1.7 billion at December 31, 2007, compared with $781 million at year-end 2006. Such advances are collateralized by securities and mortgage loans and do not have restrictive covenants. Refer to Note 17 to the consolidated financial statements for additional information. At December 31, 2007, the banking subsidiaries had a borrowing capacity at the FED discount window of approximately $3.0 billion, which remained unused, compared with $2.9 billion at December 31, 2006. This facility is a collateralized source of credit that is highly reliable even under difficult market conditions. The amount available under this line is dependent upon the balance of loans and securities pledged as collateral. Bank Holding Companies Bank Holding Companies Bank Holding Companies Bank Holding Companies Bank Holding Companies The principal sources of funding for the holding companies have included dividends received from its banking and non-banking subsidiaries and proceeds from the issuance of medium-term notes, commercial paper, junior subordinated debentures and equity. 46 Banking laws place certain restrictions on the amount of dividends a bank may make to its parent company. Such restrictions have not had, and are not expected to have, any material effect on the Corporation’s ability to meet its cash obligations. The principal uses of these funds include the repayment of maturing debt, dividend payments to shareholders and subsidiary funding through capital or debt. The Corporation’s bank holding companies (“BHCs”, Popular, Inc., Popular North America and Popular International Bank, Inc.) have borrowed in the money markets and the corporate debt market primarily to finance their non-banking subsidiaries. The recent restructuring and asset sales related to the Corporation’s U.S. non-banking business will substantially reduce the BHC’s need for capital markets borrowings in the future. However, it may pursue such transactions if market conditions are sufficiently favorable, to sell assets or refund maturing debt. Current conditions have made market access more uncertain. As an alternative to capital markets financing, the Corporation worked on several initiatives to ensure that adequate funding sources are available, notwithstanding potential market conditions. At December 31, 2007, the BHCs had borrowings (excluding intercompany balances) maturing as indicated in the table below: (In thousands) 2008 2009 2010 2011 2012 and thereafter $1,736,802 914,843 2,000 1,000 1,123,305 $3,777,950 The BHCs renewed a revolving credit agreement in October 2007. This facility was used as backup for the Corporation’s commercial paper program, which was a source of short-term funding. Due to adverse market conditions, the size of the facility was reduced from $555 million at December 31, 2006 to $235 million in October 2007. In December 2007, the entire balance of commercial paper outstanding backed-up by this facility was repaid and the revolving credit facility was terminated. During the fourth quarter of 2007, the Corporation successfully completed a capital markets-based financing and issued $275 million of its 6.85% senior notes maturing in December 2012. These funds were used to repay short-term borrowings. Also, the Corporation successfully negotiated a committed credit facility with a leading global banking institution, whereby the Corporation can borrow up to $500 million secured by PFH loans eligible per terms under the credit line agreement. This credit line is intended to serve as a contingent source of readily-available liquidity, and matures in November 2008. The BHCs have additional sources of liquidity available, in the form of credit facilities available from affiliate banking subsidiaries and third party providers, as well as dividends that can be paid by the subsidiaries and assets that could be sold or financed. N o n - b a n k i n g s u b s i d i a r i e s N o n - b a n k i n g s u b s i d i a r i e s N o n - b a n k i n g s u b s i d i a r i e s N o n - b a n k i n g s u b s i d i a r i e s N o n - b a n k i n g s u b s i d i a r i e s The principal sources of funding for the non-banking subsidiaries include internally generated cash flows from operations, borrowed funds from the holding companies or their direct parent companies, wholesale funding and asset securitizations, loan sales repurchase agreements and warehousing lines of credit. The principal uses of funds for the non-banking subsidiaries include loan portfolio growth, repayment of maturing debt and operational needs. The Corporation, as a result of previously announced U.S. restructuring initiatives and expected asset sales, has exited its PFH non-banking lending businesses. Consequently, what will remain is primarily a discontinued business line, principally with a portfolio of mortgage and consumer loans which is running off. The financing required for this remaining business is expected to be minimal. Any operating cash needs that may be required by the discontinued business are expected to be provided by funding from affiliates. Additional sources of liquidity can be provided by asset sales and secured financings. The Corporation, acting as servicer in certain securitization transactions, is required under certain servicing agreements to advance its own funds to meet contractual remittance requirements for investors, process foreclosures and pay property taxes and insurance premiums. Funds are also advanced to maintain and market real estate properties on behalf of investors. As the servicer, the Corporation is required to advance funds only to the extent that it believes the advances are recoverable. The advances have the highest standing in terms of repayment priority over payments made to bondholders of each securitization trust. Servicing advance requirements have increased in 2007 primarily as a result of slower prepayment rates and higher delinquency levels. The Corporation funds these advances from several internal and external funding sources. Other Funding Sources Other Funding Sources Other Funding Sources Other Funding Sources Other Funding Sources The Corporation may also raise funding through approved, but uncommitted revolving lines of credit or federal funds lines with authorized counterparties. These lines are available at the option of the counterparty. The investment securities portfolio provides an additional source of liquidity, which may be created through either securities sales or repurchase agreements. The Corporation’s portfolio consists primarily of liquid U.S. Treasury and government sponsored agency securities that can be used to raise funds in the 2007 Annual Report 47 2007 2007 Popular, Inc. 2007 2007 Table L Table L Table L Table L Table L Maturity Distribution of Earning Assets (In thousands) Money market securities Investment and trading securities Loans: Commercial Construction Lease financing Consumer Mortgage Total As of December 31, 2007 Maturities After one year through five years After five years Fixed interest rates Variable interest rates Fixed interest rates Variable interest rates $3,494,566 $128,169 $2,302,180 2,602,186 21,734 674,842 1,710,400 1,721,474 2,691,172 631,303 398,694 339,714 1,289,815 15,219 9,028 200,086 2,217,324 $1,902,719 12,286 342,252 326,036 One year or less $1,006,712 3,808,688 5,199,899 1,260,830 480,569 3,033,168 2,830,252 Total $1,006,712 9,733,603 13,685,791 1,941,372 1,164,439 5,684,600 7,434,800 $17,620,118 $10,225,202 $4,189,052 $6,033,652 $2,583,293 $40,651,317 Notes: Equity securities available-for-sale and other investment securities, including Federal Reserve Bank stock and Federal Home Loan Bank stock held by the Corporation, are not included in this table. Loans held-for-sale have been allocated according to the expected sale date. repo markets. At December 31, 2007, the investment and trading securities portfolios, as shown in Table L, totaled $9.7 billion, of which $3.8 billion, or 39%, had maturities of one year or less. Mortgage-related investments in Table L are presented based on expected maturities, which may differ from contractual maturities, since they could be subject to prepayments. The availability of the repurchase agreement would be subject to having sufficient available un-pledged collateral at the time the transactions are to be consummated. The Corporation’s un-pledged investment and trading securities, excluding other investment securities, amounted to $1.9 billion as of December 31, 2007. A substantial portion of these securities could be used to raise financing quickly in the U.S. money markets. Additional liquidity may be provided through loan maturities, prepayments and sales. The loan portfolio can also be used to obtain funding in the capital markets. In particular, mortgage loans and some types of consumer loans, have secondary markets which the Corporation may use. The maturity distribution of the loan portfolio as of December 31, 2007 is presented in Table L. As of that date, $12.8 billion or 43% of the loan portfolio was expected to mature within one year. The contractual maturities of loans have been adjusted to include prepayments based on historical data and prepayment trends. Another potential source of funding is the issuance of shares of common or preferred stock, or hybrid securities. Risks to Liquidity Risks to Liquidity Risks to Liquidity Risks to Liquidity Risks to Liquidity The importance of the Puerto Rico market for the Corporation is an additional risk factor that could affect its financing activities. In the case of an extended economic slowdown in Puerto Rico, the credit quality of the Corporation could be affected and, as a result of higher credit costs, profitability may decrease. The substantial integration of Puerto Rico with the U.S. economy may limit the probability of a prolonged recession in Puerto Rico, but a U.S. recession, concurrently with a slowdown in Puerto Rico, may make a recovery in the local economic cycle more challenging. Factors that the Corporation does not control, such as the economic outlook of its principal markets and regulatory changes, could affect its ability to obtain funding. In order to prepare for the possibility of such a scenario, management has adopted contingency plans for raising financing under stress scenarios when important sources of funds that are usually fully available, are temporarily unavailable. These plans call for using alternate funding mechanisms such as the pledging or securitization of certain asset classes and accessing committed credit lines and loan facilities put in place with the FHLB, leading commercial banks and the FED. The Corporation has a substantial amount of assets available for raising funds through these channels and is confident that it has adequate alternatives to rely on under a scenario where some primary funding sources are temporarily unavailable. Total lines of credit outstanding are not necessarily a measure of the total credit available on a continuing basis. Certain of these 48 Table M Table M Table M Table M Table M Average Total Deposits (Dollars in thousands) 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2006 2005 2004 2003 Five-Year C.G.R. Non-interest bearing demand deposits $ 4 , 0 4 3 , 4 2 7 $ 4 , 0 4 3 , 4 2 7 $ 4 , 0 4 3 , 4 2 7 $ 4 , 0 4 3 , 4 2 7 $ 4 , 0 4 3 , 4 2 7 $3,969,740 $4,068,397 $3,918,452 $3,495,099 4.62% Savings accounts NOW, money market and other interest 5 , 6 9 7 , 5 0 9 5 , 6 9 7 , 5 0 9 5 , 6 9 7 , 5 0 9 5 , 6 9 7 , 5 0 9 5 , 6 9 7 , 5 0 9 5,440,101 5,676,452 5,407,600 5,190,527 3.60 bearing demand accounts 4 , 4 2 9 , 4 4 8 4 , 4 2 9 , 4 4 8 4 , 4 2 9 , 4 4 8 4 , 4 2 9 , 4 4 8 4 , 4 2 9 , 4 4 8 3,877,678 3,731,905 2,965,941 2,550,480 12.10 For the Year Certificates of deposit: Under $100,000 $100,000 and over Certificates of deposit Other time deposits 3 , 9 4 9 , 2 6 2 3 , 9 4 9 , 2 6 2 3 , 9 4 9 , 2 6 2 3 , 9 4 9 , 2 6 2 3 , 9 4 9 , 2 6 2 5 , 9 2 8 , 9 8 3 5 , 9 2 8 , 9 8 3 5 , 9 2 8 , 9 8 3 5 , 9 2 8 , 9 8 3 5 , 9 2 8 , 9 8 3 9 , 8 7 8 , 2 4 5 9 , 8 7 8 , 2 4 5 9 , 8 7 8 , 2 4 5 9 , 8 7 8 , 2 4 5 9 , 8 7 8 , 2 4 5 1 , 5 2 0 , 4 7 1 1 , 5 2 0 , 4 7 1 1 , 5 2 0 , 4 7 1 1 , 5 2 0 , 4 7 1 1 , 5 2 0 , 4 7 1 3,768,653 4,963,534 8,732,187 1,244,426 3,382,445 4,266,983 7,649,428 1,126,887 3,067,220 3,144,173 6,211,393 905,669 2,877,946 2,881,836 5,759,782 762,080 Total interest bearing deposits 2 1 , 5 2 5 , 6 7 3 2 1 , 5 2 5 , 6 7 3 2 1 , 5 2 5 , 6 7 3 2 1 , 5 2 5 , 6 7 3 2 1 , 5 2 5 , 6 7 3 19,294,392 18,184,672 15,490,603 14,262,869 7.05 15.23 11.52 15.10 9.37 Total deposits $ 2 5 , 5 6 9 , 1 0 0 $ 2 5 , 5 6 9 , 1 0 0 $ 2 5 , 5 6 9 , 1 0 0 $ 2 5 , 5 6 9 , 1 0 0 $ 2 5 , 5 6 9 , 1 0 0 $23,264,132 $22,253,069 $19,409,055 $17,757,968 8.53% lines could be subject to collateral requirements, standards of creditworthiness, leverage ratios and other regulatory requirements, among other factors. Maintaining adequate credit ratings on Popular’s debt obligations is an important factor for liquidity, because the credit ratings influence the Corporation’s ability to borrow, the cost at which it can raise financing and access to funding sources. The credit ratings are based on the financial strength, credit quality and concentrations in the loan portfolio, the level and volatility of earnings, capital adequacy, the quality of management, the liquidity of the balance sheet, the availability of a significant base of core retail and commercial deposits, and the Corporation’s ability to access a broad array of wholesale funding sources, among other factors. Changes in the credit rating of the Corporation or any of its subsidiaries to a level below “investment grade” may affect the Corporation’s ability to raise funds in the capital markets. The Corporation’s counterparties are sensitive to the risk of a rating downgrade. In the event of a downgrade, it may be expected that the cost of borrowing funds in the institutional market would increase. In addition, the ability of the Corporation to raise new funds or renew maturing debt may be more difficult. In December 2007, Moody’s Investor Service (“Moodys”) downgraded by one notch to “A3”, the senior debt rating of the Corporation and reduced the short-term rating to “P-2”. The ratings were put on “watch negative”, which implies that within a short period of time there was the possibility of an additional downgrade. The funding challenges at the bank holding company as well as the profitability of the U.S. business were given as the primary concerns underlying the downgrades. In January 2008, Moodys upgraded the ratings outlook to “stable” and removed the ratings watch which had been in effect. Initiatives executed by management to address the bank holding companies’ funding challenges were cited as prompting the change, although the profitability of the U.S. business continues to be a ratings concern. After the end of the third quarter of 2007, Fitch Ratings reduced the short-term credit rating of Popular, Inc. and Popular North America, Inc. to “F-2” from “F-1”, and placed their long-term senior debt rating of “A-” on negative rating watch. Fitch Ratings mentioned that the rating actions reflected credit quality pressures from our sub-prime loan exposure as well as a more difficult environment for bank holding company funding. In both cases, Fitch Ratings maintained that it believes that both situations are challenging but manageable. In January 2008, Fitch Ratings announced that it was affirming the Corporation’s senior debt rating at “A-” as well as removing the rating from “watch negative”. The outlook was maintained “negative”. Management actions related to bank holding company liquidity were highlighted by the agency as underlying the removal of the “watch”, but U.S. business profitability concerns have kept the ratings outlook negative, until these challenges are resolved. Standard & Poor’s Rating Services (“S&P”) currently rates our debt “BBB+” for long-term debt and “A-2” for short-term obligations, both with a stable outlook. Credit ratings are an important factor in accessing the credit markets. Even though the Corporation is currently several notches above the investment-grade threshold with each of the rating agencies, the possibility of ratings downgrades can affect our ability to raise unsecured financing at competitive rates. The Corporation and BPPR’s debt ratings at December 31, 2007 were as follows: Popular, Inc. BPPR Short-term debt F-2 P-2 A-2 Fitch Moody’s S&P Long-term Short-term Long-term debt F-1 P-1 A-2 debt A- A3 BBB+ debt A- A2 A- The ratings above are subject to revisions or withdrawal at any time by the assigning rating agency. Each rating should be evaluated independently of any other rating. Some of the Corporation’s borrowings and deposits are subject to “rating triggers”, contractual provisions that accelerate the maturity of the underlying obligations in the case of a change in rating. Therefore, the need for the Corporation to raise funding in the marketplace could increase more than usual in the case of a rating downgrade. The amount of obligations subject to rating triggers that could accelerate the maturity of the underlying obligations was $38 million at December 31, 2007. In the course of borrowing from institutional lenders, the Corporation has entered into contractual agreements to maintain certain levels of debt, capital and asset quality, among other financial covenants. If the Corporation were to fail to comply with those agreements, it may result in an event of default. Such failure may accelerate the repayment of the related obligations. An event of default could also affect the ability of the Corporation to raise new funds or renew maturing borrowings. At December 31, 2007, the Corporation had $215 million in outstanding obligations subject to covenants, including those which are subject to rating triggers. At December 31, 2007, one of the Corporation’s U.S. subsidiaries was not complying with a particular covenant with respect to one credit facility. A written waiver was obtained. Obligations outstanding under this credit facility approximated $87 million at December 31, 2007, and was paid in full in February 2008. Contractual Obligations and Commercial Contractual Obligations and Commercial Contractual Obligations and Commercial Contractual Obligations and Commercial Contractual Obligations and Commercial C o m m i t m e n t s C o m m i t m e n t s C o m m i t m e n t s C o m m i t m e n t s C o m m i t m e n t s The Corporation has various financial obligations, including contractual obligations and commercial commitments, which require future cash payments on debt and lease agreements. Also, in the normal course of business, the Corporation enters into contractual arrangements whereby it commits to future purchases of products or services from third parties. Obligations that are legally binding agreements whereby the Corporation agrees to purchase products or services with a specific minimum quantity 2007 Annual Report 49 2007 2007 Popular, Inc. 2007 2007 defined at a fixed, minimum or variable price over a specified period of time are defined as purchase obligations. At December 31, 2007, the aggregate contractual cash obligations including purchase obligations and borrowings maturities were: Payments Due by Period (In millions) Less than 1 year 1 to 3 years 3 to 5 After 5 years years Total Certificates of deposit Fed funds and repurchase agreements Other short-term borrowings Long-term debt Purchase obligations Annual rental commitments under operating leases Capital leases Total contractual cash $9,911 $2,534 $854 $115 $13,414 4,038 237 1,502 1,490 170 - 1,302 67 49 1 74 3 763 - 654 29 55 3 399 5,437 - 1,175 9 1,502 4,621 275 203 19 381 26 obligations $17,161 $4,217 $2,358 $1,920 $25,656 Purchase obligations include major legal and binding contractual obligations outstanding at the end of 2007, primarily for services, equipment and real estate construction projects. Services include software licensing and maintenance, facilities maintenance, supplies purchasing, and other goods or services used in the operation of the business. Generally, these contracts are renewable or cancelable at least annually, although in some cases to secure favorable pricing concessions, the Corporation has committed to contracts that may extend for several years. As of December 31, 2007, the Corporation’s liability on its pension and postretirement benefit plans amounted to $164.0 million. During 2008, the Corporation expects to contribute $5.7 million to the pension and benefit restoration plans, and $6.3 million to the postretirement benefit plan to fund current benefit payment requirements. Obligations to these plans are based on current and projected obligations of the plans, performance of the plan assets, if applicable, and any participant contributions. Refer to Note 24 to the consolidated financial statements for further information on these plans. Management believes the effect of the pension and postretirement plans on liquidity is not significant to the Corporation’s overall financial condition. As of December 31, 2007, the liability for uncertain tax positions, excluding associated interest and penalties, was $22.2 million pursuant to FIN No. 48, which was described in the Critical Accounting Policies section. This liability represents an estimate of tax positions that the Corporation has taken in its tax returns which may ultimately not be sustained upon examination by the tax authorities. The ultimate amount and 50 timing of any future cash settlements cannot be predicted with reasonable certainty. Under the statute of limitation, the liability for uncertain tax positions expire as follows: 2008 - $2.3 million, 2009 - $4.2 million, 2010 - $4.4 million, 2011 - $5.9 million and 2012 - $5.4 million. A number of business and asset acquisition agreements to which the Corporation is a party may require the Corporation to make contingent payments in future years if certain predetermined goals, such as revenue or loan origination targets, are achieved within a specified time. Management estimates that the maximum future payments under these agreements at December 31, 2007 approximated $5.8 million. The Corporation also utilizes lending-related financial instruments in the normal course of business to accommodate the financial needs of its customers. The Corporation’s exposure to credit losses in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, standby letters of credit and commercial letters of credit is represented by the contractual notional amount of these instruments. The Corporation uses credit procedures and policies in making those commitments and conditional obligations as it does in extending loans to customers. Since many of the commitments may expire without being drawn upon, the total contractual amounts are not representative of the Corporation’s actual future credit exposure or liquidity requirements for these commitments. At December 31, 2007 the contractual amounts related to the Corporation’s off-balance sheet lending and other activities were: Amount of Commitment – Expiration Period Less than 1 year 1 to 3 3 to 5 After 5 years years years Total $6,240 $1,149 $370 $151 $7,910 (In millions) Commitments to extend credit Commercial letters of credit Standby letters of credit Commitments to originate mortgage loans Unfunded investment obligations 25 145 95 - 1 27 18 7 2 - - - - - - 32 26 174 113 39 The Corporation is a member of the Visa USA network through its subsidiary BPNA. On October 3, 2007, the Visa organization completed a series of restructuring transactions to combine its affiliated operating companies, including Visa USA, under a single holding company, Visa, Inc. As a result of Visa’s restructuring, the Corporation’s membership interest in Visa USA was exchanged for an approximately 0.00874% equity interest in Visa Inc. Class USA stock. On November 11, 2007, Visa Inc. filed a registration statement with the Securities and Exchange Commission for the offer and sale of its common stock to the public. Visa has disclosed that it plans to use the proceeds from its initial public offering to partially redeem Visa USA members’ equity interests and to fund the settlement of certain Visa USA related litigation. Pursuant to the Visa USA bylaws, BPNA is obligated to indemnify Visa, Inc. for certain losses. On October 3, 2007, a Loss Sharing Agreement (“LSA”) became effective which reaffirmed the Corporation’s obligation to indemnify Visa, Inc. for potential future settlement of certain litigation. The Corporation’s indemnification obligation is limited to its 0.00874% proportionate equity interest in Visa USA. The Corporation recorded an estimated liability related to its obligation to indemnify Visa for covered litigation of $223 thousand as of December 31, 2007. If the Visa initial public offering is successfully completed, the Corporation is expected to receive cash in partial redemption of its equity interest currently carried at zero value. Further, management expects that the indemnification obligation to Visa will be reduced when Visa either disburses funds for negotiated settlements, or funds an escrow account designated for settlement of covered litigation. Management expects that the gain to be realized from redemption of Visa shares will more than exceed the indemnification obligations recorded to date. BPPR is a member of Visa International, as such is not impacted by the indemnification obligation. Refer to the notes to the consolidated financial statements for further information on the Corporation’s contractual obligations, commercial commitments, and derivative contracts. Total $6,505 $1,202 $372 $183 $8,262 The Corporation also enters into derivative contracts under which it is required either to receive cash or pay cash, depending on changes in interest rates. These contracts are carried at fair value on the consolidated statements of condition with the fair value representing the net present value of the expected future cash receipts and payments based on market rates of interest as of the statement of condition date. The fair value of the contract changes daily as interest rates change. Credit Risk Management and Loan Quality Credit Risk Management and Loan Quality Credit Risk Management and Loan Quality Credit Risk Management and Loan Quality Credit Risk Management and Loan Quality Credit risk represents the possibility of loss from the failure of a borrower or counterparty to perform according to the terms of a credit-related contract. Credit risk arises primarily from the Corporation’s lending activities, as well as from other on- and off-balance sheet credit instruments. Credit risk management is based on analyzing the creditworthiness of the borrower, the adequacy of underlying collateral given current events and conditions, and the existence and strength of any guarantor support. 2007 Annual Report 51 2007 2007 Popular, Inc. 2007 2007 The Corporation manages credit risk by maintaining sound underwriting standards, monitoring and evaluating loan portfolio quality, its trends and collectibility, and assessing reserves and loan concentrations. Also, credit risk is mitigated by recruiting qualified and highly skilled credit officers, implementing and monitoring lending policies and collateral requirements, and instituting credit review procedures to ensure appropriate actions to comply with laws and regulations. The Corporation’s credit policies require prompt identification and quantification of asset quality deterioration or potential loss in order to ensure the adequacy of the allowance for loan losses. Included in these policies, primarily determined by the amount, type of loan and risk characteristics of the credit facility, are various approval levels and lending limit constraints, ranging from the branch or department level to those that are more centralized. When considered necessary, the Corporation requires collateral to support credit extensions and commitments, which is generally in the form of real estate and personal property, cash on deposit and other highly liquid instruments. At December 31, 2007, the Corporation’s credit exposure was centered in its $29.9 billion total loan portfolio, which represented 73% of its earning assets. The portfolio composition for the last five years is presented in Table G. The Corporation’s Credit Strategy Committee (“CRESCO”) oversees all credit-related activities and is responsible for managing the Corporation’s overall credit exposure and developing credit policies, standards and guidelines that define, quantify, and monitor credit risk. Through the CRESCO, management reviews asset quality ratios, trends and forecasts, problem loans, evaluates the provision for loan losses and assesses the methodology and adequacy of the allowance for loan losses on a monthly basis. The analysis of the allowance adequacy is presented to the Risk Management Committee of the Board of Directors for review, consideration and ratification on a quarterly basis. The Corporation also has a Corporate Credit Risk Management Division (“CCRMD”), which is centralized and independent of the lending function. It oversees the credit risk rating system and reviews the adequacy of the allowance for loan losses in accordance with generally accepted accounting principles (“GAAP”) and regulatory standards. In addition, there is a Credit Risk Management (“CRM”) function at the Corporation's Puerto Rico and U.S. mainland operations. The CCRMD’s functions include managing and controlling the Corporation’s credit risk, which is accomplished through various techniques applied at different stages of the credit-granting process. A CRM representative, who is a permanent member of the Executive Credit Committee, oversees adherence to policies and procedures established for the initial underwriting of the credit portfolio. Also, the CRM performs ongoing monitoring of the portfolio, including potential areas of concern for specific borrowers and / or geographic regions. The CRM strives to identify problem loans early and has specialized workout officers, who are independent of the originating unit, that handle substantially all commercial loans which are past due over 90 days, have filed bankruptcy, or are considered problem loans based on their risk profile. The Corporation also has a Credit Process Review Group within the CRM, which performs annual comprehensive credit process reviews of several middle markets, construction, asset-based and corporate banking lending groups in BPPR. This group evaluates the credit risk profile of each originating unit along with each unit’s credit administration effectiveness, including the assessment of the risk rating representative of the current credit quality of the loans, and the evaluation of collateral documentation. The monitoring performed by this group contributes to assess compliance with credit policies and underwriting standards, determine the current level of credit risk, evaluate the effectiveness of the credit management process and identify control deficiencies that may arise in the credit-granting process. Based on its findings, the Credit Process Review Group recommends corrective actions, if necessary, that help in maintaining a sound credit process. CCRMD has contracted an outside loan review firm to perform the credit process reviews in the U.S. mainland operations. The CCRMD and CRM participate in defining the review plan with the outside loan review firm and actively participate in the discussions of the results of the loan reviews with the business units. The CRM may periodically review the work performed by the outside loan review firm. CRM reports the results of the loan process reviews to the Audit Committee of the Corporation’s Board of Directors. Beginning in 2008, the loan review function for the U.S. mainland operations will have an internal officer in charge of this process. The loan review plan for 2008 will be conducted by this internal resource in a joint effort with the outside loan review firm. The Corporation issues certain credit-related off-balance sheet financial instruments including commitments to extend credit, standby letters of credit and commercial letters of credit to meet the financing needs of its customers. For these financial instruments, the contract amount represents the credit risk associated with failure of the counterparty to perform in accordance with the terms and conditions of the contract, and the decline in value of the underlying collateral. The credit risk associated with these financial instruments varies depending on the counterparty’s creditworthiness and the value of any collateral held. Refer to Note 28 to the consolidated financial statements and to the Contractual Obligations and Commercial Commitments section of this MD&A for the Corporation’s involvement in these credit-related activities. The Corporation is also exposed to credit risk by using derivative instruments, but manages the level of risk by only 52 dealing with counterparties of good credit standing, entering into master netting agreements whenever possible and, when appropriate, obtaining collateral. Refer to Note 30 to the consolidated financial statements for further information on the Corporation’s involvement in derivative instruments and hedging activities. The Corporation manages the exposure to a single borrower, industry or product type through participations and loan sales. The Corporation maintains a diversified portfolio intended to spread its risk and reduce its exposure to economic downturns, which may occur in different segments of the economy or in particular industries. Industry and loan type diversification is reviewed quarterly. The Corporation’s credit risk exposure is spread among individual consumers, small and medium businesses, as well as corporate borrowers engaged in a wide variety of industries. Only 327 of these commercial lending relationships have credit relations with an aggregate exposure of $10 million or more. Highly leveraged transactions and credit facilities to finance speculative real estate ventures are minimal, and there are no loans to less developed countries. The Corporation limits its exposure to concentrations of credit risk by the nature of its lending limits. The Corporation has made a substantial number of loans to subprime borrowers mainly through its subsidiary PFH. The actual rates of delinquencies, foreclosures and losses on these loans could be higher during economic slowdowns. Rising unemployment, higher interest rates or declines in housing prices tend to have a greater negative effect on the ability of such borrowers to repay their mortgage loans. All the factors mentioned above also impact the value of residual interests created as a result of off-balance sheet securitizations conducted through PFH. Refer to the Overview of Mortgage Loan Exposure section for further information. Geographical and Government Risk Geographical and Government Risk Geographical and Government Risk Geographical and Government Risk Geographical and Government Risk The Corporation is also exposed to geographical and government risk. The Corporation’s assets and revenue composition by geographical area and by business segment is presented in Note 32 to the consolidated financial statements. A significant portion of the Corporation’s financial activities and credit exposure is concentrated in Puerto Rico. Consequently, its financial condition and results of operations are dependent on the Island’s economic conditions. An extended economic slowdown or recessionary cycle, adverse political or economic developments in Puerto Rico or natural disasters, such as hurricanes affecting the Island, could result in a downturn in loan originations, an increase in the level of non-performing assets, an increase in the rate of foreclosure loss on mortgage loans and a reduction in the value of the Corporation’s loans and loan servicing portfolio, all of which would adversely affect the Corporation’s profitability and financial condition. The economy of Puerto Rico continued deteriorating during 2007. The weak fiscal position of the P.R. Government and strained consumer finances, which were impacted by the effects of rising unemployment rates, oil prices, utilities and taxes, among others, affected the P.R. economy considerably. The current state of the economy and uncertainty in the private and public sectors has had an adverse effect on the credit quality of the Corporation’s loan portfolios. A prolonged economic slowdown, which has led to a recessionary cycle could cause those adverse effects to continue, as delinquency rates may continue to increase in the short-term until more sustainable growth resumes. Even though Puerto Rico’s Government and many of its instrumentalities are investment-grade rated borrowers in the U.S. capital markets, the current fiscal situation of the Puerto Rico ("P.R. Government") led nationally recognized rating agencies to downgrade the credit rating of the P.R. Government's debt obligations during 2006. In November 2007, Moody’s changed the outlook of the P.R. Government’s credit ratings to “stable” from “negative”. In justifying its change in outlook, Moody’s recognized the progress the P.R. Government has made in addressing the fiscal challenges it has faced in recent years. In particular, it mentioned the controls imposed on public spending and the implementation of the sales tax as two favorable developments. The rating agencies have maintained the negative outlook for the Puerto Rico obligation bonds. Factors, such as the government’s ability to implement meaningful steps to curb operating expenditures, improve managerial and budgetary controls, and eliminate the government’s reliance on loans from the Government Development Bank of Puerto Rico to cover budget deficits, will be key determinants of future rating changes. At December 31, 2007, the Corporation had $1.0 billion of credit facilities granted to or guaranteed by the P.R. Government and its political subdivisions, of which $150 million were uncommitted lines of credit. Of these total credit facilities granted, $914 million in loans were outstanding at December 31, 2007. A substantial portion of the Corporation’s credit exposure to the Government of Puerto Rico are either collateralized loans or obligations that have a specific source of income or revenues identified for its repayment. Some of these obligations consist of senior and subordinated loans to public corporations that obtain revenues from rates charged for services or products, such as water and electric power utilities. Public corporations have varying degrees of independence from the Central Government and many receive appropriations or other payments from it. The Corporation also has loans to various municipalities for which the good faith, credit and unlimited taxing power of the applicable municipality has been pledged to their repayment. These municipalities are required by law to levy special property taxes in such amounts as 2007 Annual Report 53 2007 2007 Popular, Inc. 2007 2007 shall be required for the payment of all of its general obligation bonds and loans. Another portion of these loans consists of special obligations of various municipalities that are payable from the basic real and personal property taxes collected within such municipalities. The good faith and credit obligations of the municipalities have a first lien on the basic property taxes. Furthermore, as of December 31, 2007, the Corporation had outstanding $178 million in Obligations of Puerto Rico, States and Political Subdivisions as part of its investment portfolio. Refer to Notes 6 and 7 to the consolidated financial statements for additional information. Of that total, $155 million was exposed to the creditworthiness of the P.R. Government and its municipalities. Of that portfolio, $55 million was in the form of Puerto Rico Commonwealth Appropriation Bonds, which are currently rated Ba1, one notch below investment grade, by Moody’s, while Standard & Poor’s Rating Services ("S&P") rates them as investment grade. At December 31, 2007, the Appropriation Bonds represented approximately $1.8 million in unrealized losses in the Corporation’s portfolio of investment securities available-for-sale. The Corporation is closely monitoring the political and economic situation of the Island and evaluates the portfolio for any declines in value that management may consider being other-than-temporary. Management has the intent and ability to hold these investments for a reasonable period of time or up to maturity for a forecasted recovery of fair value up to (or beyond) the cost of these investments. As further detailed in Notes 6 and 7 to the consolidated financial statements, a substantial portion of the Corporation’s investment securities represented exposure to the U.S. Government in the form of U.S. Treasury securities and obligations of U.S. Government sponsored entities. In addition, $134 million of residential mortgages and $352 million in commercial loans were insured or guaranteed by the U.S. Government or its agencies at December 31, 2007. Overview of Mortgage Loan Exposure Overview of Mortgage Loan Exposure Overview of Mortgage Loan Exposure Overview of Mortgage Loan Exposure Overview of Mortgage Loan Exposure Deteriorating conditions in the U.S. mainland housing market and, to a lesser extent, in Puerto Rico accelerated throughout 2007. As many lenders have been forced out of business or have severely curtailed their operations and most remaining lenders have increased nonconforming mortgage interest rates and tightened underwriting standards, many borrowers, particularly subprime borrowers and borrowers in markets with declining housing prices, have been unable to refinance existing loans. Borrowers in markets with declining housing prices may find themselves unable to refinance their loans, as a result of diminished equity in their homes. In a stressed housing market with increasing delinquencies and declining housing prices, such as currently exists, the adequacy of collateral securing the loan becomes a much more important factor in determining future loan performance, as a borrower with more equity in the property has a greater vested interest in keeping the loan current than a borrower with little to no equity in the property. Also, in the event that the Corporation has to foreclose on a property, the extent to which the outstanding balance on the loan exceeds the collateral value will determine the severity of loss. The residential mortgage loan origination business has historically been cyclical, with periods of strong growth and profitability followed by periods of shrinking volumes and industry-wide losses. Because the Corporation made loans to borrowers that have FICO® scores of 660 or below, the actual rates of delinquencies, foreclosures and losses on these loans could be higher during economic slowdowns. Rising unemployment, higher interest rates, declines in housing prices and an overall tightening of credit standards by lenders tend to have a greater negative effect on the ability of such borrowers to repay their mortgage loans. The following table provides information on the Corporation’s mortgage loan exposure for loans held-in-portfolio, (thus excluding loans held-for-sale) at December 31, 2007. Subprime mortgage loans refer to mortgage loans made to individuals with a FICO® score of 660 or below. FICO® scores are used as an indicator of the probability of default for loans. (In billions) Banco Popular de Puerto Rico Banco Popular North America Popular Financial Holdings: - Owned-in-trust - Owned - originated through wholesale channels ("centralized") - Owned - originated through consumer branches Sub-total Other not classified as prime or subprime loans Total Popular, Inc. Prime Subprime loans $1,119 510 loans $1,236 1,199 Total $2,355 1,709 57 229 286 199 74 $1,959 716 69 $3,449 915 143 5,408 663 $6,071 Mortgage loans held-in-portfolio that are considered subprime under the above definition for the Banco Popular de Puerto Rico reportable segment approximated 42% of its total mortgage loans held-in-portfolio as of December 31, 2007. The Corporation, however, believes that the particular characteristics of BPPR’s subprime portfolio limit its exposure under current market conditions. BPPR’s loans are fixed-rate fully amortizing, full- documentation loans that do not have the level of layered risk associated with subprime loans offered by certain major U.S. mortgage loan originators. Deteriorating economic conditions have impacted the mortgage delinquency rates in Puerto Rico increasing the levels of non-accruing mortgage loans. However, BPPR has not to date experienced significant increases in losses. The annualized ratio of mortgage loans net charge-offs to average 54 mortgage loans held-in-portfolio for this subprime portfolio was 0.04% for the year ended December 31, 2007. BPNA’s mortgage loans held-in-portfolio considered subprime under the above definition, isolating E-LOAN, approximated 71% of its total mortgage loans held-in-portfolio as of December 31, 2007. This portfolio has principally two products - either 7/1 ARMs (fixed-rate interest until end of year seven in which interest rate begins to reset annually until maturity) or 30 years fixed-rate mortgages that do not have the level of layered risk associated with subprime loans offered by certain major U.S. mortgage loan originators. For example, BPNA’s subprime mortgage loan portfolio has minimal California market exposure, loans are underwritten to the fully indexed rate, and there are no interest- only, piggybacks or option ARM loans (Refer to Glossary for general descriptions of these loan types). Furthermore, the loans are 100% owner occupied. Also, the first interest rate reset on the 7/1 ARMs is not until 2012. Deteriorating economic conditions in the U.S. mainland housing market have impacted the mortgage industry delinquency rates; however, the levels of non-accruing mortgage loans in BPNA’s subprime mortgage portfolio have been lower than PFH’s subprime mortgage portfolio. The non-accruing loans to loans held-in-portfolio ratio for BPNA’s subprime mortgage loans was 3.67% at December 31, 2007. The annualized ratio of mortgage loans net charge-offs to average mortgage loans held-in-portfolio for this subprime portfolio was 1.28% for the year ended December 31, 2007. As a result of higher delinquency and net charge-offs experience, BPNA recorded a higher provision for loan losses in the fourth quarter of 2007 to cover for inherent losses in this portfolio. The average loan to value (“LTV”) at December 31, 2007 in BPNA’s portfolio was 89.36%. Effective late December 2007, BPNA launched several initiatives designed to reduce the overall credit exposure in the portfolio that involve the purchase, by either the borrower or BPNA, of private mortgage insurance. Mortgage loans held-in-portfolio for PFH, excluding Popular FS, that are considered subprime approximated 73% of its total mortgage loans held-in-portfolio as of December 31, 2007. In the past, PFH originated mortgage loans through various channels including bulk acquisitions, mortgage loan brokers and its retail branch network. As part of the PFH Restructuring Plan, PFH ceased originating loans through all channels except for loans originated directly through its consumer finance branches and the customer loan center. This resulted in a significant reduction in total originations of mortgage loans at PFH during 2007. Also, as a result of the loan recharacterization transaction discussed previously, the Corporation reduced its exposure to subprime mortgage loans by the end of 2007. The loan recharacterization transaction contributed with a reduction of approximately $2.4 billion in subprime mortgages based on portfolio data reported in the Corporation’s Form 10-Q as of September 30, 2007. Also, as indicated in the Events Subsequent to Year-End 2007 section of this MD&A, during December 2007, the Corporation reclassified approximately $1.4 billion carrying amount in mortgage and consumer loans originated through PFH’s consumer branches from loans held-in-portfolio to loans held-for-sale with the intent to sell these loans by the end of the first quarter of 2008. Since the exposure in this held-for-sale portfolio is short-term and a sales price was set with the prospective buyer, these loans are excluded from the previous tabular presentation which segregates prime and subprime mortgage loans. The prospective sale of this consumer branch portfolio is expected to reduced the Corporation’s subprime mortgage loan exposure in its portfolio of loans to be held until maturity by over $700 million. Approximately $287 million of the loans held-in-portfolio by PFH as of December 31, 2007 were identified as “owned-in-trust” for purposes of these disclosures. These loans were pledged as collateral for asset-backed securities issued by the Corporation (in the form of bond certificates) as a financing vehicle through on-balance sheet securitization transactions. Because these loan securitizations did not meet the sale criteria under SFAS No. 140, the transactions were treated as on-balance sheet securitizations for accounting purposes. These “owned-in-trust” loans do not pose the same magnitude of risk to the Corporation as those loans owned outright because the potential losses related to “owned-in- trust” loans above overcollaterization levels will be borne by the holde rs o f t he b onds and no t by t he C o rpora tion . Overcollateralization is defined as a type of credit enhancement by which an issuer of bond certificates pledges mortgage loans as collateral in excess of the principal amount of bond certificates issued to cover possible losses. As of December 31, 2007, the collateral balance on the five securitizations deals accounted as “on-balance sheet securitizations” approximated $308 million, which exceeded the outstanding balance of the bond certificates by $24 million. The allowance for loan losses recorded for these “owned-in-trust” loans amounted to approximately $5.3 million at December 31, 2007. An additional risk factor related to the residential mortgage loan sector is the repricing of adjustable rate mortgage loans (“ARMs”). In the U.S. mortgage market, a substantial amount of ARMs were originated in recent years. These loans typically have a low fixed rate for an initial period (two or three years) and afterwards the rate “floats” or adjusts periodically based on a market rate of interest, such as LIBOR. Of PFH’s subprime mortage loans held-in-portfolio at December 31, 2007, $320 million or 32% were ARMs. Many of the ARMs currently outstanding are schedule to reset before the end of 2008. It is possible that in some of these loans, when rates adjust, there will be a substantial increase in the underlying loan payment, possibly enough to pressure the cash flow of the underlying debtor and increase the likehood of delinquency. The table below provides information on PFH’s mortgage loans held-in-portfolio segregated between owned and “owned-in-trust” loans. Owned (a) Owned-in-Trust (b) 12-31-07 12-31-06 12-31-07 12-31-06 $1,063 $925 $138 8.76% 85.59% $286 $284 $2 8.76% 81.45% $112 596 4.31% 21.35% 6.20% 2.38% 3.88% 8.89% $2,191 $1,868 $323 8.87% 82.66% $69 607 2.95% 8.66% 2.54% 0.89% 2.48% 2.75% $4,543 $4,511 $32 7.55% 83.39% $140 620 2.18% 10.93% 3.48% 1.30% 1.84% 4.31% ($ in millions) Current Balance (c) ($ in millions) First Liens Second Liens Weighted-average coupon (WAC) Avg. Loan-to-Value (LTV) (d) Avg. Loan Balance ($ in thousands) $91 606 Avg. FICO score (e) 3.81% Bankruptcy (% of $) 18.52% Total Delinquency 4.78% 30 Days (% of $) 2.41% 60 Days (% of $) 4.80% 90+ Days (% of $) 6.53% Foreclosure (% of $) Business Channel 29% Broker 24% Asset Acquisition Retail Mortgage (call centers) 7% Customer Loan Center ("CLC") (f) 23% 14% Decentralized (branches) 3% Other Product Type 60% Fixed-rate 29% ARM (Adjustable rate mortgage) 4% Balloon 1% Interest only - Fixed 6% Interest only - ARM (a) Owned portfolio - represents mortgage loans originated / acquired, but not sold / securitized. (b) Owned-in-trust - represents mortgage loans securitized in on-balance sheet securitizations, as such, are part of PFH’s portfolio under SFAS No. 140. (c) Excluding deferred fees, origination costs, net premiums and other items. (d) LTV – a lending risk ratio calculated by dividing the total amount of the mortgage or loan by the fair value of the property. The LTV presented is based on amounts at loan origination date. (e) FICO® - the Corporation uses external credit scores as a useful measure for assessing the credit quality of a borrower. These scores are numbers supplied by credit information providers, based on statistical models that summarize an individual’s credit record. FICO® scores, developed by Fair Isaac Corporation, are the most commonly used credit scores. (f) CLC - unit that anticipates possible refinancing needs of the customer and makes efforts to retain the customer by offering the company’s products. 17% 72% 6% 4% - 1% 22% 17% 5% 6% 47% 3% 53% 10% 16% 19% - 2% 35% 51% 13% - 1% 69% 20% 10% - 1% 62% 21% 16% - 1% The U.S. government and the mortgage industry have taken steps to limit the negative effects of the subprime mortgage crisis on the financial markets and the economy as a whole. Many of these initiatives have focused on lenders being able to modify mortgages so that distressed or potentially distressed debtors can continue to make payments on their mortgages. Refer to the Off-Balance Financing Entities section in this MD&A for information on certain of these market initiatives. Non-Performing Assets Non-Performing Assets Non-Performing Assets Non-Performing Assets Non-Performing Assets A summary of non-performing assets by loan categories and related ratios is presented in Table N. Non-performing assets include past-due loans that are no longer accruing interest, renegotiated 2007 Annual Report 55 2007 2007 Popular, Inc. 2007 2007 loans and real estate property acquired through foreclosure. During 2004, the Corporation adopted the standard industry practice of placing commercial and construction loans on non-accrual status if payments of principal or interest are delinquent 90 days or more, instead of 60 days or more, which was its previous policy. The level of non-performing loans has been mostly impacted by the effects of a continuing downturn in the economy of Puerto Rico and a slowdown in the U.S. economy, which has affected both the commercial and consumer sectors. The Puerto Rico economy continued to contract during 2007 as it has been impacted by consumers’ finances under stress, unemployment rates at high levels, rising operational costs which pressure businesses, caution on capital spending, slowdown in the housing market, among other factors. The growth of the U.S. economy also fell in the latter part of 2007, in part, as a result of the credit crunch that took effect in the second half of 2007. The slowdown was triggered by a slump in building activity as housing prices significanttly declined. Also, the U.S. economy faced the threats of lower consumer spending while, at the same time, addressing inflation as oil and other commodity costs were rising. With the aim of boosting the economy and avoiding a recession in the U.S. mainland, the U.S. Government approved an economic stimulus package during early 2008, which includes a series of tax rebates. The economic stimulus package, which is also applicable to Puerto Rico, is anticipated to also have a positive impact on the economy of Puerto Rico. Also, as indicated in the Net Interest Income section of this MD&A, the FED reduced its key interest rate to 3% as it tries to stimulate economic momentum. Non-performing commercial loans as of December 31, 2007 reflected an increase of $204 million from December 31, 2006, mainly due to deteriorating economic conditions in Puerto Rico and the U.S. mainland. The percentage of non-performing commercial loans to commercial loans held-in-portfolio rose from 1.09% at the end of 2006 to 2.32% at the same date in 2007. For December 31, 2005, this ratio was 1.06%. Of the total increase in non-performing commercial loans between the end of 2006 and 2007, $95 million of the increase pertained to commercial construction loans. Commercial loans considered impaired under the Corporation’s criteria for FAS 114 amounted to $322 million at December 31, 2007, compared with $208 million at the same date in 2006. Non-performing consumer loans represented 0.94%, 0.92% and 0.83% of consumer loans held-in-portfolio at December 31, 2007, 2006, and 2005, respectively. The ratio for 2007 remained at a level very close to 2006, in part, because the portfolio growth in consumer loans has been mostly in credit cards which are not placed in non-accrual status under the Corporation’s policy and in home equity lines of credit which is mostly a relatively newly originated portfolio from the 2007 vintage. The increase in this 56 Table N Table N Table N Table N Table N Non-Performing Assets (Dollars in thousands) Non-accrual loans: 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2006 As of December 31, 2005 2004 2003 Commercial (including construction) Lease financing Mortgage Consumer Total non-performing loans Other real estate Total non-performing assets Accruing loans past-due 90 days or more Non-performing assets to loans held-in-portfolio Non-performing loans to loans held-in-portfolio Non-performing assets to assets Interest lost $ 3 6 2 , 0 1 9 $ 3 6 2 , 0 1 9 $ 3 6 2 , 0 1 9 $ 3 6 2 , 0 1 9 $ 3 6 2 , 0 1 9 1 0 , 1 8 2 1 0 , 1 8 2 1 0 , 1 8 2 1 0 , 1 8 2 1 0 , 1 8 2 3 4 9 , 3 8 1 3 4 9 , 3 8 1 3 4 9 , 3 8 1 3 4 9 , 3 8 1 3 4 9 , 3 8 1 4 9 , 0 9 0 4 9 , 0 9 0 4 9 , 0 9 0 4 9 , 0 9 0 4 9 , 0 9 0 7 7 0 , 6 7 2 7 7 0 , 6 7 2 7 7 0 , 6 7 2 7 7 0 , 6 7 2 7 7 0 , 6 7 2 8 1 , 4 1 0 8 1 , 4 1 0 8 1 , 4 1 0 8 1 , 4 1 0 8 1 , 4 1 0 $ 8 5 2 , 0 8 2 $ 8 5 2 , 0 8 2 $ 8 5 2 , 0 8 2 $ 8 5 2 , 0 8 2 $ 8 5 2 , 0 8 2 $ 1 0 9 , 5 6 9 $ 1 0 9 , 5 6 9 $ 1 0 9 , 5 6 9 $ 1 0 9 , 5 6 9 $ 1 0 9 , 5 6 9 3 . 0 4 % 3 . 0 4 % 3 . 0 4 % 3 . 0 4 % 3 . 0 4 % 2 . 7 5 2 . 7 5 2 . 7 5 2 . 7 5 2 . 7 5 1 . 9 2 1 . 9 2 1 . 9 2 1 . 9 2 1 . 9 2 $ 7 1 , 0 3 7 $ 7 1 , 0 3 7 $ 7 1 , 0 3 7 $ 7 1 , 0 3 7 $ 7 1 , 0 3 7 $158,214 11,898 499,402 48,074 717,588 84,816 $802,404 $99,996 2.51% 2.24 1.69 $58,223 $133,746 2,562 371,885 39,316 547,509 79,008 $626,517 $86,662 2.02% 1.77 1.29 $46,198 $122,593 3,665 395,749 32,010 554,017 59,717 $613,734 $168,266 7,494 344,916 36,350 557,026 53,898 $610,924 $79,091 2.19% 1.98 1.38 $45,089 $75,557 2.74% 2.49 1.68 $45,541 ratio from 2005 to 2006 resulted from higher delinquency levels, partially offset by portfolio growth. Non-performing mortgage loans, which decreased by $150 million, or 30%, since December 31, 2006, represented 41% of total non-performing assets and 5.75% of total mortgage loans held-in-portfolio at December 31, 2007, compared with 62% and 4.51%, respectively, at December 31, 2006, and 59% and 3.02%, respectively, at December 31, 2005. The decline was directly related to the PFH loan recharacterization transaction which resulted in a reduction in non-performing mortgage loans of approximately $316 million, which was partially offset by increases in non-performing mortgage loans in PFH’s remaining owned portfolio, the Puerto Rico operations and BPNA in the amount of $167 million. The increase at these reportable segments was mainly due to the continued deterioration in the subprime market in the U.S. mainland, as well as higher delinquencies triggered by deteriorating economic conditions in Puerto Rico. The increase in non-performing mortgage loans since December 31, 2005 to 2006 was also due to similar factors, which were already being experienced to a lesser extent during 2006. Ratios of mortgage loans net charge-offs as a percentage of the average mortgage loans held-in-portfolio are presented later in the Allowance for Loan Losses section of this MD&A. Non-performing financing leases represented 0.93% of the lease financing portfolio at December 31, 2007, compared with 0.97% at the end of 2006, remaining at a relatively stable level. Non- performing financing leases represented 0.20% of the lease financing portfolio at December 31, 2005.The increase in non- performing leases for 2006, compared to the earlier year, was mainly the impact of a system conversion. The new lease system identifies non-accruing leases at actual days past due instead of installments past due, which was the previous system parameter. The impact in interest reversals or charge-offs, as a result of this system conversion, was not significant. Other real estate owned, representing real estate property acquired through foreclosure, at December 31, 2007 reflected a decrease of $3 million, or 4%, compared with December 31, 2006. This decline resulted because of the elimination of $68 million in other real estate property, as a result of PFH’s loan recharacterization transaction since the properties belong to the trust and had to be excluded from the Corporation’s accounting records at the time the securitization was recharacterized as a sale transaction. This decline was offset by increases in other of the Corporation’s reportable segments. With the slowdown in the housing market, there is a continued economic deterioration in certain geographic areas, which also has a softening effect on the market for resale of repossessed real estate properties. Defaulted loans have increased, and these loans move through the default process to the other real estate classification. The combination of increased flow of defaulted loans from the loan portfolio to other real estate owned and the slowing of the liquidation market has resulted in an increase in the number of units on hand. Under the standard industry practice, closed-end consumer loans are not customarily placed on non-accrual status prior to being charged-off. Excluding the closed-end consumer loans from non-accruing at December 31, 2007, adjusted non-performing assets would have been $803 million, or 2.87%, of loans held-in- portfolio, compared with $754 million or 2.36%, respectively, at December 31, 2006. The allowance to non-performing loans ratio at December 31, 2007 and 2006 would have been 76.06% and 2007 Annual Report 57 2007 2007 Popular, Inc. 2007 2007 78.00%, respectively. The decline in this ratio reflects a higher proportion of real estate secured loans in non-performing status. Given the change in policy in 2004 for placing commercial loans on non-accrual status as previously discussed, and excluding the closed-end consumer loans from non-accruing at December 31, 2005, adjusted non-performing assets would have been $587 million, or 1.89%, of loans held-in-portfolio, and the allowance to non-performing loans ratio would have been 90.85% at December 31, 2005. Once a loan is placed in non-accrual status, the interest previously accrued and uncollected is charged against current earnings and thereafter income is recorded only to the extent of any interest collected. Refer to Table N for information on the interest income that would have been realized had these loans been performing in accordance with their original terms. In addition to the non-performing loans discussed earlier, there were $50 million of commercial loans at December 31, 2007, which in management’s opinion are currently subject to potential future classification as non-performing, and therefore are considered impaired for purposes of the analysis under SFAS No. 114. At December 31, 2006 and 2005, these potential problem loans approximated $103 million and $30 million, respectively. The decline from December 31, 2006 to the same date in 2007 was mainly due to a particular commercial lending relationship in the Corporation’s Puerto Rico banking operations. Another key measure used to evaluate and monitor the Corporation’s asset quality is loan delinquencies. Loans delinquent 30 days or more and delinquencies as a percentage of their related portfolio category at December 31, 2007 and 2006 are presented below. (Dollars in millions) Loans delinquent 30 days or more Total delinquencies as a percentage 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 $ 2 , 0 1 1 $ 2 , 0 1 1 $ 2 , 0 1 1 $ 2 , 0 1 1 $ 2 , 0 1 1 2006 $1,917 of total loans: Commercial Lease financing Mortgage Consumer Total 4 . 9 7 % 4 . 9 7 % 4 . 9 7 % 4 . 9 7 % 4 . 9 7 % 4 . 3 6 4 . 3 6 4 . 3 6 4 . 3 6 4 . 3 6 1 2 . 2 8 1 2 . 2 8 1 2 . 2 8 1 2 . 2 8 1 2 . 2 8 4 . 7 5 4 . 7 5 4 . 7 5 4 . 7 5 4 . 7 5 6 . 7 2 % 6 . 7 2 % 6 . 7 2 % 6 . 7 2 % 6 . 7 2 % 2.93% 9.30 9.97 4.00 5.86% Accruing loans past due 90 days or more are composed primarily of credit cards, FHA / VA and other insured mortgage loans, and delinquent mortgage loans included in the Corporation’s financial statements pursuant to GNMA’s buy-back option program. Under SFAS No. 140, servicers of loans underlying Ginnie Mae mortgage-backed securities must report as their own assets the defaulted loans that they have the option to purchase, even when they elect not to exercise that option. Also, accruing loans past due 90 days or more include residential conventional loans purchased from other financial institutions that, although delinquent, the Corporation has received timely payment from the sellers / servicers, and, in some instances, have partial guarantees under recourse agreements. Allowance for Loan Losses Allowance for Loan Losses Allowance for Loan Losses Allowance for Loan Losses Allowance for Loan Losses The allowance for loan losses is maintained at a level sufficient to provide for estimated loan losses based on evaluations of inherent risks in the loan portfolio. The Corporation’s management evaluates the adequacy of the allowance for loan losses on a monthly basis. Some of the factors that management considers in determining the allowance are current economic conditions and the resulting impact on Popular’s loan portfolio, the composition of the portfolio by loan types and risk profiles, historical loss experience, the current level of the allowance in relation to total loans and to historical loss levels, results of periodic credit reviews of individual loans, collateral values of properties securing certain loans, regulatory requirements and loan impairment measurement, among others. The Corporation’s methodology to determine its allowance for loan losses follows the guidance in SFAS No. 114 (as amended by SFAS No. 118) and SFAS No. 5. Under SFAS No. 114, commercial loans over a predetermined amount are identified for impairment evaluation on an individual basis and specific impairment reserves are calculated. SFAS No. 5 provides for the recognition of a loss contingency for a group of homogeneous loans, which are not individually evaluated under SFAS No. 114, when it is probable that a loss has been incurred and the amount can be reasonably estimated. To determine the allowance for loan losses under SFAS No. 5, the Corporation applies a historic loss and volatility factor to specific loan balances segregated by loan type and legal entity. The result of the exercise described above is compared to stress-tested levels of historic losses over a period of time, recent tendencies of losses and industry trends. Management considers all indicators derived from the process described herein, along with qualitative factors that may cause estimated credit losses associated with the loan portfolios to differ from historical loss experience. The final outcome of the provision for loan losses and the appropriate level of the allowance for loan losses for each subsidiary and the Corporation is a determination made by the CRESCO, which actively reviews the Corporation’s allowance for loan losses. Management’s evaluation of the quantitative factors (historical net charge-offs, statistical loss estimates, etc.), as well as qualitative factors (current economic conditions, portfolio composition, delinquency trends, etc.), results in the final determination of the provision for loan losses to maintain a level of allowance for loan losses which is deemed to be adequate. Since the determination of the allowance for loans losses considers 58 Table O Table O Table O Table O Table O Allowance for Loan Losses and Selected Loan Losses Statistics (Dollars in thousands) Balance at beginning of year Allowances acquired Provision for loan losses Impact of change in reporting period* Charge-offs: Commercial (including construction) Lease financing Mortgage Consumer Recoveries: Commercial (including construction) Lease financing Mortgage Consumer Net loans charged-off: Commercial Lease financing Mortgage Consumer Write-downs related to loans transferred 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 $ 5 2 2 , 2 3 2 $ 5 2 2 , 2 3 2 $ 5 2 2 , 2 3 2 $ 5 2 2 , 2 3 2 $ 5 2 2 , 2 3 2 7 , 2 9 0 7 , 2 9 0 7 , 2 9 0 7 , 2 9 0 7 , 2 9 0 5 6 2 , 6 5 0 5 6 2 , 6 5 0 5 6 2 , 6 5 0 5 6 2 , 6 5 0 5 6 2 , 6 5 0 ----- 1 , 0 9 2 , 1 7 2 1 , 0 9 2 , 1 7 2 1 , 0 9 2 , 1 7 2 1 , 0 9 2 , 1 7 2 1 , 0 9 2 , 1 7 2 9 8 , 5 4 2 9 8 , 5 4 2 9 8 , 5 4 2 9 8 , 5 4 2 9 8 , 5 4 2 2 3 , 7 2 2 2 3 , 7 2 2 2 3 , 7 2 2 2 3 , 7 2 2 2 3 , 7 2 2 1 4 4 , 6 5 4 1 4 4 , 6 5 4 1 4 4 , 6 5 4 1 4 4 , 6 5 4 1 4 4 , 6 5 4 2 2 2 , 1 5 5 2 2 2 , 1 5 5 2 2 2 , 1 5 5 2 2 2 , 1 5 5 2 2 2 , 1 5 5 4 8 9 , 0 7 3 4 8 9 , 0 7 3 4 8 9 , 0 7 3 4 8 9 , 0 7 3 4 8 9 , 0 7 3 1 9 , 9 8 5 1 9 , 9 8 5 1 9 , 9 8 5 1 9 , 9 8 5 1 9 , 9 8 5 8 , 6 9 5 8 , 6 9 5 8 , 6 9 5 8 , 6 9 5 8 , 6 9 5 1 , 3 1 4 1 , 3 1 4 1 , 3 1 4 1 , 3 1 4 1 , 3 1 4 3 5 , 9 8 2 3 5 , 9 8 2 3 5 , 9 8 2 3 5 , 9 8 2 3 5 , 9 8 2 6 5 , 9 7 6 6 5 , 9 7 6 6 5 , 9 7 6 6 5 , 9 7 6 6 5 , 9 7 6 7 8 , 5 5 7 7 8 , 5 5 7 7 8 , 5 5 7 7 8 , 5 5 7 7 8 , 5 5 7 1 5 , 0 2 7 1 5 , 0 2 7 1 5 , 0 2 7 1 5 , 0 2 7 1 5 , 0 2 7 1 4 3 , 3 4 0 1 4 3 , 3 4 0 1 4 3 , 3 4 0 1 4 3 , 3 4 0 1 4 3 , 3 4 0 1 8 6 , 1 7 3 1 8 6 , 1 7 3 1 8 6 , 1 7 3 1 8 6 , 1 7 3 1 8 6 , 1 7 3 4 2 3 , 0 9 7 4 2 3 , 0 9 7 4 2 3 , 0 9 7 4 2 3 , 0 9 7 4 2 3 , 0 9 7 2006 $461,707 - 287,760 2,510 751,977 55,605 24,526 59,613 149,776 289,520 17,283 10,643 979 30,870 59,775 38,322 13,883 58,634 118,906 229,745 2005 $437,081 6,291 195,272 1,586 640,230 64,559 20,568 48,212 108,110 241,449 22,067 10,939 775 29,145 62,926 42,492 9,629 47,437 78,965 178,523 2004 $408,542 27,185 178,657 - 614,384 64,931 37,125 33,032 103,393 238,481 19,778 11,385 1,440 28,575 61,178 45,153 25,740 31,592 74,818 177,303 2003 $372,797 13,697 195,939 - 582,433 80,069 22,995 29,495 100,040 232,599 20,594 11,477 467 26,170 58,708 59,475 11,518 29,028 73,870 173,891 to loans held-for-sale Balance at end of year Loans held-in-portfolio: Outstanding at year end Average Ratios: Allowance for loan losses to year end loans held-in-portfolio Recoveries to charge-offs Net charge-offs to average loans held-in-portfolio Net charge-offs earnings coverage Allowance for loan losses to net charge-offs Provision for loan losses to: Net charge-offs Average loans held-in-portfolio Allowance to non-performing assets Allowance to non-performing loans 1 2 0 , 2 4 3 1 2 0 , 2 4 3 1 2 0 , 2 4 3 1 2 0 , 2 4 3 1 2 0 , 2 4 3 - - - - $ 5 4 8 , 8 3 2 $ 5 4 8 , 8 3 2 $ 5 4 8 , 8 3 2 $ 5 4 8 , 8 3 2 $ 5 4 8 , 8 3 2 $522,232 $461,707 $437,081 $408,542 $ 2 8 , 0 2 1 , 4 5 6 $ 2 8 , 0 2 1 , 4 5 6 $ 2 8 , 0 2 1 , 4 5 6 $ 2 8 , 0 2 1 , 4 5 6 $ 2 8 , 0 2 1 , 4 5 6 3 2 , 1 8 1 , 5 9 6 3 2 , 1 8 1 , 5 9 6 3 2 , 1 8 1 , 5 9 6 3 2 , 1 8 1 , 5 9 6 3 2 , 1 8 1 , 5 9 6 $32,017,017 31,246,079 $31,011,026 28,830,965 $27,991,533 24,881,341 $22,330,600 20,258,913 1 . 9 6 % 1 . 9 6 % 1 . 9 6 % 1 . 9 6 % 1 . 9 6 % 1 3 . 4 9 1 3 . 4 9 1 3 . 4 9 1 3 . 4 9 1 3 . 4 9 1 . 3 1 1 . 3 1 1 . 3 1 1 . 3 1 1 . 3 1 1 . 0 4 x 1 . 0 4 x 1 . 0 4 x 1 . 0 4 x 1 . 0 4 x 1 . 3 0 1 . 3 0 1 . 3 0 1 . 3 0 1 . 3 0 1 . 3 3 1 . 3 3 1 . 3 3 1 . 3 3 1 . 3 3 1 . 7 5 % 1 . 7 5 % 1 . 7 5 % 1 . 7 5 % 1 . 7 5 % 6 4 . 4 1 6 4 . 4 1 6 4 . 4 1 6 4 . 4 1 6 4 . 4 1 7 1 . 2 1 7 1 . 2 1 7 1 . 2 1 7 1 . 2 1 7 1 . 2 1 1.63% 20.65 0.74 3.27x 2.27 1.25 0.92% 65.08 72.78 1.49% 26.06 0.62 4.94x 2.59 1.09 0.68% 73.69 84.33 1.56% 25.65 0.71 4.59x 2.47 1.01 0.72% 71.22 78.89 1.83% 25.24 0.86 4.59x 2.35 1.13 0.97% 66.87 73.34 *Represents the net effect of provision for loan losses, less net charge-offs corresponding to the impact of the change in fiscal period at certain subsidiaries described in the overview section (change from fiscal to calendar reporting year for non-banking subsidiaries). 2007 Annual Report 59 2007 2007 Popular, Inc. 2007 2007 Table P Table P Table P Table P Table P Allocation of the Allowance for Loan Losses (Dollars in millions) 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2006 2005 2004 2003 As of December, Percentage of Percentage of Percentage of Percentage of Percentage of Percentage of Allowance Allowance Loans in Each Loans in Each Allowance Loans in Each Allowance Loans in Each Allowance Allowance Loans in Each Loans in Each f o r f o r Category to Category to f o r Category to f o r f o r Category to Category to Category to Total Loans* Total Loans* Loan Losses Loan Losses Total Loans* Loan Losses Total Loans* Loan Losses Total Loans* Total Loans* Loan Losses Loan Losses for Percentage of Percentage of Allowance Loans in Each Allowance Loans in Each Allowance Loans in Each Category to Loan Losses Total Loans* Loan Losses Total Loans* Loan Losses Total Loans* Percentage of Category to Category to for for for Commercial Lease financing Mortgage Consumer Total $ 2 2 2 . 7 $ 2 2 2 . 7 $ 2 2 2 . 7 $ 2 2 2 . 7 $ 2 2 2 . 7 2 5 . 6 2 5 . 6 2 5 . 6 2 5 . 6 2 5 . 6 7 0 . 0 7 0 . 0 7 0 . 0 7 0 . 0 7 0 . 0 2 3 0 . 5 2 3 0 . 5 2 3 0 . 5 2 3 0 . 5 2 3 0 . 5 $ 5 4 8 . 8 $ 5 4 8 . 8 $ 5 4 8 . 8 $ 5 4 8 . 8 $ 5 4 8 . 8 5 5 . 7 % 5 5 . 7 % 5 5 . 7 % 5 5 . 7 % 5 5 . 7 % 3 . 93 . 93 . 93 . 93 . 9 2 1 . 7 2 1 . 7 2 1 . 7 2 1 . 7 2 1 . 7 1 8 . 7 1 8 . 7 1 8 . 7 1 8 . 7 1 8 . 7 1 0 0 . 0 % 1 0 0 . 0 % 1 0 0 . 0 % 1 0 0 . 0 % 1 0 0 . 0 % $204.0 24.8 92.2 201.2 $522.2 45.3% 3.8 34.6 16.3 100.0% $184.4 27.6 72.7 177.0 $461.7 40.7% 4.2 39.7 15.4 100.0% $179.0 28.7 67.7 161.7 $437.1 38.9% 4.2 42.5 14.4 100.0% $171.5 29.8 55.5 151.7 $408.5 38.4% 4.7 42.3 14.6 100.0% *Note: For purposes of this table, the term loans refers to loans held-in-portfolio (excludes loans held-for-sale). projections and assumptions, actual losses can vary from the estimated amounts. Refer to Table O for a summary of the activity in the allowance for loan losses and selected loan losses statistics for the past 5 years. Table P details the breakdown of the allowance for loan losses by loan categories. The breakdown is made for analytical purposes, and it is not necessarily indicative of the categories in which future loan losses may occur. Also, the following table presents net charge-offs to average loans held-in-portfolio by loan category for the years ended December 31, 2007, 2006 and 2005: Commercial (including construction) Lease financing Mortgage Consumer Total 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2006 2005 0 . 5 2 % 0 . 5 2 % 0 . 5 2 % 0 . 5 2 % 0 . 5 2 % 1 . 2 8 1 . 2 8 1 . 2 8 1 . 2 8 1 . 2 8 1 . 3 7 1 . 3 7 1 . 3 7 1 . 3 7 1 . 3 7 3 . 4 1 3 . 4 1 3 . 4 1 3 . 4 1 3 . 4 1 1 . 3 1 % 1 . 3 1 % 1 . 3 1 % 1 . 3 1 % 1 . 3 1 % 0.28% 1.08 0.51 2.38 0.74% 0.36% 0.74 0.42 1.81 0.62% The increase in the ratio of commercial loans net charge-offs to average loans held-in-portfolio for the year ended December 31, 2007 was mostly associated with deterioration in the economic conditions in Puerto Rico and in the U.S. mainland. The ratio of commercial loans net charge-offs to average commercial loans held-in-portfolio in the Banco Popular de Puerto Rico reportable segment was 0.62% for the year ended December 31, 2007, compared to 0.33% for the previous year. Also, an increase was experienced in the Banco Popular North America reportable segment, whose ratio was 0.31% for 2007, compared with 0.21% for 2006. The allowance for loan losses corresponding to commercial loans held-in-portfolio represented 1.43% of that portfolio at December 31, 2007, compared with 1.41% in 2006 and 1.46% in 2005. The ratio of allowance to non-performing loans in the commercial loan category was 61.50% at the end of 2007, compared with 129.0% in 2006 and 137.9% in 2005. The decrease in this ratio from 2006 to 2007 was related to the significant increase in commercial non-performing loans which are mostly secured by real estate and other collateral and for which no specific reserves were considered necessary as part of the SFAS No. 114 impairment analysis. The portion of the allowance for loan losses related to impaired loans at December 31, 2007, 2006 and 2005 was $54 million, $37 million and $20 million, respectively. Further disclosures with respect to impaired loans are included in Note 7 to the consolidated financial statements. The increase in net charge-offs to average loans held-in- portfolio in the lease financing portfolio from 2006 to 2007 was the result of higher delinquencies in the Banco Popular de Puerto Rico reportable segment. This was partially offset by a decrease in net charge-offs to average loans held-in-portfolio in the lease financing portfolio of the Banco Popular North America operations. There was a large amount of charge-offs in the U.S. leasing subsidiary during 2006 related to a particular customer lending relationship. The allowance for loan losses to the lease financing portfolio was 2.34% at December 31, 2007, compared with 2.03% at the same date in 2006 and 2.11% in 2005. Mortgage loans net charge-offs as a percentage of average mortgage loans held-in-portfolio increased primarily due to the slowdown in the housing sector and higher delinquency levels, primarily in the Corporation’s U.S. subprime mortgage loan portfolio. This increase also reflects the impact of the reduction in the mortgage loan portfolio at PFH. The increase in net charge- offs on mortgage loans for 2007, when compared to 2006, included an increase of $34 million in net charge-offs on second liens mortgages at PFH. The mortgage loans net charge-offs to average mortgage loans held-in-portfolio ratio at PFH, excluding Popular FS, for 2007 was 2.10%, compared with 0.77% in 2006 and 0.62% in 2005. Refer to the Overview of Mortgage Loan Exposure section 60 in this MD&A for information on PFH’s mortgage loan portfolio, including credit statistics. Deteriorating economic conditions have also impacted the mortgage delinquency rates in Puerto Rico, thus increasing the levels of non-accruing mortgage loans. However, no significant increase in losses has occurred. The mortgage loans net charge-off to average mortgage loans held-in- portfolio ratio in the Banco Popular de Puerto Rico reportable segment was 0.04% for the year ended December 31, 2007. Historically, the Corporation has experienced a low level of losses in its Puerto Rico mortgage loan portfolio. The Corporation’s allowance for loan losses for mortgage loans held-in-portfolio represented 1.15% of that portfolio at December 31, 2007, compared with 0.83% in 2006 and 0.59% in 2005. The increase in this ratio from 2006 to 2007 was the result of higher trend of net charge-offs, the inherent losses in the subprime portfolio due to economic conditions and the slowdown in that sector’s housing market, which has affected home values and thus, impacts the initial write-downs to fair value at the time of a property foreclosure. Consumer loans net-charge offs for 2007 reflected an increase of 57%, when compared to 2006, and also as a percentage of the average consumer loan portfolio. The increase in this ratio was associated with higher delinquencies in Puerto Rico and growth in unsecured consumer loans, primarily personal loans and credit cards. The allowance for loan losses for consumer loans held-in- portfolio represented 4.39% of that portfolio at December 31, 2007, compared with 3.86% in 2006 and 3.71% in 2005. The increase in this ratio was the result of increased levels of delinquencies and charge-offs coupled with higher loan volumes. Included in Table O as part of the reconciliation of the allowance for loan losses as of December 31, 2007 was $120 million of write- downs in value due to credit considerations arising from loan transfers to held-for-sale. This amount principally consisted of $74 million pertaining to the loans recharacterized in December 2007 and $43 million related to the $1.5 billion portfolio that will be sold by PFH in the first quarter of 2008. The loans were reclassified from held-in-portfolio to held-for-sale at the lower of cost or fair value at the time the decision to sell was made. The charge-off ratios included in Table O does not consider the removal of the allowance for loan losses upon the transfer of loans to held- for-sale. Operational Risk Management Operational Risk Management Operational Risk Management Operational Risk Management Operational Risk Management Operational risk can manifest itself in various ways, including errors, fraud, business interruptions, inappropriate behavior of employees, and failure to perform in a timely manner, among others. These events can potentially result in financial losses and other damages to the Corporation, including reputational harm. The successful management of operational risk is particularly important to a diversified financial services company like Popular because of the nature, volume and complexity of its various businesses. To monitor and control operational risk and mitigate related losses, the Corporation maintains a system of comprehensive policies and controls. The Corporation’s Operational Risk Committee (“ORCO”), which is composed of senior level representatives from the business lines and corporate functions, provides executive oversight to facilitate consistency of effective policies, best practices, controls and monitoring tools for managing and assessing all types of operational risks across the Corporation. The Operational Risk Management Division, within the Corporation’s Risk Management Group, serves as ORCO’s operating arm and is responsible for establishing baseline processes to measure, monitor, limit and manage operational risk. In addition, the Internal Audit Division provides oversight about policy compliance and ensures adequate attention is paid to correct the identified issues. Operational risks fall into two major categories: business specific and corporate-wide affecting all business lines. The primary responsibility for the day-to-day management of business specific risks relies on business unit managers. Accordingly, business unit managers are responsible of ensuring that appropriate risk containment measures, including corporate-wide or business segment specific policies and procedures, controls and monitoring tools, are in place to minimize risk occurrence and loss exposures. Examples of these include personnel management practices, data reconciliation processes, transaction processing monitoring and analysis and contingency plans for systems interruptions. To manage corporate-wide risks, specialized groups such as Legal, Information Security, Business Continuity, Finance and Compliance, assist the business units in the development and implementation of risk management practices specific to the needs of the individual businesses. Operational risk management plays a different role in each category. For business specific risks, the Operational Risk Management Group works with the segments to ensure consistency in policies, processes, and assessments. With respect to corporate-wide risks, such as information security, business continuity, legal and compliance, the risks are assessed and a consolidated corporate view is developed and communicated to the business level. LLLLL OSSOSSOSSOSSOSS M M M M MITIGATION ECURITIZED M M M M MORTGAGE ITIGATION F F F F F OROROROROR S S S S SECURITIZED ORTGAGE ORTGAGE ECURITIZED ECURITIZED ITIGATION ITIGATION ORTGAGE ORTGAGE ECURITIZED ITIGATION LLLLL O A N S O A N S O A N S O A N S O A N S Loan Modification Program Loan Modification Program Loan Modification Program Loan Modification Program Loan Modification Program In October 2007, in response to market conditions and guidance issued by the American Securitization Forum (“ASF”) and the SEC’s Office of Chief Accountant (the “OCA”), PFH instituted a loan modification program (the “Modification Program”) for its 2007 Annual Report 61 2007 2007 Popular, Inc. 2007 2007 securitized U.S. subprime residential adjustable-rate mortgage loans (“Subprime ARM Loans”). In addition to having to comply with parameters set forth in the transaction documents governing the securitized loans, a concern was raised by the industry that modifying a Subprime ARM Loan owned by a QSPE could result in disqualification of that QSPE, thereby disallowing the related securitization transaction from being accounted for using off- balance sheet accounting treatment. The OCA, in a July 18, 2007 Memorandum to SEC Chairman Christopher Cox regarding “Accounting for Loan Modifications,” concluded that, subject to certain limitations, modifying a Subprime ARM Loan when default is “reasonably foreseeable” does not preclude continued off-balance sheet treatment for the related QSPE under SFAS No. 140. Consistent with the above-referenced guidance and the transaction documents governing the securitization transactions, the Modification Program permitted PFH, as servicer, to modify a Subprime ARM Loan if, among other things, the modification: • would be consistent with generally accepted servicing practices; • would be in the collective best interest of the holders of the related asset-backed securities; • would be in response to a default or a “reasonably foreseeable” default; and • would provide the borrower with a long term and sustainable solution. Permissible modifications to a Subprime ARM Loan under the Modification Program included the postponement of the loan’s interest rate reset date, conversion to a fixed-rate loan and reduction of the loan’s interest rate cap on reset. The ASF Framework and Subprime ARM Loans The ASF Framework and Subprime ARM Loans The ASF Framework and Subprime ARM Loans The ASF Framework and Subprime ARM Loans The ASF Framework and Subprime ARM Loans On December 6, 2007, the ASF, working with various constituency groups as well as representatives of U.S. federal government agencies, issued the Streamlined Foreclosure and Loss Avoidance Framework for Securitized Subprime Adjustable Rate Mortgage Loans (the “ASF Framework”). The ASF Framework provides guidance for servicers to streamline borrower evaluation procedures and to facilitate the use of foreclosure and loss prevention efforts in an attempt to reduce the number of U.S. subprime residential mortgage borrowers who might default in the coming year because the borrowers cannot afford to pay the increased loan interest rate after their Subprime ARM Loan interest rate resets. The ASF Framework is focused on Subprime ARM Loans that have an initial fixed interest rate period of 36 months or less, are included in securitized pools, were originated between January 1, 2005 and July 31, 2007, and have an initial interest rate reset date between January 1, 2008 and July 31, 2010. The ASF Framework directs servicers to categorize Subprime ARM Loans into one of three segments: • Segment 1: Current Subprime ARM Loans (under the ASF Framework, “current” means a Subprime ARM Loan that is not more than 30 days delinquent, and has not been more than 1 x 60 days delinquent in the last 12 months, both determined under the OTS method) where the borrower is likely to be able to refinance into any available mortgage product, including FHA, FHA Secure or other readily available mortgage industry products. • Segment 2: Current Subprime ARM Loans where the borrower is unlikely to be able to refinance into any readily available mortgage industry product. (cid:132) Subprime ARM Loans belong in Segment 2 (a “Segment 2 Subprime ARM Loan”), if (cid:132) they have a current loan-to-value ratio (based on the first lien Subprime ARM Loan only) greater than 97%, or (cid:132) t h e y d o n o t s a t i s f y t h e o t h e r F H A S e c u r e requirements, including that program’s delinquency history, debt-to-income ratio at origination and loan amount standards, and the servicer cannot determine whether they are eligible for another mortgage i n d u s t r y p r o d u c t w i t h o u t c o n d u c t i n g a n underwriting analysis. (cid:132) Subject to certain limitations, Segment 2 Subprime ARM loans are eligible for a fast track loan modification under which the interest rate will be kept at the existing initial rate, generally for five years following the upcoming reset date. • Segment 3: Subprime ARM Loans where the borrower is not Current and is demonstrating difficulty meeting the introductory rate on the Subprime ARM Loan. Since its issuance on December 6, 2007, PFH, in its capacity as servicer and in conjunction with its Modification Program, has followed the guidance provided by the ASF Framework with respect to Subprime ARM Loans. While a uniform industry definition of what constitutes a “subprime loan” does not exist, PFH generally considers a loan to be a Subprime ARM Loan if its FICO score is less than 660. The following supplemental information regarding PFH’s implementation of the ASF Framework with respect to Subprime ARM Loans securitized by PFH is provided as of December 31, 2007: • Segment 1: (cid:132) Amount of Subprime ARM Loans that fall within this category: $398 million (cid:132) During 2007, $996.3 thousand worth of loans in this segment were subject to a loan modification. 62 • Segment 2: (cid:132) Amount of Subprime ARM Loans that fall within this category: $62.4 million (cid:132) During 2007, $175.9 thousand worth of loans in this segment were subject to a loan modification. • Segment 3: (cid:132) Amount of Subprime ARM Loans that fall within this category: $128.3 million (cid:132) During 2007, $1.92 million worth of loans in this segment were subject to loss mitigation activities. On January 8, 2008, the OCA issued a letter (the “OCA Letter”) addressing accounting issues that may be raised by the ASF Framework. Specifically, the OCA Letter expressed the view that if a Segment 2 Subprime ARM Loan is modified pursuant to the ASF Framework and that loan could legally be modified, the OCA will not object to continued status of the transferee as a QSPE under SFAS No. 140. In reaching its ultimate conclusion, the OCA noted that the ASF Framework indicated that for a Segment 2 Subprime ARM Loan, the servicer could presume that the borrower would be unable to pay pursuant to the original terms of the loan after the interest rate reset, and thus, a default on the loan would be “reasonably foreseeable” in the absence of a modification. Concurrent with the issuance of the OCA Letter, the OCA requested the FASB to immediately address the issues that have arisen in the application of the QSPE guidance in SFAS No. 140. Any loan modifications we make in accordance with the ASF Framework will not have an impact on our off-balance sheet accounting treatment of the Subprime ARM Loans securitized by PFH and currently owned by QSPEs and will not have a material effect on our accounting treatment of our retained interests in those securitizations of Subprime ARM Loans. The following supplemental information regarding QSPE’s that own Subprime ARM Loans that were securitized by PFH is provided as of December 31, 2007: Total assets ............................................................ $5.34 billion Subprime ARM Loan ......................................... $1.51 billion Other assets (including real estate owned) ...... $0.15 billion Total beneficial interest isssued ............................ $5.05 billion Held by third-party investors .......................... $5.01 billion Retained by the Corporation ........................... $0.04 billion As of December 31, 2007 and 2006 the amount of loans classified as real estate owned in QSPE’s that owned Subprime ARM Loans totaled $153.6 million and $13.3 million respectively. The $140.3 million increase was due to a $39.5 million increase in defaults and the progression of delinquent loans into real estate owned status and the addition of $100.7 million of loans in real estate owned status owned by securitization trusts that prior to December 31, 2007 did not qualify as QSPE’s. R e c e n t l y I s s u e d A c c o u n t i n g P r o n o u n c e m e n t s a n d R e c e n t l y I s s u e d A c c o u n t i n g P r o n o u n c e m e n t s a n d R e c e n t l y I s s u e d A c c o u n t i n g P r o n o u n c e m e n t s a n d R e c e n t l y I s s u e d A c c o u n t i n g P r o n o u n c e m e n t s a n d R e c e n t l y I s s u e d A c c o u n t i n g P r o n o u n c e m e n t s a n d I n t e r p r e t a t i o n s I n t e r p r e t a t i o n s I n t e r p r e t a t i o n s I n t e r p r e t a t i o n s I n t e r p r e t a t i o n s SFAS No. 157 “Fair Value Measurements” SFAS No. 157, issued in September 2006, defines fair value, establishes a framework of measuring fair value and requires enhanced disclosures about fair value measurements. SFAS No. 157 requires companies to disclose the fair value of its financial instruments according to a fair value hierarchy. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values. Financial assets carried at fair value will be classified and disclosed in one of the three categories in accordance with the hierarchy. The three levels of the fair value hierarchy are (1) quoted market prices for identical assets or liabilities in active markets, (2) observable market-based inputs or unobservable inputs that are corroborated by market data, and (3) unobservable inputs that are not corroborated by market data. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. In February 2008, the FASB decided to issue a final staff position that defers for one year the effective date for nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value on a nonrecurring basis. The staff position also amends SFAS No. 157 to exclude SFAS No. 13 “Accounting for Leases” and its related interpretive accounting pronouncements that address leasing transactions. The Corporation adopted the provisions of SFAS No. 157 that were not deferred, commencing in the first quarter of 2008. The provisions of SFAS 157 are to be applied prospectively. The Corporation is currently assessing the impact of SFAS No. 157 on its consolidated financial statements, including disclosures. SFAS No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115” In February 2007, the FASB issued SFAS No. 159, which provides companies with an option to report selected financial assets and liabilities at fair value. The election to measure a financial asset or liability at fair value can be made on an instrument-by-instrument basis and is irrevocable. The difference between the carrying amount and the fair value at the election date is recorded as a transition adjustment to opening retained earnings. Subsequent changes in fair value are recognized in earnings. The statement also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. 2007 Annual Report 63 2007 2007 Popular, Inc. 2007 2007 It also requires entities to display the fair value of those assets and liabilities for which the company has chosen to use fair value on the face of the balance sheet. The new statement does not eliminate disclosure requirements included in other accounting standards, including requirements for disclosures about fair value measurements included in SFAS No. 157, “Fair Value Measurements,” and SFAS No. 107, “Disclosures about Fair Value of Financial Instruments.” The Corporation adopted the provisions of SFAS No. 159 in January 2008. Refer to the Events Subsequent to Year-End 2007 section for a discussion of the estimated impact of the adoption of SFAS No. 159. FSP FIN No. 39-1 “Amendment of FASB Interpretation No. 39” In April 2007, the FASB issued Staff Position FSP FIN No. 39-1, which defines “right of setoff” and specifies what conditions must be met for a derivative contract to qualify for this right of setoff. It also addresses the applicability of a right of setoff to derivative instruments and clarifies the circumstances in which it is appropriate to offset amounts recognized for those instruments in the statement of financial position. In addition, this FSP permits the offsetting of fair value amounts recognized for multiple derivative instruments executed with the same counterparty under a master netting arrangement and fair value amounts recognized for the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) arising from the same master netting arrangement as the derivative instruments. This interpretation is effective for fiscal years beginning after November 15, 2007, with early application permitted. The adoption of FSP FIN No. 39-1 in 2008 did not have a material impact on the Corporation’s consolidated financial statements. SOP 07-01“Clarification of the Scope of the Audit and Accounting Guide Investment Companies and Accounting by Parent Companies and Equity Method Investors for Investments in Investment Companies” The Statement of Position 07-1 (“SOP 07-01”), issued in June 2007, provides guidance for determining whether an entity is within the scope of the American Institute of Certified Public Accountants (“AICPA”) Audit and Accounting Guide for Investment Companies (“the AICPA Guide”). Additionally, it provides guidance as to whether a parent company or an equity method investor can apply the specialized industry accounting principles of the AICPA Guide. SOP 07-01 was to be effective for fiscal years beginning on or after December 15, 2007. On February of 2008, the FASB issued a final staff position that indefinitely defers the effective dates of SOP 07-01 and, for entities that meet the definition of an “investment company” in SOP 07-01, of FSP FIN 46(R)-7, “Application of FASB Interpretation No. 46(R) to Investment Companies.” The FASB decision was in response to several implementation issues that arose after SOP 07-1 was issued. Nevertheless, management is evaluating the impact, if any, that the adoption of SOP 07-01 may have on its consolidated financial statements and disclosures. FSP FIN No. 46(R) – 7 “Application of FASB Interpretation No. 46(R) to Investment Companies” In May 2007, the FASB issued Staff Position FSP FIN No.46(R) - 7, which amends the scope of the exception on FIN No.46(R) to indicate that investments accounted for at fair value, in accordance with the specialized accounting guidance in the AICPA Guide, are not subject to consolidation under FIN No. 46(R). Management is evaluating the impact, if any, that the adoption of this interpretation may have on its consolidated financial statements and disclosures. As indicated under the guidance of SOP 07-01, which was previously described, the implementation of FSP FIN No. 46(R) - 7 is indefinitely delayed until further notification by the FASB. SFAS No. 141-R “Statement of Financial Accounting Standards No. 141(R), Business Combinations (a revision of SFAS No. 141)” In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations.” SFAS No. 141(R) will significantly change how entities apply the acquisition method to business combinations. The most significant changes affecting how the Corporation will account for business combinations under this statement include the following: the acquisition date will be the date the acquirer obtains control; all (and only) identifiable assets acquired, liabilities assumed, and noncontrolling interests in the acquiree will be stated at fair value on the acquisition date; assets or liabilities arising from noncontractual contingencies will be measured at their acquisition date at fair value only if it is more likely than not that they meet the definition of an asset or liability on the acquisition date; adjustments subsequently made to the provisional amounts recorded on the acquisition date will be made retroactively during a measurement period not to exceed one year; acquisition-related restructuring costs that do not meet the criteria in SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” will be expensed as incurred; transaction costs will be expensed as incurred; reversals of deferred income tax valuation allowances and income tax contingencies will be recognized in earnings subsequent to the measurement period; and the allowance for loan losses of an acquiree will not be permitted to be recognized by the acquirer. Additionally, SFAS 141(R) will require new and modified disclosures surrounding subsequent changes to acquisition-related contingencies, contingent consideration, noncontrolling interests, acquisition- related transaction costs, fair values and cash flows not expected to be collected for acquired loans, and an enhanced goodwill rollforward. The Corporation will be required to prospectively apply SFAS 141(R) to all business combinations completed on or 64 after January 1, 2009. Early adoption is not permitted. For business combinations in which the acquisition date was before the effective date, the provisions of SFAS 141(R) will apply to the subsequent accounting for deferred income tax valuation allowances and income tax contingencies and will require any changes in those amounts to be recorded in earnings. Management will be evaluating the effects that SFAS 141(R) will have on the financial condition, results of operations, liquidity, and the disclosures that will be presented on the consolidated financial statements. SFAS No. 160 “Statement of Financial Accounting Standards No. 160, Noncontrolling Interest in Consolidated Financial Statements, an amendment of ARB No. 51” In December 2007, the FASB issued SFAS No. 160, which amends ARB No. 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS No. 160 will require entities to classify noncontrolling interests as a component of stockholders’ equity in the consolidated financial statements and will require subsequent changes in ownership interests in a subsidiary to be accounted for as an equity transaction. Additionally, SFAS No. 160 will require entities to recognize a gain or loss upon the loss of control of a subsidiary and to remeasure any ownership interest retained at fair value on that date. This statement also requires expanded disclosures that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS 160 is effective on a prospective basis for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008, except for the presentation and disclosure requirements, which are required to be applied retrospectively. Early adoption is not permitted. Management will be evaluating the effects, if any, that the adoption of this statement will have on its consolidated financial statements. Staff Accounting Bulletin No. 109 (“SAB 109”) “Written Loan Commitments Recorded at Fair Value through Earnings” On November 5, 2007, the SEC issued Staff Accounting Bulletin No. 109 (SAB 109), which requires that the fair value of a written loan commitment that is marked to market through earnings should include the future cash flows related to the loan’s servicing rights. However, the fair value measurement of a written loan commitment still must exclude the expected net cash flows related to internally developed intangible assets (such as customer relationship intangible assets). SAB 109 applies to two types of loan commitments: (1) written mortgage loan commitments for loans that will be held-for-sale when funded that are marked to market as derivatives under FAS 133 (derivative loan commitments); and (2) other written loan commitments that are accounted for at fair value through earnings under Statement 159’s fair-value election. SAB 109 supersedes SAB 105, which applied only to derivative loan commitments and allowed the expected future cash flows related to the associated servicing of the loan to be recognized only after the servicing asset had been contractually separated from the underlying loan by sale or securitization of the loan with servicing retained. SAB 109 will be applied prospectively to derivative loan commitments issued or modified in fiscal quarters beginning after December 15, 2007. The Corporation is currently evaluating the potential impact of adopting this SAB 109. Staff Position (FSP) FAS 140-d, “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions” (“FSP FAS 140-d”) In February 2008, the FASB issued FASB Staff Position (FSP) FAS 140-d, “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions.” The objective of this FSP is to provide implementation guidance on whether the security transfer and contemporaneous repurchase financing involving the transferred financial asset must be evaluated as one linked transaction or two separate de-linked transactions. Current practice records the transfer as a sale and the repurchase agreement as a financing. The FSP requires the recognition of the transfer and the repurchase agreement as one linked transaction, unless all of the following criteria are met: (1) the initial transfer and the repurchase financing are not contractually contingent on one another; (2) the initial transferor has full recourse upon default, and the repurchase agreement’s price is fixed and not at fair value; (3) the financial asset is readily obtainable in the marketplace and the transfer and repurchase financing are executed at market rates; and (4) the maturity of the repurchase financing is before the maturity of the financial asset. The scope of this FSP is limited to transfers and subsequent repurchase financings that are entered into contemporaneously or in contemplation of one another. The FSP will be effective for the Corporation on January 1, 2009. Early adoption is prohibited. The Corporation will be evaluating the potential impact of adopting this FSP. Glossary of Selected Financial Terms 2007 Annual Report 65 2007 2007 Popular, Inc. 2007 2007 Allowance for Loan Losses Allowance for Loan Losses Allowance for Loan Losses - The reserve established to cover Allowance for Loan Losses Allowance for Loan Losses credit losses inherent in loans held-in-portfolio. and interest), whereas average life computes the average time needed to collect one dollar of principal. Asset Securitization Asset Securitization Asset Securitization - The process of converting receivables Asset Securitization Asset Securitization and other assets that are not readily marketable into securities that can be placed and traded in capital markets. Earning Assets Earning Assets Earning Assets - Assets that earn interest, such as loans, Earning Assets Earning Assets investment securities, money market investments and trading account securities. Basis Point Basis Point Basis Point - Equals to one-hundredth of one percent. Used to Basis Point Basis Point express changes or differences in interest yields and rates. Efficiency Ratio Efficiency Ratio Efficiency Ratio - Non-interest expense divided by net interest Efficiency Ratio Efficiency Ratio income plus recurring non-interest income. Book Value Per Common Share Book Value Per Common Share Book Value Per Common Share - Total common shareholders’ Book Value Per Common Share Book Value Per Common Share equity divided by the total number of common shares outstanding. Effective Tax Rate Effective Tax Rate Effective Tax Rate - Income tax expense divided by income Effective Tax Rate Effective Tax Rate before taxes. Brokered Certificate of Deposit - Deposit purchased from a Brokered Certificate of Deposit Brokered Certificate of Deposit Brokered Certificate of Deposit Brokered Certificate of Deposit broker acting as an agent for depositors. The broker, often a securities broker-dealer, pools CDs from many small investors and markets them to financial institutions and negotiates a higher rate for CDs placed with the purchaser. Cash Flow Hedge - Cash Flow Hedge - Cash Flow Hedge - A derivative designated as hedging the Cash Flow Hedge - Cash Flow Hedge - exposure to variable cash flows of a forecasted transaction. Common Shares Outstanding Common Shares Outstanding Common Shares Outstanding - Total number of shares of Common Shares Outstanding Common Shares Outstanding common stock issued less common shares held in treasury. Core Deposits Core Deposits Core Deposits - A deposit category that includes all non-interest Core Deposits Core Deposits bearing deposits, savings deposits and certificates of deposit under $100,000, excluding brokered certificates of deposit with denominations under $100,000. These deposits are considered a stable source of funds. C u m u l a t i v e T o t a l R e t u r n t o C o m m o n S t o c k h o l d e r s C u m u l a t i v e T o t a l R e t u r n t o C o m m o n S t o c k h o l d e r s C u m u l a t i v e T o t a l R e t u r n t o C o m m o n S t o c k h o l d e r s - C u m u l a t i v e T o t a l R e t u r n t o C o m m o n S t o c k h o l d e r s C u m u l a t i v e T o t a l R e t u r n t o C o m m o n S t o c k h o l d e r s Was obtained by dividing (i) the cumulative amount of dividends per share, assuming dividend reinvestment since the measurement point December 31, 2001 plus (ii) the change in the per share price since the measurement date, by the share price at the measurement date. Derivative Derivative Derivative - A contractual agreement between two parties to Derivative Derivative exchange cash or other assets in response to changes in an external factor, such as an interest rate or a foreign exchange rate. Dividend Payout Ratio Dividend Payout Ratio Dividend Payout Ratio - Dividends paid on common shares Dividend Payout Ratio Dividend Payout Ratio divided by net income applicable to shares of common stock. Duration Duration Duration - Expected life of a financial instrument taking into Duration Duration account its coupon yield / cost, interest payments, maturity and call features. Duration attempts to measure actual maturity, as opposed to final maturity. Duration measures the time required to recover a dollar of price in present value terms (including principal Fair Value Hedge - Fair Value Hedge - Fair Value Hedge - A derivative designated as hedging the Fair Value Hedge - Fair Value Hedge - exposure to changes in the fair value of a recognized asset or liability or a firm commitment. GapGapGapGapGap - The difference that exists at a specific period of time between the maturities or repricing terms of interest-sensitive assets and interest-sensitive liabilities. Goodwill Goodwill Goodwill - The excess of the purchase price of net assets over Goodwill Goodwill the fair value of net assets acquired in a business combination. Interest-only Loan - A non-amortized loan in which interest Interest-only Loan Interest-only Loan Interest-only Loan Interest-only Loan is due at regular intervals until maturity, when the entire balance is due. Interest-only Strip Interest-only Strip Interest-only Strip - The holder receives interest payments Interest-only Strip Interest-only Strip based on the current value of the loan collateral. High prepayments can return less to the holder than the dollar amount invested. Interest Rate Caps / Floors Interest Rate Caps / Floors Interest Rate Caps / Floors - An interest rate cap is a Interest Rate Caps / Floors Interest Rate Caps / Floors contractual agreement between two counterparties in which the buyer, in return for paying a fee, will receive cash payments from the seller at specified dates if rates go above a specified interest rate level known as the strike rate (cap). An interest rate floor is a contractual agreement between two counterparties in which the buyer, in return for paying a fee, will receive cash payments from the seller at specified dates if interest rates go below the strike rate. Interest Rate Swap Interest Rate Swap Interest Rate Swap – Financial transactions in which two Interest Rate Swap Interest Rate Swap counterparties agree to exchange streams of payments over time according to a predetermined formula. Swaps are normally used to transform the market exposure associated with a loan or bond borrowing from one interest rate base (fixed-term or floating rate). 66 Interest-Sensitive Assets / Liabilities - Interest-earning Interest-Sensitive Assets / Liabilities Interest-Sensitive Assets / Liabilities Interest-Sensitive Assets / Liabilities Interest-Sensitive Assets / Liabilities assets / liabilities for which interest rates are adjustable within a specified time period due to maturity or contractual arrangements. Four basic payment options that exist are the minimum payment option, interest-only payment, 30-year payment and 15-year payment. Net Charge-Offs - The amount of loans written-off as Net Charge-Offs Net Charge-Offs Net Charge-Offs Net Charge-Offs uncollectible, net of the recovery of loans previously written-off. Net Income Applicable to Common Stock Net Income Applicable to Common Stock Net Income Applicable to Common Stock - Net income Net Income Applicable to Common Stock Net Income Applicable to Common Stock less dividends paid on the Corporation’s preferred stock. Basic Basic Net Income Per Common Share Net Income Per Common Share Basic - Net income Net Income Per Common Share - Basic Net Income Per Common Share Basic Net Income Per Common Share applicable to common stock divided by the number of weighted- average common shares outstanding. Diluted Diluted Net Income Per Common Share Net Income Per Common Share Diluted - Net income Net Income Per Common Share - Diluted Net Income Per Common Share Diluted Net Income Per Common Share applicable to common stock divided by the sum of weighted- average common shares outstanding plus the effect of common stock equivalents that have the potential to be converted into common shares. Net Interest Income Net Interest Income Net Interest Income -The difference between the revenue Net Interest Income Net Interest Income generated on earning assets, less the interest cost of funding those assets. Net Interest Margin Net Interest Margin Net Interest Margin - Net interest income divided by total Net Interest Margin Net Interest Margin average earning assets. Net Interest Spread Net Interest Spread Net Interest Spread - Difference between the average yield on Net Interest Spread Net Interest Spread earning assets and the average rate paid on interest bearing liabilities, and the contribution of non-interest bearing funds supporting earning assets (primarily demand deposits and stockholders’ equity). Non-Performing Assets - Includes loans on which the accrual Non-Performing Assets Non-Performing Assets Non-Performing Assets Non-Performing Assets of interest income has been discontinued due to default on interest and / or principal payments or other factors indicative of doubtful collection, loans for which the interest rates or terms of repayment have been renegotiated, and real estate which has been acquired through foreclosure. Options Adjustable Rate Mortgage - is an adjustable rate Options Adjustable Rate Mortgage Options Adjustable Rate Mortgage Options Adjustable Rate Mortgage Options Adjustable Rate Mortgage mortgage (“ARM”) which consists of taking an index (i.e 12- month Treasury Average, Cost of Deposit Index, etc.), then adding a margin to total the final interest rate. Unlike other ARM’s where the principal and interest or simple interest payment is calculated from the total of the index and margin, the Options ARM may offer 4 monthly payment options every month depending on the loan program, giving the borrower the opportunity to choose which payment gets made based on the borrower’s economic condition at the time the payment is due. Option Contract Option Contract Option Contract - Conveys a right, but not an obligation, to Option Contract Option Contract buy or sell a specified number of units of a financial instrument at a specific price per unit within a specified time period. The instrument underlying the option may be a security, a futures contract (for example, an interest rate option), a commodity, a currency, or a cash instrument. Options may be bought or sold on organized exchanges or over the counter on a principal-to- principal basis or may be individually negotiated. A call option gives the holder the right, but not the obligation, to buy the underlying instrument. A put option gives the holder the right, but not the obligation, to sell the underlying instrument. Overcollaterization Overcollaterization Overcollaterization - A type of credit enhancement by which Overcollaterization Overcollaterization an issuer of securities pledged collateral in excess of what is needed to adequately cover the repayment of the securities plus a reserve. By pledging collateral with a higher face value than the securities being offered for sale, an issuer of mortgage-backed bonds can get a more favorable rating from a rating agency and also guard against the possibility that the bonds may be called before maturity because of mortgage prepayments. Overhead Ratio Overhead Ratio Overhead Ratio - Operating expenses less non-interest income Overhead Ratio Overhead Ratio divided by net interest income. Piggyback Loan Piggyback Loan Piggyback Loan - is a home financing option in which a Piggyback Loan Piggyback Loan property is purchased using more than one mortgage from two or more lenders. As compared with standard home mortgage programs, combined rates for piggyback loans are often higher than standard loans. This is because of the risk amounts that each lender is assuming. Also, many piggyback loans attach a large balloon payment at the end of a loan that is substantially larger than the standard mortgage payments. Provision For Loan Losses Provision For Loan Losses Provision For Loan Losses - The periodic expense needed to Provision For Loan Losses Provision For Loan Losses maintain the level of the allowance for loan losses at a level consistent with management’s assessment of the loan portfolio in light of current economic conditions and market trends, and taking into account loan impairment and net charge-offs. Return on Assets Return on Assets Return on Assets - Net income as a percentage of average total Return on Assets Return on Assets assets. Return on Equity Return on Equity Return on Equity - Net income applicable to common stock as Return on Equity Return on Equity a percentage of average common stockholders’ equity. 2007 Annual Report 67 2007 2007 Popular, Inc. 2007 2007 Servicing Right - A contractual agreement to provide certain Servicing Right Servicing Right Servicing Right Servicing Right billing, bookkeeping and collection services with respect to a pool of loans. Tangible Equity - Consists of stockholders’ equity less Tangible Equity Tangible Equity Tangible Equity Tangible Equity goodwill and other intangible assets. Tier 1 Leverage Ratio - Tier 1 Risk-Based Capital divided by Tier 1 Leverage Ratio Tier 1 Leverage Ratio Tier 1 Leverage Ratio Tier 1 Leverage Ratio average adjusted quarterly total assets. Average adjusted quarterly assets are adjusted to exclude non-qualifying intangible assets and disallowed deferred tax assets. T i e r 1 R i s k - B a s e d C a p i t a l T i e r 1 R i s k - B a s e d C a p i t a l T i e r 1 R i s k - B a s e d C a p i t a l - C o n s i s t s o f c o m m o n T i e r 1 R i s k - B a s e d C a p i t a l T i e r 1 R i s k - B a s e d C a p i t a l stockholders’ equity (including the related surplus, retained earnings and capital reserves), qualifying noncumulative perpetual preferred stock, qualifying trust preferred securities and minority interest in the equity accounts of consolidated subsidiaries, less goodwill and other disallowed intangible assets, disallowed portion of deferred tax assets and the deduction for nonfinancial equity investments. Total Risk-Adjusted Assets Total Risk-Adjusted Assets Total Risk-Adjusted Assets - The sum of assets and credit Total Risk-Adjusted Assets Total Risk-Adjusted Assets equivalent off-balance sheet amounts that have been adjusted according to assigned regulatory risk weights, excluding the non-qualifying portion of allowance for loan and lease losses, goodwill and other intangible assets. Total Risk-Based Capital Total Risk-Based Capital Total Risk-Based Capital - Consists of Tier 1 Capital plus Total Risk-Based Capital Total Risk-Based Capital the allowance for loan losses, qualifying subordinated debt and the allowed portion of the net unrealized gains on available-for- sale equity securities. Treasury Stock - Common stock repurchased and held by the Treasury Stock Treasury Stock Treasury Stock Treasury Stock issuing corporation for possible future issuance. 68 Statistical Summary 2003-2007 Statements of Condition (In thousands) A s s e t s A s s e t s A s s e t s A s s e t s A s s e t s Cash and due from banks Money market investments: Federal funds sold and securities purchased under agreements to resell Time deposits with other banks Bankers’ acceptances Trading securities, at fair value Investment securities available-for-sale, at fair value Investment securities held-to-maturity, at amortized cost Other investment securities, at lower of cost or 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2006 2005 2004 2003 As of December 31, $ 8 1 8 , 8 2 5 $ 8 1 8 , 8 2 5 $ 8 1 8 , 8 2 5 $ 8 1 8 , 8 2 5 $ 8 1 8 , 8 2 5 $950,158 $906,397 $716,459 $688,090 8 8 3 , 6 8 6 8 8 3 , 6 8 6 8 8 3 , 6 8 6 8 8 3 , 6 8 6 8 8 3 , 6 8 6 1 2 3 , 0 2 6 1 2 3 , 0 2 6 1 2 3 , 0 2 6 1 2 3 , 0 2 6 1 2 3 , 0 2 6 ----- 1 , 0 0 6 , 7 1 2 1 , 0 0 6 , 7 1 2 1 , 0 0 6 , 7 1 2 1 , 0 0 6 , 7 1 2 1 , 0 0 6 , 7 1 2 7 6 7 , 9 5 5 7 6 7 , 9 5 5 7 6 7 , 9 5 5 7 6 7 , 9 5 5 7 6 7 , 9 5 5 286,531 15,177 - 301,708 382,325 740,770 8,653 - 749,423 519,338 879,321 319 - 879,640 385,139 764,780 8,046 67 772,893 605,119 8 , 5 1 5 , 1 3 5 8 , 5 1 5 , 1 3 5 8 , 5 1 5 , 1 3 5 8 , 5 1 5 , 1 3 5 8 , 5 1 5 , 1 3 5 4 8 4 , 4 6 6 4 8 4 , 4 6 6 4 8 4 , 4 6 6 4 8 4 , 4 6 6 4 8 4 , 4 6 6 9,850,862 91,340 11,716,586 153,104 11,162,145 340,850 10,051,579 186,821 realizable value Loans held-for-sale, at lower of cost or market Loans held-in-portfolio: Less - Unearned income Allowance for loan losses Premises and equipment, net Other real estate Accrued income receivable Servicing Assets Other assets Goodwill Other intangible assets 2 1 6 , 5 8 4 2 1 6 , 5 8 4 2 1 6 , 5 8 4 2 1 6 , 5 8 4 2 1 6 , 5 8 4 1 , 8 8 9 , 5 4 6 1 , 8 8 9 , 5 4 6 1 , 8 8 9 , 5 4 6 1 , 8 8 9 , 5 4 6 1 , 8 8 9 , 5 4 6 2 8 , 2 0 3 , 5 6 6 2 8 , 2 0 3 , 5 6 6 2 8 , 2 0 3 , 5 6 6 2 8 , 2 0 3 , 5 6 6 2 8 , 2 0 3 , 5 6 6 1 8 2 , 1 1 0 1 8 2 , 1 1 0 1 8 2 , 1 1 0 1 8 2 , 1 1 0 1 8 2 , 1 1 0 5 4 8 , 8 3 2 5 4 8 , 8 3 2 5 4 8 , 8 3 2 5 4 8 , 8 3 2 5 4 8 , 8 3 2 2 7 , 4 7 2 , 6 2 4 2 7 , 4 7 2 , 6 2 4 2 7 , 4 7 2 , 6 2 4 2 7 , 4 7 2 , 6 2 4 2 7 , 4 7 2 , 6 2 4 5 8 8 , 1 6 3 5 8 8 , 1 6 3 5 8 8 , 1 6 3 5 8 8 , 1 6 3 5 8 8 , 1 6 3 8 1 , 4 1 0 8 1 , 4 1 0 8 1 , 4 1 0 8 1 , 4 1 0 8 1 , 4 1 0 2 1 6 , 1 1 4 2 1 6 , 1 1 4 2 1 6 , 1 1 4 2 1 6 , 1 1 4 2 1 6 , 1 1 4 1 9 6 , 6 4 5 1 9 6 , 6 4 5 1 9 6 , 6 4 5 1 9 6 , 6 4 5 1 9 6 , 6 4 5 1 , 4 5 6 , 9 9 4 1 , 4 5 6 , 9 9 4 1 , 4 5 6 , 9 9 4 1 , 4 5 6 , 9 9 4 1 , 4 5 6 , 9 9 4 6 3 0 , 7 6 1 6 3 0 , 7 6 1 6 3 0 , 7 6 1 6 3 0 , 7 6 1 6 3 0 , 7 6 1 6 9 , 5 0 3 6 9 , 5 0 3 6 9 , 5 0 3 6 9 , 5 0 3 6 9 , 5 0 3 $ 4 4 , 4 1 1 , 4 3 7 $ 4 4 , 4 1 1 , 4 3 7 $ 4 4 , 4 1 1 , 4 3 7 $ 4 4 , 4 1 1 , 4 3 7 $ 4 4 , 4 1 1 , 4 3 7 297,394 719,922 32,325,364 308,347 522,232 31,494,785 595,140 84,816 248,240 164,999 1,446,891 667,853 107,554 $47,403,987 Equity Equity Liabilities and Stockholders Liabilities and Stockholders Equity Liabilities and Stockholders’’’’’ Equity Liabilities and Stockholders Equity Liabilities and Stockholders Liabilities: Deposits: Non-interest bearing Interest bearing Federal funds purchased and assets sold under agreements to repurchase Other short-term borrowings Notes payable Subordinated notes Other liabilities Minority interest in consolidated subsidiaries Stockholders’ equity: Preferred stock Common stock Surplus Retained earnings Treasury stock - at cost Accumulated other comprehensive (loss) income, $ 4 , 5 1 0 , 7 8 9 $ 4 , 5 1 0 , 7 8 9 $ 4 , 5 1 0 , 7 8 9 $ 4 , 5 1 0 , 7 8 9 $ 4 , 5 1 0 , 7 8 9 2 3 , 8 2 3 , 6 8 9 2 3 , 8 2 3 , 6 8 9 2 3 , 8 2 3 , 6 8 9 2 3 , 8 2 3 , 6 8 9 2 3 , 8 2 3 , 6 8 9 2 8 , 3 3 4 , 4 7 8 2 8 , 3 3 4 , 4 7 8 2 8 , 3 3 4 , 4 7 8 2 8 , 3 3 4 , 4 7 8 2 8 , 3 3 4 , 4 7 8 5 , 4 3 7 , 2 6 5 5 , 4 3 7 , 2 6 5 5 , 4 3 7 , 2 6 5 5 , 4 3 7 , 2 6 5 5 , 4 3 7 , 2 6 5 1 , 5 0 1 , 9 7 9 1 , 5 0 1 , 9 7 9 1 , 5 0 1 , 9 7 9 1 , 5 0 1 , 9 7 9 1 , 5 0 1 , 9 7 9 4 , 6 2 1 , 3 5 2 4 , 6 2 1 , 3 5 2 4 , 6 2 1 , 3 5 2 4 , 6 2 1 , 3 5 2 4 , 6 2 1 , 3 5 2 ----- 9 3 4 , 3 7 2 9 3 4 , 3 7 2 9 3 4 , 3 7 2 9 3 4 , 3 7 2 9 3 4 , 3 7 2 4 0 , 8 2 9 , 4 4 6 4 0 , 8 2 9 , 4 4 6 4 0 , 8 2 9 , 4 4 6 4 0 , 8 2 9 , 4 4 6 4 0 , 8 2 9 , 4 4 6 1 0 91 0 91 0 91 0 91 0 9 1 8 6 , 8 7 5 1 8 6 , 8 7 5 1 8 6 , 8 7 5 1 8 6 , 8 7 5 1 8 6 , 8 7 5 1 , 7 6 1 , 9 0 8 1 , 7 6 1 , 9 0 8 1 , 7 6 1 , 9 0 8 1 , 7 6 1 , 9 0 8 1 , 7 6 1 , 9 0 8 5 6 8 , 1 8 4 5 6 8 , 1 8 4 5 6 8 , 1 8 4 5 6 8 , 1 8 4 5 6 8 , 1 8 4 1 , 3 1 9 , 4 6 7 1 , 3 1 9 , 4 6 7 1 , 3 1 9 , 4 6 7 1 , 3 1 9 , 4 6 7 1 , 3 1 9 , 4 6 7 ( 2 0 7 , 7 4 0 ) ( 2 0 7 , 7 4 0 ) ( 2 0 7 , 7 4 0 ) ( 2 0 7 , 7 4 0 ) ( 2 0 7 , 7 4 0 ) $4,222,133 20,216,198 24,438,331 5,762,445 4,034,125 8,737,246 - 811,424 43,783,571 110 186,875 1,753,146 526,856 1,594,144 (206,987) 319,103 699,181 31,308,639 297,613 461,707 30,549,319 596,571 79,008 245,646 141,489 1,184,311 653,984 110,208 $48,623,668 $3,958,392 18,679,613 22,638,005 8,702,461 2,700,261 9,893,577 - 1,240,002 45,174,306 115 186,875 1,736,443 452,398 1,456,612 (207,081) 302,440 750,728 28,253,923 262,390 437,081 27,554,452 545,681 59,717 207,542 57,183 989,191 411,308 39,101 $44,401,576 233,144 271,592 22,613,879 283,279 408,542 21,922,058 485,452 53,898 176,152 56,792 712,245 191,490 27,390 $36,434,715 $4,173,268 16,419,892 20,593,160 $3,726,707 14,371,121 18,097,828 6,436,853 3,139,639 10,180,710 125,000 821,491 41,296,853 102 5,835,587 1,996,624 6,992,025 125,000 633,129 33,680,193 105 186,875 186,875 837,566 1,680,096 314,638 278,840 1,129,793 1,601,851 (206,437) (205,527) net of tax ( 4 6 , 8 1 2 ) ( 4 6 , 8 1 2 ) ( 4 6 , 8 1 2 ) ( 4 6 , 8 1 2 ) ( 4 6 , 8 1 2 ) 3 , 5 8 1 , 8 8 2 3 , 5 8 1 , 8 8 2 3 , 5 8 1 , 8 8 2 3 , 5 8 1 , 8 8 2 3 , 5 8 1 , 8 8 2 $ 4 4 , 4 1 1 , 4 3 7 $ 4 4 , 4 1 1 , 4 3 7 $ 4 4 , 4 1 1 , 4 3 7 $ 4 4 , 4 1 1 , 4 3 7 $ 4 4 , 4 1 1 , 4 3 7 (233,728) 3,620,306 $47,403,987 (176,000) 3,449,247 $48,623,668 35,454 3,104,621 $44,401,576 19,014 2,754,417 $36,434,715 Statistical Summary 2003-2007 Statements of Operations (In thousands, except per common share information) Interest IIIIIncome: ncome: ncome: Interest Interest ncome: Interest ncome: Interest Loans Money market investments Investment securities Trading securities Total interest income Less - Interest expense Net interest income Provision for loan losses Net interest income after provision for loan losses Net gain on sale and valuation adjustment of investment securities Trading account (loss) profit (Loss) gain on sale of loans and valuation adjustments on loans held-for-sale All other operating income Operating EEEEE xpenses: xpenses: xpenses: Operating Operating xpenses: Operating xpenses: Operating Personnel costs All other operating expenses (Loss) income before tax, minority interest and cumulative effect of accounting change Income tax (benefit) expense Net gain of minority interest (Loss) income before cumulative effect of accounting change Cumulative effect of accounting change, net of tax 2007 Annual Report 69 2007 2007 Popular, Inc. 2007 2007 For the year ended December 31, 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2006 2005 2004 2003 $ 2 , 6 1 5 , 3 1 4 $ 2 , 6 1 5 , 3 1 4 $ 2 , 6 1 5 , 3 1 4 $ 2 , 6 1 5 , 3 1 4 $ 2 , 6 1 5 , 3 1 4 2 5 , 1 9 0 2 5 , 1 9 0 2 5 , 1 9 0 2 5 , 1 9 0 2 5 , 1 9 0 4 4 5 , 7 6 9 4 4 5 , 7 6 9 4 4 5 , 7 6 9 4 4 5 , 7 6 9 4 4 5 , 7 6 9 4 1 , 8 9 8 4 1 , 8 9 8 4 1 , 8 9 8 4 1 , 8 9 8 4 1 , 8 9 8 3 , 1 2 8 , 1 7 1 3 , 1 2 8 , 1 7 1 3 , 1 2 8 , 1 7 1 3 , 1 2 8 , 1 7 1 3 , 1 2 8 , 1 7 1 1 , 6 7 8 , 7 8 1 1 , 6 7 8 , 7 8 1 1 , 6 7 8 , 7 8 1 1 , 6 7 8 , 7 8 1 1 , 6 7 8 , 7 8 1 1 , 4 4 9 , 3 9 0 1 , 4 4 9 , 3 9 0 1 , 4 4 9 , 3 9 0 1 , 4 4 9 , 3 9 0 1 , 4 4 9 , 3 9 0 5 6 2 , 6 5 0 5 6 2 , 6 5 0 5 6 2 , 6 5 0 5 6 2 , 6 5 0 5 6 2 , 6 5 0 $2,486,453 29,626 516,237 32,125 3,064,441 1,636,531 1,427,910 287,760 $2,116,299 30,736 488,814 30,010 2,665,859 1,241,652 1,424,207 195,272 $1,751,150 25,660 413,492 25,963 2,216,265 840,754 1,375,511 178,657 $1,550,036 25,881 422,295 36,026 2,034,238 749,550 1,284,688 195,939 8 8 6 , 7 4 0 8 8 6 , 7 4 0 8 8 6 , 7 4 0 8 8 6 , 7 4 0 8 8 6 , 7 4 0 1,140,150 1,228,935 1,196,854 1,088,749 5 5 , 1 5 9 5 5 , 1 5 9 5 5 , 1 5 9 5 5 , 1 5 9 5 5 , 1 5 9 ( 2 , 4 6 4 ) ( 2 , 4 6 4 ) ( 2 , 4 6 4 ) ( 2 , 4 6 4 ) ( 2 , 4 6 4 ) 4,359 35,288 52,113 30,051 15,254 (159) 71,094 (10,214) ( 3 8 , 9 7 0 ) ( 3 8 , 9 7 0 ) ( 3 8 , 9 7 0 ) ( 3 8 , 9 7 0 ) ( 3 8 , 9 7 0 ) 6 8 0 , 5 9 1 6 8 0 , 5 9 1 6 8 0 , 5 9 1 6 8 0 , 5 9 1 6 8 0 , 5 9 1 117,421 652,417 83,297 619,814 44,168 549,508 53,572 511,558 1 , 5 8 1 , 0 5 6 1 , 5 8 1 , 0 5 6 1 , 5 8 1 , 0 5 6 1 , 5 8 1 , 0 5 6 1 , 5 8 1 , 0 5 6 1,949,635 2,014,210 1,805,625 1,714,759 6 6 8 , 1 8 9 6 6 8 , 1 8 9 6 6 8 , 1 8 9 6 6 8 , 1 8 9 6 6 8 , 1 8 9 1 , 0 3 6 , 3 6 2 1 , 0 3 6 , 3 6 2 1 , 0 3 6 , 3 6 2 1 , 0 3 6 , 3 6 2 1 , 0 3 6 , 3 6 2 1 , 7 0 4 , 5 5 1 1 , 7 0 4 , 5 5 1 1 , 7 0 4 , 5 5 1 1 , 7 0 4 , 5 5 1 1 , 7 0 4 , 5 5 1 668,671 816,402 1,485,073 622,689 705,511 1,328,200 571,018 599,994 1,171,012 526,444 586,639 1,113,083 ( 1 2 3 , 4 9 5 ) ( 1 2 3 , 4 9 5 ) ( 1 2 3 , 4 9 5 ) ( 1 2 3 , 4 9 5 ) ( 1 2 3 , 4 9 5 ) ( 5 9 , 0 0 2 ) ( 5 9 , 0 0 2 ) ( 5 9 , 0 0 2 ) ( 5 9 , 0 0 2 ) ( 5 9 , 0 0 2 ) ----- ( 6 4 , 4 9 3 ) ( 6 4 , 4 9 3 ) ( 6 4 , 4 9 3 ) ( 6 4 , 4 9 3 ) ( 6 4 , 4 9 3 ) ----- 464,562 106,886 - 357,676 - 686,010 148,915 - 537,095 3,607 634,613 144,705 - 601,676 130,326 (435) 489,908 - 470,915 - ncome ncome (Loss) I NetNetNetNetNet (Loss) I (Loss) I ncome (Loss) Income ncome (Loss) I ( $ 6 4 , 4 9 3 ) ( $ 6 4 , 4 9 3 ) ( $ 6 4 , 4 9 3 ) ( $ 6 4 , 4 9 3 ) ( $ 6 4 , 4 9 3 ) $357,676 $540,702 $489,908 $470,915 ommon SSSSS tock tock tock ommon pplicable to CCCCCommon ommon pplicable to ncome AAAAApplicable to pplicable to ncome ncome (Loss) I Net Net Net Net Net (Loss) I (Loss) I tock (Loss) Income tock ommon pplicable to ncome (Loss) I ( $ 7 6 , 4 0 6 ) ( $ 7 6 , 4 0 6 ) ( $ 7 6 , 4 0 6 ) ( $ 7 6 , 4 0 6 ) ( $ 7 6 , 4 0 6 ) $345,763 $528,789 $477,995 $460,996 Basic EPS Before Cumulative Effect of Accounting Change* Basic EPS Before Cumulative Effect of Accounting Change* Basic EPS Before Cumulative Effect of Accounting Change* Basic EPS Before Cumulative Effect of Accounting Change* Basic EPS Before Cumulative Effect of Accounting Change* Diluted EPS Before Cumulative Effect of Accounting Change* Diluted EPS Before Cumulative Effect of Accounting Change* Diluted EPS Before Cumulative Effect of Accounting Change* Diluted EPS Before Cumulative Effect of Accounting Change* Diluted EPS Before Cumulative Effect of Accounting Change* Basic EPS After Cumulative Effect of Accounting Change* Basic EPS After Cumulative Effect of Accounting Change* Basic EPS After Cumulative Effect of Accounting Change* Basic EPS After Cumulative Effect of Accounting Change* Basic EPS After Cumulative Effect of Accounting Change* EPS After Cumulative Effect of Accounting Change* EPS After Cumulative Effect of Accounting Change* Diluted Diluted EPS After Cumulative Effect of Accounting Change* Diluted EPS After Cumulative Effect of Accounting Change* EPS After Cumulative Effect of Accounting Change* Diluted Diluted ommon S S S S Shareharehareharehare ommon eclared per CCCCCommon ommon eclared per ividends DDDDDeclared per eclared per ividends DDDDDividends ividends ommon eclared per ividends ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) $ 0 . 6 4 $ 0 . 6 4 $ 0 . 6 4 $ 0 . 6 4 $ 0 . 6 4 $1.24 $1.24 $1.24 $1.24 $0.64 $1.97 $1.96 $1.98 $1.97 $0.64 $1.79 $1.79 $1.79 $1.79 $0.62 $1.74 $1.74 $1.74 $1.74 $0.51 279,494,150 for 2007; 279,494,150 for 2007; per common share were per common share were (losses) (losses) earnings earnings basic basic *The average common shares used in the computation of *The average common shares used in the computation of 279,494,150 for 2007; per common share were 279,494,150 for 2007; (losses) per common share were earnings (losses) basic earnings *The average common shares used in the computation of basic 279,494,150 for 2007; per common share were (losses) earnings basic *The average common shares used in the computation of *The average common shares used in the computation of 278,468,552 for 2006; 267,334,606 for 2005; 266,302,105 for 2004 and 265,481,840 for 2003. The average common shares 278,468,552 for 2006; 267,334,606 for 2005; 266,302,105 for 2004 and 265,481,840 for 2003. The average common shares 278,468,552 for 2006; 267,334,606 for 2005; 266,302,105 for 2004 and 265,481,840 for 2003. The average common shares 278,468,552 for 2006; 267,334,606 for 2005; 266,302,105 for 2004 and 265,481,840 for 2003. The average common shares 278,468,552 for 2006; 267,334,606 for 2005; 266,302,105 for 2004 and 265,481,840 for 2003. The average common shares used in the computation of diluted earnings (losses) per common share were 279,494,150 for 2007; 278,703,924 for 2006; used in the computation of diluted earnings (losses) per common share were 279,494,150 for 2007; 278,703,924 for 2006; used in the computation of diluted earnings (losses) per common share were 279,494,150 for 2007; 278,703,924 for 2006; used in the computation of diluted earnings (losses) per common share were 279,494,150 for 2007; 278,703,924 for 2006; used in the computation of diluted earnings (losses) per common share were 279,494,150 for 2007; 278,703,924 for 2006; 267,839,018 for 2005; 266,674,856 for 2004 and 265,595,832 for 2003. 267,839,018 for 2005; 266,674,856 for 2004 and 265,595,832 for 2003. 267,839,018 for 2005; 266,674,856 for 2004 and 265,595,832 for 2003. 267,839,018 for 2005; 266,674,856 for 2004 and 265,595,832 for 2003. 267,839,018 for 2005; 266,674,856 for 2004 and 265,595,832 for 2003. A v e r a g e A v e r a g e A v e r a g e A v e r a g e A v e r a g e B a l a n c e B a l a n c e B a l a n c e B a l a n c e B a l a n c e 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 I n t e r e s t I n t e r e s t I n t e r e s t I n t e r e s t I n t e r e s t A v e r a g e A v e r a g e A v e r a g e A v e r a g e A v e r a g e Rate Rate Rate Rate Rate Average Balance 2006 Interest Average Rate $ 5 1 3 , 7 0 4 $ 5 1 3 , 7 0 4 $ 5 1 3 , 7 0 4 $ 5 1 3 , 7 0 4 $ 5 1 3 , 7 0 4 4 9 8 , 2 3 2 4 9 8 , 2 3 2 4 9 8 , 2 3 2 4 9 8 , 2 3 2 4 9 8 , 2 3 2 $ 2 6 , 5 6 5 $ 2 6 , 5 6 5 $ 2 6 , 5 6 5 $ 2 6 , 5 6 5 $ 2 6 , 5 6 5 2 1 , 1 6 4 2 1 , 1 6 4 2 1 , 1 6 4 2 1 , 1 6 4 2 1 , 1 6 4 5 . 1 7 % 5 . 1 7 % 5 . 1 7 % 5 . 1 7 % 5 . 1 7 % 4 . 2 5 4 . 2 5 4 . 2 5 4 . 2 5 4 . 2 5 $564,423 521,917 $31,382 22,930 5.56% 4.39 70 Statistical Summary 2003-2007 Average Balance Sheet and Summary of Net Interest Income On a Taxable Equivalent Basis* (Dollars in thousands) Assets Assets Assets Assets Assets Interest earning assets: Money market investments U.S. Treasury securities Obligations of U.S. Government entities Obligations of Puerto Rico, States and political subdivisions Collateralized mortgage obligations and mortgage-backed securities Other Total investment securities 6 , 2 9 4 , 4 8 9 6 , 2 9 4 , 4 8 9 6 , 2 9 4 , 4 8 9 6 , 2 9 4 , 4 8 9 6 , 2 9 4 , 4 8 9 3 1 0 , 6 3 2 3 1 0 , 6 3 2 3 1 0 , 6 3 2 3 1 0 , 6 3 2 3 1 0 , 6 3 2 1 8 5 , 0 3 5 1 8 5 , 0 3 5 1 8 5 , 0 3 5 1 8 5 , 0 3 5 1 8 5 , 0 3 5 1 2 , 5 4 6 1 2 , 5 4 6 1 2 , 5 4 6 1 2 , 5 4 6 1 2 , 5 4 6 2 , 5 7 5 , 9 4 1 2 , 5 7 5 , 9 4 1 2 , 5 7 5 , 9 4 1 2 , 5 7 5 , 9 4 1 2 , 5 7 5 , 9 4 1 2 9 9 , 8 9 4 2 9 9 , 8 9 4 2 9 9 , 8 9 4 2 9 9 , 8 9 4 2 9 9 , 8 9 4 9 , 8 5 3 , 5 9 1 9 , 8 5 3 , 5 9 1 9 , 8 5 3 , 5 9 1 9 , 8 5 3 , 5 9 1 9 , 8 5 3 , 5 9 1 1 4 8 , 6 2 0 1 4 8 , 6 2 0 1 4 8 , 6 2 0 1 4 8 , 6 2 0 1 4 8 , 6 2 0 1 8 , 2 4 6 1 8 , 2 4 6 1 8 , 2 4 6 1 8 , 2 4 6 1 8 , 2 4 6 5 1 1 , 2 0 8 5 1 1 , 2 0 8 5 1 1 , 2 0 8 5 1 1 , 2 0 8 5 1 1 , 2 0 8 Trading account securities 6 7 2 , 4 0 5 6 7 2 , 4 0 5 6 7 2 , 4 0 5 6 7 2 , 4 0 5 6 7 2 , 4 0 5 4 3 , 3 0 7 4 3 , 3 0 7 4 3 , 3 0 7 4 3 , 3 0 7 4 3 , 3 0 7 Loans (net of unearned income) Total interest earning assets/ Interest income 3 2 , 7 4 9 , 9 9 3 3 2 , 7 4 9 , 9 9 3 3 2 , 7 4 9 , 9 9 3 3 2 , 7 4 9 , 9 9 3 3 2 , 7 4 9 , 9 9 3 2 , 6 3 6 , 9 5 4 2 , 6 3 6 , 9 5 4 2 , 6 3 6 , 9 5 4 2 , 6 3 6 , 9 5 4 2 , 6 3 6 , 9 5 4 $3,218,034 $3,218,034 4 3 , 7 8 9 , 6 9 3 4 3 , 7 8 9 , 6 9 3 $3,218,034 4 3 , 7 8 9 , 6 9 3 $3,218,034 $3,218,034 4 3 , 7 8 9 , 6 9 3 4 3 , 7 8 9 , 6 9 3 7 . 3 5 % 7 . 3 5 % 7 . 3 5 % 7 . 3 5 % 7 . 3 5 % Total non-interest earning assets 3 , 3 1 5 , 2 4 2 3 , 3 1 5 , 2 4 2 3 , 3 1 5 , 2 4 2 3 , 3 1 5 , 2 4 2 3 , 3 1 5 , 2 4 2 Total assets tockholders’ ’ ’ ’ ’ EEEEEquity quity quity tockholders Liabilities and SSSSStockholders tockholders Liabilities and Liabilities and quity Liabilities and quity tockholders Liabilities and Interest bearing liabilities: $ 4 7 , 1 0 4 , 9 3 5 $ 4 7 , 1 0 4 , 9 3 5 $ 4 7 , 1 0 4 , 9 3 5 $ 4 7 , 1 0 4 , 9 3 5 $ 4 7 , 1 0 4 , 9 3 5 Savings, NOW, money market and other interest bearing demand accounts Time deposits Short-term borrowings Notes payable Subordinated notes Preferred beneficial interest in junior subordinated deferrable interest debentures guaranteed by the Corporation $ 1 0 , 1 2 6 , 9 5 6 $ 1 0 , 1 2 6 , 9 5 6 $ 1 0 , 1 2 6 , 9 5 6 $ 1 0 , 1 2 6 , 9 5 6 $ 1 0 , 1 2 6 , 9 5 6 1 1 , 3 9 8 , 7 1 5 1 1 , 3 9 8 , 7 1 5 1 1 , 3 9 8 , 7 1 5 1 1 , 3 9 8 , 7 1 5 1 1 , 3 9 8 , 7 1 5 8 , 6 8 5 , 6 6 3 8 , 6 8 5 , 6 6 3 8 , 6 8 5 , 6 6 3 8 , 6 8 5 , 6 6 3 8 , 6 8 5 , 6 6 3 8 , 1 8 1 , 0 8 9 8 , 1 8 1 , 0 8 9 8 , 1 8 1 , 0 8 9 8 , 1 8 1 , 0 8 9 8 , 1 8 1 , 0 8 9 4 . 9 3 4 . 9 3 4 . 9 3 4 . 9 3 4 . 9 3 6 . 7 8 6 . 7 8 6 . 7 8 6 . 7 8 6 . 7 8 5 . 7 7 5 . 7 7 5 . 7 7 5 . 7 7 5 . 7 7 6 . 0 8 6 . 0 8 6 . 0 8 6 . 0 8 6 . 0 8 5 . 1 9 5 . 1 9 5 . 1 9 5 . 1 9 5 . 1 9 6 . 4 4 6 . 4 4 6 . 4 4 6 . 4 4 6 . 4 4 8 . 0 5 8 . 0 5 8 . 0 5 8 . 0 5 8 . 0 5 7,527,841 368,738 4.90 188,690 13,249 7.02 3,063,097 472,746 11,774,291 177,206 23,465 605,588 512,960 34,004 32,078,716 2,508,870 5.79 4.96 5.14 6.63 7.82 $3,179,844 7.08% 44,930,390 3,364,176 $48,294,566 $ 2 2 6 , 9 2 4 $ 2 2 6 , 9 2 4 $ 2 2 6 , 9 2 4 $ 2 2 6 , 9 2 4 $ 2 2 6 , 9 2 4 5 3 8 , 8 6 9 5 3 8 , 8 6 9 5 3 8 , 8 6 9 5 3 8 , 8 6 9 5 3 8 , 8 6 9 4 4 8 , 1 7 2 4 4 8 , 1 7 2 4 4 8 , 1 7 2 4 4 8 , 1 7 2 4 4 8 , 1 7 2 4 6 4 , 8 1 6 4 6 4 , 8 1 6 4 6 4 , 8 1 6 4 6 4 , 8 1 6 4 6 4 , 8 1 6 2 . 2 4 % 2 . 2 4 % 2 . 2 4 % 2 . 2 4 % 2 . 2 4 % 4 . 7 3 4 . 7 3 4 . 7 3 4 . 7 3 4 . 7 3 5 . 1 6 5 . 1 6 5 . 1 6 5 . 1 6 5 . 1 6 5 . 6 8 5 . 6 8 5 . 6 8 5 . 6 8 5 . 6 8 $9,317,779 9,976,613 10,677,161 9,868,385 $157,431 422,663 518,960 537,477 1.69% 4.24 4.86 5.45 Total interest bearing liabilities/ Interest expense 3 8 , 3 9 2 , 4 2 3 3 8 , 3 9 2 , 4 2 3 3 8 , 3 9 2 , 4 2 3 3 8 , 3 9 2 , 4 2 3 3 8 , 3 9 2 , 4 2 3 1 , 6 7 8 , 7 8 1 1 , 6 7 8 , 7 8 1 1 , 6 7 8 , 7 8 1 1 , 6 7 8 , 7 8 1 1 , 6 7 8 , 7 8 1 4 . 3 7 4 . 3 7 4 . 3 7 4 . 3 7 4 . 3 7 39,839,938 1,636,531 4.11 Total non-interest bearing liabilities Total liabilities Stockholders’ equity Total liabilities and stockholders’ equity Net interest income on a taxable 4 , 8 5 1 , 0 8 6 4 , 8 5 1 , 0 8 6 4 , 8 5 1 , 0 8 6 4 , 8 5 1 , 0 8 6 4 , 8 5 1 , 0 8 6 4 3 , 2 4 3 , 5 0 9 4 3 , 2 4 3 , 5 0 9 4 3 , 2 4 3 , 5 0 9 4 3 , 2 4 3 , 5 0 9 4 3 , 2 4 3 , 5 0 9 3 , 8 6 1 , 4 2 6 3 , 8 6 1 , 4 2 6 3 , 8 6 1 , 4 2 6 3 , 8 6 1 , 4 2 6 3 , 8 6 1 , 4 2 6 $ 4 7 , 1 0 4 , 9 3 5 $ 4 7 , 1 0 4 , 9 3 5 $ 4 7 , 1 0 4 , 9 3 5 $ 4 7 , 1 0 4 , 9 3 5 $ 4 7 , 1 0 4 , 9 3 5 equivalent basis Cost of funding earning assets Net interest margin $ 1 , 5 3 9 , 2 5 3 $ 1 , 5 3 9 , 2 5 3 $ 1 , 5 3 9 , 2 5 3 $ 1 , 5 3 9 , 2 5 3 $ 1 , 5 3 9 , 2 5 3 3 . 8 3 % 3 . 8 3 % 3 . 8 3 % 3 . 8 3 % 3 . 8 3 % 3 . 5 2 % 3 . 5 2 % 3 . 5 2 % 3 . 5 2 % 3 . 5 2 % Effect of the taxable equivalent adjustment Net interest income per books 8 9 , 8 6 3 8 9 , 8 6 3 8 9 , 8 6 3 8 9 , 8 6 3 8 9 , 8 6 3 $ 1 , 4 4 9 , 3 9 0 $ 1 , 4 4 9 , 3 9 0 $ 1 , 4 4 9 , 3 9 0 $ 1 , 4 4 9 , 3 9 0 $ 1 , 4 4 9 , 3 9 0 4,713,355 44,553,293 3,741,273 $48,294,566 $1,543,313 115,403 $1,427,910 3.64% 3.44% *Shows the effect of the tax exempt status of some loans and investments on their yield, using the applicable statutory income tax rates. *Shows the effect of the tax exempt status of some loans and investments on their yield, using the applicable statutory income tax rates. *Shows the effect of the tax exempt status of some loans and investments on their yield, using the applicable statutory income tax rates. *Shows the effect of the tax exempt status of some loans and investments on their yield, using the applicable statutory income tax rates. *Shows the effect of the tax exempt status of some loans and investments on their yield, using the applicable statutory income tax rates. The computation considers the interest expense disallowance required by the Puerto Rico Internal Revenue Code. This adjustment is The computation considers the interest expense disallowance required by the Puerto Rico Internal Revenue Code. This adjustment is The computation considers the interest expense disallowance required by the Puerto Rico Internal Revenue Code. This adjustment is The computation considers the interest expense disallowance required by the Puerto Rico Internal Revenue Code. This adjustment is The computation considers the interest expense disallowance required by the Puerto Rico Internal Revenue Code. This adjustment is shown in order to compare the yields of the tax exempt and taxable assets on a taxable basis. shown in order to compare the yields of the tax exempt and taxable assets on a taxable basis. shown in order to compare the yields of the tax exempt and taxable assets on a taxable basis. shown in order to compare the yields of the tax exempt and taxable assets on a taxable basis. shown in order to compare the yields of the tax exempt and taxable assets on a taxable basis. Note: Average loan balances include the average balance of non-accruing loans. No interest income is recognized for these loans in Note: Average loan balances include the average balance of non-accruing loans. No interest income is recognized for these loans in Note: Average loan balances include the average balance of non-accruing loans. No interest income is recognized for these loans in Note: Average loan balances include the average balance of non-accruing loans. No interest income is recognized for these loans in Note: Average loan balances include the average balance of non-accruing loans. No interest income is recognized for these loans in accordance with the Corporation’s policy. accordance with the Corporation’s policy. accordance with the Corporation’s policy. accordance with the Corporation’s policy. accordance with the Corporation’s policy. 2007 Annual Report 71 2007 2007 Popular, Inc. 2007 2007 Average Balance 2005 Interest Average Rate Average Balance 2004 Interest Average Rate Average Balance 2003 Interest Average Rate $797,166 551,328 $33,319 25,613 4.18% 4.65 $835,139 550,997 $25,660 26,600 3.07% 4.83 $833,237 472,114 $25,881 24,615 3.11% 5.21 7,574,297 364,081 247,220 14,954 3,338,925 518,516 12,230,286 487,319 163,853 22,588 591,089 32,427 29,730,913 2,135,511 4.81 6.05 4.91 4.36 4.83 6.65 7.18 6,720,329 322,854 255,244 13,504 3,233,378 402,112 11,162,060 480,890 128,421 15,406 506,785 27,387 25,143,559 1,765,290 4.80 5.29 3.97 3.83 4.54 5.70 7.02 6,451,157 356,008 201,505 13,570 3,062,564 407,105 10,594,445 623,632 118,097 16,267 528,557 37,887 20,730,041 1,562,083 5.52 6.73 3.86 4.00 4.99 6.08 7.54 $2,792,346 43,245,684 3,116,645 $46,362,329 6.46% 37,621,648 2,277,127 $39,898,775 $2,325,122 6.18% 32,781,355 1,893,406 $34,674,761 $2,154,408 6.57% $9,408,358 8,776,314 10,327,417 9,644,925 119,178 $125,585 305,228 349,203 453,489 8,147 1.33% $8,373,541 7,117,062 3.48 8,782,042 3.38 8,047,867 4.70 125,000 6.84 $92,026 238,325 165,425 336,415 8,563 1.10% 3.35 1.88 4.18 6.85 $7,741,007 6,521,861 8,390,874 5,124,604 125,000 $102,293 240,598 147,456 234,776 8,539 194,959 15,888 38,276,192 1,241,652 3.24 32,445,512 840,754 2.59 28,098,305 749,550 4,811,329 43,087,521 3,274,808 $46,362,329 4,550,126 36,995,638 2,903,137 $39,898,775 4,031,343 32,129,648 2,545,113 $34,674,761 $1,550,694 $1,484,368 $1,404,858 2.87% 3.59% 2.23% 3.95% 126,487 $1,424,207 108,857 $1,375,511 120,170 $1,284,688 1.32% 3.69 1.76 4.58 6.83 8.15 2.67 2.29% 4.28% 72 Statistical Summary 2006-2007 Quarterly Financial Data 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2006 F o u r t h F o u r t h F o u r t h F o u r t h F o u r t h Q u a r t e r Q u a r t e r Q u a r t e r Q u a r t e r Q u a r t e r Third Third Third Third Third Q u a r t e r Q u a r t e r Q u a r t e r Q u a r t e r Q u a r t e r S e c o n d S e c o n d First First S e c o n d First First S e c o n d S e c o n d First Q u a r t e r Q u a r t e r Q u a r t e r Q u a r t e r Q u a r t e r Q u a r t e r Q u a r t e r Q u a r t e r Q u a r t e r Q u a r t e r Fourth Quarter Third Quarter Second Quarter First Quarter $779,439 $779,439 $779,439 $779,439 $779,439 416,564 416,564 416,564 416,564 416,564 362,875 362,875 362,875 362,875 362,875 203,044 203,044 203,044 203,044 203,044 $790,226 $790,226 $790,226 $790,226 $790,226 430,110 430,110 430,110 430,110 430,110 360,116 360,116 360,116 360,116 360,116 148,093 148,093 148,093 148,093 148,093 $773,595 $773,595 $784,911 $784,911 $784,911 $773,595 $773,595 $784,911 $773,595 $784,911 418,613 418,613 413,494 413,494 418,613 413,494 418,613 413,494 418,613 413,494 354,982 354,982 371,417 371,417 354,982 371,417 354,982 371,417 354,982 371,417 96,346 96,346 115,167 115,167 96,346 115,167 96,346 96,346 115,167 115,167 $778,863 418,534 360,329 108,272 $781,331 439,293 342,038 63,445 $762,037 396,258 365,779 67,096 $742,210 382,446 359,764 48,947 (24,698) (24,698) (24,698) (24,698) (24,698) 96,458 96,458 96,458 96,458 96,458 621,197 621,197 621,197 621,197 621,197 (3,089) (3,089) (3,089) (3,089) (3,089) 170,094 170,094 170,094 170,094 170,094 346,973 346,973 346,973 346,973 346,973 1 , 1 7 5 1 , 1 7 5 1 , 1 7 5 1 , 1 7 5 1 , 1 7 5 202,200 202,200 202,200 202,200 202,200 361,053 361,053 361,053 361,053 361,053 81,771 81,771 81,771 81,771 81,771 170,405 170,405 170,405 170,405 170,405 375,328 375,328 375,328 375,328 375,328 (389,606) (389,606) (389,606) (389,606) (389,606) (95,513) (95,513) (95,513) (95,513) (95,513) ($294,093) ($294,093) ($294,093) ($294,093) ($294,093) 32,055 32,055 32,055 32,055 32,055 (3,948) (3,948) (3,948) (3,948) (3,948) $36,003 $36,003 $36,003 $36,003 $36,003 98,572 98,572 135,484 135,484 98,572 135,484 98,572 98,572 135,484 135,484 23,622 23,622 16,837 16,837 23,622 16,837 16,837 23,622 23,622 16,837 $118,647 $118,647 $74,950 $74,950 $118,647 $74,950 $118,647 $118,647 $74,950 $74,950 (680) 205,997 378,916 78,458 18,826 $59,632 7,123 184,226 359,923 110,019 27,859 $82,160 (14,424) 198,410 362,980 12,340 216,493 383,254 119,689 22,308 $97,381 156,396 37,893 $118,503 (In thousands, except per common share information) Summary of Operations Summary of Operations Summary of Operations Summary of Operations Summary of Operations Interest income Interest expense Net interest income Provision for loan losses Net (loss) gain on sale and valuation adjustment of investment securities Other non-interest income Operating expenses (Loss) income before income tax Income tax (benefit) expense Net (loss) income Net (loss) income applicable to common stock ($297,071) ($297,071) ($297,071) ($297,071) ($297,071) $33,024 $33,024 $33,024 $33,024 $33,024 $115,669 $115,669 $71,972 $71,972 $115,669 $71,972 $115,669 $115,669 $71,972 $71,972 $56,654 $79,181 $94,403 $115,525 Net (loss) income per common share: (basic and diluted) ($1.06) ($1.06) ($1.06) ($1.06) ($1.06) $ 0 . 1 2 $ 0 . 1 2 $ 0 . 1 2 $ 0 . 1 2 $ 0 . 1 2 $ 0 . 2 6 $ 0 . 2 6 $ 0 . 2 6 $ 0 . 2 6 $ 0 . 2 6 $ 0 . 4 1 $ 0 . 4 1 $ 0 . 4 1 $ 0 . 4 1 $ 0 . 4 1 $0.20 $0.28 $0.34 $0.42 Selected Average Balances Selected Average Balances Selected Average Balances Selected Average Balances Selected Average Balances (In millions) Total assets Loans Interest earning assets Deposits Interest bearing liabilities Selected Ratios Selected Ratios Selected Ratios Selected Ratios Selected Ratios Return on assets Return on equity $46,918 $46,918 $46,918 $46,918 $46,918 32,700 32,700 32,700 32,700 32,700 43,630 43,630 43,630 43,630 43,630 27,339 27,339 27,339 27,339 27,339 38,099 38,099 38,099 38,099 38,099 (2.49%) (2.49%) (2.49%) (2.49%) (2.49%) (32.32) (32.32) (32.32) (32.32) (32.32) $47,057 $47,057 $47,057 $47,057 $47,057 32,875 32,875 32,875 32,875 32,875 43,728 43,728 43,728 43,728 43,728 25,646 25,646 25,646 25,646 25,646 38,391 38,391 38,391 38,391 38,391 $47,140 $47,140 $47,140 $47,140 $47,140 32,766 32,766 32,766 32,766 32,766 43,828 43,828 43,828 43,828 43,828 24,924 24,924 24,924 24,924 24,924 38,422 38,422 38,422 38,422 38,422 $47,310 $47,310 $47,310 $47,310 $47,310 32,658 32,658 32,658 32,658 32,658 43,978 43,978 43,978 43,978 43,978 24,333 24,333 24,333 24,333 24,333 38,663 38,663 38,663 38,663 38,663 $47,299 32,171 43,992 24,204 38,732 $48,376 32,273 44,948 23,217 39,841 $48,565 31,941 45,196 22,976 40,094 $48,957 31,924 45,604 22,644 40,714 0 . 3 0 % 0 . 3 0 % 0 . 3 0 % 0 . 3 0 % 0 . 3 0 % 3 . 5 2 3 . 5 2 3 . 5 2 3 . 5 2 3 . 5 2 0 . 6 4 % 0 . 6 4 % 0 . 6 4 % 0 . 6 4 % 0 . 6 4 % 7 . 8 0 7 . 8 0 7 . 8 0 7 . 8 0 7 . 8 0 1 . 0 2 % 1 . 0 2 % 1 . 0 2 % 1 . 0 2 % 1 . 0 2 % 1 2 . 9 1 1 2 . 9 1 1 2 . 9 1 1 2 . 9 1 1 2 . 9 1 0.50% 6.20 0.67% 8.75 0.80% 10.72 1.02% 14.04 Management's Report to Stockholders 2007 Annual Report 73 2007 2007 Popular, Inc. 2007 2007 To Our Stockholders: s Assessment of Internal Control Over Financial Reporting s Assessment of Internal Control Over Financial Reporting Management Management s Assessment of Internal Control Over Financial Reporting Management’s Assessment of Internal Control Over Financial Reporting s Assessment of Internal Control Over Financial Reporting Management Management The management of Popular, Inc. (the Corporation) is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a - 15(f) and 15d - 15(f) under the Securities Exchange Act of 1934 and for our assessment of internal control over financial reporting. The Corporation’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America, and includes controls over the preparation of financial statements in accordance with the instructions to the Consolidated Financial Statements for Bank Holding Companies (Form FR Y-9C) to comply with the reporting requirements of Section 112 of the Federal Deposit Insurance Corporation Improvement Act (FDICIA). The Corporation’s internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Corporation; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the Corporation are being made only in accordance with authorizations of management and directors of the Corporation; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Corporation’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. The management of Popular, Inc. has assessed the effectiveness of the Corporation’s internal control over financial reporting as of December 31, 2007. In making this assessment, management used the criteria set forth in the Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our assessment, management concluded that the Corporation maintained effective internal control over financial reporting as of December 31, 2007 based on the criteria referred to above. The Corporation’s independent registered public accounting firm, PricewaterhouseCoopers, LLP, has audited the effectiveness of the Corporation’s internal control over financial reporting as of December 31, 2007, as stated in their report dated February 29, 2008 which appears herein. Richard L. Carrión Chairman of the Board, President and Chief Executive Officer Jorge A. Junquera Senior Executive Vice President and Chief Financial Officer 74 Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Popular, Inc. In our opinion, the accompanying consolidated statements of condition and the related consolidated statements of operations, comprehensive income, changes in stockholders’ equity and cash flows present fairly, in all material respects, the financial position of Popular, Inc. and its subsidiaries at December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Corporation’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report to Stockholders. Our responsibility is to express opinions on these financial statements and on the Corporation’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included 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. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. As discussed in Note 1 to the consolidated financial statements, the Corporation changed the manner in which it accounts for defined benefit pension and other postretirement pension plans in 2006. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Management’s assessment and our audit of Popular, Inc.’s internal control over financial reporting also included controls over the preparation of financial statements in accordance with the instructions to the Consolidated Financial Statements for Bank Holding Companies (Form FR Y-9C) to comply with the reporting requirements of Section 112 of the Federal Deposit Insurance Corporation Improvement Act (FDICIA). A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. 2007 Annual Report 75 2007 2007 Popular, Inc. 2007 2007 Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. PRICEWATERHOUSECOOPERS LLP San Juan, Puerto Rico February 29, 2008 CERTIFIED PUBLIC ACCOUNTANTS (OF PUERTO RICO) License No. 216 Expires December 1, 2010 Stamp 2287568 of the P.R. Society of Certified Public Accountants has been affixed to the file copy of this report. 76 Consolidated Statements of Condition (In thousands, except share information) A s s e t s A s s e t s A s s e t s A s s e t s A s s e t s Cash and due from banks Money market investments: Federal funds sold Securities purchased under agreements to resell Time deposits with other banks Trading securities, at fair value: Pledged securities with creditors’ right to repledge Other trading securities 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 $818,825 $818,825 $818,825 $818,825 $818,825 737,815 737,815 737,815 737,815 737,815 145,871 145,871 145,871 145,871 145,871 123,026 123,026 123,026 123,026 123,026 1,006,712 1,006,712 1,006,712 1,006,712 1,006,712 673,958 673,958 673,958 673,958 673,958 93,997 93,997 93,997 93,997 93,997 Investment securities available-for-sale, at fair value: Pledged securities with creditors’ right to repledge Other securities available-for-sale 4,249,295 4,249,295 4,249,295 4,249,295 4,249,295 4,265,840 4,265,840 4,265,840 4,265,840 4,265,840 484,466 484,466 484,466 Investment securities held-to-maturity, at amortized cost (market value 2007 - $486,139; 2006 - $92,764) 484,466 484,466 Other investment securities, at lower of cost or realizable value (fair value 2007 - $216,819; 216,584 216,584 216,584 216,584 216,584 1,889,546 1,889,546 1,889,546 1,889,546 1,889,546 149,610 149,610 149,610 149,610 149,610 28,053,956 28,053,956 28,053,956 28,053,956 28,053,956 182,110 182,110 182,110 182,110 182,110 548,832 548,832 548,832 548,832 548,832 27,472,624 27,472,624 27,472,624 27,472,624 27,472,624 588,163 588,163 588,163 588,163 588,163 81,410 81,410 81,410 81,410 81,410 216,114 216,114 216,114 216,114 216,114 196,645 196,645 196,645 196,645 196,645 1,456,994 1,456,994 1,456,994 1,456,994 1,456,994 630,761 630,761 630,761 630,761 630,761 69,503 69,503 69,503 69,503 69,503 $44,411,437 $44,411,437 $44,411,437 $44,411,437 $44,411,437 $4,510,789 $4,510,789 $4,510,789 $4,510,789 $4,510,789 23,823,689 23,823,689 23,823,689 23,823,689 23,823,689 28,334,478 28,334,478 28,334,478 28,334,478 28,334,478 5,437,265 5,437,265 5,437,265 5,437,265 5,437,265 1,501,979 1,501,979 1,501,979 1,501,979 1,501,979 4,621,352 4,621,352 4,621,352 4,621,352 4,621,352 934,372 934,372 934,372 934,372 934,372 40,829,446 40,829,446 40,829,446 40,829,446 40,829,446 2006 - $412,593) Loans held-for-sale, at lower of cost or market value Loans held-in-portfolio: Loans held-in-portfolio pledged with creditors’ right to repledge Other loans held-in-portfolio Less - Unearned income Allowance for loan losses Premises and equipment, net Other real estate Accrued income receivable Servicing assets (2007 - $191,624 at fair value) Other assets Goodwill Other intangible assets Equity Equity Liabilities and Stockholders Liabilities and Stockholders Equity Liabilities and Stockholders’’’’’ Equity Equity Liabilities and Stockholders Liabilities and Stockholders Liabilities: Deposits: Non-interest bearing Interest bearing Federal funds purchased and assets sold under agreements to repurchase Other short-term borrowings Notes payable Other liabilities Commitments and contingencies (See Notes 26, 28, 30, 33, 34) Minority interest in consolidated subsidiaries Stockholders’ Equity: Preferred stock, $25 liquidation value; 30,000,000 shares authorized; 7,475,000 issued and outstanding in both periods presented Common stock, $6 par value; 470,000,000 shares authorized in both periods presented; 293,651,398 shares issued (2006 - 292,190,924) and 280,029,215 shares outstanding (2006 - 278,741,547) Surplus Retained earnings Treasury stock-at cost, 13,622,183 shares (2006 - 13,449,377) Accumulated other comprehensive loss, net of tax of ($15,438) (2006 - ($84,143)) The accompanying notes are an integral part of the consolidated financial statements. The accompanying notes are an integral part of the consolidated financial statements. The accompanying notes are an integral part of the consolidated financial statements. The accompanying notes are an integral part of the consolidated financial statements. The accompanying notes are an integral part of the consolidated financial statements. December 31, 2006 $950,158 84,350 202,181 15,177 301,708 193,619 188,706 3,743,924 6,106,938 91,340 297,394 719,922 306,320 32,019,044 308,347 522,232 31,494,785 595,140 84,816 248,240 164,999 1,446,891 667,853 107,554 $47,403,987 $4,222,133 20,216,198 24,438,331 5,762,445 4,034,125 8,737,246 811,424 43,783,571 1 0 91 0 91 0 91 0 91 0 9 110 186,875 186,875 186,875 186,875 186,875 186,875 1,761,908 1,761,908 1,761,908 1,761,908 1,761,908 568,184 568,184 568,184 568,184 568,184 1,319,467 1,319,467 1,319,467 1,319,467 1,319,467 (207,740) (207,740) (207,740) (207,740) (207,740) (46,812) (46,812) (46,812) (46,812) (46,812) 3,581,882 3,581,882 3,581,882 3,581,882 3,581,882 $44,411,437 $44,411,437 $44,411,437 $44,411,437 $44,411,437 1,753,146 526,856 1,594,144 (206,987) (233,728) 3,620,306 $47,403,987 2007 Annual Report 77 2007 2007 Popular, Inc. 2007 2007 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 Year ended December 31, 2006 2005 $ 2 , 6 1 5 , 3 1 4 $ 2 , 6 1 5 , 3 1 4 $ 2 , 6 1 5 , 3 1 4 $ 2 , 6 1 5 , 3 1 4 $ 2 , 6 1 5 , 3 1 4 2 5 , 1 9 0 2 5 , 1 9 0 2 5 , 1 9 0 2 5 , 1 9 0 2 5 , 1 9 0 4 4 5 , 7 6 9 4 4 5 , 7 6 9 4 4 5 , 7 6 9 4 4 5 , 7 6 9 4 4 5 , 7 6 9 4 1 , 8 9 8 4 1 , 8 9 8 4 1 , 8 9 8 4 1 , 8 9 8 4 1 , 8 9 8 3 , 1 2 8 , 1 7 1 3 , 1 2 8 , 1 7 1 3 , 1 2 8 , 1 7 1 3 , 1 2 8 , 1 7 1 3 , 1 2 8 , 1 7 1 $2,486,453 29,626 516,237 32,125 3,064,441 $2,116,299 30,736 488,814 30,010 2,665,859 Consolidated Statements of Operations (In thousands, except per share information) Interest Income: Interest Income: Interest Income: Interest Income: Interest Income: Loans Money market investments Investment securities Trading securities Interest Expense: Interest Expense: Interest Expense: Interest Expense: Interest Expense: Deposits Short-term borrowings Long-term debt Net interest income Provision for loan losses Net interest income after provision for loan losses Service charges on deposit accounts Other service fees (Note 35) Net gain on sale and valuation adjustment of investment securities Trading account (loss) profit (Loss) gain on sale of loans and valuation adjustments on loans held-for-sale Other operating income Operating Expenses: Operating Expenses: Operating Expenses: Operating Expenses: Operating Expenses: Personnel costs: Salaries Pension, profit sharing and other benefits Net occupancy expenses Equipment expenses Other taxes Professional fees Communications Business promotion Printing and supplies Impairment losses on long-lived assets Other operating expenses Impact of change in fiscal period at certain subsidiaries Goodwill and trademark impairment losses Amortization of intangibles (Loss) income before income tax and cumulative effect of accounting change Income tax (benefit) expense (Loss) income before cumulative effect of accounting change Cumulative effect of accounting change, net of tax N e t ( L o s s ) I n c o m e N e t ( L o s s ) I n c o m e N e t ( L o s s ) I n c o m e N e t ( L o s s ) I n c o m e N e t ( L o s s ) I n c o m e Net (Loss) Income Applicable to Common Stock Net (Loss) Income Applicable to Common Stock Net (Loss) Income Applicable to Common Stock Net (Loss) Income Applicable to Common Stock Net (Loss) Income Applicable to Common Stock B a s i c ( L o s s ) E a r n i n g s p e r C o m m o n S h a r e ( E P S ) B a s i c ( L o s s ) E a r n i n g s p e r C o m m o n S h a r e ( E P S ) B a s i c ( L o s s ) E a r n i n g s p e r C o m m o n S h a r e ( E P S ) B a s i c ( L o s s ) E a r n i n g s p e r C o m m o n S h a r e ( E P S ) B a s i c ( L o s s ) E a r n i n g s p e r C o m m o n S h a r e ( E P S ) B e f o r e C u m u l a t i v e E f f e c t o f A c c o u n t i n g C h a n g e B e f o r e C u m u l a t i v e E f f e c t o f A c c o u n t i n g C h a n g e B e f o r e C u m u l a t i v e E f f e c t o f A c c o u n t i n g C h a n g e B e f o r e C u m u l a t i v e E f f e c t o f A c c o u n t i n g C h a n g e B e f o r e C u m u l a t i v e E f f e c t o f A c c o u n t i n g C h a n g e D i l u t e d E P S B e f o r e C u m u l a t i v e E f f e c t o f A c c o u n t i n g C h a n g e D i l u t e d E P S B e f o r e C u m u l a t i v e E f f e c t o f A c c o u n t i n g C h a n g e D i l u t e d E P S B e f o r e C u m u l a t i v e E f f e c t o f A c c o u n t i n g C h a n g e D i l u t e d E P S B e f o r e C u m u l a t i v e E f f e c t o f A c c o u n t i n g C h a n g e D i l u t e d E P S B e f o r e C u m u l a t i v e E f f e c t o f A c c o u n t i n g C h a n g e B a s i c E P S A f t e r C u m u l a t i v e E f f e c t o f A c c o u n t i n g C h a n g e B a s i c E P S A f t e r C u m u l a t i v e E f f e c t o f A c c o u n t i n g C h a n g e B a s i c E P S A f t e r C u m u l a t i v e E f f e c t o f A c c o u n t i n g C h a n g e B a s i c E P S A f t e r C u m u l a t i v e E f f e c t o f A c c o u n t i n g C h a n g e B a s i c E P S A f t e r C u m u l a t i v e E f f e c t o f A c c o u n t i n g C h a n g e D i l u t e d E P S A f t e r C u m u l a t i v e E f f e c t o f A c c o u n t i n g C h a n g e D i l u t e d E P S A f t e r C u m u l a t i v e E f f e c t o f A c c o u n t i n g C h a n g e D i l u t e d E P S A f t e r C u m u l a t i v e E f f e c t o f A c c o u n t i n g C h a n g e D i l u t e d E P S A f t e r C u m u l a t i v e E f f e c t o f A c c o u n t i n g C h a n g e D i l u t e d E P S A f t e r C u m u l a t i v e E f f e c t o f A c c o u n t i n g C h a n g e 7 6 5 , 7 9 3 7 6 5 , 7 9 3 7 6 5 , 7 9 3 7 6 5 , 7 9 3 7 6 5 , 7 9 3 4 4 8 , 1 7 2 4 4 8 , 1 7 2 4 4 8 , 1 7 2 4 4 8 , 1 7 2 4 4 8 , 1 7 2 4 6 4 , 8 1 6 4 6 4 , 8 1 6 4 6 4 , 8 1 6 4 6 4 , 8 1 6 4 6 4 , 8 1 6 1 , 6 7 8 , 7 8 1 1 , 6 7 8 , 7 8 1 1 , 6 7 8 , 7 8 1 1 , 6 7 8 , 7 8 1 1 , 6 7 8 , 7 8 1 1 , 4 4 9 , 3 9 0 1 , 4 4 9 , 3 9 0 1 , 4 4 9 , 3 9 0 1 , 4 4 9 , 3 9 0 1 , 4 4 9 , 3 9 0 5 6 2 , 6 5 0 5 6 2 , 6 5 0 5 6 2 , 6 5 0 5 6 2 , 6 5 0 5 6 2 , 6 5 0 8 8 6 , 7 4 0 8 8 6 , 7 4 0 8 8 6 , 7 4 0 8 8 6 , 7 4 0 8 8 6 , 7 4 0 1 9 6 , 0 7 2 1 9 6 , 0 7 2 1 9 6 , 0 7 2 1 9 6 , 0 7 2 1 9 6 , 0 7 2 3 6 3 , 2 5 7 3 6 3 , 2 5 7 3 6 3 , 2 5 7 3 6 3 , 2 5 7 3 6 3 , 2 5 7 5 5 , 1 5 9 5 5 , 1 5 9 5 5 , 1 5 9 5 5 , 1 5 9 5 5 , 1 5 9 ( 2 , 4 6 4 ) ( 2 , 4 6 4 ) ( 2 , 4 6 4 ) ( 2 , 4 6 4 ) ( 2 , 4 6 4 ) ( 3 8 , 9 7 0 ) ( 3 8 , 9 7 0 ) ( 3 8 , 9 7 0 ) ( 3 8 , 9 7 0 ) ( 3 8 , 9 7 0 ) 1 2 1 , 2 6 2 1 2 1 , 2 6 2 1 2 1 , 2 6 2 1 2 1 , 2 6 2 1 2 1 , 2 6 2 1 , 5 8 1 , 0 5 6 1 , 5 8 1 , 0 5 6 1 , 5 8 1 , 0 5 6 1 , 5 8 1 , 0 5 6 1 , 5 8 1 , 0 5 6 5 1 9 , 5 2 3 5 1 9 , 5 2 3 5 1 9 , 5 2 3 5 1 9 , 5 2 3 5 1 9 , 5 2 3 1 4 8 , 6 6 6 1 4 8 , 6 6 6 1 4 8 , 6 6 6 1 4 8 , 6 6 6 1 4 8 , 6 6 6 6 6 8 , 1 8 9 6 6 8 , 1 8 9 6 6 8 , 1 8 9 6 6 8 , 1 8 9 6 6 8 , 1 8 9 1 2 3 , 6 2 1 1 2 3 , 6 2 1 1 2 3 , 6 2 1 1 2 3 , 6 2 1 1 2 3 , 6 2 1 1 2 7 , 4 7 2 1 2 7 , 4 7 2 1 2 7 , 4 7 2 1 2 7 , 4 7 2 1 2 7 , 4 7 2 5 0 , 1 1 1 5 0 , 1 1 1 5 0 , 1 1 1 5 0 , 1 1 1 5 0 , 1 1 1 1 4 9 , 8 5 4 1 4 9 , 8 5 4 1 4 9 , 8 5 4 1 4 9 , 8 5 4 1 4 9 , 8 5 4 6 6 , 8 7 7 6 6 , 8 7 7 6 6 , 8 7 7 6 6 , 8 7 7 6 6 , 8 7 7 1 1 5 , 3 8 8 1 1 5 , 3 8 8 1 1 5 , 3 8 8 1 1 5 , 3 8 8 1 1 5 , 3 8 8 1 7 , 4 3 8 1 7 , 4 3 8 1 7 , 4 3 8 1 7 , 4 3 8 1 7 , 4 3 8 1 2 , 3 4 4 1 2 , 3 4 4 1 2 , 3 4 4 1 2 , 3 4 4 1 2 , 3 4 4 1 5 1 , 0 6 2 1 5 1 , 0 6 2 1 5 1 , 0 6 2 1 5 1 , 0 6 2 1 5 1 , 0 6 2 ----- 2 1 1 , 7 5 0 2 1 1 , 7 5 0 2 1 1 , 7 5 0 2 1 1 , 7 5 0 2 1 1 , 7 5 0 1 0 , 4 4 5 1 0 , 4 4 5 1 0 , 4 4 5 1 0 , 4 4 5 1 0 , 4 4 5 1 , 7 0 4 , 5 5 1 1 , 7 0 4 , 5 5 1 1 , 7 0 4 , 5 5 1 1 , 7 0 4 , 5 5 1 1 , 7 0 4 , 5 5 1 ( 1 2 3 , 4 9 5 ) ( 1 2 3 , 4 9 5 ) ( 1 2 3 , 4 9 5 ) ( 1 2 3 , 4 9 5 ) ( 1 2 3 , 4 9 5 ) ( 5 9 , 0 0 2 ) ( 5 9 , 0 0 2 ) ( 5 9 , 0 0 2 ) ( 5 9 , 0 0 2 ) ( 5 9 , 0 0 2 ) ( 6 4 , 4 9 3 ) ( 6 4 , 4 9 3 ) ( 6 4 , 4 9 3 ) ( 6 4 , 4 9 3 ) ( 6 4 , 4 9 3 ) ----- ( $ 6 4 , 4 9 3 ) ( $ 6 4 , 4 9 3 ) ( $ 6 4 , 4 9 3 ) ( $ 6 4 , 4 9 3 ) ( $ 6 4 , 4 9 3 ) ( $ 7 6 , 4 0 6 ) ( $ 7 6 , 4 0 6 ) ( $ 7 6 , 4 0 6 ) ( $ 7 6 , 4 0 6 ) ( $ 7 6 , 4 0 6 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) ( $ 0 . 2 7 ) D i v i d e n d s D e c l a r e d p e r C o m m o n S h a r e D i v i d e n d s D e c l a r e d p e r C o m m o n S h a r e D i v i d e n d s D e c l a r e d p e r C o m m o n S h a r e D i v i d e n d s D e c l a r e d p e r C o m m o n S h a r e D i v i d e n d s D e c l a r e d p e r C o m m o n S h a r e The accompanying notes are an integral part of the consolidated financial statements. The accompanying notes are an integral part of the consolidated financial statements. The accompanying notes are an integral part of the consolidated financial statements. The accompanying notes are an integral part of the consolidated financial statements. The accompanying notes are an integral part of the consolidated financial statements. $ 0 . 6 4 $ 0 . 6 4 $ 0 . 6 4 $ 0 . 6 4 $ 0 . 6 4 580,094 518,960 537,477 1,636,531 1,427,910 287,760 1,140,150 190,079 320,875 4,359 35,288 117,421 141,463 1,949,635 517,178 151,493 668,671 116,742 135,877 44,543 141,534 68,283 129,965 17,741 7,232 118,128 9,741 14,239 12,377 1,485,073 464,562 106,886 357,676 - $357,676 $345,763 $1.24 $1.24 $1.24 $1.24 $0.64 430,813 349,203 461,636 1,241,652 1,424,207 195,272 1,228,935 181,749 331,501 52,113 30,051 83,297 106,564 2,014,210 474,636 148,053 622,689 108,386 124,276 39,197 119,281 63,395 100,434 18,378 - 122,585 - - 9,579 1,328,200 686,010 148,915 537,095 3,607 $540,702 $528,789 $1.97 $1.96 $1.98 $1.97 $0.64 78 Consolidated Statements of Cash Flows (In thousands) Cash Flows from Operating Activities: Cash Flows from Operating Activities: Cash Flows from Operating Activities: Cash Flows from Operating Activities: Cash Flows from Operating Activities: Net (loss) income Less: Cumulative effect of accounting change, net of tax Less: Impact of change in fiscal period of certain subsidiaries, net of tax Net (loss) income before cumulative effect of accounting change and change in fiscal period Adjustments to reconcile net (loss) income to net cash provided by operating activities: Depreciation and amortization of premises and equipment Provision for loan losses Goodwill and trademark impairment losses Impairment losses on long-lived assets Amortization of intangibles Amortization and fair value adjustment of servicing assets Net gain on sale and valuation adjustment of investment securities Net gain on disposition of premises and equipment Loss (gain) on sale of loans and valuation adjustments on loans held-for-sale Net amortization of premiums and accretion of discounts on investments Net amortization of premiums on loans and deferred loan origination fees and costs Earnings from investments under the equity method Stock options expense Net disbursements on loans held-for-sale Acquisitions of loans held-for-sale Proceeds from sale of loans held-for-sale Net decrease in trading securities Net decrease (increase) in accrued income receivable Net (increase) decrease in other assets Net increase in interest payable Deferred income taxes Net increase in postretirement benefit obligation Net increase (decrease) in other liabilities Total adjustments Net cash provided by operating activities Cash Flows from Investing Activities: Cash Flows from Investing Activities: Cash Flows from Investing Activities: Cash Flows from Investing Activities: Cash Flows from Investing Activities: Net (increase) decrease in money market investments Purchases of investment securities: Available-for-sale Held-to-maturity Other Proceeds from calls, paydowns, maturities and redemptions of investment securities: Available-for-sale Held-to-maturity Other Proceeds from sales of investment securities available-for-sale Proceeds from sale of other investment securities Net disbursements on loans Proceeds from sale of loans Acquisition of loan portfolios Net liabilities assumed (assets acquired), net of cash Mortgage servicing rights purchased Acquisition of premises and equipment Proceeds from sale of premises and equipment Proceeds from sale of foreclosed assets Net cash provided by (used in) investing activities Cash Flows from Financing Activities: Cash Flows from Financing Activities: Cash Flows from Financing Activities: Cash Flows from Financing Activities: Cash Flows from Financing Activities: Net increase in deposits Net (decrease) increase in federal funds purchased and assets sold under agreements to repurchase Net (decrease) increase in other short-term borrowings Payments of notes payable Proceeds from issuance of notes payable Dividends paid Proceeds from issuance of common stock Treasury stock acquired Net cash (used in) provided by financing activities Cash effect of change in fiscal period and change in accounting principle Net (decrease) increase in cash and due from banks Cash and due from banks at beginning of period Cash and due from banks at end of period Year ended December 31, 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2006 2005 ( $ 6 4 , 4 9 3 ) ( $ 6 4 , 4 9 3 ) ( $ 6 4 , 4 9 3 ) ( $ 6 4 , 4 9 3 ) ( $ 6 4 , 4 9 3 ) ----- ----- ( 6 4 , 4 9 3 ) ( 6 4 , 4 9 3 ) ( 6 4 , 4 9 3 ) ( 6 4 , 4 9 3 ) ( 6 4 , 4 9 3 ) 7 8 , 5 6 3 7 8 , 5 6 3 7 8 , 5 6 3 7 8 , 5 6 3 7 8 , 5 6 3 5 6 2 , 6 5 0 5 6 2 , 6 5 0 5 6 2 , 6 5 0 5 6 2 , 6 5 0 5 6 2 , 6 5 0 2 1 1 , 7 5 0 2 1 1 , 7 5 0 2 1 1 , 7 5 0 2 1 1 , 7 5 0 2 1 1 , 7 5 0 1 2 , 3 4 4 1 2 , 3 4 4 1 2 , 3 4 4 1 2 , 3 4 4 1 2 , 3 4 4 1 0 , 4 4 5 1 0 , 4 4 5 1 0 , 4 4 5 1 0 , 4 4 5 1 0 , 4 4 5 6 1 , 1 1 0 6 1 , 1 1 0 6 1 , 1 1 0 6 1 , 1 1 0 6 1 , 1 1 0 ( 5 5 , 1 5 9 ) ( 5 5 , 1 5 9 ) ( 5 5 , 1 5 9 ) ( 5 5 , 1 5 9 ) ( 5 5 , 1 5 9 ) ( 1 2 , 2 9 6 ) ( 1 2 , 2 9 6 ) ( 1 2 , 2 9 6 ) ( 1 2 , 2 9 6 ) ( 1 2 , 2 9 6 ) 3 8 , 9 7 0 3 8 , 9 7 0 3 8 , 9 7 0 3 8 , 9 7 0 3 8 , 9 7 0 2 0 , 2 3 8 2 0 , 2 3 8 2 0 , 2 3 8 2 0 , 2 3 8 2 0 , 2 3 8 9 0 , 5 1 1 9 0 , 5 1 1 9 0 , 5 1 1 9 0 , 5 1 1 9 0 , 5 1 1 ( 2 1 , 3 4 7 ) ( 2 1 , 3 4 7 ) ( 2 1 , 3 4 7 ) ( 2 1 , 3 4 7 ) ( 2 1 , 3 4 7 ) 1 , 7 6 3 1 , 7 6 3 1 , 7 6 3 1 , 7 6 3 1 , 7 6 3 ( 4 , 8 0 3 , 9 2 7 ) ( 4 , 8 0 3 , 9 2 7 ) ( 4 , 8 0 3 , 9 2 7 ) ( 4 , 8 0 3 , 9 2 7 ) ( 4 , 8 0 3 , 9 2 7 ) ( 5 5 0 , 3 9 2 ) ( 5 5 0 , 3 9 2 ) ( 5 5 0 , 3 9 2 ) ( 5 5 0 , 3 9 2 ) ( 5 5 0 , 3 9 2 ) 4 , 1 2 7 , 7 9 4 4 , 1 2 7 , 7 9 4 4 , 1 2 7 , 7 9 4 4 , 1 2 7 , 7 9 4 4 , 1 2 7 , 7 9 4 1 , 2 2 2 , 5 8 5 1 , 2 2 2 , 5 8 5 1 , 2 2 2 , 5 8 5 1 , 2 2 2 , 5 8 5 1 , 2 2 2 , 5 8 5 1 1 , 8 3 2 1 1 , 8 3 2 1 1 , 8 3 2 1 1 , 8 3 2 1 1 , 8 3 2 ( 9 4 , 2 1 5 ) ( 9 4 , 2 1 5 ) ( 9 4 , 2 1 5 ) ( 9 4 , 2 1 5 ) ( 9 4 , 2 1 5 ) 5 , 0 1 3 5 , 0 1 3 5 , 0 1 3 5 , 0 1 3 5 , 0 1 3 ( 2 2 3 , 7 4 0 ) ( 2 2 3 , 7 4 0 ) ( 2 2 3 , 7 4 0 ) ( 2 2 3 , 7 4 0 ) ( 2 2 3 , 7 4 0 ) 2 , 3 8 8 2 , 3 8 8 2 , 3 8 8 2 , 3 8 8 2 , 3 8 8 7 1 , 5 7 5 7 1 , 5 7 5 7 1 , 5 7 5 7 1 , 5 7 5 7 1 , 5 7 5 7 6 8 , 4 5 5 7 6 8 , 4 5 5 7 6 8 , 4 5 5 7 6 8 , 4 5 5 7 6 8 , 4 5 5 7 0 3 , 9 6 2 7 0 3 , 9 6 2 7 0 3 , 9 6 2 7 0 3 , 9 6 2 7 0 3 , 9 6 2 $357,676 - (6,129) 363,805 84,388 287,760 14,239 7,232 12,377 62,819 (4,359) (25,929) (117,421) 23,918 130,091 (12,270) 3,006 (6,580,246) (1,503,017) 6,782,081 1,368,975 (4,209) 49,708 32,477 (26,208) 4,112 (83,544) 505,980 869,785 $540,702 3,607 - 537,095 81,947 195,272 - - 9,579 25,766 (52,113) (29,079) (83,297) 35,288 127,235 (10,982) 5,226 (4,321,658) (733,536) 4,127,381 1,160,980 (30,808) (172,879) 35,218 (3,679) 5,451 20,431 391,743 928,838 ( 6 3 8 , 5 6 8 ) ( 6 3 8 , 5 6 8 ) ( 6 3 8 , 5 6 8 ) ( 6 3 8 , 5 6 8 ) ( 6 3 8 , 5 6 8 ) 381,421 160,061 ( 1 6 0 , 7 1 2 ) ( 1 6 0 , 7 1 2 ) ( 1 6 0 , 7 1 2 ) ( 1 6 0 , 7 1 2 ) ( 1 6 0 , 7 1 2 ) ( 2 9 , 3 2 0 , 2 8 6 ) ( 2 9 , 3 2 0 , 2 8 6 ) ( 2 9 , 3 2 0 , 2 8 6 ) ( 2 9 , 3 2 0 , 2 8 6 ) ( 2 9 , 3 2 0 , 2 8 6 ) ( 1 1 2 , 1 0 8 ) ( 1 1 2 , 1 0 8 ) ( 1 1 2 , 1 0 8 ) ( 1 1 2 , 1 0 8 ) ( 1 1 2 , 1 0 8 ) (254,930) (20,863,367) (66,026) (4,243,162) (33,579,802) (77,716) 1 , 6 0 8 , 6 7 7 1 , 6 0 8 , 6 7 7 1 , 6 0 8 , 6 7 7 1 , 6 0 8 , 6 7 7 1 , 6 0 8 , 6 7 7 2 8 , 9 3 5 , 5 6 1 2 8 , 9 3 5 , 5 6 1 2 8 , 9 3 5 , 5 6 1 2 8 , 9 3 5 , 5 6 1 2 8 , 9 3 5 , 5 6 1 4 4 , 1 8 5 4 4 , 1 8 5 4 4 , 1 8 5 4 4 , 1 8 5 4 4 , 1 8 5 5 8 , 1 6 7 5 8 , 1 6 7 5 8 , 1 6 7 5 8 , 1 6 7 5 8 , 1 6 7 2 4 6 , 3 5 2 2 4 6 , 3 5 2 2 4 6 , 3 5 2 2 4 6 , 3 5 2 2 4 6 , 3 5 2 ( 1 , 4 5 7 , 9 2 5 ) ( 1 , 4 5 7 , 9 2 5 ) ( 1 , 4 5 7 , 9 2 5 ) ( 1 , 4 5 7 , 9 2 5 ) ( 1 , 4 5 7 , 9 2 5 ) 4 1 5 , 2 5 6 4 1 5 , 2 5 6 4 1 5 , 2 5 6 4 1 5 , 2 5 6 4 1 5 , 2 5 6 ( 2 2 , 3 1 2 ) ( 2 2 , 3 1 2 ) ( 2 2 , 3 1 2 ) ( 2 2 , 3 1 2 ) ( 2 2 , 3 1 2 ) 7 1 9 , 6 0 4 7 1 9 , 6 0 4 7 1 9 , 6 0 4 7 1 9 , 6 0 4 7 1 9 , 6 0 4 ( 2 6 , 5 0 7 ) ( 2 6 , 5 0 7 ) ( 2 6 , 5 0 7 ) ( 2 6 , 5 0 7 ) ( 2 6 , 5 0 7 ) ( 1 0 4 , 8 6 6 ) ( 1 0 4 , 8 6 6 ) ( 1 0 4 , 8 6 6 ) ( 1 0 4 , 8 6 6 ) ( 1 0 4 , 8 6 6 ) 6 3 , 4 5 5 6 3 , 4 5 5 6 3 , 4 5 5 6 3 , 4 5 5 6 3 , 4 5 5 1 7 5 , 9 7 4 1 7 5 , 9 7 4 1 7 5 , 9 7 4 1 7 5 , 9 7 4 1 7 5 , 9 7 4 4 2 3 , 9 4 7 4 2 3 , 9 4 7 4 2 3 , 9 4 7 4 2 3 , 9 4 7 4 2 3 , 9 4 7 1,876,458 20,925,847 88,314 208,802 - (1,587,326) 938,862 (448,708) (3,034) (23,769) (104,593) 87,913 138,703 1,294,567 3,317,198 33,787,268 61,053 388,596 - (343,093) 297,805 (2,650,540) (411,782) (5,039) (159,166) 71,053 117,159 (3,270,107) 2 , 8 8 9 , 5 2 4 2 , 8 8 9 , 5 2 4 2 , 8 8 9 , 5 2 4 2 , 8 8 9 , 5 2 4 2 , 8 8 9 , 5 2 4 1,789,662 1,371,668 ( 3 2 5 , 1 8 0 ) ( 3 2 5 , 1 8 0 ) ( 3 2 5 , 1 8 0 ) ( 3 2 5 , 1 8 0 ) ( 3 2 5 , 1 8 0 ) ( 2 , 6 1 2 , 8 0 1 ) ( 2 , 6 1 2 , 8 0 1 ) ( 2 , 6 1 2 , 8 0 1 ) ( 2 , 6 1 2 , 8 0 1 ) ( 2 , 6 1 2 , 8 0 1 ) ( 2 , 4 6 3 , 2 7 7 ) ( 2 , 4 6 3 , 2 7 7 ) ( 2 , 4 6 3 , 2 7 7 ) ( 2 , 4 6 3 , 2 7 7 ) ( 2 , 4 6 3 , 2 7 7 ) 1 , 4 2 5 , 2 2 0 1 , 4 2 5 , 2 2 0 1 , 4 2 5 , 2 2 0 1 , 4 2 5 , 2 2 0 1 , 4 2 5 , 2 2 0 ( 1 9 0 , 6 1 7 ) ( 1 9 0 , 6 1 7 ) ( 1 9 0 , 6 1 7 ) ( 1 9 0 , 6 1 7 ) ( 1 9 0 , 6 1 7 ) 2 0 , 4 1 4 2 0 , 4 1 4 2 0 , 4 1 4 2 0 , 4 1 4 2 0 , 4 1 4 ( 2 , 5 2 5 ) ( 2 , 5 2 5 ) ( 2 , 5 2 5 ) ( 2 , 5 2 5 ) ( 2 , 5 2 5 ) ( 1 , 2 5 9 , 2 4 2 ) ( 1 , 2 5 9 , 2 4 2 ) ( 1 , 2 5 9 , 2 4 2 ) ( 1 , 2 5 9 , 2 4 2 ) ( 1 , 2 5 9 , 2 4 2 ) ----- ( 1 3 1 , 3 3 3 ) ( 1 3 1 , 3 3 3 ) ( 1 3 1 , 3 3 3 ) ( 1 3 1 , 3 3 3 ) ( 1 3 1 , 3 3 3 ) 9 5 0 , 1 5 8 9 5 0 , 1 5 8 9 5 0 , 1 5 8 9 5 0 , 1 5 8 9 5 0 , 1 5 8 $ 8 1 8 , 8 2 5 $ 8 1 8 , 8 2 5 $ 8 1 8 , 8 2 5 $ 8 1 8 , 8 2 5 $ 8 1 8 , 8 2 5 (3,053,167) 1,226,973 (3,469,429) 1,506,298 (188,321) 55,846 (367) (2,132,505) 11,914 43,761 906,397 $950,158 2,227,888 (766,277) (2,650,972) 2,341,011 (182,751) 193,679 (1,467) 2,532,779 (1,572) 189,938 716,459 $906,397 The accompanying notes are an integral part of the consolidated financial statements. The accompanying notes are an integral part of the consolidated financial statements The accompanying notes are an integral part of the consolidated financial statements The accompanying notes are an integral part of the consolidated financial statements The accompanying notes are an integral part of the consolidated financial statements 2007 Annual Report 79 2007 2007 Popular, Inc. 2007 2007 Year ended December 31, Consolidated Statements of Changes in Stockholders’’’’’ Equity (In thousands, except share information) Preferred Stock: Preferred Stock: Preferred Stock: Preferred Stock: Preferred Stock: Balance at beginning and end of year C o m m o n S t o c k : C o m m o n S t o c k : C o m m o n S t o c k : C o m m o n S t o c k : C o m m o n S t o c k : Balance at beginning of year Common stock issued under Dividend Reinvestment Plan Issuance of common stock Options exercised Balance at end of year S u r p l u s : S u r p l u s : S u r p l u s : S u r p l u s : S u r p l u s : Balance at beginning of year Common stock issued under Dividend Reinvestment Plan Issuance of common stock Issuance cost of common stock Stock options expense on unexercised options, net of forfeitures Options exercised Transfer from retained earnings Balance at end of year Retained Earnings: Retained Earnings: Retained Earnings: Retained Earnings: Retained Earnings: Balance at beginning of year Net (loss) income Cumulative effect of accounting change (adoption of SFAS No. 156 and EITF 06-5) Cash dividends declared on common stock Cash dividends declared on preferred stock Transfer to surplus Balance at end of year Treasury Stock - At Cost: Treasury Stock - At Cost: Treasury Stock - At Cost: Treasury Stock - At Cost: Treasury Stock - At Cost: Balance at beginning of year Purchase of common stock Reissuance of common stock Balance at end of year Accumulated Other Comprehensive Accumulated Other Comprehensive Accumulated Other Comprehensive Accumulated Other Comprehensive Accumulated Other Comprehensive L o s s : L o s s : L o s s : L o s s : L o s s : Balance at beginning of year Other comprehensive income (loss), net of tax Adoption of SFAS No. 158 Balance at end of year Total stockholders’ equity Total stockholders’ equity Total stockholders’ equity Total stockholders’ equity Total stockholders’ equity 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 $ 1 8 6 , 8 7 5 $ 1 8 6 , 8 7 5 $ 1 8 6 , 8 7 5 $ 1 8 6 , 8 7 5 $ 1 8 6 , 8 7 5 1 , 7 5 3 , 1 4 6 1 , 7 5 3 , 1 4 6 1 , 7 5 3 , 1 4 6 1 , 7 5 3 , 1 4 6 1 , 7 5 3 , 1 4 6 8 , 7 0 2 8 , 7 0 2 8 , 7 0 2 8 , 7 0 2 8 , 7 0 2 ----- 6 06 06 06 06 0 1 , 7 6 1 , 9 0 8 1 , 7 6 1 , 9 0 8 1 , 7 6 1 , 9 0 8 1 , 7 6 1 , 9 0 8 1 , 7 6 1 , 9 0 8 5 2 6 , 8 5 6 5 2 6 , 8 5 6 5 2 6 , 8 5 6 5 2 6 , 8 5 6 5 2 6 , 8 5 6 1 1 , 4 6 6 1 1 , 4 6 6 1 1 , 4 6 6 1 1 , 4 6 6 1 1 , 4 6 6 ----- ----- 1 , 7 1 3 1 , 7 1 3 1 , 7 1 3 1 , 7 1 3 1 , 7 1 3 1 4 91 4 91 4 91 4 91 4 9 2 8 , 0 0 0 2 8 , 0 0 0 2 8 , 0 0 0 2 8 , 0 0 0 2 8 , 0 0 0 5 6 8 , 1 8 4 5 6 8 , 1 8 4 5 6 8 , 1 8 4 5 6 8 , 1 8 4 5 6 8 , 1 8 4 1 , 5 9 4 , 1 4 4 1 , 5 9 4 , 1 4 4 1 , 5 9 4 , 1 4 4 1 , 5 9 4 , 1 4 4 1 , 5 9 4 , 1 4 4 ( 6 4 , 4 9 3 ) ( 6 4 , 4 9 3 ) ( 6 4 , 4 9 3 ) ( 6 4 , 4 9 3 ) ( 6 4 , 4 9 3 ) 8 , 6 6 7 8 , 6 6 7 8 , 6 6 7 8 , 6 6 7 8 , 6 6 7 ( 1 7 8 , 9 3 8 ) ( 1 7 8 , 9 3 8 ) ( 1 7 8 , 9 3 8 ) ( 1 7 8 , 9 3 8 ) ( 1 7 8 , 9 3 8 ) ( 1 1 , 9 1 3 ) ( 1 1 , 9 1 3 ) ( 1 1 , 9 1 3 ) ( 1 1 , 9 1 3 ) ( 1 1 , 9 1 3 ) ( 2 8 , 0 0 0 ) ( 2 8 , 0 0 0 ) ( 2 8 , 0 0 0 ) ( 2 8 , 0 0 0 ) ( 2 8 , 0 0 0 ) 1 , 3 1 9 , 4 6 7 1 , 3 1 9 , 4 6 7 1 , 3 1 9 , 4 6 7 1 , 3 1 9 , 4 6 7 1 , 3 1 9 , 4 6 7 ( 2 0 6 , 9 8 7 ) ( 2 0 6 , 9 8 7 ) ( 2 0 6 , 9 8 7 ) ( 2 0 6 , 9 8 7 ) ( 2 0 6 , 9 8 7 ) ( 2 , 5 2 5 ) ( 2 , 5 2 5 ) ( 2 , 5 2 5 ) ( 2 , 5 2 5 ) ( 2 , 5 2 5 ) 1 , 7 7 2 1 , 7 7 2 1 , 7 7 2 1 , 7 7 2 1 , 7 7 2 ( 2 0 7 , 7 4 0 ) ( 2 0 7 , 7 4 0 ) ( 2 0 7 , 7 4 0 ) ( 2 0 7 , 7 4 0 ) ( 2 0 7 , 7 4 0 ) ( 2 3 3 , 7 2 8 ) ( 2 3 3 , 7 2 8 ) ( 2 3 3 , 7 2 8 ) ( 2 3 3 , 7 2 8 ) ( 2 3 3 , 7 2 8 ) 1 8 6 , 9 1 6 1 8 6 , 9 1 6 1 8 6 , 9 1 6 1 8 6 , 9 1 6 1 8 6 , 9 1 6 ----- ( 4 6 , 8 1 2 ) ( 4 6 , 8 1 2 ) ( 4 6 , 8 1 2 ) ( 4 6 , 8 1 2 ) ( 4 6 , 8 1 2 ) $ 3 , 5 8 1 , 8 8 2 $ 3 , 5 8 1 , 8 8 2 $ 3 , 5 8 1 , 8 8 2 $ 3 , 5 8 1 , 8 8 2 $ 3 , 5 8 1 , 8 8 2 2006 $186,875 1,736,443 5,154 11,312 237 1,753,146 452,398 11,323 28,281 1,462 2,826 566 30,000 526,856 1,456,612 357,676 - (178,231) (11,913) (30,000) 1,594,144 (207,081) (367) 461 (206,987) (176,000) (17,877) (39,851) (233,728) $3,620,306 Disclosure of changes in number of shares: Disclosure of changes in number of shares: Disclosure of changes in number of shares: Disclosure of changes in number of shares: Disclosure of changes in number of shares: Preferred Stock: Preferred Stock: Preferred Stock: Preferred Stock: Preferred Stock: Balance at beginning and end of year Common Stock - Issued: Common Stock - Issued: Common Stock - Issued: Common Stock - Issued: Common Stock - Issued: Balance at beginning of year Issued under the Dividend Reinvestment Plan Issuance of common stock Options exercised Balance at end of year Treasury stock Common Stock - Outstanding Common Stock - Outstanding Common Stock - Outstanding Common Stock - Outstanding Common Stock - Outstanding 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 7 , 4 7 5 , 0 0 0 7 , 4 7 5 , 0 0 0 7 , 4 7 5 , 0 0 0 7 , 4 7 5 , 0 0 0 7 , 4 7 5 , 0 0 0 2 9 2 , 1 9 0 , 9 2 4 2 9 2 , 1 9 0 , 9 2 4 2 9 2 , 1 9 0 , 9 2 4 2 9 2 , 1 9 0 , 9 2 4 2 9 2 , 1 9 0 , 9 2 4 1 , 4 5 0 , 4 1 0 1 , 4 5 0 , 4 1 0 1 , 4 5 0 , 4 1 0 1 , 4 5 0 , 4 1 0 1 , 4 5 0 , 4 1 0 ----- 1 0 , 0 6 4 1 0 , 0 6 4 1 0 , 0 6 4 1 0 , 0 6 4 1 0 , 0 6 4 2 9 3 , 6 5 1 , 3 9 8 2 9 3 , 6 5 1 , 3 9 8 2 9 3 , 6 5 1 , 3 9 8 2 9 3 , 6 5 1 , 3 9 8 2 9 3 , 6 5 1 , 3 9 8 ( 1 3 , 6 2 2 , 1 8 3 ) ( 1 3 , 6 2 2 , 1 8 3 ) ( 1 3 , 6 2 2 , 1 8 3 ) ( 1 3 , 6 2 2 , 1 8 3 ) ( 1 3 , 6 2 2 , 1 8 3 ) 2 8 0 , 0 2 9 , 2 1 5 2 8 0 , 0 2 9 , 2 1 5 2 8 0 , 0 2 9 , 2 1 5 2 8 0 , 0 2 9 , 2 1 5 2 8 0 , 0 2 9 , 2 1 5 Year ended December 31, 2006 7,475,000 289,407,190 858,905 1,885,380 39,449 292,190,924 (13,449,377) 278,741,547 The accompanying notes are an integral part of the consolidated financial statements. The accompanying notes are an integral part of the consolidated financial statements. The accompanying notes are an integral part of the consolidated financial statements. The accompanying notes are an integral part of the consolidated financial statements. The accompanying notes are an integral part of the consolidated financial statements. 2005 $186,875 1,680,096 4,372 51,688 287 1,736,443 278,840 13,263 129,219 (5,636) 5,003 709 31,000 452,398 1,129,793 540,702 - (170,970) (11,913) (31,000) 1,456,612 (206,437) (1,467) 823 (207,081) 35,454 (211,454) - (176,000) $3,449,247 2005 7,475,000 280,016,007 728,705 8,614,620 47,858 289,407,190 (13,451,799) 275,955,391 80 Consolidated Statements of Comprehensive Income (In thousands) Net (loss) income Other comprehensive income (loss), before tax: Foreign currency translation adjustment Adjustment of pension and postretirement benefit plans Unrealized holding gains (losses) on securities available-for-sale arising during the period Reclassification adjustment for gains included in net income Unrealized net losses on cash flow hedges Reclassification adjustment for losses included in net income Cumulative effect of accounting change Reclassification adjustment for gains included in net income Income tax (expense) benefit Total other comprehensive income (loss), net of tax Comprehensive income, net of tax Year ended December 31, 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2006 2005 ( $ 6 4 , 4 9 3 ) ( $ 6 4 , 4 9 3 ) ( $ 6 4 , 4 9 3 ) ( $ 6 4 , 4 9 3 ) ( $ 6 4 , 4 9 3 ) $357,676 $540,702 2 , 1 1 3 2 , 1 1 3 2 , 1 1 3 2 , 1 1 3 2 , 1 1 3 1 8 , 1 2 1 1 8 , 1 2 1 1 8 , 1 2 1 1 8 , 1 2 1 1 8 , 1 2 1 2 3 9 , 3 9 0 2 3 9 , 3 9 0 2 3 9 , 3 9 0 2 3 9 , 3 9 0 2 3 9 , 3 9 0 ( 5 5 ) ( 5 5 ) ( 5 5 ) ( 5 5 ) ( 5 5 ) ( 4 , 7 8 2 ) ( 4 , 7 8 2 ) ( 4 , 7 8 2 ) ( 4 , 7 8 2 ) ( 4 , 7 8 2 ) 1 , 0 7 7 1 , 0 7 7 1 , 0 7 7 1 , 0 7 7 1 , 0 7 7 ( 2 4 3 ) ( 2 4 3 ) ( 2 4 3 ) ( 2 4 3 ) ( 2 4 3 ) ----- 2 5 5 , 6 2 1 2 5 5 , 6 2 1 2 5 5 , 6 2 1 2 5 5 , 6 2 1 2 5 5 , 6 2 1 ( 6 8 , 7 0 5 ) ( 6 8 , 7 0 5 ) ( 6 8 , 7 0 5 ) ( 6 8 , 7 0 5 ) ( 6 8 , 7 0 5 ) 1 8 6 , 9 1 6 1 8 6 , 9 1 6 1 8 6 , 9 1 6 1 8 6 , 9 1 6 1 8 6 , 9 1 6 (386) (1,539) (12,194) (4,359) (1,573) 1,839 - - (18,212) 335 (17,877) (785) (2,354) (222,604) (51,591) (3,316) 4,247 (103) (20) (276,526) 65,072 (211,454) $ 1 2 2 , 4 2 3 $ 1 2 2 , 4 2 3 $ 1 2 2 , 4 2 3 $ 1 2 2 , 4 2 3 $ 1 2 2 , 4 2 3 $339,799 $329,248 Tax effects allocated to each component of other comprehensive income: Tax effects allocated to each component of other comprehensive income: Tax effects allocated to each component of other comprehensive income: Tax effects allocated to each component of other comprehensive income: Tax effects allocated to each component of other comprehensive income: (In thousands) Underfunding of pension and postretirement benefit plans Unrealized holding gains (losses) on securities available-for-sale arising during the period Reclassification adjustment for gains included in net income Unrealized net losses on cash flow hedges Reclassification adjustment for losses included in net income Income tax (expense) benefit Year ended December 31, 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2006 ( $ 6 , 9 2 6 ) ( $ 6 , 9 2 6 ) ( $ 6 , 9 2 6 ) ( $ 6 , 9 2 6 ) ( $ 6 , 9 2 6 ) ( 6 3 , 1 0 4 ) ( 6 3 , 1 0 4 ) ( 6 3 , 1 0 4 ) ( 6 3 , 1 0 4 ) ( 6 3 , 1 0 4 ) 88888 1 , 7 2 3 1 , 7 2 3 1 , 7 2 3 1 , 7 2 3 1 , 7 2 3 ( 4 0 6 ) ( 4 0 6 ) ( 4 0 6 ) ( 4 0 6 ) ( 4 0 6 ) ( $ 6 8 , 7 0 5 ) ( $ 6 8 , 7 0 5 ) ( $ 6 8 , 7 0 5 ) ( $ 6 8 , 7 0 5 ) ( $ 6 8 , 7 0 5 ) $600 2,747 (2,898) 630 (744) $335 2005 $918 62,225 2,270 1,916 (2,257) $65,072 D i s c l o s u r e o f a c c u m u l a t e d o t h e r c o m p r e h e n s i v e ( l o s s ) i n c o m e : D i s c l o s u r e o f a c c u m u l a t e d o t h e r c o m p r e h e n s i v e ( l o s s ) i n c o m e : D i s c l o s u r e o f a c c u m u l a t e d o t h e r c o m p r e h e n s i v e ( l o s s ) i n c o m e : D i s c l o s u r e o f a c c u m u l a t e d o t h e r c o m p r e h e n s i v e ( l o s s ) i n c o m e : D i s c l o s u r e o f a c c u m u l a t e d o t h e r c o m p r e h e n s i v e ( l o s s ) i n c o m e : (In thousands) 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 2 0 0 7 Year ended December 31, 2006 2005 Foreign currency translation adjustment ( $ 3 4 , 5 8 8 ) ( $ 3 4 , 5 8 8 ) ( $ 3 4 , 5 8 8 ) ( $ 3 4 , 5 8 8 ) ( $ 3 4 , 5 8 8 ) ($36,701) ($36,315) Minimum pension liability adjustment Tax effect Adoption of SFAS No. 158 Tax effect Net of tax amount Underfunding of pension and postretirement benefit plans Tax effect Net of tax amount Unrealized gains (losses) on securities available-for-sale Tax effect Net of tax amount Unrealized (losses) gains on cash flow hedges Tax effect Net of tax amount Cumulative effect of accounting change, net of tax ----- ----- ----- ----- ----- ( 5 1 , 1 3 9 ) ( 5 1 , 1 3 9 ) ( 5 1 , 1 3 9 ) ( 5 1 , 1 3 9 ) ( 5 1 , 1 3 9 ) 2 0 , 1 0 8 2 0 , 1 0 8 2 0 , 1 0 8 2 0 , 1 0 8 2 0 , 1 0 8 ( 3 1 , 0 3 1 ) ( 3 1 , 0 3 1 ) ( 3 1 , 0 3 1 ) ( 3 1 , 0 3 1 ) ( 3 1 , 0 3 1 ) 2 7 , 0 9 2 2 7 , 0 9 2 2 7 , 0 9 2 2 7 , 0 9 2 2 7 , 0 9 2 ( 5 , 9 5 0 ) ( 5 , 9 5 0 ) ( 5 , 9 5 0 ) ( 5 , 9 5 0 ) ( 5 , 9 5 0 ) 2 1 , 1 4 2 2 1 , 1 4 2 2 1 , 1 4 2 2 1 , 1 4 2 2 1 , 1 4 2 ( 3 , 6 1 5 ) ( 3 , 6 1 5 ) ( 3 , 6 1 5 ) ( 3 , 6 1 5 ) ( 3 , 6 1 5 ) 1 , 2 8 0 1 , 2 8 0 1 , 2 8 0 1 , 2 8 0 1 , 2 8 0 ( 2 , 3 3 5 ) ( 2 , 3 3 5 ) ( 2 , 3 3 5 ) ( 2 , 3 3 5 ) ( 2 , 3 3 5 ) ----- (3,893) 1,518 3,893 (1,518) - (69,260) 27,034 (42,226) (212,243) 57,146 (155,097) 90 (37) 53 243 (2,354) 918 - - (1,436) - - - (195,690) 57,297 (138,393) (176) 77 (99) 243 Accumulated other comprehensive loss ( $ 4 6 , 8 1 2 ) ( $ 4 6 , 8 1 2 ) ( $ 4 6 , 8 1 2 ) ( $ 4 6 , 8 1 2 ) ( $ 4 6 , 8 1 2 ) ($233,728) ($176,000) The accompanying notes are an integral part of the consolidated financial statements. The accompanying notes are an integral part of the consolidated financial statements. The accompanying notes are an integral part of the consolidated financial statements. The accompanying notes are an integral part of the consolidated financial statements. The accompanying notes are an integral part of the consolidated financial statements. Notes to Consolidated Financial Statements 2007 Annual Report 81 2007 2007 Popular, Inc. 2007 2007 Note 1 - Nature of operations and summary of significant accounting policies ............................................... 82 Note 2 - Restructuring plans ................................................ 95 Note 3 - Subsequent events .................................................. 96 Note 4 - Restrictions on cash and due from banks and highly liquid securities ......................................... 97 Note 5 - Securities purchased under agreements to resell ..... 97 Note 6 - Investment securities available-for-sale ................... 98 Note 7 - Investment securities held-to-maturity ................. 100 Note 8 - Pledged assets ...................................................... 102 Note 9 - Loans and allowance for loan losses ...................... 102 Note 10 - Related party transactions ................................... 103 Note 11 - Premises and equipment ...................................... 104 Note 12 - Goodwill and other intangible assets ................... 104 Note 13 -Deposits ............................................................... 105 Note 14 - Federal funds purchased and assets sold under agreements to repurchase ............................ 106 Note 15 -Other short-term borrowings ............................... 107 Note 16 - Notes payable ....................................................... 108 Note 17 - Unused lines of credit and other funding sources 108 Note 18 -Trust preferred securities .................................... 109 Note 19 - (Loss) earnings per common share ....................... 110 Note 20 - Stockholders’ equity ............................................ 110 Note 21 - Regulatory capital requirements ........................... 111 Note 22 - Servicing assets ................................................... 112 Note 23 -Retained interests on transfers of financial assets 114 Note 24 - Employee benefits ................................................ 118 Note 25 -Stock-based compensation .................................. 123 Note 26 - Rental expense and commitments ......................... 125 Note 27 - Income tax ........................................................... 125 Note 28 -Off-balance sheet activities and concentration of credit risk ................................. 127 Note 29 - Disclosures about fair value of financial instruments .......................................................... 128 Note 30 -Derivative instruments and hedging activities .... 129 Note 31 -Supplemental disclosure on the consolidated statements of cash flows ...................................... 133 Note 32 - Segment reporting .............................................. 133 Note 33 - Contingent liabilities ......................................... 137 Note 34 - Guarantees .......................................................... 137 Note 35 - Other service fees ............................................... 139 Note 36 - Popular, Inc. (Holding Company only) financial information ........................................................... 139 Note 37 - Condensed consolidating financial information of guarantor and issuers of registered guaranteed securities ............................................................. 141 82 N o t e 1 - N a t u r e o f O p e r a t i o n s a n d S u m m a r y o f N o t e 1 - N a t u r e o f O p e r a t i o n s a n d S u m m a r y o f N o t e 1 - N a t u r e o f O p e r a t i o n s a n d S u m m a r y o f N o t e 1 - N a t u r e o f O p e r a t i o n s a n d S u m m a r y o f N o t e 1 - N a t u r e o f O p e r a t i o n s a n d S u m m a r y o f S i g n i f i c a n t A c c o u n t i n g P o l i c i e s : S i g n i f i c a n t A c c o u n t i n g P o l i c i e s : S i g n i f i c a n t A c c o u n t i n g P o l i c i e s : S i g n i f i c a n t A c c o u n t i n g P o l i c i e s : S i g n i f i c a n t A c c o u n t i n g P o l i c i e s : The accounting and financial reporting policies of Popular, Inc. and its subsidiaries (the “Corporation”) conform with accounting principles generally accepted in the United States of America and with prevailing practices within the financial services industry. The following is a description of the most significant of these policies: Nature of operations The Corporation is a diversified, publicly owned financial holding company subject to the supervision and regulation of the Board of Governors of the Federal Reserve System. The Corporation is a full service financial services provider with operations in Puerto Rico, the United States, the Caribbean and Latin America. As the leading financial institution in Puerto Rico, the Corporation offers retail and commercial banking services through its principal banking subsidiary, Banco Popular de Puerto Rico (“BPPR”), as well as auto and equipment leasing and financing, mortgage loans, consumer lending, investment banking, broker-dealer and insurance services through specialized subsidiaries. In the United States, the Corporation operates Banco Popular North America (“BPNA”), including its wholly-owned subsidiary E-LOAN, and Popular Financial Holdings (“PFH”). BPNA is a community bank providing a broad range of financial services and products to the communities it serves. BPNA operates branches in New York, California, Illinois, New Jersey, Florida and Texas. E-LOAN offers online consumer direct lending and provides an online platform to raise deposits for BPNA. As described in Note 2 to the consolidated financial statements, E-LOAN is currently in a restructuring process of its operations. PFH, after certain restructuring events discussed in Note 2 to the consolidated financial statements, is in the process of exiting the loan origination business, but continues to carry a maturing loan portfolio and operates a mortgage loan servicing unit. The Corporation, through its transaction processing company, EVERTEC, continues to use its expertise in technology as a competitive advantage in its expansion throughout the United States, the Caribbean and Latin America, as well as internally servicing many of its subsidiaries’ system infrastructures and transactional processing businesses. Note 32 to the consolidated financial statements presents further information about the Corporation’s business segments. Business combinations During the fourth quarter of 2007, the Corporation acquired Citibank’s retail banking operations in Puerto Rico, which added 17 branches to BPPR’s retail branch network prior to branch closings due to synergies, and contributed with approximately $997,000,000 in deposits and $220,000,000 in loans. The purchase price paid was approximately $123,540,000. Also, Popular Securities, a subsidiary within the Banco Popular de Puerto Rico reportable segment, strengthened its brokerage sales force and increased its assets under management by acquiring Smith Barney’s retail brokerage operations in Puerto Rico. This acquisition added approximately $1,200,000,000 in assets under its management (thus, are not included in the Corporation’s consolidated financial statements). As part of these acquisitions, which were accounted as business combinations, the Corporation recorded approximately $125,893,000 in goodwill and $21,325,000 in other intangibles assets. The later consisted primarily of core deposit intangibles. Business combinations are accounted for under the purchase method of accounting. Under the purchase method, assets and liabilities of the business acquired are recorded at their estimated fair values as of the date of acquisition with any excess of the cost of the acquisition over the fair value of the net tangible and intangible assets acquired recorded as goodwill. Results of operations of the acquired business are included in the income statement from the date of acquisition. Principles of consolidation The consolidated financial statements include the accounts of Popular, Inc. and its subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation. In accordance w i t h F i n a n c i a l A c c o u n t i n g S t a n d a r d s B o a r d ( “ F A S B ” ) Interpretation (“FIN”) No. 46(R), “Consolidation of Variable Interest Entities (revised December 2003) - an interpretation of ARB No. 51” (“FIN No. 46(R)”), the Corporation also consolidates any variable interest entities (“VIEs”) for which it is the primary beneficiary and therefore will absorb the majority of the entity’s expected losses, receive a majority of the entity’s expected returns, or both. Assets held in a fiduciary capacity are not assets of the Corporation and, accordingly, are not included in the consolidated statements of condition. Unconsolidated investments, in which there is at least 20% ownership, are generally accounted for by the equity method, with earnings recorded in other operating income; those in which there is less than 20% ownership, are generally carried under the cost method of accounting, unless significant influence is exercised. Under the cost method, the Corporation recognizes income when dividends are received. Limited partnerships are accounted for by the equity method as required by EITF D-46 “Accounting for Limited Partnership Investments” (“EITF D-46”). EITF D-46 requires that all limited partnerships are accounted for by the equity method pursuant to paragraph 8 of AICPA Statement of Position 78-9 “Accounting for Investments in Real Estate Ventures”, which requires the use of the equity method unless the investor’s interest is so “minor” that the limited partner may have virtually no influence over partnership operating and financial policies. Statutory business trusts that are wholly-owned by the Corporation and are issuers of trust preferred securities are not consolidated in the Corporation’s consolidated financial statements in accordance with the provisions of FIN No. 46(R). In the normal course of business, except for the Corporation’s banks and the parent holding company, the Corporation utilized a one-month lag in the consolidation of the financial results of its other subsidiaries (the “non-banking subsidiaries”), mainly to facilitate timely reporting. In 2005, the Corporation commenced a two-year plan to change the reporting period of its non-banking subsidiaries to a December 31st calendar period, primarily as part of a strategic plan to put in place an integrated corporate- wide financial system and to facilitate the consolidation process. The impact of this change in net income was included as a cumulative effect of accounting change in the Corporation’s consolidated financial results for the quarter ended March 31, 2005, and corresponds to the financial results for the month of December 2004 of the non-banking subsidiaries which implemented the change in the first reporting period of 2005. In the first quarter of 2006, the Corporation completed the second phase of the two-year plan, and as such, the financial results for the month of December 2005 of PFH (excluding E-LOAN which already had a December 31st year-end closing), Popular FS, Popular Securities and Popular North America (holding company only) were included in a separate line within operating expenses (before tax) in the consolidated statement of operations for the year ended December 31, 2006. The financial impact amounted to a loss of $9,741,000 (before tax). After tax, this change resulted in a net loss of $6,129,000. As of the end of the first quarter of 2006, all subsidiaries of the Corporation had aligned their year-end closings to December 31st, similar to the parent holding company. There are no unadjusted significant intervening events resulting from the difference in fiscal periods which management believes may materially affect the financial position or results of operations of the Corporation for the year ended December 31, 2006. Use of estimates in the preparation of financial statements The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 2007 Annual Report 83 2007 2007 Popular, Inc. 2007 2007 Investment securities Investment securities are classified in four categories and accounted for as follows: • Debt securities that the Corporation has the intent and ability to hold to maturity are classified as securities held- to-maturity and reported at amortized cost. The Corporation may not sell or transfer held-to-maturity securities without calling into question its intent to hold other debt securities to maturity, unless a nonrecurring or unusual event that could not have been reasonably anticipated has occurred. • Debt and equity securities classified as trading securities are reported at fair value, with unrealized gains and losses included in earnings. • Debt and equity securities not classified as either securities held-to-maturity or trading securities, and which have a readily available fair value, are classified as securities available-for-sale and reported at fair value, with unrealized gains and losses excluded from earnings and reported, net of taxes, in accumulated other comprehensive income. The specific identification method is used to determine realized gains and losses on securities available-for-sale, which are included in net gain (loss) on sale and valuation adjustment of investment securities in the consolidated statements of operations. • Investments in equity or other securities that do not have readily available fair values are classified as other investment securities in the consolidated statements of condition. These securities are stated at the lower of cost or realizable value. The source of this value varies according to the nature of the investment, and is primarily obtained by the Corporation from valuation analyses prepared by third- parties or from information derived from financial statements available for the corresponding venture capital and mutual funds. Stock that is owned by the Corporation to comply with regulatory requirements, such as Federal Reserve Bank and Federal Home Loan Bank (“FHLB”) stock, is included in this category. Their realizable value equals their cost. The amortization of premiums is deducted and the accretion of discounts is added to net interest income based on the interest method over the outstanding period of the related securities, except for a small portfolio of mortgage-backed securities for which the Corporation utilizes a method which approximates the interest method, but which incorporates factors such as actual prepayments. The results of the alternative method do not differ materially from those obtained using the interest method. The cost of securities sold is determined by specific identification. Net realized gains or losses on sales of investment securities and unrealized loss valuation adjustments considered other than temporary, if any, on securities available-for-sale, held-to-maturity 84 and other investment securities are determined using the specific identification method and are reported separately in the consolidated statements of operations. Purchases and sales of securities are recognized on a trade-date basis. Derivative financial instruments The Corporation uses derivative financial instruments as part of its overall interest rate risk management strategy to minimize significant unplanned fluctuations in earnings and cash flows caused by interest rate volatility. All derivatives are recognized on the statement of condition at fair value. When the Corporation enters into a derivative contract, the derivative instrument is designated as either a fair value hedge, cash flow hedge or as a free-standing derivative instrument. For a fair value hedge, changes in the fair value of the derivative instrument and changes in the fair value of the hedged asset or liability or of an unrecognized firm commitment attributable to the hedged risk are recorded in current period earnings. For a cash flow hedge, changes in the fair value of the derivative instrument, to the extent that it is effective, are recorded net of taxes in accumulated other comprehensive income and subsequently reclassified to net income in the same period(s) that the hedged transaction impacts earnings. The ineffective portions of cash flow hedges are immediately recognized in current earnings. For free-standing derivative instruments, changes in the fair values are reported in current period earnings. Prior to entering a hedge transaction, the Corporation formally documents the relationship between hedging instruments and hedged items, as well as the risk management objective and strategy for undertaking various hedge transactions. This process includes linking all derivative instruments that are designated as fair value or cash flow hedges to specific assets and liabilities on the statement of condition or to specific forecasted transactions or firm commitments along with a formal assessment, at both inception of the hedge and on an ongoing basis, as to the effectiveness of the derivative instrument in offsetting changes in fair values or cash flows of the hedged item. If it is determined that the derivative instrument is not highly effective as a hedge, hedge accounting is discontinued and the adjustment to fair value of the derivative instrument is recorded in current period earnings. In January 2007, the Corporation adopted SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments - an Amendment of FASB Statements No. 133 and 140.” SFAS No. 155 permits companies to elect, on a transaction-by-transaction basis, to apply a fair value measurement to hybrid financial instruments that contain an embedded derivative that would otherwise require bifurcation under SFAS No. 133. The statement also clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133; establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation; clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives; and amends SFAS No. 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. The adoption of SFAS No. 155 did not have a material impact on the Corporation’s consolidated financial statements during 2007. Loans Loans are classified as loans held-in-portfolio when management has the intent and ability to hold the loan for the foreseeable future, or until maturity or payoff. The foreseeable future is a management judgment which is determined based upon the type of loan, business strategies, current market conditions, balance sheet management and liquidity needs. Management’s view of the foreseeable future may change based on changes in these conditions. When a decision is made to sell or securitize a loan that was not originated or initially acquired with the intent to sell or securitize, the loan is reclassified from held-in-portfolio into held-for-sale. Due to changing market conditions or other strategic initiatives, management’s intent with respect to the disposition of the loan may change, and accordingly, loans previously classified as held- for-sale may be reclassified into held-in-portfolio. Loans transferred between loans held-for-sale and held-in-portfolio classifications are recorded at the lower of cost or market at the date of transfer. Loans held-for-sale include residential mortgages, and to a lesser extent consumer and commercial loans. Loans held-for-sale are stated at the lower of cost or market, cost being determined based on the outstanding loan balance less unearned income, and fair value determined, generally in the aggregate. Fair value is measured based on current market prices for similar loans, outstanding investor commitments, bids received from potential purchasers, prices of recent sales or securitizations or discounted cash flow analyses which utilizes inputs and assumptions which are believed to be consistent with market participants’ views. The cost basis also includes consideration of deferred origination fees and costs, which are recognized in earnings at the time of sale. The amount, by which cost exceeds market value, if any, is accounted for as a valuation allowance with changes therein included in the determination of net income (loss) for the period in which the change occurs. At December 31, 2007, the lower of cost or market valuation allowance for outstanding loans held- for-sale amounted to $652,000. As of December 31, 2006, the fair value of loans held-for-sale substantially exceeded their cost. Loans held-in-portfolio are reported at their outstanding principal balances net of any unearned income, charge-offs, unamortized deferred fees and costs on originated loans, and 2007 Annual Report 85 2007 2007 Popular, Inc. 2007 2007 premiums or discounts on purchased loans. Fees collected and costs incurred in the origination of new loans are deferred and amortized using the interest method or a method which approximates the interest method over the term of the loan as an adjustment to interest yield. Nonaccrual loans are those loans on which the accrual of interest is discontinued. When a loan is placed on nonaccrual status, any interest previously recognized and not collected is generally reversed from current earnings. Recognition of interest income on commercial loans, construction loans, lease financing, conventional mortgage loans and closed-end consumer loans is discontinued when the loans are 90 days or more in arrears on payments of principal or interest or when other factors indicate that the collection of principal and interest is doubtful. Income is generally recognized on open-end (revolving credit) consumer loans until the loans are charged-off. Closed–end consumer loans and leases are charged-off when they are 120 days in arrears. In the case of the Corporation’s non-bank consumer and mortgage lending subsidiaries, however, closed- end consumer loans, including second mortgages, are charged-off when payments are 180 days delinquent. Open-end (revolving credit) consumer loans are charged-off when 180 days in arrears. Lease financing The Corporation leases passenger and commercial vehicles and equipment to individual and corporate customers. The finance method of accounting is used to recognize revenue on lease contracts that meet the criteria specified in SFAS No. 13, “Accounting for Leases,” as amended. Aggregate rentals due over the term of the leases less unearned income are included in finance lease contracts receivable. Unearned income is amortized using a method which results in approximate level rates of return on the principal amounts outstanding. Finance lease origination fees and costs are deferred and amortized over the average life of the loans as an adjustment to the interest yield. Revenue for other leases is recognized as it becomes due under the terms of the agreement. Allowance for loan losses The Corporation follows a systematic methodology to establish and evaluate the adequacy of the allowance for loan losses to provide for inherent losses in the loan portfolio. This methodology includes the consideration of factors such as current economic conditions, portfolio risk characteristics, prior loss experience and results of periodic credit reviews of individual loans. The provision for loan losses charged to current operations is based on such methodology. Loan losses are charged and recoveries are credited to the allowance for loan losses. The methodology used to establish the allowance for loan losses is based on SFAS No. 114 “Accounting by Creditors for Impairment of a Loan” (as amended by SFAS No. 118) and SFAS No. 5 “Accounting for Contingencies.” Under SFAS No. 114, commercial loans over a predefined amount are identified for impairment evaluation on an individual basis. The Corporation has defined as impaired loans those commercial loans that amount to $250,000 or more and with interest and /or principal 90 days or more past due. Also, specific commercial loans over $500,000 are deemed impaired when, based on current information and events, management considers that it is probable that the debtor will be unable to pay all amounts due according to the contractual terms of the loan agreement. A specific allowance for loan impairment is recognized to the extent that the carrying value of an impaired commercial loan exceeds the present value of the expected future cash flows discounted at the loan’s effective rate; the observable market price of the loan; or the fair value of the collateral if the loan is collateral dependent. The allowance for impaired commercial loans is part of the Corporation’s overall allowance for loan losses. Meanwhile, SFAS No. 5 provides for the recognition of a loss allowance for groups of homogeneous loans. To determine the allowance for loan losses under SFAS No. 5, the Corporation applies a historic loss and volatility factor to specific loan balances segregated by loan type and legal entity. Cash payments received on impaired loans are recorded in accordance with the contractual terms of the loan. The principal portion of the payment is used to reduce the principal balance of the loan, whereas the interest portion is recognized as interest income. However, when management believes the ultimate collectibility of principal is in doubt, the interest portion is applied to principal. Transfers and servicing of financial assets and extinguishment of liabilities The transfer of financial assets in which the Corporation surrenders control over the assets is accounted for as a sale to the extent that consideration other than beneficial interests is received in exchange. SFAS No. 140 “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - a Replacement of SFAS No. 125” sets forth the criteria that must be met for control over transferred assets to be considered to have been surrendered, which includes, amongst others: (1) the assets must be isolated from creditors of the transferor, (2) the transferee must obtain the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the transferor cannot maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. When the Corporation transfers financial assets and the transfer fails any one of the SFAS No. 140 criteria, the Corporation is prevented from derecognizing the transferred financial assets and the transaction is accounted for as a secured borrowing. For federal and Puerto Rico income 86 tax purposes, the Corporation treats the transfers of loans which do not qualify as “true sales” under SFAS No. 140, as sales, recognizing a deferred tax asset or liability on the transaction. Upon completion of a transfer of financial assets that satisfies the conditions to be accounted for as a sale, the Corporation derecognizes all assets sold; recognizes all assets obtained and liabilities incurred in consideration as proceeds of the sale, including servicing assets and servicing liabilities, if applicable; initially measures at fair value assets obtained and liabilities incurred in a sale; and recognizes in earnings any gain or loss on the sale. SFAS No. 140 requires a true sale analysis of the treatment of the transfer under state law as if the Corporation was a debtor under the bankruptcy code. A true sale legal analysis includes several legally relevant factors, such as the nature and level of recourse to the transferor, and the nature of retained interests in the loans sold. The analytical conclusion as to a true sale is never absolute and unconditional, but contains qualifications based on the inherent equitable powers of a bankruptcy court, as well as the unsettled state of the common law. Once the legal isolation test has been met under SFAS 140, other factors concerning the nature and extent of the transferor’s control over the transferred assets are taken into account in order to determine whether derecognition of assets is warranted, including whether the special purpose entity (“SPE”) has complied with rules concerning qualifying special-purpose entities (“QSPEs”). Paragraphs 35-55 of SFAS No. 140, as interpreted by the FASB Staff Implementation Guide: A Guide to Implementation of Statement 140 on Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (“Statement 140 Guide”), provides numerous conditions that must be met for a transferee to meet the QSPE exception in paragraph 9(b) of SFAS No. 140. The basic underlying principle in this guidance is that assets transferred to a securitization trust should be accounted for as a sale, and recorded off-balance sheet, only when the transferor has given up control, including decision-making ability, over those assets. If the servicer maintains effective control over the transferred financial assets, off-balance sheet accounting by the transferor is not appropriate. Paragraphs 35(b) and 35(d) of SFAS No. 140 and the related interpretative guidance in SFAS No. 140 and the Statement 140 Guide discuss the permitted activities of a QSPE. The objective is to significantly limit the permitted activities so that it is clear that the transferor does not maintain effective control over the transferred financial assets. The Corporation, through its subsidiary PFH, conducted asset securitizations that involved the transfer of mortgage loans to QSPEs, which in turn transferred these assets and their titles to different trusts, thus isolating those loans from the Corporation’s assets. These off-balance sheet securitizations completed by PFH consisted primarily of subprime mortgage loans, which PFH continues to service. The Corporation’s defines subprime loans as those loans with a current FICO score of 660 or below. A uniform industry definition of what constitutes a subprime loan does not exist. As part of the initiatives taken by the government and the mortgage industry, in late 2007, the American Securitization Forum (“ASF”) issued the “Streamlined Foreclosure and Loss Avoidance Framework for Securitized Subprime Adjustable Rate Mortgage Loans” (the “ASF Framework”). This ASF Framework provides recommended guidance for servicers to streamline borrower evaluation procedures and to facilitate the effective use of all forms of foreclosure and loss prevention efforts for securitized subprime ARMs. Segment 2 includes current loans where the borrower is unlikely to be able to refinance into any readily available mortgage industry product. The ASF Framework indicates that for Segment 2 subprime ARM loans, the servicer can presume that the borrower would be unable to pay pursuant to the original terms of the loan after the interest rate reset, and thus, the loan is “reasonable foreseeable” of default in absence of a modification. The PFH off-balance sheet QSPE’s have limitations on permitted activities. The permitted activities include the ability of the servicer to modify subprime mortgages when default is “reasonably foreseeable.” The Corporation adopted the screening criteria in Segment 2 of the ASF Framework for purposes of determining the subprime adjustable rate mortgage (“ARM”) loans where default is “reasonably foreseeable”. The Corporation sells mortgage loans to the Government National Mortgage Association (“GNMA”) in the normal course of business and retains the servicing rights. The GNMA programs under which the loans are sold allow the Corporation to repurchase individual delinquent loans that meet certain criteria. At the Corporation’s option, and without GNMA’s prior authorization, the Corporation may repurchase the delinquent loan for an amount equal to 100% of the remaining principal balance of the loan. Under SFAS No. 140, once the Corporation has the unconditional ability to repurchase the delinquent loan, the Corporation is deemed to have regained effective control over the loan and recognizes the loan on its balance sheet as well as an offsetting liability, regardless of the Corporation’s intent to repurchase the loan. Servicing assets The Corporation periodically sells or securitizes loans while retaining the obligation to perform the servicing of such loans. In addition, the Corporation may purchase or assume the right to service loans originated by others. Whenever the Corporation undertakes an obligation to service a loan, management assesses whether a servicing asset or liability should be recognized. A servicing asset is recognized whenever the compensation for 2007 Annual Report 87 2007 2007 Popular, Inc. 2007 2007 servicing is expected to more than adequately compensate the servicer for performing the servicing. Likewise, a servicing liability would be recognized in the event that servicing fees to be received are not expected to adequately compensate the Corporation for its expected cost. Servicing assets are separately presented on the consolidated statement of condition. Upon adoption of SFAS No. 156 “Accounting for Servicing of Financial Assets - an Amendment of FASB No. 140” in January 2007, the Corporation no longer records mortgage servicing rights on securitizations accounted for as secured borrowings. Commencing in January 2007, all separately recognized servicing assets are initially recognized at fair value. For subsequent measurement of servicing rights, the Corporation has elected the fair value method for mortgage servicing rights (“MSRs”) while all other servicing assets, particularly related to Small Business Administration (“SBA”) commercial loans, follow the amortization method. Under the fair value measurement method, MSRs are recorded at fair value each reporting period, and changes in fair value are reported in other service fees in the consolidated statement of operations. Under the amortization method, servicing assets are amortized in proportion to, and over the period of, estimated servicing income and assessed for impairment based on fair value at each reporting period. Contractual servicing fees including ancillary income and late fees, as well as fair value adjustments, and impairment losses, if any, are reported in other service fees in the consolidated statement of operations. Loan servicing fees, which are based on a percentage of the principal balances of the loans serviced, are credited to income as loan payments are collected. The fair value of servicing rights is estimated by using a cash flow valuation model which calculates the present value of estimated future net servicing cash flows, taking into consideration actual and expected loan prepayment rates, discount rates, servicing costs, and other economic factors, which are determined based on current market conditions. For purposes of evaluating and measuring impairment of capitalized servicing assets that are accounted under the amortization method, the amount of impairment recognized, if any, is the amount by which the capitalized servicing assets per stratum exceed their estimated fair value. Temporary impairment is recognized through a valuation allowance with changes included in net income for the period in which the change occurs. If it is later determined that all or a portion of the temporary impairment no longer exists for a particular stratum, the valuation allowance is reduced through a recovery in earnings. Any fair value in excess of the cost basis of the servicing asset for a given stratum is not recognized. Servicing rights subsequently accounted under the amortization method are also reviewed for other-than-temporary impairment. When the recoverability of an impaired servicing asset accounted under the amortization method is determined to be remote, the unrecoverable portion of the valuation allowance is applied as a direct write-down to the carrying value of the servicing rights, precluding subsequent recoveries. Refer to Note 22 to the consolidated financial statements for information on the classes of servicing assets defined by the Corporation and the impact of adopting SFAS No. 156 in January 2007. Residual interests The Corporation sells residential mortgage loans to QSPEs, which in turn issue asset-backed securities to investors. The Corporation retains an interest in the loans sold in the form of mortgage servicing rights and residual interests. The residual interest represents the present value of future excess cash flows resulting from the difference between the interest received from the obligors on the loans and the interest paid to the investors on the asset- backed securities, net of credit losses, servicing fees and other expenses. The assets and liabilities of the QSPEs are not included in the Corporation’s consolidated statements of condition, except for the retained interests previously described. The residual interests related with securitizations performed prior to 2006 are classified as available-for-sale securities and are measured at fair value. The residual interests derived from securitizations performed in 2006 and thereafter, including those residual interests derived from the recharacterization transaction that is described in Note 23 to the consolidated financial statements, are accounted as trading securities and are also measured at fair value. Refer to Note 23 for additional information on the residual interests classifications. The classification of the residual interests as trading securities was driven by accounting considerations as permitted under SFAS No. 115 and the interpretative guidance. It is not management’s intention to actively trade these residual interests. Fair value estimates of the residual interests are based on the present value of the expected cash flows of each residual interest. Factors considered in the valuation model for calculating the fair value of these subordinated interests include market discount rates, anticipated prepayment, delinquency and loss rates on the underlying assets. The residual interests are valued using forward yield curves for interest rate projections. The valuations are performed by using a third-party model with assumptions provided by the Corporation. The Corporation recognizes the excess of cash flows related to the residual interests at the acquisition date over the initial investment (accretable yield) as interest income over the life of the residual using the effective yield method. The yield accreted becomes a component of the residuals basis. On a regular basis, estimated cash flows are updated based on revised fair value estimates of the residual, and as such accretable yields are 88 recalculated to reflect the change in the underlying cash flow. Adjustments to the yield are accounted for prospectively as a change in estimate, with the amount of periodic accretion adjusted over the remaining life of the beneficial interest. investment less cash received to date less other-than-temporary impairments recognized to date plus the yield accreted to date. This is based on the accounting guidance prescribed by EITF 99-20. On a quarterly basis, management performs a fair value analysis of the residual interests that are classified as available-for-sale and evaluates whether any unfavorable change in fair value is other- than-temporary as required under SFAS No 115 “Accounting for Certain Investments in Debt and Equity Securities”. The Corporation follows the accounting guidance in EITF 99-20, “Recognition of Interest Income and Impairment on Purchased and Retained Interests in Securitized Financial Assets” to evaluate when a decline in fair value of a beneficial interest that results from an adverse change in estimated cash flows should be considered an other-than-temporary impairment. Whenever the current fair value of the residual interest classified as available- for-sale is lower than its current amortized cost, management evaluates to see if an impairment charge for the deficiency is required to be taken through earnings. If there has been an adverse change in estimated cash flows (considering both the timing and amount of flows), then the residual interest is written-down to fair value, which becomes the new amortized cost basis. To determine whether a change is adverse, the present value of the remaining estimated cash flows as estimated on the last revision are compared against the present value of the estimated cash flows at the current reporting date. If the present value of the cash flows estimated at the last revision is greater than the present value of the current estimated cash flows, the change is considered other-than- temporary. During 2006 and 2007, all declines in fair value in residual interests classified as available-for-sale were considered other-than-temporary. For residual interests classified as trading securities, the fair value determinations are also performed on a quarterly basis. SFAS No. 115 provides that changes in fair value in those securities are reflected in earnings as they occur. For residual interests held in the trading category, there is no need to evaluate them for other- than-temporary impairments. The methodology for determining other-than-temporary impairment is different from the periodic adjustment of accretable yield because the periodic adjustment of accretable yield is used to determine the appropriate interest income to be recognized in the residual interest and the other-than-temporary assessment is used to determine whether the recorded value of the residual interest is impaired. For both, the estimate of cash flows is a critical component. For the adjustment to accretable yield when there is a favorable or an adverse change in estimated cash flows from the cash flows previously projected, the amount of accretable yield should be recalculated as the excess of the estimated cash flows over a reference amount. The reference amount is the initial Premises and equipment Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed on a straight-line basis over the estimated useful life of each type of asset. Amortization of leasehold improvements is computed over the terms of the respective leases or the estimated useful 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 betterments are capitalized. When assets are disposed of, their cost and related accumulated depreciation are removed from the accounts and any gain or loss is reflected in earnings as realized or incurred, respectively. The Corporation capitalizes interest cost incurred in the construction of significant real estate projects, which consist primarily of facilities for its own use or intended for lease. The amount of interest cost capitalized is to be an allocation of the interest cost incurred during the period required to substantially complete the asset. The interest rate for capitalization purposes is to be based on a weighted average rate on the Corporation’s outstanding borrowings, unless there is a specific new borrowing associated with the asset. Interest cost capitalized for the years ended December 31, 2007, 2006 and 2005 was not significant. The Corporation has operating lease arrangements primarily associated with the rental of premises to support the branch network or for general office space. Certain of these arrangements are non-cancelable and provide for rent escalations and renewal options. Rent expense on non-cancelable operating leases with scheduled rent increases are recognized on a straight-line basis over the lease term. Impairment on long-lived assets The Corporation evaluates for impairment its long-lived assets to be held and used, and long-lived assets to be disposed of, whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable under the provision of SFAS No. 144 “Accounting for the Impairment of Disposal of Long-Lived Assets”. In the event of an asset retirement, the Corporation recognizes a liability for an asset retirement obligation in the period in which it is incurred if a reasonable estimate of fair value of such liability can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. 2007 Annual Report 89 2007 2007 Popular, Inc. 2007 2007 this intangible; the after-tax royalty savings derived from the ownership of the intangible; and the discount rate to apply to the projected benefits to arrive at the present value of this intangible.Since estimates are an integral part of this trademark impairment analysis, changes in these estimates could have a significant impact on the calculated fair value. Trademark impairment losses are recorded as part of operating expenses in the consolidated statements of operations. Other identifiable intangible assets with a finite useful life, mainly core deposits, are amortized using various methods over the periods benefited, which range from 3 to 11 years. These intangibles are evaluated periodically for impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable. Impairments on intangible assets with a finite useful life are evaluated as long-lived assets under the guidance of SFAS No. 144 and are included as part of “impairments on long-lived assets” in the category of operating expenses in the consolidated statements of operations. For further disclosures required by SFAS No. 142, refer to Note 12 to the consolidated financial statements. Bank-Owned Life Insurance Bank-owned life insurance represents life insurance on the lives of certain employees who have provided positive consent allowing the Corporation to be the beneficiary of the policy. Bank-owned life insurance policies are carried at their cash surrender value. The Corporation recognizes income from the periodic increases in the cash surrender value of the policy, as well as insurance proceeds received, which are recorded as other operating income, and are not subject to income taxes. The cash surrender value and any additional amounts provided by the contractual terms of the bank-owned insurance policy that are realizable at the balance sheet date are considered in determining the amount that could be realized, and any amounts that are not immediately payable to the policyholder in cash are discounted to their present value. In determining “the amount that could be realized,” it is assumed that policies will be surrendered on an individual-by-individual basis. This accounting policy follows the guidance in EITF Issue No. 06-5 “Accounting for Purchases of Life Insurance – Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance” (“EITF 06-5”), which became effective in 2007. The Corporation adopted the EITF 06- 5 guidance in the first quarter of 2007 and as a result recorded a $907,000 cumulative effect adjustment to beginning retained earnings (reduction of capital) for the existing bank-owned life insurance arrangement. Other real estate Other real estate, received in satisfaction of debt, is recorded at the lower of cost (carrying value of the loan) or the appraised value less estimated costs of disposal of the real estate acquired, by charging the allowance for loan losses. Subsequent to foreclosure, any losses in the carrying value arising from periodic reevaluations of the properties, and any gains or losses on the sale of these properties are credited or charged to expense in the period incurred and are included as a component of other operating expenses. The cost of maintaining and operating such properties is expensed as incurred. Goodwill and other intangible assets The Corporation accounts for goodwill and identifiable intangible assets under the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets.” Goodwill is recognized when the purchase price is higher than the fair value of net assets acquired in business combinations under the purchase method of accounting. Goodwill is not amortized, but is tested for impairment at least annually or more frequently if events or circumstances indicate possible impairment using a two-step process at each reporting unit level. The first step of the goodwill impairment test, used to identify potential impairment, compares the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, the goodwill of the reporting unit is not considered impaired and the second step of the impairment test is unnecessary. If needed, the second step consists of comparing the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill. In determining the fair value of a reporting unit, the Corporation generally uses a combination of methods, which include market price multiples of comparable companies and the discounted cash flow analysis. Goodwill impairment losses are recorded as part of operating expenses in the consolidated statement of operations. Other intangible assets deemed to have an indefinite life are not amortized, but are tested for impairment using a one-step process which compares the fair value with the carrying amount of the asset. In determining that an intangible asset has an indefinite life, the Corporation considers expected cash inflows and legal, regulatory, contractual, competitive, economic and other factors, which could limit the intangible asset’s useful life. The evaluation of E-LOAN’s trademark, an indefinite life intangible asset, was performed using a valuation approach called the “relief-from-royalty” method. The basis of the “relief-from- royalty” method is that, by virtue of having ownership of the trademark, the Corporation is relieved from having to pay a royalty, usually expressed as a percentage of revenue, for the use of the trademark. The main estimates involved in the valuation of this intangible asset included the determination of an appropriate royalty rate; the revenue projections that benefit from the use of 90 Assets sold/purchased under agreements to repurchase/resell Repurchase and resell agreements are treated as collateralized financing transactions and are carried at the amounts at which the assets will be subsequently reacquired or resold as specified in the respective agreements. It is the Corporation’s policy to take possession of securities purchased under resell agreements. However, the counterparties to such agreements maintain effective control over such securities, and accordingly those are not reflected in the Corporation’s consolidated statements of condition. The Corporation monitors the market value of the underlying securities as compared to the related receivable, including accrued interest, and requests additional collateral if deemed appropriate. It is the Corporation’s policy to maintain effective control over assets sold under agreements to repurchase; accordingly, such securities continue to be carried on the consolidated statements of condition. Guarantees, including indirect guarantees of indebtedness of others The Corporation, as a guarantor, recognizes at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. Refer to Note 34 to the consolidated financial statements for further disclosures. Treasury stock Treasury stock is recorded at cost and is carried as a reduction of stockholders’ equity in the consolidated statements of condition. At the date of retirement or subsequent reissue, the treasury stock account is reduced by the cost of such stock. The difference between the consideration received upon issuance and the specific cost is charged or credited to surplus. Income and expense recognition – Processing business Revenue from information processing and other services is recognized at the time services are rendered. Rental and maintenance service revenue is recognized ratably over the corresponding contractual periods. Revenue from software and hardware sales and related costs is recognized at the time software and equipment is installed or delivered depending on the contractual terms. Revenue from contracts to create data processing centers and the related cost is recognized as project phases are completed and accepted. Operating expenses are recognized as incurred. Project expenses are deferred and recognized when the related income is earned. The Corporation applies Statement of Position (SOP) 81-1 “Accounting for Performance of Construction-Type and Certain Production-Type Contracts” as the guidance to determine what project expenses must be deferred until the related income is earned on certain long-term projects that involve the outsourcing of technological services. Income Recognition – Insurance agency business Commissions and fees are recognized when related policies are effective. Additional premiums and rate adjustments are recorded as they occur. Contingent commissions are recorded on the accrual basis when the amount to be received is notified by the insurance company. Commission income from advance business is deferred. An allowance is created for expected adjustments to commissions earned relating to policy cancellations. Income Recognition – Investment banking revenues Investment banking revenue is recorded as follows: underwriting fees at the time the underwriting is completed and income is reasonably determinable; corporate finance advisory fees as earned, according to the terms of the specific contracts and sales commissions on a trade-date basis. Foreign exchange Assets and liabilities denominated in foreign currencies are translated to U.S. dollars using prevailing rates of exchange at the end of the period. Revenues, expenses, gains and losses are translated using weighted average rates for the period. The resulting foreign currency translation adjustment from operations for which the functional currency is other than the U.S. dollar is reported in accumulated other comprehensive income (loss), except for highly inflationary environments in which the effects are included in other operating income. The Corporation conducts business in certain Latin American markets through several of its processing and information technology services and products subsidiaries. Also, it holds interests in Consorcio de Tarjetas Dominicanas, S.A. (“CONTADO”) and Centro Financiero BHD, S.A. (“BHD”) in the Dominican Republic. Although not significant, some of these businesses are conducted in the country’s foreign currency. The Corporation monitors the inflation levels in the foreign countries where it operates to evaluate whether they meet the “highly inflationary economy” test prescribed by SFAS No. 52, “Foreign Currency Translation.” Such statement defines highly inflationary as a “cumulative inflation of approximately 100 percent or more over a 3-year period.” In accordance with the provisions of SFAS No. 52, the financial statements of a foreign entity in a highly inflationary economy are remeasured as if the functional currency were the reporting currency. During 2007, the foreign currency translation adjustment from operations in the Dominican Republic were reported in accumulated other comprehensive income (loss). Since June 2004 through December 31, 2006, the Corporation’s interests in the Dominican Republic were remeasured into the U.S. dollar because the economy was considered highly inflationary under the test prescribed by SFAS No. 52. During the year ended December 31, 2006, approximately $765,000 in net remeasurement gains on the investments held by the Corporation in the Dominican Republic were reflected in other operating income instead of accumulated other comprehensive (loss) income (2005 - $568,000). These net gains relate to improvement in the Dominican peso’s exchange rate to the U.S. dollar from $45.50 at June 30, 2004, when the economy reached the “highly inflationary” threshold, to $33.35 at the end of 2006. The unfavorable cumulative translation adjustment associated with these interests at the reporting date in which the economy became highly inflationary approximated $31,787,000. Refer to the disclosure of accumulated comprehensive income included in the accompanying consolidated statements of comprehensive income (loss) for the outstanding balances of unfavorable foreign currency translation adjustments at December 31, 2007, 2006 and 2005. Income taxes The Corporation recognizes deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Corporation’s financial statements or tax returns. Deferred income tax assets and liabilities are determined for differences between financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future. The computation is based on enacted tax laws and rates applicable to periods in which the temporary differences are expected to be recovered or settled. A deferred tax valuation allowance is established if it is considered more likely than not that all or a portion of the deferred tax assets will not be realized. Positions taken in the Corporation’s tax returns may be subject to challenge by the taxing authorities upon examination. Uncertain tax positions are initially recognized in the financial statements when it is more likely than not the position will be sustained upon examination by the tax authorities. Such tax positions are both initially and subsequently measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon settlement with the tax authority, assuming full knowledge of the position and all relevant facts. Interest on income tax uncertainties is classified within income tax expense in the statement of operations; while the penalties, if any, are accounted for as other operating expenses. The Corporation accounts for the taxes collected from customers and remitted to governmental authorities on a net basis (excluded from revenues). During the first quarter of 2007, the Corporation adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement 109” (“FIN 48”). FIN 48 prescribes a recognition threshold and measurement 2007 Annual Report 91 2007 2007 Popular, Inc. 2007 2007 attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Based on management’s assessment, there was no impact on retained earnings as of January 1, 2007 due to the initial application of the provisions of FIN 48. Also, as a result of the implementation, the Corporation did not recognize any change in the liability for unrecognized tax benefits. Refer to Note 27 to the consolidated financial statements for further information on the impact of FIN 48. Employees’ retirement and other postretirement benefit plans Pension costs are computed on the basis of accepted actuarial methods and are charged to current operations. Net pension costs are based on various actuarial assumptions regarding future experience under the plan, which include costs for services rendered during the period, interest costs and return on plan assets, as well as deferral and amortization of certain items such as actuarial gains or losses. The funding policy is to contribute to the plan as necessary to provide for services to date and for those expected to be earned in the future. To the extent that these requirements are fully covered by assets in the plan, a contribution may not be made in a particular year. The cost of postretirement benefits, which is determined based on actuarial assumptions and estimates of the costs of providing these benefits in the future, is accrued during the years that the employee renders the required service. SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” requires the recognition of the funded status of each defined pension benefit plan, retiree health care and other postretirement benefit plans on the statement of condition. The Corporation adopted SFAS No. 158 as of December 31, 2006. See Note 24 for disclosures on the impact of this accounting pronouncement. Stock-based compensation In 2002, the Corporation opted to use the fair value method of recording stock-based compensation as described in SFAS No. 123 “Accounting for Stock Based Compensation”. The Corporation adopted SFAS No. 123-R “Share-Based Payment” on January 1, 2006 using the modified prospective transition method. Comprehensive income Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances, except those resulting from investments by owners and distributions to owners. The presentation of comprehensive income is included in separate consolidated statements of comprehensive income (loss). 92 Earnings (losses) per common share Basic earnings (losses) per common share are computed by dividing net income, reduced by dividends on preferred stock, by the weighted average number of common shares of the Corporation outstanding during the year. Diluted earnings per common share take into consideration the weighted average common shares adjusted for the effect of stock options and restricted stock, using the treasury stock method. Statement of cash flows For purposes of reporting cash flows, cash includes cash on hand and amounts due from banks. Reclassifications Certain reclassifications have been made to the 2006 and 2005 consolidated financial statements to conform with the 2007 presentation. Recently issued accounting pronouncements and interpretations SFAS No. 157 “Fair Value Measurements” SFAS No. 157, issued in September 2006, defines fair value, establishes a framework of measuring fair value and requires enhanced disclosures about fair value measurements. SFAS No. 157 requires companies to disclose the fair value of its financial instruments according to a fair value hierarchy. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values. Financial assets carried at fair value will be classified and disclosed in one of the three categories in accordance with the hierarchy. The three levels of the fair value hierarchy are (1) quoted market prices for identical assets or liabilities in active markets, (2) observable market-based inputs or unobservable inputs that are corroborated by market data, and (3) unobservable inputs that are not corroborated by market data. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. In February 2008, the FASB decided to issue a final staff position that defers for one year the effective date for nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value on a nonrecurring basis. The staff position also amends SFAS No. 157 to exclude SFAS No. 13 “Accounting for Leases” and its related interpretive accounting pronouncements that address leasing transactions. The Corporation adopted the provisions of SFAS No. 157 that were not deferred, commencing in the first quarter of 2008. The provisions of SFAS 157 are to be applied prospectively. The Corporation is currently assessing the impact of SFAS No. 157 on its consolidated financial statements, including disclosures. SFAS No. 159 “The Fair Value Option for Financial Assets and Liabilities - Including an Amendment of FASB Statement No. 115” In February 2007, the FASB issued SFAS No. 159, which provides companies with an option to report selected financial assets and liabilities at fair value. The election to measure a financial asset or liability at fair value can be made on an instrument-by-instrument basis and is irrevocable. The difference between the carrying amount and the fair value at the election date is recorded as a transition adjustment to opening retained earnings. Subsequent changes in fair value are recognized in earnings. The statement also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. It also requires entities to display the fair value of those assets and liabilities for which the company has chosen to use fair value on the face of the balance sheet. The new statement does not eliminate disclosure requirements included in other accounting standards, including requirements for disclosures about fair value measurements included in SFAS No. 157, “Fair Value Measurements,” and SFAS No. 107, “Disclosures about Fair Value of Financial Instruments.” The Corporation adopted the provisions of SFAS No. 159 in January 2008. Management adopted the fair value option for approximately $287 million of loans and $287 million of bond certificates associated to PFH’s on-balance sheet securitizations that were outstanding at December 31, 2007 (transactions excluded from the recharacterization transaction described in Note 23 to the consolidated financial statements). These loans serve as collateral for the bond certificates. Due to accounting constraints, the Corporation is unable to recharacterize these loan securitizations as sales. Additionally, the Corporation plans to elect the fair value option for approximately $1.2 billion of whole loans held-in- portfolio by PFH. These whole loans consist principally of mortgage loans and second-liens that were originated through the exited business of PFH and home equity lines of credit that had been originated by E-LOAN prior to the 2007 U.S. Reorganization, which is described in Note 2 to the consolidated financial statements. Due to their subprime characteristics and current market disruptions, these loans are being held-in-portfolio as potential buyers have withdrawn from the market, given heightened concerns over credit quality of borrowers and continued deterioration in the housing markets. Management understands that accounting for these loans at fair value provides a more relevant and transparent measurement of the realizable value of the assets and differentiates the PFH portfolio from that loan portfolio that the Corporation will continue to originate through other channels outside PFH. The measurement of the bond certificates at fair value reflects the actual liability of the Corporation, after considering the credit risk to be borne by the certificateholders on the on-balance sheet securitization. Management understands 2007 Annual Report 93 2007 2007 Popular, Inc. 2007 2007 that the adoption of the fair value option for the financial assets and liabilities selected better reflects the inherent risks of these instruments and reflects the intention of the Corporation to discontinue most of the businesses previously conducted at PFH. The Corporation expects to recognize a negative pre-tax adjustment that could range between $280 million and $300 million ($158 million and $169 million after tax) due to the transitional adjustment for electing the fair value option on the previously described financial instruments. That amount represents the difference between the fair value and the carrying value of the loans at date of adoption. This negative adjustment would not impact earnings but instead be reflected as a reduction of beginning retained earnings as of January 1, 2008. Subsequent increases or decreases in the fair value of the assets and liabilities accounted under SFAS No. 159 provisions will be recorded as valuation adjustments through earnings in the consolidated statement of income. The fair value adjustments from the adoption of SFAS No. 159 disclosed here are only estimates as management is in the process of validating the methodologies used to value the assets and liabilities and the results of such valuations. Also, management continues to evaluate the impact that SFAS No. 159 will have on the consolidated financial statements, including disclosures. FSP FIN No. 39-1 “Amendment of FASB Interpretation No. 39” In April 2007, the FASB issued Staff Position FSP FIN No. 39-1, which defines “right of setoff” and specifies what conditions must be met for a derivative contract to qualify for this right of setoff. It also addresses the applicability of a right of setoff to derivative instruments and clarifies the circumstances in which it is appropriate to offset amounts recognized for those instruments in the statement of financial position. In addition, this FSP permits the offsetting of fair value amounts recognized for multiple derivative instruments executed with the same counterparty under a master netting arrangement and fair value amounts recognized for the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) arising from the same master netting arrangement as the derivative instruments. This interpretation is effective for fiscal years beginning after November 15, 2007, with early application permitted. The adoption of FSP FIN No. 39-1 in 2008 did not have a material impact on the Corporation’s consolidated financial statements and disclosures. SOP 07-01“Clarification of the Scope of the Audit and Accounting Guide Investment Companies and Accounting by Parent Companies and Equity Method Investors for Investments in Investment Companies” The Statement of Position 07-1 (“SOP 07-01”), issued in June 2007, provides guidance for determining whether an entity is within the scope of the American Institute of Certified Public Accountants (“AICPA”) Audit and Accounting Guide for Investment Companies (“the AICPA Guide”). Additionally, it provides guidance as to whether a parent company or an equity method investor can apply the specialized industry accounting principles of the AICPA Guide. SOP 07-01 was to be effective for fiscal years beginning on or after December 15, 2007. On February of 2008, the FASB issued a final staff position that indefinitely defers the effective dates of SOP 07-01 and, for entities that meet the definition of an “investment company” in SOP 07-01, of FSP FIN 46(R)-7, “Application of FASB Interpretation No. 46(R) to Investment Companies.” The FASB decision was in response to several implementation issues that arose after SOP 07-1 was issued. Nevertheless, management is evaluating the impact, if any, that the adoption of SOP 07-01 may have on its consolidated financial statements and disclosures. FSP FIN No. 46(R) – 7 “Application of FASB Interpretation No. 46(R) to Investment Companies” In May 2007, the FASB issued Staff Position FSP FIN No.46(R) - 7, which amends the scope of the exception on FIN No.46(R) to indicate that investments accounted for at fair value, in accordance with the specialized accounting guidance in the AICPA Guide, are not subject to consolidation under FIN No. 46(R). Management is evaluating the impact, if any, that the adoption of this interpretation may have on its consolidated financial statements and disclosures. As indicated under the guidance of SOP 07-01, which was previously described, the implementation of FSP FIN No. 46(R) - 7 is indefinitely delayed until further notification by the FASB. SFAS No. 141-R “Statement of Financial Accounting Standards No. 141(R), Business Combinations (a revision of SFAS No. 141)” In December 2007, the FASB issued SFAS No. 141(R) “Business Combinations.” SFAS No. 141(R) will significantly change how entities apply the acquisition method to business combinations. The most significant changes affecting how the Corporation will account for business combinations under this statement include the following: the acquisition date will be the date the acquirer obtains control; all (and only) identifiable assets acquired, liabilities assumed, and noncontrolling interests in the acquiree will be stated at fair value on the acquisition date; assets or liabilities arising from noncontractual contingencies will be measured at their acquisition date at fair value only if it is more likely than not that they meet the definition of an asset or liability on the acquisition date; adjustments subsequently made to the provisional amounts recorded on the acquisition date will be made retroactively during a measurement period not to exceed one year; acquisition-related restructuring costs that do not meet the criteria in SFAS No. 146 “Accounting for Costs Associated with 94 Exit or Disposal Activities” will be expensed as incurred; transaction costs will be expensed as incurred; reversals of deferred income tax valuation allowances and income tax contingencies will be recognized in earnings subsequent to the measurement period; and the allowance for loan losses of an acquiree will not be permitted to be recognized by the acquirer. Additionally, SFAS 141(R) will require new and modified disclosures surrounding subsequent changes to acquisition-related contingencies, contingent consideration, noncontrolling interests, acquisition- related transaction costs, fair values and cash flows not expected to be collected for acquired loans, and an enhanced goodwill rollforward. The Corporation will be required to prospectively apply SFAS 141(R) to all business combinations completed on or after January 1, 2009. Early adoption is not permitted. For business combinations in which the acquisition date was before the effective date, the provisions of SFAS 141(R) will apply to the subsequent accounting for deferred income tax valuation allowances and income tax contingencies and will require any changes in those amounts to be recorded in earnings. Management will be evaluating the effects that SFAS 141(R) will have on the financial condition, results of operations, liquidity, and the disclosures that will be presented on the consolidated financial statements. SFAS No. 160 “Statement of Financial Accounting Standards No. 160, Noncontrolling Interest in Consolidated Financial Statements, an amendment of ARB No. 51” In December 2007, the FASB issued SFAS No. 160, which amends ARB No. 51, to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS No. 160 will require entities to classify noncontrolling interests as a component of stockholders’ equity on the consolidated financial statements and will require subsequent changes in ownership interests in a subsidiary to be accounted for as an equity transaction. Additionally, SFAS No. 160 will require entities to recognize a gain or loss upon the loss of control of a subsidiary and to remeasure any ownership interest retained at fair value on that date. This statement also requires expanded disclosures that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS 160 is effective on a prospective basis for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008, except for the presentation and disclosure requirements, which are required to be applied retrospectively. Early adoption is not permitted. Management will be evaluating the effects, if any, that the adoption of this statement will have on its consolidated financial statements. Staff Accounting Bulletin No. 109 (“SAB 109”) “Written Loan Commitments Recorded at Fair Value through Earnings” On November 5, 2007, the SEC issued Staff Accounting Bulletin No. 109 (SAB 109), which requires that the fair value of a written loan commitment that is marked to market through earnings should include the future cash flows related to the loan’s servicing rights. However, the fair value measurement of a written loan commitment still must exclude the expected net cash flows related to internally developed intangible assets (such as customer relationship intangible assets). SAB 109 applies to two types of loan commitments: (1) written mortgage loan commitments for loans that will be held-for-sale when funded that are marked to market as derivatives under FAS 133 (derivative loan commitments); and (2) other written loan commitments that are accounted for at fair value through earnings under Statement 159’s fair-value election. SAB 109 supersedes SAB 105, which applied only to derivative loan commitments and allowed the expected future cash flows related to the associated servicing of the loan to be recognized only after the servicing asset had been contractually separated from the underlying loan by sale or securitization of the loan with servicing retained. SAB 109 will be applied prospectively to derivative loan commitments issued or modified in fiscal quarters beginning after December 15, 2007. The Corporation is currently evaluating the potential impact of adopting this SAB 109. Staff Position (FSP) FAS 140-d, “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions” (“FSP FAS 140-d”) In February 2008, the FASB issued FASB Staff Position (FSP) FAS 140-d, “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions.” The objective of this FSP is to provide implementation guidance on whether the security transfer and contemporaneous repurchase financing involving the transferred financial asset must be evaluated as one linked transaction or two separate de-linked transactions. Current practice records the transfer as a sale and the repurchase agreement as a financing. The FSP requires the recognition of the transfer and the repurchase agreement as one linked transaction, unless all of the following criteria are met: (1) the initial transfer and the repurchase financing are not contractually contingent on one another; (2) the initial transferor has full recourse upon default, and the repurchase agreement’s price is fixed and not at fair value; (3) the financial asset is readily obtainable in the marketplace and the transfer and repurchase financing are executed at market rates; and (4) the maturity of the repurchase financing is before the maturity of the financial asset. The scope of this FSP is limited to transfers and subsequent repurchase financings that are entered into contemporaneously or in contemplation of one another. 2007 Annual Report 95 2007 2007 Popular, Inc. 2007 2007 The FSP will be effective for the Corporation on January 1, 2009. Early adoption is prohibited. The Corporation will be evaluating the potential impact of adopting this FSP. The PFH Restructuring Plan resulted in charges between the fourth quarter of 2006 and the year ended December 31, 2007 as follows: Note 2 - Restructuring plans: Note 2 - Restructuring plans: Note 2 - Restructuring plans: Note 2 - Restructuring plans: Note 2 - Restructuring plans: PFH Restructuring Plan In January 2007, the Corporation announced the adoption of a Restructuring and Integration Plan for PFH, including PFH’s Internet financial services subsidiary E-LOAN (the “PFH Restructuring Plan”). Based on a comprehensive strategic and financial assessment of all the PFH operations by Popular’s management, the Plan called for PFH to exit the wholesale nonprime mortgage origination business, focus on existing profitable businesses at the time, and consolidate support functions with its sister U.S. banking entity BPNA, creating a single integrated North American financial services unit. The PFH Restructuring Plan for 2007 included among the principal milestones: • Exiting the wholesale nonprime mortgage origination business at PFH during early first quarter 2007 and shutting down the wholesale broker, retail and call center business divisions; • Consolidating support activities at PFH (Finance, Credit Risk, Compliance, Human Resources, Facilities) within BPNA; • Integrating PFH’s existing commercial lending businesses into BPNA’s business lending groups; • Focusing on the core Equity One (subsidiary of PFH) network of consumer finance branches; • Growing the third party mortgage servicing business operated by Popular Mortgage Servicing Inc., a subsidiary of PFH (“PMSI”); and • Leveraging the E-LOAN brand, technology and Internet financial services platform over the next several years to complement BPNA’s community banking growth strategy. Refer to the PFH Branch Network Restructuring Plan section presented in this Note 2 to the consolidated financial statements for information on additional actions at PFH in January 2008. SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” requires that a liability for a cost associated with an exit or disposal activity shall be recognized and measured initially at its fair value in the period in which the liability is incurred, except for a liability for one-time termination benefits that is incurred over time. (In millions) Personnel costs Net occupancy expenses Equipment expenses Professional fees Other operating expenses Total restructuring charges Impairment of long-lived assets Impairment of goodwill Total December 31, December 31, 2007 $7.8 (a) 4.5 (b) 0.3 1.8 (c) 0.3 $14.7 - - $14.7 2006 - - - - - - $7.2 (d) 14.2 (e) $21.4 (a) Severance, stay bonuses, related taxes, and other employee benefits (b) Lease terminations (c) Outplacement and professional services contract terminations (d) Consists mostly of software and leasehold improvements (e) Attributable to businesses exited at PFH Of the above restructuring costs, approximately $3.2 million was recognized as a liability as of December 31, 2007. The Corporation does not expect to incur additional significant restructuring costs related to the PFH Restructuring Plan. As part of the PFH Restructuring Plan, during early 2007, the Corporation actively worked in an internal corporate reorganization of its U.S. subsidiaries (the “Reorganization”). After notifying the Board of Governors of the Federal Reserve System and obtaining approval of the Corporation’s Board of Directors in January 2007, E-LOAN, as well as all of its direct and indirect subsidiaries, with the exception of E-LOAN Insurance Services, Inc. and E-LOAN International, Inc., became operating subsidiaries of BPNA. Prior to the consummation of this U.S. Reorganization, E-LOAN was a direct wholly-owned subsidiary of PFH. E-LOAN Restructuring Plan In November 2007, the Board of Directors of the Corporation adopted a restructuring plan for its Internet financial services subsidiary E-LOAN (the “E-LOAN Restructuring Plan”). Considering E-LOAN’s operating losses in light of current market conditions and other factors, the Board of Directors approved a substantial reduction of marketing and personnel costs at E-LOAN and changes in E-LOAN’s business model to align it with revenue expectations. The changes include concentrating marketing investment toward the Internet and the origination of first mortgage loans that qualify for sale to government sponsored entities (“GSEs”). Also, as a result of escalating credit costs in the current economic environment and lower liquidity in the secondary markets for mortgage related products, the Corporation 96 determined to hold back the origination by E-LOAN of home equity lines of credit, closed-end second lien mortgage loans and auto loans. The E-LOAN Restructuring Plan continues to promote the Internet deposit gathering initiative with BPNA. As part of the E-LOAN Restructuring Plan, the Corporation evaluated the value of E-LOAN’s recorded goodwill and trademark by considering the changes in E-LOAN’s business model and the unprecedented conditions in the mortgage loan business. The E-LOAN Restructuring Plan costs were as follows: functions. The individuals whose jobs will be eliminated will receive from Equity One a transitional severance package, professional counseling, outplacement and support during this process. This strategic initiative resulted in the adoption of an additional restructuring plan at PFH (the “PFH Branch Network Restructuring Plan”) during the first quarter of 2008. It is anticipated that this restructuring plan (the “PFH Branch Network Restructuring Plan”) will result in estimated combined charges for the Corporation broken down as follows: (In millions) Personnel costs Net occupancy expenses Equipment expenses Professional fees Total restructuring charges Impairment of long-lived assets Impairment of goodwill and trademark Total Year ended December 31, 2007 $4.6 (a) 4.2 (b) 0.4 (c) 0.4 (c) $9.6 10.5 (d) 211.8 (e) $231.9 (a) Severance, stay bonuses, related taxes, and other employee benefits (b) Lease terminations (c) Service contract terminations (d) Consists mostly of leasehold improvements, equipment and intangible assets with definitive lives (e) Goodwill impairment of $164.4 million and trademark impairment of $47.4 million The above restructuring costs were recognized as a liability as of December 31, 2007. PFH Branch Network Restructuring Plan Given the unforeseen disruption in the capital markets since the summer of 2007 and its impact on funding, management of the Corporation concluded during the fourth quarter of 2007 that it would be difficult to generate an adequate return on the capital invested at Equity One’s consumer service branches. In January 2008, the Corporation announced the signing of an Asset Purchase Agreement (the “Agreement”) to sell certain assets of Equity One to American General Finance, Inc., a member of American International Group. The closing of the Agreement with effective date of March 1, 2008 resulted in the sale of a significant portion of Equity One’s mortgage loan and consumer loan portfolio approximating $1.4 billion. This portfolio was reclassified by the Corporation from loans held-in-portfolio to loans held-for-sale in December 2007. American General Finance, Inc. will hire certain Equity One’s consumer services employees and will retain certain branch locations. Equity One will close all remaining consumer branches not purchased by American General. Workforce reductions at Equity One will result in the loss of employment for those employees at the consumer services branches not hired by American General, as well as for other related support (In millions) Personnel costs Net occupancy expenses Other Total restructuring charges Impairment of long-lived assets Other costs Total combined estimated costs Fourth Quarter 2007 - - - - $1.9 - $1.9 Total $8.1 (a) 5.6 (b) 2.1 (c) 15.8 1.9 (d) 1.8 (e) $19.5 2008 $8.1 5.6 2.1 15.8 - 1.8 $17.6 (a) Severance, retention bonuses and other benefits (b) Lease terminations (c) Contract cancellations and branch closing costs (d) Leasehold improvements, furniture and equipment (e) Bonuses and other benefits for retained employees These estimates are preliminary and may vary as Popular’s management implements the PFH Branch Network Restructuring Plan. The estimates do not incorporate the final outcome of the number of employees and branches retained by American General under the final agreement. Note 3 - Subsequent events: Note 3 - Subsequent events: Note 3 - Subsequent events: Note 3 - Subsequent events: Note 3 - Subsequent events: In January 2008, the Corporation signed the Agreement to sell certain assets of Equity One to American General Finance, Inc. Refer to Note 2 to the consolidated financial statements for additional information. On January 10, 2008, the Corporation completed the sale of six Houston branches of BPNA to Prosperity Bank. Prosperity Bank paid a premium of 10.10% for approximately $125,340,000 in deposits, as well as purchased certain loans and other assets attributable to the branches. The purchase price approximated $104,287,000. Prosperity retained all branch-based employees. BPNA will continue to operate its mortgage business based in Houston, as well as its franchise and small business lending activities in Texas. BPNA will also continue to maintain a retail branch in Arlington, Texas. 2007 Annual Report 97 2007 2007 Popular, Inc. 2007 2007 N o t e 5 - S e c u r i t i e s p u r c h a s e d u n d e r a g r e e m e n t s N o t e 5 - S e c u r i t i e s p u r c h a s e d u n d e r a g r e e m e n t s N o t e 5 - S e c u r i t i e s p u r c h a s e d u n d e r a g r e e m e n t s N o t e 5 - S e c u r i t i e s p u r c h a s e d u n d e r a g r e e m e n t s N o t e 5 - S e c u r i t i e s p u r c h a s e d u n d e r a g r e e m e n t s to resell: to resell: to resell: to resell: to resell: The securities purchased underlying the agreements to resell were delivered to, and are held by, the Corporation. The counterparties to such agreements maintain effective control over such securities. The Corporation is permitted by contract to repledge the securities, and has agreed to resell to the counterparties the same or substantially similar securities at the maturity of the agreements. The fair value of the collateral securities held by the Corporation on these transactions at December 31, was as follows: (In thousands) Repledged Not repledged Total 2007 2006 $146,712 14,193 $160,905 $179,303 103,124 $282,427 The repledged securities were used as underlying securities for repurchase agreement transactions. Note 4 - Restrictions on cash and due from banks Note 4 - Restrictions on cash and due from banks Note 4 - Restrictions on cash and due from banks Note 4 - Restrictions on cash and due from banks Note 4 - Restrictions on cash and due from banks and highly liquid securities: and highly liquid securities: and highly liquid securities: and highly liquid securities: and highly liquid securities: The Corporation’s subsidiary banks are required by federal and state regulatory agencies to maintain average reserve balances with the Federal Reserve Bank or with a correspondent bank. Those required average reserve balances were approximately $678,473,000 at December 31, 2007 (2006 - $621,387,000). Cash and due from banks, as well as other short-term, highly liquid securities, are used to cover the required average reserve balances. In compliance with rules and regulations of the Securities and Exchange Commission, at December 31, 2007, the Corporation had securities with a market value of $273,000 (2006 - $445,000) segregated in a special reserve bank account for the benefit of brokerage customers of its broker-dealer subsidiary. These securities are classified in the consolidated statement of condition within the other trading securities category. As required by the Puerto Rico International Banking Center Law, at December 31, 2007 and 2006, the Corporation maintained separately for its two international banking entities (“IBEs”), $600,000 in time deposits, equally split for the two IBEs, which were considered restricted assets. As part of a line of credit facility with a financial institution, at December 31, 2007 and 2006, the Corporation maintained restricted cash of $1,860,000 as collateral for the line of credit. The cash is being held in certificates of deposit, which mature in less than 90 days. The line of credit is used to support letters of credit. At December 31, 2007, the Corporation had restricted cash of $3,500,000 to support a letter of credit related to a service settlement agreement. 98 Note 6 - Investment securities available-for-sale: Note 6 - Investment securities available-for-sale: Note 6 - Investment securities available-for-sale: Note 6 - Investment securities available-for-sale: Note 6 - Investment securities available-for-sale: The amortized cost, gross unrealized gains and losses, approximate market value (or fair value for certain investment securities where no market quotations are available), weighted average yield and contractual maturities of investment securities available-for-sale at December 31, 2007 and 2006 (2005 - only market value is presented) were as follows: U.S. Treasury securities Within 1 year After 5 to 10 years Obligations of U.S. government sponsored entities Within 1 year After 1 to 5 years After 5 to 10 years After 10 years Obligations of Puerto Rico, States and political subdivisions Within 1 year After 1 to 5 years After 5 to 10 years After 10 years Collateralized mortgage obligations Within 1 year After 1 to 5 years After 5 to 10 years After 10 years Mortgage-backed securities Within 1 year After 1 to 5 years After 5 to 10 years After 10 years Equity securities (without contractual maturity) Other After 1 to 5 years After 5 to 10 years After 10 years Amortized cost 2007 Gross unrealized gains (Dollars in thousands) Gross unrealized losses Weighted average yield Market value $9,993 466,111 476,104 $3 - 3 - $5,011 5,011 $9,996 461,100 471,096 3.57% 3.83 3.82 1,315,128 3,593,239 470,357 71,304 5,450,028 113 49,022 2,669 1,167 52,971 12,429 7,889 23,947 58,941 103,206 190 7,491 127,490 1,268,121 1,403,292 27,318 94,119 69,223 826,642 56 96 255 63 470 - 3 370 3,381 3,754 1 104 206 4,379 4,642 487 756 - 5,885 54 25 88 2,017 2,184 - 34 609 9,863 1,310,599 3,641,774 472,270 72,471 5,497,114 12,431 7,960 24,114 56,987 101,492 190 7,460 127,251 1,261,639 10,506 1,396,540 203 872 523 10,266 27,116 93,351 68,906 820,755 3.75 4.45 4.24 5.96 4.28 4.94 5.69 4.44 4.98 4.90 6.06 5.25 5.00 5.15 5.14 2.97 3.94 4.60 5.33 1,017,302 4,690 11,864 1,010,128 5.08 33,299 690 36 33,953 4.53 23 68 4,721 4,812 - - - - - - - - 23 68 4,721 4,812 13.27 $8,488,043 $62,578 $35,486 $8,515,135 4.51% 2006 Gross Gross Amortized unrealized unrealized Market value (Dollars in thousands) losses gains cost Weighted average yield - $271 29,547 - 29,818 - $29,072 445,763 - 474,835 - 3.99% 3.82 - 3.83 2005 M a r k e t value $14,792 29,108 - 460,425 504,325 U.S. Treasury securities Within 1 year After 1 to 5 years After 5 to 10 years After 10 years Obligations of U.S. government sponsored entities Within 1 year After 1 to 5 years After 5 to 10 years After 10 years - $29,343 475,310 - 504,653 902,898 2,234,285 3,393,190 72,879 6,603,252 Obligations of Puerto Rico, States and political subdivisions Within 1 year After 1 to 5 years After 5 to 10 years After 10 years 6,695 19,688 18,227 73,604 118,214 - - - - - - $57 - - 57 18 105 20 122 265 10,040 134,487 1,513,086 1,657,613 150,884 74,668 836,298 1,061,850 - 343 4,561 4,904 54 46 1,358 1,458 Collateralized mortgage obligations After 1 to 5 years After 5 to 10 years After 10 years Mortgage-backed securities After 1 to 5 years After 5 to 10 years After 10 years Equity securities (without contractual maturity) Other Within 1 year After 1 to 5 years After 5 to 10 years After 10 years 5,711 897,187 43,896 2,190,446 96,794 3,296,396 71,756 1,123 147,524 6,455,785 3.63 4.03 4.45 5.93 4.21 1,194,359 2,929,326 3,513,737 73,254 7,710,676 10 179 164 3,184 3,537 6,703 19,614 18,083 70,542 114,942 105 1,890 15,196 17,191 9,935 132,940 1,502,451 1,645,326 5.44 5.32 5.10 5.04 5.12 5.75 5.01 5.34 5.32 147,277 3,661 72,426 2,288 20,543 817,113 26,492 1,036,816 4.37 4.43 5.35 5.15 451 26,971 12,793 66,439 106,654 12,707 41,236 1,794,820 1,848,763 209,991 109,688 1,054,063 1,373,742 70,954 6,692 3,901 73,745 1.85 82,534 - 121 307 45,898 46,326 - 27 329 2,731 3,087 - - - - - - 148 636 48,629 49,413 14.06 6,655 11,892 1,265 70,080 89,892 $10,062,862 $16,463 $228,463 $9,850,862 4.51% $11,716,586 The weighted average yield on investment securities available- for-sale is based on amortized cost; therefore, it does not give effect to changes in fair value. Securities not due on a single contractual maturity date, such as mortgage-backed securities and collateralized mortgage obligations, are classified in the period of final contractual maturity. The expected maturities of collateralized mortgage obligations, mortgage-backed securities and certain other securities may differ from their contractual maturities because they may be subject to prepayments or may be called by the issuer. The “other” category is composed substantially of residual interests derived from off-balance sheet mortgage loan securitizations by PFH. The aggregate amortized cost and approximate market value of investment securities available-for-sale at December 31, 2007, by contractual maturity, are shown below: (In thousands) Within 1 year After 1 to 5 years After 5 to 10 years After 10 years Total Equity securities Total investment securities available-for-sale Amortized cost Market value $1,365,058 3,702,761 1,157,196 2,229,729 $8,454,744 33,299 $1,360,332 3,750,568 1,153,709 2,216,573 $8,481,182 33,953 $8,488,043 $8,515,135 Proceeds from the sale of investment securities available-for- sale during 2007 were $58,167,000 (2006 - $208,802,000; 2005 - $388,596,000). Gross realized gains and losses on securities available-for-sale during 2007 were $8,036,000 and $4,299,000, respectively (2006 - $22,924,000 and $691,000; 2005 - $68,946,000 and $1,529,000). The following table shows the Corporation’s gross unrealized losses and fair value of investment securities available-for-sale, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2007 and 2006: December 31, 2007 (In thousands) Obligations of U.S. government sponsored entities Obligations of Puerto Rico, States and political subdivisions Collateralized mortgage obligations Mortgage-backed securities Equity securities (In thousands) U.S. Treasury securities Obligations of U.S. government sponsored entities Obligations of Puerto Rico, States and political subdivisions Collateralized mortgage obligations Mortgage-backed securities Equity securities Less than 12 months Amortized Unrealized Market Value Losses Cost $67,107 $185 $66,922 2,600 349,084 99,328 28 2 2,453 667 10 2,598 346,631 98,661 18 $518,147 $3,317 $514,830 12 months or more Amortized Unrealized Market Value Losses Cost $466,111 $5,011 $461,100 1,807,457 5,700 1,801,757 65,642 430,034 656,879 300 2,182 8,053 11,197 26 63,460 421,981 645,682 274 $3,426,423 $32,169 $3,394,254 2007 Annual Report 99 2007 2007 Popular, Inc. 2007 2007 Total (In thousands) U.S. Treasury securities Obligations of U.S. government sponsored entities Obligations of Puerto Rico, States and political subdivisions Collateralized mortgage obligations Mortgage-backed securities Equity securities Amortized Unrealized Market Value Losses Cost $466,111 $5,011 $461,100 1,874,564 5,885 1,868,679 68,242 779,118 756,207 328 2,184 10,506 11,864 36 66,058 768,612 744,343 292 $3,944,570 $35,486 $3,909,084 December 31, 2006 (In thousands) U.S. Treasury securities Obligations of U.S. government sponsored entities Obligations of Puerto Rico, States and political subdivisions Collateralized mortgage obligations Mortgage-backed securities Equity securities (In thousands) U.S. Treasury securities Obligations of U.S. government sponsored entities Obligations of Puerto Rico, States and political subdivisions Collateralized mortgage obligations Mortgage-backed securities Equity securities Less than 12 months Amortized Unrealized Market Value Losses Cost $19,421 $134 $19,287 425,076 4,345 420,731 21,426 501,705 28,958 11,180 259 4,299 484 3,699 21,167 497,406 28,474 7,481 $1,007,766 $13,220 $994,546 12 months or more Amortized Unrealized Market Value Losses Cost $485,232 $29,684 $455,548 6,097,274 143,179 5,954,095 55,238 564,217 954,293 300 3,278 12,892 26,008 202 51,960 551,325 928,285 98 $8,156,554 $215,243 $7,941,311 Total (In thousands) U.S. Treasury securities Obligations of U.S. government sponsored entities Obligations of Puerto Rico, States and political subdivisions Collateralized mortgage obligations Mortgage-backed securities Equity securities Amortized Unrealized Market Value Losses Cost $504,653 $29,818 $474,835 6,522,350 147,524 6,374,826 76,664 1,065,922 983,251 11,480 3,537 17,191 26,492 3,901 73,127 1,048,731 956,759 7,579 $9,164,320 $228,463 $8,935,857 At December 31, 2007, “Obligations of Puerto Rico, States and political subdivisions” include approximately $55 million in Commonwealth of Puerto Rico Appropriation Bonds (“Appropriation Bonds”). The rating on these bonds by Moody’s Investors Service (“Moody’s”) is Ba1, one notch below investment grade, while Standard & Poor's (“S&P”) rates them as investment grade. As of December 31, 2007, the Appropriation Bonds indicated above represented approximately $1.8 million in Investment securities held-to-maturity: Investment securities held-to-maturity: Note 7 - Note 7 - Investment securities held-to-maturity: Note 7 - Investment securities held-to-maturity: Investment securities held-to-maturity: Note 7 - Note 7 - The amortized cost, gross unrealized gains and losses, approximate market value (or fair value for certain investment securities where no market quotations are available), weighted average yield and contractual maturities of investment securities held-to-maturity at December 31, 2007 and 2006 (2005 - only amortized cost is presented) were as follows: 2007 Amortized unrealized cost gains Gross Gross unrealized losses (Dollars in thousands) Market value Weighted average yield Obligations of U.S. goverment sponsored entities Within 1 year $395,974 $15 $1,497 $394,492 4.11% Obligations of Puerto Rico, States and political subdivisions Within 1 year After 1 to 5 years After 5 to 10 years After 10 years 1,785 11,745 12,754 50,180 76,464 2 197 690 2,219 3,108 1 - 25 - 26 1,786 11,942 13,419 52,399 79,546 5.59 4.84 5.92 6.00 5.80 Collateralized mortgage obliga- tions After 10 years Other Within 1 year After 1 to 5 years 310 - 17 293 5.45 6,228 5,490 11,718 $484,466 25 69 94 $3,217 2 2 4 $1,544 6,251 5,557 11,808 $486,139 6.47 5.71 6.12 4.43% 100 unrealized losses in the Corporation’s available-for-sale investment securities portfolio. The Corporation is closely monitoring the political and economic situation of the Island and evaluates its available-for-sale portfolio for any declines in value that management may consider being other-than-temporary. Management has the intent and ability to hold these investments for a reasonable period of time for a forecasted recovery of fair value up to (or beyond) the cost of these investments. During the year ended December 31, 2007, the Corporation recognized through earnings approximately $65,169,000 in losses in the investment securities available-for-sale portfolio that management considered to be other-than-temporarily impaired. These realized losses were associated with interest-only strips and equity securities. The unrealized loss positions of available-for-sale securities at December 31, 2007 are primarily associated with U.S. agency- issued collateralized mortgage obligations, mortgage-backed securities, and to a lesser extent, U.S. Government-sponsored entities and Treasury obligations. The vast majority of these securities are rated the equivalent of AAA by the major rating agencies. The investment portfolio is structured primarily with highly liquid securities, which possess a large and efficient secondary market. Valuations are performed at least on a quarterly basis using third party providers and dealer quotes. Management believes that the unrealized losses in the available-for-sale portfolio at December 31, 2007 are temporary and are substantially related to market interest rate fluctuations and not to deterioration in the creditworthiness of the issuers. Also, management has the intent and ability to hold these investments for a reasonable period of time for a forecasted recovery of fair value up to (or beyond) the cost of these investments. The following table states the name of issuers, and the aggregate amortized cost and market value of the securities of such issuer (includes available-for-sale and held-to-maturity securities), when the aggregate amortized cost of such securities exceeds 10% of stockholders’ equity. This information excludes securities of the U.S. Government agencies and corporations. Investments in obligations issued by a state of the U.S. and its political subdivisions and agencies, which are payable and secured by the same source of revenue or taxing authority, other than the U.S. Government, are considered securities of a single issuer. (In thousands) FNMA FHLB Freddie Mac 2007 2006 Amortized Market Value cost Amortized Market Value cost $1,132,834 5,649,729 918,976 $1,128,544 5,693,170 913,609 $1,539,651 6,230,841 1,149,185 $1,517,525 6,086,885 1,134,853 Gross 2006 Gross 2005 Weighted Amortized unrealized unrealized Market average Amortized cost gains losses value (Dollars in thousands) yield cost 2007 Annual Report 101 2007 2007 Popular, Inc. 2007 2007 The following table shows the Corporation’s gross unrealized losses and fair value of investment securities held-to-maturity, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2007 and 2006: $3,017 - - $3,017 5.19% $42,011 December 31, 2007 Obligations of U.S. goverment sponsored entities Within 1 year Obligations of Puerto Rico, States and political subdivisions Within 1 year After 1 to 5 years After 5 to 10 years After 10 years 1,360 7,002 10,515 53,275 Collateralized mortgage obliga- tions After 10 years Other Within 1 year After 1 to 5 years After 5 to 10 years 72,152 381 6,570 9,220 - 15,790 - $28 213 1,318 1,559 - 16 44 - 60 - $53 3 105 161 21 - 13 - 13 (In thousands) 1,360 6,977 10,725 54,488 73,550 4.94 5.47 5.93 6.06 5.96 5,270 6,918 9,870 56,190 78,248 Obligations of U.S. government sponsored entities Obligations of Puerto Rico, States and political subdivisions Other 360 5.45 497 6,586 9,251 - 15,837 5.52 5.65 - 5.59 29,928 1,420 1,000 32,348 (In thousands) Collateralized mortgage obligations Other Less than 12 months Amortized Unrealized Market Value Losses Cost $196,129 $1,497 $194,632 1,883 1,250 $199,262 26 1 $1,524 1,857 1,249 $197,738 12 months or more Amortized Unrealized Market Value Losses Cost $293 1,247 $1,540 $310 1,250 $1,560 $17 3 $20 Total Amortized Unrealized Market Value Losses Cost $196,129 $1,497 $194,632 1,883 310 2,500 $200,822 26 17 4 $1,544 1,857 293 2,496 $199,278 (In thousands) Obligations of U.S. government sponsored entities Obligations of Puerto Rico, States and political subdivisions Collateralized mortgage obligations Other December 31, 2006 (In thousands) Obligations of Puerto Rico, States and political subdivisions Collaterized mortgage obligations Other 12 months or more and Total Amortized Unrealized Market Value Losses Cost $26,623 381 1,250 $28,254 $161 21 13 $195 $26,462 360 1,237 $28,059 Management believes that the unrealized losses in the held-to- maturity portfolio at December 31, 2007 are temporary and are substantially related to market interest rate fluctuations and not to deterioration in the creditworthiness of the issuers. Also, management has the intent and ability to hold these investments until maturity. $91,340 $1,619 $195 $92,764 5.87% $153,104 Securities not due on a single contractual maturity date, such as collateralized mortgage obligations, are classified in the period of final contractual maturity. The expected maturities of collateralized mortgage obligations and certain other securities may differ from their contractual maturities because they may be subjet to prepayments or may be called by the issuer. The aggregate amortized cost and approximate market value of investment securities held-to-maturity at December 31, 2007, by contractual maturity, are shown below: (In thousands) Within 1 year After 1 to 5 years After 5 to 10 years After 10 years Total investment securities held-to-maturity Amortized cost Market value $402,529 17,499 13,419 52,692 $403,987 17,235 12,754 50,490 $484,466 $486,139 102 Note 8 - Pledged assets: Note 8 - Pledged assets: Note 8 - Pledged assets: Note 8 - Pledged assets: Note 8 - Pledged assets: At December 31, 2007 and 2006, certain securities and loans were pledged to secure public and trust deposits, assets sold under agreements to repurchase, other borrowings and credit facilities available. The classification and carrying amount of pledged assets, which the secured parties are not permitted to sell or repledge the collateral, at December 31, were as follows: 2007 include $49,090,000 (2006 - $48,074,000; 2005 - $39,316,000) in consumer loans. The commercial loans that were considered impaired at December 31, and the related disclosures follow: (In thousands) Impaired loans with a related allowance Impaired loans that do not require allowance December 31, 2007 $174,029 147,653 $321,682 2006 $125,728 82,462 $208,190 $53,959 $36,998 $288,374 $156,951 $9,484 $3,858 (In thousands) Investment securities available-for-sale Investment securities held-to-maturity Loans held-for-sale Loans held-in-portfolio 2007 2006 Total impaired loans $2,944,643 339 42,428 8,489,814 $11,477,224 $2,644,027 658 332,058 10,260,198 $13,236,941 Allowance for impaired loans Average balance of impaired loans during the year Interest income recognized on impaired loans during the year Pledged securities and loans that the creditor has the right by custom or contract to repledge are presented separately on the consolidated statements of condition. Note 9 - Loans and allowance for loan losses: Note 9 - Loans and allowance for loan losses: Note 9 - Loans and allowance for loan losses: Note 9 - Loans and allowance for loan losses: Note 9 - Loans and allowance for loan losses: The composition of loans held-in-portfolio at December 31, was as follows: (In thousands) Loans secured by real estate: Insured or guaranteed by the U.S. Government or its agencies Guaranteed by the Commonwealth of Puerto Rico Commercial loans secured by real estate Residential conventional mortgages Construction and land development Consumer loans secured by real estate Depository institutions Commercial, industrial and agricultural Lease financing Consumer for household, credit cards and other consumer expenditures 3,820,457 Obligations of states and political subdivisions 582,310 447,073 Other $28,203,566 2007 2006 $134,116 $94,125 138,823 7,497,731 5,731,809 2,301,254 1,426,800 17,230,533 10,209 4,842,500 1,270,484 125,600 7,185,965 10,739,777 1,664,592 701,934 20,511,993 11,267 4,741,862 1,410,728 4,636,398 510,844 502,272 $32,325,364 As of December 31, 2007, loans on which the accrual of interest income had been discontinued amounted to $770,672,000 (2006 - $717,588,000; 2005 - $547,509,000). If these loans had been accruing interest, the additional interest income realized would have been approximately $71,037,000 (2006 - $58,223,000; 2005 - $46,198,000). Non-accruing loans as of December 31, Note 1 to the consolidated financial statements, under the heading of “Allowance for Loan Losses,” describes the characteristics of those loans that the Corporation considers impaired loans for evaluation under the SFAS No. 114 accounting framework. As prescribed by SFAS No. 114, when a loan is impaired, the measurement of the impairment may be based on (1) the present value of the expected future cash flows of the impaired loan discounted at the loan’s original effective interest rate, (2) the observable market price of the impaired loan, or (3) the fair value of the collateral if the loan is collateral dependent. A loan is collateral dependent if the repayment of the loan is expected to be provided solely by the underlying collateral. The loans classified as “Impaired loans that do not require an allowance” in the previous table were collateral dependent commercial loans. The Corporation performed a detailed analysis based on the fair value of the individual loans’ collateral less estimated costs to sell and determined it to be adequate to cover any losses. Management monitors on a quarterly basis if there have been any significant changes (increases or decreases) in the fair value of the collateral of a collateral dependent impaired loan and adjusts their specific credit reserves to the extent necessary. The changes in the allowance for loan losses for the year ended December 31, were as follows: (In thousands) Balance at beginning of year Net allowances acquired Provision for loan losses Impact of change in reporting period Recoveries Charge-offs Write-downs related to loans 2007 $522,232 7,290 562,650 - 65,976 (489,073) 2006 $461,707 - 287,760 2,510 59,775 (289,520) 2005 $437,081 6,291 195,272 1,586 62,926 (241,449) transferred to loans held-for-sale Balance at end of year (120,243) $548,832 - $522,232 - $461,707 2007 Annual Report 103 2007 2007 Popular, Inc. 2007 2007 From time to time, the Corporation, in the ordinary course of business, obtains services from related parties or makes contributions to non-profit organizations that have some association with the Corporation. Management believes the terms of such arrangements are consistent with arrangements entered into with independent third parties. During 2007, the Corporation engaged, in the ordinary course of business, the legal services of certain law firms in Puerto Rico, in which the Secretary of the Board of Directors of Popular, Inc. and immediate family members of an executive officer of the Corporation acted as Senior Counsel or as partners. The fees paid to these law firms for fiscal year 2007 amounted to approximately $2,004,000 (2006 - $1,622,000). These fees included $507,000 (2006 - $93,000) paid by the Corporation’s clients in connection with commercial loan transactions and $50,000 (2006 - $23,000) paid by mutual funds managed by the Bank. In addition, one of these law firms leases office space in the Corporation’s headquarters building, which is owned by BPPR. During 2007, this law firm made lease payments of approximately $889,000. It also engages BPPR as trustee of its retirement plan and paid approximately $50,000 for these services. During 2006, the Corporation paid to an insurance broker, who was considered a related party, approximately $1,642,000 in commissions for the institutional insurance business of the Corporation and its subsidiaries. During 2006, the Corporation made payments of approximately $1,163,000 under construction contracts granted to a special partnership whose officer and partner is considered a related party. These contracts were granted on the basis of competitive bids or approved by the Audit Committee, as required by the Corporation’s policy. For the year ended December 31, 2007, the Corporation made contributions of approximately $2,097,000 to non-profit organizations, principally Banco Popular Foundations dedicated to philanthropic work (2006 - $2,508,000). The components of the net financing leases receivable at December 31, were: (In thousands) Total minimum lease payments Estimated residual value of leased property Deferred origination costs, net of fees Less - Unearned financing income Net minimum lease payments Less - Allowance for loan losses 2007 $1,050,011 211,473 9,000 172,680 1,097,804 25,648 $1,072,156 2006 $1,168,685 237,235 4,808 184,238 1,226,490 24,842 $1,201,648 At December 31, 2007, future minimum lease payments are expected to be received as follows: (In thousands) 2008 2009 2010 2011 2012 and thereafter $334,803 277,753 217,003 136,983 83,469 $1,050,011 Note 10 - Related party transactions: Note 10 - Related party transactions: Note 10 - Related party transactions: Note 10 - Related party transactions: Note 10 - Related party transactions: The Corporation grants loans to its directors, executive officers and certain related individuals or organizations in the ordinary course of business. The movement and balance of these loans were as follows: (In thousands) Balance at December 31, 2005 New loans Payments Other changes Balance at December 31, 2006 New loans Payments Other changes Balance at December 31, 2007 Executive Officers Directors $5,263 2,084 (1,535) (1,851) $3,961 2,781 (2,199) 54 $4,597 $29,439 26,705 (23,903) (7,138) $25,103 34,897 (25,886) (1,295) $32,819 Total $34,702 28,789 (25,438) (8,989) $29,064 37,678 (28,085) (1,241) $37,416 The amounts reported as “other changes” include changes in the status of those who are considered related parties. Management believes these loans have been consummated on terms no less favorable to the Corporation than those that would have been obtained if the transactions had been with unrelated parties and do not involve more than the normal risk of collection. At December 31, 2007, the Corporation’s banking subsidiaries held deposits from related parties amounting to $38,149,000 (2006 - $32,760,000). 104 Note 11 - Premises and equipment: Note 11 - Premises and equipment: Note 11 - Premises and equipment: Note 11 - Premises and equipment: Note 11 - Premises and equipment: Premises and equipment are stated at cost less accumulated depreciation and amortization as follows: Useful life in years 2007 2006 (In thousands) Land Buildings Equipment Leasehold improvements 10-50 3-10 2-10 Less - Accumulated depreciation and amortization Construction in progress $80,254 400,808 579,842 107,497 1,088,147 624,959 463,188 44,721 $588,163 $84,753 397,863 586,001 111,794 1,095,658 610,267 485,391 24,996 $595,140 Depreciation and amortization of premises and equipment for the year 2007 was $78,563,000 (2006 - $84,388,000; 2005 - $81,947,000), of which $26,913,000 (2006 - $26,398,000; 2005 - $23,979,000) was charged to occupancy expense and $51,650,000 (2006 - $57,990,000; 2005 - $57,968,000) was charged to equipment, communications and other operating expenses. Occupancy expense is net of rental income of $29,521,000 (2006 - $28,374,000; 2005 - $23,100,000). Note 12 - Goodwill and other intangible assets: Note 12 - Goodwill and other intangible assets: Note 12 - Goodwill and other intangible assets: Note 12 - Goodwill and other intangible assets: Note 12 - Goodwill and other intangible assets: The changes in the carrying amount of goodwill for the years ended December 31, 2007 and 2006, allocated by reportable segment, and in the case of Banco Popular de Puerto Rico, as an additional disclosure, by business area, were as follows (refer to Note 32 for a discussion of the Corporation’s reportable segments): 2007 Balance at January 1, Goodwill acquired 2007 Purchase accounting adjustments Other Balance at December 31, 2007 (In thousands) Banco Popular de Puerto Rico: Commercial Banking Consumer and Retail Banking Other Financial Services Banco Popular North America: Banco Popular North America E-LOAN Popular Financial Holdings EVERTEC $14,674 34,999 4,391 404,237 164,410 - 45,142 $20,697 101,408 3,788 - - $442 - - - $35,371 136,407 8,621 - - - - - ($164,410) - - - 46,125 - (183) - 329 404,237 837 Total Popular, Inc. $667,853 $126,730 $771 ($164,593) $630,761 2006 Balance at January 1, Goodwill Purchase accounting acquired adjustments Balance at December 31, 2006 Other (In thousands) Banco Popular de Puerto Rico: 2006 Commercial Banking Consumer and Retail Banking Other Financial Services Banco Popular North America: $14,674 34,999 4,110 - - - Banco Popular North America 404,447 138,387 E-LOAN 14,236 43,131 Popular Financial Holdings EVERTEC - - - $1,511 - - $281 - 26,023 3 500 - - - ($210) - (14,239) - $14,674 34,999 4,391 404,237 164,410 - 45,142 Total Popular, Inc. $653,984 $1,511 $26,807 ($14,449) $667,853 In 2007, the goodwill acquired was related to the acquisitions of Citibank’s retail branch network in Puerto Rico and Smith Barney’s retail brokerage operations in Puerto Rico. These acquisitions were described in Note 1 to the consolidated financial statements. The amount included in the “other” category was related mostly to goodwill impairment losses of $164,410,000 in the Banco Popular North America reportable segment that were associated with the write-off of E-LOAN’s goodwill as a result of E-LOAN’s Restructuring Plan described in Note 2 to the consolidated financial statements. In determining the fair value of a reporting unit, the Corporation generally uses a combination of methods, including market price multiples of comparable companies and the discounted cash flow analysis. The valuation technique used to evaluate E-LOAN at the time of the goodwill impairment determination considered both of these approaches. Refer to Note 1 to the consolidated financial statements for the Corporation’s accounting policy with respect to goodwill and other intangible assets. In 2006, the amount included in the “other” category was mainly related to goodwill impairment losses of $14,239,000 in the Popular Financial Holdings reportable segment. These losses were associated with the updated goodwill impairment evaluation during the fourth quarter of 2006 due to the exited operations of PFH as part of the PFH Restructuring Plan. Refer to Note 2 to the consolidated financial statements for information on this plan. The Banco Popular North America reportable segment also included an amount in the “other” category related to the sale of the remaining retail outlets of Popular Cash Express (“PCE”) to PLS Financial during the first quarter of 2006. Purchase accounting adjustments consist of adjustments to the value of the assets acquired and liabilities assumed resulting from the completion of appraisals or other valuations, adjustments to initial estimates recorded for transaction costs, if any, and contingent consideration paid during a contractual contingency period. The purchase accounting adjustments for 2006 at the Banco Popular North America reportable segment were mostly related to E-LOAN’s acquisition. 2007 Annual Report 105 2007 2007 Popular, Inc. 2007 2007 At December 31, 2007, other than goodwill, the Corporation had $17,270,000 of identifiable intangibles with indefinite useful lives, mostly associated with E-LOAN’s trademark (2006 - $64,555,000; 2005 - $58,919,000). During the fourth quarter of 2007, the Corporation recognized impairment losses of $47,341,000 related to E-LOAN’s trademark, as a result of the E- LOAN’s Restructuring Plan described in Note 2 to the consolidated financial statements. There were no impairment losses recognized in 2006 and 2005 related to other intangible assets with indefinitive lives. The valuation of the E-LOAN trademark was performed using a valuation approach called the “relief-from-royalty” method. The basis of the “relief-from-royalty” method is that, by virtue of having ownership of the trademark, the Corporation is relieved from having to pay a royalty, usually expressed as a percentage of revenue, for the use of trademark. The main attributes involved in the valuation of this intangible asset include the royalty rate, revenue projections that benefit from the use of this intangible, after-tax royalty savings derived from the ownership of the intangible, and the discount rate to apply to the projected benefits to arrive at the present value of this intangible. The following table reflects the components of other intangible assets subject to amortization at December 31: (In thousands) Core deposits Other customer relationships Other intangibles 2007 2006 Gross Accumulated Gross Accumulated Amount Amortization Amount Amortization $66,381 $23,171 $76,708 $48,367 10,375 8,164 4,131 5,385 11,156 9,099 2,171 3,426 Total $84,920 $32,687 $96,963 $53,964 During the year ended December 31, 2007, the Corporation recognized $10,445,000 in amortization expense related to other intangible assets with definite lives (2006 - $12,377,000; 2005 - $9,579,000). During the fourth quater of 2007, core deposits intangibles with a gross amount of $21,068,000 were acquired as a result of the acquisition of the retail branches of Citibank in Puerto Rico based on a preliminary estimate prepared by management. On the other hand, certain core deposits with a gross amount of $31,395,000 became fully amortized during 2007 and, as such, their gross amount and accumulated amortization were eliminated from the tabular disclosure presented above. Also in December 2007, the Corporation recorded impairment losses of $846,000 and $725,000 associated with the write-off of a customer relationship and other intangibles, respectively, as a result of the E-LOAN Restructuring Plan. The other intangibles were principally related to lease contracts and proprietary technology intangibles that were recorded when E-LOAN was acquired in 2005. This amount is included in the caption of impairment losses on long-lived assets on the consolidated statement of operations. In December 2006, the Corporation recorded an impairment loss of $654,000 associated with the write-off of a customer relationship intangible asset due to the exited operations at PFH, also included in the caption of impairment losses on long-lived assets. The following table presents the estimated aggregate amortization expense of the intangible assets with definite lives that the Corporation has at December 31, 2007, for each of the next five years: (In thousands) 2008 2009 2010 2011 2012 $9,728 8,370 7,518 6,163 5,154 Note 13 - Deposits: Note 13 - Deposits: Note 13 - Deposits: Note 13 - Deposits: Note 13 - Deposits: Total interest bearing deposits at December 31, consisted of: (In thousands) Savings accounts NOW, money market and other interest bearing demand Certificates of deposit: Under $100,000 $100,000 and over 2007 2006 $5,638,862 $5,811,192 4,770,829 10,409,691 8,136,308 5,277,690 4,078,255 9,889,447 5,774,438 4,552,313 13,413,998 10,326,751 $23,823,689 $20,216,198 A summary of certificates of deposit by maturity at December 31, 2007, follows: (In thousands) 2008 2009 2010 2011 2012 2013 and thereafter $9,911,475 1,645,847 887,574 359,820 494,256 115,026 $13,413,998 At December 31, 2007, the Corporation had brokered certificates of deposit amounting to $3,116,274,000 (2006 - $865,685,000). Brokered certificates of deposit amounting to $2,992,897,000 acquired in denominations of $1,000 under a 106 master certificate of deposit have been classified in the “under $100,000” category at December 31, 2007 (2006 - $740,746,000). The aggregate amount of overdrafts in demand deposit accounts that were reclassified to loans was $144,000,000 as of December 31, 2007 (2006 - $135,764,000). Note 14 - Federal funds purchased and assets sold Note 14 - Federal funds purchased and assets sold Note 14 - Federal funds purchased and assets sold Note 14 - Federal funds purchased and assets sold Note 14 - Federal funds purchased and assets sold under agreements to repurchase: under agreements to repurchase: under agreements to repurchase: under agreements to repurchase: under agreements to repurchase: The following table summarizes certain information on federal funds purchased and assets sold under agreements to repurchase at December 31: (Dollars in thousands) 2007 2006 2005 Federal funds purchased Assets sold under agreements to repurchase Total amount outstanding Maximum aggregate balance outstanding at any month-end Average monthly aggregate balance outstanding Weighted average interest rate: For the year At December 31 $303,492 $1,276,818 $1,500,575 5,133,773 $5,437,265 4,485,627 $5,762,445 7,201,886 $8,702,461 $6,942,722 $8,963,244 $8,883,733 $5,644,863 $7,290,853 $7,430,174 5.24% 4.40 5.03% 5.12 3.61% 4.22 The following table presents the liability associated with the repurchase transactions (including accrued interest), their maturities and weighted average interest rates. Also, it includes the carrying value and approximate market value of the collateral (including accrued interest) as of December 31, 2007 and 2006. The information excludes repurchase agreement transactions which were collateralized with securities or other assets held-for- trading purposes or which have been obtained under agreements to resell: 2007 Repurchase liability Carrying value of collateral Market value of collateral (Dollars in thousands) Weighted average interest rate $173,924 173,924 $173,826 173,826 $173,826 173,826 4.31% 4.31 79 844,189 716,972 632,460 558 866,577 736,239 717,494 558 866,577 736,239 717,494 2,193,700 2,320,868 2,320,868 17,257 51,225 60,069 538,440 666,991 57,747 611,385 304,416 175,099 15,568 54,844 43,442 523,265 637,119 61,080 641,017 305,086 200,535 15,568 54,844 43,442 523,265 637,119 61,080 641,017 305,086 200,535 1,148,647 1,207,718 1,207,718 216,311 216,311 331,131 331,131 331,131 331,131 3.84 4.69 4.58 4.34 4.55 3.84 4.97 2.75 4.19 4.11 3.84 4.99 5.33 4.37 4.93 5.54 5.54 $4,399,573 $4,670,662 $4,670,662 4.62% U.S. Treasury securities After 30 to 90 days Obligations of U.S. government sponsored entities Overnight Within 30 days After 30 to 90 days After 90 days Mortgage-backed securities Overnight Within 30 days After 30 to 90 days After 90 days Collateralized mortgage obligations Overnight Within 30 days After 30 to 90 days After 90 days Loans Within 30 days 2006 Repurchase liability Carrying value of collateral Market value of collateral (Dollars in thousands) $182,721 $179,717 $179,717 239,623 239,623 245,169 419,340 419,340 427,890 310,970 824,313 704,362 383,639 316,302 834,329 715,041 421,510 316,302 834,329 715,041 421,510 2,223,284 2,287,182 2,287,182 45,319 31,903 50,045 465,447 592,714 53,201 281,146 232,083 566,430 110,087 147,513 257,600 51,601 34,449 44,699 435,756 566,505 61,755 288,715 244,418 594,888 183,038 150,724 333,762 51,601 34,449 44,699 435,756 566,505 61,755 288,715 244,418 594,888 183,038 150,724 333,762 U.S. Treasury securities Within 30 days After 30 to 90 days Obligations of U.S. government sponsored entities Overnight Within 30 days After 30 to 90 days After 90 days Mortgage-backed securities Overnight Within 30 days After 30 to 90 days After 90 days Collateralized mortgage obligations Overnight Within 30 days After 90 days Loans Overnight Within 30 days Weighted average interest rate 5.21% 5.22 5.21 5.28 5.30 5.26 4.50 5.15 3.16 5.32 2.32 4.22 4.03 3.16 5.33 4.66 4.85 5.90 5.80 5.84 $4,067,918 $4,201,677 $4,201,677 4.99% 2007 Annual Report 107 2007 2007 Popular, Inc. 2007 2007 Note 15 - Other short-term borrowings: Note 15 - Other short-term borrowings: Note 15 - Other short-term borrowings: Note 15 - Other short-term borrowings: Note 15 - Other short-term borrowings: Other short-term borrowings as of December 31, consisted of: 2007 2006 (Dollars in thousands) Advances with FHLB paying interest monthly at a fixed rate of 4.63% (2006 - 5.39% to 5.40%) Advances with FHLB paying interest at maturity at fixed rates ranging from 4.38% to 4.58% Advances under credit facilities with other institutions at: - fixed rates ranging from 4.59% to 5.50% (2006 - 5.38% to 5.65%) - floating rates ranging from 0.45% to 0.75% over the 1-month LIBOR rate (1-month LIBOR rate at December 31, 2006 was 5.32%) - a floating rate of 0.20% over the 3-month LIBOR rate (3-month LIBOR rate at December 31, 2006 was 5.36%) Commercial paper at rates ranging from 4.25% to 5.00% (2006 - 4.80% to 5.44%) Term funds purchased at: - fixed rates of 4.92% (2006 - 5.30% to 5.38%) - floating rates ranging from 0.06% to 0.08% over the fed funds rate (Fed funds rate at December 31, 2006 was 5.38%) Others $72,000 $230,000 570,000 - 487,000 386,000 - - 481,062 10,000 7,329 193,383 280,000 2,140,900 - 85,650 500,000 92,780 $1,501,979 $4,034,125 The weighted average interest rate of other short-term borrowings at December 31, 2007 was 4.74% (2006 - 5.36%; 2005 - 4.31%). The maximum aggregate balance outstanding at any month-end was approximately $3,797,270,000 (2006 - $4,034,125,000; 2005 - $3,370,943,000). The average aggregate balance outstanding during the year was approximately $3,040,801,000 (2006-$3,386,308,000;2005-$2,897,243,000). The weighted average interest rate during the year was 5.00% (2006 - 4.50%; 2005 - 2.89%). Note 17 presents additional information with respect to available credit facilities. 108 Note 16 - Notes payable: Note 16 - Notes payable: Note 16 - Notes payable: Note 16 - Notes payable: Note 16 - Notes payable: Notes payable outstanding at December 31, consisted of the following: The aggregate amounts of maturities of notes payable at December 31, 2007 were as follows: 2007 2006 Year (In thousands) (Dollars in thousands) Advances with FHLB: - with maturities ranging from 2008 through 2018 paying interest at fixed rates ranging from 2.51% to 6.98% (2006 - 2.44% to 6.98%) - maturing in 2007 paying interest quarterly at the 3-month LIBOR rate less 0.04% (3-month LIBOR rate at December 31, 2006 was 5.36%) - maturing in 2007 paying interest monthly at the 1-month LIBOR rate plus 0.02% (1-month LIBOR rate at December 31, 2006 was 5.32%) - maturing in 2008 paying interest monthly at a floating rate of 0.0075% over the 1-month LIBOR rate (1-month LIBOR rate at December 31, 2007 was 4.60%; 2006 - 5.32%) Advances under revolving lines of credit maturing in 2007 paying interest monthly at a floating rate of 0.90% over the 1-month LIBOR rate (1-month LIBOR rate at December 31, 2006 was 5.32%) Advances under revolving lines of credit with maturities ranging form 2008 through 2009 paying interest quarterly at florating rates ranging from of 0.20% to 0.35% (0.35% - December 31, 2006) over the 3-month LIBOR rate (3-month LIBOR rate at December 31, 2007 was 4.70%; 2006 - 5.36%) Term notes with maturities ranging from 2008 through 2012 paying interest semiannually at fixed rates ranging from 3.60% to 6.85% (2006 - 3.25% to 5.65%) Term notes maturing in 2030 paying interest monthly $813,958 $289,881 - - 6,000 5,000 250,000 250,000 - 426,687 110,000 69,994 2,038,259 2,014,928 at fixed rates ranging from 3.00% to 6.00% 3,100 3,100 Term notes with maturities ranging from 2008 through 2013 paying interest monthly at floating rates of 3.00% over the 10-year U.S. treasury notes rate (10-year U.S. treasury notes rate at December 31, 2007 was 4.03%; 2006 - 4.70%) Term notes with maturities until 2009 paying interest quarterly at a floating rate of 0.40% (2006 - 0.35% to 0.40%) over the 3-month LIBOR rate (3-month LIBOR rate at December 31, 2007 was 4.70%; 2006 - 5.36%) Secured borrowings with maturities ranging from 2009 through 2032 paying interest monthly at fixed rates ranging from 6.04% to 7.04% (2006 - 3.52% to 7.12%) Secured borrowings with maturities ranging from 2008 through 2046 paying interest monthly at rates ranging from 0.32% to 3.12% (2006 - 0.10% to 3.50%) over the 1-month LIBOR rate(1-month LIBOR rate at December 31, 2007 was 4.60%; 2006 - 5.32%) Notes linked to the S&P 500 Index maturing in 2008 Junior subordinated deferrable interest debentures with maturities ranging from 2027 through 2034 with fixed interest rates ranging from 6.13% to 8.33% (Refer to Note 18) Other 6,805 10,428 199,706 349,295 59,241 2,695,916 227,743 36,498 1,708,650 36,112 849,672 26,370 849,672 21,583 $4,621,352 $8,737,246 2008 2009 2010 2011 2012 Later years Total Notes Payable $1,490,227 1,037,361 264,748 154,197 500,249 1,174,570 $4,621,352 Note 17 - Unused lines of credit and other funding Note 17 - Unused lines of credit and other funding Note 17 - Unused lines of credit and other funding Note 17 - Unused lines of credit and other funding Note 17 - Unused lines of credit and other funding s o u r c e s : s o u r c e s : s o u r c e s : s o u r c e s : s o u r c e s : At December 31, 2007, the Corporation had borrowing facilities available with the Federal Home Loan Banks (FHLB) whereby the Corporation could borrow up to approximately $2,569,498,000 based on the assets pledged with the FHLB at that date (2006 - $897,269,000). Refer to Notes 15 and 16 for the amounts of FHLB advances outstanding under these facilities at December 31, 2007 and 2006. The FHLB advances are collateralized with investment securities and mortgage loans, do not have restrictive covenants and do not have callable features. The maximum borrowing potential with the FHLB is dependent on certain restrictive computations determined by the FHLB and which are dependent on the amount and type of assets available for collateral, among the principal factors. The available lines of credit with the FHLB included in this note are based on the assets pledged as collateral with the FHLB as of the end of the years presented. At December 31, 2007 and 2006, the FHLB advances had no callable features. Also, at December 31, 2007, there were $35,000,000 in putable advances with fixed rates ranging from 5.34% to 6.55% and maturities extending up to 2010 (2006 - $35,000,000). The FHLB has the option to convert the putable advances before maturity on any given conversion date to an adjustable rate advance of predetermined index for the remaining term to maturity, at the FHLB’s discretion. At December 31, 2007, the Corporation maintained a committed line of credit with an unaffiliated bank under formal agreement that provides for financing of consumer loans. The maximum committed amount under this credit facility amounted to $86,500,000 at December 31, 2007. The full amount was drawn under the credit facility at December 31, 2007 and is included in Note 14 to the consolidated financial statements in the category of repurchase agreements. The interest rate charged on these borrowings is based on LIBOR plus a spread. This credit facility requires compliance with certain financial and non-financial 2007 Annual Report 109 2007 2007 Popular, Inc. 2007 2007 commercial paper program. As of December 31, 2007, this short- term credit facility had been terminated. Note 18 – Trust preferred securities: Note 18 – Trust preferred securities: Note 18 – Trust preferred securities: Note 18 – Trust preferred securities: Note 18 – Trust preferred securities: At December 31, 2007 and 2006, the Corporation had established four trusts for the purpose of issuing trust preferred securities (the “capital securities”) to the public. The proceeds from such issuances, together with the proceeds of the related issuances of common securities of the trusts (the “common securities”), were used by the trusts to purchase junior subordinated deferrable interest debentures (the “junior subordinated debentures”) issued by the Corporation. The sole assets of the trusts consisted of the junior subordinated debentures of the Corporation and the related accrued interest receivable. These trusts are not consolidated by the Corporation under FIN No. 46 (R). The junior subordinated debentures are included by the Corporation as notes payable in the consolidated statements of condition. The Corporation also recorded in the caption of other investment securities in the consolidated statements of condition, the common securities issued by the issuer trusts. The common securities of each trust are wholly-owned, or indirectly wholly- owned, by the Corporation. covenants. As of December 31, 2007, the Corporation was in breach of a tangible net worth covenant, but received a written waiver for the covenant violation. This collateralized credit facility was paid in full in early 2008. In 2007, the Corporation entered into a master repurchase agreement to finance the loan portfolio of PFH. This agreement provides a maximum committed amount of $500,000,000 as of December 31, 2007. The full amount, subject to collateralization requirements under the credit line, was available for use as of such date. The Corporation paid a commitment fee of $5,000,000 during 2007, which is being amortized to interest expense during the term of the agreement. This agreement has a termination date in November 2008. The interest rate charged is based on LIBOR plus a spread. This credit facility requires compliance with certain financial and non-financial covenants. As of December 31, 2007, the Corporation was in compliance with all financial covenants. Popular, Inc. and Popular North America holding companies serve as guarantors under the agreement. As of December 31, 2006, the Corporation maintained committed lines of credit under formal agreements for the financing of auto, mortgage and consumer loans. As of such date, the maximum committed amount available under these lines of credit approximated $1,810,000,000, of which $1,022,847,000 was outstanding. At December 31, 2006, the amount outstanding was distributed in the statement of condition within the categories of repurchase agreements (Note 14), advances under credit facilities with other institutions (Note 15) and advances under revolving lines of credit (Note 16). Borrowings under these facilities are collateralized by the related mortgage, consumer or auto loans being financed or their security interests. These committed lines of credit expired or had renewal dates in 2007. The Corporation has established a borrowing facility at the discount window of the Federal Reserve Bank of New York. At December 31, 2007, the borrowing capacity at the discount window approximated $3,004,752,000, which remained unused at December 31, 2007 (2006 - $2,935,472,000). The facility is a collateralized source of credit that is highly reliable even under difficult market conditions. The amount available under this line is dependent upon the balance of loans and securities pledged as collateral. At December 31, 2006, the Corporation and its subsidiary Popular North America had obtained a committed credit facility from a syndicate of institutions (the lenders). Under this credit facility, which required the payment of facility and utilization fees, the Corporation could have requested the lenders to extend credit in the form of revolving loans, in an aggregate principal amount at any time outstanding not in excess of $555,000,000. This facility could had been used for general corporate purposes and also served as a backup facility to the Corporation’s 110 Financial data pertaining to the trusts follows: (Dollars in thousands, including reference notes) BanPonce Trust I Popular North Popular Capital America Capital Popular Capital Trust I Trust I Trust II February 1997 October 2003 $300,000 6.700% $9,279 $144,000 8.327% $4,640 September 2004 November 2004 $130,000 6.125% $4,021 $250,000 6.564% $7,732 Issuer Issuance date Capital securities Distribution rate Common securities Junior subordinated debentures aggregate liquidation amount $148,640 $309,279 $257,732 $134,021 Stated maturity date February 2027 November 2033 September 2034 December 2034 Reference notes (a),(c),(e),(f),(g) (b),(d),(f) (a),(c),(f) (b),(d),(f) (a) Statutory business trust that is wholly-owned by Popular North America (PNA) and indirectly wholly-owned by the Corporation. (b) Statutory business trust that is wholly-owned by the Corporation. (c) The obligations of PNA under the junior subordinated debentures and its guarantees of the capital securities under the trust are fully and unconditionally guaranteed on a subordinated basis by the Corporation to the extent set forth in the applicable guarantee agreement. (d) These capital securities are fully and unconditionally guaranteed on a subordinated basis by the Corporation to the extent set forth in the applicable guarantee agreement. (e) The original issuance was for $150,000. The Corporation had reacquired $6,000 of the 8.327% capital securities. (f) The Corporation has the right, subject to any required prior approval from the Federal Reserve, to redeem after certain dates or upon the occurrence of certain events mentioned below, the junior subordinated debentures at a redemption price equal to 100% of the principal amount, plus accrued and unpaid interest to the date of redemption. The maturity of the junior subordinated debentures may be shortened at the option of the Corporation prior to their stated maturity dates (i) on or after the stated optional redemption dates stipulated in the agreements, in whole at any time or in part from time to time, or (ii) in whole, but not in part, at any time within 90 days following the occurrence and during the continuation of a tax event, an investment company event or a capital treatment event as set forth in the indentures relating to the capital securities, in each case subject to regulatory approval. A capital treatment event would include a change in the regulatory capital treatment of the capital securities as a result of the recent accounting changes affecting the criteria for consolidation of variable interest entities such as the trust under FIN 46(R). (g) Same as (f) above, except that the investment company event does not apply for early redemption. _______________________________________________________________________ The Capital Securities of Popular Capital Trust I and Popular Capital Trust II are traded on the NASDAQ under the symbols “BPOPN” and “BPOPM”, respectively. Note 19 - (Loss) earnings per common share: Note 19 - (Loss) earnings per common share: Note 19 - (Loss) earnings per common share: Note 19 - (Loss) earnings per common share: Note 19 - (Loss) earnings per common share: The following table sets forth the computation of (loss) earnings per common share (“EPS”), basic and diluted, for the years ended December 31: (In thousands, except share information) Net (loss) income Less: Preferred stock dividends 2007 ($64,493) 11,913 2006 $357,676 11,913 2005 $540,702 11,913 Net (loss) income applicable to common stock after cumulative effect of accounting change Net (loss) income applicable to common stock ($76,406) $345,763 $528,789 before cumulative effect of accounting change ($76,406) $345,763 $525,182 Average common shares outstanding Average potential common shares Average common shares outstanding - assuming dilution Basic EPS before cumulative effect of accounting change Diluted EPS before cumulative effect of accounting change Basic EPS after cumulative effect of accounting change Diluted EPS after cumulative effect of accounting change 279,494,150 - 278,468,552 235,372 267,334,606 504,412 279,494,150 278,703,924 267,839,018 ($0.27) ($0.27) ($0.27) ($0.27) $1.24 $1.24 $1.24 $1.24 $1.97 $1.96 $1.98 $1.97 Potential common shares consist of common stock issuable under the assumed exercise of stock options and under restricted stock awards, using the treasury stock method. This method assumes that the potential common shares are issued and the proceeds from exercise, in addition to the amount of compensation cost attributed to future services, are used to purchase common stock at the exercise date. The difference between the number of potential shares issued and the shares purchased is added as incremental shares to the actual number of shares outstanding to compute diluted earnings per share. Stock options that result in lower potential shares issued than shares purchased under the treasury stock method are not included in the computation of dilutive earnings per share since their inclusion would have an antidilutive effect in earnings per share. For year 2007, there were 2,431,830 weighted average antidilutive stock options outstanding (2006 - 1,896,057; 2005 - 1,511,877). Note 20 - Stockholders’’’’’ equity: equity: equity: Note 20 - Stockholders Note 20 - Stockholders equity: Note 20 - Stockholders equity: Note 20 - Stockholders During the fourth quarter of 2005, existing shareholders of record of the Corporation's common stock at November 7, 2005 fully subscribed to an offering of 10,500,000 newly issued shares of Popular, Inc.’s common stock at a price of $21.00 per share under a subscription rights offering. This offering resulted in $216,326,000 in additional capital, of which $175,271,000 impacted stockholders’ equity at December 31, 2005 and the remainder impacted the Corporation’s financial condition in the 2007 Annual Report 111 2007 2007 Popular, Inc. 2007 2007 Note 21 - Regulatory capital requirements: Note 21 - Regulatory capital requirements: Note 21 - Regulatory capital requirements: Note 21 - Regulatory capital requirements: Note 21 - Regulatory capital requirements: The Corporation and its banking subsidiaries are subject to various regulatory capital requirements imposed by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Corporation’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Federal Reserve Bank and the other bank regulators have adopted quantitative measures which assign risk weightings to assets and off-balance sheet items and also define and set minimum regulatory capital requirements. The regulations define well- capitalized levels of Tier I, total capital and Tier I leverage of 6%, 10% and 5%, respectively. Management has determined that as of December 31, 2007 and 2006, the Corporation exceeded all capital adequacy requirements to which it is subject. At December 31, 2007 and 2006, BPPR, BPNA and Banco Popular, National Association (BP, N.A.) were well-capitalized under the regulatory framework for prompt corrective action, and there are no conditions or events since December 31, 2007 that management believes have changed the institutions’ category. The adjustment to capital as a result of the adoption of SFAS No. 158 on December 31, 2006 did not impact the regulatory capital ratios of the Corporation or any of its banking subsidiaries. In December 2006, regulatory agencies announced an interim decision that SFAS No. 158 would not affect regulatory capital of banking organizations. This is the position taken by the Corporation until the agencies issue the final rules. The Corporation has been designated by the Federal Reserve Board as a Financial Holding Company (“FHC”) and is eligible to engage in certain financial activities permitted under the Gramm-Leach-Bliley Act of 1999. FHC status is subject to certain requirements including maintenance of the Corporation’s banking subsidiaries’ status as being well-capitalized and well managed and maintaining satisfactory CRA (“Community Reinvestment Act”) ratings. There are no conditions or events since December 31, 2006 that management believes have changed the Corporation’s FHC status. first quarter of 2006. As of December 31, 2005, this subscription rights offering resulted in 8,614,620 newly issued shares of common stock; the remaining 1,885,380 were issued during the first quarter of 2006. The Corporation has a dividend reinvestment and stock purchase plan under which stockholders may reinvest their quarterly dividends in shares of common stock at a 5% discount from the average market price at the time of issuance, as well as purchase shares of common stock directly from the Corporation by making optional cash payments at prevailing market prices. The Corporation’s authorized preferred stock may be issued in one or more 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. The Corporation’s only outstanding class of preferred stock is its 6.375% noncumulative monthly income preferred stock, 2003 Series A. These shares of preferred stock are perpetual, nonconvertible and are redeemable solely at the option of the Corporation beginning on March 31, 2008. The redemption price per share is $25.50 from March 31, 2008 through March 30, 2009, $25.25 from March 31, 2009 through March 30, 2010 and $25.00 from March 31, 2010 and thereafter. During the year 2007, cash dividends of $0.64 (2006 - $0.64; 2005 - $0.64) per common share outstanding amounting to $178,938,000 (2006 - $178,231,000; 2005 - $170,970,000) were declared. In addition, dividends declared on preferred stock amounted to $11,913,000 (2006 - $11,913,000; 2005 - $11,913,000). Dividends payable to shareholders of common stock at December 31, 2007 was $44,849,000 (2006 - $44,614,000; 2005 - $42,791,000). The Banking Act of the Commonwealth of Puerto Rico requires that a minimum of 10% of BPPR’s net income for the year be transferred to a statutory reserve account until such statutory reserve equals the total of paid-in capital on common and preferred stock. Any losses incurred by a bank must first be charged to retained earnings and then to the reserve fund. Amounts credited to the reserve fund may not be used to pay dividends without the prior consent of the Puerto Rico Commissioner of Financial Institutions. The failure to maintain sufficient statutory reserves would preclude BPPR from paying dividends. BPPR’s statutory reserve fund totaled $374,192,000 at December 31, 2007 (2006 - $346,192,000; 2005 - $316,192,000). During 2007, $28,000,000 (2006 - $30,000,000; 2005 - $31,000,000) was transferred to the statutory reserve account. At December 31, 2007, 2006 and 2005, BPPR was in compliance with the statutory reserve requirement. 112 The Corporation’s risk-based capital and leverage ratios at December 31, were as follows: The following table also presents the minimum amounts and ratios for the Corporation’s banks to be categorized as well- capitalized under prompt corrective action: (Dollars in thousands) Amount Ratio Amount Ratio 2007 Actual Capital adequacy minimum requirement Total Capital (to Risk-Weighted Assets): Corporation BPPR BPNA Tier I Capital (to Risk-Weighted Assets): Corporation BPPR BPNA Tier I Capital (to Average Assets): Corporation BPPR BPNA $3,778,264 2,173,648 1,103,117 11.38% 11.15 10.32 $2,656,781 1,559,039 855,338 $3,361,132 1,498,030 976,878 10.12% 7.69 9.14 $1,328,391 779,519 427,669 $3,361,132 7.33% 1,498,030 5.82 976,878 7.55 $1,375,270 1,833,694 772,414 1,029,886 388,233 517,644 8% 8 8 4% 4 4 3% 4 3 4 3 4 (Dollars in thousands) Amount Ratio Amount Ratio 2006 Actual Capital adequacy minimum requirement Total Capital (to Risk-Weighted Assets): Corporation BPPR BPNA Tier I Capital (to Risk-Weighted Assets): Corporation BPPR BPNA Tier I Capital (to Average Assets): Corporation BPPR BPNA $4,169,451 2,362,713 1,032,555 11.86% 12.81 11.04 $2,811,418 1,475,460 748,329 $3,727,860 1,700,583 944,506 10.61% 9.22 10.10 $1,405,709 737,730 374,165 $3,727,860 8.05% 1,700,583 6.90 944,506 7.91 $1,389,915 1,853,220 739,850 986,467 358,115 477,486 8% 8 8 4% 4 4 3% 4 3 4 3 4 (Dollars in thousands) 2007 2006 Amount Ratio Amount Ratio Total Capital (to Risk-Weighted Assets): BPPR BPNA Tier I Capital (to Risk-Weighted Assets): BPPR BPNA Tier I Capital (to Average Assets): BPPR BPNA $1,948,798 1,069,173 10% 10 $1,844,325 935,412 10% 10 $1,169,279 641,504 $1,287,357 647,055 6% 6 5% 5 $1,106,595 561,247 $1,233,083 596,858 6% 6 5% 5 Note 22 - Servicing assets: Note 22 - Servicing assets: Note 22 - Servicing assets: Note 22 - Servicing assets: Note 22 - Servicing assets: The Corporation recognizes as assets the rights to service loans for others, whether these rights are purchased or result from asset transfers (sales and securitizations). Commencing in 2007 and in accordance with SFAS No. 156, the Corporation no longer records servicing rights in connection with on-balance sheet mortgage loan securitizations. Effective January 1, 2007, under SFAS No. 156, the Corporation identified servicing rights related to residential mortgage loans as a class of servicing rights and elected to apply fair value accounting to these mortgage servicing rights (“MSRs”). These MSRs are segregated between loans serviced by PFH and by the Corporation’s banking subsidiaries. Fair value determination is performed on a subsidiary basis, with assumptions varying in accordance with the types of assets or markets served (i.e. PFH - primarily subprime mortgage loans vs. banking subsidiaries – primarily conforming loans). Classes of servicing rights were determined based on the different markets or types of assets served. Management also considered trends in the markets and elections by other major participants in the industries served in determining the accounting methodology to be followed for the different types of servicing rights. Under the fair value accounting method of SFAS No. 156, purchased MSRs and MSRs resulting from asset transfers are capitalized and carried at fair value. Prior to the adoption of SFAS No. 156, the Corporation capitalized purchased residential MSRs at cost, and MSRs from asset transfers based on the relative fair value of the servicing right and the residential mortgage loan at 2007 Annual Report 113 2007 2007 Popular, Inc. 2007 2007 the time of sale. Prior to SFAS No. 156, both purchased MSRs and MSRs from asset transfers were accounted for at quarter-end at the lower of cost or market value. Residential mortgage loans serviced for others were $20,509,655,000 at December 31, 2007 (2006 - $13,267,700,000; 2005 - $9,164,361,000). The changes in amortized MSR's for the years ended December 31, 2006 and 2005 were as follows: (In thousands) Balance at beginning of year Rights originated Rights purchased Amortization Balance at end of year Less: Valuation allowance Balance at end of year, net of valuation allowance Fair value at end of year 2006 $137,701 62,877 23,769 (63,202) 161,145 1,006 $160,139 $175,469 2005 $54,326 103,092 5,039 (24,756) 137,701 951 $136,750 $150,627 Included in the table above were $11,207,000 in rights originated and $2,796,000 in amortization corresponding to the activity for the month of December 2005 for PFH, which changed its fiscal year in the first quarter of 2006, as described in Note 1 to the consolidated financial statements. The activity in the valuation allowance for impairment of recognized servicing assets for the years ended December 31, 2006 and 2005 was as follows: (In thousands) Balance at beginning of year Additions charged to operations Reductions credited to operations Balance at end of year 2006 2005 $951 536 (481) $1,006 $920 362 (331) $951 Net mortgage servicing fees, a component of other service fees in the consolidated statement of income, include the changes from period to period in fair value of the MSRs, which may result from changes in the valuation model inputs or assumptions (principally reflecting changes in discount rates and prepayment speed assumptions) and other changes, representing changes due to collection / realization of expected cash flow. Prior to the adoption of SFAS No. 156, the Corporation carried residential MSRs at the lower cost of market, with amortization of MSRs and changes in the MSRs valuation allowance recognized in net mortgage servicing fees. Effective January 1, 2007, upon the remeasurement of the MSRs at fair value in accordance with SFAS No. 156, the Corporation recorded a cumulative effect adjustment to increase the 2007 beginning balance of MSRs by $15,330,000, which resulted in a $9,574,000, net of tax, increase in the retained earnings account of stockholders’ equity. The table below reconciles the balance of MSRs as of December 31, 2006 and January 1, 2007. (In thousands) Residential MSRs Residential MSRs Total Banking subsidiaries PFH Balance at December 31, 2006 Remeasurement upon adoption of $77,801 $82,338 $160,139 SFAS No. 156 (a) 15,330 Balance at January 1, 2007 $175,469 (a) The remeasurement effect, net of deferred taxes, amounted to $9.6 million on a consolidated basis. 13,630 $91,431 1,700 $84,038 At the end of each quarter, the Corporation uses a discounted cash flow model to estimate the fair value of MSRs, which is benchmarked against third party opinions of fair value. The discounted cash flow model incorporates assumptions that market participants would use in estimating future net servicing income, including estimates of prepayment speeds, discount rate, cost to service, escrow account earnings, contractural servicing fee income, prepayment and late fees, among other considerations. The Corporation uses assumptions in the model that it believes are comparable to those used by brokers or other service providers. Refer to Note 23 to the consolidated financial statements for information on assumptions used in the valuation model of MSRs as of December 31, 2007. The changes in mortgage servicing assets for the year ended December 31, 2007 were as follows: Banking subsidiaries PFH (In thousands) Fair value at January 1, 2007 Purchases Servicing from securitizations or asset transfers Changes due to payments on loans (1) Changes in fair value due to Residential MSRs Residential MSRs Total $91,431 4,256 $84,038 22,251 $175,469 26,507 22,817 26,048 48,865 (9,117) (35,516) (44,633) changes in valuation model inputs or assumptions (14,530) (54) Other changes Fair value at December 31, 2007 $191,624 (1) Represents changes due to collection / realization of expected cash flows over time. 1,213 12 $110,612 (15,743) (66) $81,012 114 The changes in servicing rights associated with Small Business Administration (“SBA”) commercial loans, the other class of servicing assets held by the Corporation, will continue to be accounted for at the lower of cost or market method as follows: (In thousands) Balance at beginning of year Rights originated Rights purchased Amortization Balance at end of year Less: Valuation allowance Balance at end of year, net of valuation allowance $5,021 $7,324 Fair value at end of year 2007 $4,860 2,051 3 (1,893) $5,021 - 2006 $4,739 2,534 - (2,413) $4,860 - $4,860 $7,705 2005 $3,777 1,972 - (1,010) $4,739 - $4,739 $7,200 SBA loans serviced for others were $527,241,000 at December 31, 2007 (2006 - $477,869,000; 2005 - $367,352,000). N o t e 2 3 - R e t a i n e d i n t e r e s t s o n t r a n s f e r s o f N o t e 2 3 - R e t a i n e d i n t e r e s t s o n t r a n s f e r s o f N o t e 2 3 - R e t a i n e d i n t e r e s t s o n t r a n s f e r s o f N o t e 2 3 - R e t a i n e d i n t e r e s t s o n t r a n s f e r s o f N o t e 2 3 - R e t a i n e d i n t e r e s t s o n t r a n s f e r s o f f i n a n c i a l a s s e t s : f i n a n c i a l a s s e t s : f i n a n c i a l a s s e t s : f i n a n c i a l a s s e t s : f i n a n c i a l a s s e t s : During the years ended December 31, 2007 and 2006, the Corporation retained servicing responsibilities and other residual interests on various securitization transactions and whole loan sales of residential mortgage and commercial loans performed by various subsidiaries. Valuation methodologies used in determining the fair value of the retained interests, including servicing assets and residual assets, are disclosed in Note 1 to the consolidated financial statements. Popular Financial Holdings During 2007 and 2006, the Corporation, through its subsidiary PFH, retained mortgage servicing rights (“MSRs”) and residual interests on mortgage loan securitizations. During 2007, the Corporation conducted one off-balance sheet asset securitization that involved the transfer of mortgage loans to a qualifying special purpose entity (“QSPE”), which in turn transferred these assets and their titles to different trusts, thus isolating those loans from the Corporation’s assets. Approximately $460,767,000 in adjustable (“ARM”) and fixed-rate loans were securitized and sold by PFH during 2007 as part of this off-balance sheet asset securitization and PFH realized a gain on sale of approximately $13,466,000. As part of this transaction, the Corporation initially recognized MSRs of $8,040,000 and residual interests of $4,667,000. Also, in December 2007, the Corporation completed the recharacterization of certain on-balance sheet securitizations that allowed the Corporation to recognize the transactions as sales under SFAS No. 140. From 2001 through 2006, the Corporation conducted 21 mortgage loan securitizations that were sales for legal purposes but did not qualify for sale accounting treatment at the time of inception because the securitization trusts did not meet the criteria for QSPEs contained in SFAS No. 140. As a result, the transfers of the mortgage loans pursuant to these securitizations were initially accounted for as secured borrowings with the mortgage loans continuing to be reflected as assets on the Corporation’s consolidated statement of financial condition with appropriate footnote disclosure indicating that the mortgage loans were, for legal purposes, sold to the securitization trusts. As part of the Corporation’s strategy of exiting the subprime business at PFH and improving the Corporation’s capital ratios, on December 19, 2007, PFH and the trustee for each of the related securitization trusts amended the provisions of the related pooling and servicing agreements to delete the discretionary provisions that prevented the Corporation from removing the loans from its accounting books. These changes in the primary discretionary provisions included: • deleting the provision that grants the servicer “sole discretion” to have the right to purchase for its own account or for resale from the trust fund any loan which is 91 days or more delinquent; • deleting the provision that grants the servicer (PFH) “sole discretion” to sell loans with respect to which it believes default is imminent; • deleting the provision that grants the servicer “sole discretion” to determine whether an immediate sale of a real estate owned (“REO”) property or continued management of such REO property is in the best interest of the certificateholders; and • deleting the provision that grants the residual holder (PFH) to direct the trustee to acquire derivatives post closing. The Corporation obtained a legal opinion which among other considerations indicated that each amendment (a) is authorized or permitted under the pooling and servicing agreement related to such amendment, and (b) will not adversely affect in any material respect the interests of any certificateholders covered by the related pooling and servicing agreement. The amendments to the provisions of the pooling and servicing agreement allowed the Corporation to recognize 16 out of the 21 transactions as sales under SFAS No. 140. When accounting for the transfers as sales, the Corporation (i) reclassified the loans as held-for-sale with the corresponding lower of cost or market adjustment as of the date of the transfer, (ii) removed from the Corporation’s books approximately $3,221,003,000 in mortgage loans and $3,083,259,000 in related liabilities representing secured borrowings, (iii) recognized assets referred to as residual interests, which represent the fair value of residual interest certificates that were issued by the securitization trusts and retained by PFH, and (iv) recognized mortgage servicing rights, which represent the fair value of PFH’s right to continue to service 2007 Annual Report 115 2007 2007 Popular, Inc. 2007 2007 been an adverse change in estimated cash flows (considering both the timing and amount of flows), then residual interest security is written down to fair value, which becomes the new amortized cost basis. The Corporation recognized other-than-temporary impairment losses on these residual interests of $45,379,000 for the year ended December 31, 2007 (2006 - $17,761,000) and are classified as part of net gain (loss) on sale and valuation adjustment of investment securities in the consolidated statement of income. During 2007, all declines in fair value in residual interests classified as available-for-sale have been considered other-than- temporary. Commencing in January 2006 and as permitted by accounting guidance, the residual interests derived from newly-issued PFH’s off-balance sheet securitizations and from the recharacterization previously described, were accounted as trading securities. Management’s determination to prospectively classify the residual interests as trading securities was driven by accounting considerations and not by intent to actively trade these assets. Trading securities are marked-to-market through earnings (favorable and unfavorable value changes) as opposed to available- for-sale securities in which the changes in value are recorded as unrealized gains (losses) through equity, unless unfavorable changes are considered other-than-temporary. The fair value determinations for residual interests classified as trading securities are also performed on a quarterly basis. Any valuation adjustment related to these particular residual interests is reflected in earnings as it occurs and is recorded as part of trading account profit (loss) in the consolidated statements of operations. Residual interests from PFH’s securitizations and recharacterization accounted for as trading securities amounted to $40,197,000 at December 31, 2007 (2006 - $36,552,000). The Corporation recognized trading losses on these residual interests of $39,661,000 for the year ended December 31, 2007 (2006 - $970,000). PFH receives average annual servicing fees based on a percentage of the outstanding loan balance. In 2007, those average fees were 0.50% for mortgage loans (2006 – 0.50%). the mortgage loans transferred to the securitization trusts. As part of the recharacterization, the Corporation recognized residual interests of $38,308,000 and MSRs of $18,008,000. The Corporation had previously recorded MSRs in several of these securitization transactions and their outstanding fair value approximated $17,505,000 at December 31, 2007. The impact of the recharacterization transaction was a pre-tax loss of $90,143,000, which is included in the caption “(Loss) gain on sale of loans and valuation adjustments on loans held-for-sale” in the consolidated statement of income. During 2006, the Corporation conducted three off-balance sheet asset securitizations that involved the transfer of mortgage loans to QSPEs. Approximately $1,024,633,000 in ARM and fixed- rate loans were securitized and sold by PFH during 2006, with a gain on sale of approximately $18,849,000. As part of these transactions, the Corporation initially recognized MSRs of $18,542,000 and residual interests of $36,927,000. When the Corporation transfers financial assets and the transfer fails any one of the SFAS No. 140 criteria, the Corporation is not permitted to derecognize the transferred financial assets and the transaction is accounted for as a secured borrowing (“on-balance sheet securitization”). The loans are included in Note 8 as pledged loans held-in-portfolio. The Corporation did not execute any on-balance sheet securitization during 2007. During 2006, the Corporation completed three on-balance sheet securitizations consisting of approximately $1,163,619,000 in adjustable and fixed-rate nonprime mortgage loans. As part of these transactions, the Corporation recognized MSRs of $16,521,000. Under SFAS No. 140, interest-only strips, retained interests in securitizations or other financial assets that can contractually be prepaid or otherwise settled in such a way that the holder would not recover substantially all of its investment shall be subsequently measured like investments in debt securities classified as available- for-sale or trading under SFAS No. 115. Residual interests retained as part of off-balance sheet securitizations of subprime mortgage loans prior to 2006 had been classified as investment securities available-for-sale and are presented at fair value in the consolidated statements of condition. PFH’s residual interests classified as available-for-sale as of December 31, 2007 amounted to $4,812,000 (2006 - $49,413,000). The Corporation reviews the residual interests for potential impairment on a quarterly basis and records impairment in accordance with SFAS No. 115 and EITF 99-20. Management’s basis in determining when these securities must be written down to fair value due to other-than-temporary impairment is based on EITF 99-20. Whenever the current fair value of the residual interests classified as available-for-sale is lower than its current amortized cost, management evaluates to see if an impairment charge for the deficiency is required to be taken through earnings. If there has 116 Key economic assumptions used in measuring the retained interests at the date of the securitization and recharacterization transactions completed during the year ended December 31, 2007 were: At December 31, 2007 and 2006, key economic assumptions used to estimate the fair value of the residual interests and MSRs derived from PFH’s securitizations and the sensitivity of residual cash flows to immediate changes in those assumptions were as follows: MSRs Residual interests Fixed-rate loans ARM loans Average prepayment speed 20.7% to 28% 20.7% to 28% 30% to 35% (Fixed-rate loans) 30% to 35% (ARM loans) Weighted average life of collateral (in years) 6.8 years 4.2 years 2.6 years Cumulative credit losses Discount rate (annual rate) 4.21% to 13.13% - - 25% to 40% 17% 17% In connection with the securitizations, PFH’s retained interests are subordinated to investors’ interests. Their value is subject to credit, prepayment and interest rate risks on the transferred financial assets. The securitization related assets recorded in the statements of condition at year-end were as follows: (Dollars in thousands) Carrying amount of retained interests Fair value of retained interests December 31, 2007 Residual interests $45,009 $45,009 MSRs Fixed-rate loans $47,243 $47,243 ARM loans $11,335 $11,335 Weighted average collateral life (in years) 7.6 years 4.3 years 2.6 years Weighted average prepayment speed (annual rate) 20.7% (Fixed-rate loans) 30% (ARM loans) 20.7% 30.0% Impact on fair value of 10% adverse change Impact on fair value of 20% adverse change $5,031 ($192) $6,766 ($886) $272 $688 Weighted average discount rate (annual rate) 40.0% 17.0% 17.0% Impact on fair value of 10% adverse change Impact on fair value of 20% adverse change ($2,884) ($1,466) ($225) ($5,427) ($2,846) ($441) (In thousands) Residual interests MSRs Servicing advances 2007 $45,009 58,578 167,610 2006 $85,965 67,855 42,617 Impact on fair value of 10% adverse change Impact on fair value of 20% adverse change ($8,829) ($15,950) December 31, 2006 Cumulative credit losses 3.35% to 11.03% - - - - - - (Dollars in thousands) Carrying amount of retained interests Fair value of retained interests Weighted average collateral life (in years) Residual interests $85,965 $85,965 3.2 years MSRs Fixed-rate loans $38,017 $37,815 3.1 years ARM loans $29,838 $32,212 2.1 years Weighted average prepayment speed (annual rate) 28% (Fixed-rate loans) 35% (ARM loans) Impact on fair value of 10% adverse change Impact on fair value of 20% adverse change ($5,543) ($9,284) Weighted average discount rate (annual rate) 17% 28% 35% $210 $234 16% ($149) ($200) 16% Impact on fair value of 10% adverse change Impact on fair value of 20% adverse change ($4,172) ($901) ($542) ($8,081) ($1,761) ($1,060) Cumulative credit losses 1.28% to 3.19% Impact on fair value of 10% adverse change Impact on fair value of 20% adverse change ($4,792) ($9,558) - - - - - - 2007 Annual Report 117 2007 2007 Popular, Inc. 2007 2007 PFH, as servicer, collects prepayment penalties on a substantial portion of the underlying serviced loans. As such, an adverse change in the prepayment assumptions with respect to the MSRs could be partially offset by the benefit derived from the prepayment penalties estimated to be collected. The amounts included in the tables above exclude any purchased MSRs since these assets were not derived from securitizations or loan sales executed by the Corporation. Certain cash flows received from and paid to securitization trusts for the years ended December 31, 2007 and 2006, included: (In thousands) Servicing fees received Servicing advances, net of repayments Other cash flows received on retained interests 2007 $18,115 124,993 19,899 2006 $20,440 8,726 25,250 Banking subsidiaries In addition, the Corporation’s banking subsidiaries retain servicing responsibilities on the sale of wholesale mortgage loans and loans guaranteed by the Small Business Administration (“SBA”). Also, servicing responsibilities are retained under pooling / selling arrangements of mortgage loans into mortgage-backed securities, primarily GNMA and FNMA securities. Substantially all mortgage loans securitized by the banking subsidiaries have fixed rates. Under these servicing agreements, the banking subsidiaries do not earn significant prepayment penalties on the underlying loans serviced. Gains of $21,092,000 and $42,672,000 were realized by the banking subsidiaries on the securitization transactions that met the sale criteria under SFAS No. 140 and the whole loan sales involving retained interests, which took place in 2007 and 2006, respectively. The banking subsidiaries receive average annual servicing fees based on a percentage of the outstanding loan balance. In 2007, those weighted average fees were 0.26% for mortgage loans (2006 - 0.27%) and 1.07% for SBA loans (2006 - 1.10%). Key economic assumptions used in measuring the servicing rights retained at the date of the securitizations and whole loan sales by the banking subsidiaries were: Residential Mortgage Loans SBA Loans 2007 2006 2007 2006 Prepayment speed Weighted average life (in years) Discount rate (annual rate) 9.5% 10.6 years 10.7% 13.9% 8.3 years 10.2% 18.3% 17.0% 3.0 years 3.3 years 13.0% 13.0% At December 31, 2007 and 2006, key economic assumptions used to estimate the fair value of servicing rights derived from transactions performed by the banking subsidiaries and the sensitivity of residual cash flows to immediate changes in those assumptions were as follows: December 31, 2007 (Dollars in thousands) Carrying amount of retained interests Fair value of retained interests Weighted average life (in years) Weighted average prepayment speed (annual rate) Impact on fair value of 10% adverse change Impact on fair value of 20% adverse change Weighted average discount rate (annual rate) Impact on fair value of 10% adverse change Impact on fair value of 20% adverse change Residential Mortgage Loans $86,453 $86,453 12.5 years 8.0% ($1,983) ($3,902) 10.83% ($2,980) ($5,795) December 31, 2006 (Dollars in thousands) Carrying amount of retained interests Fair value of retained interests Weighted average life (in years) Weighted average prepayment speed (annual rate) Impact on fair value of 10% adverse change Impact on fair value of 20% adverse change Weighted average discount rate (annual rate) Impact on fair value of 10% adverse change Impact on fair value of 20% adverse change Residential Mortgage Loans $62,784 $73,332 9.2 years 14.0% ($1,868) ($4,151) 10.3% ($2,142) ($4,200) SBA Loans $5,021 $7,324 3.0 years 18.3% ($348) ($706) 13.00% ($209) ($427) SBA Loans $4,860 $7,705 3.3 years 17.0% ($355) ($724) 13.0% ($235) ($479) The amounts of MSRs presented in the table above exclude purchased MSRs. The expected credit losses for the residential mortgage loans securitized / sold are minimal. Also, no credit losses are anticipated on the retained servicing assets derived from the sale of SBA loans since the participation sold is substantially guaranteed by SBA. The sensitivity analyses presented in the tables above for residual interests and servicing rights of PFH and the banking subsidiaries are hypothetical and should be used with caution. As the figures indicate, changes in fair value based on a 10 and 20 percent variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in the sensitivity tables included herein, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated without changing any other assumption; in reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments and increased credit losses), which might magnify or counteract the sensitivities. 118 Quantitative information about delinquencies, net credit losses, and components of securitized financial assets and other assets managed together with them by the Corporation for the years ended December 31, 2007 and 2006, were as follows: 2007 Total principal Principal amount amount of loans, net of unearned past due 60 days or more Net credit (In thousands) Loans (owned and managed): Commercial Lease financing Mortgage Consumer Less: Loans securitized / sold Loans held-for-sale Loans held-in-portfolio (In thousands) Loans (owned and managed): Commercial Lease financing Mortgage Consumer Less: Loans securitized / sold Loans held-for-sale Loans held-in-portfolio losses $78,557 15,027 160,319 186,173 losses $38,322 13,883 67,478 118,906 $15,746,646 1,164,439 16,026,827 5,684,600 $478,067 18,653 1,325,228 141,142 (8,711,510) (1,889,546) $28,021,456 (760,931) - $1,202,159 (16,979) - $423,097 2006 Total principal Principal amount amount of loans, net of unearned past due 60 days or more Net credit $14,599,245 1,226,490 17,083,839 5,278,456 $186,257 35,083 927,036 117,976 (5,451,091) (719,922) $32,017,017 (204,701) - $1,061,651 (8,844) - $229,745 Under the GNMA securitizations, the Corporation, as servicer, has the right to repurchase, at its option and without GNMA’s prior authorization, any loan that is collateral for a GNMA guaranteed mortgage-backed security when certain delinquency criteria are met. At the time that individual loans meet GNMA’s specified delinquency criteria and are eligible for repurchase, the Corporation is deemed to have regained effective control over these loans. At December 31, 2007, the Corporation had recorded $41,564,000 in mortgage loans under this buy-back option program (2006 - $24,822,000). Note 24 - Employee benefits: Note 24 - Employee benefits: Note 24 - Employee benefits: Note 24 - Employee benefits: Note 24 - Employee benefits: Pension and benefit restoration plans Certain employees of BPPR and BPNA are covered by non- contributory defined benefit pension plans. Pension benefits are based on age, years of credited service, and final average compensation. BPPR’s non-contributory, defined benefit retirement plan is currently closed to new hires and to employees who as of December 31, 2005 were under 30 years of age or were credited with less than 10 years of benefit service. The retirement plan’s benefit formula is based on a percentage of average final compensation and years of service. Normal retirement age under the retirement plans is age 65 with 5 years of service. Pension costs are funded in accordance with minimum funding standards under the Employee Retirement Income Security Act of 1974 (“ERISA”). Benefits under the BPPR retirement plan are subject to the U.S. Internal Revenue Code limits on compensation and benefits. Benefits under restoration plans restore benefits to selected employees that are limited under the retirement plan due to U.S. Internal Revenue Code limits and a compensation definition that excludes amounts deferred pursuant to nonqualified arrangements. Effective April 1, 2007, the Corporation froze its non- contributory, defined benefit retirement plan, which covered substantially all salaried employees of BPNA hired before June 30, 2004. This plan was in the process of termination on December 31, 2007. These actions were also applicable to the related plan that restored benefits to select employees that were limited under the retirement plan. The Corporation’s funding policy is to make annual contributions to the plans in amounts which fully provide for all benefits as they become due under the plans. The Corporation’s pension fund investment strategy is to invest in a prudent manner for the exclusive purpose of providing benefits to participants. A well defined internal structure has been established to develop and implement a risk-controlled investment strategy that is targeted to produce a total return that, when combined with the bank’s contributions to the fund, will maintain the fund’s ability to meet all required benefit obligations. Risk is controlled through diversification of asset types, such as investments in domestic and international equities and fixed income. Equity investments include various types of stock and index funds. Also, this category includes Popular, Inc.’s common stock. Fixed income investments include U.S. Government securities and other U.S. agencies’ obligations, corporate bonds, mortgage loans, mortgage-backed securities and index funds, among others. A designated committee, with the assistance of an external consultant, periodically reviews the performance of the pension plans’ investments and assets allocation. The Trustee and the money managers are allowed to exercise investment discretion, subject to limitations established by the pension plans’ investment policies. The plans forbid money managers to enter into derivative transactions, unless approved by the Trustee. The overall expected long-term rate-of-return-on-assets assumption reflects the average rate of earnings expected on the funds invested or to be invested to provide for the benefits included in the benefit obligation. The assumption has been determined by reflecting expectations regarding future rates of return for the plan assets, with consideration given to the distribution of the investments by asset class and historical rates of return for each 2007 Annual Report 119 2007 2007 Popular, Inc. 2007 2007 individual asset class. This process is reevaluated at least on an annual basis and if market, actuarial and economic conditions change, adjustments to the rate of return may come into place. The plans’ weighted-average asset allocations at December 31, by asset category were as follows: Equity securities Fixed income securities Other 2007 69% 31 - 100% 2006 67% 31 2 100% The plans’ target allocation for 2007 and 2006, by asset category, approximated 70% in equity securities and 30% in debt securities. At December 31, 2007, these plans included 2,745,720 shares (2006 - 2,745,720) of the Corporation’s common stock with a market value of approximately $29,105,000 (2006 - $49,286,000). Dividends paid on shares of the Corporation’s common stock held by the plan during 2007 amounted to $1,757,000 (2006 - $1,757,000). As indicated in Note 1, the Corporation adopted SFAS No. 158 as of December 31, 2006. Under SFAS No. 158 each overfunded plan is recognized as an asset and each underfunded plan is recognized as a liability. The initial impact of the standard due to unrecognized prior service costs or credits and net actuarial gains or losses as well as subsequent changes in the funded status was recognized as a component of accumulated comprehensive loss in stockholders’ equity. Additional minimum pension liabilities (“AMPL”) and related intangible assets were also derecognized upon adoption of the new standard. The following table summarizes the effect of required changes in the AMPL as of December 31, 2006 prior to the adoption of SFAS No. 158 as well as the impact of the initial adoption of SFAS No. 158. Pension Plans: December 31, 2006 prior AMPL and December 31, 2006 Post AMPL and SFAS Benefit Restoration Plans: December 31, 2006 prior to AMPL and December 31, 2006 Post AMPL and SFAS (In thousands) SFAS No. 158 AMPL No. 158 SFAS No. 158 AdjustmentsAdjustment Adjustment Adjustment Prepaid pension costs Benefit liabilities Accumulated other $2,057 (5,634) - - ($2,057) (6,507) - ($12,141) comprehensive loss 2,354 $1,539 8,564 12,457 The following table sets forth the aggregate status of the plans and the amounts recognized in the consolidated financial statements at December 31: (In thousands) Change in benefit obligation: Benefit obligation at beginning of year Service cost Interest cost Curtailment gain Actuarial (gain) loss Benefits paid Benefit obligations at end of year Change in plan assets: Fair value of plan assets at beginning of year Actual return on plan assets Employer contributions Benefits paid Fair value of plan assets at Pension Plans Benefit Restoration Plans 2007 Total $569,457 11,023 31,850 (1,291) (30,314) (25,392) $29,619 898 1,677 (334) (2,511) (284) $599,076 11,921 33,527 (1,625) (32,825) (25,676) $555,333 $29,065 $584,398 $536,856 13,624 1,002 (25,392) $17,477 2,053 1,154 (284) $554,333 15,677 2,156 (25,676) end of year $526,090 $20,400 $546,490 Amounts recognized in accumulated other comprehensive loss under SFAS No. 158: Net prior service cost Net loss Accumulated other $1,130 44,879 ($356) 8,709 $774 53,588 comprehensive loss (AOCL) $46,009 $8,353 $54,362 (In thousands) SFAS No. 158 AMPL No. 158 SFAS No. 158 AdjustmentsAdjustment Adjustment Adjustment Reconciliation of net (liability) / asset: Net (liability) / asset at beginning Prepaid pension costs Benefit liabilities Accumulated other comprehensive loss $21,071 (4,595) - - - - ($21,071) (28,007) - ($32,602) 49,078 49,078 of year ($32,602) ($12,141) ($44,743) Amount recognized in AOCL at beginning of year, pre-tax 49,078 12,457 61,535 (Accrual) / prepaid at beginning of year Net periodic benefit (cost) / income Additional benefit (cost) / income Contributions (Accrual) / prepaid at end of year Amount recognized in AOCL Net (liability) / asset at end of year Accumulated benefit obligation 16,476 (959) 247 1,002 16,766 (46,009) ($29,243) $512,238 316 (2,040) 258 1,154 (312) (8,353) ($8,665) $24,438 16,792 (2,999) 505 2,156 16,454 (54,362) ($37,908) $536,676 Pension Plans Benefit Restoration Plans 2006 The change in accumulated other comprehensive loss Total (“AOCL”), pre-tax for the plans was as follows: 120 (In thousands) Change in benefit obligation: Benefit obligation at beginning of year Service cost Interest cost Actuarial (gain) loss Benefits paid Transfer of obligation* Benefit obligations at end of year Change in plan assets: Fair value of plan assets at beginning of year Actual return on plan assets Employer contributions Benefits paid Fair value of plan assets at $567,154 12,509 30,558 (18,265) (23,561) 1,062 $29,316 1,047 1,601 (983) (300) (1,062) $596,470 13,556 32,159 (19,248) (23,861) - $569,457 $29,619 $599,076 $509,457 49,037 1,923 (23,561) $12,259 (20) 5,538 (300) $521,716 49,017 7,461 (23,861) end of year $536,856 $17,477 $554,333 Amounts recognized in accumulated other comprehensive loss under SFAS No. 158: Net prior service cost Net loss Accumulated other comprehensive loss $1,340 47,738 ($412) 12,869 $928 60,607 $49,078 $12,457 $61,535 Reconciliation of net (liability) asset: Net (liability) asset at beginning of year Net periodic benefit cost Contributions Amount recognized in AOCL Transfer of unrecognized amounts* Net (liability) asset at end of year Accumulated benefit obligation $20,485 (5,289) 1,923 (49,078) (643) ($32,602) $504,976 ($3,228) (2,637) 5,538 (12,457) 643 ($12,141) $20,801 $17,257 (7,926) 7,461 (61,535) - ($44,743) $525,777 * Benefit obligations were transferred from the benefit restoration plans to the qualified retirement plan due to removal of the compensation limit "sunset provisions" under the Pension Protection Act of 2006. Pro-rata amounts of the unrecognized prior service costs and losses were also transferred. (In thousands) Pension Plans Restoration Plans Total Accumulated other comprehensive loss at January 1, 2007 $49,078 $12,457 $61,535 Benefit Increase (decrease) in AOCL: Recognized during the year: Prior service (cost) / credit Actuarial (losses) / gains Ocurring during the year: Net actuarial losses / (gains) Total decrease in AOCL Accumulated other comprehensive (210) 250 (3,109) (3,069) 56 (736) (3,424) (4,104) (154) (486) (6,533) (7,173) loss at December 31, 2007 $46,009 $8,353 $54,362 The amounts in accumulated other comprehensive loss that are expected to be recognized as components of net periodic benefit cost (credit) during 2008 are as follows: (In thousands) Net prior service cost (credit) Net loss Pension Plans Benefit Restoration Plans $266 (250) ($53) 686 Information for plans with an accumulated benefit obligation in excess of plan assets for the years ended December 31, follows: (In thousands) Pension Plans 2006 2007 Projected benefit obligation Accumulated benefit obligation Fair value of plan assets $13,075 13,075 9,616 $13,721 9,318 8,075 Benefit Restoration Plans 2006 2007 $29,065 24,438 20,400 $29,619 20,801 17,477 Information for plans with plan assets in excess of the accumulated benefit obligation for the years ended December 31, follows: Of the total liabilities of the pension plans and benefit restoration plans as of December 31, 2007, approximately $3,459,000 and $294,000, respectively, were considered current liabilities. (In thousands) Projected benefit obligation Accumulated benefit obligation Fair value of plan assets Pension Plans 2007 $542,258 499,163 516,474 2006 $555,736 495,658 528,781 The actuarial assumptions used to determine benefit obligations for the years ended December 31, were as follows: Discount rate Rate of compensation 2007 6.40% (P.R. Plan) 4.50% (U.S. Plan)* 2006 5.75% increase - weighted average 4.20% * A discount rate of 4.50% was used to remeasure liabilities under the U.S. retirement plan as of January 31, 2007 to reflect plan freeze as of April 1, 2007 and pending plan termination. 4.60% 2007 Annual Report 121 2007 2007 Popular, Inc. 2007 2007 The actuarial assumptions used to determine the components of net periodic pension cost for the years ended December 31, were as follows: The following benefit payments, attributable to past and estimated future service, as appropriate, are expected to be paid: (In thousands) 2008 2009 2010 2011 2012 2013 - 2017 Pension $39,854 28,075 29,436 30,847 32,336 185,002 Benefit Restoration Plans $842 781 1,019 1,253 1,467 10,749 Postretirement health care benefits In addition to providing pension benefits, BPPR provides certain health care benefits for retired employees. Regular employees of BPPR, except for employees hired after February 1, 2000, may become eligible for health care benefits, provided they reach retirement age while working for BPPR. The adoption of SFAS No. 158 also impacted the accounting for the postretirement health care benefits plan. The following table summarizes the impact of the initial adoption of SFAS No. 158 on December 31, 2006. (In thousands) Postretirement liabilities Accumulated other comprehensive loss December 31, 2006 prior SFAS No. 158 adjustments December 31, 2006 Post SFAS No 158. SFAS No. 158 adjustment Adjustment ($126,881) ($7,725) ($134,606) - $7,725 $7,725 The amounts in accumulated other comprehensive loss that are expected to be recognized as components of net periodic benefit cost for the postretirement health care benefit plan during 2008 are as follows: (In thousands) Net prior service cost (credit) ($1,046) Pension Plans 2006 2005 2007 Benefit Restoration Plans 2005 2007 2006 Discount rate 5.75% (P.R. Plan) 5.50% 5.75% 5.75% 5.50% 5.75% 4.50% (U.S. Plan) Expected return on plan assets Rate of compensation 8.00% 8.00% 8.00% 8.00% 8.00% 8.00% increase - weighted average 4.80% 4.20% 5.10% 4.80% 4.20% 5.10% The components of net periodic pension cost for the years ended December 31, were as follows: Pension Plans Benefit Restoration Plans (In thousands) 2007 2006 2005 2007 2006 2005 Components of net periodic pension cost: Service cost Interest cost Expected return on plan assets Amortization of asset obligation Amortization of prior service cost Amortization of net loss Net periodic cost (benefit) Curtailment loss (gain) Total cost $11,023 31,850 $12,509 30,558 $15,274 29,873 $898 1,677 $1,047 1,601 $967 1,330 (42,121) (39,901) (40,674) (1,473) (1,056) (843) - 207 - 959 (247) $712 - 177 1,946 5,289 - $5,289 (862) - - - 345 271 4,227 1,982 $6,209 (53) (55) (93) 991 1,100 719 2,040 (258) $1,782 2,637 - $2,637 2,080 (338) $1,742 In October 2005, the Board of Directors of BPPR adopted an amendment for the Puerto Rico Retirement and Tax Qualified Retirement Restoration Plans to freeze benefits for all employees under age 30 or who have less than 10 years of credited service effective January 1, 2006. As part of the amendment, these employees were 100% vested in their accrued benefit as of December 31, 2005. The expense for these plans was remeasured as of September 30, 2005 to consider this change using a discount rate of 5.50%. Curtailment costs were considered for these plans and are included as part of the December 31, 2005 disclosures. In connection with the plan's change, these employees received a base salary increase according to their age and years of service, effective January 1, 2006. During 2008, the Corporation expects to contribute $3,359,000 to the pension plans and $2,302,000 to the benefit restoration plans. 122 The status of the Corporation’s unfunded postretirement benefit plan at December 31, was as follows: (In thousands) Change in benefit obligation: Benefit obligation at beginning of the year Service cost Interest cost Benefits paid Actuarial gain Benefit obligation at end of year Funded status at end of year: Benefit obligation at end of year Fair value of plan assets Funded status at end of year Amounts recognized in accumulated other comprehensive loss under SFAS No. 158: Net prior service cost Net loss Accumulated other 2007 2006 $134,606 2,312 7,556 (6,434) (11,994) $126,046 $143,183 2,797 7,707 (6,304) (12,777) $134,606 ($126,046) - ($126,046) ($134,606) - ($134,606) ($4,299) 1,076 ($5,345) 13,070 comprehensive (income) loss ($3,223) $7,725 Reconciliation of net (liability) / asset: Net (liability) / asset at beginning of year Amount recognized in accumulated other comprehensive loss at beginning of year, pre-tax (Accrual) / prepaid at beginning of year Net periodic benefit (cost) / income Contributions (Accrual) / prepaid at end of year Amount recognized in accumulated other comprehensive income (loss) Net (liability) / asset at end of year ($134,606) ($122,769) 7,725 (126,881) (8,822) 6,434 (129,269) - (122,769) (10,416) 6,304 (126,881) 3,223 ($126,046) (7,725) ($134,606) Of the total postretirement liabilities as of December 31, 2007, approximately $6,284,000 were considered current liabilities. The change in accumulated other comprehensive income, pre- tax for the postretirement plan was as follows: The weighted average discount rate used to determine the components of net periodic postretirement benefit cost for the year ended December 31, 2007 was 5.75% (2006 - 5.50%; 2005 - 5.75%). The components of net periodic postretirement benefit cost for the year ended December 31, were as follows: (In thousands) Service cost Interest cost Amortization of prior service benefit Amortization of net loss Total net periodic benefit cost 2007 2006 2005 $2,312 7,556 (1,046) - $8,822 $2,797 7,707 (1,046) 958 $10,416 $2,713 8,267 (1,046) 1,691 $11,625 The assumed health care cost trend rates at December 31, were as follows: To determine postretirement benefit obligation: Initial health care cost trend rate Ultimate health care cost trend rate Year that the ultimate trend rate is reached To determine net periodic benefit cost: Initial health care cost trend rate Ultimate health care cost trend rate Year that the ultimate trend rate is reached 2007 8.00% 5.00% 2011 2007 9.00% 5.00% 2011 2006 9.00% 5.00% 2011 2006 10.00% 5.00% 2011 The Plan provides that the cost will be capped to 3% of the annual health care cost increase affecting only those employees retiring after February 1, 2001. Assumed health care trend rates generally have a significant effect on the amounts reported for a health care plan. A one- percentage-point change in assumed health care cost trend rates would have the following effects: (In thousands) Accumulated other comprehensive loss at January 1, 2007 Increase (decrease) in accumulated other comprehensive income (loss): Recognized during the year: Prior service (cost) / credit Ocurring during the year: Net actuarial losses (gains) Total decrease in accumulated other comprehensive loss Accumulated other comprehensive income at December 31, 2007 $7,725 (In thousands) Effect on total service cost and interest cost components 1,046 Effect on postretirement benefit obligation 1-Percentage Point Increase 1-Percentage Point Decrease $436 6,100 ($379) (5,300) (11,994) ($10,948) ($3,223) The Corporation expects to contribute $6,284,000 to the postretirement benefit plan in 2008 to fund current benefit payment requirements. The weighted average discount rate used in determining the accumulated postretirement benefit obligation at December 31, 2007 was 6.40% (2006 - 5.75%). 2007 Annual Report 123 2007 2007 Popular, Inc. 2007 2007 The Corporation’s policy has been to use authorized but unissued shares of common stock to cover each grant. The maximum option term is ten years from the date of grant. Unless an option agreement provides otherwise, all options granted are 20% exercisable after the first year and an additional 20% is exercisable after each subsequent year, subject to an acceleration clause at termination of employment due to retirement. The following table presents information on stock options as of December 31, 2007: Exercise Price Range per Share $14.39 - $18.50 $19.25 - $27.20 Options Outstanding 1,511,613 1,580,579 Weighted- Average Exercise Price of Options Outstanding $15.81 $25.27 Weighted- Average Remaining Life of Options Outstanding in Years 4.73 6.50 Options Exercisable (fully vested) 1,394,068 1,008,413 Weighted- Average Exercise Price of Options Exercisable $15.73 $25.02 $14.39 - $27.20 3,092,192 $20.64 5.63 2,402,481 $19.63 The aggregate intrinsic value of options outstanding as of December 31, 2007 was $7,311,000 (2006 - $24,097,000). There was no intrinsic value of options exercisable as of December 31, 2007 (2006 - $2,642,000). The following table summarizes the stock option activity and related information: Outstanding at January 1, 2005 Granted Exercised Forfeited Outstanding at December 31, 2005 Granted Exercised Forfeited Expired Outstanding at December 31, 2006 Granted Exercised Forfeited Expired Options Outstanding 2,584,620 707,342 (47,858) (20,401) 3,223,703 - (39,449) (37,818) (1,637) 3,144,799 - (10,064) (19,063) (23,480) Weighted-Average Exercise Price $18.76 27.20 16.14 22.18 $20.63 - 15.78 23.75 24.05 $20.65 - 15.83 25.50 20.08 Outstanding at December 31, 2007 3,092,192 $20.64 The stock options exercisable at December 31, 2007 totaled 2,402,481 (2006 - 1,949,522; 2005 - 1,501,447). The cash received from the stock options exercised during the year ended December 31, 2007 amounted to $159,000. The total intrinsic value of options exercised during the year ended December 31, 2007 was $28,000 (2006 - $86,000; 2005 - $247,000). The following benefit payments, attributable to past and estimated future service, as appropiate, are expected to be paid: (In thousands) 2008 2009 2010 2011 2012 2013 - 2017 $6,284 6,628 6,939 7,223 7,458 41,915 Savings plans The Corporation also provides contributory savings plans pursuant to Section 1165(e) of the Puerto Rico Internal Revenue Code and Section 401(k) of the U.S. Internal Revenue Code, as applicable, for substantially all the employees of the Corporation. Investments in the plans are participant-directed, and employer matching contributions are determined based on the specific provisions of each plan. Employees are fully vested in the employer’s contribution after five years of service. The cost of providing these benefits in 2007 was $17,383,000 (2006 - $27,306,000; 2005 - $32,975,000). The plans held 14,972,919 (2006 - 14,483,925; 2005 - 15,950,027) shares of common stock of the Corporation with a market value of approximately $158,713,000 at December 31, 2007 (2006 - $259,986,000; 2005 - $337,343,000). Note 25 - Stock-based compensation: Note 25 - Stock-based compensation: Note 25 - Stock-based compensation: Note 25 - Stock-based compensation: Note 25 - Stock-based compensation: The Corporation maintained a Stock Option Plan (the “Stock Option Plan”), which permitted the granting of incentive awards in the form of qualified stock options, incentive stock options, or non-statutory stock options of the Corporation. In April 2004, the Corporation’s shareholders adopted the Popular, Inc. 2004 Omnibus Incentive Plan (the “Incentive Plan”), which replaced and superseded the Stock Option Plan. Nevertheless, all outstanding award grants under the Stock Option Plan continue to remain in effect at December 31, 2007 under the original terms of the Stock Option Plan. Stock Option Plan Employees and directors of the Corporation or any of its subsidiaries were eligible to participate in the Stock Option Plan. The Board of Directors or the Compensation Committee of the Board had the absolute discretion to determine the individuals that were eligible to participate in the Stock Option Plan. This plan provides for the issuance of Popular, Inc.’s common stock at a price equal to its fair market value at the grant date, subject to certain plan provisions. The shares are to be made available from authorized but unissued shares of common stock or treasury stock. 124 The fair value of these options was estimated on the date of the grants using the Black-Scholes Option Pricing Model. The weighted average assumptions used for the grant issued during 2005 was: Expected dividend yield Expected life of options Expected volatility Risk-free interest rate Weighted average fair value of options granted (per option) 2005 2.56% 10 years 17.54% 4.16% $5.95 There were no new stock option grants issued by the Corporation under the Stock Option Plan during 2007 and 2006. During the year ended December 31, 2007, the Corporation recognized $1,763,000 in stock options expense, with a tax benefit of $700,000 (2006 - $3,006,000, with a tax benefit of $1,221,000; 2005 - $5,226,000, with a tax benefit of $2,095,000). The total unrecognized compensation cost at December 31, 2007 related to non-vested stock option awards was $1,674,000 and is expected to be recognized over a weighted-average period of 1.3 years. Incentive Plan The Incentive Plan permits the granting of incentive awards in the form of Annual Incentive Awards, Long-term Performance Unit Awards, Options, Stock Appreciation Rights, Restricted Stock, Restricted Units, or Performance Shares. Participants in the Incentive Plan are designated by the Compensation Committee of the Board of Directors (or its delegate as determined by the Board). Employees and directors of the Corporation and / or any of its subsidiaries are eligible to participate in the Incentive Plan. The shares may be made available from common stock purchased by the Corporation for such purpose, authorized but unissued shares of common stock or treasury stock. The Corporation’s policy with respect to the shares of restricted stock has been to purchase such shares in the open market to cover each grant. Under the Incentive Plan, the Corporation has issued only restricted shares, which become vested based on the employees’ continued service with Popular. The compensation cost associated with the shares of restricted stock is estimated based on a two- prong vesting schedule, unless otherwise stated in an agreement. The first part is vested ratably over five years commencing at the date of grant and the second part is vested at termination of employment after attainment of 55 years of age and 10 years of service. The five-year vesting part is accelerated at termination of employment after attaining 55 years of age and 10 years of service. Beginning in 2007, the Corporation authorized the issuance of performance shares, in addition to restricted shares, under a long-term incentive plan. The perfomance shares award consists of the opportunity to receive shares of Popular Inc.’s common stock provided the Corporation achieves certain perfomance goals during a 3-year perfomance cycle. The compensation cost associated with the perfomance shares will be recorded ratably over a three-year perfomance period. The performance shares will be granted at the end of the three-year period and will be vested at grant date. As of December 31, 2007, no shares have been granted under this plan. The following table summarizes the restricted stock activity under the Incentive Plan and related information to members of management: Nonvested at January 1, 2005 Granted Vested Forfeited Nonvested at January 1, 2006 Granted Vested Forfeited Nonvested at December 31, 2006 Granted Vested Forfeited Nonvested at December 31, 2007 Restricted Stock - 172,622 - - 172,622 444,036 - (5,188) 611,470 - (304,003) (3,781) 303,686 Weighted-Average Grant Date Fair Value - $27.65 - - $27.65 20.54 - 19.95 $22.55 - 22.76 19.95 $22.37 During the year ended December 31, 2007, no shares of restricted stock were awarded to management under the Incentive Plan (2006 - 444,036; 2005 - 172,622). During the year ended December 31, 2007, the Corporation recognized $2,432,000 of restricted stock expense related to management incentive awards, with an income tax benefit of $944,000 (2006 - $2,296,000, with a tax benefit of $898,000; 2005 - $3,998,000, with a tax benefit of $1,524,000). The fair market value of the restricted stock was $1,538,000 at grant date and $1,286,000 at vesting date. This difference triggers a shortfall of $252,000 that was recorded as an additional income tax expense since the Corporation does not have any pool of windfall tax benefit. The fair market value at grant date of the restricted stocks earned was $5,383,000. The total unrecognized compensation cost related to non-vested restricted stock awards was $3,984,000 and is expected to be recognized over a weighted- average period of 2.8 years. 2007 Annual Report 125 2007 2007 Popular, Inc. 2007 2007 The following table summarizes the restricted stock activity under the Incentive Plan and related information to members of the Board of Directors: Note 27 - Income tax: Note 27 - Income tax: Note 27 - Income tax: Note 27 - Income tax: Note 27 - Income tax: The components of income tax expense for the years ended December 31, are summarized below. (In thousands) 2007 2006 2005 Current income tax expense: Puerto Rico Federal and States Subtotal Deferred income tax (benefit) expense: Puerto Rico Federal and States Subtotal Total income tax (benefit) expense $157,436 7,302 164,738 (11,982) (211,758) (223,740) ($59,002) $131,687 2,848 134,535 (6,596) (21,053) (27,649) $113,888 38,162 152,050 (10,986) 7,851 (3,135) $106,886 $148,915 The reasons for the difference between the income tax expense applicable to income before provision for income taxes and the amount computed by applying the statutory tax rate in Puerto Rico, were as follows: 2007 2006 2005 % of pre-tax loss % of pre-tax income Amount % of pre-tax income Amount (Dollars in thousands) Amount Computed income tax at statutory rates ($48,163) 39% $202,084 43.5% $284,694 41.5% Benefits of net tax exempt interest income Effect of income subject to capital gain tax rate Non deductible goodwill (60,304) (24,555) 49 20 (70,250) (15) (78,216) (11) (2,426) (1) (24,612) (4) impairment 57,544 (47) Difference in tax rates due to multiple jurisdictions 27,038 (22) (12,549) States taxes and other (10,562) 9 (9,973) (3) (2) (14,886) (2) (18,065) (3) Income tax (benefit) expense ($59,002) 48% $106,886 22.5% $148,915 21.5% Nonvested at January 1, 2005 Granted Vested Forfeited Nonvested at January 1, 2006 Granted Vested Forfeited Nonvested at December 31, 2006 Granted Vested Forfeited Nonvested at December 31, 2007 Restricted Stock 20,802 29,208 (3,062) - 46,948 32,267 (2,601) - 76,614 38,427 (115,041) - - Weighted-Average Grant Date Fair Value $23.51 23.71 23.87 - $23.61 19.82 23.54 - $22.02 15.89 19.97 - - During the year ended December 31, 2007, the Corporation granted 38,427 (2006 - 32,267; 2005 - 29,208) shares of restricted stock to members of the Board of Directors of Popular, Inc. and BPPR, which became vested at grant date. During this period, the Corporation recognized $538,000 of restricted stock expense related to these restricted stock grants, with a tax benefit of $210,000 (2006 - $570,000, with a tax benefit of $222,000; 2005 - $635,000, with a tax benefit of $247,000). The fair value of all restricted stocks outstanding as of December 31, 2007 was $2,196,000. Note 26 - Rental expense and commitments: Note 26 - Rental expense and commitments: Note 26 - Rental expense and commitments: Note 26 - Rental expense and commitments: Note 26 - Rental expense and commitments: At December 31, 2007, the Corporation was obligated under a number of noncancelable leases for land, buildings, and equipment which require rentals (net of related sublease rentals) as follows: Year 2008 2009 2010 2011 2012 Later years Minimum payments Sublease rentals Net (In thousands) $49,018 40,231 33,957 28,785 26,205 202,742 $380,938 $2,169 1,842 1,331 1,260 997 4,452 $12,051 $46,849 38,389 32,626 27,525 25,208 198,290 $368,887 Total rental expense for the year ended December 31, 2007 was $84,515,000 (2006 - $70,562,000; 2005 - $62,395,000), w h i c h i s i n c l u d e d i n n e t o c c u p a n c y , e q u i p m e n t a n d communication expenses, according to their nature. 126 Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and their tax bases. Significant components of the Corporation’s deferred tax assets and liabilities at December 31, were as follows: likelihood of its realization. Based on the information available, the Corporation expects to fully realize all other items comprising the net deferred tax asset as of December 31, 2007. The net operating loss carryforwards (“NOLs”) outstanding at December 31, 2007 expire as follows: 2007 2006 (In thousands) (In thousands) Deferred tax assets: Tax credits available for carryforward Net operating loss and donation carryforward available Deferred compensation Postretirement and pension benefits Unrealized net loss on trading and available-for-sale securities Deferred loan origination fees Allowance for loan losses Amortization of intangibles Unearned income Deferred gains Unrealized loss on derivatives Basis difference related to securitizations treated as sales for tax and borrowings for books Intercompany deferred gains Other temporary differences Total gross deferred tax assets Deferred tax liabilities: Differences between the assigned values and the tax bases of assets and liabilities recognized in purchase business combinations Unrealized net gain on trading and available for sale securities Deferred loan origination costs Accelerated depreciation Amortization of intangibles Unrealized gain on derivatives Other temporary differences Total gross deferred tax liabilities Valuation allowance Net deferred tax asset The net deferred tax asset shown in the table above at December 31, 2007 is reflected in the consolidated statements of condition as $525,369,000 in deferred tax assets (in the “other assets” caption) (2006 - $359,433,000) and $5,398,000 in deferred tax liabilities (in the “other liabilities” caption) (2006 - $23,000), reflecting the aggregate deferred tax assets or liabilities of individual tax-paying subsidiaries of the Corporation. At December 31, 2007, the Corporation had total credits of $20,132,000 that will reduce the regular income tax liability in future years expiring in annual installments through the year 2016. A valuation allowance of $39,000 is reflected in 2007 and 2006, related to deferred tax assets arising from temporary differences for which the Corporation could not determine the $20,132 $23,568 175,349 4,993 62,548 - 8,333 214,544 - 1,488 16,355 932 66,105 17,017 14,204 602,000 17,254 19,367 9,938 10,346 8,819 - 16,266 81,990 39 35,327 4,452 71,277 51,417 5,766 200,155 168 1,218 - - 7,588 16,369 19,725 437,030 38,546 - 24,112 12,037 - 258 2,628 77,581 39 $519,971 $359,410 2013 2014 2016 2017 2018 2019 2021 2022 2023 2026 2027 $1,573 1,832 7,263 8,542 14,640 1 76 971 1,248 495 138,708 $175,349 Under the Puerto Rico Internal Revenue Code, the Corporation and its subsidiaries are treated as separate taxable entities and are not entitled to file consolidated tax returns. The Code provides a dividend received deduction of 100% on dividends received from “controlled” subsidiaries subject to taxation in Puerto Rico and 85% on dividends received from other taxable domestic corporations. The Corporation has never received any dividend payments from its U.S. subsidiaries. Any such dividend paid from a U.S. subsidiary to the Corporation would be subject to a 10% withholding tax based on the provisions of the U.S. Internal Revenue Code. The Corporation’s U.S. subsidiaries (which are considered foreign under Puerto Rico income tax law) have never remitted retained earnings. The Corporation considers the reinvestment of such earnings permanent. The Corporation’s subsidiaries in the United States file a consolidated return. As of December 31, 2007, the Corporation had no current or accumulated earnings and profits on its combined U.S. subsidiaries’ operations and, accordingly, the recognition of a deferred tax liability was not considered necessary. The Corporation’s subsidiaries in the United States file a consolidated federal income tax return. The Corporation’s federal income tax (benefit) provision for 2007 was ($196,462,000) (2006 - $26,994,000; 2005 - $34,571,000). The intercompany settlement of taxes paid is based on tax sharing agreements which generally allocate taxes to each entity based on a separate return basis. The transitory provision approved by the Government of Puerto Rico which increased the statutory tax rate for corporations expired in year 2007, accordingly, the maximum rate is 39%. 2007 Annual Report 127 2007 2007 Popular, Inc. 2007 2007 The Corporation adopted FIN 48 effective January 1, 2007. The initial adoption of FIN 48 had no impact on the Corporation’s financial statements since management determined that there was no need to recognize changes in the liability for unrecognized tax benefits. The reconciliation of unrecognized tax benefits, including accrued interest, was as follows: (In millions) Balance as of January 1, 2007 Additions for tax positions related to the current year Additions for tax positions of prior years Reductions for tax positions of prior years Balance as of December 31, 2007 Total $20.4 5.9 0.2 (4.3) $22.2 As of December 31, 2007, the related accrued interest approximated $2,900,000. Management determined that as of December 31, 2007 there was no need to accrue for the payment of penalties. The Corporation’s policy is to report interest related to unrecognized tax benefits in income tax expense, while the penalties, if any, are reported in other operating expenses in the consolidated statements of operations. After consideration of the effect on U.S. federal tax of unrecognized U.S. state tax benefits, the total amount of unrecognized tax benefits, including U.S. and Puerto Rico that, if recognized, would affect the Corporation’s effective tax rate, was approximately $20,900,000 as of December 31, 2007. The amount of unrecognized tax benefits may increase or decrease in the future for various reasons including adding amounts for current tax year positions, expiration of open income tax returns due to the statutes of limitation, changes in management’s judgment about the level of uncertainty, status of examinations, litigation and legislative activity, and the addition or elimination of uncertain tax positions. The Corporation and its subsidiaries file income tax returns in Puerto Rico, the U.S. federal jurisdiction, various U.S. states and political subdivisions, and foreign jurisdictions. As of December 31, 2007, the following years remain subject to examination: U.S. Federal jurisdiction – 2005 and 2006 and Puerto Rico – 2003 through 2006. The U.S. Internal Revenue Service (“IRS”) commenced an examination of the Corporation’s U.S. operations tax return for 2005 that is anticipated to be finished by the first quarter of 2008. As of December 31, 2007, the IRS has not proposed any adjustment as a result of the audit. Although the outcome of tax audits is uncertain, the Corporation believes that adequate amounts of tax, interest, and penalties have been provided for any adjustments that are expected to result from open years. The Corporation does not anticipate a significant change to the total amount of unrecognized tax benefits within the next 12 months. - O f f - b a l a n c e s h e e t a c t i v i t i e s a n d - O f f - b a l a n c e s h e e t a c t i v i t i e s a n d - O f f - b a l a n c e s h e e t a c t i v i t i e s a n d - O f f - b a l a n c e s h e e t a c t i v i t i e s a n d - O f f - b a l a n c e s h e e t a c t i v i t i e s a n d N o t e 2 8 N o t e 2 8 N o t e 2 8 N o t e 2 8 N o t e 2 8 concentration of credit risk: concentration of credit risk: concentration of credit risk: concentration of credit risk: concentration of credit risk: Off-balance sheet risk The Corporation is a party to financial instruments with off- balance sheet credit risk in the normal course of business to meet the financial needs of its customers. These financial instruments include loan commitments, letters of credit, and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated statements of condition. The Corporation’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, standby letters of credit and financial guarantees written is represented by the contractual notional amounts of those instruments. The Corporation uses the same credit policies in making these commitments and conditional obligations as it does for those reflected on the consolidated statements of condition. Financial instruments with off-balance sheet credit risk at December 31, whose contract amounts represent potential credit risk were as follows: (In thousands) Commitments to extend credit: 2007 2006 Credit card lines Commercial lines of credit Other unused credit commitments Commercial letters of credit Standby letters of credit Commitments to originate mortgage loans $3,143,717 4,259,851 506,680 25,584 174,080 112,704 $2,896,090 4,329,664 508,815 20,689 180,869 547,695 Commitments to extend credit Contractual commitments to extend credit are legally binding agreements to lend money to customers for a specified period of time. To extend credit, the Corporation evaluates each customer’s creditworthiness. The amount of collateral obtained, if deemed necessary, is based on management’s credit evaluation of the counterparty. Collateral held varies but may include cash, accounts receivable, inventory, property, plant and equipment and investment securities, among others. Since many of the loan commitments may expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. Letters of credit There are two principal types of letters of credit: commercial and standby letters of credit. The credit risk involved in issuing 128 letters of credit is essentially the same as that involved in extending loan facilities to customers. value of derivative instruments refer to Note 30 to the consolidated financial statements. In general, commercial letters of credit are short-term instruments used to finance a commercial contract for the shipment of goods from a seller to a buyer. This type of letter of credit ensures prompt payment to the seller in accordance with the terms of the contract. Although the commercial letter of credit is contingent upon the satisfaction of specified conditions, it represents a credit exposure if the buyer defaults on the underlying transaction. Standby letters of credit are issued by the Corporation to disburse funds to a third party beneficiary if the Corporation’s customer fails to perform under the terms of an agreement with the beneficiary. These letters of credit are used by the customer as a credit enhancement and typically expire without being drawn upon. Other commitments At December 31, 2007, the Corporation also maintained other non-credit commitments for $38,750,000, primarily for the acquisition of other investments (2006 - $43,378,000). Geographic concentration As of December 31, 2007, the Corporation had no significant concentrations of credit risk and no significant exposure to highly leveraged transactions in its loan portfolio. Note 32 provides further information on the asset composition of the Corporation by geographical area as of December 31, 2007 and 2006. Included in total assets of Puerto Rico are investments in obligations of the U.S. Treasury and U.S. Government agencies amounting to $5,397,104,000 and $5,439,152,000 in 2007 and 2006, respectively. Note 29 - Disclosures about fair value of financial Note 29 - Disclosures about fair value of financial Note 29 - Disclosures about fair value of financial Note 29 - Disclosures about fair value of financial Note 29 - Disclosures about fair value of financial i n s t r u m e n t s : i n s t r u m e n t s : i n s t r u m e n t s : i n s t r u m e n t s : i n s t r u m e n t s : The fair value of financial instruments is the amount at which an asset or obligation could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Fair value estimates are made at a specific point in time based on the type of financial instrument and relevant market information. Many of these estimates involve various assumptions and may vary significantly from amounts that could be realized in actual transactions. The information about the estimated fair values of financial instruments presented hereunder excludes all nonfinancial instruments and certain other specific items. Derivatives are considered financial instruments and their carrying value equals fair value. For disclosures about the fair For those financial instruments with no quoted market prices available, fair values have been estimated using present value calculations or other valuation techniques, as well as management’s best judgment with respect to current economic conditions, including discount rates, estimates of future cash flows, and prepayment assumptions. The fair values reflected herein have been determined based on the prevailing interest rate environment as of December 31, 2007 and 2006, respectively. In different interest rate environments, fair value estimates can differ significantly, especially for certain fixed rate financial instruments. In addition, the fair values presented do not attempt to estimate the value of the Corporation’s fee generating businesses and anticipated future business activities, that is, they do not represent the Corporation’s value as a going concern. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Corporation. The following methods and assumptions were used to estimate the fair values of significant financial instruments at December 31, 2007 and 2006: Short-term financial assets and liabilities have relatively short maturities, or no defined maturities, and little or no credit risk. The carrying amounts reported in the consolidated statements of condition approximate fair value. Included in this category are: cash and due from banks, federal funds sold and securities purchased under agreements to resell, time deposits with other banks, bankers acceptances, customers’ liabilities on acceptances, accrued interest receivable, federal funds purchased and assets sold under agreements to repurchase, short-term borrowings, acceptances outstanding and accrued interest payable. Resell and repurchase agreements with long-term maturities are valued using discounted cash flows based on market rates currently available for agreements with similar terms and remaining maturities. Trading and investment securities, except for investments classified as other investment securities in the consolidated statement of condition, are financial instruments that regularly trade on secondary markets. The estimated fair value of these securities was determined using either market prices or dealer quotes, where available, or quoted market prices of financial instruments with similar characteristics. Trading account securities and securities available-for-sale are reported at their respective fair values in the consolidated statements of condition since they are marked-to-market for accounting purposes. These instruments are detailed in the consolidated statements of condition and in Notes 4, 5 and 30. The estimated fair value for loans held-for-sale is based on secondary market prices. The fair values of the loan portfolios have been determined for groups of loans with similar characteristics. Loans were segregated by type such as commercial, construction, residential mortgage, consumer, and credit cards. Each loan category was further segmented based on loan characteristics, including repricing term and pricing. The fair value of most fixed-rate loans was estimated by discounting scheduled cash flows using interest rates currently being offered on loans with similar terms. For variable rate loans with frequent repricing terms, fair values were based on carrying values. Prepayment assumptions have been applied to the mortgage and installment loan portfolio. The fair value of the loans was also reduced by an estimate of credit losses in the portfolio. Generally accepted accounting principles do not require, and the Corporation has not performed a fair valuation of its lease financing portfolio, therefore it is included in the loans total at its carrying amount. The fair value of deposits with no stated maturity, such as non-interest bearing demand deposits, savings, NOW, and money market accounts is, for purposes of this disclosure, equal to the amount payable on demand as of the respective dates. The fair value of certificates of deposit is based on the discounted value of contractual cash flows, using interest rates currently being offered on certificates with similar maturities. Long-term borrowings were valued using discounted cash flows, based on market rates currently available for debt with similar terms and remaining maturities and in certain instances using quoted market rates for similar instruments at December 31, 2007 and 2006, respectively. Commitments to extend credit were valued using the fees currently charged to enter into similar agreements. For those commitments where a future stream of fees is charged, the fair value was estimated by discounting the projected cash flows of fees on commitments, which are expected to be disbursed, based on historical experience. The fair value of letters of credit is based on fees currently charged on similar agreements. 2007 Annual Report 129 2007 2007 Popular, Inc. 2007 2007 Carrying or notional amounts, as applicable, and estimated fair values for financial instruments at December 31, were: 2007 2006 Carrying amount Fair value Carrying amount Fair value $1,825,537 767,955 $1,825,537 767,955 $1,251,866 382,325 $1,251,866 382,325 8,515,135 8,515,135 9,850,862 9,850,862 484,466 486,139 91,340 92,764 216,585 1,889,546 27,472,624 216,819 1,983,502 27,511,573 297,394 719,922 31,494,785 412,593 737,439 31,448,328 $28,334,478 303,492 $28,432,009 303,492 $24,438,331 1,276,818 $24,416,523 1,276,818 5,133,773 1,501,979 4,621,352 Notional amount 5,149,571 1,501,979 4,536,434 4,485,627 4,034,125 8,737,246 Fair value Notional amount 4,474,171 4,034,125 8,647,942 Fair value (In thousands) Financial Assets: Cash and money market investments Trading securities Investment securities available-for-sale Investment securities held-to-maturity Other investment securities Loans held-for-sale Loans held-in-porfolio, net Financial Liabilities: Deposits Federal funds purchased Assets sold under agreements to repurchase Short-term borrowings Notes payable (In thousands) Commitments to extend credit and letters of credit: Commitments to extend credit Letters of credit 199,664 1,960 201,558 $7,910,248 $17,199 $7,734,569 $19,110 1,935 N o t e 3 0 - D e r i v a t i v e i n s t r u m e n t s a n d h e d g i n g N o t e 3 0 - D e r i v a t i v e i n s t r u m e n t s a n d h e d g i n g N o t e 3 0 - D e r i v a t i v e i n s t r u m e n t s a n d h e d g i n g N o t e 3 0 - D e r i v a t i v e i n s t r u m e n t s a n d h e d g i n g N o t e 3 0 - D e r i v a t i v e i n s t r u m e n t s a n d h e d g i n g a c t i v i t i e s : a c t i v i t i e s : a c t i v i t i e s : a c t i v i t i e s : a c t i v i t i e s : The discussion and tables below provide a description of the derivative instruments used as part of the Corporation’s interest rate risk management strategies. The Corporation incorporates the use of derivative instruments as part of the overall interest rate risk management strategy to minimize significant unplanned fluctuations in earnings and cash flows that are caused by interest rate volatility. The Corporation’s goal is to manage interest rate sensitivity by modifying the repricing or maturity characteristics of certain balance sheet assets and liabilities so that the net interest income is not, on a material basis, adversely affected by movements in interest rates. The Corporation uses derivatives in its trading activities to facilitate customer transactions, to take proprietary positions and as means of risk management. As a result of interest rate fluctuations, hedged fixed and variable interest rate assets and liabilities will appreciate or depreciate in market value. The effect of this unrealized appreciation or depreciation is expected to be substantially offset by the Corporation’s gains or losses on 2 0 0 6 N o t i o n a l D e r i v a t i v e D e r i v a t i v e E q u i t y Amount Assets Liabilities OCI Ineffectiveness (In thousands) Asset Hedges Forward commitments $190,000 $175 $2 $106 Liability Hedges Interest rate swaps Total $390,000 $580,000 $887 $1,062 $523 $525 $237 $343 - - The Corporation utilizes forward contracts to hedge the sale of mortgage-backed securities with duration terms over one month. Interest rate forwards are contracts for the delayed delivery of securities, which the seller agrees to deliver on a specified future date at a specified price or yield. These securities are hedging a forecasted transaction and thus qualify for cash flow hedge accounting in accordance with SFAS No. 133, as amended. Changes in the fair value of the derivatives are recorded in other comprehensive income. The amount included in accumulated other comprehensive income corresponding to these forward contracts is expected to be reclassified to earnings in the next twelve months. These contracts have a maximum remaining maturity of 78 days. During 2006, the Corporation entered into interest rate swap contracts to convert floating rate debt to fixed rate debt with the objective of minimizing the exposure to changes in cash flows due to changes in interest rates. These interest rate swaps have a maximum remaining maturity of 1.3 years. For cash flow hedges, gains and losses on derivative contracts that are reclassified from accumulated other comprehensive income to current period earnings are included in the line item in which the hedged item is recorded and in the same period in which the forecasted transaction affects earnings. Fair Value Hedges At December 31, 2007 and 2006, there were no derivatives designated as fair value hedges. 130 the derivative instruments that are linked to these hedged assets and liabilities. As a matter of policy, the Corporation does not use highly leveraged derivative instruments for interest rate risk management. By using derivative instruments, the Corporation exposes itself to credit and market risk. If a counterparty fails to fulfill its performance obligations under a derivative contract, the Corporation’s credit risk will equal the fair value gain in a derivative. Generally, when the fair value of a derivative contract is positive, this indicates that the counterparty owes the Corporation, thus creating a repayment risk for the Corporation. When the fair value of a derivative contract is negative, the Corporation owes the counterparty and, therefore, assumes no repayment risk. To manage the level of credit risk, the Corporation deals with counterparties of good credit standing, enters into master netting agreements whenever possible and, when appropriate, obtains collateral. Credit risk related to derivatives was not significant at December 31, 2007 and 2006. The Corporation has not incurred any losses from counterparty nonperformance on derivatives. Market risk is the adverse effect that a change in interest rates, currency exchange rates, or implied volatility rates might have on the value of a financial instrument. The Corporation manages the market risk associated with interest rates, and to a limited extent, with fluctuations in foreign currency exchange rates, by establishing and monitoring limits for the types and degree of risk that may be undertaken. The Corporation regularly measures this risk by using static gap analysis, simulations and duration analysis. The Corporation’s treasurers and senior finance officers at the subsidiaries are responsible for evaluating and implementing hedging strategies that are developed through analysis of data derived from financial simulation models and other internal and industry sources. The resulting hedging strategies are then incorporated into the Corporation’s overall interest rate risk management and trading strategies. The resulting derivative activities are monitored by the Corporate Treasury and Corporate Comptroller’s areas within the Corporation. Cash Flow Hedges Derivative financial instruments designated as cash flow hedges for the years ended December 31, 2007, and 2006 are presented below: 2007 Notional Amount Derivative Assets Derivative Liabilities Equity OCI Ineffectiveness (In thousands) Asset Hedges Forward commitments $142,700 $169 $509 ($207) Liability Hedges Interest rate swaps Total $200,000 $342,700 - $169 $3,179 $3,688 ($2,066) ($2,273) - - - Trading and Non-Hedging Activities The fair value and notional amounts of non-hedging derivatives at December 31, 2007, and 2006 were: December 31, 2007 Fair Values Notional Amount Derivative Assets Derivative Liabilities $693,096 $74 $3,232 (In thousands) Forward contracts Interest rate swaps associated with: - short-term borrowings - bond certificates offered in an on-balance sheet securitization - swaps with corporate clients - swaps offsetting position of corporate client swaps Credit default swap Foreign currency and exchange rate commitments w/clients Foreign currency and exchange rate commitments w/counterparty Interest rate caps Interest rate caps for benefit of corporate clients Index options on deposits Index options on S&P notes Bifurcated embedded options Mortgage rate lock commitments Total 200,000 185,315 802,008 802,008 33,463 146 146 150,000 50,000 211,267 31,152 218,327 148,501 $3,525,429 - - - 24,593 - - 2 27 - 45,954 5,962 - 258 $76,870 1,129 2,918 24,593 - - - - 1 18 - - 50,227 386 $82,504 2007 Annual Report 131 2007 2007 Popular, Inc. 2007 2007 December 31, 2006 Fair Values Notional Amount Derivative Assets Derivative Liabilities $1,277 83 $400,572 37,500 $125 46 400,000 2,153 - (In thousands) Forward contracts Call options and put options Interest rate swaps associated with: - short-term borrowings - bond certificates offered in an on-balance sheet securitization - financing of auto loans held-in-portfolio - auto loans approvals locked interest rates - swaps with corporate clients - swaps offsetting position of corporate client swaps - investment securities - mortgage loans prior to securitization Credit default swap Foreign currency and 516,495 470,146 17,442 410,533 410,533 89,385 75,000 33,463 90 728 22 - 2,146 - 302 - exchange rate commitments w/clients Foreign currency and exchange rate commitments w/counterparty Interest rate caps Interest rate caps for benefit of corporate clients Index options on deposits Index options on S&P notes Bifurcated embedded options Mortgage rate lock commitments Total 103 - 103 889,417 50,000 204,946 31,152 229,455 215,676 $4,481,921 2 4,099 - 38,323 5,648 - 13 $54,886 1,168 - - 2,146 - 1,645 - - - - 2 90 - - 43,844 635 $49,701 Forward Contracts The Corporation has forward contracts to sell mortgage-backed securities with terms lasting less than a month, which were accounted for as trading derivatives. Also, the Corporation has loan sale commitments to economically hedge the changes in fair value of mortgage loans held-for-sale and mortgage pipeline associated with interest rate lock commitments through both mandatory and best efforts forward sale agreements. These contracts are recognized at fair value with changes directly reported in income. These contracts are entered into in order to optimize the gain on sales of loans and / or mortgage-backed securities, given levels of interest rate risk consistent with the Corporation’s business strategies. Call Options and Put Options The Corporation has option contracts that grant the purchaser the right to buy or sell the underlying asset by a certain date at a specified price. 132 Interest Rates Swaps and Foreign Currency and Exchange Rate Commitments The Corporation has outstanding interest rate swap derivative contracts to economically hedge the cost of certain short-term borrowings. Changes in their fair value are recognized in interest expense. The Corporation also has an interest rate swap to economically hedge the payments of bond certificates offered as part of an on- b a l a n c e s h e e t s e c u r i t i z a t i o n . T h e s w a p c o n t r a c t i s marked-to-market and the resulting impact is recognized as part of interest expense. At the end of 2007, the Corporation canceled certain amortizing swap contracts that economically converted to a fixed rate the cost of funds associated with certain auto loans held-in-portfolio as a result of selling most of the auto loan portfolio. In 2006 and most of 2007, these amortizing swaps economically hedged the interest rate changes in auto loan approvals. Changes in fair value were recognized as part of interest expense. In addition to using derivative instruments as part of its interest rate risk management strategy, the Corporation also utilizes derivatives, such as interest rate swaps and foreign exchange contracts in its capacity as an intermediary on behalf of its customers. The Corporation minimizes its market risk and credit risk by taking offsetting positions under the same terms and conditions with credit limit approvals and monitoring procedures. Market value changes on these swaps and other derivatives are recognized in income in the period of change. Credit Default Swaps The credit default swap (“CDS”) allows one party to transfer the credit risk to another for a fee in case of a credit default. The credit default relates to the failure to make payment obligations due to bankruptcy or insolvency. It is not foreseen that the Corporation will have to make any payments associated with the CDS. The CDS outstanding at December 31, 2006 and 2007 to which the Corporation is a party is associated to net settlement payments on interest rate swaps, not principal bond payments. The payment obligation is the net spread between two rates. A number of firms participated in the economics of the CDS transaction and the Corporation was allocated a percentage of the total notional amount of the underlying interest rate swaps. Under the CDS, the Corporation guarantees the third-party entity’s (“the third-party entity”) performance under a series of interest rate swaps that the third-party entity has with the counterparty to the CDS (“the counterparty”). The nature of the specific credit default event that will trigger a payment obligation by the Corporation under the CDS consists of the failure by the third-party entity to pay any one of the periodic payments due under the underlying swaps or a termination payment with the counterparty. Also, although not a third-party entity credit event under the terms of the CDS, the interest rate swaps agreement between the third-party entity and the counterparty has an additional termination event which is the withdrawal, suspension or ratings downgrade of the third-party entity to a rating below BBB- by any of the three major agencies. The termination event will only trigger the Corporation’s performance if the third-party entity fails to pay its obligation under the interest rate swaps. Neither of these events is expected to occur because of the third-party entity’s credit standing. The underlying interest rate swaps are in the money in favor of the third-party entity. The CDS matures in April 2008, which also reduces the Corporation’s exposure to losses. Under the CDS, the counterparty has no obligation to the Corporation other than having made the initial premium payment, which amounted to $104,000. As a result, the Corporation is not subject to the credit risk of the counterparty. Interest Rate Caps During 2007, the Corporation entered into a $100,000,000 interest rate cap to mitigate its exposure to rising interest rates on short-term borrowings. The Corporation also entered into interest rate caps as an intermediary on behalf of its customers and simultaneously took offseting positions under the same terms and conditions thus minimizing its market and credit risks. As a result of the recharacterization transactions in 2007, the interest rate caps that the Corporation had in conjunction with a series of mortgage loans under securitization were no longer required to be consolidated under the Corporation's statement of condition. Changes in fair value of these caps were recognized in the consolidated statement of operations as part of interest expense, while the derivative contract value was included as other assets. Index and Embedded Options In connection with customers’ deposits offered by the Corporation whose returns are tied to the performance of the Standard and Poor’s 500 (S&P 500) stock market indexes, other deposits whose returns are tied to other stock market indexes, certain equity securities performance or a commodity index, the Corporation bifurcated the related options embedded within the customers’ deposits from the host contract which does not qualify for hedge accounting in accordance with SFAS No. 133. In order to limit the Corporation’s exposure to changes in these indexes, the Corporation purchases index options from major broker dealer companies which returns are tied to the same indexes. Accordingly, the embedded options and the related index options are marked-to-market through earnings. These options are traded in the over the counter (“OTC”) market. OTC options are not listed on an options exchange and do not have standardized terms. OTC contracts are executed between two counterparties that negotiate specific agreement terms, including the underlying instrument, amount, exercise price and expiration date. The Corporation also had bifurcated and accounted for separately the option related to the issuance of notes payable whose return is linked to the S&P 500 Index. In order to limit its exposure, the Corporation has a related S&P 500 index option intended to produce the same cash outflows that the notes could produce. Mortgage Rate Lock Commitments Mortgage rate lock commitments to fund mortgage loans at interest rates previously agreed for a specified period of time are accounted for as derivatives as per SFAS No. 133, as amended. Forward sale commitments are utilized to economically hedge the interest rate risk associated with the time lag between when fixed rate mortgage loans are rate-locked and when they are committed for sale or exchange in the secondary market. t h e t h e t h e t h e t h e - S u p p l e m e n t a l d i s c l o s u r e o n - S u p p l e m e n t a l d i s c l o s u r e o n - S u p p l e m e n t a l d i s c l o s u r e o n - S u p p l e m e n t a l d i s c l o s u r e o n - S u p p l e m e n t a l d i s c l o s u r e o n N o t e 3 1 N o t e 3 1 N o t e 3 1 N o t e 3 1 N o t e 3 1 consolidated statements of cash flows: consolidated statements of cash flows: consolidated statements of cash flows: consolidated statements of cash flows: consolidated statements of cash flows: As previously mentioned in Note 1 in 2005, the Corporation commenced a two-year plan to change the reporting period of its non-banking subsidiaries to a December 31st calendar period. The impact of this change corresponded to the financial results for the month of December 2004 of those non-banking subsidiaries which implemented the change in the first reporting period of 2005 and the month of December 2005 for those which implemented the change in the first reporting period of 2006 . The following table reflects the effect in the Consolidated Statements of Cash Flows of the change in reporting period mentioned above for the year ended December 31: (In thousands) Net cash used in operating activities Net cash (used in) provided by investing activities Net cash provided by financing activities Net increase (decrease) in cash and due from banks 2006 ($80,906) (104,732) 197,552 $11,914 2005 ($26,648) 19,503 5,573 ($1,572) Also, related to the difference in the reporting period of certain non-banking subsidiaries, as a result of the one-month lag, certain intercompany transactions between subsidiaries having different year-end periods remained outstanding at December 31, 2005. In balancing the consolidated statement of condition, management reversed an intercompany elimination in order to reinstall loans outstanding to third parties. The impact of this reversal resulted in an increase of $429,000,000 in the caption of other liabilities at December 31, 2005. For the cash flow statement presentation, for the year ended December 31, 2005, this amount was reflected 2007 Annual Report 133 2007 2007 Popular, Inc. 2007 2007 as cash provided by financing activities, while the reinstallment of loan disbursements was presented as cash flows used in investing activities. As of December 31, 2006, all subsidiaries have aligned their year-end closing to that of the Corporation’s calendar year. Additional disclosures on cash flow information as well as non-cash activities are listed in the following table: (In thousands) Income taxes paid Interest paid 2007 $160,271 1,673,768 2006 $194,423 1,604,054 2005 $196,028 1,206,434 Non-cash activities: Loans transferred to other real estate Loans transferred to other property 203,965 36,337 Total loans transferred to foreclosed assets 240,302 Assets and liabilities removed as part of the recharacterization of on-balance sheet 116,250 34,340 150,590 113,840 24,395 138,235 securitizations: Mortgage loans Secured borrowings Other assets Other liabilities 3,221,003 (3,083,259) 111,446 (13,513) - - - - Transfers from loans held-in-portfolio to loans held-for-sale (a) 1,580,821 23,634 Transfers from loans held-for-sale to - - - - - loans held-in-portfolio 244,675 Loans securitized into trading securities (b) 1,321,655 591,365 1,398,342 668,591 1,304,749 Available-for-sale securities transferred to loans held-in-portfolio - - 42,174 Recognition of mortgage servicing rights on securitizations or asset transfers 48,865 62,877 103,092 Recognition of residual interests on securitizations Business acquisitions: 42,975 36,927 61,126 Fair value of loans and other assets acquired 225,972 Goodwill and other intangible assets acquired 149,123 Deposits and other liabilities assumed (1,094,699) - 4,005 (971) 1,491,521 337,180 (1,416,919) (a) In 2007 it excludes the $3.2 billion in mortgage loans from the recharacterization that were classified to loans held-for-sale and immediately removed from the Corporation's books. In 2006 it excludes $589 million in individual mortgage loans transferred to held-for-sale and sold as well as $613 million (2005 - $552 million) securitized into trading securities and immediately sold. (b) Includes loans securitized into trading securities and subsequently sold before year end. Note 32 - Segment reporting: Note 32 - Segment reporting: Note 32 - Segment reporting: Note 32 - Segment reporting: Note 32 - Segment reporting: The Corporation’s corporate structure consists of four reportable segments – Banco Popular de Puerto Rico, Banco Popular North America, Popular Financial Holdings and EVERTEC. Also, a corporate group has been defined to support the reportable segments. In early 2007, the Corporation changed its basis of presentation by combining the operations of Banco Popular North America and 134 Popular Financial Holdings segments into a single reportable segment named Popular North America. This was the result of a restructuring plan of the Popular Financial Holdings operations and the Corporation’s U.S. Reorganization described in Note 2 to the consolidated financial statements. At that time, the Corporation decided to continue the operations of Equity One and its subsidiaries (“Equity One”), which are principally dedicated to direct subprime loan origination, consumer finance and mortgage servicing. However, given the unforeseen disruption in the capital markets since the summer of 2007 and its impact on funding, management now believes that it will be difficult to generate an adequate return on the capital invested at Equity One. As such, commencing in late fourth quarter of 2007, the Corporation redefined its Popular North America reportable segment by segregating it in two separate reportable segments: Banco Popular North America and Popular Financial Holdings. Management re-defined its plans and allocation of resources with respect to the Corporation’s U.S. operations and is taking steps to exit the PFH business, except for its mortgage servicing unit. Part of these steps included the recharacterization of a substantial portion of PFH’s on-balance sheet mortgage loan securitization as sales, the signing in early 2008 of an Asset Purchase Agreement to sell certain assets of Equity One and the expected closure of its remaining consumer branch network during 2008. The remaining loan portfolio that will remain in PFH’s books will decline as it runs off. Due to the expected discontinuance of the business, management has redefined how to allocate resources for future growth potential in the U.S. operations. Management determined the reportable segments based on the internal reporting used to evaluate performance and to assess where to allocate resources. The segments were determined based on the organizational structure, which focuses primarily on the markets the segments serve, as well as on the products and services offered by the segments. Banco Popular de Puerto Rico: Given that Banco Popular de Puerto Rico constitutes a significant portion of the Corporation’s results of operations and total assets as of December 31, 2007, additional disclosures are provided for the business areas included in this reportable segment, as described below: • Commercial banking represents the Corporation’s banking operations conducted at BPPR, which are targeted mainly to corporate, small and middle size businesses. It includes aspects of the lending and depository businesses, as well as other finance and advisory services. BPPR allocates funds across segments based on duration matched transfer pricing at market rates. This area also incorporates income related with the investment of excess funds, as well as a proportionate share of the investment function of BPPR. • Consumer and retail banking represents the branch banking operations of BPPR which focus on retail clients. It includes the consumer lending business operations of BPPR, as well as the lending operations of Popular Auto, Popular Finance, and Popular Mortgage. These three subsidiaries focus respectively on auto and lease financing, small personal loans and mortgage loan originations. This area also incorporates income related with the investment of excess funds from the branch network, as well as a proportionate share of the investment function of BPPR. • Other financial services include the trust and asset management service units of BPPR, the brokerage and investment banking operations of Popular Securities, and the insurance agency and reinsurance businesses of Popular Insurance, Popular Insurance V.I. and Popular Life Re. Most of the services that are provided by these subsidiaries generate profits based on fee income. Banco Popular North America: Banco Popular North America’s reportable segment consists of the banking operations of BPNA, E-LOAN, Popular Equipment Finance, Inc. and Popular Insurance Agency, U.S.A. BPNA operates through a branch network with presence in 6 states, while E- LOAN provides online consumer direct lending and supports BPNA’s deposit gathering through its online platform. As indicated in Note 2 to the consolidated financial statements, E- LOAN is in the process of restructuring its operations, which include refocusing its loan origination efforts toward a reduced mix of loan product offerings. Popular Insurance Agency, U.S.A. offers investment and insurance services across the BPNA branch network. Popular Equipment Finance, Inc. provides mainly small to mid-ticket commercial and medical equipment financing. The U.S. operations also include the mortgage business unit of Banco Popular, National Association. Due to the significant losses in the E-LOAN operations, impacted in part by the restructuring charges and impairment losses as described in Note 2 to the consolidated financial statements, management has determined to provide as additional disclosure the results of E-LOAN apart from the other BPNA subsidiaries. 2007 Annual Report 135 2007 2007 Popular, Inc. 2007 2007 Popular, Inc. 2007 At December 31, 2007 (In thousands) Net interest income (loss) Provision for loan losses Non-interest income (loss) Goodwill and trademark impairment losses Amortization of intangibles Depreciation expense Other operating expenses Income tax expense (benefit) Net income (loss) Segment assets (In thousands) Net interest income (loss) Provision for loan losses Non-interest income Goodwill and trademark impairment losses Amortization of intangibles Depreciation expense Other operating expenses Income tax benefit Net (loss) income Segment assets Banco Popular de Puerto Rico North America Banco Popular Popular Financial $957,822 243,727 485,548 1,909 41,684 714,457 114,311 $370,605 95,486 185,962 211,750 7,602 16,069 450,576 (29,477) Holdings $140,670 221,431 (179,379) Intersegment EVERTEC Eliminations ($823) $3,301 241,627 (150,390) 2,352 157,476 (150,520) 934 16,162 174,877 17,547 (72) (137,688) (2,086) $327,282 ($195,439) ($269,448) $31,284 ($7,243) $27,102,493 $13,364,306 $3,905,279 $228,746 ($417,828) At December 31, 2007 Total Reportable Segments $1,471,575 560,644 583,368 211,750 10,445 76,195 1,359,698 (50,225) Corporate Eliminations ($23,382) 2,006 117,981 $1,197 (7,033) 2,368 55,205 (9,215) (11,110) 438 Total Popular, Inc. $1,449,390 562,650 694,316 211,750 10,445 78,563 1,403,793 (59,002) ($113,564) $44,182,996 $44,235 $6,550,752 $4,836 ($6,322,311) ($64,493) $44,411,437 Popular, Inc. 2006 At December 31, 2006 Banco Popular de Puerto Rico North America Banco Popular Popular Financial (In thousands) Net interest income (loss) Provision for loan losses Non-interest income Goodwill and trademark impairment losses Amortization of intangibles Depreciation expense Other operating expenses Impact of change in fiscal period Income tax expense (benefit) Net income (loss) Segment assets $914,907 141,083 431,940 $379,977 46,472 218,590 2,540 43,556 679,892 (2,072) 125,985 $355,863 8,881 15,811 422,640 37,280 $67,483 Holdings $173,532 100,205 38,977 14,239 357 6,159 179,907 6,181 (32,809) Intersegment EVERTEC Eliminations ($1,894) 229,237 ($141,096) 599 16,599 169,117 15,052 (72) (140,392) (367) ($265) $25,501,522 $13,565,992 $8,396,926 $223,384 ($588,707) ($61,730) $25,976 Popular Financial Holdings: PFH’s clientele is primarily subprime borrowers. After considering the restructuring events discussed in Note 2 to the consolidated financial statements, PFH continues to carry a maturing loan portfolio that approximated $3.3 billion at December 31, 2007, of which $1.4 billion was classified as held-for-sale. Also, PFH continues to provide mortgage loan services for others. As previously indicated, PFH is in the process of exiting the mortgage loan and consumer loan origination business. EVERTEC: This reportable segment includes the financial transaction processing and technology functions of the Corporation, including EVERTEC, with offices in Puerto Rico, Florida, the Dominican Republic and Venezuela; EVERTEC USA, Inc. incorporated in the United States; and ATH Costa Rica, S.A., EVERTEC LATINOAMERICA, SOCIEDAD ANONIMA and T.I.I. Smart Solutions Inc. located in Costa Rica. In addition, this reportable segment includes the equity investments in Consorcio de Tarjetas Dominicanas, S.A. and Servicios Financieros, S.A. de C.V. (“Serfinsa”), which operate in the Dominican Republic and El Salvador, respectively. This segment provides processing and technology services to other units of the Corporation as well as to third parties, principally other financial institutions in Puerto Rico, the Caribbean and Central America. The Corporate group consists primarily of the holding companies: Popular, Inc., Popular North America and Popular International Bank, excluding the equity investments in CONTADO and Serfinsa, which due to the nature of their operations, are included as part of the EVERTEC segment. The holding companies obtain funding in the capital markets to finance the Corporation’s growth, including acquisitions. The Corporate group also includes the expenses of the four administrative corporate areas that are identified as critical for the organization: Finance, Risk Management, Legal and People, Communications and Planning. These corporate administrative areas have the responsibility of establishing policy, setting up controls and coordinating the activities of their corresponding groups in each of the reportable segments. The Corporation may periodically reclassify reportable segment results based on modifications to its management reporting and profitability measurement methodologies and changes in organizational alignment. The accounting policies of the individual operating segments are the same as those of the Corporation described in Note 1. Transactions between reportable segments are primarily conducted at market rates, resulting in profits that are eliminated for reporting consolidated results of operations. 136 At December 31, 2006 Additional disclosures with respect to the Banco Popular de (In thousands) Net interest income (loss) Provision for loan losses Non-interest income Goodwill and trademark impairment losses Amortization of intangibles Depreciation expense Other operating expenses Impact of change in fiscal period Income tax expense (benefit) Net income (loss) Segment assets Total Reportable Segments $1,466,522 287,760 777,648 14,239 12,377 82,053 1,311,164 4,109 145,141 Corporate Eliminations ($39,741) $1,129 36,642 (4,805) 2,335 57,342 3,495 (37,515) (4,178) 2,137 (740) Total Popular, Inc. $1,427,910 287,760 809,485 14,239 12,377 84,388 1,364,328 9,741 106,886 $387,327 $47,099,117 ($28,756) $6,376,487 ($895) ($6,071,617) $357,676 $47,403,987 Popular, Inc. 2005 At December 31, 2005 (In thousands) Net interest income (loss) Provision for loan losses Non-interest income Amortization of intangibles Depreciation expense Other operating expenses Income tax expense Net income before cumulative effect of accounting change Cumulative effect of accounting change Net income after cumulative Banco Popular de Puerto Rico North America Banco Popular Popular Financial $897,007 98,732 428,249 2,522 42,508 681,133 104,907 $359,836 23,238 149,604 6,783 15,678 309,151 56,796 Holdings $201,349 73,288 52,664 30 4,916 159,087 6,205 Intersegment EVERTEC Eliminations ($404) 221,369 244 17,405 166,929 12,149 ($139,633) (71) (139,502) (57) $395,454 $97,794 $10,487 $24,238 ($3) 3,221 (209) 412 (247) effect of accounting change $398,675 $97,585 $10,487 $24,650 ($250) Puerto Rico reportable segment are as follows: Banco Popular de Puerto Rico 2007 At December 31, 2007 (In thousands) Net interest income Provision for loan losses Non-interest income Amortization of intangibles Depreciation expense Other operating expenses Impact of change in fiscal period Income tax expense Net income Segment assets Commercial Banking $379,673 79,810 91,596 565 14,457 178,193 Consumer and Retail Banking $566,635 163,917 303,945 860 26,001 470,184 Other Financial Services Eliminations $10,909 $605 90,969 484 1,226 66,466 Total Banco Popular de Puerto Rico $957,822 243,727 485,548 1,909 41,684 714,457 114,311 $327,282 (962) (386) 26 $3 56,613 46,812 $141,631 $162,806 10,860 $22,842 $11,601,186 $19,407,327 $478,252 ($4,384,272) $27,102,493 Banco Popular de Puerto Rico 2006 At December 31, 2006 (In thousands) Net interest income Provision for loan losses Non-interest income Amortization of intangibles Depreciation expense Other operating expenses Impact of change in fiscal period Income tax expense Commercial Banking $342,419 43,952 94,517 881 14,192 174,427 Consumer and Retail Banking $561,788 97,131 248,117 1,338 28,214 444,024 60,476 51,351 Other Financial Services Eliminations $10,229 $471 91,303 321 1,150 62,175 (2,072) 14,491 (1,997) (734) (333) ($459) Total Banco Popular de Puerto Rico $914,907 141,083 431,940 2,540 43,556 679,892 (2,072) 125,985 $355,863 Segment assets $26,522,983 $12,593,434 $9,411,263 $250,749 ($509,764) Net income $143,008 $187,847 $25,467 At December 31, 2005 Total Reportable Segments $1,457,788 195,258 712,253 9,579 80,436 1,176,798 180,000 Corporate Eliminations ($34,959) 14 73,612 1,511 59,988 (31,417) $1,378 (590) (112) 332 Total Popular, Inc. $1,424,207 195,272 785,275 9,579 81,947 1,236,674 148,915 $527,970 $8,557 $568 $537,095 3,177 430 3,607 Segment assets $11,283,178 $17,935,610 $581,981 ($4,299,247) $25,501,522 Banco Popular de Puerto Rico 2005 At December 31, 2005 (In thousands) Net interest income Provision for loan losses Non-interest income Amortization of intangibles Depreciation expense Other operating expenses Income tax expense Net income before cumulative Commercial Banking $304,142 26,600 144,008 881 14,296 199,670 47,706 Consumer and Retail Banking $579,852 72,132 208,567 1,332 26,903 424,783 47,309 Other Financial Services Eliminations $12,970 $43 77,351 309 1,309 58,112 9,988 (1,677) (1,432) (96) Total Banco Popular de Puerto Rico $897,007 98,732 428,249 2,522 42,508 681,133 104,907 $531,147 $8,987 $568 $540,702 effect of accounting change $158,997 $215,960 $20,603 ($106) $395,454 (In thousands) Net interest income (loss) Provision for loan losses Non-interest income Amortization of intangibles Depreciation expense Other operating expenses Income tax expense (benefit) Net income before cumulative effect of accounting change Cumulative effect of accounting change Net income after cumulative effect of accounting change Segment assets $48,268,665 $6,333,610 ($5,978,607) $48,623,668 During the year ended December 31, 2007, the Corporation’s holding companies realized net gains on sale of securities, mainly marketable equity securities, of approximately $114,944,000 (2006 - $14,000,000; 2005 - $59,706,000). These gains are included as part of “non-interest income” within the Corporate group. Cumulative effect of accounting change Net income after cumulative 3,797 755 (1,331) 3,221 effect of accounting change $158,997 $219,757 $21,358 ($1,437) $398,675 Segment assets $10,404,721 $18,537,688 $1,043,096 ($3,462,522) $26,522,983 Additional disclosures with respect to the Banco Popular North America reportable segment are as follows: Banco Popular North America 2007 At December 31, 2007 (In thousands) Net interest income Provision for loan losses Non-interest income Goodwill and trademark impairment losses Amortization of intangibles Depreciation expense Other operating expenses Impact of change in fiscal period Income tax expense (benefit) Net income (loss) Segment assets Banco Popular North America $348,728 77,832 112,954 4,810 12,835 287,831 27,863 $50,511 E-LOAN Eliminations $20,925 17,654 74,270 211,750 2,792 3,234 162,706 (57,218) ($245,723) $952 (1,262) 39 (122) ($227) Total Banco Popular North America $370,605 95,486 185,962 211,750 7,602 16,069 450,576 (29,477) ($195,439) $13,965,898 $1,178,438 ($1,780,030) $13,364,306 Banco Popular North America 2006 At December 31, 2006 E-LOAN Eliminations (In thousands) Net interest income Provision for loan losses Non-interest income Amortization of intangibles Depreciation expense Other operating expenses Income tax expense (benefit) Net income (loss) Segment assets Banco Popular North America $363,249 37,834 127,697 6,041 12,917 272,158 60,707 $101,289 $12,259,704 $16,601 8,638 92,188 2,840 2,894 150,482 (23,018) ($33,047) $1,308,263 Total Banco Popular North America $379,977 46,472 218,590 8,881 15,811 422,640 37,280 $67,483 $127 (1,295) (409) ($759) ($1,975) $13,565,992 Banco Popular North America 2005 At December 31, 2005 (In thousands) Net interest income Provision for loan losses Non-interest income Amortization of intangibles Depreciation expense Other operating expenses Income tax expense (benefit) Net income (loss) before cumulative Banco Popular North America $357,256 22,871 130,538 6,368 15,156 286,374 57,617 Total Banco Popular North America $359,836 23,238 149,604 6,783 15,678 309,151 56,796 E-LOAN $2,580 367 19,066 415 522 22,777 (821) effect of accounting change 99,408 (1,614) 97,794 Cumulative effect of accounting change Net income (loss) after cumulative (209) (209) effect of accounting change $99,199 ($1,614) $97,585 Segment assets $12,037,377 $556,057 $12,593,434 2007 Annual Report 137 2007 2007 Popular, Inc. 2007 2007 Intersegment revenues* (In thousands) Banco Popular de Puerto Rico: P.R. Commercial Banking P.R. Consumer and Retail Banking P.R. Other Financial Services EVERTEC Banco Popular North America: Banco Popular North America E-LOAN Popular Financial Holdings Total intersegment revenues 2007 $1,519 3,311 (449) (140,949) (8,597) (8,220) 6,296 ($147,089) 2006 2005 ($619) (1,409) (326) (138,172) (1,212) (608) 1,250 ($141,096) ($2,437) (5,743) (399) (139,100) 1,563 (24) 6,507 ($139,633) * For purposes of the intersegment revenues disclosure, revenues include interest income (expense) related to internal funding and other non-interest income derived from intercompany transactions, mainly related to gain on sales of loans and processing / information technology services. Geographic Information (In thousands) 2007 2006 Revenues*: Puerto Rico United States Other Total consolidated revenues $1,567,276 488,038 88,392 $2,143,706 $1,396,714 762,313 78,368 $2,237,395 2005 $1,252,906 891,820 64,756 $2,209,482 * Total revenues include net interest income, service charges on deposit accounts, other service fees, net gain on sale and valuation adjustment of investment securities, trading account (loss) profit, (loss) gain on sale of loans and valuation adjustments on loans held-for-sale and other operating income. Selected Balance Sheet Information: (In thousands) Puerto Rico Total assets Loans Deposits United States Total assets Loans Deposits Other Total assets Loans Deposits 2007 2006 2005 $26,017,716 15,679,181 17,341,601 $24,621,684 14,735,092 13,504,860 $25,759,437 14,130,645 13,093,540 $17,093,929 13,517,728 9,737,996 $21,570,276 17,363,382 9,735,264 $21,780,226 17,023,443 8,370,150 $1,299,792 714,093 1,254,881 $1,212,027 638,465 1,198,207 $1,084,005 556,119 1,174,315 Note 33 - Contingent liabilities: Note 33 - Contingent liabilities: Note 33 - Contingent liabilities: Note 33 - Contingent liabilities: Note 33 - Contingent liabilities: 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 operations. Note 34 - Guarantees: Note 34 - Guarantees: Note 34 - Guarantees: Note 34 - Guarantees: Note 34 - Guarantees: The Corporation has obligations upon the occurrence of certain events under financial guarantees provided in certain contractual agreements. These various arrangements are summarized below. The Corporation issues financial standby letters of credit and has risk participation in standby letters of credit issued by other financial institutions, in each case to guarantee the performance 138 of various customers to third parties. If the customer fails to meet its financial or performance obligation to the third party under the terms of the contract, then, upon their request, the Corporation would be obligated to make the payment to the guaranteed party. In accordance with the provisions of FIN No. 45, at December 31, 2007 and 2006, the Corporation recorded a liability of $636,000 and $658,000, respectively, which represents the fair value of the obligations undertaken in issuing the guarantees under the standby letters of credit issued or modified after December 31, 2002. The fair value approximates the fee received from the customer for issuing such commitments. These fees are deferred and are recognized over the commitment period. The contract amounts in standby letters of credit outstanding at December 31, 2007 and 2006, shown in Note 28, represent the maximum potential amount of future payments the Corporation could be required to make under the guarantees in the event of nonperformance by the customers. These standby letters of credit are used by the customer as a credit enhancement and typically expire without being drawn upon. The Corporation’s standby letters of credit are generally secured, and in the event of nonperformance by the customers, the Corporation has rights to the underlying collateral provided, which normally includes cash and marketable securities, real estate, receivables and others. Management does not anticipate any material losses related to these instruments. The Corporation securitizes mortgage loans into guaranteed mortgage-backed securities subject to limited, and in certain instances, lifetime credit recourse on the loans that serve as collateral for the mortgage-backed securities. Also, from time to time, the Corporation may sell in bulk sale transactions, residential mortgage loans and SBA commercial loans subject to credit recourse or to certain representations and warranties from the Corporation to the purchaser. These representations and warranties may relate to borrower creditworthiness, loan documentation, collateral, prepayment and early payment defaults. The Corporation may be required to repurchase the loans under the credit recourse agreements or representation and warranties. Generally, the Corporation retains the right to service the loans when securitized or sold with credit recourse. At December 31, 2007, the Corporation serviced $3,386,885,000 (2006 - $3,054,325,000) in residential mortgage loans with credit recourse or other servicer-provided credit enhancement. In the event of any customer default, pursuant to the credit recourse provided, the Corporation is required to reimburse the third party investor. The maximum potential amount of future payments that the Corporation would be required to make under the agreement in the event of nonperformance by the borrowers is equivalent to the total outstanding balance of the r e s i d e n t i a l m o r t g a g e l o a n s s e r v i c e d . I n t h e e v e n t o f nonperformance, the Corporation has rights to the underlying collateral securing the mortgage loan, thus, historically the losses associated to these guarantees had not been significant. At December 31, 2007, the Corporation had reserves of approximately $4,731,000 (2006 - $3,066,000) to cover the estimated credit loss exposure. At December 31, 2007, the Corporation also serviced $17,122,770,000 (2006 - $10,213,375,000) in mortgage loans without recourse or other servicer-provided credit enhancement. Although the Corporation may, from time to time, be required to make advances to maintain a regular flow of scheduled interest and principal payments to investors, including special purpose entities, this does not represent an insurance against losses. These loans serviced are mostly insured by FHA, VA, and others, or the certificates arising in securitization transactions may be covered by a funds guaranty insurance policy. Also, in the ordinary course of business, the Corporation sold SBA loans with recourse, in which servicing was retained. At December 31, 2007, SBA loans serviced with recourse amounted to $119,483,000 (2006 - $62,408,000). Due to the guaranteed nature of the SBA loans sold, the Corporation’s exposure to loss under these agreements should not be significant. Popular, Inc. Holding Company (“PIHC”) fully and unconditionally guarantees certain borrowing obligations issued by certain of its wholly-owned consolidated subsidiaries totaling $2,877,794,000 at December 31, 2007 (2006 - $3,278,827,000). In addition, at December 31, 2007 and 2006, PIHC fully and unconditionally guaranteed $824,000,000 of Capital Securities issued by four wholly-owned issuing trust entities that have been deconsolidated based on FIN No. 46R. Refer to Note 18 to the consolidated financial statements for further information. A number of the acquisition agreements to which the Corporation is a party and under which it has purchased various types of assets, including the purchase of entire businesses, require the Corporation to make additional payments in future years if certain predetermined goals, such as revenue targets, are achieved or certain specific events occur within a specified time. Management’s estimated maximum future payments at December 31, 2007 approximated $5,829,000 (2006 -$4,606,000). Due to the nature and size of the operations acquired, management does not anticipate that these additional payments will have a material impact on the Corporation’s financial condition or results of future operations. The Corporation is a member of the Visa USA network through its subsidiary BPNA. On October 3, 2007, the Visa organization completed a series of restructuring transactions to combine its affiliated operating companies, including Visa USA, under a single holding company, Visa, Inc. As a result of Visa’s restructuring, the Corporation’s membership interest in Visa USA was exchanged for an approximately 0.00874% equity interest in Visa Inc. Class USA stock. On November 11, 2007, Visa Inc. filed a registration statement with the Securities and Exchange Commission for the 2007 Annual Report 139 2007 2007 Popular, Inc. 2007 2007 N o t e 3 6 - P o p u l a r , I n c . ( H o l d i n g C o m p a n y o n l y ) N o t e 3 6 - P o p u l a r , I n c . ( H o l d i n g C o m p a n y o n l y ) N o t e 3 6 - P o p u l a r , I n c . ( H o l d i n g C o m p a n y o n l y ) N o t e 3 6 - P o p u l a r , I n c . ( H o l d i n g C o m p a n y o n l y ) N o t e 3 6 - P o p u l a r , I n c . ( H o l d i n g C o m p a n y o n l y ) f i n a n c i a l i n f o r m a t i o n : f i n a n c i a l i n f o r m a t i o n : f i n a n c i a l i n f o r m a t i o n : f i n a n c i a l i n f o r m a t i o n : f i n a n c i a l i n f o r m a t i o n : The following condensed financial information presents the financial position of Holding Company only as of December 31, 2007 and 2006, and the results of its operations and cash flows for each of the three years in the period ended December 31, 2007. Statements of Condition (In thousands) ASSETS Cash Money market investments Investments securities held-to-maturity, at amortized cost Other investment securities, at lower of cost or realizable value Investment in BPPR and subsidiaries, at equity Investment in Popular International Bank and subsidiaries, at equity Investment in other subsidiaries, at equity Advances to subsidiaries Loans to affiliates Loans Less - Allowance for loan losses Premises and equipment Other assets Total assets LIABILITIES AND STOCKHOLDERS’ EQUITY Other short-term borrowings Notes payable Accrued expenses and other liabilities Stockholders’ equity December 31, 2007 $1,391 46,400 2006 $2 8,700 626,129 430,000 14,425 1,817,354 767,608 232,972 712,500 10,000 2,926 60 23,772 42,969 143,469 1,690,968 1,257,748 228,655 452,400 10,000 5,249 40 25,628 62,042 $4,298,386 $4,314,821 $165,000 480,117 71,387 3,581,882 $150,787 484,406 59,322 3,620,306 Total liabilities and stockholders’ equity $4,298,386 $4,314,821 offer and sale of its common stock to the public. Visa has disclosed that it plans to use the proceeds from its initial public offering to partially redeem Visa USA members’ equity interests and to fund the settlement of certain Visa USA related litigation. Pursuant to the Visa USA bylaws, BPNA is obligated to indemnify Visa, Inc. for certain losses. On October 3, 2007, a Loss Sharing Agreement (“LSA”) became effective which reaffirmed the Corporation’s obligation to indemnify Visa, Inc. for potential future settlement of certain litigation. The Corporation’s indemnification obligation is limited to its 0.00874% proportionate equity interest in Visa USA. The Corporation recorded an estimated liability related to its obligation to indemnify Visa for covered litigation of $223,000 as of December 31, 2007. If the Visa initial public offering is successfully completed, the Corporation is expected to receive cash in partial redemption of its equity interest currently carried at zero value. Further, management expects that the indemnification obligation to Visa will be reduced when Visa either disburses funds for negotiated settlements, or funds an escrow account designated for settlement of covered litigation. Management expects that the gain to be realized from redemption of Visa shares will more than exceed the indemnification obligations recorded to date. Note 35 - Other service fees: Note 35 - Other service fees: Note 35 - Other service fees: Note 35 - Other service fees: Note 35 - Other service fees: The caption of other service fees in the consolidated statements of income consists of the following major categories as of December 31, (In thousands) Credit card fees and discounts Debit card fees Insurance fees Processing fees Mortgage servicing fees, net of amortization and fair value adjustments Other Total 2007 $102,176 76,573 55,824 47,476 11,708 69,500 2006 $89,827 61,643 53,889 44,050 (2,750) 74,216 2005 $82,062 52,675 50,734 42,773 6,226 97,031 $363,257 $320,875 $331,501 140 Statements of Operations Statements of Cash Flows (In thousands) Income: Dividends from subsidiaries Interest on money market and investment securities Other operating income Gain on sale and valuation adjustment of investment securities Interest on advances to subsidiaries Interest on loans to affiliates Interest on loans Total income Expenses: Interest expense Provision for loan losses Operating expenses Total expenses Income before income taxes and equity in undistributed earnings of subsidiaries Income taxes Income before equity in undistributed earnings of subsidiaries Equity in undistributed (losses) earnings of subsidiaries Net (loss) income Year ended December 31, 2006 2005 2007 $383,100 $247,899 $171,000 38,555 9,862 115,567 19,114 1,144 382 567,724 37,095 2,007 2,226 41,328 526,396 30,288 39,286 17,518 290 6,069 1,256 457 34,259 11,771 50,469 416 1,176 530 312,775 269,621 36,154 1,057 37,211 43,850 14 1,380 45,244 275,564 1,648 224,377 3,155 496,108 273,916 221,222 (560,601) ($64,493) 83,760 $357,676 319,480 $540,702 accretion of discounts on investments (8,244) (In thousands) Cash flows from operating activities: Net (loss) income Adjustments to reconcile net (loss) income to net cash provided by operating activities: Equity in undistributed losses (earnings) of subsidiaries and dividends from subsidiaries Provision for loan losses Net gain on sale and valuation adjustment of investment securities Net amortization of premiums and Net amortization of premiums and deferred loan origination fees and costs Earnings from investments under the equity method Stock options expense Net decrease (increase) in other assets Deferred income taxes Net increase in interest payable Net increase in other liabilities Total adjustments Net cash provided by operating activities Cash flows from investing activities: Net (increase) decrease in money market investments Purchases of investment securities: Available-for-sale Held-to-maturity Other Proceeds from maturities and redemptions of investment securities: Available-for-sale Held-to-maturity Other Proceeds from sales of investment securities available-for-sale Proceeds from sale of other investment securities Year ended December 31, 2006 2005 2007 ($64,493) $357,676 $540,702 177,501 2,007 (115,567) (4,612) 568 28,340 1,156 1,508 4,354 87,011 22,518 (331,659) (290) (427) (54) (2,507) 684 (9,192) (569) 647 10,158 (490,480) 14 (50,469) (546) (99) (3,097) 305 6,941 (182) 1,349 5,722 (333,209) (530,542) 24,467 10,160 (37,700) 221,300 (181,500) (6,808) (4,087,972) (269,683) 3,900,087 5,783 245,484 269,683 2,646 17,781 (127,628) (445) 110,432 150,000 500 57,458 Capital contribution to subsidiaries Net change in advances to subsidiaries and affiliates Net repayments on loans Acquisition of premises and equipment Proceeds from sale of premises and equpment Proceeds from sale of foreclosed assets Dividends received from subsidiaries Net cash provided by investing activities (260,100) 337 (522) 11 383,100 141,700 Cash flows from financing activities: Net decrease in assets sold under agreements to repurchase Net decrease in commercial paper Net increase in other short-term borrowings Payments of notes payable Proceeds from issuance of notes payable Cash dividends paid Proceeds from issuance of common stock Treasury stock acquired Net cash used in financing activities Net increase (decrease) in cash Cash at beginning of year Cash at end of year 14,213 (5,000) 397 (190,617) 20,414 (2,236) (162,829) 1,389 2 $1,391 (36,000) (75,000) (442,400) 459 (4,939) 99 247,899 6,845 150,787 (50,450) 393 (188,321) 55,678 (93) 15,569 216 (3) 297 171,000 120,896 (6,690) (4,501) (135,763) 5,383 (182,751) 193,679 (32,006) (130,643) (694) 696 $2 413 283 $696 The principal source of income for the Holding Company consists of dividends from BPPR. As members subject to the 2007 Annual Report 141 2007 2007 Popular, Inc. 2007 2007 regulations of the Federal Reserve System, BPPR and BPNA must obtain the approval of the Federal Reserve Board for any dividend if the total of all dividends declared by each entity during the calendar year would exceed the total of its net income for that year, as defined by the Federal Reserve Board, combined with its retained net income for the preceding two years, less any required transfers to surplus or to a fund for the retirement of any preferred stock. The payment of dividends by BPPR may also be affected by other regulatory requirements and policies, such as the maintenance of certain minimum capital levels described in Note 21. At December 31, 2007, BPPR could have declared a dividend of approximately $44,954,000 (2006 - $208,109,000; 2005 - $230,685,000) without the approval of the Federal Reserve Board. At December 31, 2007, BPNA was required to obtain the approval of the Federal Reserve Board to declare a dividend. The Corporation has never received dividend payments from its U.S. subsidiaries. PNA is an operating subsidiary of PIBI and is the holding company of its wholly-owned subsidiaries: • PFH, including its wholly-owned subsidiaries Equity One, Inc., Popular Financial Management, LLC, Popular Housing Services, Inc., and Popular Mortgage Servicing, Inc.; • BPNA, including its wholly-owned subsidiaries Popular Equipment Finance, Inc. (formerly Popular Leasing, U.S.A.), Popular Insurance Agency, U.S.A., Popular FS, LLC, and E-LOAN; • BP, N.A., including its wholly-owned subsidiary Popular Insurance, Inc.; and • EVERTEC USA, Inc. PIHC fully and unconditionally guarantees all registered debt securities and preferred stock issued by PIBI and PNA. As described in Note 36 to the consolidated financial statements, the principal source of income for PIHC consists of dividends from BPPR. N o t e 3 7 - C o n d e n s e d c o n s o l i d a t i n g f i n a n c i a l N o t e 3 7 - C o n d e n s e d c o n s o l i d a t i n g f i n a n c i a l N o t e 3 7 - C o n d e n s e d c o n s o l i d a t i n g f i n a n c i a l N o t e 3 7 - C o n d e n s e d c o n s o l i d a t i n g f i n a n c i a l N o t e 3 7 - C o n d e n s e d c o n s o l i d a t i n g f i n a n c i a l information of guarantor and issuers of registered information of guarantor and issuers of registered information of guarantor and issuers of registered information of guarantor and issuers of registered information of guarantor and issuers of registered g u a r a n t e e d s e c u r i t i e s : g u a r a n t e e d s e c u r i t i e s : g u a r a n t e e d s e c u r i t i e s : g u a r a n t e e d s e c u r i t i e s : g u a r a n t e e d s e c u r i t i e s : The following condensed consolidating financial information presents the financial position of Popular, Inc. Holding Company (“PIHC”) (parent only), Popular International Bank, Inc. (“PIBI”), Popular North America, Inc. (“PNA”) and all other subsidiaries of the Corporation as of December 31, 2007 and 2006, and the results of their operations and cash flows for each of the years ended December 31, 2007, 2006 and 2005, respectively. In 2005, the Corporation commenced a two-year plan to change its non-banking subsidiaries to a calendar reporting year-end. As of December 31, 2005, Popular Securities, Inc., Popular North America (holding company), Popular FS, LLC and Popular Financial Holdings, Inc. (“PFH”), including its wholly-owned subsidiaries, except E-LOAN, which already had a December 31st year-end since its acquisition, continued to have a fiscal year that ended on November 30. Accordingly, their financial information as of November 30, 2005 corresponds to their financial information included in the consolidated financial statements of Popular, Inc. as of December 31, 2005. As of December 31, 2006, all subsidiaries have aligned their year-end closing to that of the Corporation’s calendar year. PIHC, PIBI and PNA are authorized issuers of debt securities and preferred stock under a shelf registration statement filed with the Securities and Exchange Commission. PIBI is an operating subsidiary of PIHC and is the holding company of its wholly-owned subsidiaries: ATH Costa Rica S.A., EVERTEC LATINOAMERICA, SOCIEDAD ANONIMA (formerly named EVERTEC, Centroamérica Sociedad Anónima), T.I.I. Smart Solutions Inc., Popular Insurance V.I., Inc. and PNA. 142 Condensed Consolidating Statement of Condition At December 31, 2007 (In thousands) Popular, Inc. Holding Co. PIBI Holding Co. PNA Holding Co. All other Subsidiaries Elimination Entries Popular, Inc. Consolidated ASSETS Cash and due from banks Money market investments Trading account securities, at fair value Investment securities available-for-sale, at fair value Investment securities held-to-maturity, at amortized cost Other investment securities, at lower of cost or realizable value Investment in subsidiaries Loans held-for-sale, at lower of cost or market value Loans held-in-portfolio Less - Unearned income Allowance for loan losses Premises and equipment, net Other real estate Accrued income receivable Servicing assets Other assets Goodwill Other intangible assets LIABILITIES AND STOCKHOLDERS’ EQUITY Liabilities: Deposits: Non-interest bearing Interest bearing Federal funds purchased and assets sold under agreements to repurchase Other short-term borrowings Notes payable Subordinated notes Other liabilities Minority interest in consolidated subsidiaries Stockholders’ equity: Preferred stock Common stock Surplus Retained earnings (deficit) Treasury stock, at cost Accumulated other comprehensive loss, net of tax $1,391 46,400 626,129 14,425 2,817,934 725,426 60 725,366 23,772 1,675 40,740 554 $4,298,386 $165,000 480,117 71,387 716,504 186,875 1,761,908 563,183 1,324,468 (207,740) (46,812) 3,581,882 $4,298,386 ($93,645) (321,345) (1,743) $910,303 1,281,206 769,698 8,483,430 287,087 (430,000) 189,766 413,566 1,889,546 32,737,346 182,110 548,772 32,006,464 564,393 81,410 233,010 196,645 1,349,916 630,761 68,949 $49,356,150 $4,604,376 24,015,437 28,619,813 5,391,273 2,494,090 7,303,782 430,000 884,859 45,123,817 109 (5,598,043) (8,262,884) (8,262,884) (133) (32,904) (41,686) ($14,782,383) ($93,587) (191,748) (285,335) (122,900) (2,312,884) (5,916,886) (430,000) (84,049) (9,152,054) 70,421 3,404,586 770,339 (664) (74,384) (4,985,742) (628,637) 664 $376 300 31,705 1,250 1 648,720 $400 151 12,392 1,717,823 25,150 2,978,528 25,150 62 60,814 2,978,528 131 14,271 47,210 $768,378 $4,770,906 $168,892 1,155,773 2,754,339 62,059 4,141,063 2 734,964 (99,806) $116 116 3,961 851,193 (46,897) (39,995) 768,262 $768,378 (5,317) 629,843 $4,770,906 (12,458) 4,232,224 $49,356,150 57,770 (5,630,329) ($14,782,383) $818,825 1,006,712 767,955 8,515,135 484,466 216,584 1,889,546 28,203,566 182,110 548,832 27,472,624 588,163 81,410 216,114 196,645 1,456,994 630,761 69,503 $44,411,437 $4,510,789 23,823,689 28,334,478 5,437,265 1,501,979 4,621,352 934,372 40,829,446 109 186,875 1,761,908 568,184 1,319,467 (207,740) (46,812) 3,581,882 $44,411,437 2007 Annual Report 143 2007 2007 Popular, Inc. 2007 2007 Condensed Consolidating Statement of Condition At December 31, 2006 (In thousands) Popular, Inc. Holding Co. PIBI Holding Co. PNA Holding Co. All other Subsidiaries Elimination Entries Popular, Inc. Consolidated ASSETS Cash and due from banks Money market investments Trading account securities, at fair value Investment securities available-for-sale, at fair value Investment securities held-to-maturity, at amortized cost Other investment securities, at lower of cost or realizable value Investment in subsidiaries Loans held-for-sale, at lower of cost or market value Loans held-in-portfolio Less - Unearned income Allowance for loan losses Premises and equipment, net Other real estate Accrued income receivable Other assets Goodwill Other intangible assets LIABILITIES AND STOCKHOLDERS’ EQUITY Liabilities: Deposits: Non-interest bearing Interest bearing Federal funds purchased and assets sold under agreements to repurchase Other short-term borrowings Notes payable Subordinated notes Other liabilities Minority interest in consolidated subsidiaries Stockholders’ equity: Preferred stock Common stock Surplus Retained earnings Treasury stock, at cost Accumulated other comprehensive loss, net of tax $2 8,700 430,000 143,469 3,177,371 467,649 40 467,609 25,628 1,058 60,430 554 $4,314,821 $150,787 484,406 59,322 694,515 186,875 1,753,146 521,855 1,599,145 (206,987) (233,728) 3,620,306 $4,314,821 $157 1,075 71,262 2,157 5,001 1,135,808 12 42,883 26,152 2,062,710 2,958,559 2,958,559 134 11,581 28,125 $1,258,355 $5,090,136 $159,829 894,959 2,835,595 78,988 3,969,371 2 734,964 406,811 $60 60 3,961 851,193 458,922 $322 2,553 $1,015,470 508,424 382,325 ($65,793) (219,044) $950,158 301,708 382,325 9,782,815 (3,215) 9,850,862 89,183 (430,000) 122,772 816,684 719,922 35,467,096 308,347 522,192 34,636,557 569,545 84,816 264,089 1,528,398 667,853 107,000 $51,295,853 $4,287,868 20,283,441 24,571,309 5,739,416 5,297,595 9,651,217 430,000 758,613 46,448,150 110 (7,192,573) (6,567,940) (6,567,940) (167) (28,500) (47,946) ($14,555,178) ($65,735) (67,243) (132,978) (136,800) (2,309,216) (4,233,972) (430,000) (85,559) (7,328,525) 70,421 3,182,285 1,804,476 (2,146) (74,384) (4,763,441) (2,675,210) 2,146 91,340 297,394 719,922 32,325,364 308,347 522,232 31,494,785 595,140 84,816 248,240 1,611,890 667,853 107,554 $47,403,987 $4,222,133 20,216,198 24,438,331 5,762,445 4,034,125 8,737,246 811,424 43,783,571 110 186,875 1,753,146 526,856 1,594,144 (206,987) (233,728) 3,620,306 $47,403,987 (55,781) 1,258,295 $1,258,355 (21,012) 1,120,765 $5,090,136 (207,443) 4,847,593 $51,295,853 284,236 (7,226,653) ($14,555,178) 144 Condensed Consolidating Statement of Operations Year ended December 31, 2007 Popular, Inc. Holding Co. PIBI Holding Co. PNA Holding Co. Other Subsidiaries Elimination Entries Popular, Inc. Consolidated (In thousands) INTEREST INCOME: Loans Money market investments Investment securities Trading securities INTEREST EXPENSE: Deposits Short-term borrowings Long-term debt Net interest income (loss) Provision for loan losses Net interest income (loss) after provision for loan losses Service charges on deposit accounts Other service fees Net gain (loss) on sale and valuation adjustment of investment securities Trading account loss Loss on sale of loans and valuation adjustments on loans held-for-sale Other operating income (loss) OPERATING EXPENSES: Personnel costs: Salaries Pension, profit sharing and other benefits Net occupancy expenses Equipment expenses Other taxes Professional fees Communications Business promotion Printing and supplies Impairment losses on long-lived assets Other operating expenses Impact of change in fiscal period at certain subsidiaries Goodwill and trademark impairment losses Amortization of intangibles $20,640 1,147 37,408 59,195 3,644 33,451 37,095 22,100 2,007 20,093 $343 370 1,800 2,513 2,513 $158,510 52 894 159,456 59,801 149,461 209,262 (49,806) 2,513 (49,806) 115,567 (20,083) 9,862 145,522 15,410 (2,160) (1,592) (51,398) 389 69 458 29 20 21,062 5,878 26,940 2,327 1,755 1,557 12,103 518 2,768 75 (45,817) (400) 3 3 47 1 446 500 (51,898) (18,164) (33,734) (473,478) ($507,212) $2,803,356 36,833 434,406 41,898 3,316,493 774,840 502,115 577,406 1,854,361 1,462,132 560,643 901,489 196,072 475,510 (40,325) (2,343) (30,823) 137,025 1,636,605 500,709 143,464 644,173 121,262 125,914 48,554 281,537 66,517 113,319 17,362 12,344 198,038 211,750 10,445 1,851,215 (214,610) (71,315) (143,295) (499,018) ($367,535) (13,212) (28,739) (409,486) (9,047) (117,388) (295,502) (421,937) 12,451 12,451 (112,253) (121) (8,147) (39,443) (147,513) (2,637) (745) (3,382) (200) (143,853) (158) (699) (1,205) (149,497) 1,984 189 1,795 1,654,143 $2,615,314 25,190 445,769 41,898 3,128,171 765,793 448,172 464,816 1,678,781 1,449,390 562,650 886,740 196,072 363,257 55,159 (2,464) (38,970) 121,262 1,581,056 519,523 148,666 668,189 123,621 127,472 50,111 149,854 66,877 115,388 17,438 12,344 151,062 211,750 10,445 1,704,551 (123,495) (59,002) (64,493) ($642,313) $1,655,938 ($64,493) Income (loss) before income tax and equity in earnings (losses) of subsidiaries Income tax expense (benefit) Income (loss) before equity in earnings (losses) of subsidiaries Equity in (losses) earnings of subsidiaries NET (LOSS) INCOME 2,226 143,296 30,288 113,008 (177,501) ($64,493) 107 (2,267) (2,267) (504,146) ($506,413) 2007 Annual Report 145 2007 2007 Popular, Inc. 2007 2007 Condensed Consolidating Statement of Operations Year ended December 31, 2006 Popular, Inc. Holding Co. PIBI Holding Co. PNA Holding Co. Other Subsidiaries Elimination Entries Popular, Inc. Consolidated (In thousands) INTEREST INCOME: Loans Money market investments Investment securities Trading securities INTEREST EXPENSE: Deposits Short-term borrowings Long-term debt $7,782 2,199 37,087 47,068 537 35,617 36,154 10,914 $143 1,397 1,540 1,238 1,238 302 $149,166 520 1,403 151,089 26,806 177,061 203,867 (52,778) 10,914 302 (52,778) 290 13,598 7,006 20,906 (271) (53,049) Net interest income (loss) Provision for loan losses Net interest income (loss) after provision for loan losses Service charges on deposit accounts Other service fees Net gain (loss) on sale and valuation adjustment of investment securities Trading account profit Gain on sale of loans and valuation adjustments on loans held-for-sale Other operating income (loss) OPERATING EXPENSES: Personnel costs: Salaries Pension, profit sharing and other benefits Net occupancy expenses Equipment expenses Other taxes Professional fees Communications Business promotion Printing and supplies Impairment losses on long-lived assets Other operating expenses Impact of change in fiscal period at certain subsidiaries Goodwill impairment losses Amortization of intangibles 17,518 28,722 19,812 5,487 25,299 2,341 1,820 1,218 14,631 621 4,590 70 379 66 445 14 8 46 (49,533) (399) Income (loss) before income tax and equity in earnings (losses) of subsidiaries Income tax expense (benefit) Income (loss) before equity in earnings (losses) of subsidiaries Equity in earnings (losses) of subsidiaries NET INCOME (LOSS) 1,057 27,665 1,648 26,017 331,659 $357,676 114 20,792 20,792 (42,410) ($21,618) 2 12 225 1 436 3,495 4,171 (57,220) (15,363) (41,857) (2,602) ($44,459) $2,615,635 38,785 504,376 32,125 3,190,921 ($286,130) (12,021) (28,026) (326,177) $2,486,453 29,626 516,237 32,125 3,064,441 583,850 559,750 585,618 1,729,218 1,461,703 287,760 1,173,943 190,079 429,805 (16,253) 18,346 122,853 157,896 2,076,669 500,209 146,832 647,041 114,385 134,150 43,325 264,672 67,764 126,604 17,670 7,232 169,125 4,109 14,239 12,377 1,622,693 453,976 116,867 337,109 (46,768) $290,341 (3,756) (69,371) (260,819) (333,946) 7,769 7,769 (108,930) 6,724 16,942 (5,432) (40,686) (123,613) (3,222) (892) (4,114) (113) (138,040) (102) (1,229) (1,501) 2,137 (142,962) 19,349 3,734 15,615 (239,879) ($224,264) 580,094 518,960 537,477 1,636,531 1,427,910 287,760 1,140,150 190,079 320,875 4,359 35,288 117,421 141,463 1,949,635 517,178 151,493 668,671 116,742 135,877 44,543 141,534 68,283 129,965 17,741 7,232 118,128 9,741 14,239 12,377 1,485,073 464,562 106,886 357,676 $357,676 146 Condensed Consolidating Statement of Operations Year ended December 31, 2005 Popular, Inc. Holding Co. PIBI Holding Co. PNA Holding Co. Other Subsidiaries Elimination Entries Popular, Inc. Consolidated (In thousands) INTEREST INCOME: Loans Money market investments Investment securities Trading securities INTEREST EXPENSE: Deposits Short-term borrowings Long-term debt Net interest (loss) income Provision for loan losses Net interest (loss) income after provision for loan losses Service charges on deposit accounts Other service fees Net gain (loss) on sale and valuation adjustment of investment securities Trading account profit Gain on sale of loans and valuation adjustment on loans held-for-sale Other operating income OPERATING EXPENSES: Personnel costs: Salaries Pension, profit sharing and other benefits Net occupancy expenses Equipment expenses Other taxes Professional fees Communications Business promotion Printing and supplies Other operating expenses Amortization of intangibles Income (loss) before income tax, cumulative effect of accounting change and equity in earnings of subsidiaries Income tax expense (benefit) Income (loss) before cumulative effect of accounting change and equity in earnings of subsidiaries Cumulative effect of accounting change, net of tax Income (loss) before equity in earnings of subsidiaries Equity in earnings of subsidiaries NET INCOME $2,122 3,955 30,304 36,381 256 43,594 43,850 (7,469) 14 (7,483) $8 598 606 988 988 $142,050 90 1,264 143,404 17,488 154,508 171,996 (382) (28,592) (382) (28,592) 50,469 9,236 11,771 54,757 5,971 14,825 (28,592) 367 58 425 14 2 16 32 489 14,336 14,336 691 15,027 84,018 $99,045 31 1,021 4,536 56 6,292 (10,556) 1,380 53,377 3,155 50,222 50,222 490,480 $540,702 10 80 486 576 (29,168) (10,266) (18,902) (18,902) 101,512 $82,610 $2,207,183 45,350 484,345 30,010 2,766,888 439,269 387,362 488,839 1,315,470 1,451,418 195,258 1,256,160 181,749 435,505 (6,694) 16,625 106,598 127,680 2,117,623 478,118 149,092 627,210 108,372 124,294 38,176 249,558 63,412 94,142 18,378 134,136 9,579 1,467,257 650,366 156,797 493,569 4,494 498,063 62,055 ($235,056) (18,667) (27,697) (281,420) (8,456) (56,891) (225,305) (290,652) 9,232 9,232 (104,004) (898) 13,426 (23,301) (38,858) (144,403) (3,849) (1,097) (4,946) (61) (134,909) (73) (1,513) (141,502) (2,901) (771) (2,130) (1,578) (3,708) (738,065) $2,116,299 30,736 488,814 30,010 2,665,859 430,813 349,203 461,636 1,241,652 1,424,207 195,272 1,228,935 181,749 331,501 52,113 30,051 83,297 106,564 2,014,210 474,636 148,053 622,689 108,386 124,276 39,197 119,281 63,395 100,434 18,378 122,585 9,579 1,328,200 686,010 148,915 537,095 3,607 540,702 $560,118 ($741,773) $540,702 2007 Annual Report 147 2007 2007 Popular, Inc. 2007 2007 Condensed Consolidating Statement of Cash Flows Popular, Inc. Holding Co. Year ended December 31, 2007 PIBI Holding Co. PNA Holding Co. Other Subsidiaries Elimination Entries Popular, Inc. Consolidated (In thousands) Cash flows from operating activities: Net loss Adjustments to reconcile net loss to net cash provided by operating activities: Equity in undistributed losses of subsidiaries Depreciation and amortization of premises and equipment Provision for loan losses Goodwill and trademark impairment losses Impairment losses on long-lived assets Amortization of intangibles Amortization and fair value adjustment of servicing assets Net (gain) loss on sale and valuation adjustment of investment securities Net loss (gain) on disposition of premises and equipment Loss on sale of loans and valuation adjustments on loans held-for-sale Net amortization of premiums and accretion of discounts on investments Net amortization of premiums on loans and deferred loan origination fees and costs Earnings from investments under the equity method Stock options expense Net disbursements on loans held-for-sale Acquisitions of loans held-for-sale Proceeds from sale of loans held-for-sale Net decrease in trading securities Net (increase) decrease in accrued income receivable Net decrease (increase) in other assets Net increase (decrease) in interest payable Deferred income taxes Net increase in postretirement benefit obligation Net increase in other liabilities Total adjustments Net cash provided by (used in) operating activities Cash flows from investing activities: Net (increase) decrease in money market investments Purchases of investment securities: Available-for-sale Held-to-maturity Other Proceeds from calls, paydowns, maturities and redemptions of investment securities: Available-for-sale Held-to-maturity Other Proceeds from sales of investment securities available-for-sale Proceeds from sale of other investment securities Net disbursements on loans Proceeds from sale of loans Acquisition of loan portfolios Capital contribution to subsidiary Net liabilities assumed, net of cash Mortgage servicing rights purchased Acquisition of premises and equipment Proceeds from sale of premises and equipment Proceeds from sale of foreclosed assets Dividends received from subsidiary Net cash provided by (used in) investing activities Cash flows from financing activities: Net increase in deposits Net increase (decrease) in federal funds purchased and assets sold under agreements to repurchase Net increase (decrease) in other short-term borrowings Payments of notes payable Proceeds from issuance of notes payable Dividends paid to parent company Dividends paid Proceeds from issuance of common stock Treasury stock acquired Capital contribution from parent Net cash (used in) provided by financing activities Net increase (decrease) in cash and due from banks Cash and due from banks at beginning of period Cash and due from banks at end of period ($64,493) ($506,413) ($507,212) ($642,313) $1,655,938 ($64,493) 177,501 2,365 2,007 (115,567) 1 (8,244) (4,612) 568 (617) 26,591 1,508 1,156 4,354 87,011 22,518 (37,700) (6,808) (4,087,972) 3,900,087 5,783 245,484 (259,763) (522) 11 383,100 141,700 14,213 (5,000) 397 (190,617) 20,414 (2,236) (162,829) 1,389 2 $1,391 504,146 473,478 3 20,083 7 (15,410) 1,592 (2,690) (8,339) (7,762) (18,164) 8,180 446,298 (60,914) 2,402 (928) 865 (129,969) (51) 4,005 55 512,835 6,422 775 (2) 900 17,572 2 (25,150) (300) 499,018 76,271 560,643 211,750 12,344 10,445 61,110 40,325 (12,297) 30,823 28,508 100,153 (1,293) 1,195 (4,803,927) (550,392) 4,127,794 1,220,842 10,786 (123,355) 15,617 (237,455) 2,388 95,369 1,376,662 734,349 (706,347) (886,267) (25,232,314) (111,180) 2,344,225 25,034,574 44,185 34,812 1 (2,904,713) 415,256 (22,312) (111,025) 719,604 (26,507) (104,386) 63,444 175,974 (6,203) (127,630) (1,272,976) (1,654,143) (76) 8,147 (33) (9,642) (1,624) 1,743 4,404 6,883 (4,350) 30,723 (36,383) (1,654,351) 1,587 102,302 732,365 (735,548) 1,861,670 111,325 42 (383,100) 1,689,056 78,563 562,650 211,750 12,344 10,445 61,110 (55,159) (12,296) 38,970 20,238 90,511 (21,347) 1,763 (4,803,927) (550,392) 4,127,794 1,222,585 11,832 (94,215) 5,013 (223,740) 2,388 71,575 768,455 703,962 (638,568) (160,712) (29,320,286) (112,108) 1,608,677 28,935,561 44,185 58,167 246,352 (1,457,925) 415,256 (22,312) 719,604 (26,507) (104,866) 63,455 175,974 423,947 9,063 260,815 (444,583) 363,327 188,622 78 322 $400 3,041,881 (152,357) 2,889,524 (348,143) (2,292,160) (3,913,642) 4,217,588 (383,100) (289) 111,325 433,460 (105,167) 1,015,470 $910,303 13,900 (595,669) 1,899,948 (3,156,092) 383,100 (111,325) (1,718,495) (27,852) (65,793) ($93,645) (325,180) (2,612,801) (2,463,277) 1,425,220 (190,617) 20,414 (2,525) (1,259,242) (131,333) 950,158 $818,825 219 157 $376 148 Condensed Consolidating Statement of Cash Flows (290) 4 (427) (54) (2,507) 684 (527) (11,002) 647 (569) 10,158 (333,209) 24,467 221,300 (269,683) 269,683 2,646 17,781 (441,941) (In thousands) Cash flows from operating activities: Net income (loss) Less: Impact of change in fiscal period of certain subsidiaries, net of tax Net income (loss) before impact of change in fiscal period Adjustments to reconcile net income (loss) to net cash provided by operating activities: Equity in undistributed (earnings) losses of subsidiaries Depreciation and amortization of premises and equipment Provision for loan losses Goodwill and trademark impairment losses Amortization of intangibles Impairment losses on long-lived assets Amortization of servicing assets Net (gain) loss on sale and valuation adjustment of investment securities Net loss (gain) on disposition of premises and equipment Net gain on sale of loans Net amortization of premiums and accretion of discounts on investments Net amortization of premiums on loans and deferred loan origination fees and costs Earnings from investments under the equity method Stock options expense Net disbursements on loans held-for-sale Acquisitions of loans held-for-sale Proceeds from sale of loans held-for-sale Net decrease in trading securities Net (increase) decrease in accrued income receivable Net (increase) decrease in other assets Net increase (decrease) in interest payable Deferred income taxes Net increase in postretirement benefit obligation Net increase (decrease) in other liabilities Total adjustments Net cash provided by operating activities Cash flows from investing activities: Net decrease (increase) in money market investments Purchases of investment securities: Available-for-sale Held-to-maturity Other Proceeds from calls, paydowns, maturities and redemptions of investment securities: Available-for-sale Held-to-maturity Other Proceeds from sales of investment securities available-for-sale Net disbursements on loans Proceeds from sale of loans Acquisition of loan portfolios Capital contribution to subsidiary Assets acquired, net of cash Mortgage servicing rights purchased Acquisition of premises and equipment Proceeds from sale of premises and equipment Proceeds from sale of foreclosed assets Dividends received from subsidiary Net cash provided by (used in) investing activities Cash flows from financing activities: Net increase in deposits Net increase (decrease) in federal funds purchased and assets sold under agreements to repurchase Net increase (decrease) in other short-term borrowings Payments of notes payable Proceeds from issuance of notes payable Dividends paid to parent company Dividends paid Proceeds from issuance of common stock Treasury stock acquired Capital contribution from parent Net cash (used in) provided by financing activities Cash effect of change in fiscal period Net (decrease) increase in cash and due from banks Cash and due from banks at beginning of period Cash and due from banks at end of period Popular, Inc. Holding Co. Year ended December 31, 2006 PIBI Holding Co. PNA Holding Co. Other Subsidiaries Elimination Entries Popular, Inc. Consolidated $357,676 ($21,618) ($44,459) $290,341 ($224,264) $357,676 357,676 (21,618) (2,271) (42,188) (2,638) 292,979 (1,220) (223,044) (6,129) 363,805 (331,659) 2,333 42,410 2,602 2 (13,598) 14 (118) 24,648 (6,995) 21 4,636 (23) 6 26,471 4,853 (775) (20,574) 963 24,566 2,828 (15,471) 30,341 45,713 3,525 (2,407) (13,010) 10,360 28,662 (127,083) 46,768 82,126 287,760 14,239 12,377 7,232 62,849 16,253 (25,933) (122,853) 135,974 (1,286) 2,322 (6,580,246) (1,547,800) 6,826,864 1,369,462 (11,612) 25,715 35,984 (48,800) 4,112 (86,169) 529,986 822,965 239,879 (73) (30) (6,724) 5,432 (199) (5,829) (1,482) 44,783 (44,783) (487) 6,946 5,793 (6,959) 38,632 (37,880) 237,019 13,975 84,388 287,760 14,239 12,377 7,232 62,819 (4,359) (25,929) (117,421) 23,918 130,091 (12,270) 3,006 (6,580,246) (1,503,017) 6,782,081 1,368,975 (4,209) 49,708 32,477 (26,208) 4,112 (83,544) 505,980 869,785 485,269 (321,966) 381,421 (708,142) (20,593,684) (53,016) 473,786 (254,930) (20,863,367) (66,026) 2,338,309 20,656,164 85,668 154,426 (1,881,055) 938,862 (448,708) (30,084) (3,034) (23,769) (102,971) 91,230 138,604 60,763 1,104,832 1,724,205 (3,328,993) 1,128,136 (3,464,344) 2,318,236 (308,662) 3,300 (274) 34,104 (1,894,292) 19,570 53,075 962,395 $1,015,470 (472,211) 7,933 862,753 74,211 3,317 (3,317) (308,662) 315,844 1,876,458 20,925,847 88,314 208,802 (1,587,326) 938,862 (448,708) (3,034) (23,769) (104,593) 87,913 138,703 1,294,567 65,457 1,789,662 257,697 (541,695) 952,427 (1,297,945) 308,662 (3,132) (70,104) (328,633) (7,734) (6,548) (59,245) ($65,793) (3,053,167) 1,226,973 (3,469,429) 1,506,298 (188,321) 55,846 (367) (2,132,505) 11,914 43,761 906,397 $950,158 (36,000) (4,000) (4,127) (4,939) 99 247,899 6,845 150,787 (50,450) 393 (188,321) 55,678 (93) (32,006) (694) 696 $2 3,313 (136,267) (46,112) 36,000 (10,112) (1,946) 2,103 $157 18,129 535,857 (907,062) 485,614 132,538 78 (126) 448 $322 2007 Annual Report 149 2007 2007 Popular, Inc. 2007 2007 Condensed Consolidating Statement of Cash Flows Year ended December 31, 2005 PIBI Holding Co. PNA Holding Co. Other Subsidiaries Elimination Entries Popular, Inc. Consolidated $99,045 691 98,354 $82,610 82,610 $560,118 4,494 555,624 ($741,773) (1,578) (740,195) $540,702 3,607 537,095 (84,018) (101,512) (62,055) 738,065 Popular, Inc. Holding Co. (490,480) $540,702 1,511 14 (In thousands) Cash flows from operating activities: Net income Less: Cumulative effect of accounting change, net of tax Net income before cumulative effect of accounting change 540,702 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Equity in undistributed earnings of subsidiaries Depreciation and amortization of premises and equipment Provision for loan losses Amortization of intangibles Amortization of servicing assets Net (gain) loss on sale and valuation adjustment of investment securities Net gain on disposition of premises and equipment Net gain on sale of loans Net amortization of premiums and accretion of discounts on investments Net amortization of premiums on loans and deferred loan origination fees and costs Earnings from investments under the equity method Stock options expense Net disbursements on loans held-for-sale Acquisitions of loans held-for-sale Proceeds from sale of loans held-for-sale Net decrease in trading securities Net increase in accrued income receivable Net decrease (increase) in other assets Net increase in interest payable Deferred income taxes Net increase in postretirement benefit obligation Net increase (decrease) in other liabilities 5,722 (347) 5,777 1,349 (182) (99) (3,097) 305 (50,469) (546) (530,542) 10,160 (181,500) (127,628) (445) 110,432 150,000 500 57,458 15,785 Total adjustments Net cash provided by (used in) operating activities Cash flows from investing activities: Net ( increase) decrease in money market investments Purchases of investment securities: Available-for-sale Held-to-maturity Other Proceeds from calls, paydowns, maturities and redemptions of investment securities: Available-for-sale Held-to-maturity Other Proceeds from sales of investment securities available-for-sale Net repayments (disbursements) on loans Proceeds from sale of loans Acquisition of loan portfolios Capital contribution to subsidiary Assets acquired, net of cash Mortgage servicing rights purchased Acquisition of premises and equipment Proceeds from sale of premises and equipment Proceeds from sale of foreclosed assets Dividends received from subsidiary Net cash provided by (used in) investing activities Cash flows from financing activities: Net increase in deposits Net (decrease) increase in federal funds purchased and assets sold under agreements to repurchase Net (decrease) increase in other short-term borrowings Payments of notes payable Proceeds from issuance of notes payable Dividends paid to parent company Dividends paid Proceeds from issuance of common stock Treasury stock acquired Capital contribution from parent Net cash (used in) provided by financing activities Cash effect of change in accounting principle Net increase in cash and due from banks Cash and due from banks at beginning of period Cash and due from banks at end of period (9,236) 10 (5,518) (33) 2,613 3 (21) (96,200) 2,154 (71,293) (2,431) 250 32,111 (1,146) 2,856 323 (10,266) 7,010 (102,735) (20,125) (31) (770) 4,978 (156,327) (75,000) (75,000) (478,510) (3) 297 171,000 120,896 (6,690) (4,501) (135,763) 5,383 (182,751) 193,679 (130,643) 413 283 $696 (116,363) 41,286 75,000 116,286 (28) 2,049 54 $2,103 150,000 (480,660) 45,926 382,213 (15,808) 13,518 75,000 500,849 64 384 $448 80,508 195,258 9,579 25,813 6,694 (29,079) (106,598) 36,518 134,452 (790) 4,887 (4,321,658) (733,536) 4,127,381 1,161,956 (32,159) (159,492) 36,421 7,097 5,451 7,627 394,275 949,899 209,122 (4,954,363) (33,577,371) (76,501) 4,115,508 33,637,018 60,553 299,027 (568,155) 297,805 (2,650,540) (306,868) (411,782) (5,039) (159,163) 71,053 116,862 52,500 (3,850,334) (72) (47) 898 23,301 (694) (7,118) (1,577) 34 (976) 2,877 (24,633) (2,878) (328) 93 726,945 (13,250) 132,470 910,122 (913,720) 365,604 935,378 (373,500) 1,056,354 81,947 195,272 9,579 25,766 (52,113) (29,079) (83,297) 35,288 127,235 (10,982) 5,226 (4,321,658) (733,536) 4,127,381 1,160,980 (30,808) (172,879) 35,218 (3,679) 5,451 20,431 391,743 928,838 160,061 (4,243,162) (33,579,802) (77,716) 3,317,198 33,787,268 61,053 388,596 (343,093) 297,805 (2,650,540) (411,782) (5,039) (159,166) 71,053 117,159 (3,270,107) 1,261,945 109,723 1,371,668 2,438,448 (817,323) (3,558,141) 3,362,405 (373,500) (1,467) 784,915 3,097,282 (1,544) 195,303 767,092 $962,395 (249,796) (367,952) 1,058,740 (1,040,295) 373,500 (934,915) (1,050,995) (7,891) (51,354) ($59,245) 2,227,888 (766,277) (2,650,972) 2,341,011 (182,751) 193,679 (1,467) 2,532,779 (1,572) 189,938 716,459 $906,397 P.O. Box 362708 San Juan, Puerto Rico 00936-2708 

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