POPULAR, INC.
Table of Contents

 
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
     
þ   Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2005
Commission File Number: 0-13818
POPULAR, INC.
(Exact name of registrant as specified in its charter)
     
Puerto Rico   66-0416582
     
(State or other jurisdiction of
incorporation or organization)
  (IRS Employer Identification Number)
     
Popular Center Building
209 Muñoz Rivera Avenue, Hato Rey
San Juan, Puerto Rico
  00918
     
(Address of principal executive offices)   (Zip code)
(787) 765-9800
(Registrant’s telephone number, including area code)
NOT APPLICABLE
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
     þ Yes           o No
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
     þ Yes           o No
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
     o Yes           þ No
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: Common Stock $6.00 par value, 267,427,048 Shares Outstanding as of October 28, 2005.
 
 

 


Table of Contents

POPULAR, INC.
INDEX
         
    Page
Part I — Financial Information
       
 
       
       
 
       
    4  
 
       
    5  
 
       
    6  
 
       
    7  
 
       
    8  
 
       
    9  
 
       
    49  
 
       
    70  
 
       
    74  
 
       
       
 
       
    74  
 
       
    74  
 
       
    74  
 
       
    75  
 EX-12.1 COMPUTATION OF RATIOS OF EARNINGS
 EX-31.1 SECTION 302 CERTIFICATION OF THE CEO
 EX-31.2 SECTION 302 CERTIFICATION OF THE CFO
 EX-32.1 SECTION 906 CERTIFICATION OF THE CEO
 EX-32.2 SECTION 906 CERTIFICATION OF THE CFO

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Forward-Looking Information.
The information included in this Form 10-Q contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements may relate to the Corporation’s financial condition, results of operations, plans, objectives, future performance and business, including, but not limited to, statements with respect to the adequacy of the allowance for loan losses, market risk and the impact of interest rate changes, capital adequacy and liquidity, and the effect of legal proceedings and new accounting standards on the Corporation’s financial condition and results of operations. All statements contained herein that are not clearly historical in nature are forward-looking, and the words “anticipate,” “believe,” “continues,” “expect,” “estimate,” “intend,” “project” and similar expressions and future or conditional verbs such as “will,” “would,” “should,” “could,” “might,” “can,” “may,” or similar expressions are generally intended to identify forward-looking statements.
These statements are not guarantees of future performance and 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.
Moreover, the outcome of legal proceedings, as discussed in “Part II, Item I. Legal Proceedings,” is inherently uncertain and depends on judicial interpretations of law and the findings of regulators, judges and juries.
All forward-looking statements included in this document are based upon information available to the Corporation as of the date of this document, and we assume 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.

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Table of Contents

ITEM 1. FINANCIAL STATEMENTS
POPULAR, INC.
CONSOLIDATED STATEMENTS OF CONDITION
(UNAUDITED)
                         
    September 30,   December 31,   September 30,
(In thousands, except share information)   2005   2004   2004
 
ASSETS
                       
Cash and due from banks
  $ 889,145     $ 716,459     $ 758,057  
 
Money market investments:
                       
Federal funds sold and securities purchased under agreements to resell
    631,641       879,321       845,280  
Time deposits with other banks
    6,580       319       319  
Bankers’ acceptances
                69  
 
 
    638,221       879,640       845,668  
 
Investment securities available-for-sale, at market value:
                       
Pledged securities with creditors’ right to repledge
    5,607,849       4,828,716       4,864,037  
Other investment securities available-for-sale
    5,885,359       6,333,429       6,375,582  
Investment securities held-to-maturity, at amortized cost
    359,228       340,850       137,317  
Other investment securities, at lower of cost or realizable value
    331,141       302,440       276,521  
Trading account securities, at market value:
                       
Pledged securities with creditors’ right to repledge
    361,411       257,857       235,884  
Other trading securities
    180,578       127,282       85,479  
Loans held-for-sale, at lower of cost or market
    867,059       750,728       265,753  
 
Loans held-in-portfolio:
                       
Loans held-in-portfolio pledged with creditors’ right to repledge
    259,779       318,409       801,744  
Other loans held-in-portfolio
    29,717,001       27,935,514       26,722,900  
Less – Unearned income
    293,756       262,390       273,099  
        Allowance for loan losses
    459,425       437,081       445,845  
 
 
    29,223,599       27,554,452       26,805,700  
 
Premises and equipment
    592,250       545,681       535,388  
Other real estate
    77,993       59,717       58,814  
Accrued income receivable
    261,097       207,542       227,259  
Other assets
    1,276,576       1,046,374       946,208  
Goodwill
    525,036       411,308       394,316  
Other intangible assets
    43,566       39,101       43,611  
 
 
  $ 47,120,108     $ 44,401,576     $ 42,855,594  
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
                       
Liabilities:
                       
Deposits:
                       
Non-interest bearing
  $ 3,733,226     $ 4,173,268     $ 4,076,535  
Interest bearing
    18,845,483       16,419,892       16,406,683  
 
 
    22,578,709       20,593,160       20,483,218  
Federal funds purchased and assets sold under agreements to repurchase
    8,017,783       6,436,853       7,306,235  
Other short-term borrowings
    2,908,523       3,139,639       2,454,872  
Notes payable
    9,564,425       10,180,710       8,774,868  
Subordinated notes
    125,000       125,000       125,000  
Other liabilities
    704,171       821,491       700,802  
 
 
    43,898,611       41,296,853       39,844,995  
 
Commitments and contingencies (See Note 8)
                       
 
Minority interest in consolidated subsidiaries
    101       102       104  
 
Stockholders’ equity:
                       
Preferred stock, $25 liquidation value; 30,000,000 shares authorized; 7,475,000 shares issued and outstanding in all periods presented
    186,875       186,875       186,875  
Common stock, $6 par value; 470,000,000 shares authorized in all periods presented; 280,604,768 shares issued (December 31, 2004 – 280,016,007; September 30, 2004 – 279,779,228) and 267,152,969 shares outstanding (December 31, 2004 – 266,582,103; September 30, 2004 – 266,345,324)
    1,683,629       1,680,096       1,678,675  
Surplus
    292,418       278,840       327,366  
Retained earnings
    1,403,133       1,129,793       994,206  
Accumulated other comprehensive (loss) income, net of tax of ($40,310) (December 31, 2004 - $6,780; September 30, 2004 - $8,662)
    (137,578 )     35,454       29,810  
Treasury stock – at cost, 13,451,799 shares (December 31, 2004 – 13,433,904; September 30, 2004 – 13,433,904)
    (207,081 )     (206,437 )     (206,437 )
 
 
    3,221,396       3,104,621       3,010,495  
 
 
  $ 47,120,108     $ 44,401,576     $ 42,855,594  
 
The accompanying notes are an integral part of these unaudited consolidated financial statements.

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POPULAR, INC.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
                                 
    Quarter ended   Nine months ended
    September 30,   September 30,
(In thousands, except per share information)   2005   2004   2005   2004
 
INTEREST INCOME:
                               
Loans
  $ 527,134     $ 445,204     $ 1,542,639     $ 1,271,541  
Money market investments
    7,502       6,512       22,942       18,674  
Investment securities
    123,701       106,322       358,757       303,798  
Trading account securities
    7,751       5,729       22,126       20,766  
 
 
    666,088       563,767       1,946,464       1,614,779  
 
INTEREST EXPENSE:
                               
Deposits
    113,799       83,467       310,543       240,852  
Short-term borrowings
    89,213       44,830       232,392       112,440  
Long-term debt
    114,966       87,278       340,703       241,878  
 
 
    317,978       215,575       883,638       595,170  
 
Net interest income
    348,110       348,192       1,062,826       1,019,609  
Provision for loan losses
    49,960       46,614       144,232       132,641  
 
Net interest income after provision for loan losses
    298,150       301,578       918,594       886,968  
Service charges on deposit accounts
    46,836       41,455       135,660       123,077  
Other service fees
    85,004       71,063       247,860       218,476  
Net (loss) gain on sale and valuation adjustment of investment securities
    (920 )           50,891       13,435  
Trading account profit (loss)
    4,707       803       28,138       (748 )
Gain on sale of loans
    17,585       11,855       42,675       30,170  
Other operating income
    21,836       19,380       65,871       64,351  
 
 
    473,198       446,134       1,489,689       1,335,729  
 
OPERATING EXPENSES:
                               
Personnel costs:
                               
Salaries
    120,012       108,807       351,361       315,785  
Profit sharing
    4,890       5,083       16,805       16,404  
Pension and other benefits
    29,780       28,762       96,684       92,587  
 
 
    154,682       142,652       464,850       424,776  
Net occupancy expenses
    27,719       23,572       78,414       67,437  
Equipment expenses
    31,185       28,601       90,029       83,899  
Other taxes
    10,368       9,269       29,088       28,490  
Professional fees
    27,888       26,121       82,787       68,755  
Communications
    15,640       15,706       46,579       46,589  
Business promotion
    23,940       20,492       69,860       54,418  
Printing and supplies
    4,845       4,069       13,971       13,458  
Other operating expenses
    30,759       25,407       88,098       75,863  
Amortization of intangibles
    2,387       1,984       6,770       5,586  
 
 
    329,413       297,873       970,446       869,271  
 
Income before income tax and cumulative effect of accounting change
    143,785       148,261       519,243       466,458  
Income tax
    28,569       32,880       112,395       104,774  
 
Income before cumulative effect of accounting change
    115,216       115,381       406,848       361,684  
Cumulative effect of accounting change, net of tax
                3,607        
 
NET INCOME
  $ 115,216     $ 115,381     $ 410,455     $ 361,684  
 
NET INCOME APPLICABLE TO COMMON STOCK
  $ 112,237     $ 112,402     $ 401,520     $ 352,749  
 
BASIC AND DILUTED EARNINGS PER COMMON SHARE (EPS) BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE
  $ 0.42     $ 0.42     $ 1.49     $ 1.32  
 
BASIC AND DILUTED EPS AFTER CUMULATIVE EFFECT OF ACCOUNTING CHANGE
  $ 0.42     $ 0.42     $ 1.50     $ 1.32  
 
DIVIDENDS DECLARED PER COMMON SHARE
  $ 0.16     $ 0.16     $ 0.48     $ 0.46  
 
The accompanying notes are an integral part of these unaudited consolidated financial statements.

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POPULAR, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(UNAUDITED)
                 
    Nine months ended
    September 30,
(In thousands)   2005   2004
 
Preferred stock:
               
Balance at beginning and end of year
  $ 186,875     $ 186,875  
 
Common stock:
               
Balance at beginning of year
    1,680,096       837,566  
Common stock issued under the Dividend Reinvestment Plan
    3,307       1,618  
Transfer from retained earnings resulting from stock split
          839,266  
Options exercised
    226       225  
 
Balance at end of period
    1,683,629       1,678,675  
 
Surplus:
               
Balance at beginning of year
    278,840       314,638  
Common stock issued under the Dividend Reinvestment Plan
    10,211       9,507  
Options granted
    2,791       2,371  
Options exercised
    576       850  
 
Balance at end of period
    292,418       327,366  
 
Retained earnings:
               
Balance at beginning of year
    1,129,793       1,601,851  
Net income
    410,455       361,684  
Cash dividends declared on common stock
    (128,180 )     (121,128 )
Cash dividends declared on preferred stock
    (8,935 )     (8,935 )
Transfer to common stock resulting from stock split
          (839,266 )
 
Balance at end of period
    1,403,133       994,206  
 
Accumulated other comprehensive (loss) income:
               
Balance at beginning of year
    35,454       19,014  
Other comprehensive (loss) income, net of tax
    (173,032 )     10,796  
 
Balance at end of period
    (137,578 )     29,810  
 
Treasury stock — at cost:
               
Balance at beginning of year
    (206,437 )     (205,527 )
Purchase of common stock
    (1,467 )     (1,259 )
Reissuance of common stock
    823       349  
 
Balance at end of period
    (207,081 )     (206,437 )
 
Total stockholders’ equity
  $ 3,221,396     $ 3,010,495  
 
                         
Disclosure of changes in number of shares:
    September 30,   December 31,   September 30,
    2005   2004   2004
 
Preferred Stock:
                       
Balance at beginning and end of period
    7,475,000       7,475,000       7,475,000  
 
Common Stock — Issued:
                       
Balance at beginning of year
    280,016,007       139,594,296       139,594,296  
Issued under the Dividend Reinvestment Plan
    551,175       447,138       269,596  
Stock split
          139,877,770       139,877,770  
Options exercised
    37,586       96,803       37,566  
 
Balance at end of period
    280,604,768       280,016,007       279,779,228  
 
Treasury stock
    (13,451,799 )     (13,433,904 )     (13,433,904 )
 
Common Stock — Outstanding
    267,152,969       266,582,103       266,345,324  
 
The accompanying notes are an integral part of these unaudited consolidated financial statements.

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POPULAR, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
(UNAUDITED)
                                 
    Quarter ended   Nine months ended
    September 30,   September 30,
(In thousands)   2005   2004   2005   2004
 
Net income
  $ 115,216     $ 115,381     $ 410,455     $ 361,684  
 
Other comprehensive (loss) income, before tax:
                               
Foreign currency translation adjustment
    (183 )     424       (611 )     (10,832 )
Unrealized (losses) gains on securities arising during the period
    (166,553 )     205,837       (170,856 )     40,793  
Reclassification adjustment for losses (gains) included in net income
    920             (50,368 )     (11,998 )
Net losses on cash flow hedges
    (1,717 )     (8,949 )     (3,496 )     (7,597 )
Reclassification adjustment for losses included in net income
    2,210       6,151       5,209       6,178  
 
 
    (165,323 )     203,463       (220,122 )     16,544  
Income tax benefit (expense)
    40,646       (51,319 )     47,090       (5,748 )
 
Total other comprehensive (loss) income, net of tax
    (124,677 )     152,144       (173,032 )     10,796  
 
Comprehensive (loss) income
  ($ 9,461 )   $ 267,525     $ 237,423     $ 372,480  
 
Disclosure of accumulated other comprehensive (loss) income:
                         
    September 30,   December 31,   September 30,
(In thousands)   2005   2004   2004
 
Foreign currency translation adjustment
  ($ 36,141 )   ($ 35,530 )   ($ 35,329 )
 
Unrealized (losses) gains on securities
    (142,719 )     78,505       79,053  
Tax effect
    40,512       (7,198 )     (10,752 )
 
Net of tax amount
    (102,207 )     71,307       68,301  
 
Unrealized gains (losses) on cash flows hedges
    606       (1,107 )     (5,618 )
Tax effect
    (202 )     418       2,090  
 
Net of tax amount
    404       (689 )     (3,528 )
 
Cumulative effect of accounting change
    366       366       366  
 
 
Accumulated other comprehensive (loss) income, net of tax
  ($ 137,578 )   $ 35,454     $ 29,810  
 
The accompanying notes are an integral part of these unaudited consolidated financial statements.

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POPULAR, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
                 
    Nine months ended
    September 30,
(In thousands)   2005   2004
 
Cash flows from operating activities:
               
Net income
  $ 410,455     $ 361,684  
Less: Cumulative effect of accounting change, net of tax
    3,607        
 
Net income before cumulative effect of accounting change
    406,848       361,684  
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization of premises and equipment
    60,767       55,086  
Provision for loan losses
    144,232       132,641  
Amortization of intangibles
    6,770       5,586  
Net gain on sale and valuation adjustment of investment securities
    (50,891 )     (13,435 )
Net gain on disposition of premises and equipment
    (11,165 )     (13,977 )
Net gain on sale of loans, excluding loans held-for-sale
    (6,732 )     (11,268 )
Net amortization of premiums and accretion of discounts on investments
    30,709       30,226  
Net amortization of premiums and deferred loan origination fees and costs
    92,586       88,974  
Earnings from investments under the equity method
    (8,917 )     (5,191 )
Stock options expense
    2,970       2,617  
Net decrease (increase) in loans held-for-sale
    1,860,216       (34,643 )
Net decrease (increase) in trading securities
    392,894       (105,050 )
Net increase in accrued income receivable
    (46,259 )     (43,930 )
Net increase in other assets
    (43,653 )     (46,535 )
Net increase in interest payable
    35,737       33,400  
Net (decrease) increase in deferred and current taxes
    (47,316 )     5,012  
Net increase in postretirement benefit obligation
    3,631       3,000  
Net decrease in other liabilities
    (57,248 )     (11,740 )
 
Total adjustments
    2,358,331       70,773  
 
Net cash provided by operating activities
    2,765,179       432,457  
 
Cash flows from investing activities:
               
Net decrease (increase) in money market investments
    271,264       (72,576 )
Purchases of investment securities:
               
Available-for-sale
    (3,321,802 )     (4,256,151 )
Held-to-maturity
    (49,193,426 )     (597,447 )
Other
    (63,394 )     (44,907 )
Proceeds from calls, paydowns, maturities and redemptions of investment securities:
               
Available-for-sale
    2,716,663       3,351,629  
Held-to-maturity
    49,194,005       538,427  
Other
    34,693       1,530  
Proceeds from sale of investment securities available-for-sale
    272,609       374,627  
Net disbursements on loans
    (1,735,102 )     (1,222,463 )
Proceeds from sale of loans
    109,244       274,928  
Acquisition of loan portfolios
    (2,301,771 )     (2,633,723 )
Assets acquired, net of cash
    (180,744 )     (166,740 )
Acquisition of premises and equipment
    (118,382 )     (109,410 )
Proceeds from sale of premises and equipment
    30,631       25,433  
 
Net cash used in investing activities
    (4,285,512 )     (4,536,843 )
 
Cash flows from financing activities:
               
Net increase in deposits
    1,313,013       1,226,373  
Net increase in federal funds purchased and assets sold under agreements to repurchase
    1,543,210       1,503,593  
Net (decrease) increase in other short-term borrowings
    (234,365 )     418,748  
Net (payments of) proceeds from notes payable and capital securities
    (802,927 )     1,138,266  
Dividends paid
    (137,014 )     (123,322 )
Proceeds from issuance of common stock
    14,141       11,954  
Treasury stock acquired
    (1,467 )     (1,259 )
 
Net cash provided by financing activities
    1,694,591       4,174,353  
 
Cash effect of change in accounting principle
    (1,572 )      
 
Net increase in cash and due from banks
    172,686       69,967  
Cash and due from banks at beginning of period
    716,459       688,090  
 
Cash and due from banks at end of period
  $ 889,145     $ 758,057  
 
The accompanying notes are an integral part of these unaudited consolidated financial statements.

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Notes to Unaudited Consolidated Financial Statements
Note 1 – Nature of operations and basis of presentation
Popular, Inc. (the “Corporation”, “Popular”) 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 banking subsidiary, Banco Popular de Puerto Rico (“BPPR”), as well as investment banking, auto and equipment leasing and financing, mortgage loans, consumer lending and insurance services through specialized subsidiaries. In the United States, the Corporation provides complete financial solutions to all the communities it serves through branches of Banco Popular North America (“BPNA”) in California, Texas, Illinois, New York, New Jersey and Florida, and financial services stores under the name of Popular Cash Express. The Corporation’s consumer finance subsidiary in the United States, Popular Financial Holdings, Inc. (“PFH”), offers mortgage and personal loans, and also maintains a substantial wholesale loan brokerage network, a warehouse lending division and loan servicing and assets acquisition units. The Corporation strives to use its expertise in technology and electronic banking as a competitive advantage in its Caribbean and Latin America expansion, as well as internally servicing many of its subsidiaries’ system infrastructures and transactional processing businesses. EVERTEC, Inc. (“EVERTEC”), the Corporation’s main subsidiary in this business segment, is the leading provider of financial transaction processing and information technology solutions in Puerto Rico and the Caribbean. With offices in San Juan, Caracas, Santo Domingo, and Miami, EVERTEC has a solid record of success in 11 Latin American countries. Note 16 to the unaudited consolidated financial statements presents information about each of the Corporation’s business segments.
The unaudited consolidated financial statements include the accounts of Popular, Inc. and its majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. These unaudited statements are, in the opinion of management, a fair statement of the results for the periods reported and include all necessary adjustments, of a normal recurring nature, for a fair statement of such results. Certain reclassifications have been made to the prior period unaudited consolidated financial statements to conform to the 2005 presentation.
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 calendar period. 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. Refer to Note 17 for further information on the subsidiaries which continue to have a fiscal year-end in November 2005.
Certain information and note disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States of America have been condensed or omitted from these statements pursuant to the rules and regulations of the Securities and Exchange Commission and, accordingly, these financial statements should be read in conjunction with the audited Consolidated Financial Statements of the Corporation for the year ended December 31, 2004, included in the Corporation’s Annual Report on Form 10-K.

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Principal acquisition during 2005
In January 2005, the Corporation completed the acquisition of Kislak Financial Corporation (“Kislak”), the holding company of Kislak National Bank, based in South Florida. Immediately prior to the acquisition, Kislak had assets of approximately $965 million, a loan portfolio of approximately $590 million and deposits of approximately $659 million.
Expected Acquisitions announced in the third quarter of 2005
Popular, Inc. completed the acquisition of 100% of the issued and outstanding shares of common stock and common stock equivalents of E-LOAN, Inc. (“E-LOAN”), a California-based online consumer direct lender, for $4.25 per share in cash, or approximately $300 million. E-LOAN, which becomes a wholly-owned subsidiary of PFH, originated over $5 billion in mortgage, home equity, and auto loans in 2004. Through this merger, Popular, Inc. further expands its presence in the mainland U.S. market, complements its existing non-prime and warehouse lending businesses, and significantly enhances its technology platform to support its growth strategy in which the internet plays an important role. This transaction became effective on November 1, 2005.
Also, in September 2005, Popular, Inc. announced a definitive merger agreement to acquire the assets of Infinity Mortgage Corporation, based in New Jersey. The operations of Infinity Mortgage will become part of the mortgage business of Equity One, Inc., a subsidiary of PFH. The transaction, which is expected to be completed during the fourth quarter of 2005, will help increase Popular, Inc.’s market share in the U.S. as well as strengthen its existing mortgage and loan servicing businesses. Infinity Mortgage Corporation originated over $220 million in mortgage loans during 2004 and operates in New Jersey, New York, Connecticut, Maryland, Massachusetts and Pennsylvania.
Operations to be disposed of by sale
On September 21, 2005, Popular, Inc. announced that ACE Cash Express, Inc. (“ACE”) will acquire substantially all of the assets of Popular Cash Express, Inc. (“PCE”), our wholly-owned check cashing business in the U.S., for $36 million. The Corporation has been constrained in its ability to compete against non-bank owned check cashing operations, which are less regulated than banking institutions, but is committed to remain an active participant in the industry as a lender and servicer to other retail check cashing institutions, and will continue to collaborate with regulators and lawmakers to accelerate the integration of unbanked and underbanked individuals into mainstream financial services. The agreements signed by Popular and ACE do not require regulatory approval and are subject to customary closing terms and conditions. PCE had approximately $62 million in total assets as of September 30, 2005, consisting principally of cash, premises and equipment, and goodwill. Total revenues for the nine months ended September 30, 2005 were approximately $19 million and pre-tax losses approximated $4.3 million. The financial results of PCE are part of the “United States Financial Services” reportable segment in Note 16 – Segment Reporting, included in the accompanying notes to the unaudited consolidated financial statements in this Form 10-Q. The transaction is expected to be completed during the fourth quarter of 2005. No significant gain or loss is expected on this sale transaction.
Subsequent event
On January 18, 2005, the Corporation announced that it had been informed by the Antitrust Division of the U.S. Department of Justice that the Department of Justice was conducting an investigation concerning the participation by its subsidiary, GM Group, Inc. (which after a reorganization in 2004 became part of EVERTEC), in the E-rate program, which is administered by the Federal Communications Commission (FCC) and pays for telecommunications services and related equipment for schools and libraries.
On October 13, 2005, the Corporation entered into a Settlement Agreement with the Department of Justice and the Federal Communications Commission in connection with this matter. Pursuant to the Settlement Agreement, EVERTEC, without admitting liability and denying any allegations of misconduct, agreed to make a $4.8 million payment to the United States and agreed to voluntarily disqualify itself from bidding on or performing any work related to contracts funded by the Federal Communications Commission for a three year period. EVERTEC also agreed to cooperate with U.S. governmental authorities in any investigation or

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litigation related to its participation in the E-rate program. The Settlement Agreement did not have and is not expected to have an impact on the Corporation’s third or fourth quarter results of operations or the Corporation’s financial condition because the full amount of the settlement payment has been previously accrued and because EVERTEC is not engaged in work related to Federal Communications Commission contracts.
Foreign Currency Translation
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 (loss) income, except for highly inflationary environments in which the effects are included in other operating income, as described below.
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. in the Dominican Republic. Although not significant, some of these businesses are conducted in the country’s foreign currency. At September 30, 2005, the Corporation had approximately $36 million in an unfavorable foreign currency translation adjustment as part of accumulated other comprehensive (loss) income (December 31, 2004 — $36 million; September 30, 2004 — $35 million).
The Corporation has been monitoring the inflation levels in the Dominican Republic to evaluate whether it still meets 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.” The cumulative inflation in the Dominican Republic for the 36 months ended September 30, 2005 exceeded the 100 percent threshold. 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. Accordingly, the Corporation’s interests in the Dominican Republic were remeasured into the U.S. dollar. During the quarter ended September 30, 2005, approximately $1.0 million in 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. For the nine months ended September 30, 2005, net remeasurement gains totaled $1.3 million. 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 $30.85 at December 31, 2004 and $29.05 at September 30, 2005. These remeasurement gains / losses will continue to be reflected in earnings until the economy is no longer considered highly inflationary. The unfavorable cumulative translation adjustment associated with these interests at the reporting date in which the economy became highly inflationary approximated $32 million. The cumulative inflation rate in the Dominican Republic over a 3-year period approximated 101.5 percent at September 30, 2005.

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Note 2 – Recent Accounting Developments
Statement of Position 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer”
In December 2003, the Accounting Standards Executive Committee issued Statement of Position 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer” (“SOP 03-3”). This statement addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor’s initial investment in loans or debt securities acquired in a transfer if those differences are attributable, at least in part, to credit quality. SOP 03-3 does not apply to loans originated by the entity. SOP 03-3 limits the yield that may be accreted (accretable yield) to the excess of the investor’s estimate of undiscounted expected principal, interest, and other cash flows (cash flows expected at acquisition to be collected) over the investor’s initial investment in the loan. SOP 03-3 requires that the excess of contractual cash flows over cash flows expected to be collected (nonaccretable difference) not be recognized as an adjustment of yield, loss accrual, or valuation allowance. SOP 03-3 prohibits investors from displaying accretable securities, yield and nonaccretable difference in the balance sheet. Subsequent substantial increases in cash flows expected to be collected generally should be recognized prospectively through adjustment of the loan’s yield over its remaining life. Decreases in cash flows expected to be collected should be recognized as impairments.
SOP 03-3 prohibits “carrying over” or the creation of valuation allowances in the initial accounting of all loans acquired in a transfer that are within the scope of this statement. The prohibition of the valuation allowance carryover applies to the purchase of an individual loan, a pool of loans, a group of loans, and loans acquired in a purchase business combination, subject to certain exceptions stipulated in the statement. SOP 03-3 is effective for loans acquired in fiscal years beginning after December 31, 2004.
Issue 03-1, “Meaning of Other Than Temporary Impairment”
In March 2004, the Emerging Issues Task Force reached a consensus on EITF Issue 03-1, “Meaning of Other Than Temporary Impairment and Its Application to Certain Investments” (“Issue 03-1”). Issue 03-1 provides recognition and measurement guidance regarding when impairments of equity and debt securities are considered other-than-temporary requiring a charge to earnings, and also requires additional annual disclosures for investments in unrealized loss positions. The additional annual disclosure requirements were implemented by the Corporation for the year ended December 31, 2003. In September 2004, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) EITF Issue 03-1-a, to address the application of Issue 03-1 to debt securities that are impaired solely because of interest rates and / or sector spread increases and that are analyzed for impairment under paragraph 16 of Issue 03-1. EITF Issue 03-1-1 expanded the scope of the deferral to include all securities covered by Issue 03-1. Both delayed the recognition and measurement provisions of Issue 03-1 pending the issuance of further implementation guidance.
In June 2005, the FASB decided to not provide additional guidance on the meaning of other-than-temporary impairment, but directed the staff to issue proposed FSP EITF 03-1-a, “Implementation Guidance for the Application of Paragraph 16 of EITF Issue No. 03-1,” as final. The final FSP will supersede EITF Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” and EITF Topic No. D-44, “Recognition of Other-Than-Temporary Impairment upon the Planned Sale of a Security Whose Cost Exceeds Fair Value.” The final FSP (retitled FSP FAS 115-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”) will replace the guidance set forth in paragraphs 10-18 of Issue 03-1 with references to existing other than temporary impairment guidance, such as SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, SEC Staff Accounting Bulletin 59, Accounting for Noncurrent Marketable Equity Securities, and APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock. FSP FAS 115-1 will codify the guidance set forth in EITF Topic D-44 and clarify that an investor should recognize an impairment loss no later than when the impairment is deemed other-than-temporary, even if a decision to sell has not been made. The FASB directed the staff to proceed to a draft of a final FSP for vote by written ballot. The FASB decided that FSP FAS 115-1 would be effective for other-than-temporary impairment analysis conducted in periods beginning after September 15, 2005.

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The Corporation is waiting for the issuance of the final guidance to evaluate the effects of the recognition and measurement provisions that the proposed statement, as amended, may have on its financial condition and results of operations.
SFAS No. 123-R, “Share-Based Payment”
In December 2004, the FASB issued a revision to SFAS No. 123, “Accounting for Stock-Based Compensation,” SFAS No. 123-R, “Share-Based Payment.” SFAS No. 123-R focuses primarily on transactions in which an entity exchanges its equity instruments for employee services and generally establishes standards for the accounting for transactions in which an entity obtains goods or services in share-based payment transactions. SFAS No. 123-R requires companies to (1) use fair value to measure stock-based compensation awards and (2) cease using the “intrinsic value” method of accounting, which APB 25 allowed and resulted in no expense for many awards of stock options for which the exercise price of the option did not exceed the price of the underlying stock at the grant date. In addition, SFAS No. 123-R retains the modified grant date model from SFAS No. 123. Under that model, compensation cost is measured at the grant date fair value of the award and is adjusted to reflect actual forfeitures and the outcome of certain conditions. The fair value of an award is not remeasured after its initial estimation on the grant date, except in the case of a liability award or if the award is modified, based on specific criteria included in SFAS No. 123-R. Also, SFAS 123-R clarifies the financial impact of vesting and/or acceleration clauses due at retirement. Under the revised SFAS, the expense should be fully accrued for any employee that is eligible to retire regardless of the actual retirement experience of the employer. In April 2005, the Securities and Exchange Commission approved a rule that delays the effective date of SFAS No. 123-R to annual, rather than interim, periods that begin after September 15, 2005. Management is currently evaluating the effect of the adoption of SFAS No. 123-R, but does not expect the adoption to have a material effect on the Corporation’s financial condition, results of operations or cash flows due to the fact that in 2002, the Corporation voluntarily adopted the fair value recognition method under SFAS No. 123. The Corporation will prospectively apply SFAS No. 123-R to its financial statements as of January 1, 2006.
SFAS No. 153, “Exchanges of Nonmonetary Assets”
In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions.” This statement amends the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged and more broadly provides for exceptions regarding exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The entity’s future cash flows are expected to significantly change if either of the following criteria is met: a) the configuration (risk, timing, and amount) of the future cash flows of the asset(s) received differs significantly from the configuration of the future cash flows of the asset(s) transferred; b) the entity-specific value of the asset(s) received differs from the entity-specific value of the asset(s) transferred, and the difference is significant in relation to the fair values of the assets exchanged. A qualitative assessment will, in some cases, be conclusive in determining that the estimated cash flows of the entity are expected to significantly change as a result of the exchange. SFAS No. 153 is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. The adoption of this statement is not expected to have a material impact on the Corporation’s financial condition, results of operations, or cash flows.
SFAS No. 154, “Accounting Changes and Error Corrections”
In May 2005, the FASB has issued SFAS No. 154, “Accounting Changes and Error Corrections”, a replacement of APB Opinion No. 20 and FASB Statement No. 3. The Statement applies to all voluntary changes in accounting principle, and changes the requirements for accounting for and reporting of a change in accounting principle.
SFAS No. 154 requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principle unless it is impracticable. Statement 154 is the result of a broader effort by the FASB to improve the comparability of cross-border financial reporting by working with the International Accounting Standards Board toward development of a single set of high-quality accounting standards. SFAS No. 154 requires

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that a change in method of depreciation, amortization, or depletion for long-lived, nonfinancial assets be accounted for as a change in accounting estimate that is effected by a change in accounting principle. APB Opinion No. 20 previously required that such a change be reported as a change in accounting principle.
SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Earlier application is permitted for accounting changes and corrections of errors occurring in fiscal years beginning after June 1, 2005. The Statement does not change the transition provisions of any existing accounting pronouncements, including those that are in a transition phase as of the effective date of this Statement. The Corporation is currently evaluating the impact that this new accounting pronouncement may have on its financial condition and results of operations.
FIN No. 47, Accounting for Conditional Asset Retirement Obligations – an interpretation of FASB Statement No. 143
In March 2005, the FASB issued financial interpretation (“FIN”) No. 47, Accounting for Conditional Asset Retirement Obligations – an interpretation of FASB Statement No. 143. This Interpretation clarifies the term conditional asset retirement obligation as used in SFAS No. 143 and requires a liability to be recorded if the fair value of the obligation can be reasonably estimated. The types of asset retirement obligations that are covered by this Interpretation are those for which an entity has a legal obligation to perform an asset retirement activity, however the timing and (or) method of settling the obligation are conditional on a future event that may or may not be within the control of the entity. FIN No. 47 also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. This Interpretation is effective no later than the end of fiscal years ending after December 15, 2005. The adoption of this statement is not expected to have a material impact on the Corporation’s financial condition, results of operations, or cash flows.
FASB Staff Position No. FAS 109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004
In December 2004, the FASB issued FASB Staff Position No. FAS 109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004 (“FSP 109-2”). The American Jobs Creation Act of 2004 (the “Act”) provides for a special one-time deduction of 85 percent of certain foreign earnings repatriated into the U.S. from non-U.S. subsidiaries through September 30, 2006. To date, the Corporation has not provided for income taxes on unremitted earnings generated by the non-U.S. subsidiary given the Corporation’s intent to permanently reinvest those earnings.
Note 3 — Investment Securities Available-For-Sale
The amortized cost, gross unrealized gains and losses and approximate market value (or fair value for certain investment securities where no market quotations are available) of investment securities available-for-sale as of September 30, 2005, December 31, 2004 and September 30, 2004 were as follows:
                                 
    AS OF SEPTEMBER 30, 2005
            Gross   Gross    
    Amortized   Unrealized   Unrealized   Market
(In thousands)   Cost   Gains   Losses   Value
 
U.S. Treasury securities
  $ 551,152           $ 22,803     $ 528,349  
Obligations of other U.S. Government agencies and corporations
    7,640,659     $ 1,158       121,114       7,520,703  
Obligations of Puerto Rico, States and political subdivisions
    165,872       4,402       931       169,343  
Collateralized mortgage obligations
    1,694,299       5,639       12,914       1,687,024  
Mortgage-backed securities
    1,441,383       10,161       18,540       1,433,004  
Equity securities
    61,453       12,102       304       73,251  
Others
    80,743       1,048       257       81,534  
 
 
  $ 11,635,561     $ 34,510     $ 176,863     $ 11,493,208  
 

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    AS OF DECEMBER 31, 2004
            Gross   Gross    
    Amortized   Unrealized   Unrealized   Market
(In thousands)   Cost   Gains   Losses   Value
 
U.S. Treasury securities
  $ 547,581           $ 23,596     $ 523,985  
Obligations of other U.S. Government agencies and corporations
    6,882,662     $ 28,196       31,995       6,878,863  
Obligations of Puerto Rico, States and political subdivisions
    128,900       4,616       1,558       131,958  
Collateralized mortgage obligations
    1,606,721       6,598       7,365       1,605,954  
Mortgage-backed securities
    1,828,919       25,476       6,626       1,847,769  
Equity securities
    22,796       84,425       298       106,923  
Others
    65,695       1,243       245       66,693  
 
 
  $ 11,083,274     $ 150,554     $ 71,683     $ 11,162,145  
 
                                 
    AS OF SEPTEMBER 30, 2004
            Gross   Gross    
    Amortized   Unrealized   Unrealized   Market
(In thousands)   Cost   Gains   Losses   Value
 
U.S. Treasury securities
  $ 549,696           $ 22,919     $ 526,777  
Obligations of other U.S. Government agencies and corporations
    6,942,634     $ 33,279       30,520       6,945,393  
Obligations of Puerto Rico, States and political subdivisions
    132,317       5,078       1,514       135,881  
Collateralized mortgage obligations
    1,645,654       5,264       6,124       1,644,794  
Mortgage-backed securities
    1,799,413       28,784       4,556       1,823,641  
Equity securities
    23,035       72,427       299       95,163  
Others
    67,451       1,179       660       67,970  
 
 
  $ 11,160,200     $ 146,011     $ 66,592     $ 11,239,619  
 
During the quarter ended September 30, 2005, the Corporation reassessed the appropriateness of the classification of certain earning assets and reclassified $42 million from investment securities available-for-sale to commercial loans based on the underlying characteristics of the instrument and the source of its cash flows. The assets were transferred at cost and evaluated for any credit risk exposure.
The following table shows the Corporation’s gross unrealized losses and market 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 September 30, 2005, December 31, 2004 and September 30, 2004:

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    AS OF SEPTEMBER 30, 2005
    Less than 12 Months
    Amortized   Unrealized   Market
(In thousands)   Cost   Losses   Value
 
U.S. Treasury securities
  $ 24,814     $ 271     $ 24,543  
Obligations of other U.S. Government agencies and corporations
    6,276,514       89,341       6,187,173  
Obligations of Puerto Rico, States and political subdivisions
    13,240       41       13,199  
Collateralized mortgage obligations
    673,542       6,256       667,286  
Mortgage-backed securities
    520,241       7,628       512,613  
Equity securities
    29       5       24  
Others
    11,180       257       10,923  
 
 
  $ 7,519,560     $ 103,799     $ 7,415,761  
 
                         
    12 months or more
    Amortized   Unrealized   Market
(In thousands)   Cost   Losses   Value
 
U.S. Treasury securities
  $ 526,238     $ 22,532     $ 503,706  
Obligations of other U.S. Government agencies and corporations
    1,163,926       31,773       1,132,153  
Obligations of Puerto Rico, States and political subdivisions
    52,370       890       51,480  
Collateralized mortgage obligations
    225,321       6,658       218,663  
Mortgage-backed securities
    482,962       10,912       472,050  
Equity securities
    300       299       1  
 
 
  $ 2,451,117     $ 73,064     $ 2,378,053  
 
                         
    Total
    Amortized   Unrealized   Market
(In thousands)   Cost   Losses   Value
 
U.S. Treasury securities
  $ 551,052     $ 22,803     $ 528,249  
Obligations of other U.S. Government agencies and corporations
    7,440,440       121,114       7,319,326  
Obligations of Puerto Rico, States and political subdivisions
    65,610       931       64,679  
Collateralized mortgage obligations
    898,863       12,914       885,949  
Mortgage-backed securities
    1,003,203       18,540       984,663  
Equity securities
    329       304       25  
Others
    11,180       257       10,923  
 
 
  $ 9,970,677     $ 176,863     $ 9,793,814  
 

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    AS OF DECEMBER 31, 2004
    Less than 12 Months
    Amortized   Unrealized   Market
(In thousands)   Cost   Losses   Value
 
U.S. Treasury securities
  $ 54,889     $ 292     $ 54,597  
Obligations of other U.S. Government agencies and corporations
    3,371,503       19,038       3,352,465  
Obligations of Puerto Rico, States and political subdivisions
    10,957       129       10,828  
Collateralized mortgage obligations
    434,001       4,690       429,311  
Mortgage-backed securities
    921,534       6,581       914,953  
Equity securities
    300       298       2  
Others
    6,553       245       6,308  
 
 
  $ 4,799,737     $ 31,273     $ 4,768,464  
 
                         
    12 months or more
    Amortized   Unrealized   Market
(In thousands)   Cost   Losses   Value
 
U.S. Treasury securities
  $ 492,692     $ 23,304     $ 469,388  
Obligations of other U.S. Government agencies and corporations
    492,816       12,957       479,859  
Obligations of Puerto Rico, States and political subdivisions
    43,700       1,429       42,271  
Collateralized mortgage obligations
    136,923       2,675       134,248  
Mortgage-backed securities
    1,217       45       1,172  
 
 
  $ 1,167,348     $ 40,410     $ 1,126,938  
 
                         
    Total
    Amortized   Unrealized   Market
(In thousands)   Cost   Losses   Value
 
U.S. Treasury securities
  $ 547,581     $ 23,596     $ 523,985  
Obligations of other U.S. Government agencies and corporations
    3,864,319       31,995       3,832,324  
Obligations of Puerto Rico, States and political subdivisions
    54,657       1,558       53,099  
Collateralized mortgage obligations
    570,924       7,365       563,559  
Mortgage-backed securities
    922,751       6,626       916,125  
Equity securities
    300       298       2  
Others
    6,553       245       6,308  
 
 
  $ 5,967,085     $ 71,683     $ 5,895,402  
 

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    AS OF SEPTEMBER 30, 2004
    Less than 12 Months
    Amortized   Unrealized   Market
(In thousands)   Cost   Losses   Value
 
U.S. Treasury securities
  $ 54,910     $ 164     $ 54,746  
Obligations of other U.S. Government agencies and corporations
    2,808,521       17,182       2,791,339  
Obligations of Puerto Rico, States and political subdivisions
    7,810       26       7,784  
Collateralized mortgage obligations
    503,785       5,179       498,606  
Mortgage-backed securities
    470,165       2,767       467,398  
Equity securities
    300       299       1  
Others
    12,541       660       11,881  
 
 
  $ 3,858,032     $ 26,277     $ 3,831,755  
 
                         
    12 months or more
    Amortized   Unrealized   Market
(In thousands)   Cost   Losses   Value
 
U.S. Treasury securities
  $ 494,786     $ 22,755     $ 472,031  
Obligations of other U.S. Government agencies and corporations
    435,513       13,338       422,175  
Obligations of Puerto Rico, States and political subdivisions
    43,700       1,488       42,212  
Collateralized mortgage obligations
    88,409       945       87,464  
Mortgage-backed securities
    318,474       1,789       316,685  
 
 
  $ 1,380,882     $ 40,315     $ 1,340,567  
 
                         
    Total
    Amortized   Unrealized   Market
(In thousands)   Cost   Losses   Value
 
U.S. Treasury securities
  $ 549,696     $ 22,919     $ 526,777  
Obligations of other U.S. Government agencies and corporations
    3,244,034       30,520       3,213,514  
Obligations of Puerto Rico, States and political subdivisions
    51,510       1,514       49,996  
Collateralized mortgage obligations
    592,194       6,124       586,070  
Mortgage-backed securities
    788,639       4,556       784,083  
Equity securities
    300       299       1  
Others
    12,541       660       11,881  
 
 
  $ 5,238,914     $ 66,592     $ 5,172,322  
 
The unrealized loss positions of available-for-sale securities at September 30, 2005 are primarily associated with U.S. Agency and Treasury obligations, and to a lesser extent, U.S. Agency-issued collateralized mortgage obligations, and mortgage-backed securities. 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 September 30, 2005 are substantially related to market interest rate fluctuations and not to deterioration in the creditworthiness of the issuers.
During the nine months ended September 30, 2005, the Corporation recognized through earnings approximately $12.6 million in losses in the available-for-sale portfolio that management considered to be other than temporarily

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impaired. These realized losses were associated with interest only strips and equity securities.
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.
                                                 
    September 30, 2005   December 31, 2004   September 30, 2004
(In thousands)   Amortized Cost   Market Value   Amortized Cost   Market Value   Amortized Cost   Market Value
 
FNMA
  $ 1,694,826     $ 1,688,626     $ 1,915,392     $ 1,931,026     $ 1,954,660     $ 1,971,204  
FHLB
    7,422,223       7,304,602       6,669,002       6,671,910       6,478,314       6,480,478  
Freddie Mac
    1,189,090       1,177,706       1,322,095       1,318,525       1,298,896       1,297,099  
Note 4 — Investment Securities Held-to-Maturity
The amortized cost, gross unrealized gains and losses and approximate market value (or fair value for certain investment securities where no market quotations are available) of investment securities held-to-maturity as of September 30, 2005, December 31, 2004 and September 30, 2004 were as follows:
                                 
    AS OF SEPTEMBER 30, 2005
            Gross   Gross    
    Amortized   Unrealized   Unrealized   Market
(In thousands)   Cost   Gains   Losses   Value
 
Obligations of other U.S. Government agencies and corporations
  $ 246,861           $ 96     $ 246,765  
Obligations of Puerto Rico, States and political subdivisions
    79,550     $ 2,879       129       82,300  
Collateralized mortgage obligations
    527             26       501  
Others
    32,290       357       10       32,637  
 
 
  $ 359,228     $ 3,236     $ 261     $ 362,203  
 
                                 
    AS OF DECEMBER 31, 2004
            Gross   Gross    
    Amortized   Unrealized   Unrealized   Market
(In thousands)   Cost   Gains   Losses   Value
 
Obligations of other U.S. Government agencies and corporations
  $ 176,954     $ 9     $ 1     $ 176,962  
Obligations of Puerto Rico, States and political subdivisions
    116,878       2,904       119       119,663  
Collateralized mortgage obligations
    623             65       558  
Others
    46,395       1,325       4       47,716  
 
 
  $ 340,850     $ 4,238     $ 189     $ 344,899  
 
                                 
    AS OF SEPTEMBER 30, 2004
            Gross   Gross    
    Amortized   Unrealized   Unrealized   Market
(In thousands)   Cost   Gains   Losses   Value
 
Obligations of other U.S. Government agencies and corporations
  $ 8,053                 $ 8,053  
Obligations of Puerto Rico, States and political subdivisions
    82,100       2,745     $ 125       84,720  
Collateralized mortgage obligations
    684             88       596  
Others
    46,480       1,431       3       47,908  
 
 
  $ 137,317     $ 4,176     $ 216     $ 141,277  
 

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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 September 30, 2005, December 31, 2004 and September 30, 2004:
                         
    AS OF SEPTEMBER 30, 2005
    Less than 12 months
    Amortized   Unrealized   Market
(In thousands)   Cost   Losses   Value
 
Obligations of other U.S. Government agencies and corporations
  $ 237,818     $ 96     $ 237,722  
Obligations of Puerto Rico, States and political subdivisions
    4,205       21       4,184  
Others
    750       10       740  
 
 
  $ 242,773     $ 127     $ 242,646  
 
                         
    12 months or more
    Amortized   Unrealized   Market
(In thousands)   Cost   Losses   Value
 
Obligations of Puerto Rico, States and political subdivisions
  $ 21,580     $ 108     $ 21,472  
Collateralized mortgage obligations
    527       26       501  
Others
    250             250  
 
 
  $ 22,357     $ 134     $ 22,223  
 
                         
    Total
    Amortized   Unrealized   Market
(In thousands)   Cost   Losses   Value
 
Obligations of other U.S. Government agencies and corporations
  $ 237,818     $ 96     $ 237,722  
Obligations of Puerto Rico, States and political subdivisions
    25,785       129       25,656  
Collateralized mortgage obligations
    527       26       501  
Others
    1,000       10       990  
 
 
  $ 265,130     $ 261     $ 264,869  
 

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    AS OF DECEMBER 31, 2004
    Less than 12 months
    Amortized   Unrealized   Market
(In thousands)   Cost   Losses   Value
 
Obligations of other U.S. Government agencies and corporations
  $ 21,983     $ 1     $ 21,982  
Obligations of Puerto Rico, States and political subdivisions
    1,078       9       1,069  
Others
    750       4       746  
 
 
  $ 23,811     $ 14     $ 23,797  
 
                         
    12 months or more
    Amortized   Unrealized   Market
(In thousands)   Cost   Losses   Value
 
Obligations of Puerto Rico, States and political subdivisions
  $ 22,080     $ 110     $ 21,970  
Collateralized mortgage obligations
    623       65       558  
Others
    250             250  
 
 
  $ 22,953     $ 175     $ 22,778  
 
                         
    Total
    Amortized   Unrealized   Market
(In thousands)   Cost   Losses   Value
 
Obligations of other U.S. Government agencies and corporations
  $ 21,983     $ 1     $ 21,982  
Obligations of Puerto Rico, States and political subdivisions
    23,158       119       23,039  
Collateralized mortgage obligations
    623       65       558  
Others
    1,000       4       996  
 
 
  $ 46,764     $ 189     $ 46,575  
 

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    AS OF SEPTEMBER 30, 2004
    Less than 12 months
    Amortized   Unrealized   Market
(In thousands)   Cost   Losses   Value
 
Obligations of Puerto Rico, States and political subdivisions
  $ 2,085     $ 15     $ 2,070  
Others
    1,000       3       997  
 
 
  $ 3,085     $ 18     $ 3,067  
 
                         
    12 months or more
    Amortized   Unrealized   Market
(In thousands)   Cost   Losses   Value
 
Obligations of Puerto Rico, States and political subdivisions
  $ 22,080     $ 110     $ 21,970  
Collateralized mortgage obligations
    683       88       595  
 
 
  $ 22,763     $ 198     $ 22,565  
 
                         
    Total
    Amortized   Unrealized   Market
(In thousands)   Cost   Losses   Value
 
Obligations of Puerto Rico, States and political subdivisions
  $ 24,165     $ 125     $ 24,040  
Collateralized mortgage obligations
    683       88       595  
Others
    1,000       3       997  
 
 
  $ 25,848     $ 216     $ 25,632  
 
Management believes that the unrealized losses in the held-to-maturity portfolio at September 30, 2005 are substantially related to market interest rate fluctuations and not to deterioration in the creditworthiness of the issuers.
Note 5 — Pledged and Other Restricted Assets
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 the Corporation’s pledged assets, in which the secured parties are not permitted to sell or repledge the collateral, were as follows:
                         
    September 30,   December 31,   September 30,
(In thousands)   2005   2004   2004
 
Investment securities available-for-sale
  $ 2,928,729     $ 2,802,647     $ 2,842,033  
Investment securities held-to-maturity
    1,255       1,378       1,380  
Loans
    11,289,750       10,749,244       10,892,942  
 
 
  $ 14,219,734     $ 13,553,269     $ 13,736,355  
 
Pledged securities and loans in which the creditor has the right by custom or contract to repledge are presented separately in the consolidated statements of condition.
In compliance with rules and regulations of the Securities and Exchange Commission, at September 30, 2005, the Corporation had securities with a market value of $699 thousand segregated in a special reserve bank account for the benefit of brokerage customers of its broker-dealer subsidiary (December 31, 2004 — $899 thousand; September 30, 2004 — $895 thousand). These securities are classified in the consolidated statements of condition within the trading securities category.

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As required by the Puerto Rico International Banking Center Law, at September 30, 2005, December 31, 2004 and September 30, 2004, the Corporation maintained separately for its two international banking entities (“IBEs”), $600 thousand, equally split for the two IBEs, in assets which were considered restricted.
Note 6 — Derivative Instruments and Hedging Activities
In managing its market risk, the Corporation enters, to a limited extent, into certain derivative transactions, primarily interest rate swaps, interest rate forwards and future contracts, interest rate caps, index options, foreign exchange contracts, floors and options embedded in financial contracts.
There were no changes in derivative instruments and hedging activities having a significant impact in the Corporation’s financial condition or results of operations from December 31, 2004 to September 30, 2005.
Note 7 — Goodwill and Other Intangible Assets
The changes in the carrying amount of goodwill for the nine months ended September 30, 2004 and 2005, allocated by reportable segment, and in the case of Popular Puerto Rico, as an additional disclosure, by business area, were as follows (refer to Note 16 for the definition of the Corporation’s reportable segments):
                         
    Balance at   Goodwill   Balance at
(In thousands)   January 1, 2005   acquired   September 30, 2005
 
Popular Puerto Rico:
                       
P.R. Commercial Banking
  $ 14,674           $ 14,674  
P.R. Consumer and Retail Banking
    34,999             34,999  
P.R. Other Financial Services
    3,322     $ 513       3,835  
U.S. Financial Services
    309,709       109,064       418,773  
Popular Financial Holdings
    9,514             9,514  
Processing
    39,090       4,151       43,241  
 
Total Popular, Inc.
  $ 411,308     $ 113,728     $ 525,036  
 
                         
    Balance at   Goodwill   Balance at
(In thousands)   January 1, 2004   Acquired (1)   September 30, 2004
 
Popular Puerto Rico:
                       
P.R. Commercial Banking
  $ 14,674           $ 14,674  
P.R. Consumer and Retail Banking
    34,999             34,999  
P.R. Other Financial Services
    1,556     $ 2,056       3,612  
U.S. Financial Services
    93,586       200,148       293,734  
Popular Financial Holdings
    8,870       644       9,514  
Processing
    37,805       (22 )     37,783  
 
Total Popular, Inc.
  $ 191,490     $ 202,826     $ 394,316  
 
(1)   Negative amount represents adjustment to purchase accounting entries during the allowable period after purchase date.
 
No goodwill was written-down during the nine months ended September 30, 2005 and 2004.
The Corporation performed the annual impairment test required by SFAS No. 142, “Goodwill and Other Intangible Assets.” The results of this test did not reveal impairment in the Corporation’s recorded goodwill.

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At September 30, 2005 and December 31, 2004, other than goodwill, the Corporation had $65 thousand of identifiable intangibles with an indefinite useful life related to a trademark. There were no identifiable intangibles with an indefinite useful life at September 30, 2004. The following table reflects the components of other intangible assets subject to amortization:
                                                 
    September 30, 2005   December 31, 2004   September 30, 2004
    Gross   Accumulated   Gross   Accumulated   Gross   Accumulated
(In thousands)   Amount   Amortization   Amount   Amortization   Amount   Amortization
 
Core deposits
  $ 76,956     $ 38,901     $ 86,327     $ 50,376     $ 88,771     $ 48,215  
Other customer relationships
    2,875       229       726       59       550       46  
Other intangibles
    4,328       1,528       3,295       877       3,345       794  
 
Total
  $ 84,159     $ 40,658     $ 90,348     $ 51,312     $ 92,666     $ 49,055  
 
The increase in goodwill from the end of 2004 to September 30, 2005 was mostly the result of the acquisition of Kislak. Other intangible assets subject to amortization decreased from December 31, 2004 partly due to certain core deposits intangibles that became fully amortized during 2005 and, as such, their gross amount and accumulated amortization were eliminated from the accounting records and the tabular disclosure presented above.
During the quarter and nine months ended September 30, 2005, the Corporation recognized $2.4 million and $6.8 million, respectively, in amortization expense related to other intangible assets with definite lives (September 30, 2004 — $2.0 million and $5.6 million, respectively).
The following table presents the estimated aggregate annual amortization expense of the intangible assets with definite lives for each of the following fiscal years:
         
    (In thousands)
2005
  $ 9,063  
2006
    9,002  
2007
    6,796  
2008
    5,142  
2009
    4,621  
No significant events or circumstances have occurred that would reduce the fair value of any reporting unit below its carrying amount.
Note 8 — Retained Interests on Sales of Mortgage Loans
During the nine-month period ended September 30, 2005, the Corporation, through its mortgage and consumer lending subsidiary in the mainland United States, PFH, retained servicing responsibilities and interest-only strips on securitization transactions involving the transfer of non-prime mortgage loans to a special purpose entity, which in turn transferred the loans to a securitization trust vehicle.
During the first nine months of 2005, the Corporation completed four off-balance sheet securitizations which met the criteria for sale accounting under SFAS No. 140. Approximately, $1.7 billion in adjustable (“ARM”) and fixed rate non-prime mortgage loans were securitized and sold by the Corporation during this period, with a gain on sale of $24.8 million. As part of these transactions, the Corporation recognized mortgage servicing rights (“MSRs”) of $36 million and interest-only strips (“IOs”) of $49 million. Key economic assumptions used in measuring the retained interests at the date of these securitizations were: discount rates ranging from 14% to 15%, conditional prepayment rates ranging from 28% to 35% in adjustable rate loans and 20% to 28% in fixed rate loans; and loss rates ranging from 1.28% to 2.34%.

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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. In these cases, the assets remain on the Corporation’s financial statements and a liability is recorded for the related asset-backed bonds (“on-balance sheet securitizations”). The loans transferred to the trusts are included on the balance sheet as loans pledged as collateral for secured borrowings. Since the Corporation retains the servicing of the loans in on-balance sheet securitizations, it recognizes MSRs at the time of securitization as they become a distinct asset that can be contractually separated from the underlying loans.
During the first nine months of 2005, the Corporation completed two on-balance sheet securitizations involving approximately $1.2 billion in adjustable and fixed rate non-prime mortgage loans. As part of these transactions, the Corporation recognized mortgage servicing rights of $25 million. Key economic assumptions used in measuring the retained interests at the date of these securitizations were: discount rate of 14% and conditional prepayment rates ranging from 28% to 35% in adjustable rate loans and 20% to 25% in fixed rate loans.
IOs retained as part of off-balance sheet securitizations of non-prime mortgage loans have been classified as investment securities available-for-sale and are presented at fair value in the unaudited consolidated statements of condition. The Corporation reviews the IOs for potential impairment on a quarterly basis and records impairment in accordance with SFAS No. 115. During the nine-month period ended September 30, 2005, the Corporation recorded other-than-temporary impairment losses of $11.7 million related with the IOs derived from the off-balance sheet securitizations.
As of September 30, 2005, key economic assumptions used to estimate the fair value of IOs and MSRs derived from PFH’s securitizations and the sensitivity to immediate changes in those assumptions were as follows:
                         
            MSRs
(In thousands)   Interest-only Strips   Fixed   ARM
 
Carrying amount of retained interests
  $ 52,246     $ 34,545     $ 21,562  
Fair value of retained interests
  $ 52,246     $ 35,341     $ 22,926  
Weighted average collateral life (in years)
  2.1 years   3.4 years   2.4 years
Conditional prepayment rate
  28% Fixed / 35% ARM     28 %     35 %
Impact on fair value of 10% adverse change
  $ (5,425 )   $ (45 )   $ 146  
Impact on fair value of 20% adverse change
  $ (10,052 )   $ 357     $ 267  
Discount rate (annual rate)
    15 %     14 %     14 %
Impact on fair value of 10% adverse change
  $ (2,507 )   $ (827 )   $ (392 )
Impact on fair value of 20% adverse change
  $ (4,846 )   $ (1,622 )   $ (771 )
 
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.
Also, BPPR retains servicing responsibilities on the sale of mortgage loans, which substantially have fixed interest rates. BPPR as servicer does not earn significant prepayment penalties on the underlying loans serviced. As of September 30, 2005, key economic assumptions used to estimate the fair value of MSRs recorded by BPPR and the sensitivity to immediate changes in those assumptions were as follows:

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(In thousands)   MSRs
 
Carrying amount of retained interests
  $ 60,837  
Fair value of retained interests
  $ 66,340  
Weighted average life (in years)
    9.0 years  
Conditional prepayment rate
    11.5 %
Impact on fair value of 10% adverse change
  $ (2,212 )
Impact on fair value of 20% adverse change
  $ (4,281 )
Discount rate (annual rate)
    10.0 %
Impact on fair value of 10% adverse change
    (2,246 )
Impact on fair value of 20% adverse change
  $ (4,351 )
 
The sensitivity analyses presented above for IOs and MSRs 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.
Note 9 — Commitments and Contingencies
In the normal course of business the Corporation has outstanding commercial letters of credit and stand-by letters of credit, which contract amounts at September 30, 2005 were $15 million and $251 million, respectively (December 31, 2004 — $19 million and $187 million; September 30, 2004 — $17 million and $151 million). There were also other commitments outstanding and contingent liabilities, such as commitments to extend credit and commitments to originate mortgage loans, which were not reflected in the accompanying financial statements.
At September 30, 2005, the Corporation recorded a liability of $425 thousand (December 31, 2004 - $333 thousand; September 30, 2004 — $277 thousand), 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. This liability was included as part of “other liabilities” in the consolidated statements of condition. The standby letters of credit were issued to guarantee the performance of various customers to third parties. The contract amounts in standby letters of credit outstanding 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.
The Corporation fully and unconditionally guarantees certain borrowing obligations issued by certain of its wholly-owned consolidated subsidiaries which aggregated $4.0 billion at September 30, 2005 (December 31, 2004 — $3.9 billion; September 30, 2004 — $3.9 billion). In addition, at September 30, 2005, the Corporation fully and unconditionally guaranteed $824 million of capital securities (December 31, 2004 — $824 million; September 30, 2004 — $444 million) issued by four (December 31, 2004 — four; September 30, 2004 — two) wholly-owned issuing trust entities that have been deconsolidated pursuant to FIN No. 46R. During the quarter ended March 31, 2005, Popular North America, Inc. concluded its full and unconditional guarantee of certain borrowing obligations issued by one of its non-banking subsidiaries, which as of September 30, 2004 and December 31, 2004 amounted to $495 million and $210 million, respectively.
The Corporation is a defendant in a number of legal proceedings arising in the normal course of business. Based on the opinion of legal counsel, management believes that the final disposition of these matters will not have a material adverse effect on the Corporation’s financial position or results of operations.

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Note 10 — Stock Option and Other Incentive Plans
Since 2001, 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. All outstanding award grants under the Stock Option Plan continue to remain outstanding at September 30, 2005 under the original terms of the Stock Option Plan.
The Corporation recognized $1.3 million and $3.0 million in stock option expense for the quarter and nine months ended September 30, 2005, respectively (September 30, 2004 — $0.6 million and $2.6 million, respectively).
The following table presents information on stock options at September 30, 2005:
                                         
(Not in thousands)                            
            Weighted Average   Weighted Average           Weighted Average
Exercise Price   Options   Exercise Price of   Remaining Life of   Options   Exercise Price of
Range per Share   Outstanding   Options Outstanding   Options Outstanding   Exercisable   Options Exercisable
 
$14.39 - $18.50
    1,600,385     $ 15.80     6.98 years     817,366     $ 15.61  
$19.25 - $27.20
    1,653,991     $ 25.29     8.76 years     241,340     $ 23.74  
 
$14.39 - $27.20
    3,254,376     $ 20.62     7.88 years     1,058,706     $ 17.46  
 
The following table summarizes the stock option activity and related information:
                 
    Options   Weighted-Average
(Not in thousands)   Outstanding   Exercise Price
 
Outstanding at January 1, 2004
    1,779,219     $ 15.88  
Granted
    997,232       23.95  
Exercised
    (110,681 )     15.82  
Forfeited
    (81,150 )     23.22  
 
Outstanding at December 31, 2004
    2,584,620     $ 18.76  
Granted
    707,342       27.20  
Exercised
    (37,586 )     16.56  
 
Outstanding at September 30, 2005
    3,254,376     $ 20.62  
 
The stock options exercisable at September 30, 2005 totaled 1,058,706 (September 30, 2004 — 642,545).
The fair value of the options was estimated on the date of the grants using the Black-Scholes Option Pricing Model. The weighted average assumptions used for the grants issued during 2005 and 2004 were:
                 
    2005   2004
 
Expected dividend yield
    2.56 %     2.00 %
Expected life of options
  10 years   10 years
Expected volatility
    17.54 %     16.50 %
Risk-free interest rate
    4.16 %     4.06 %
Weighted average fair value of options granted (per option)
  $ 5.95     $ 5.74  
 
During the quarter ended September 30, 2005, the Corporation granted 750 shares of restricted stock under the Incentive Plan for members of the Board of Directors of Popular, Inc. and BPPR. For the nine months ended September 30, 2005 there were 200,214 shares purchased and granted under the Incentive Plan for both corporate executive officers and members of the Board of Directors of Popular, Inc. and BPPR.

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Also, during the first quarter of 2005, the Compensation Committee approved incentive awards for certain corporate executive officers under the Incentive Plan based on the 2005 performance, payable in the form of restricted stock. Shares of restricted stock will be granted at the beginning of 2006 subject to the attainment of the established performance goals for 2005. During the quarter and nine months ended September 30, 2005, the Corporation recognized $1.3 million and $2.5 million, respectively, of restricted stock expense related to the executive officers incentive awards. The compensation cost was estimated based upon the shorter of the vesting period stipulated in the short and long-term incentive awards or the participant attaining 55 years of age.
During the quarter and nine months ended September 30, 2005, the Corporation recognized $158 thousand and $421 thousand, respectively, of restricted stock expense related to shares of restricted stock granted to members of the Board of Directors of Popular, Inc. and BPPR.
Note 11 — Pension and Other Benefits
The Corporation has noncontributory defined benefit pension plans and supplementary pension plans for regular employees of certain of its subsidiaries.
The components of net periodic pension cost for the quarters and nine months ended September 30, 2005 and 2004 were as follows:
                                                                 
    Pension Plans   Benefit Restoration Plans
    Quarters ended   Nine months ended   Quarters ended   Nine months ended
    September 30,   September 30,   September 30,   September 30,
(In thousands)   2005   2004   2005   2004   2005   2004   2005   2004
 
Service cost
  $ 3,858     $ 3,465     $ 11,689     $ 10,864     $ 240     $ 163     $ 720     $ 489  
Interest cost
    7,438       6,956       22,314       20,939       313       233       939       699  
Expected return on plan assets
    (10,281 )     (9,340 )     (30,462 )     (28,002 )     (203 )     (172 )     (609 )     (516 )
Amortization of asset obligation
    (215 )     (615 )     (645 )     (1,845 )                        
Amortization of prior service cost
    100       100       300       320       (27 )     (26 )     (81 )     (78 )
Amortization of net loss
    17       15       51       40       147       75       441       225  
 
Net periodic cost
    917       581       3,247       2,316       470       273       1,410       819  
Curtailment loss
                      849                          
Early retirement cost
                      2,219                          
 
Total cost
  $ 917     $ 581     $ 3,247     $ 5,384     $ 470     $ 273     $ 1,410     $ 819  
 
During the nine months ended September 30, 2005, contributions made to the pension and restoration plans approximated $2.8 million. The Corporation expects to contribute $0.8 million to the pension plans and $2.6 million to the benefit restoration plans during 2005.
The Corporation also provides certain health care benefits for retired employees of certain subsidiaries. The components of net periodic postretirement benefit cost for the quarters and nine months ended September 30, 2005 and 2004 were as follows:
                                 
    Postretirement benefit plan
    Quarters ended   Nine months ended
    September 30,   September 30,
(In thousands)   2005   2004   2005   2004
 
Service cost
  $ 680     $ 628     $ 2,033     $ 2,202  
Interest cost
    2,067       2,022       6,201       6,667  
Amortization of prior service cost
    (262 )     (239 )     (786 )     (764 )
Amortization of net loss
    423       334       1,269       1,712  
 
Net periodic cost
    2,908       2,745       8,717       9,817  
Curtailment gain
                      (1,005 )
Early retirement cost
                      347  
 
Total cost
  $ 2,908     $ 2,745     $ 8,717     $ 9,159  
 

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As of September 30, 2005, contributions made to the postretirement benefit plan approximated $4.6 million. The Corporation presently expects to contribute $6.7 million to the postretirement benefit plan during 2005.
Note 12 — Trust Preferred Securities
At September 30, 2005, 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 the provisions of FIN No. 46.
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.
                                 
(In thousands, including reference notes)
                    Popular North      
    BanPonce     Popular Capital     America Capital     Popular Capital  
Issuer   Trust I     Trust I     Trust I     Trust II  
 
Issuance date
  February 1997     October 2003     September 2004     November 2004  
Capital Securities
  $ 144,000     $ 300,000     $ 250,000     $ 130,000  
Distribution rate
    8.327 %     6.700 %     6.564 %     6.125 %
Common Securities
  $ 4,640     $ 9,279     $ 7,732     $ 4,021  
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. In 2003, the Corporation 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 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 46R.
(g) Same as (f) above, except that the investment company event does not apply for early redemption.

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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.
Under the Federal Reserve Board’s risk-based capital guidelines, the capital securities are includable in the Corporation’s Tier I capital.
Note 13 — Stockholders’ Equity
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 thereafter.
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 $285 million at September 30, 2005 (December 31, 2004 — $285 million; September 30, 2004 — $338 million). During the nine months ended September 30, 2005 and September 30, 2004 there were no transfers between the statutory reserve account and the retained earnings account.
Note 14 — Earnings per Common Share
The computation of earnings per common share and diluted earnings per common share follows:
                                 
    Quarter ended     Nine months ended  
    September 30,     September 30,  
(In thousands, except share information)   2005     2004     2005     2004  
 
Net income
  $ 115,216     $ 115,381     $ 410,455     $ 361,684  
Less: Preferred stock dividends
    2,979       2,979       8,935       8,935  
 
Net income applicable to common stock after cumulative effect of accounting change
  $ 112,237     $ 112,402     $ 401,520     $ 352,749  
 
Net income applicable to common stock before cumulative effect of accounting change
  $ 112,237     $ 112,402     $ 397,913     $ 352,749  
 
 
                               
Average common shares outstanding
    267,244,997       266,414,016       267,043,298       266,197,350  
Average potential common shares
    590,367       404,362       539,824       310,586  
 
Average common shares outstanding — assuming dilution
    267,835,364       266,818,378       267,583,122       266,507,936  
 
 
Basic earnings per common share before cumulative effect of accounting change
  $ 0.42     $ 0.42     $ 1.49     $ 1.32  
 
Diluted earnings per common share before cumulative effect of accounting change
  $ 0.42     $ 0.42     $ 1.49 *   $ 1.32  
 
Basic and diluted earnings per common share after cumulative effect of accounting change
  $ 0.42     $ 0.42     $ 1.50     $ 1.32  
 
*   Quarterly amounts for 2005 do not add to the year-to-date total due to rounding.

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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 the quarter and nine months periods ended September 30, 2005, there were 245,332 and 555,961 weighted average antidilutive stock options outstanding, respectively (September 30, 2004 – 943,347 and 929,350, respectively). All shares of restricted stock are treated as outstanding for purposes of this computation.
Note 15 — Supplemental Disclosure on the Consolidated Statements of Cash Flows
For the nine months ended September 30, 2005, the Corporation paid interest and income taxes amounting to $848 million and $158 million, respectively (September 30, 2004 – $562 million and $95 million, respectively). Loans receivable transferred to other real estate and other property for the nine months ended September 30, 2005, amounted to $105 million and $18 million, respectively (September 30, 2004 — $85 million and $20 million, respectively).
In addition, during the nine months ended September 30, 2005, the Corporation transferred $2.3 billion of mortgage loans held-in-portfolio to loans held-for-sale with the intent to securitize the financial assets in transactions structured as sales under the provisions of SFAS No. 140, or for future whole-loan sales in the secondary market. The transfer was accounted at lower of cost or fair value. Since the beginning of 2005, the Corporation, through its subsidiary PFH, completed four securitization transactions of mortgage loans held-for-sale which met the criteria for sale accounting under SFAS No. 140. The cash inflows from these transactions were reflected as part of operating activities in the consolidated statement of cash flows. During 2004, PFH’s securitization transactions did not meet the criteria for sale accounting under SFAS No. 140, as such the transactions were accounted as secured borrowings and the cash inflows were reflected as financing activities in the consolidated statement of cash flows.
Note 16 — Segment Reporting
In connection with the reorganization of the Corporation’s corporate structure during 2004, the Corporation realigned its business segments to reflect its new business structure, referred to by management as “business circles”. There is one circle for each of the Corporation’s four principal businesses – Popular Puerto Rico, United States Financial Services, Popular Financial Holdings and Processing. Each business circle has been identified as a reportable segment. Also, a corporate circle has been defined to support the business circles.
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 new organizational structure which focuses primarily towards products and services as well as on the markets the segments serve. Other factors, such as the credit risk characteristics of the loan products, distribution channels and clientele, were also considered in the determination of reportable segments.
Popular Puerto Rico:
Given that Popular Puerto Rico constitutes approximately 72% of the Corporation’s net income and 56% of its total assets as of September 30, 2005, 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

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      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.
United States Financial Services:
This reportable segment includes principally the activities of BPNA, including its subsidiaries Popular Leasing, U.S.A and Popular Insurance Agency, U.S.A. BPNA operates through a branch network of over 135 branches in six states. Popular Insurance Agency, U.S.A. offers investment and insurance services across the BPNA branch network. Popular Leasing, U.S.A. provides mainly small to mid-ticket commercial and medical equipment financing. The U.S. Financial Services segment also includes the retail financial services of Popular Cash Express, a fee driven business that serves the unbanked, retail customer. As stated in Note 1, the sale of PCE’s operations is expected to be completed during the fourth quarter of 2005.
Popular Financial Holdings:
This reportable segment corresponds to the Corporation’s consumer lending subsidiaries in the United States, principally Popular Financial Holdings, Inc. and its wholly-owned subsidiaries Equity One, Inc., Popular Financial Management, LLC, Popular Mortgage Servicing, Inc. and Popular Housing Services, Inc. These subsidiaries are primarily engaged in the business of originating non-prime mortgage and personal loans, acquiring retail installment contracts and providing warehouse lines to small and medium-sized mortgage companies. This segment also maintains a substantial wholesale broker network as well as loan servicing and asset acquisition units.
Processing:
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; and ATH Costa Rica, S.A. and CreST, S.A., located in Costa Rica. In addition, this reportable segment includes the equity investments in CONTADO 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.
Corporate:
Corporate 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 processing segment. The holding companies obtain funding in the capital markets to finance the Corporation’s growth, including acquisitions. The Corporate circle also includes the expenses of the four administrative corporate areas that were 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 business circles.
The Corporation may periodically reclassify business segment results based on modifications to its management reporting and profitability measurement methodologies and changes in organizational alignment.

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The accounting policies of the individual operating segments are the same as those of the Corporation described in Note 1. Transactions between operating segments are primarily conducted at fair value, resulting in profits that are eliminated for reporting consolidated results of operations.
Prior period amounts corresponding to the periods ended September 30, 2004 and December 31, 2004 have been restated to reflect changes in segment reporting.
2005
For the quarter ended September 30, 2005
                                                 
                    Popular                   Total
            U.S. Financial   Financial           Intersegment   Reportable
(In thousands)   Popular Puerto Rico   Services   Holdings   Processing   Eliminations   Segments
 
Net interest income (loss)
  $ 224,050     $ 88,430     $ 43,769     $ (84 )         $ 356,165  
Provision for loan losses
    25,268       6,750       17,942                   49,960  
Other income
    99,740       31,472       9,049       55,413     $ (35,080 )     160,594  
Amortization of intangibles
    633       1,676             78             2,387  
Depreciation expense
    10,171       3,835       1,311       4,472       (18 )     19,771  
Other operating expenses
    170,793       73,741       40,311       41,722       (35,196 )     291,371  
Income tax
    24,473       12,317       (2,336 )     3,204       (84 )     37,574  
 
 
Net income (loss)
  $ 92,452     $ 21,583     $ (4,410 )   $ 5,853     $ 218     $ 115,696  
 
 
Segment Assets
  $ 26,187,604     $ 12,201,801     $ 8,711,470     $ 251,989     $ (582,443 )   $ 46,770,421  
 
For the quarter ended September 30, 2005
                                 
    Total Reportable            
(In thousands)   Segments   Corporate   Eliminations   Popular, Inc.
 
Net interest income (loss)
  $ 356,165     $ (8,400 )   $ 345     $ 348,110  
Provision for loan losses
    49,960                   49,960  
Other income
    160,594       14,494       (40 )     175,048  
Amortization of intangibles
    2,387                   2,387  
Depreciation expense
    19,771       377             20,148  
Other operating expenses
    291,371       15,547       (40 )     306,878  
Income tax
    37,574       (9,235 )     230       28,569  
 
 
Net income (loss)
  $ 115,696     $ (595 )   $ 115     $ 115,216  
 
 
Segment Assets
  $ 46,770,421     $ 6,160,815     $ (5,811,128 )   $ 47,120,108  
 

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For the nine months ended September 30, 2005
                                                 
                    Popular                   Total
    Popular Puerto   U.S. Financial   Financial           Intersegment   Reportable
(In thousands)   Rico   Services   Holdings   Processing   Eliminations   Segments
 
Net interest income (loss)
  $ 669,778     $ 265,033     $ 153,173     $ (386 )         $ 1,087,598  
Provision for loan losses
    74,679       21,045       48,508                   144,232  
Other income
    316,991       87,976       36,898       166,070     $ (105,641 )     502,294  
Amortization of intangibles
    1,889       4,732             149             6,770  
Depreciation expense
    31,409       11,535       3,553       13,191       (54 )     59,634  
Other operating expenses
    507,034       217,094       118,840       123,057       (105,220 )     860,805  
Income tax
    79,493       36,760       7,375       9,832       (197 )     133,263  
 
Net income before cumulative effect of accounting change
  $ 292,265     $ 61,843     $ 11,795     $ 19,455     $ (170 )   $ 385,188  
Cumulative effect of accounting change
    3,221       (209 )           412       (247 )     3,177  
 
Net income after cumulative effect of accounting change
  $ 295,486     $ 61,634     $ 11,795     $ 19,867     $ (417 )   $ 388,365  
 
For the nine months ended September 30, 2005
                                 
    Total Reportable            
(In thousands)   Segments   Corporate   Eliminations   Popular, Inc.
 
Net interest income (loss)
  $ 1,087,598     $ (25,806 )   $ 1,034     $ 1,062,826  
Provision for loan losses
    144,232                   144,232  
Other income
    502,294       68,880       (79 )     571,095  
Amortization of intangibles
    6,770                   6,770  
Depreciation expense
    59,634       1,133             60,767  
Other operating expenses
    860,805       42,183       (79 )     902,909  
Income tax
    133,263       (21,266 )     398       112,395  
 
Net income before cumulative effect of accounting change
  $ 385,188     $ 21,024     $ 636     $ 406,848  
Cumulative effect of accounting change
    3,177       430             3,607  
 
Net income after cumulative effect of accounting change
  $ 388,365     $ 21,454     $ 636     $ 410,455  
 
2004
For the quarter ended September 30, 2004
                                                 
                    Popular                   Total
    Popular Puerto   U.S. Financial   Financial           Intersegment   Reportable
(In thousands)   Rico   Services   Holdings   Processing   Eliminations   Segments
 
Net interest income (loss)
  $ 220,890     $ 73,375     $ 63,686     $ 100     $ (17 )   $ 358,034  
Provision for loan losses
    24,800       8,561       13,253                   46,614  
Other income
    91,175       23,816       5,576       49,525       (30,289 )     139,803  
Amortization of intangibles
    635       1,335             13             1,983  
Depreciation expense
    10,160       3,315       1,039       3,793       (18 )     18,289  
Other operating expenses
    159,674       58,883       35,700       41,342       (30,473 )     265,126  
Income tax
    21,967       8,606       7,227       1,114       75       38,989  
 
Net income
  $ 94,829     $ 16,491     $ 12,043     $ 3,363     $ 110     $ 126,836  
 
Segment Assets
  $ 24,199,704     $ 9,965,389     $ 8,513,233     $ 222,604     $ (353,200 )   $ 42,547,730  
 

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For the quarter ended September 30, 2004
                                 
    Total Reportable            
(In thousands)   Segments   Corporate   Eliminations   Popular, Inc.
 
Net interest income (loss)
  $ 358,034     $ (10,036 )   $ 194     $ 348,192  
Provision for loan losses
    46,614                   46,614  
Other income
    139,803       4,771       (18 )     144,556  
Amortization of intangibles
    1,983             1       1,984  
Depreciation expense
    18,289       261             18,550  
Other operating expenses
    265,126       12,233       (20 )     277,339  
Income tax
    38,989       (6,211 )     102       32,880  
 
Net income (loss)
  $ 126,836     $ (11,548 )   $ 93     $ 115,381  
 
Segment Assets
  $ 42,547,730     $ 5,145,171     $ (4,837,307 )   $ 42,855,594  
 
For the nine months ended September 30, 2004
                                                 
                    Popular                   Total
    Popular Puerto   U.S. Financial   Financial           Intersegment   Reportable
(In thousands)   Rico   Services   Holdings   Processing   Eliminations   Segments
 
Net interest income (loss)
  $ 657,506     $ 194,649     $ 193,514     $ (1,447 )   $ (47 )   $ 1,044,175  
Provision for loan losses
    72,230       24,069       36,342                   132,641  
Other income
    270,313       68,037       15,484       150,406       (78,136 )     426,104  
Amortization of intangibles
    1,916       3,628             41             5,585  
Depreciation expense
    30,366       9,862       2,810       10,437       943       54,418  
Other operating expenses
    459,558       168,186       103,440       123,877       (80,260 )     774,801  
Income tax
    67,937       19,740       24,902       3,631       449       116,659  
 
Net income
  $ 295,812     $ 37,201     $ 41,504     $ 10,973     $ 685     $ 386,175  
 
For the nine months ended September 30, 2004
                                 
    Total Reportable            
(In thousands)   Segments   Corporate   Eliminations   Popular, Inc.
 
Net interest income (loss)
  $ 1,044,175     $ (25,142 )   $ 576     $ 1,019,609  
Provision for loan losses
    132,641                   132,641  
Other income
    426,104       22,724       (67 )     448,761  
Amortization of intangibles
    5,585             1       5,586  
Depreciation expense
    54,418       668             55,086  
Other operating expenses
    774,801       33,867       (69 )     808,599  
Income tax
    116,659       (12,101 )     216       104,774  
 
Net income (loss)
  $ 386,175     $ (24,852 )   $ 361     $ 361,684  
 
During the nine-month period ended September 30, 2005, Popular Financial Holdings recorded other-than temporary impairment losses of $11.7 million on the valuation of the interest-only strips derived from the off-balance sheet securitizations. These unfavorable adjustments are included in the caption of “other income” in the corresponding tables above and resulted primarily from higher prepayments than anticipated caused by continued low long-term interest rates.

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During the quarter and nine months ended September 30, 2005, the holding companies realized net gains on sale of marketable equity securities (before tax) of approximately $9.2 million and $59.7 million, respectively. No such net gains were realized in the third quarter of 2004, while for the nine-month period ended September 30, 2004, the net gains (before tax) approximated $12.7 million. These net gains are included in “other income” within the “Corporate” circle.
Additional disclosures with respect to Popular Puerto Rico reportable segment follow:
2005
For the quarter ended September 30, 2005
                                         
    Commercial   Consumer and   Other Financial           Total Popular
(In thousands)   Banking   Retail Banking   Services   Eliminations   Puerto Rico
 
Net interest income
  $ 77,891     $ 143,034     $ 3,108     $ 17     $ 224,050  
Provision for loan losses
    6,920       18,348                   25,268  
Other income
    38,789       42,411       20,745       (2,205 )     99,740  
Amortization of intangibles
    225       332       76             633  
Depreciation expense
    3,901       5,970       300             10,171  
Other operating expenses
    55,806       99,663       15,656       (332 )     170,793  
Income tax
    12,278       10,185       2,748       (738 )     24,473  
 
Net income
  $ 37,550     $ 50,947     $ 5,073     $ (1,118 )   $ 92,452  
 
Segment Assets
  $ 10,216,277     $ 18,119,091     $ 968,357     $ (3,116,121 )   $ 26,187,604  
 
For the nine months ended September 30, 2005
                                         
    Commercial   Consumer and   Other Financial           Total Popular
(In thousands)   Banking   Retail Banking   Services   Eliminations   Puerto Rico
 
Net interest income
  $ 223,959     $ 435,873     $ 9,929     $ 17     $ 669,778  
Provision for loan losses
    21,425       53,254                   74,679  
Other income
    122,187       139,053       57,178       (1,427 )     316,991  
Amortization of intangibles
    665       993       231             1,889  
Depreciation expense
    11,259       19,112       1,038             31,409  
Other operating expenses
    165,325       299,287       43,486       (1,064 )     507,034  
Income tax
    34,373       37,770       7,502       (152 )     79,493  
 
Net income before cumulative effect of accounting change
  $ 113,099     $ 164,510     $ 14,850     $ (194 )   $ 292,265  
Cumulative effect of accounting change
          3,797       755       (1,331 )     3,221  
 
Net income after cumulative effect of accounting change
  $ 113,099     $ 168,307     $ 15,605     $ (1,525 )   $ 295,486  
 

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2004
For the quarter ended September 30, 2004
                                         
    Commercial   Consumer and   Other Financial           Total Popular
(In thousands)   Banking   Retail Banking   Services   Eliminations   Puerto Rico
 
Net interest income
  $ 80,013     $ 136,641     $ 4,236           $ 220,890  
Provision for loan losses
    3,760       21,040                   24,800  
Other income
    38,090       36,599       17,210     $ (724 )     91,175  
Amortization of intangibles
          558       77             635  
Depreciation expense
    4,023       5,812       325             10,160  
Other operating expenses
    53,465       93,211       13,368       (370 )     159,674  
Income tax
    14,368       4,019       3,737       (157 )     21,967  
 
Net income
  $ 42,487     $ 48,600     $ 3,939     $ (197 )   $ 94,829  
 
Segment Assets
  $ 8,874,581     $ 16,192,053     $ 1,154,603     $ (2,021,533 )   $ 24,199,704  
 
For the nine months ended September 30, 2004
                                         
    Commercial   Consumer and   Other Financial           Total Popular
(In thousands)   Banking   Retail Banking   Services   Eliminations   Puerto Rico
 
Net interest income
  $ 213,439     $ 431,688     $ 12,379           $ 657,506  
Provision for loan losses
    10,821       61,409                   72,230  
Other income
    114,618       108,191       48,817     $ (1,313 )     270,313  
Amortization of intangibles
          1,685       231             1,916  
Depreciation expense
    10,541       18,748       1,077             30,366  
Other operating expenses
    147,099       276,599       36,589       (729 )     459,558  
Income tax
    34,416       25,725       8,024       (228 )     67,937  
 
Net income
  $ 125,180     $ 155,713     $ 15,275     $ (356 )   $ 295,812  
 
For the nine months ended September 30, 2005, the “commercial banking” and “consumer and retail banking” business areas within Popular Puerto Rico included $4.9 million and $3.4 million, respectively, in gains on the sale of various real estate properties. These gains totaled $10.9 million for the quarter and nine months ended September 30, 2004, and are all included as part of “other income” in the “commercial banking” business area within Popular Puerto Rico.
                                 
INTERSEGMENT REVENUES   Quarter ended   Nine months ended
    September 30,   September 30,   September 30,   September 30,
(In thousands)   2005   2004   2005   2004
 
Popular Puerto Rico:
                               
P.R. Commercial Banking
  $ (363 )   $ (221 )   $ (1,047 )   $ (841 )
P.R. Consumer and Retail Banking
    (891 )     (504 )     (2,368 )     (1,568 )
P.R. Other Financial Services
    (129 )     (72 )     (370 )     (150 )
U.S. Financial Services
    280       27       590       322  
Popular Financial Holdings
    934       648       2,681       1,863  
Processing
    (34,911 )     (30,184 )     (105,127 )     (77,809 )
 
Total reportable segments
  $ (35,080 )   $ (30,306 )   $ (105,641 )   $ (78,183 )
 
The increase in intersegment revenues for the nine months ended September 30, 2005, compared with the corresponding period in the previous year, for the “Processing” segment corresponds to financial transaction processing and information technology services provided by EVERTEC to other subsidiaries of the Corporation. As a result of the reorganization to consolidate the information processing and technology functions into EVERTEC effective during the second quarter of 2004, certain internal services previously provided by BPPR or internally serviced by other subsidiaries, are being provided by EVERTEC. The revenues are categorized by the service provider as “other income” while the service receivers categorize the amounts billed as “other operating expenses.”

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Geographic Information
                                 
    Quarter ended   Nine months ended
    September 30,   September 30,   September 30,   September 30,
(In thousands)   2005   2004   2005   2004
 
Revenues**
                               
Puerto Rico
  $ 340,441     $ 314,031     $ 1,058,100     $ 953,816  
United States
    170,164       164,337       528,619       469,968  
Other
    12,553       14,380       47,202       44,586  
         
Total consolidated revenues
  $ 523,158     $ 492,748     $ 1,633,921     $ 1,468,370  
 
**   Total revenues include net interest income, service charges on deposit accounts, other service fees, net gain (loss) on sale and valuation adjustment of investment securities, trading account profit (loss), gain on sale of loans and other operating income.
                         
    September 30,   December 31,   September 30,
(In thousands)   2005   2004   2004
 
Selected Balance Sheet Information:
                       
Puerto Rico
                       
Total assets
  $ 25,956,498     $ 24,226,240     $ 23,598,519  
Loans
    13,513,112       12,540,668       12,008,580  
Deposits
    13,083,189       12,630,045       12,635,000  
Mainland United States
                       
Total assets
  $ 20,141,315     $ 19,303,924     $ 18,429,063  
Loans
    16,506,652       15,736,033       15,061,145  
Deposits
    8,376,354       6,898,517       6,850,482  
Other
                       
Total assets
  $ 1,022,295     $ 871,412     $ 828,012  
Loans
    530,319       465,560       447,573  
Deposits *
    1,119,166       1,064,598       997,736  
 
*   Represents deposits from BPPR operations located in the U.S. and British Virgin Islands
Note 17 — Condensed Consolidating Financial Information of Guarantor and Issuers of Registered Guaranteed Securities:
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 September 30, 2005, December 31, 2004 and September 30, 2004, and the results of their operations and cash flows for the periods ended September 30, 2005 and 2004.
PIBI, PNA, and their wholly-owned subsidiaries, except for Banco Popular North America (“BPNA”) and Banco Popular, National Association (“BP, N.A.”), had a fiscal year that ended on November 30. Accordingly, the consolidated financial information of PIBI and PNA as of August 31, 2004 and November 30, 2004, corresponded to their financial information included in the consolidated financial statements of Popular, Inc. as of September 30, 2004 and December 31, 2004.
As stated in Note 1, in 2005, the Corporation commenced a two-year plan to change its non-banking subsidiaries to a calendar reporting year-end. As of September 30, 2005, Popular Securities, Inc., Popular North America (holding company), Popular FS, LLC and Popular Financial Holdings, Inc. (“PFH”), including its wholly-owned subsidiaries, continue to have a fiscal year that ends on November 30. Accordingly, their financial information as of August 31, 2005 corresponds to their financial information included in the consolidated financial statements of Popular, Inc. as of September 30, 2005. All other subsidiaries have aligned their year end closing to that of the Corporation’s calendar year.

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PIBI is an operating subsidiary of PIHC and is the holding company of its wholly-owned subsidiaries, ATH Costa Rica, CreST, S.A., Popular Insurance V.I., Inc. and PNA.
PNA is an operating subsidiary of PIBI and is the holding company of its wholly-owned subsidiaries:
  -   Popular Cash Express, Inc.;
 
  -   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 Leasing, U.S.A., Popular Insurance Agency, U.S.A. and Popular FS, LLC;
 
  -   BP, N.A., including its wholly-owned subsidiary Popular Insurance, Inc.
PIHC, PIBI and PNA are authorized issuers of debt securities and preferred stock under a shelf registration filed with the SEC.
PIHC fully and unconditionally guarantees all registered debt securities and preferred stock issued by PIBI and PNA.
The principal source of income for PIHC consists of dividends from BPPR. As a member of the Federal Reserve System, BPPR is subject to the regulations of the Federal Reserve Board. BPPR must obtain the approval of the Federal Reserve Board for any dividend if the total of all dividends declared by it 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. At September 30, 2005, BPPR could have declared a dividend of approximately $210 million without the approval of the Federal Reserve Board (September 30, 2004 — $272 million; December 31, 2004 — $222 million). Refer to Popular, Inc.’s Form 10-K for the year ended December 31, 2004 for further information on dividend restrictions imposed by regulatory requirements and policies on the payment of dividends by BPPR, BPNA and BP, N.A.

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POPULAR, INC.
CONDENSED CONSOLIDATING STATEMENT OF CONDITION
SEPTEMBER 30, 2005
(UNAUDITED)
                                                 
    Popular, Inc.   PIBI   PNA   All other   Elimination   Popular, Inc.
(In thousands)   Holding Co.   Holding Co.   Holding Co.   Subsidiaries   Entries   Consolidated
 
ASSETS
                                               
Cash and due from banks
  $ 781     $ 3,032     $ 419     $ 940,348     $ (55,435 )   $ 889,145  
Money market investments
    164,300       300       220       1,196,681       (723,280 )     638,221  
Investment securities available-for-sale, at market value
    17,654       68,536       7,295       11,398,575       1,148       11,493,208  
Investment securities held-to-maturity, at amortized cost
    430,000       2,174               357,054       (430,000 )     359,228  
Other investment securities, at lower of cost or realizable value
    145,785       5,001       12,642       167,713               331,141  
Trading account securities, at market value
                            542,755       (766 )     541,989  
Investment in subsidiaries
    3,066,272       1,153,679       1,507,428       458,779       (6,186,158 )        
Loans held-for-sale, at lower of cost or market
                            702,559       164,500       867,059  
       
Loans held-in-portfolio
    25,927               3,210,339       33,067,354       (6,326,840 )     29,976,780  
Less – Unearned income
                            293,756               293,756  
Allowance for loan losses
    40                       459,385               459,425  
       
 
    25,887               3,210,339       32,314,213       (6,326,840 )     29,223,599  
           
Premises and equipment
    23,405                       569,104       (259 )     592,250  
Other real estate
    18                       77,975               77,993  
Accrued income receivable
    572       35       11,777       268,680       (19,967 )     261,097  
Other assets
    49,852       41,568       20,518       1,157,075       7,563       1,276,576  
Goodwill
                            525,036               525,036  
Other intangible assets
                            43,566               43,566  
     
 
  $ 3,924,526     $ 1,274,325     $ 4,770,638     $ 50,720,113     $ (13,569,494 )   $ 47,120,108  
             
 
                                               
LIABILITIES AND STOCKHOLDERS’ EQUITY
                                               
Liabilities:
                                               
Deposits:
                                               
Non-interest bearing
                          $ 3,788,585       ($55,359 )   $ 3,733,226  
Interest bearing
                            19,237,755       (392,272 )     18,845,483  
       
 
                            23,026,340       (447,631 )     22,578,709  
Federal funds purchased and assets sold under agreements to repurchase
                  $ 132,635       8,201,162       (316,014 )     8,017,783  
Other short-term borrowings
          $ 41,663       600,117       4,153,601       (1,886,858 )     2,908,523  
Notes payable
  $ 527,086               2,837,729       10,408,944       (4,209,334 )     9,564,425  
Subordinated notes
    125,000                       430,000       (430,000 )     125,000  
Other liabilities
    51,044       586       55,629       641,172       (44,260 )     704,171  
             
 
    703,130       42,249       3,626,110       46,861,219       (7,334,097 )     43,898,611  
             
Minority interest in consolidated subsidiaries
                            101               101  
     
Stockholders’ equity:
                                               
Preferred stock
    186,875                                       186,875  
Common stock
    1,683,629       3,962       2       70,385       (74,349 )     1,683,629  
Surplus
    289,807       815,193       734,964       2,140,696       (3,688,242 )     292,418  
Retained earnings
    1,405,744       452,470       424,085       1,770,058       (2,649,224 )     1,403,133  
Accumulated other comprehensive loss, net of tax
    (137,578 )     (39,549 )     (14,523 )     (120,012 )     174,084       (137,578 )
Treasury stock, at cost
    (207,081 )                     (2,334 )     2,334       (207,081 )
         
 
    3,221,396       1,232,076       1,144,528       3,858,793       (6,235,397 )     3,221,396  
             
 
  $ 3,924,526     $ 1,274,325     $ 4,770,638     $ 50,720,113       ($13,569,494 )   $ 47,120,108  
             

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POPULAR, INC.
CONDENSED CONSOLIDATING STATEMENT OF CONDITION
DECEMBER 31, 2004
(UNAUDITED)
                                                 
    Popular, Inc.   PIBI   PNA   All other   Elimination   Popular, Inc.
(In thousands)   Holding Co.   Holding Co.   Holding Co.   Subsidiaries   Entries   Consolidated
 
ASSETS
                                               
Cash and due from banks
  $ 283     $ 54     $ 384     $ 767,092     $ (51,354 )   $ 716,459  
Money market investments
    48,500       300       214       1,236,659       (406,033 )     879,640  
Investment securities available-for-sale, at market value
    66,428       39,207       7,067       11,054,856       (5,413 )     11,162,145  
Investment securities held-to-maturity, at amortized cost
    579,985                       190,865       (430,000 )     340,850  
Other investment securities, at lower of cost or realizable value
    145,590       5,001       12,372       139,477               302,440  
Trading account securities, at market value
                            391,420       (6,281 )     385,139  
Investment in subsidiaries
    2,878,211       1,036,960       1,376,296       287,639       (5,579,106 )        
Loans held-for-sale, at lower of cost or market value
                            750,728               750,728  
     
Loans held-in-portfolio
    41,509               2,836,701       30,711,045       (5,335,332 )     28,253,923  
Less – Unearned income
                            262,390               262,390  
Allowance for loan losses
    40                       437,041               437,081  
       
 
    41,469               2,836,701       30,011,614       (5,335,332 )     27,554,452  
           
Premises and equipment
    24,534                       521,460       (313 )     545,681  
Other real estate
    240                       59,477               59,717  
Accrued income receivable
    185               10,836       213,977       (17,456 )     207,542  
Other assets
    45,178       36,905       65,662       1,012,132       (113,503 )     1,046,374  
Goodwill
                            411,308               411,308  
Other intangible assets
                            39,101               39,101  
     
 
  $ 3,830,603     $ 1,118,427     $ 4,309,532     $ 47,087,805       ($11,944,791 )   $ 44,401,576  
             
LIABILITIES AND STOCKHOLDERS’ EQUITY
                                               
Liabilities:
                                               
Deposits:
                                               
Non-interest bearing
                          $ 4,224,546       ($51,278 )   $ 4,173,268  
Interest bearing
                            16,685,578       (265,686 )     16,419,892  
       
 
                            20,910,124       (316,964 )     20,593,160  
Federal funds purchased and assets sold under agreements to repurchase
  $ 6,690             $ 71,300       6,492,165       (133,302 )     6,436,853  
Other short-term borrowings
    4,501     $ 4,825       339,653       3,962,975       (1,172,315 )     3,139,639  
Notes payable
    536,673               2,835,325       10,839,526       (4,030,814 )     10,180,710  
Subordinated notes
    125,000                       430,000       (430,000 )     125,000  
Other liabilities
    53,118       100       35,048       966,387       (233,162 )     821,491  
             
 
    725,982       4,925       3,281,326       43,601,177       (6,316,557 )     41,296,853  
             
Minority interest in consolidated subsidiaries
                            102               102  
     
Stockholders’ equity:
                                               
Preferred stock
    186,875                                       186,875  
Common stock
    1,680,096       3,961       2       77,393       (81,356 )     1,680,096  
Surplus
    276,229       740,193       659,964       1,805,514       (3,203,060 )     278,840  
Retained earnings
    1,132,404       381,496       368,661       1,612,126       (2,364,894 )     1,129,793  
Accumulated other comprehensive income (loss), net of tax
    35,454       (12,148 )     (421 )     (6,817 )     19,386       35,454  
Treasury stock, at cost
    (206,437 )                     (1,690 )     1,690       (206,437 )
         
 
    3,104,621       1,113,502       1,028,206       3,486,526       (5,628,234 )     3,104,621  
             
 
  $ 3,830,603     $ 1,118,427     $ 4,309,532     $ 47,087,805     $ (11,944,791 )   $ 44,401,576  
             

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POPULAR, INC.
CONDENSED CONSOLIDATING STATEMENT OF CONDITION
SEPTEMBER 30, 2004
(UNAUDITED)
                                                 
    Popular, Inc.   PIBI   PNA   All other   Elimination   Popular, Inc.
(In thousands)   Holding Co.   Holding Co.   Holding Co.   Subsidiaries   Entries   Consolidated
 
ASSETS
                                               
Cash and due from banks
  $ 282     $ 20     $ 618     $ 817,199     $ (60,062 )   $ 758,057  
Money market investments
    72,400       300       242       1,185,216       (412,490 )     845,668  
Investment securities available-for-sale, at market value
    57,904       36,070       7,091       11,170,902       (32,348 )     11,239,619  
Investment securities held-to-maturity, at amortized cost
                            137,317               137,317  
Other investment securities, at lower of cost or realizable value
    441,813       5,001       4,640       125,067       (300,000 )     276,521  
Trading account securities, at market value
                            321,974       (611 )     321,363  
Investment in subsidiaries
    2,948,181       1,010,400       1,395,115       367,695       (5,721,391 )        
Loans held-for-sale, at lower of cost or market value
                            265,753               265,753  
     
Loans held-in-portfolio
    41,537               2,690,267       29,833,774       (5,040,934 )     27,524,644  
Less — Unearned income
                            273,099               273,099  
Allowance for loan losses
    47                       445,798               445,845  
       
 
    41,490               2,690,267       29,114,877       (5,040,934 )     26,805,700  
           
Premises and equipment
    24,849                       510,870       (331 )     535,388  
Other real estate
    827                       57,987               58,814  
Accrued income receivable
    209               10,839       233,935       (17,724 )     227,259  
Other assets
    30,839       34,646       2,427       874,938       3,358       946,208  
Goodwill
                            394,316               394,316  
Other intangible assets
                            43,611               43,611  
     
 
  $ 3,618,794     $ 1,086,437     $ 4,111,239     $ 45,621,657     $ (11,582,533 )   $ 42,855,594  
             
 
                                               
LIABILITIES AND STOCKHOLDERS’ EQUITY
                                               
Liabilities:
                                               
Deposits:
                                               
Non-interest bearing
                          $ 4,136,521     $ (59,986 )   $ 4,076,535  
Interest bearing
                            16,630,218       (223,535 )     16,406,683  
       
 
                            20,766,739       (283,521 )     20,483,218  
Federal funds purchased and assets sold under agreements to repurchase
                  $ 112,000       7,394,309       (200,074 )     7,306,235  
Other short-term borrowings
  $ 35,000     $ 4,761       359,670       3,019,932       (964,491 )     2,454,872  
Notes payable
    393,929               2,596,028       9,838,918       (4,054,007 )     8,774,868  
Subordinated notes
    125,000                                       125,000  
Other liabilities
    54,370       86       41,853       636,335       (31,842 )     700,802  
             
 
    608,299       4,847       3,109,551       41,656,233       (5,533,935 )     39,844,995  
             
Minority interest in consolidated subsidiaries
                            104               104  
     
Stockholders’ equity:
                                               
Preferred stock
    186,875                       300,000       (300,000 )     186,875  
Common stock
    1,678,675       3,962       2       69,393       (73,357 )     1,678,675  
Surplus
    324,755       740,193       659,964       1,850,745       (3,248,291 )     327,366  
Retained earnings
    996,817       350,070       339,695       1,748,323       (2,440,699 )     994,206  
Accumulated other comprehensive income (loss), net of tax
    29,810       (12,635 )     2,027       (1,451 )     12,059       29,810  
Treasury stock, at cost
    (206,437 )                     (1,690 )     1,690       (206,437 )
         
 
    3,010,495       1,081,590       1,001,688       3,965,320       (6,048,598 )     3,010,495  
             
 
  $ 3,618,794     $ 1,086,437     $ 4,111,239     $ 45,621,657     $ (11,582,533 )   $ 42,855,594  
             

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POPULAR, INC.
CONDENSED CONSOLIDATING STATEMENT OF INCOME
FOR THE QUARTER ENDED SEPTEMBER 30, 2005
(UNAUDITED)
                                                 
    Popular, Inc.   PIBI   PNA   All other   Elimination   Popular, Inc.
(In thousands)   Holding Co.   Holding Co.   Holding Co.   Subsidiaries   Entries   Consolidated
 
INTEREST INCOME:
                                               
Loans
  $ 542             $ 35,544     $ 550,328     $ (59,280 )   $ 527,134  
Money market investments
    1,151     $ 2       9       10,428       (4,088 )     7,502  
Investment securities
    7,637       289       316       122,442       (6,983 )     123,701  
Trading account securities
                            7,751               7,751  
     
 
    9,330       291       35,869       690,949       (70,351 )     666,088  
             
INTEREST EXPENSE:
                                               
Deposits
                            115,101       (1,302 )     113,799  
Short-term borrowings
    68       426       4,098       99,634       (15,013 )     89,213  
Long-term debt
    11,026               38,644       121,615       (56,319 )     114,966  
           
 
    11,094       426       42,742       336,350       (72,634 )     317,978  
             
Net interest (loss) income
    (1,764 )     (135 )     (6,873 )     354,599       2,283       348,110  
Provision for loan losses
                            49,960               49,960  
     
Net interest (loss) income after provision for loan losses
    (1,764 )     (135 )     (6,873 )     304,639       2,283       298,150  
Service charges on deposit accounts
                            46,836               46,836  
Other service fees
                            111,190       (26,186 )     85,004  
Net gain (loss) on sale and valuation adjustment of investment securities
            9,237               (9,648 )     (509 )     (920 )
Trading account profit
                            4,529       178       4,707  
Gain on sale of loans
                            23,768       (6,183 )     17,585  
Other operating income
    3,292       2,877               25,472       (9,805 )     21,836  
           
 
    1,528       11,979       (6,873 )     506,786       (40,222 )     473,198  
             
OPERATING EXPENSES:
                                               
Personnel costs:
                                               
Salaries
            92               120,877       (957 )     120,012  
Profit sharing
                            4,890               4,890  
Pension and other benefits
            14               30,038       (272 )     29,780  
         
 
            106               155,805       (1,229 )     154,682  
Net occupancy expenses
            4               27,715               27,719  
Equipment expenses
    8               2       31,190       (15 )     31,185  
Other taxes
    237                       10,131               10,368  
Professional fees
    1,299       4       9       60,584       (34,008 )     27,888  
Communications
    18                       15,640       (18 )     15,640  
Business promotion
    1,967                       21,973               23,940  
Printing and supplies
                            4,845               4,845  
Other operating expenses
    (3,265 )     5       112       34,265       (358 )     30,759  
Amortization of intangibles
                            2,387               2,387  
     
 
    264       119       123       364,535       (35,628 )     329,413  
             
Income (loss) before income tax and equity in earnings of subsidiaries
    1,264       11,860       (6,996 )     142,251       (4,594 )     143,785  
Income tax
                    (2,463 )     32,301       (1,269 )     28,569  
         
Income (loss) before equity in earnings of subsidiaries
    1,264       11,860       (4,533 )     109,950       (3,325 )     115,216  
Equity in earnings of subsidiaries
    113,952       10,867       14,951       4,277       (144,047 )        
           
NET INCOME
  $ 115,216     $ 22,727     $ 10,418     $ 114,227     $ (147,372 )   $ 115,216  
             

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POPULAR, INC.
CONDENSED CONSOLIDATING STATEMENT OF INCOME
FOR THE QUARTER ENDED SEPTEMBER 30, 2004
(UNAUDITED)
                                                 
    Popular, Inc.   PIBI   PNA   All other   Elimination   Popular, Inc.
(In thousands)   Holding Co.   Holding Co.   Holding Co.   Subsidiaries   Entries   Consolidated
 
INTEREST INCOME:
                                               
Loans
  $ 514             $ 31,693     $ 461,903       ($48,906 )   $ 445,204  
Money market investments
    359     $ 1       116       8,543       (2,507 )     6,512  
Investment securities
    676               189       105,312       145       106,322  
Trading account securities
                            5,729               5,729  
     
 
    1,549       1       31,998       581,487       (51,268 )     563,767  
             
INTEREST EXPENSE:
                                               
Deposits
                            84,300       (833 )     83,467  
Short-term borrowings
    163       17       1,537       50,079       (6,966 )     44,830  
Long-term debt
    8,917               32,950       90,652       (45,241 )     87,278  
           
 
    9,080       17       34,487       225,031       (53,040 )     215,575  
             
Net interest (loss) income
    (7,531 )     (16 )     (2,489 )     356,456       1,772       348,192  
Provision for loan losses
                            46,614               46,614  
     
Net interest (loss) income after provision for loan losses
    (7,531 )     (16 )     (2,489 )     309,842       1,772       301,578  
Service charges on deposit accounts
                            41,455               41,455  
Other service fees
                            95,536       (24,473 )     71,063  
Trading account profit
                            1,024       (221 )     803  
Gain on sale of loans
                            16,970       (5,115 )     11,855  
Other operating income
    4,112       987               21,015       (6,734 )     19,380  
           
 
    (3,419 )     971       (2,489 )     485,842       (34,771 )     446,134  
             
OPERATING EXPENSES:
                                               
Personnel costs:
                                               
Salaries
            82               109,118       (393 )     108,807  
Profit sharing
                            5,083               5,083  
Pension and other benefits
            12               28,845       (95 )     28,762  
         
 
                                               
 
            94               143,046       (488 )     142,652  
Net occupancy expenses
            3               23,569               23,572  
Equipment expenses
    2                       28,614       (15 )     28,601  
Other taxes
    273                       8,996               9,269  
Professional fees
    392               57       55,749       (30,077 )     26,121  
Communications
    34                       15,690       (18 )     15,706  
Business promotion
                            20,492               20,492  
Printing and supplies
                            4,069               4,069  
Other operating expenses
    477       20       134       25,203       (427 )     25,407  
Amortization of intangibles
                            1,984               1,984  
     
 
    1,178       117       191       327,412       (31,025 )     297,873  
             
(Loss) income before income tax and equity in earnings of subsidiaries
    (4,597 )     854       (2,680 )     158,430       (3,746 )     148,261  
Income tax
    (1,037 )             (840 )     35,784       (1,027 )     32,880  
 
(Loss) income before equity in earnings of subsidiaries
    (3,560 )     854       (1,840 )     122,646       (2,719 )     115,381  
Equity in earnings of subsidiaries
    118,941       28,075       29,735       13,770       (190,521 )        
 
NET INCOME
  $ 115,381     $ 28,929     $ 27,895     $ 136,416       ($193,240 )   $ 115,381  
             

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POPULAR, INC.
CONDENSED CONSOLIDATING STATEMENT OF INCOME
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005
(UNAUDITED)
                                                 
    Popular, Inc.   PIBI   PNA   All other   Elimination   Popular, Inc.
(In thousands)   Holding Co.   Holding Co.   Holding Co.   Subsidiaries   Entries   Consolidated
 
INTEREST INCOME:
                                               
Loans
  $ 1,572             $ 104,803     $ 1,606,368     $ (170,104 )   $ 1,542,639  
Money market investments
    2,671     $ 5       27       30,957       (10,718 )     22,942  
Investment securities
    22,650       322       948       355,585       (20,748 )     358,757  
Trading account securities
                            22,126               22,126  
 
 
    26,893       327       105,778       2,015,036       (201,570 )     1,946,464  
 
INTEREST EXPENSE:
                                               
Deposits
                            314,211       (3,668 )     310,543  
Short-term borrowings
    184       534       10,403       259,060       (37,789 )     232,392  
Long-term debt
    32,920               115,876       359,056       (167,149 )     340,703  
 
 
    33,104       534       126,279       932,327       (208,606 )     883,638  
 
Net interest (loss) income
    (6,211 )     (207 )     (20,501 )     1,082,709       7,036       1,062,826  
Provision for loan losses
                            144,232               144,232  
 
Net interest (loss) income after provision for loan losses
    (6,211 )     (207 )     (20,501 )     938,477       7,036       918,594  
Service charges on deposit accounts
                            135,660               135,660  
Other service fees
                            325,194       (77,334 )     247,860  
Net gain (loss) on sale and valuation adjustment of investment securities
    50,469       9,237               (8,306 )     (509 )     50,891  
Trading account profit
                            14,968       13,170       28,138  
Gain on sale of loans
                            60,172       (17,497 )     42,675  
Other operating income
    7,268       5,190               84,027       (30,614 )     65,871  
 
 
    51,526       14,220       (20,501 )     1,550,192       (105,748 )     1,489,689  
 
OPERATING EXPENSES:
                                               
Personnel costs:
                                               
Salaries
            274               353,850       (2,763 )     351,361  
Profit sharing
                            16,805               16,805  
Pension and other benefits
            45               97,436       (797 )     96,684  
 
 
            319               468,091       (3,560 )     464,850  
Net occupancy expenses
            11               78,403               78,414  
Equipment expenses
    24       1       7       90,043       (46 )     90,029  
Other taxes
    784                       28,304               29,088  
Professional fees
    2,693       9       21       182,191       (102,127 )     82,787  
Communications
    42                       46,592       (55 )     46,579  
Business promotion
    4,467                       65,393               69,860  
Printing and supplies
                            13,971               13,971  
Other operating expenses
    (7,104 )     27       345       95,940       (1,110 )     88,098  
Amortization of intangibles
                            6,770               6,770  
 
 
    906       367       373       1,075,698       (106,898 )     970,446  
 
Income (loss) before income tax, cumulative effect of accounting change and equity in earnings of subsidiaries
    50,620       13,853       (20,874 )     474,494       1,150       519,243  
Income tax
    3,155               (7,349 )     116,151       438       112,395  
 
Income (loss) before cumulative effect of accounting change and equity in earnings of subsidiaries
    47,465       13,853       (13,525 )     358,343       712       406,848  
Cumulative effect of accounting change, net of tax
            691               4,494       (1,578 )     3,607  
 
Income (loss) before equity in earnings of subsidiaries
    47,465       14,544       (13,525 )     362,837       (866 )     410,455  
Equity in earnings of subsidiaries
    362,990       56,430       68,949       55,008       (543,377 )        
 
NET INCOME
  $ 410,455     $ 70,974     $ 55,424     $ 417,845     $ (544,243 )   $ 410,455  
 

45


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POPULAR, INC.
CONDENSED CONSOLIDATING STATEMENT OF INCOME
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004
(UNAUDITED)
                                                 
    Popular, Inc.   PIBI   PNA   All other   Elimination   Popular, Inc.
(In thousands)   Holding Co.   Holding Co.   Holding Co.   Subsidiaries   Entries   Consolidated
 
INTEREST INCOME:
                                               
Loans
  $ 1,790             $ 95,618     $ 1,319,001     $ (144,868 )   $ 1,271,541  
Money market investments
    799     $ 3       254       24,519       (6,901 )     18,674  
Investment securities
    1,096               573       301,536       593       303,798  
Trading account securities
                            20,766               20,766  
 
 
    3,685       3       96,445       1,665,822       (151,176 )     1,614,779  
 
INTEREST EXPENSE:
                                               
Deposits
                            243,570       (2,718 )     240,852  
Short-term borrowings
    488       38       4,424       126,156       (18,666 )     112,440  
Long-term debt
    25,818       63       94,445       256,974       (135,422 )     241,878  
 
 
    26,306       101       98,869       626,700       (156,806 )     595,170  
 
Net interest (loss) income
    (22,621 )     (98 )     (2,424 )     1,039,122       5,630       1,019,609  
Provision for loan losses
                            132,641               132,641  
 
Net interest (loss) income after provision for loan losses
    (22,621 )     (98 )     (2,424 )     906,481       5,630       886,968  
Service charges on deposit accounts
                            123,077               123,077  
Other service fees
                            260,267       (41,791 )     218,476  
Net gain on sale and valuation adjustment of investment securities
    10,535       2,206       14       680               13,435  
Trading account loss
                            (527 )     (221 )     (748 )
Gain on sale of loans
                            43,539       (13,369 )     30,170  
Other operating income
    7,651       3,282       81       65,309       (11,972 )     64,351  
 
 
    (4,435 )     5,390       (2,329 )     1,398,826       (61,723 )     1,335,729  
 
OPERATING EXPENSES:
                                               
Personnel costs:
                                               
Salaries
            244               312,942       2,599       315,785  
Profit sharing
                            16,149       255       16,404  
Pension and other benefits
            42               91,999       546       92,587  
 
 
            286               421,090       3,400       424,776  
Net occupancy expenses
            9               66,882       546       67,437  
Equipment expenses
    2                       81,207       2,690       83,899  
Other taxes
    990                       27,318       182       28,490  
Professional fees
    1,386       2       217       128,578       (61,428 )     68,755  
Communications
    61                       46,208       320       46,589  
Business promotion
                            54,406       12       54,418  
Printing and supplies
                            13,280       178       13,458  
Other operating expenses
    886       64       408       74,737       (232 )     75,863  
Amortization of intangibles
                            5,586               5,586  
 
 
    3,325       361       625       919,292       (54,332 )     869,271  
 
(Loss) income before income tax and equity in earnings of subsidiaries
    (7,760 )     5,029       (2,954 )     479,534       (7,391 )     466,458  
Income tax
    280               (472 )     106,740       (1,774 )     104,774  
 
(Loss) income before equity in earnings of subsidiaries
    (8,040 )     5,029       (2,482 )     372,794       (5,617 )     361,684  
Equity in earnings of subsidiaries
    369,724       81,202       82,818       44,476       (578,220 )        
 
NET INCOME
  $ 361,684     $ 86,231     $ 80,336     $ 417,270     $ (583,837 )   $ 361,684  
 

46


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POPULAR, INC.
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005
(UNAUDITED)
                                                 
    Popular, Inc.   PIBI   PNA   All other   Elimination   Consolidated
(In thousands)   Holding Co.   Holding Co.   Holding Co.   Subsidiaries   Entries   Popular, Inc.
 
Cash flows from operating activities:
                                               
Net income
  $ 410,455     $ 70,974     $ 55,424     $ 417,845     $ (544,243 )   $ 410,455  
Less: Cumulative effect of accounting change, net of tax
            691               4,494       (1,578 )     3,607  
 
Net income before cumulative effect of accounting change
    410,455       70,283       55,424       413,351       (542,665 )     406,848  
 
Adjustments to reconcile net income to net cash provided by operating activities:
                                               
Equity in undistributed earnings of subsidiaries
    (362,990 )     (56,430 )     (68,949 )     (55,008 )     543,377          
Depreciation and amortization of premises and equipment
    1,133                       59,688       (54 )     60,767  
Provision for loan losses
                            144,232               144,232  
Amortization of intangibles
                            6,770               6,770  
Net (gain) loss on sale and valuation adjustment of investment securities
    (50,469 )     (9,237 )             8,306       509       (50,891 )
Net gain on disposition of premises and equipment
                            (11,165 )             (11,165 )
Net gain on sale of loans, excluding loans held-for-sale
                            (6,732 )             (6,732 )
Net amortization of premiums and accretion of discounts on investments
    (403 )     7               31,666       (561 )     30,709  
Net amortization of premiums and deferred loan origination fees and costs
    (76 )                     98,086       (5,424 )     92,586  
Earnings from investments under the equity method
    (2,344 )     (4,859 )             (507 )     (1,207 )     (8,917 )
Stock options expense
    253                       2,714       3       2,970  
Net decrease in loans held-for-sale
                            1,860,216               1,860,216  
Net decrease in trading securities
                            394,003       (1,109 )     392,894  
Net increase in accrued income receivable
    (387 )     (34 )     (941 )     (47,021 )     2,124       (46,259 )
Net decrease (increase) in other assets
    48       911       2,414       (31,290 )     (15,736 )     (43,653 )
Net increase (decrease) in interest payable
    3,544       (2 )     14,859       19,460       (2,124 )     35,737  
Net decrease in deferred and current taxes
    (318 )             (1,431 )     (45,845 )     278       (47,316 )
Net increase in postretirement benefit obligation
                            3,631               3,631  
Net increase (decrease) in other liabilities
    3,518       (14 )     (196 )     (56,139 )     (4,417 )     (57,248 )
 
Total adjustments
    (408,491 )     (69,658 )     (54,244 )     2,375,065       515,659       2,358,331  
 
Net cash provided by operating activities
    1,964       625       1,180       2,788,416       (27,006 )     2,765,179  
 
Cash flows from investing activities:
                                               
Net (increase) decrease in money market investments
    (115,800 )             (6 )     61,028       326,042       271,264  
Purchases of investment securities:
                                               
Available-for-sale
    (127,628 )     (64,386 )             (3,834,956 )     705,168       (3,321,802 )
Held-to-maturity
            (2,431 )             (49,190,995 )             (49,193,426 )
Other
    (195 )             (270 )     (62,929 )             (63,394 )
Proceeds from calls, paydowns, maturities and redemptions of investment securities:
                                               
Available-for-sale
    110,432                       3,316,108       (709,877 )     2,716,663  
Held-to-maturity
    150,000       250               49,043,755               49,194,005  
Other
                            34,693               34,693  
Proceeds from sale of investment securities available for sale
    57,458       32,111               183,040               272,609  
Net collections (disbursements) on loans
    15,601               (373,639 )     (2,158,550 )     781,486       (1,735,102 )
Proceeds from sale of loans
                            109,244               109,244  
Acquisition of loan portfolios
                            (2,301,771 )             (2,301,771 )
Capital contribution to subsidiary
    (75,000 )     (75,000 )     (176,433 )     (2,500 )     328,933          
Assets acquired, net of cash
                            (180,744 )             (180,744 )
Acquisition of premises and equipment
    (5 )                     (118,377 )             (118,382 )
Proceeds from sale of premises and equipment
                            30,631               30,631  
Dividends received from subsidiary
    128,200               150,000       52,500       (330,700 )        
 
Net cash provided by (used in) investing activities
    143,063       (109,456 )     (400,348 )     (5,019,823 )     1,101,052       (4,285,512 )
 
Cash flows from financing activities:
                                               
Net increase in deposits
                            1,452,474       (139,461 )     1,313,013  
Net (decrease) increase in federal funds purchased and assets sold under agreements to repurchase
    (6,690 )             61,335       1,671,278       (182,713 )     1,543,210  
Net (decrease) increase in other short-term borrowings
    (4,501 )     36,837       260,464       138,443       (665,608 )     (234,365 )
Net (payments of) proceeds from notes payable and capital securities
    (10,465 )             2,404       (701,995 )     (92,871 )     (802,927 )
Dividends paid to parent company
                            (330,700 )     330,700          
Dividends paid
    (137,014 )                                     (137,014 )
Proceeds from issuance of common stock
    14,141                                       14,141  
Treasury stock acquired
                            (1,467 )             (1,467 )
Capital contribution from parent
            75,000       75,000       178,174       (328,174 )        
 
Net cash (used in) provided by financing activities
    (144,529 )     111,837       399,203       2,406,207       (1,078,127 )     1,694,591  
 
Cash effect of change in accounting principle
            (28 )             (1,544 )             (1,572 )
 
Net increase in cash and due from banks
    498       2,978       35       173,256       (4,081 )     172,686  
Cash and due from banks at beginning of period
    283       54       384       767,092       (51,354 )     716,459  
 
Cash and due from banks at end of period
  $ 781     $ 3,032     $ 419     $ 940,348     $ (55,435 )   $ 889,145  
 

47


Table of Contents

POPULAR, INC.
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004
(UNAUDITED)
                                                 
    Popular, Inc.   PIBI   PNA   All other   Elimination   Consolidated
(In thousands)   Holding Co.   Holding Co.   Holding Co.   Subsidiaries   Entries   Popular, Inc.
 
Cash flows from operating activities:
                                               
Net income
  $ 361,684     $ 86,231     $ 80,336     $ 417,270     $ (583,837 )   $ 361,684  
 
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
                                               
Equity in undistributed earnings of subsidiaries
    (369,724 )     (81,202 )     (82,818 )     (44,476 )     578,220          
Depreciation and amortization of premises and equipment
    668                       53,475       943       55,086  
Provision for loan losses
                            132,641               132,641  
Amortization of intangibles
                            5,586               5,586  
Net gain on sale of investment securities
    (10,535 )     (2,206 )     (14 )     (680 )             (13,435 )
Net gain on disposition of premises and equipment
                            (13,977 )             (13,977 )
Net gain on sale of loans, excluding loans held-for-sale
                            (11,268 )             (11,268 )
Net amortization of premiums and accretion of discounts on investments
                            30,927       (701 )     30,226  
Net amortization of premiums and deferred loan origination fees and costs
    (15 )                     88,989               88,974  
Earnings from investments under the equity method
    (1,761 )     (2,967 )             (463 )             (5,191 )
Stock options expense
    398                       2,197       22       2,617  
Net increase in loans held-for-sale
                            (34,643 )             (34,643 )
Net increase in trading securities
                            (105,660 )     610       (105,050 )
Net (increase) decrease in accrued income receivable
    (4 )     1       341       (44,818 )     550       (43,930 )
Net (increase) decrease in other assets
    (2,133 )     (21,248 )     182       (35,531 )     12,195       (46,535 )
Net increase (decrease) in interest payable
    2,788       (27 )     12,299       18,639       (299 )     33,400  
Net increase (decrease) in deferred and current taxes
    1,395               (1,367 )     6,759       (1,775 )     5,012  
Net increase in postretirement benefit obligation
                            3,000               3,000  
Net increase (decrease) in other liabilities
    2,020       (19 )     223       (547 )     (13,417 )     (11,740 )
 
Total adjustments
    (376,903 )     (107,668 )     (71,154 )     50,150       576,348       70,773  
 
Net cash (used in) provided by operating activities
    (15,219 )     (21,437 )     9,182       467,420       (7,489 )     432,457  
 
Cash flows from investing activities:
                                               
Net decrease (increase) in money market investments
    41,897               56,647       (45,304 )     (125,816 )     (72,576 )
Purchases of investment securities:
                                               
Available-for-sale
                    (1,500 )     (4,651,077 )     396,426       (4,256,151 )
Held-to-maturity
                            (597,447 )             (597,447 )
Other
    (126 )                     (44,781 )             (44,907 )
Proceeds from calls, paydowns, maturities and redemptions of investment securities:
                                               
Available-for-sale
                            3,720,105       (368,476 )     3,351,629  
Held-to-maturity
                            538,427               538,427  
Other
                            1,530               1,530  
Proceeds from sale of investment securities available-for-sale
    12,444       3,272       1,514       357,397               374,627  
Net collections (disbursements) on loans
    41,949               (179,005 )     (1,503,145 )     417,738       (1,222,463 )
Proceeds from sale of loans
                            279,438       (4,510 )     274,928  
Acquisition of loan portfolios
    (4,509 )                     (2,633,724 )     4,510       (2,633,723 )
Capital contribution to subsidiary
    (55,559 )     (40,000 )     (375,265 )             470,824          
Assets acquired, net of cash
                            (166,740 )             (166,740 )
Acquisition of premises and equipment
    (15,139 )                     (93,659 )     (612 )     (109,410 )
Proceeds from sale of premises and equipment
                            25,433               25,433  
Dividends received from subsidiary
    136,375                               (136,375 )        
 
Net cash provided by (used in) investing activities
    157,332       (36,728 )     (497,609 )     (4,813,547 )     653,709       (4,536,843 )
 
Cash flows from financing activities:
                                               
Net increase in deposits
                            1,168,199       58,174       1,226,373  
Net increase in federal funds purchased and assets sold under agreements to repurchase
                    112,000       1,331,941       59,652       1,503,593  
Net (decrease) increase in other short-term borrowings
    (675 )     4,556       183,909       248,027       (17,069 )     418,748  
Net (payments of) proceeds from notes payable and capital securities
    (30,783 )     (8,573 )     150,692       1,456,466       (429,536 )     1,138,266  
Dividends paid to parent company
                            (136,375 )     136,375          
Dividends paid
    (123,322 )                                     (123,322 )
Proceeds from issuance of common stock
    11,954                                       11,954  
Treasury stock acquired
                            (1,259 )             (1,259 )
Capital contribution from parent
            62,155       40,000       374,146       (476,301 )        
 
Net cash (used in) provided by financing activities
    (142,826 )     58,138       486,601       4,441,145       (668,705 )     4,174,353  
 
Net (decrease) increase in cash and due from banks
    (713 )     (27 )     (1,826 )     95,018       (22,485 )     69,967  
Cash and due from banks at beginning of period
    995       47       2,444       722,181       (37,577 )     688,090  
 
Cash and due from banks at end of period
  $ 282     $ 20     $ 618     $ 817,199     $ (60,062 )   $ 758,057  
 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This discussion contains an analysis of the consolidated financial position and financial performance of Popular, Inc. and its subsidiaries (the “Corporation” or “Popular”). All accompanying tables, financial statements and notes included elsewhere in this report should be considered an integral part of this analysis.
Popular, Inc. 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 with over 280 branches and offices, the Corporation offers retail and commercial banking services through its banking subsidiary, Banco Popular de Puerto Rico (“BPPR”), as well as investment banking, auto and equipment leasing and financing, mortgage loans, consumer lending and insurance services through specialized subsidiaries. In the United States, the Corporation has established the largest Hispanic-owned financial services franchise, providing complete financial solutions to all the communities it serves. Banco Popular North America (“BPNA”) operates over 135 branches in California, Texas, Illinois, New York, New Jersey and Florida. The Corporation’s finance subsidiary in the United States, Popular Financial Holdings, Inc. (“PFH”), offers mortgage and personal loans, and also maintains a substantial wholesale broker network, a warehouse lending division and loan servicing and assets acquisition units. The Corporation continues to use its expertise in technology and electronic banking as a competitive advantage in its Caribbean and Latin America expansion, as well as internally servicing many of its subsidiaries systems infrastructures and transactional processing businesses. EVERTEC, Inc. (“EVERTEC”), the Corporation’s main subsidiary in this business segment, is the leading provider of financial transaction processing and information technology solutions in Puerto Rico and the Caribbean. With offices in San Juan, Caracas, Santo Domingo, and Miami, EVERTEC has a solid record of success in 11 Latin American countries.
Table A provides selected financial data for the quarter and nine months ended September 30, 2005, compared with the same periods in 2004.
Financial highlights for the quarter ended September 30, 2005 follow:
    Net interest income for the quarter ended September 30, 2005 decreased slightly compared with the same period of 2004. On a taxable equivalent basis, net interest income increased 5% for the third quarter of 2005, compared with the same quarter in 2004. The increase in net interest income, on a taxable equivalent basis, was derived from the growth in average earning assets, principally loans, partially offset by a reduction in the net interest margin. The spread between short-term and long-term interest rates compressed as a result of the flattening of the yield curve. The increase in the cost of funds from wholesale borrowings and interest bearing deposits outpaced the increase in yields from interest earning assets. Tables B and C provide information on the Corporation’s net interest income on a taxable equivalent basis.
 
    The provision for loan losses increased for the quarter ended September 30, 2005, when compared with the same quarter in the previous year primarily due to higher charge-offs combined with portfolio growth in all loan categories. In general, credit quality statistics reflected stable to favorable trends in most lending categories. Refer to the Credit Risk Management and Loan Quality section, including Tables J, K and L, for a more detailed analysis of the allowance for loan losses, net charge-offs, non-performing assets and credit quality statistics.

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TABLE A
Financial Highlights
                                                 
Balance Sheet Highlights   At September 30,     Average for the nine months  
(In thousands)   2005     2004     Variance     2005     2004     Variance  
 
Money market investments
  $ 638,221     $ 845,668     ($ 207,447 )   $ 816,484     $ 830,235     ($ 13,751 )
Investment and trading securities
    12,725,566       11,974,820       750,746       12,656,906       11,573,324       1,083,582  
Loans*
    30,550,083       27,517,298       3,032,785       29,213,718       24,222,902       4,990,816  
Total assets
    47,120,108       42,855,594       4,264,514       45,699,254       38,793,708       6,905,546  
Deposits
    22,578,709       20,483,218       2,095,491       22,169,512       18,960,531       3,208,981  
Borrowings
    20,615,731       18,660,975       1,954,756       19,602,104       16,348,650       3,253,454  
Stockholders’ equity
    3,221,396       3,010,495       210,901       3,229,283       2,860,175       369,108  
                                                 
Operating Highlights   Third Quarter   Nine months ended September 30,
(In thousands, except per share information)   2005   2004   Variance   2005   2004   Variance
 
Net interest income
  $ 348,110     $ 348,192     $ (82 )   $ 1,062,826     $ 1,019,609     $ 43,217  
Provision for loan losses
    49,960       46,614       3,346       144,232       132,641       11,591  
Non-interest income
    175,048       144,556       30,492       571,095       448,761       122,334  
Operating expenses
    329,413       297,873       31,540       970,446       869,271       101,175  
Income tax
    28,569       32,880       (4,311 )     112,395       104,774       7,621  
Cumulative effect of accounting change, net of tax
                      3,607             3,607  
Net income
  $ 115,216     $ 115,381     $ (165 )   $ 410,455     $ 361,684     $ 48,771  
Net income applicable to common stock
  $ 112,237     $ 112,402     $ (165 )   $ 401,520     $ 352,749     $ 48,771  
Basic and diluted EPS before cumulative effect of accounting change
  $ 0.42     $ 0.42           $ 1.49     $ 1.32     $ 0.17  
Basic and diluted EPS after cumulative effect of accounting change
  $ 0.42     $ 0.42           $ 1.50     $ 1.32     $ 0.18  
                                 
    Third Quarter     Nine months ended September 30,  
Selected Statistical Information   2005     2004     2005     2004  
 
Common Stock Data — Market price
                               
High
  $ 27.52     $ 26.30     $ 28.03     $ 26.30  
Low
    24.22       21.47       22.94       20.04  
End
    24.22       26.30       24.22       26.30  
Book value per share at period end
    11.36       10.60       11.36       10.60  
Dividends declared per share
    0.16       0.16       0.48       0.46  
Dividend payout ratio
    38.07 %     37.89 %     31.97 %     32.43 %
Price/earnings ratio
    12.29 x     15.38 x     12.29 x     15.38 x
 
                               
Profitability Ratios — Return on assets
    0.99 %     1.13 %     1.20 %     1.25 %
Return on common equity
    14.21       16.22       17.61       17.63  
Net interest spread (taxable equivalent)
    3.30       3.54       3.24       3.65  
Net interest yield (taxable equivalent)
    3.67       3.89       3.61       4.01  
Effective tax rate
    19.87       22.18       21.65       22.46  
Overhead ratio**
    44.34       44.03       37.57       41.24  
Efficiency ratio ***
    62.87       60.45       61.63       60.20  
 
                               
Capitalization Ratios - Equity to assets
    7.21 %     7.22 %     7.07 %     7.37 %
Tangible equity to assets
    6.04       6.56       5.92       6.79  
Equity to loans
    11.33       11.43       11.05       11.81  
Internal capital generation
    8.37       9.48       11.25       10.80  
Tier I capital to risk – adjusted assets
    11.40       10.62       11.40       10.62  
Total capital to risk – adjusted assets
    12.67       12.09       12.67       12.09  
Leverage ratio
    7.71       7.12       7.71       7.12  
 
                               
 
*   Includes loans held-for-sale
 
**   Non-interest expense less non-interest income divided by net interest income
 
***   Non-interest expense divided by net interest income plus non-interest income (excludes gain (loss) on sale and valuation adjustments of investment securities and non-recurring income, such as gains on the sale of real estate)
 

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  Non-interest income for the quarter ended September 30, 2005 increased 21% compared with the same period in 2004, mostly associated with higher service charges on deposit accounts, other service fees, gain on sale of loans and trading account profits. Refer to the Non-Interest Income section of the Management’s Discussion and Analysis (“MD&A”) for further explanations, including Table D for a breakdown of other service fees by major categories. Also, the Corporation recorded during the third quarter of 2005 unfavorable valuation adjustments on interest-only strips totaling $10.7 million, related principally to interest-only strips retained on securitizations performed during the first half of 2005. Refer to Note 8 to the unaudited consolidated financial statements for further information on the securitization transactions and retained interests. These unfavorable adjustments were partially offset by higher gains on the sale of investment securities by $9.8 million, primarily marketable equity securities.
  Operating expenses increased 11% compared with the same period in 2004, principally in the categories of personnel costs, net occupancy, business promotion, equipment expenses, professional fees, and other general operating expenses. The increase included expenses associated with the operations acquired by the Corporation’s banking subsidiary in the U.S. mainland, as well as costs incurred in support of business strategies and growth, promotional campaigns and the implementation of new systems, among other factors, as further described in the Operating Expenses section of this MD&A.
  In August 2005, the Government of Puerto Rico approved a temporary, two-year additional tax of 2.5% for corporations, which increases the marginal tax rate from a 39% to 41.5%. The unfavorable impact of this additional tax in the third quarter of 2005, which considers the retroactive application to taxable income since January 1, 2005, was subsequently offset by the favorable effect of the higher tax rate on the measurement of recorded deferred tax assets and consequently, did not have a significant impact in the Corporation’s results of operations for the period.
  Total ending loans at September 30, 2005 grew 6%, from December 31, 2004. The increase in loans was driven primarily by growth in commercial loans, including construction loans, and in the consumer and leasing portfolios as evidenced by data presented in Table E. The increases in these loan categories were partially offset by a decrease in mortgage loans which resulted from various off-balance sheet loan securitizations completed during the nine months ended September 30, 2005. For more detailed information on lending activities, refer to the Balance Sheet Comments section of this report. Contributing to the increase in loans from December 31, 2004 were the loans acquired from Kislak, which approximated $0.6 billion immediately prior to the acquisition.
  Asset growth from December 31, 2004 to September 30, 2005 was funded principally through deposits, which increased 10% from the end of 2004. The growth in deposits supported 73% of the increase in total assets from the end of 2004, while borrowings accounted for 27% of the assets increase. Kislak contributed approximately $0.7 billion in deposits at its acquisition date, excluding purchase accounting entries. Borrowed funds at September 30, 2005 increased 4% from December 31, 2004, primarily associated with repurchase agreements. For more detailed information on borrowings and deposits refer to the Balance Sheet Comments section of this report.
  In the normal course of business, except for the Corporation’s banks and the parent holding company, the Corporation has 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 calendar period. The impact of this change in the net income was included as a cumulative effect of accounting change in the Corporation’s consolidated financial results for the nine months ended September 30, 2005, and corresponds 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.
  Further discussion of operating results, financial condition and market / liquidity risks is presented in the narrative and tables included herein.
  Popular, Inc. completed the acquisition of 100% of the issued and outstanding shares of common stock and common stock equivalents of E-LOAN, Inc. (“E-LOAN”), a California-based online consumer direct

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    lender, for $4.25 per share in cash, or approximately $300 million. E-LOAN, which becomes a wholly-owned subsidiary of PFH, originated over $5 billion in mortgage, home equity, and auto loans in 2004. Through this merger, Popular, Inc. further expands its presence in the mainland U.S. market, complements its existing non-prime and warehouse lending businesses, and significantly enhances its technology platform to support its growth strategy in which the internet plays an important role. This transaction became effective on November 1, 2005.
 
  In September 2005, Popular, Inc. announced a definitive merger agreement to acquire the assets of Infinity Mortgage Corporation, based in New Jersey. The operations of Infinity Mortgage will become part of the mortgage business of Equity One, Inc., a subsidiary of PFH. The transaction, which is expected to be completed during the fourth quarter of 2005, will help increase Popular, Inc.’s market share in the U.S. as well as strengthen its existing mortgage and loan servicing businesses. Infinity Mortgage Corporation originated over $220 million in mortgage loans during 2004 and operates in New Jersey, New York, Connecticut, Maryland, Massachusetts and Pennsylvania.
 
  On September 21, 2005, Popular announced that ACE Cash Express, Inc. will acquire substantially all of the assets of Popular Cash Express, Inc. (“PCE”), our wholly-owned check cashing business in U.S., for $36 million. The Corporation has been constrained in its ability to compete against non-bank owned check cashing operations, which are less regulated than banking institutions, but is committed to remain an active participant in the industry as a lender and servicer to other retail check cashing institutions, and will continue to collaborate with regulators and lawmakers to accelerate the integration of unbanked and underbanked individuals into mainstream financial services. The agreements signed by Popular and ACE do not require regulatory approval and are subject to customary closing terms and conditions. PCE had approximately $62 million in total assets as of September 30, 2005, comprising principally cash, premises and equipment and goodwill. Total revenues for the nine months ended September 30, 2005 approximated $19 million and pre-tax losses approximated $4.3 million. The financial results of PCE are part of the “United States Financial Services” reportable segment in Note 16 – Segment Reporting, included in the accompanying unaudited consolidated financial statements in this Form 10-Q. The transaction is expected to be completed during the fourth quarter of 2005. No significant gain or loss is expected on this sale transaction.
 
  On January 18, 2005, the Corporation announced that it had been informed by the Antitrust Division of the U.S. Department of Justice that the Department of Justice was conducting an investigation concerning the participation by its subsidiary, GM Group, Inc. (which after a reorganization in 2004 became part of EVERTEC), in the E-rate program, which is administered by the Federal Communications Commission (FCC) and pays for telecommunications services and related equipment for schools and libraries. On October 13, 2005, the Corporation entered into a Settlement Agreement with the Department of Justice and the Federal Communications Commission in connection with this matter. Pursuant to the Settlement Agreement, EVERTEC, without admitting liability and denying any allegations of misconduct, agreed to make a $4.8 million payment to the United States and agreed to voluntarily disqualify itself from bidding on or performing any work related to contracts funded by the Federal Communications Commission for a three year period. EVERTEC. also agreed to cooperate with U.S. governmental authorities in any investigation or litigation related to its participation in the E-rate program. The Settlement Agreement did not have and is not expected to have an impact on the Corporation’s third or fourth quarter results of operations or the Corporation’s financial condition because the full amount of the settlement payment has been previously accrued and because EVERTEC is not engaged in work related to Federal Communications Commission contracts.
 
  The shares of the Corporation’s common and preferred stock are traded on the National Association of Securities Dealers Automated Quotation (NASDAQ) under the symbols BPOP and BPOPO, respectively.

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OTHER MATTERS
Transactions with Doral Financial Corporation
     Doral Announcements. Doral Financial Corporation (“Doral”) has announced that its previously filed financial statements for periods from January 1, 2000 through December 31, 2004 should no longer be relied on and that the financial statements for some or all of the periods included therein should be restated because of issues relating to the methodology used to calculate the fair value of its portfolio of floating rate interest-only strips (“IOs”). On September 22, 2005, Doral estimated that its consolidated stockholders’ equity at December 31, 2004, would be reduced, on a pre-tax basis, by approximately $615 million related to corrections to the valuation of its IOs. In addition, on October 25, 2005, Doral announced that it was investigating its mortgage loan sales to local financial institutions. Doral has also announced that the Securities and Exchange Commission is conducting a formal investigation, and that the U.S. Attorney’s Office for the Southern District of New York is also conducting an investigation of these matters. Actions have been brought by or on behalf of securities holders of Doral in relation to these matters.
     Estimates of Value Provided by Popular Securities. Between October 2002 and December 2004, Popular Securities, Inc., a wholly-owned subsidiary of the Corporation, provided quarterly estimates of the value of portfolios of IOs on behalf of Doral. In accordance with its understanding regarding the engagement, in providing those estimates of value, Popular Securities utilized assumptions provided by Doral that may not have been consistent with the actual terms of the IO portfolios. Doral’s Form 10-K for the year ended December 31, 2004 stated that “to determine the fair value of its IO portfolio”, Doral engaged a “party” to provide an “external valuation” that “consists of a cash flow valuation model in which all economic and portfolio assumptions are determined by the preparer”. Popular Securities believes that this characterization is not appropriate if it was meant to apply to Popular Securities’ work.
     Transactions with Doral Relating to Mortgage Loans and IOs. Between 1996 and 2004, BPPR purchased approximately $1.6 billion of mortgage loans from Doral. The remaining balance of these mortgage loans recorded on the Corporation’s consolidated statement of condition at September 30, 2005 was $570 million. In the first six months of 2000 the Corporation also sold $200 million of mortgage loans to Doral Bank, a subsidiary of Doral. The Corporation recorded a gain of $2.2 million in the first quarter of 2000 and of $1.9 million in the second quarter of 2000 from the sales of mortgages to Doral Bank. The purchases and sales of loans were often accompanied by separate recourse and other financial arrangements. Between 1996 and 2004, the Corporation purchased $110 million in IOs from Doral. The remaining balance of these IOs recorded on the Corporation’s consolidated statement of condition at September 30, 2005 was $42 million. These IOs have been reclassified from investments available-for-sale to loans to Doral because they are accompanied by 100% yield and principal guarantees from Doral and because of the source of the cash flow for payments on the IOs. See Note 3 to the Corporation’s financial statements for the quarter ended September 30, 2005. The Corporation has concluded that its previously filed financial statements are fairly stated and that no restatement is necessary.
Transactions with R&G Financial Corporation
     R&G Announcements. R&G Financial Corporation (“R&G”) has announced that its previously filed financial statements for periods from January 1, 2002 through December 31, 2004 need to be restated and should no longer be relied upon because of issues relating to the methodology used in valuing its portfolio of residual interests retained in securitization transactions. R&G has announced that the Securities and Exchange Commission is conducting a

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formal investigation of this matter. Actions have been brought by or on behalf of securities holders of R&G in relation to these matters.
     Purchases of Mortgage Loans from R&G. Between 2003 and 2004, BPPR entered into various mortgage purchase transactions with R&G in the amount of $176 million. These purchase transactions had recourse provisions and other financial arrangements. At September 30, 2005, the remaining balance of the mortgage loans purchased from R&G recorded on the Corporation’s consolidated statement of condition was $136 million. The Corporation has concluded that its previously filed financial statements are fairly stated and that no restatement is necessary.
Cooperation with Investigations; Possible Consequences
     The Corporation and its employees have provided information in connection with certain of the above-mentioned investigations by the Securities and Exchange Commission and the U.S. Attorney’s Office for the Southern District of New York and are continuing to cooperate in connection with the investigations of these matters. The Corporation is unable to predict what adverse consequences, if any, or other effects the Corporation’s dealings with Doral or R&G, the civil litigation related to Doral or R&G matters or the related investigations could have on the Corporation or BPPR.

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CRITICAL ACCOUNTING POLICIES
The accounting and reporting policies followed by the Corporation and its subsidiaries conform to generally accepted accounting principles in the United States and general practices within the financial services industry. These 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.
Various elements of the Corporation’s accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. As described in Popular, Inc.’s 2004 Financial Review and Supplementary Information to Stockholders, incorporated by reference in Popular, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2004 (the “2004 Annual Report”), the Corporation has identified as critical accounting policies those related to securities’ classification and related values, loans and allowance for loan losses, income taxes, goodwill and other intangible assets, and pension and postretirement benefit obligations. The determination and evaluation of these critical accounting policies has been discussed with the Corporation’s Audit Committee. For a summary of the Corporation’s critical accounting policies, refer to that particular section in the MD&A included in Popular, Inc.’s 2004 Annual Report. Also, refer to Note 1 to the consolidated financial statements included in the 2004 Annual Report for a summary of the Corporation’s significant accounting policies.
NET INTEREST INCOME
Table B and C present the different components of the Corporation’s net interest income, on a taxable equivalent basis, for the quarter and nine months ended September 30, 2005, as compared with the same periods in 2004, segregated by major categories of interest earning assets and interest bearing liabilities. A portion of the Corporation’s interest earning assets, mostly investments in obligations of the U.S. Government and its agencies and the Puerto Rico Commonwealth and its agencies, generate interest which is exempt from income tax, principally in Puerto Rico. Also, the taxable equivalent adjustment includes interest earned on earning assets held by the Corporation’s international banking entities, which are tax-exempt under Puerto Rico law. 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 statutory income tax rate in Puerto Rico was 39% for the quarter and nine-months ended September 30, 2004. In the third quarter of 2005, the Government of Puerto Rico approved a temporary, two-year additional tax of 2.5% for corporations, which increased the marginal tax rate from a 39% to 41.5%. The impact of the additional tax, including the retroactive amounts corresponding to the first semester of 2005, was included in the Corporation’s results of operations in the third quarter of 2005. The taxable equivalent adjustment includes the favorable impact to the Corporation of tax exempt income associated to this change, which was not deemed significant for additional disclosures. The taxable equivalent computation considers the interest expense disallowance required by Puerto Rico tax law, also affected by the mentioned increase in tax rate. The statutory income tax rate considered for the Corporation’s U.S. operations was approximately 35%.
Average outstanding securities balances are based upon 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 using the interest method over the term of the loan as an adjustment to interest yield. Interest income for the quarter and nine months ended September 30, 2005, included unfavorable impacts of $14.4 million and $28.6 million, respectively, consisting principally of amortization of net loan origination costs (net of fees), amortization of net premiums on loans purchased, and prepayment penalties and late payment charges. These amounts approximated $13.3 million and $24.4 million, respectively, for the quarter and nine months ended September 30, 2004.

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Table B shows the analysis of levels and yields on a taxable equivalent basis for the quarter ended September 30, 2005 compared with the same period in 2004.
TABLE B
ANALYSIS OF LEVELS & YIELDS ON A TAXABLE EQUIVALENT BASIS
Quarter ended September 30,
                                                                                         
                                                                            Variance  
Average Volume     Average Yields / Costs         Interest     Attributable to  
2005     2004     Variance     2005     2004     Variance         2005     2004     Variance     Rate     Volume  
($ in millions)                                                 (In thousands)          
$ 745     $ 845     ($ 100 )     4.51 %     3.07 %     1.44 %  
Money market investments
  $ 8,455     $ 6,512     $ 1,943     $ 2,142     ($ 199 )
  12,379       11,576       803       5.24       4.46       0.78    
Investment securities
    162,132       128,983       33,149       23,890       9,259  
  504       378       126       6.07       6.42       (0.35 )  
Trading
    7,719       6,092       1,627       (323 )     1,950  
         
  13,628       12,799       829       5.23       4.42       0.81    
 
    178,306       141,587       36,719       25,709       11,010  
         
                                               
Loans:
                                       
  11,959       9,519       2,440       6.94       5.94       1.00    
Commercial
    209,142       142,020       67,122       26,981       40,141  
  1,310       1,153       157       7.54       8.39       (0.85 )  
Leasing
    24,691       24,194       497       (2,615 )     3,112  
  11,612       11,276       336       6.48       6.55       (0.07 )  
Mortgage
    188,041       184,626       3,415       (2,039 )     5,454  
  4,416       3,804       612       10.06       10.32       (0.26 )  
Consumer
    111,662       98,452       13,210       (1,567 )     14,777  
         
  29,297       25,752       3,545       7.25       6.96       0.29    
 
    533,536       449,292       84,244       20,760       63,484  
         
$ 42,925     $ 38,551     $ 4,374       6.61 %     6.12 %     0.49 %  
Total earning assets
  $ 711,842     $ 590,879     $ 120,963     $ 46,469     $ 74,494  
         
                                               
Interest bearing deposits:
                                       
$ 3,783     $ 3,071     $ 712       1.51 %     1.20 %     0.31 %  
NOW and money market
  $ 14,363     $ 9,290     $ 5,073     $ 2,759     $ 2,314  
  5,727       5,396       331       1.26       1.07       0.19    
Savings
    18,141       14,491       3,650       2,588       1,062  
  9,114       7,179       1,935       3.54       3.31       0.23    
Time deposits
    81,295       59,686       21,609       4,643       16,966  
         
  18,624       15,646       2,978       2.42       2.12       0.30    
 
    113,799       83,467       30,332       9,990       20,342  
         
  10,040       9,343       697       3.53       1.91       1.62    
Short-term borrowings
    89,213       44,830       44,383       41,180       3,203  
  9,445       8,292       1,153       4.84       4.19       0.65    
Medium and long-term debt
    114,966       87,278       27,688       12,461       15,227  
         
  38,109       33,281       4,828       3.31       2.58       0.73    
Total interest bearing liabilities
    317,978       215,575       102,403       63,631       38,772  
  3,943       3,942       1                            
Demand deposits
                                       
  873       1,328       (455 )                          
Other sources of funds
                                       
         
$ 42,925     $ 38,551     $ 4,374       2.94 %     2.23 %     0.71 %  
 
                                       
                                             
                          3.67 %     3.89 %     (0.22 %)  
Net interest margin
                                       
                                                                     
                                               
Net interest income on a taxable equivalent basis
    393,864       375,304       18,560     ($ 17,162 )   $ 35,722  
                                                                             
                          3.30 %     3.54 %     (0.24 %)  
Net interest spread
                                       
                                                                     
                                               
Taxable equivalent adjustment
    45,754       27,112       18,642                  
                                                                     
                                               
Net interest income
  $ 348,110     $ 348,192     ($ 82 )                
                                                                     
Note: 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.
 
The favorable impact on interest income resulting from the increase in average earning assets for the quarter ended September 30, 2005, compared with the third quarter of 2004, was principally due to the 14% increase in the average loan portfolio. Commercial loans contributed 69% of the total increase in average loans, while consumer and mortgage loans contributed 17% and 9%, respectively. This growth includes the impact of the acquisitions of Kislak and Quaker City which had approximately $0.4 billion and $1.1 billion, respectively, in ending commercial (including construction) loans immediately prior to the acquisitions. A substantial portion of the loan portfolios of these acquired institutions, consisted primarily of commercial real estate secured loans. Loan growth continues to be attained due to stronger sales efforts, promotional campaigns, business initiatives, and acquired mortgage loan portfolios in the U.S. mainland. Also, contributing to the increase in interest income

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was the rise in the average volume of investment securities, mainly in the form of U.S. Government agencies, in part due to the portfolios of the acquired banking institutions.
The increase in the volume of earning assets was funded mainly through a combination of interest bearing deposits and short and long-term borrowings. The average balance of interest bearing deposits rose due to the impact of the acquisitions of Kislak and Quaker City and to successful marketing campaigns and sales efforts directed to money market accounts and certificates of deposit, principally in the U.S. mainland. Also, during the second half of 2004, the Corporation issued long-term debt, including medium-term notes, junior subordinated debentures (trust preferred securities) and secured borrowings, to fund the acquisitions and growth in the balance sheet.
The decrease in the net interest margin on a taxable equivalent basis for the quarter ended September 30, 2005, compared with the same quarter in 2004, was mainly due to an increase in the average cost of interest bearing liabilities, principally due to an increase in the cost of short-term borrowings reflecting the upward trend that resulted from revisions in interest rates by the Federal Reserve (FED) commencing in June 2004. During the nine months ended September 30, 2005, the FED increased the federal funds target rate an additional 150 basis points, which together with increases experienced in 2004, brought the federal funds target rate from 1.25% in June 2004 to 3.75% in September 2005. Also, there was an increase in the cost of long-term debt principally resulting from secured debt derived from mortgage loan securitization transactions. Furthermore, the increase in average deposits has been substantially in time deposits, a higher-cost category, combined with the impact of higher costs in savings accounts to sustain marketing campaigns and intense competition.
The average yield on earning assets, on a taxable equivalent basis, for the quarter ended September 30, 2005, increased compared with the same quarter in the previous year, mostly related to higher yields in commercial loans which continue being favorably impacted by rising interest rates due to a high proportion of commercial loans with floating rates. Also, there was an increase in yields in investment securities, partly due to new investments in higher yielding securities and a favorable change in the taxable equivalent adjustment, principally related with the consideration of a higher average volume of securities and the impact of the aforementioned increase in the statutory tax rate in Puerto Rico. These favorable variances were partially offset by lower yields in mortgage loans due to lower long term rates which have an impact in new volumes. Also, the yield on consumer loans was lower mainly due to the implementation of risk-based pricing strategies and promotional campaigns. The yield in the lease financing portfolio was also adversely impacted by the interest rate scenario and promotional campaigns.
As shown in Table C, for the nine-month period ended September 30, 2005, net interest income, on a taxable equivalent basis, increased by 5%, compared with the same period of 2004. This improvement was also the result of higher average volume of earning assets, partially offset by the impact of a lower net interest margin.
Average earning assets for the nine-month period ended September 30, 2005, increased by 17%, compared with the same period of 2004, primarily associated with higher average volume of loans and investment securities. The increase was funded through a combination of short and long-term debt and growth in deposits. The compression in the net interest margin for the nine months ended September 30, 2005, shown in Table C was also attributed to the factors previously described in this section for the quarterly results and in the Overview section of this MD&A.
Following the guidance in EITF Issue No. 03-11, “Reporting Realized Gains and Losses on Derivative Instruments that are Subject to FASB Statement No. 133 and “Not Held for Trading Purposes” as Defined in Issue No. 02-3,” and from the meetings held by the AICPA SEC Regulations Committee on September 16, 2003 and the AICPA Insurance Expert Panel, the Corporation included as part of interest expense, approximately $484 thousand and $513 thousand in derivative gains, for the quarter and nine months ended September 30, 2005, respectively. For the quarter and nine months ended September 30, 2004, the Corporation included approximately $10 thousand and $124 thousand in derivative losses, respectively. These net derivative gains and losses represent unrealized gains and losses on derivatives not designated as hedges, but that were considered “economic hedges”. EITF 03-11 requires that both realized and unrealized results of such economic hedges be shown within the same financial statement caption.

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TABLE C
ANALYSIS OF LEVELS & YIELDS ON A TAXABLE EQUIVALENT BASIS
Nine-month period ended September 30,
                                                                                         
                                                                            Variance  
Average Volume     Average Yields / Costs         Interest     Attributable to  
2005     2004     Variance     2005     2004     Variance         2005     2004     Variance     Rate     Volume  
($ in millions)                                 (In thousands)  
$ 816     $ 830     ($ 14 )     3.91 %     3.00 %     0.91 %  
Money market investments
  $ 23,896     $ 18,674     $ 5,222     $ 5,153     $ 69  
  12,173       11,051       1,122       4.81       4.53       0.28    
Investment securities
    438,744       375,016       63,728       23,371       40,357  
  484       522       (38 )     6.15       5.67       0.48    
Trading
    22,253       22,166       87       1,779       (1,692 )
         
  13,473       12,403       1,070       4.80       4.47       0.33    
 
    484,893       415,856       69,037       30,303       38,734  
         
                                               
Loans:
                                       
  11,571       8,957       2,614       6.60       5.77       0.83    
Commercial
    571,035       386,746       184,289       60,624       123,665  
  1,302       1,117       185       7.60       8.74       (1.14 )  
Leasing
    74,242       73,221       1,021       (10,230 )     11,251  
  12,073       10,613       1,460       6.50       6.75       (0.25 )  
Mortgage
    588,304       537,554       50,750       (21,001 )     71,751  
  4,268       3,536       732       10.12       10.74       (0.62 )  
Consumer
    323,297       284,531       38,766       (15,305 )     54,071  
         
  29,214       24,223       4,991       7.12       7.06       0.06    
 
    1,556,878       1,282,052       274,826       14,088       260,738  
         
$ 42,687     $ 36,626     $ 6,061       6.38 %     6.18 %     0.20 %  
Total earning assets
  $ 2,041,771     $ 1,697,908     $ 343,863     $ 44,391     $ 299,472  
         
                                               
Interest bearing deposits:
                                       
$ 3,761     $ 2,836     $ 925       1.46 %     1.12 %     0.34 %  
NOW and money market
  $ 41,128     $ 23,873     $ 17,255     $ 7,302     $ 9,953  
  5,659       5,358       301       1.21       1.05       0.16    
Savings
    51,178       42,067       9,111       6,390       2,721  
  8,567       6,928       1,639       3.41       3.37       0.04    
Time deposits
    218,237       174,912       43,325       2,242       41,083  
         
  17,987       15,122       2,865       2.31       2.13       0.18    
 
    310,543       240,852       69,691       15,934       53,757  
         
  9,840       8,653       1,187       3.16       1.74       1.42    
Short-term borrowings
    232,392       112,440       119,952       103,598       16,354  
  9,762       7,695       2,067       4.66       4.20       0.46    
Medium and long-term debt
    340,703       241,878       98,825       24,135       74,690  
         
  37,589       31,470       6,119       3.14       2.53       0.61    
Total interest bearing liabilities
    883,638       595,170       288,468       143,667       144,801  
         
  4,182       3,839       343                            
Demand deposits
                                       
  916       1,317       (401 )                          
Other sources of funds
                                       
         
$ 42,687     $ 36,626     $ 6,061       2.77 %     2.17 %     0.60 %  
 
                                       
                                             
                          3.61 %     4.01 %     (0.40 %)  
Net interest margin
                                       
                                                                     
                                               
Net interest income on a taxable equivalent basis
    1,158,133       1,102,738       55,395     ($ 99,276 )   $ 154,671  
                                                                             
                          3.24 %     3.65 %     (0.41 %)  
Net interest spread
                                       
                                                                     
                                               
Taxable equivalent adjustment
    95,307       83,129       12,178                  
                                                                     
                                               
Net interest income
  $ 1,062,826     $ 1,019,609     $ 43,217                  
                                                                     
Note: 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.
 
NON-INTEREST INCOME
Refer to the unaudited consolidated statements of income included in this Form 10-Q for a breakdown of non-interest income by major categories.
Service charges on deposit accounts for the third quarter of 2005 increased by 13% compared with the same quarter of 2004, principally associated with the banking operations acquired and deposit marketing initiatives in the U.S. mainland. Also, the increase was due to higher service charges related with Automated Clearing House (ACH) electronic transactions in Puerto Rico, principally from an increase in the

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volume of electronic transactions and also from revisions in the pricing structure. These favorable variances were partially offset by lower account analysis fees on commercial accounts mainly due to a higher earnings credit to customers due to higher interest rates in the current quarter.
Refer to Table D for a breakdown of other service fees by major categories. Other service fees for the quarter ended September 30, 2005 increased 20% when compared with the same quarter in the previous year. This growth was mostly associated with increased credit card fees, primarily due to higher merchant business income resulting from increased sales, higher interchange income as a result of increased transactional volume, and higher credit card late payment fees derived from higher volume and a price change. Also, the increase in other service fees was related to revenues derived from the mortgage banking business, principally related to services provided to loan brokers in the origination of mortgage loans for other institutions, such as for underwriting efforts; and higher prepayment penalty income on loans serviced by the Corporation in the mainland U.S. There were also higher fees from the Corporation’s insurance business in Puerto Rico due in part to increased volume in credit life, dwelling and title and the reinsurance business, among factors. The increase in fees on the sale and administration of investment products included higher commissions from retail broker transactions, including mutual fund sales, and higher commissions from Popular Securities’ New York office opened in the second quarter of 2004. Another category which contributed to the increase in fees was that related to processing services, principally as a result of increased transactional volume. The increase in other fees was partly related with SBA loan servicing fees, loan syndication fees and standby letters of credit related fees, among other diverse items.
TABLE D
Other Service Fees
                                                 
    Quarter ended September 30,   Nine months ended September 30,
(In thousands)   2005   2004   Variance   2005   2004   Variance
 
Other service fees:
                                               
Credit card fees and discounts
  $ 21,111     $ 17,011     $ 4,100     $ 59,694     $ 51,656     $ 8,038  
Debit card fees
    12,832       12,365       467       39,047       38,020       1,027  
Insurance fees
    12,986       10,705       2,281       37,420       28,589       8,831  
Processing fees
    11,311       9,550       1,761       31,888       30,521       1,367  
Sale and administration of investment products
    7,138       5,158       1,980       21,105       16,728       4,377  
Check cashing fees
    4,372       4,636       (264 )     14,841       16,770       (1,929 )
Mortgage banking and servicing fees, net of amortization
    4,591       1,984       2,607       11,126       7,364       3,762  
Trust fees
    2,135       2,268       (133 )     6,268       6,816       (548 )
Other fees
    8,528       7,386       1,142       26,471       22,012       4,459  
 
Total other service fees
  $ 85,004     $ 71,063     $ 13,941     $ 247,860     $ 218,476     $ 29,384  
 
For the nine-month period ended September 30, 2005, non-interest income increased 27% compared with the nine-month period ended September 30, 2004. As shown in the unaudited consolidated statements of income included in this Form 10-Q, the increase in non-interest income was mostly associated with higher net gains on the sale and valuation adjustments of investment securities. Gains on the sale of investment securities increased by $37.5 million, mainly from the sale of marketable equity securities, offset by the unfavorable valuation adjustments of interest-only strips by PFH discussed in the Overview section and Note 8 to the unaudited consolidated financial statements.
Non-interest income for the first nine months of 2005 was also favorably impacted by higher trading account profits derived principally from mortgage banking activities. Also, approximately $16 million of the trading account profits for the period were derived from the pooling of $552 million in mortgage loans and the sale of the mortgage-backed securities in June 2005. Also, as noted in Table D, other service fees made a substantial contribution to the growth in non-interest income for the nine-months period ended September 30, 2005, mostly impacted by the same factors described for the quarterly results. The decrease in check cashing fees was due in part to lower volume resulting from a lesser number of retail outlets of Popular Cash Express due to the sale or closure of several of these outlets during 2004, price competition and lower wire transfer revenues

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due to stricter requirements imposed on customers by certain state laws. Service charges on deposit accounts increased 10% for the nine months ended September 30, 2005, compared with the same period in the previous year due to the acquired operations and other factors already mentioned, and higher consumer accounts non-sufficient funds fees. Furthermore, gains on sale of loans contributed to the growth in non-interest income for the period with a rise of $12.5 million, principally resulting from mortgage loans securitizations at PFH.
OPERATING EXPENSES
Refer to the unaudited consolidated statements of income included in this Form 10-Q for a breakdown of operating expenses by major categories.
Operating expenses for the quarter ended September 30, 2005 increased 11% compared with the same period in 2004. Personnel costs rose by $12.0 million, or 8%, and accounted for 38% of the increase in operating expenses. This increase resulted mostly from higher salaries and related taxes, due in part to merit increases and higher headcount, including the acquired operations in the U.S. mainland, growth in PFH, and reinforcement of the retail network in Puerto Rico. Full-time equivalent employees were 12,685 at September 30, 2005, an increase of 683 employees from the same date in 2004. Incentive compensation and other performance bonuses for the quarter ended September 30, 2005 decreased in general compared with the same quarter in the previous year. All other operating expenses for the quarter ended September 30, 2005, excluding personnel costs, increased 13% compared with the same quarter in 2004. Contributing to this increase were higher net occupancy expenses related in part with the U.S. mainland acquisitions and business growth. Also, there were higher business promotion expenses as a result of sales efforts in the U.S. banking operations directed to deposit gathering campaigns, the New York Mets sponsorship, and promotional campaigns for the ATH network in Puerto Rico. Other increases in operating expenses included higher equipment expenses resulting in part from the operations of the banks acquired in the U.S. mainland and the implementation of new application systems and costs to support business initiatives, and higher professional fees, which rose in part due to higher support fees for system conversions, including consulting and computer services, and legal expenses. Other operating expenses increased due to higher credit and debit cards interchange expenses, costs of the reinsurance business, as well as other diverse items.
For the nine-month period ended September 30, 2005, operating expenses increased 12% compared with the same period in 2004. Categories with the major variances included personnel costs, business promotion, professional fees, net occupancy, equipment and other operating expenses. Most of the variances were associated with the same factors previously described for the quarterly results. Personnel costs for the nine months ended September 30, 2004 included $2.4 million in early-retirement window costs and net curtailment gains recorded in the first quarter of that year, which were associated with the realignment of the Corporation’s processing and technology operations. Besides the aforementioned reasons for the unfavorable variance in costs, professional fees also rose in part due to higher collection and other credit related costs to support the lending business. Other operating expenses also increased due to higher insurance business related costs incurred in 2005 due to growth, traveling expenses and costs related with foreclosed properties derived from the lending business.
INCOME TAX
Income tax expense for the quarter ended September 30, 2005 decreased 13% compared with the same quarter of 2004. The decrease was primarily due to lower income before tax and to an increase in exempt interest income, net of the disallowance of expenses attributed to such exempt income. Also, during the third quarter of 2005, the proportion of the Corporation’s income derived from the mainland U.S., which is subject to a higher income tax rate, was lower than in the same quarter in 2004. The decrease in the income tax expense was partially offset by the unfavorable impact of $5.9 million resulting from the change in the Puerto Rico statutory income tax rate from 39% to 41.5% in the third quarter of 2005 (adjusted retroactively to January 1, 2005 as required by law), net of the income tax benefit of $3.1 million which results from adjusting the deferred tax asset to reflect the increase in rate. The effective tax rate for the quarter ended September 30, 2005 was 19.87%, compared with 22.18% in the same quarter in the previous year.

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Income tax expense for the nine-month period ended September 30, 2005 increased 7% compared with the same period in 2004. This rise was primarily due to higher pretax earnings and by the aforementioned change in the statutory tax rate, partially offset by an increase in exempt interest income, net of disallowance of expenses attributed to such exempt income, and by the recognition of an income tax benefit due to the increase in the deferred tax asset as a consequence of the change in tax rate. Also, there was an increase in income subject to a lower preferential tax rate when compared with the same nine-month period in the previous year. The capital gains realized during 2005 were subject to the transitory provisions effective until June 30, 2005 that reduced the preferential tax rate from 12.5% to 6.25%. The effective tax rate for the first nine months of 2005 was 21.65%, compared with 22.46% in 2004.
BALANCE SHEET COMMENTS
Refer to the consolidated financial statements included in this report for the Corporation’s consolidated statements of condition as of September 30, 2005, December 31, 2004 and September 30, 2004. Earning assets at September 30, 2005 totaled $43.9 billion, an increase of $2.1 billion, or 5%, from December 31, 2004. At September 30, 2004, earning assets totaled $40.3 billion.
A breakdown of the Corporation’s loan portfolio is presented in Table E.
TABLE E
Loans Ending Balances
                                         
                    Variance           Variance
                    September 30, 2005           September 30, 2005
    September 30,   December 31,   vs.   September 30,   vs.
(In thousands)   2005   2004   December 31, 2004   2004   September 30, 2004
 
Commercial, industrial and agricultural *
  $ 11,551,048     $ 10,396,732     $ 1,154,316     $ 10,020,953     $ 1,530,095
Construction
    716,595       501,015       215,580       421,059       295,536
Lease financing
    1,318,105       1,164,606       153,499       1,152,749       165,356
Mortgage *
    12,481,545       12,641,329       (159,784 )     11,970,585       510,960
Consumer
    4,482,790       4,038,579       444,211       3,951,952       530,838
 
Total
  $ 30,550,083     $ 28,742,261     $ 1,807,822     $ 27,517,298     $ 3,032,785
 
 
*   Includes loans held-for-sale
 
The commercial and construction loan portfolio at September 30, 2005 increased 13% from December 31, 2004, which included the impact of the commercial loans acquired from Kislak, primarily loans secured by real estate. This commercial and construction portfolio growth was also associated with business initiatives and stronger sales efforts. Moreover, the consumer loan portfolio, which breakdown is provided in Table F, increased 11%, compared with December 31, 2004. The growth in this portfolio was mostly reflected in personal and auto loans and is the result of aggressive marketing campaigns, attractive loan rates and portfolio acquisitions.
TABLE F
Breakdown of Consumer Loans
                                         
                    Variance           Variance
                    September 30, 2005           September 30, 2005
    September 30,   December 31,   vs.   September 30,   vs.
(In thousands)   2005   2004   December 31, 2004   2004   September 30, 2004
 
Personal
  $ 2,025,442     $ 1,816,949     $ 208,493     $ 1,791,902     $ 233,540 
Auto
    1,392,582       1,244,164       148,418       1,212,946       179,636 
Credit cards
    913,972       826,961       87,011       793,745       120,227 
Other
    150,794       150,505       289       153,359       (2,565)
 
Total
  $ 4,482,790     $ 4,038,579     $ 444,211     $ 3,951,952     $ 530,838 
 
The lease financing portfolio at September 30, 2005 increased 13% from December 31, 2004, principally from sales efforts and from the portfolio acquired from Kislak.

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At September 30, 2005, the mortgage loan portfolio (including loans held-for-sale) declined 1% from December 31, 2004. This decline was associated with the sale of approximately $1.7 billion in residential mortgage loans as part of four off-balance sheet securitizations completed by PFH during the nine-month period ended September 30, 2005. This reduction was principally compensated by a greater volume of purchased mortgage loans by PFH. During the nine-months ended September 30, 2005, PFH also completed two securitization transactions involving approximately $1.2 billion in purchased mortgage loans, which were accounted for as on-balance sheet securitizations, as such the loans remained in the Corporation’s statement of condition. Refer to Note 8 to the unaudited consolidated financial statements for further information on the securitization transactions performed in 2005.
As reflected in the consolidated statements of condition, loans held-for-sale at September 30, 2005 increased $116 million from the end of 2004. These loans represent primarily mortgage loans that have been originated and are pending securitization or sale in the secondary market. At September 30, 2005, loans held-for-sale consisted primarily of conforming loans for which aggregate fair value exceeded their cost.
Variances in loan categories from September 30, 2004 to the same date in 2005 were also related to the same factors described above.
At September 30, 2005, investment securities, including trading securities, totaled $12.7 billion, compared with $12.2 billion at December 31, 2004 and $12.0 billion at September 30, 2004. Refer to notes 3 and 4 to the unaudited consolidated financial statements for a breakdown of the Corporation’s available-for-sale and held-to-maturity investment portfolios. The increase in the investment portfolio from December 31, 2004 was principally due to the reinvestment of funds derived from the mortgage loans pooling and sale transaction by BPPR in the second quarter of 2005 (approximately $552 million in loans), into securities from the U.S. Government and its Agencies, some of which are tax-exempt in Puerto Rico, and from Kislak’s investment securities portfolio.
Premises and equipment at September 30, 2005 increased $47 million from December 31, 2004 and $57 million from September 30, 2004. The increase was mostly associated with buildings under construction for business expansion and relocations and land acquisitions for future branch sites, primarily in Puerto Rico. During the nine-month period ended September 30, 2005, the Corporation capitalized approximately $0.6 million in interest costs associated with major building projects under construction that are intended principally for the Corporation’s own use.
Goodwill and other intangible assets at September 30, 2005 increased $118 million from December 31, 2004, primarily associated with the acquisition of Kislak. Note 7 to the consolidated financial statements provide additional information on goodwill and the composition of other intangible assets. As further described in the MD&A included in the 2004 Annual Report, the increase since September 30, 2004 was also associated with the acquisition of Quaker City.

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Table G presents the categories with the most significant variances within the “Other Assets” caption included in the consolidated statements of condition.
TABLE G
Breakdown of Other Assets
                                         
                    Variance             Variance  
                    September 30, 2005             September 30, 2005  
    September 30,     December 31,     vs. December 31,     September 30,     vs. September 30,  
(In thousands)   2005     2004     2004     2004     2004  
 
Net deferred tax assets
  $ 284,075     $ 231,892     $ 52,183     $ 233,156     $ 50,919  
Securitization advances and related assets
    247,565       240,304       7,261       186,360       61,205  
Bank-owned life insurance program
    195,119       155,527       39,592       104,473       90,646  
Prepaid expenses
    156,950       120,577       36,373       115,252       41,698  
Investments under the equity method
    62,682       56,996       5,686       54,041       8,641  
Derivative assets
    39,354       24,554       14,800       12,135       27,219  
Servicing rights
    121,752       57,183       64,569       60,854       60,898  
Others
    169,079       159,341       9,738       179,937       (10,858 )
 
Total
  $ 1,276,576     $ 1,046,374     $ 230,202     $ 946,208     $ 330,368  
 
The increase in the net deferred tax assets from December 31, 2004 and September 30, 2004 to September 30, 2005 was primarily the result of the net unrealized loss position of the portfolio of available-for-sale securities at the end of the third quarter of 2005, compared with net unrealized gains in the periods presented for 2004. Securitization advances and related assets at September 30, 2005 increased compared with September 30, 2004 and December 31, 2004 principally as a result of on-balance sheet securitizations completed in the fourth quarter of 2004 and the first nine months of 2005. The advances represent payments received on loans held-in-trust available to pay down security holders under scheduled terms specified in the agreements. The increase in bank-owned life insurance since September 30, 2004 and December 31, 2004 was related to additional funding permitted as a result of an increased salary base resulting from the acquired institutions. The increase in prepaid expenses at September 30, 2005 compared with both periods in 2004 was primarily related to software packages supporting new branch network and other specialized systems. The increase in derivative assets since September 30, 2004 was mostly related to additional volume of interest rate swaps used to hedge the exposure to changes in the fair value of certain loans, investments and deposits, due to movements in the benchmark interest rate index and to the impact of indexed options used to economically hedge the risk associated with certificates of deposit, which returns are tied to a stock market index. The rise in servicing rights from December 31, 2004 and September 30, 2004 was principally associated with the servicing rights derived from the securitizations performed by PFH during 2005, as further described in note 8 to the unaudited consolidated financial statements.
Asset growth from December 31, 2004 to September 30, 2005 was funded principally through deposits. Refer to the Liquidity section of this Form 10-Q for a table with the composition of the Corporation’s financing to total assets at September 30, 2005 and December 31, 2004.
Table H provides a breakdown of the Corporation’s deposits by categories. Included within time deposits, at September 30, 2005, were brokered certificates of deposit amounting to $1.3 billion, compared with $559 million at December 31, 2004 and $643 million at September 30, 2004.
TABLE H
Deposits ending balances
                                         
                    Variance           Variance
    September 30,   December 31,   September 30, 2005 vs.   September 30,   September 30, 2005 vs.
(In thousands)   2005   2004   December 31, 2004   2004   September 30, 2004
 
Demand deposits
  $ 4,182,281     $ 4,173,267     $ 9,014     $ 4,076,534     $ 105,747  
Savings deposits
    8,944,495       8,865,832       78,663       8,660,080       284,415  
Time deposits
    9,451,933       7,554,061       1,897,872       7,746,604       1,705,329  
 
Total
  $ 22,578,709     $ 20,593,160     $ 1,985,549     $ 20,483,218     $ 2,095,491  
 

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At September 30, 2005, borrowed funds reached $20.6 billion, compared with $19.9 billion at December 31, 2004 and $18.7 billion at September 30, 2004. The increase in borrowings since December 31, 2004 was mostly comprised of repurchase agreements. The rise from September 30, 2004 to the same date in 2005 included higher balances of repurchase agreements, federal funds purchased, debt issuance in the form of junior subordinated debentures (trust preferred securities), and secured borrowings from on-balance sheet securitizations.
The Federal Home Loan Banks provide funding to the Corporation’s banking subsidiaries through advances. At September 30, 2005, Popular’s short-term and long-term borrowings under these credit facilities totaled $1.8 billion, compared with $0.7 billion at September 30, 2004, and $1.9 billion at December 31, 2004. Such advances are collateralized by investment securities and mortgages loans, do not have restrictive covenants and do not have any callable features.
Refer to the unaudited consolidated statements of condition and of stockholders’ equity included in this Form 10-Q for information on the composition of stockholders’ equity at September 30, 2005, December 31, 2004 and September 30, 2004. Also, the disclosures of accumulated other comprehensive (loss) income, an integral component of stockholders’ equity, are included in the unaudited consolidated statements of comprehensive (loss) income. Other comprehensive (loss) income includes the Corporation’s unrealized gain (loss) position on securities available-for-sale and the cumulative foreign currency translation adjustment at the end of each reporting period. The increase in stockholders’ equity from December 31, 2004 and September 30, 2004 to September 30, 2005 was due to earnings retention, partially offset by an unfavorable change in the fair value of securities classified as available-for-sale. This change in the valuation of the securities when compared with December 31, 2004 was mostly due to unfavorable market interest rate fluctuations impacting the Corporation’s U.S. Agency securities and to the marketable equity securities sold by the Corporation in the first quarter of 2005. The Corporation’s market capitalization at September 30, 2005 was $6.5 billion, compared with $7.0 billion at September 30, 2004 and $7.7 billion at December 31, 2004.
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 rates.
The Corporation continues to exceed the well-capitalized guidelines under the federal banking regulations. Ratios and amounts of total risk-based capital, Tier 1 risk-based capital and Tier 1 leverage as of September 30, 2005 and 2004, and December 31, 2004 are presented on Table I. The reduction in the capital ratios since December 31, 2004 was associated with the assets acquired and the goodwill and other intangible assets recorded as a result of the Kislak acquisition, and general business growth. At September 30, 2005, December 31, 2004 and September 30, 2004, BPPR, BPNA and Banco Popular, National Association were all well-capitalized.

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TABLE I
Capital Adequacy Data
                         
    September 30,   December 31,   September 30,
(Dollars in thousands)   2005   2004   2004
 
Risk-based capital
                       
Tier I capital
  $ 3,495,710     $ 3,316,009     $ 2,860,783  
Supplementary (Tier II) capital
    389,647       389,638       395,474  
 
Total capital
  $ 3,885,357     $ 3,705,647     $ 3,256,257  
 
Risk-weighted assets Balance sheet items
                       
Balance sheet items
  $ 28,523,983     $ 26,561,212     $ 25,467,134  
Off-balance sheet items
    2,147,889       1,495,948       1,458,589  
 
Total risk-weighted assets
  $ 30,671,872     $ 28,057,160     $ 26,925,723  
 
Average assets
  $ 45,347,557     $ 42,597,513     $ 40,206,377  
 
Ratios:
                       
Tier I capital (minimum required – 4.00%)
    11.40 %     11.82 %     10.62 %
Total capital (minimum required – 8.00%)
    12.67 %     13.21 %     12.09 %
Leverage ratio *
    7.71 %     7.78 %     7.12 %
 
 
*   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.
 
    At September 30, 2005, the capital adequacy minimum requirement for Popular, Inc. was: Total Capital of $2,453,750, Tier I Capital of $1,226,875, and a Tier I Leverage of $1,360,427 based on a 3% ratio or $1,813,902 based on a 4% ratio according to the Bank’s classification.
 
OFF-BALANCE SHEET ACTIVITIES
The off-balance sheet securitizations conducted prior to 2001 and in 2005, the latter previously described in Note 8 to the unaudited consolidated financial statements, involved the transfer of mortgage loans to a qualifying special purpose entity (QSPE), which in turn transferred these assets, to different trusts, thus isolating those loans from the Corporation’s assets. These transactions qualified for sale accounting and as such, these trusts are not consolidated in the Corporation’s financial statements. The investors and the securitization trusts have no recourse to any of the Corporation’s assets or revenues. The Corporation’s creditors have no recourse to any assets or revenues of the special purpose entity, or the securitization trust funds. At September 30, 2005, these trusts held approximately $1.7 billion in assets in the form of mortgage loans. Their liabilities in the form of principal due to investors approximated $1.7 billion at the end of the third quarter of 2005. In connection with the securitizations accounted for as sales, the Corporation’s retained interests are subordinated to investors’ interests. Their value is subject to credit, prepayment and interest rate risks on the transferred financial assets.
CREDIT RISK MANAGEMENT AND LOAN QUALITY
NON-PERFORMING ASSETS
Non-performing assets consist of past-due loans that are no longer accruing interest, renegotiated loans and real estate property acquired through foreclosure. For a summary of the Corporation’s policy in placing loans on non-accrual status, refer to the sections of Loans and Allowance for Loan Losses included in Note 1 to the audited consolidated financial statements included in Popular, Inc.’s 2004 Annual Report.

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A summary of non-performing assets by loan categories and related ratios is presented in Table J.
TABLE J
Non-Performing Assets
                                         
                    Variance           Variance
                    September 30, 2005           September 30, 2005
    September 30,   December 31,   vs.   September 30,   vs.
(Dollars in thousands)   2005   2004   December 31, 2004   2004   September 30, 2004
 
Commercial and construction
  $ 140,093     $ 122,593     $ 17,500     $ 133,612     $ 6,481  
Lease financing
    3,252       3,665       (413 )     6,377       (3,125 )
Mortgage
    373,126       395,749       (22,623 )     386,520       (13,394 )
Consumer
    35,479       32,010       3,469       37,762       (2,283 )
 
Total non-performing loans
    551,950       554,017       (2,067 )     564,271       (12,321 )
Other real estate
    77,993       59,717       18,276       58,814       19,179  
 
Total non-performing assets
  $ 629,943     $ 613,734     $ 16,209     $ 623,085     $ 6,858  
 
Accruing loans past-due 90 days or more
  $ 80,401     $ 79,091     $ 1,310     $ 71,024     $ 9,377  
 
 
                                       
Non-performing assets to total loans held-in-portfolio
    2.12 %     2.19 %             2.29 %        
Non-performing assets to total assets
    1.34       1.38               1.45          
 
Non-performing commercial and construction loans represented 1.14% of that loan portfolio at September 30, 2005, compared with 1.28% at September 30, 2004, and 1.13% at December 31, 2004. The decline in that credit quality ratio since September 30, 2004 was mainly related to portfolio growth, principally due to the acquisition of Kislak’s portfolio which had low levels of non-performing loans.
Non-performing financing leases represented 0.25% of the lease financing portfolio at September 30, 2005, compared with 0.55% at September 30, 2004, and 0.31% at December 31, 2004. The decline in non-performing leases from September 30, 2004 was the result of lower delinquency levels associated principally to the small ticket equipment leasing operations of the U.S. portfolio.
Non-performing mortgage loans represented 59% of total non-performing assets and 3.21% of mortgage loans held-in-portfolio at September 30, 2005, compared with 62% of total non-performing assets and 3.30% of mortgage loans held-in-portfolio at September 30, 2004. Non-performing mortgage loans represented 64% of total non-performing assets and 3.33% of mortgage loans held-in-portfolio at December 31, 2004. The decrease in non-performing mortgage loans since September 30, 2004 was mainly reflected at PFH where non-performing mortgage loans represented 3.93% of its mortgage loans held-in-portfolio at September 30, 2005, compared with 3.96% at December 31, 2004 and 3.85% at September 30, 2004. Historically, the Corporation has experienced a low level of losses in its mortgage portfolio.
Non-performing consumer loans were 0.79% of consumer loans at September 30, 2005, compared with 0.96% at September 30, 2004 and 0.79% at December 31, 2004. The decline in the non-performing consumer loans to consumer loans ratio from September 30, 2004 was mainly due to portfolio growth, combined with better credit quality mix and improved delinquency levels.
In addition to the non-performing loans discussed earlier, there were $51 million of loans at September 30, 2005, which in management’s opinion are currently subject to potential future classification as non-performing, and are considered impaired under SFAS No. 114. At December 31, 2004 and September 30, 2004, these potential problem loans approximated $32 million and $31 million, respectively. The increase reflected in the third quarter of 2005 was mainly related to the commercial portfolio in the Puerto Rico operations.
Other real estate assets represented 12% of non-performing assets at September 30, 2005, compared with 9% at September 30, 2004, and 10% at December 31, 2004. The increase in other real estate assets since September 30, 2004 was associated with higher foreclosures in the mortgage business resulting from more dynamic foreclosure procedures.

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The impact of Hurricanes Katrina and Rita on the Corporation’s U.S. operations is not considered significant.
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 September 30, 2005, adjusted non-performing assets would have been $594 million or 2.00% of loans held-in-portfolio and the allowance to non-performing loans ratio would have been 88.95%. At December 31, 2004, adjusted non-performing assets would have been $582 million or 2.08% of loans held-in-portfolio and the allowance to non-performing loans ratio would have been 83.73%. At September 30, 2004, adjusted non-performing assets would have been $585 million or 2.15% of loans held-in-portfolio and the allowance to non-performing loans would have been 84.68%.
ALLOWANCE FOR LOAN LOSSES
In evaluating the adequacy of the allowance for loan losses, the Corporation’s management considers current economic conditions, loan portfolio risk characteristics, prior loss experience, results of periodic credit reviews of individual loans, regulatory requirements and loan impairment measurement, among other factors. The methodology used to establish the allowance for loan losses is based on SFAS No. 114, “Accounting by Creditors for Impairment of a Loan,” and SFAS No. 5, “Accounting for Contingencies.” Under SFAS No. 114, certain commercial loans are identified for evaluation on an individual basis, and specific reserves are calculated based on impairment analyses. SFAS No. 5 provides for the recognition of a loss allowance for a group of homogeneous loans when it is probable that a loss has been incurred and the amount can be reasonably estimated. As of September 30, 2005, there have been no significant changes in evaluation methods or assumptions from December 31, 2004 that have an effect on the Corporation’s methodology for assessing the adequacy of the allowance for loan losses.
Table K summarizes the movement in the allowance for loan losses and presents several loan loss statistics for the quarters and nine months ended September 30, 2005 and 2004. The ratio of allowance for loan losses to loans held-in-portfolio at September 30, 2005 when compared with September 30, 2004, reflects improvement in credit quality trends and a shift in the loan portfolio mix to include a greater proportion of real estate secured loans, which includes the portfolio from Kislak. At December 31, 2004, the allowance for loan losses amounted to $437 million or 1.56% of loans held-in-portfolio, and the allowance for loan losses as a percentage of non-performing loans was 78.89%. The corresponding ratios as of September 30, 2004 and 2005 are shown in Table K. The Corporation’s management considers the allowance for loan losses to be at a level sufficient to provide for estimated losses based on current economic conditions, the expected level of net loan losses and the methodology established to evaluate the adequacy of the allowance for loan losses.
The Corporation considers a loan to be impaired when interest and/or principal are past due 90 days or more, or, when based on current information and events, it is probable that the debtor will be unable to pay all amounts due according to the contractual terms of the loan agreement. An allowance for loan impairment is recognized to the extent that the carrying value of an impaired 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 loans is part of the Corporation’s overall allowance for loan losses. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment based on past experience adjusted for current conditions. Larger balance commercial loans are evaluated on a loan-by-loan basis. Once a specific measurement methodology is chosen, it is consistently applied unless there is a significant change in the financial position of the borrower. For more information regarding the Corporation’s allowance for loan losses methodology refer to the Credit Risk Management and Loan Quality section in the MD&A included in Popular, Inc.’s 2004 Financial Review and Supplementary Information to Stockholders, incorporated by reference in Popular, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2004.

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TABLE K
Allowance for Loan Losses and Selected Loan Losses Statistics
                                                 
    Third Quarter           Nine months ended September 30,
(Dollars in thousands)   2005   2004   Variance   2005   2004   Variance
 
Balance at beginning of period
  $ 456,954     $ 425,949     $ 31,005     $ 437,081     $ 408,542     $ 28,539  
Allowance purchased
          15,764       (15,764 )     3,685       22,741       (19,056 )
Provision for loan losses
    49,960       46,614       3,346       144,232       132,641       11,591  
Impact of change in reporting period*
                      1,586             1,586  
 
 
    506,914       488,327       18,587       586,584       563,924       22,660  
 
 
                                               
Losses charged to the allowance:
                                               
Commercial and construction
    15,774       17,143       (1,369 )     49,474       48,805       669  
Lease financing
    5,503       5,992       (489 )     14,720       15,901       (1,181 )
Mortgage
    12,037       8,544       3,493       34,144       23,367       10,777  
Consumer
    27,992       25,206       2,786       75,997       75,981       16  
 
Subtotal
    61,306       56,885       4,421       174,335       164,054       10,281  
 
 
                                               
Recoveries:
                                               
Commercial and construction
    4,174       5,152       (978 )     17,296       15,343       1,953  
Lease financing
    2,530       2,327       203       7,327       8,836       (1,509 )
Mortgage
    167       219       (52 )     588       1,050       (462 )
Consumer
    6,946       6,705       241       21,965       20,746       1,219  
 
Subtotal
    13,817       14,403       (586 )     47,176       45,975       1,201  
 
 
                                               
Net loans charged-off:
                                               
Commercial and construction
    11,600       11,991       (391 )     32,178       33,462       (1,284 )
Lease financing
    2,973       3,665       (692 )     7,393       7,065       328  
Mortgage
    11,870       8,325       3,545       33,556       22,317       11,239  
Consumer
    21,046       18,501       2,545       54,032       55,235       (1,203 )
 
Subtotal
    47,489       42,482       5,007       127,159       118,079       9,080  
 
Balance at end of period
  $ 459,425     $ 445,845     $ 13,580     $ 459,425     $ 445,845     $ 13,580  
 
 
                                               
Ratios:
                                               
Allowance for losses to loans held-in-portfolio
    1.55 %     1.64 %             1.55 %     1.64 %        
Allowance to non-performing assets
    72.93       71.55               72.93       71.55          
Allowance to non-performing loans
    83.24       79.01               83.24       79.01          
Non-performing assets to loans held-in-portfolio
    2.12       2.29               2.12       2.29          
Non-performing assets to total assets
    1.34       1.45               1.34       1.45          
Net charge-offs to average loans held-in-portfolio
    0.66       0.67               0.60       0.66          
Provision to net charge-offs
    1.05 x     1.10 x             1.13 x     1.12 x        
Net charge-offs earnings coverage **
    4.08       4.59               5.22       5.07          
 
 
*   Represents the net effect of provision for loan losses, less net charge-offs corresponding to the impact of the change in accounting principle described in Note 1 to the unaudited consolidated financial statements included in this Form 10-Q (change from fiscal to calendar reporting year for various subsidiaries).
 
**   (Income before income tax and cumulative effect of accounting change plus provision for loan losses) divided by net charge-offs.
 

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The following table shows the Corporation’s recorded investment in impaired loans and the related valuation allowance calculated under SFAS No. 114 at September 30, 2005, December 31, 2004 and September 30, 2004.
                                                 
    September 30, 2005   December 31, 2004   September 30, 2004
    Recorded   Valuation   Recorded   Valuation   Recorded   Valuation
(In millions)   Investment   Allowance   Investment   Allowance   Investment   Allowance
 
Impaired loans:
                                               
Valuation allowance required
  $ 89.7     $ 27.1     $ 69.2     $ 30.7     $ 74.5     $ 30.7  
No valuation allowance required
    52.6             44.1             41.5        
 
Total impaired loans
  $ 142.3     $ 27.1     $ 113.3     $ 30.7     $ 116.0     $ 30.7  
 
Average impaired loans during the third quarter of 2005 and 2004 were $138 million and $120 million, respectively. The Corporation recognized interest income on impaired loans of $1.4 million and $0.5 million for the quarters ended September 30, 2005 and September 30, 2004, and $3.5 million and $2.0 million for the nine months ended in those dates, respectively.
Also, Table L presents annualized net charge-offs to average loans by loan category for the quarter and nine months ended September 30, 2005 and 2004.
TABLE L
Annualized Net Charge-offs to Average Loans Held-in-Portfolio
                                 
    Quarter ended September 30,   Nine months ended September 30,
    2005   2004   2005   2004  
 
Commercial and construction
    0.39 %     0.50 %     0.37 %     0.50 %
Lease financing
    0.91       1.27       0.76       0.84  
Mortgage
    0.43       0.30       0.40       0.29  
Consumer
    1.91       1.95       1.69       2.08  
 
 
    0.66 %     0.67 %     0.60 %     0.66 %
 
The decrease from 2004 in the commercial and construction loans net charge-offs ratio presented in Table L was mostly associated with collection efforts and an increase in the mix of the commercial loan portfolio to real estate secured loans, in part due to the loan portfolios acquired.
Also, the lease financing net charge-offs ratios reflected a reduction from 2004 primarily due to one vendor who filed bankruptcy during the third quarter of 2004 pertaining to the small ticket equipment leasing segment of the U.S. portfolio.
Consumer loans net charge-offs to average consumer loans for the quarter and nine months ended September 30, 2005 declined when compared with the same periods in 2004 primarily due to portfolio growth, mainly in personal and auto loans. Also, the decline in consumer loans net charge-offs was associated with lower delinquency levels, due to better portfolio credit quality supported in part by more rigorous underwriting standards and collection strategies.
The increase for 2005 in the mortgage loans net charge-offs ratio shown in Table L was primarily associated with PFH. Mortgage loans net charge-offs to average mortgage loans held-in-portfolio at PFH were 0.61% for the quarter and 0.59% for the nine months ended September 30, 2005, compared with 0.40% and 0.37%, respectively, in the same periods of 2004, due to higher levels of charge-offs and lower growth in the portfolio due to the change in the accounting for the securitizations to also include off-balance sheet transactions during 2005.

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Item 3. Quantitative and Qualitative Disclosures About 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. Interest rate risk, a component of market risk, is the exposure to adverse changes in net interest income due to changes in interest rates. Management considers interest rate risk a prominent market risk in terms of its potential impact on earnings. Interest rate risk may occur for one or more reasons, such as the maturity or repricing of assets and liabilities at different times, changes in short and long-term market interest rates, or the maturity of assets or liabilities may be shortened or lengthened as interest rates change. Depending on the duration and repricing characteristics of the Corporation’s assets, liabilities and off-balance sheet items, changes in interest rates could either increase or decrease the level of net interest income.
The techniques for measuring the potential impact of the Corporation’s exposure to market risk from changing interest rates have remained substantially constant from the end of 2004. Due to the importance of critical assumptions in measuring market risk, the risk models currently incorporate third-party developed data for critical assumptions such as prepayment speeds on mortgage-related products and estimates on the duration of the Corporation’s deposits. Potential interest rate scenarios continue to be modified in response to economic developments and their impact on interest rate outlooks.
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 margin under varying interest rate environments. Management employs a variety of measurement techniques including the use of an earnings simulation model to analyze the net interest income sensitivity to changing 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 determine potential changes to the future earnings of the Corporation.
Computations of the prospective effects of hypothetical interest rate changes 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 upon as indicative of actual results. Further, the computations 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 actually may occur in the future.
Based on the results of the sensitivity analyses as of September 30, 2005, the Corporation’s net interest income for the next twelve months is estimated to decrease by $30.6 million in a hypothetical 200 basis points rising rate scenario, and the change for the same period, utilizing a similar hypothetical decline in the rate scenario, is an estimated increase of $13.2 million. Both hypothetical rate scenarios consider the gradual change to be achieved during a twelve-month period from the prevailing rates at September 30, 2005. These estimated changes are within the policy guidelines established by the Board of Directors.
Since December 31, 2004 there have been many uncertain market changes with respect to interest rate outlooks. The Corporation’s net interest margin could continue to be negatively impacted by a flattened yield curve if the current environment persists, and by the intense pricing competition.
The Corporation maintains an overall interest rate risk management strategy that incorporates the use of derivative instruments to minimize significant unplanned fluctuations in net interest income that are caused by interest rate volatility. The Corporation’s involvement in derivative activities since December 31, 2004 has not resulted in significant changes to its statement of condition or results of operations for the period ended September 30, 2005.
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. in the Dominican Republic. Although not

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significant, some of these businesses are conducted in the country’s foreign currency. At September 30, 2005 and December 31, 2004, the Corporation had approximately $36 million in an unfavorable foreign currency translation adjustment as part of accumulated other comprehensive (loss) income. At September 30, 2004, this figure approximated $35 million.
The Corporation has been monitoring the inflation levels in the Dominican Republic to evaluate whether it still meets 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.” The cumulative inflation in the Dominican Republic for the 36 months ended September 30, 2005 exceeded the 100 percent threshold. 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. Accordingly, the Corporation’s interests in the Dominican Republic were remeasured into the U.S. dollar. During the quarter ended September 30, 2005, approximately $1.0 million in 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. For the nine months ended September 30, 2005, net remeasurement gains totaled $1.3 million. 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 $29.05 at September 30, 2005. These remeasurement gains / losses will continue to be reflected in earnings until the economy is no longer highly inflationary. The unfavorable cumulative translation adjustment associated with these interests at the reporting date in which the economy became highly inflationary approximated $32 million. The cumulative inflation rate in the Dominican Republic over a 3-year period approximated 101.5 percent at September 30, 2005.
LIQUIDITY
Liquidity risk may arise whenever the Corporation’s ability to raise cash and the runoff of its assets are substantially less than the runoff of its liabilities and its commitments to fund loans. 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 unexpected events.
The Corporation has contingency plans for raising financing under stress scenarios, where important sources of funds that are usually fully available are temporarily not willing to lend to the Corporation. These plans call for using alternate funding mechanisms such as the pledging or securitization of certain asset classes, committed credit lines, and loan facilities put in place with the Federal Reserve Bank of New York. The Corporation has a substantial amount of assets available for raising funds through non-traditional channels and is confident that it has adequate alternatives to rely on, under a scenario during which some primary funding sources are temporarily unavailable.
The Corporation’s liquidity position is closely monitored on an ongoing basis. Management believes that available sources of liquidity are adequate to meet the funding needs in the normal course of business.

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The composition of the Corporation’s financing to total assets at September 30, 2005 and December 31, 2004 were as follows:
                                         
                    % increase (decrease)    
                    from   % of total assets
    September 30,   December 31,   December 31, 2004 to   September 30,   December 31,
(Dollars in millions)   2005   2004   September 30, 2005   2005   2004
 
Non-interest bearing deposits
    3,733       4,173       (10.5 %)     7.9 %     9.4 %
Interest-bearing core deposits
    13,820       12,835       7.7 %     29.3 %     28.9 %
Other interest-bearing deposits
    5,026       3,585       40.2 %     10.7 %     8.1 %
Federal funds and repurchase agreements
    8,018       6,437       24.6 %     17.0 %     14.5 %
Other short-term borrowings
    2,909       3,140       (7.4 %)     6.2 %     7.1 %
Notes payable and subordinated notes
    9,689       10,306       (6.0 %)     20.6 %     23.2 %
Others
    704       821       (14.3 %)     1.5 %     1.8 %
Stockholders’ equity
    3,221       3,105       3.7 %     6.8 %     7.0 %
 
The decline in non-interest bearing deposits reflected in the table above is related with approximately $449 million in certain public funds demand deposits which currently bear interest under revised contractual terms. The Corporation’s core deposits, which consist of demand, savings, money markets, and time deposits under $100 thousand, constituted 78% of total deposits at September 30, 2005. Certificates of deposit with denominations of $100 thousand and over at September 30, 2005 represented 22% of total deposits. Their distribution by maturity was as follows:
         
(In thousands)        
 
3 months or less
  $ 1,639,319  
3 to 6 months
    863,401  
6 to 12 months
    1,264,977  
Over 12 months
    1,258,114  
 
 
  $ 5,025,811  
 
The Corporation diversifies the sources and the maturities of borrowings in order to avoid undue reliance on any single source and maintain an orderly volume of borrowings maturing in the future. The Corporation has established borrowing relationships with the Federal Home Loan Bank (FHLB), the Federal Reserve Bank of New York and other correspondent banks, which further support and enhance liquidity.
As of September 30, 2005, other than the strategy followed in 2005 with respect to PFH’s securitization transactions described in Note 8 to the unaudited consolidated financial statements and the increased reliance in deposits to fund asset growth, there have been no significant changes in the Corporation’s funding activities and strategy disclosed in the MD&A included in Popular, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2004. Also, there have been no significant changes in the Corporation’s aggregate contractual obligations since the end of 2004. Refer to Note 9 to the unaudited consolidated financial statements for the Corporation’s involvement in certain commitments at September 30, 2005.
Risks to Liquidity
Credit ratings by the major credit rating agencies are an important component of the Corporation’s liquidity profile. Among other factors, 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. 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

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the institutional market would increase. In addition, the ability of the Corporation to raise new funds or refinance maturing debt may be more difficult. In early August 2005, Fitch, a nationally recognized credit rating agency, changed the Corporation’s rating outlook from “stable” to “negative”. In the opinion of management, this does not necessarily imply that a change in the actual rating of the Corporation is imminent, but does suggest that the agency has identified financial and / or business trends, which if left unchanged, may result in a rating change. Management anticipates that all concerns raised by the credit rating agency will be fully addressed. The Corporation is also rated by two other nationally recognized credit rating agencies. Management has not been advised by these agencies of any potential changes to either the Corporation’s ratings or rating outlook.
The Corporation and BPPR’s debt ratings at September 30, 2005 were as follows:
                                 
    Popular, Inc.   BPPR
    Short-term   Long-term   Short-term   Long-term
    debt   debt   debt   debt
 
Fitch
    F-1       A       F-1       A  
Moody’s
    P-2       A3       P-1       A2  
S&P
    A-2     BBB+     A-2       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 $216 million at September 30, 2005.
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. During the third quarter of 2005, one of the Corporation’s subsidiaries breached a condition under an agreement with an investment bank whereby the subsidiary did not maintain the required unborrowed capacity in the credit line agreement with its holding company. Subsequently, the subsidiary paid down the credit line with the holding company and is now in compliance with the covenant. The company and the investment bank agreed to a covenant waiver. Also, the subsidiary breached an earnings covenant in a credit facility for which the Corporation also obtained a covenant waiver. Obligations subject to the covenant waivers as of quarter end approximated $195 million. At September 30, 2005, the Corporation had $846 million in outstanding obligations subject to covenants, including those which are subject to rating triggers and those outstanding under the commercial paper program.
Management believes that there have been no significant changes in liquidity risk compared with the disclosures in Popular, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2004.

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Item 4. Controls and Procedures
Disclosure Controls and Procedures
The Corporation’s management, with the participation of the Corporation’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Corporation’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on such evaluation, the Corporation’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Corporation’s disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Corporation in the reports that it files or submits under the Exchange Act.
Internal Control Over Financial Reporting
There have been no changes in the Corporation’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the quarter ended on September 30, 2005 that have materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.
Part II — Other Information
Item 1. Legal Proceedings
The Corporation and its subsidiaries are defendants in various lawsuits arising in the ordinary course of business. Management believes, based on the opinion of legal counsel, that the aggregate liabilities, if any, arising from such actions will not have a material adverse effect on the financial position and results of operations of the Corporation.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The following table sets forth the details of purchases of Common Stock during the quarter ended September 30, 2005 under the 2004 Omnibus Incentive Plan.
Issuer Purchases of Equity Securities
                                 
Not in thousands                        
                    Total Number of  Shares   Maximum Number of Shares
    Total Number of Shares   Average Price Paid   Purchased as Part of Publicly   that May Yet be Purchased
Period   Purchased   per Share   Announced Plans or Programs   Under the Plans or Programs
 
July 1 – July 31
    750     $ 26.02       750       9,055,080  
August 1 – August 31
                      9,055,080  
September 1 – September 30
                      9,055,080  
 
Total September 30, 2005
    750     $ 26.02       750       9,055,080  
 
Item 6. Exhibits
     
Exhibit No.   Exhibit Description
12.1
  Computation of the ratios of earnings to fixed charges and preferred stock dividends.
 
   
31.1
  Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
   
31.2
  Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
   
32.1
  Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
   
32.2
  Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
             
 
      POPULAR, INC.    
 
      (Registrant)    
 
           
Date: November 4, 2005
  By:   /s/ Jorge A. Junquera    
 
           
 
      Jorge A. Junquera    
 
      Senior Executive Vice President &    
 
      Chief Financial Officer    
 
           
Date: November 4, 2005
  By:   /s/ Ileana González Quevedo    
 
           
 
      Ileana González Quevedo    
 
      Senior Vice President & Corporate Comptroller    

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