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| DRL > SEC Filings for DRL > Form 10-Q on 14-Nov-2008 | All Recent SEC Filings |
14-Nov-2008
Quarterly Report
• Net interest income for the third quarter of 2008 was $47.0 million, compared to $39.4 million for the corresponding period in 2007. The increase of $7.6 million in net interest income for 2008, compared to 2007, was primarily driven by a $9.7 million decline in interest expense partially offset by a reduction in interest income of $2.0 million. The reduction in interest expense was due to (1) a $3.0 million reduction in deposit costs as a result of the repositioning of the Company's deposit products and the general decline in interest rates, and (2) a $6.7 million reduction in borrowing costs, $5.9 million of which was associated with the decrease in interest expense for repurchase agreements, and a $2.9 million decrease in loans payable borrowing expense due to the general decline in interest rates, resulting in a reduction of 0.81% in average cost of funds, partially offset the $0.7 billion increase in average interest bearing liabilities. The decline in interest expense was offset by a decrease in interest income of $2.0 million primarily associated with the reduction of $794.0 million in average balance of investment securities and of $527.1 million of other interest-earning assets, primarily money markets. The reduction in interest income resulted in a 0.65% reduction in interest earning asset yields largely offset by a $0.9 billion increase in the interest earning asset average balance. Average interest-earning assets increased from $8.7 billion for the third quarter of 2007 to $9.6 billion for the third quarter of 2008, while the average interest bearing-liabilities increased from $7.8 billion to $8.5 billion, respectively. The growth in interest earning assets, net of the growth in interest bearing liabilities, was partially funded by the $610.0 million recapitalization of the Company in July 2007, allowing for a reduction in the Company's leverage. The reduction in leverage, together with the decline in cost of funds, resulted in an expansion in the net interest margin from 1.81% in the third quarter of 2007 to 1.96% in the third quarter of 2008 (see Tables A and C below for information regarding the Company's net interest income).
• For the third quarter of 2008, the provision for loan and lease losses amounted to $7.2 million, compared to $5.1 million for the same period in 2007, an increase of $2.1 million. The increase in the provision for loan losses is mostly due to the increase in delinquencies in the residential loan portfolio.
• Non-interest income for the third quarter of 2008 was $11.9 million, compared to a loss of $109.6 million for the same period in 2007, an increase of $121.5 million. The loss in the third quarter of 2007 was primarily related to the sale of $1.9 billion in securities and extinguishment of associated liabilities as part of the Company's effort to reduce its interest rate risk profile following the recapitalization on July 19, 2007. During the third quarter of 2008, the Company terminated its repurchase financing and TBA ("To-Be-Announced") forward agreements with Lehman Brothers, Inc. ("LBI") as LBI was placed in a Securities Investor Protection Corporation ("SIPC") liquidation proceeding after the filing for bankruptcy of its parent Lehman Brothers Holdings, Inc. The termination of the agreements has also caused Doral to recognize a previously unrealized loss on the value of the securities subject to the agreements, resulting in a $4.2 million charge during the quarter ending September 30, 2008. Please refer to note "x" for further information.
• Non-interest expense for the third quarter of 2008 was $52.4 million, compared to $73.2 million for the corresponding period in 2007. The $20.8 million reduction in non-interest expense for the quarter was driven by the elimination of expenses associated with the 2007 recapitalization efforts and cost control measures implemented by the Company in 2008. The elimination of expenses and cost control measures impacted total compensation and benefits cost by $13.8 million, other expenses by $7.4 million and professional services by $4.3 million. These reductions were partially offset by increases in the Company's communication and information systems expense of $2.8 million, largely associated with the increase in ATH and VISA debit card activity which was offset by an increase in retail banking fees of $2.7 million, and occupancy and other office expenses of $1.6 million associated with increases in utilities.
• For the third quarter of 2008, Doral Financial recognized an income tax expense of $1.1 million, compared to $86.3 million tax benefit for the corresponding period in 2007, an increase of $87.3 million. The recognition of the income tax benefit for the third quarter of 2007 was principally related to changes in the Company's valuation allowance for its deferred tax assets resulting from changes in earnings expectations used to evaluate the realization of the tax assets as a result of the Company's $610.0 million recapitalization in July 2007.
• During the third quarter of 2008, the Company had other comprehensive loss of approximately $62.1 million, compared to the recognition of other comprehensive income of $130.7 million for the corresponding 2007 period. The gain in 2007 was due to the sale of $1.9 billion in investment securities during the third quarter of 2007. The Company's other comprehensive loss for the third quarter of 2008 was driven primarily by the reduction in value of its private label CMO's. As of September 30, 2008, the Company's balance for accumulated other comprehensive loss (net of income tax benefit) increased to $195.4 million, compared to $33.1 million as of December 31, 2007, an increase of $162.3 million.
• Doral Financial's loan production for the third quarter of 2008 was $318.3 million, compared to $354.0 million for the comparable period in 2007, a decrease of approximately 10%. The decrease in Doral Financial's loan production for the third quarter of 2008 was primarily the result of tighter commercial and consumer underwriting standards and the decision to cease financing new housing projects in Puerto Rico.
• Total assets as of September 30, 2008 were $10.0 billion, an increase of 7% compared to $9.3 billion as of December 31, 2007. The increase in total assets during the three quarters of 2008 was due primarily to a net increase in the Company's available for sale securities portfolio of approximately of $0.9 billion and an increase in its loan portfolio of $0.2 billion, partially offset by a $0.5 billion reduction in money market investments and securities purchased under agreements to resell. Total liabilities increased $0.9 billion, principally due to the increase of borrowings used to finance the purchase of the securities. During September 2008, the Company reduced its assets and liabilities by $0.5 billion, associated with the termination of repurchase financing arrangements and the sale of the collateral associated with such financing arrangements with Lehman Brothers, Inc. ("LBI") as a result of the SIPC liquidation proceedings of LBI as of September 19, 2008.
INTERNAL CONTROL OVER FINANCIAL REPORTING
Doral Financial is engaged in the implementation of remediation efforts to
address the material weakness in the Company's internal control over financial
reporting. Doral Financial's remediation efforts are outlined in "-Remediation
of Material Weaknesses" under Item 9A, Controls and Procedures, in the Company's
2007 Annual Report on Form 10-K, and Part I, Item 4 "Controls and Procedures" in
this Quarterly Report on Form 10-Q.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in accordance with generally accepted
accounting principles in the United States of America requires management to
make a number of judgments, estimates and assumptions that affect the reported
amount of assets, liabilities, income and expenses in the Company's Consolidated
Financial Statements and accompanying notes. Various elements of Doral
Financial's accounting policies, by their nature, are inherently subject to
estimation techniques, valuation assumptions and other subjective assessments.
The Company believes that the judgments, estimates and assumptions used in the
preparation of its Consolidated Financial Statements included in this Quarterly
Report on Form 10-Q are appropriate given the factual circumstances as of
September 30, 2008. However, given the sensitivity of Doral Financial's
Consolidated Financial Statements to these estimates, the use of other
judgments, estimates and assumptions could result in material differences in the
Company's results of operations or financial condition.
Other than the adoption of SFAS No. 157, "Fair Value Measurements" ("SFAS
No. 157") as of January 1, 2008 and enhancements to the liability arising from
expected losses on recourse obligations (please refer to "Off-Balance Sheet
Activities" in this Management's Discussion and Analysis ("MD&A") for further
information), the Company's critical accounting policies are described in the
MD&A of Financial Condition and Results of Operations section of Doral
Financial's 2007 Annual Report on Form 10-K.
Fair Value of Financial Instruments
The Company uses fair value measurements to record fair value adjustments for
certain financial instruments and to determine fair value disclosures. Trading
assets, securities available for sale, derivatives and servicing assets are
financial instruments recorded at fair value on a recurring basis. Additionally,
from time to time, the Company may be required to record at fair value other
financial assets on a nonrecurring basis, such as loans held for sale, loans
held for investment and certain other assets. These nonrecurring fair value
adjustments typically involve the application of the lower-of-cost-or-market
accounting or write-downs of individual assets. The discussion about the extent
to which fair value is used to measure assets and liabilities, the valuation
methodologies used and its impact on earnings is included in notes "c" and "y"
of the unaudited financial statements included in this Quarterly Report on Form
10-Q.
SFAS No. 157 defines fair value as the price that would be received to sell a
financial asset or paid to transfer a financial liability in an orderly
transaction between market participants at the measurement date.
SFAS No. 157 established a three-level hierarchy for disclosure of assets and
liabilities recorded at fair value. The classification of assets and liabilities
within the hierarchy is based on whether the inputs to the valuation methodology
used for measurement are observable or unobservable. Observable inputs reflect
market-derived or market-based information obtained from independent sources,
while unobservable inputs reflect the Company's estimates about market data.
• Level 1 - Valuation is based upon quoted prices for identical instruments
traded in active markets.
• Level 2 - Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market, or are derived principally from or corroborated by observable market data, by correlation or by other means.
• Level 3 - Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect the Company's estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.
In accordance with SFAS No. 157, Doral Financial's intent is to maximize the use
of observable inputs and minimize the use of unobservable inputs when developing
fair value measurements. When available, the Company uses quoted market prices
to measure fair value. If market prices are not available, fair value
measurements are based upon models that use primarily market-based or
independently-sourced market parameters, including interest rate yield curves,
prepayment speeds, option volatilities and currency rates. Substantially all of
Doral Financial's financial instruments use either of the foregoing
methodologies, collectively Level 1 and Level 2 measurements, to determine fair
value adjustments recorded to the Company's financial statements. However, in
certain cases, when market observable inputs for model-based valuation
techniques may not be readily available, the Company is required to make
judgments about assumptions market participants would use in estimating the fair
value of the financial instruments.
The degree of management judgment involved in determining the fair value of a
financial instrument is dependent upon the availability of quoted market prices
or observable market parameters. For financial instruments that trade actively
and have quoted market prices or observable market parameters, there is minimal
subjectivity involved in measuring fair value. When observable market prices and
parameters are not fully available, management judgment is necessary to estimate
fair value. In addition, changes in the market conditions may reduce the
availability of quoted prices or observable data. For example, reduced liquidity
in the capital markets or changes in secondary market activities could result in
observable market inputs becoming unavailable. Therefore, when market data is
not available, the Company uses valuation techniques requiring more management
judgment to estimate the appropriate fair value measurement.
At September 30, 2008, $3.2 billion, or 32%, of the Company's total assets,
consisted of financial instruments recorded at fair value on a recurring basis.
The financial instruments recorded at fair value on a recurring basis consisted
of $3.0 billion that are measured using valuation methodologies involving
market-based or market-derived information, identified as Level 1 and Level 2
measurements, and $0.2 billion of financial assets, consisting principally of
interest-only strips and mortgage servicing assets, that are measured using
model-based techniques, or Level 3 measurement.
At September 30, 2008, Doral Financial's liabilities included $2.3 million of
financial instruments recorded at fair value on a recurring basis.
Please refer to notes "c" and "y" of the unaudited interim financial statements
included in this Quarterly Report Form 10-Q, for additional information on the
initial adoption of SFAS No. 157 and a complete discussion of the Company's use
of fair value of financial instruments, the measurement techniques and its
impact in the financial statements.
RECENT ACCOUNTING PRONOUNCEMENTS
Business Combinations. On December 2007, the FASB issued SFAS No. 141(revised),
"Business Combinations". This statement replaces SFAS No. 141 and applies to all
transactions or other events in which an entity (the acquirer) obtains control
of one or more businesses. SFAS 141(revised) retains the fundamental
requirements in SFAS 141 that the acquisition method of accounting (purchase
method) be used for all business combinations. This statement defines the
acquirer as the entity that obtains control in the business combination and
requires the acquirer to be identified.
SFAS 141 (revised) requires an acquirer to recognize the assets acquired, the
liabilities assumed, and any noncontrolling interest in the acquired entity at
the acquisition date, measured at their fair values as of that date. In
addition, this statement expands and improves the information reported about
assets acquired and liabilities assumed arising from contingencies.
Contingencies arising from a business combination should be recognized as of the
acquisition date and measured at their acquisition date fair values.
This Statement applies prospectively to business combinations for which the
acquisition date is on or after the beginning of the first annual reporting
period on or after December 15, 2008. Earlier application is not permitted. The
effective date of this Statement is the same as that of the related SFAS No.160,
"Noncontrolling Interest in Consolidated Financial Statements". The adoption of
this Statement is not expected to have an impact on the Company's financial
statements.
Disclosures about Derivative Instruments and Hedging Activities. In March 2008,
The FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and
Hedging Activities", an amendment of SFAS 133, "Accounting for Derivative
Instruments and Hedging Activities". This statement improves the transparency of
financial reporting and expands the disclosure requirements of SFAS 133 with the
intent to provide users of financial statements with an enhanced understanding
of: (a) how and why an entity uses derivative instruments; (b) how derivative
instruments and related hedged items are accounted for under SFAS 133 and its
related interpretations; and (c) how derivative instruments and related hedged
items affect an entity's financial position, financial performance, and cash
flows.
To meet those objectives, this statement requires qualitative disclosures about
objectives and strategies for using derivatives, quantitative disclosures about
fair value amounts of, and gains and losses, on derivatives instruments, and
disclosures about credit-risk-related contingent features in derivatives
agreements.
This statement has the same scope as SFAS 133 and accordingly, applies to all
entities. This Statement applies to all derivative instruments, including
bifurcated derivative instruments and related hedged items accounted for under
SFAS 133 and its related interpretations. This Statement is effective for
financial statements issued for fiscal years and interim periods beginning after
November 15, 2008, with early application encouraged. This Statement encourages,
but does not require, comparative disclosures for earlier periods at initial
adoption. The Company is currently evaluating the effect, if any, of the
adoption of this Statement on its financial statements, for the year ended
December 31, 2008.
The Hierarchy of Generally Accepted Accounting Principles. In May 2008, the FASB
issued SFAS No. 162, "The Hierarchy of Generally Accepted Accounting
Principles". This Statement identifies the sources of accounting principles and
the framework for selecting the principles to be used in the preparation of
financial statements of nongovernmental entities that are presented in
conformity with generally accepted accounting principles (GAAP) in the United
States (the GAAP hierarchy).
The current GAAP hierarchy, as set forth in the American Institute of Certified
Public Accountants (AICPA) Statement on Auditing Standards No. 69, The Meaning
of Present Fairly in Conformity With Generally Accepted Accounting Principles,
has been criticized because (1) it is directed to the auditor rather than the
entity, (2) it is complex, and (3) it ranks FASB Statements of Financial
Accounting Concepts, which are subject to the same level of due process as FASB
Statements of Financial Accounting Standards, below industry practices that are
widely recognized as generally accepted but that are not subject to due process.
The FASB believes that the GAAP hierarchy should be directed to entities because
it is the entity (not its auditor) that is responsible for selecting accounting
principles for financial statements that are presented in conformity with GAAP.
Accordingly, the FASB concluded that the GAAP hierarchy should reside in the
accounting literature established by the FASB and is issuing this Statement to
achieve that result.
There is no expectation that this Statement will result in a change in current
practice. However, transition provisions have been provided by the FASB in the
unusual circumstance that the application of the provisions of this Statement
results in a change in practice.
This Statement is effective 60 days following the SEC's approval of the Public
Company Accounting Oversight Board amendments to AU Section 411, "The Meaning of
Present Fairly in Conformity With Generally Accepted Accounting Principles". The
Company is currently evaluating the effect, if any, of the adoption of this
Statement on its financial statements.
Determining the Fair Value of a Financial Asset When the Market for that Asset
is not Active. On October 2008, the FASB issued FASB Staff Position (FSP) FAS
157-3, "Determining the Fair Value of a Financial Asset When the Market for that
Asset is not Active". The FSP clarifies the application of SFAS No. 157, Fair
Value Measurements, in an inactive market and illustrates how an entity would
determine fair value when the market for a financial asset is not active. The
FSP states that an entity should not automatically conclude that a particular
transaction price is determinative of fair value. In a dislocated market,
judgment is required to evaluate whether individual transactions are forced
liquidations or distressed sales. When relevant observable market information is
not available, a valuation approach that incorporates management's judgments
about the assumptions that market participants would use in pricing the asset in
a current sale transaction would be acceptable. The FSP also indicates that
quotes from brokers or pricing services may be relevant inputs when measuring
fair value, but are not necessarily determinative in the absence of an active
market for the asset. In weighing a broker quote as an input to a fair value
measurement, an entity should place less reliance on quotes that do not reflect
the result of market transactions. Further, the nature of the quote (for
example, whether the quote is an indicative price or a binding offer) should be
considered when weighing the available evidence.
The FSP is effective immediately, and for prior periods for which financial
statements have not been issued. Revisions resulting from a change in the
valuation technique or its application should be accounted for as change in
accounting estimate following the guidance in FASB Statement No. 154, Accounting
Changes and Error Corrections. Accordingly, we adopted the FSP prospectively,
beginning July 1, 2008. The adoption of the FSP did not have a material impact
on our financial statements or fair value determination.
Disclosures about Credit Derivatives and Certain Guarantees - An Amendment of
FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the
Effective Date of FASB Statement No. 161. In September 2008, the FASB issued
Staff Position No. 133-1 and FIN 45-4, Disclosures about Credit Derivatives and
Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB
Interpretation No. 45; and Clarification of the Effective Date of FASB Statement
No. 161. This FSP
is intended to improve disclosures about credit derivatives by requiring more
information about the potential adverse effects of changes in credit risk on the
financial position, financial performance, and cash flows of the sellers of
credit derivatives. It amends FAS 133, Accounting for Derivative Instruments and
Hedging Activities, to require disclosures by sellers of credit derivatives,
including credit derivatives embedded in hybrid instruments. The FSP also amends
FASB Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements
for Guarantees, Including Indirect Guarantees of Indebtedness to Others(FIN 45),
to require an additional disclosure about the current status of the
payment/performance risk of a guarantee. The provisions of the FSP that amend
FAS 133 and FIN 45 are effective for reporting periods (annual or interim)
ending after November 15, 2008. The Company is currently evaluating the effect,
if any, of the adoption of this FSP on its financial statements, commencing on
January 1, 2009.
Accounting for Transfer of Financial Assets and Repurchase Financing
Transactions. On February 2008, the FASB issued FASB Staff Position (FSP) FAS
140-3, Accounting for Transfer of Financial Assets and Repurchase Financing
Transactions. The FSP requires an initial transfer of a financial asset and a
repurchase financing that was entered into contemporaneously or in contemplation
of the initial transfer to be evaluated as a linked transaction under FAS 140
unless certain criteria are met, including that the transferred asset must be
readily obtainable in the marketplace.
The FSP is effective for financial statements issued for fiscal years beginning
after November 15, 2008, and interim periods within those fiscal years. Earlier
application is not permitted. The Company is currently evaluating the effect, if
any, of the adoption of this FSP on its financial statements, commencing on
January 1, 2009.
RESULTS OF OPERATIONS FOR THE QUARTERS AND NINE MONTH PERIODS ENDED SEPTEMBER
30, 2008 AND 2007
The components of Doral Financial's revenues are: (1) net interest income;
(2) net gain (loss) on mortgage loan sales and fees; (3) investment activities;
(4) trading activities; (5) servicing income; and (6) commissions, fees and
other income.
NET INTEREST INCOME
Net interest income is the excess of interest earned by Doral Financial on its
interest-earning assets over the interest incurred on its interest-bearing
liabilities. Doral Financial's net interest income is subject to interest rate
risk due to the repricing and maturity mismatch in the Company's assets and
liabilities. Generally, Doral Financial's assets have a longer maturity and a
later repricing date than its liabilities, which results in lower net interest
income in periods of rising short-term interest rates. Refer to "- Risk
Management" below for additional information on the Company's exposure to
interest rate risk.
Net interest income for the third quarter and nine month period ended
September 30, 2008 was $47.0 million and $134.9 million, respectively, compared
to $39.4 million and $112.2 million, in the corresponding 2007 periods, an
increase of 19% and 20%, respectively. The increase in interest income between
quarters was driven principally by a reduction in interest expense partially
offset by a smaller decline in interest income. The decline in interest expense
of $9.7 million was due to (1) a $5.9 million reduction in interest expense for
repurchase agreements largely associated with the extinguishment of liabilities
related to the sale of $1.9 billion in securities and the general decline in
interest rates, partially offset by a $4.5 million increase in interest expense
for FHLB Advances; (2) a $3.0 million reduction in deposit costs as a result of
. . .
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