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| DRL > SEC Filings for DRL > Form 10-K on 20-Mar-2009 | All Recent SEC Filings |
20-Mar-2009
Annual Report
deferred tax asset valuation allowance during 2008. This resulted in an increase
of $147.4 million during 2008 in the Company's after tax loss to $318.3 million
when compared to 2007 results.
Important factors impacting the Company's financial results for the year ended
December 31, 2008 included the following:
• Net loss for the year ended December 31, 2008 was $318.3 million, compared
to net losses of $170.9 million and $223.9 million for the years 2007 and
2006, respectively. After the payment of preferred stock dividends, there
was a net loss attributable to common shareholders of $351.6 million for the
year ended December 31, 2008, compared to a net loss attributable to common
shareholders of $204.2 million and $257.2 million for the years ended 2007
and 2006, respectively.
• Diluted loss per share for the year ended December 31, 2008 was $6.53, compared to a diluted loss per share of $7.45 and $47.66 for the years ended December 31, 2007 and 2006, respectively.
• Net interest income for the year ended December 31, 2008 was $177.5 million,
compared to $154.3 million and $201.4 million for the years ended
December 31, 2007 and 2006, respectively. The increase of $23.2 million in
net interest income for 2008, compared to 2007, was mainly related to the
decrease of $77.4 million in interest expense partially offset by the
decrease in interest income of $54.3 million. The reduction in interest
expense was principally related to (i) a $44.5 million reduction associated
with the interest expense of securities sold under agreement to repurchase;
(ii) a $14.5 million reduction in deposits costs as a result of the
repositioning of the Company's deposits products and the general decline in
interest rates; and (iii) a reduction of $32.7 million in borrowing costs
also associated with the repayment of $625.0 million in senior notes in
July 2007 and the general decline in interest rates. The decline in interest
expense was partially offset by a decrease in interest income primarily
related to the reduction of $1.6 billion in the average balance of
investment securities and other interest earning assets, primarily money
markets. Average interest earning assets decreased from $9.6 billion for the
year ended December 31, 2007 to $9.4 billion for the year ended December 31,
2008, while the average interest bearing-liabilities decreased from
$8.7 billion to $8.3 billion, respectively. The growth in interest earning
assets net of interest bearing liabilities, was partially funded by the
$610.0 million from the recapitalization of the Company during 2007, and
resulted in a reduction on the Company's leverage. This reduction in
leverage, along with the decline in cost of funds, resulted in an expansion
in the net interest margin from 1.60% for 2007 to 1.89% for 2008 (see Tables
A and B below for information regarding the Company's net interest income).
• The provision for loan and lease losses for the year ended December 31, 2008 was $48.9 million, compared to $78.2 million and $39.8 million for 2007 and 2006, respectively. The decrease in the provision is mostly driven by a reduction of $50.2 million in delinquencies in the Company's construction loan portfolio during 2008 which has attributed to higher losses in recent years, partially offset by the impact of increased delinquencies in the Company's residential mortgage and commercial loan portfolios. Non-performing loans as of December 31, 2008 increased by $85.4 million, or 13%, compared to December 31, 2007, while they increased by $258.9 million, or 69%, in the corresponding preceding period.
• Non-interest income for the year ended December 31, 2008 was $79.5 million,
compared to non-interest loss of $75.4 million and $59.2 million in 2007 and
2006, respectively. Non-interest income performance for the year ended
December 31, 2008, compared to 2007, was primarily driven by (i) an increase
of $10.9 million in gain on mortgage loans sales and fees, principally
related to the increase of $140.7 million in loan sales and securitization;
(ii) an increase of $57.7 million in income from trading activities
principally related to the Company's U.S. Treasury investments which serve
as an economic hedge to the Company's mark-to-market risk in its mortgage
servicing rights and to positive marks related to the Company's IO
investments; (iii) a $ 92.6 million reduction in losses from investment
securities principally related to a significant charge in 2007 associated
with the Company's balance sheet restructuring which was partially
offset by a charge of $4.2 million on investment securities associated with the
termination of the agreements the Company had with LBI after the filing for
bankruptcy of its parent Lehman Brothers Holding, Inc., during the third quarter
of 2008 (please refer to Note 15 for additional information); (iv) a reduction
of $28.4 million in servicing income due to the reduction in market value of the
Company's mortgage servicing rights due to the general decline in interest
rates; (v) a $6.9 million increase in retail banking fees and commissions due to
an increase is customer transactions and a re-pricing of fees charged; (vi) a
$1.7 million increase in insurance agency commissions due to increase volume of
policies written for mortgage customers; partially offset by a $1.4 million
decrease in other income as 2007 included the gain-on-sale of its New York
branches partially offset by a 2008 gain of $5.2 million from the redemption of
shares of VISA, Inc., pursuant to their global restructuring agreements.
• Non-interest expense for the year ended December 31, 2008 was
$240.4 million, compared to $303.5 million and $374.3 million for the years
ended December 31, 2007 and 2006 respectively. Compared to 2007, the
reduction of $63.1 million, or 21%, in non-interest expenses for 2008 was
driven by the elimination of expenses associated with 2007 recapitalization
and reorganization efforts and the cost control measures implemented by the
Company during 2008. The elimination of expenses and cost control measures
impacted principally expenses associated with compensation and benefits by
$48.1 million and professional services by $31.5 million. These reductions
were partially offset by a provision for claim receivable of $21.6 million
and increases in the Company's communication expenses of $2.9 million,
mainly associated to an increase in fee income of $3.4 million in ATH and
VISA debit card activity.
• For the year ended December 31, 2008, Doral Financial reported an income tax expense of $286.0 million, compared to an income tax benefit of $131.9 million and $48.1 million for the years ended December 31, 2007 and 2006, respectively. The recognition of an income tax expense for 2008 was related to the increase of $301.2 million in the valuation allowance driven by the fact that, in the fourth quarter of 2008, the Company was unable to meet the projected income, due primarily to a reduction in net interest income and increases in the provision for loan and lease losses. During the fourth quarter of 2008, the Company took action which prioritized safety of principal and liquidity over returns causing a drop in its net interest income which contributed in a fourth quarter pre-tax loss.
• For the year ended December 31, 2008, the Company had other comprehensive loss of approximately $90.1 million, compared to other comprehensive income of $73.8 million and $18.5 million for the years ended December 31, 2007 and 2006, respectively. The other comprehensive loss for the year ended December 31, 2008 was mainly driven by the reduction in value of the Company's private label CMO's as a result of the price movement on these securities that has been affected by the conditions of the U.S. financial markets, specially the non-agency mortgage market. Other comprehensive income recognized during 2007 resulted from the realization of the losses reflected in the Company's accumulated other comprehensive loss (net of income tax benefit) at December 31, 2007, as a result of the sale of the $1.9 billion in available for sale investment securities during the third quarter of 2007. As of December 31, 2008, the Company's accumulated other comprehensive loss (net of income tax benefit) was $123.2 million, compared to $33.1 million and $106.9 million as of December 31, 2007 and 2006, respectively.
• Doral Financial's loan production for the year ended December 31, 2008 was
$1.3 billion, compared to $1.3 billion for 2007. The production remained
steady during 2008 when compared to 2007. The lack of growth in Doral
Financial's loan production for 2008 was primarily the result of (i) tighter
commercial and consumer underwriting standards, (ii) the decision to cease
financing construction of new housing projects in Puerto Rico, and
(iii) changes in laws and regulations, such as the recent amendment to the
Puerto Rico Notary Law that led to an increase of the closing costs and fees
payable by persons involved in real estate purchase and mortgage loan
transactions in Puerto Rico, which in turn led to a reduction in the number
of real estate purchase and mortgage loan transactions in Puerto Rico.
• Total assets as of December 31, 2008 were $10.1 billion, compared to $9.3 billion as of December 31, 2007. The increase in total assets during 2008 was principally due to an increase in the Company's securities portfolio of $1.5 billion as a result of a Company's plan to increase its earning assets by $1.0 billion during 2008. The increase in assets was partially offset by a reduction of $718.1 million in money markets and securities purchased under agreements to resell and $272.0 million in the deferred tax asset. Total liabilities as of December 31, 2008 were $9.2 billion, compared to $8.0 billion as of December 31, 2007. The increase in liabilities resulted from the increase in borrowings used to finance the purchase of the securities. During the third quarter of 2008, the Company reduced its assets and liabilities by $0.5 billion, associated with the termination of repurchase financing arrangements and the sale of collateral associated with such financing arrangements with Lehman Brothers, Inc. ("LBI") as a result of the SIPC liquidation proceedings as of September 19, 2008.
INTERNAL CONTROL OVER FINANCIAL REPORTING
Doral Financial undertook the remediation efforts that were set forth in 2007 in
order to remedy the material weakness in its internal controls identified as of
December 31, 2007. Doral Financial's remediation efforts are outlined in
"Remediation Efforts of Material Weakness that Existed as of December 31, 2007"
under Item 9A, Controls and Procedures, of this Annual Report on Form 10-K. As a
result of its assessment, management has concluded that the Company's internal
control over financial reporting is effective as of December 31, 2008.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in accordance with GAAP requires
management to make a number of judgments, estimates and assumptions that affect
the reported amount of assets, liabilities, income and expenses in Doral
Financial's consolidated financial statements and accompanying notes. Certain of
these estimates are critical to the presentation of Doral Financial's financial
condition since they are particularly sensitive to the Company's judgment and
are highly complex in nature. Doral Financial believes that the judgments,
estimates and assumptions used in the preparation of its consolidated financial
statements are appropriate given the factual circumstances as of December 31,
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 Doral Financial's results of
operations or financial condition.
Various elements of Doral Financial's accounting policies, by their nature, are
inherently subject to estimation techniques, valuation assumptions and other
subjective assessments. Note 2 to Doral Financial's consolidated financial
statements contains a summary of the most significant accounting policies
followed by Doral Financial in the preparation of its financial statements. The
accounting policies that have a significant impact on Doral Financial's
statements and that require the most judgment are set forth below.
Fair Value Measurements
Pursuant to SFAS 157, the Company uses fair value measurements to record fair
value adjustments to certain financial instruments and to determine fair value
disclosures. Securities held for trading, 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 receivable 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 Company adopted SFAS No. 157 on January 1, 2008. SFAS No. 157 defines fair
value, establishes a consistent framework for measuring fair value and expands
disclosures requirements for fair value measurements. This statement defines
fair value as the price that would be received to sell a financial asset
or paid to transfer a financial liability (an exit price) in the principal or
most advantageous market for an asset or liability in an orderly transaction
between market participants on 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 unadjusted 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. 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 Note
36 of Doral Financial consolidated financial statements.
Gain or Loss on Mortgage Loan Sales
The Company generally securitizes a portion of the residential mortgage loans
that it originates. FHA and VA loans are generally securitized into GNMA
mortgage-backed securities and held as trading securities. After holding these
securities for a period of time, Doral Financial sells these securities for
cash. Conforming conventional loans are generally sold directly to FNMA, FHLMC
or institutional investors or exchanged for FNMA or FHLMC-issued mortgage-backed
securities, which Doral Financial sells for cash
through broker-dealers. Prior to 2007, the Company sold mortgage loans that did
not conform to GNMA, FNMA or FHLMC requirements (non-conforming loans) as whole
loan pools to financial institutions.
As part of its mortgage loan sale and securitization activities, Doral Financial
generally retains the right to service the mortgage loans it sells. In
connection with the sale of loans, generally non-conforming mortgage loan pools,
Doral Financial may also retain certain interests in the loans sold, such as the
right to receive any interest payments on such loans above the contractual
pass-through rate payable to the investor. Doral Financial determines the gain
on sale of a mortgage-backed security or loan pool by allocating the carrying
value of the underlying mortgage loans between the mortgage-backed security or
mortgage loan pool sold and its retained interests, based on their relative
estimated fair values. The gain on sale reported by Doral Financial is the
difference between the proceeds received from the sale and the cost allocated to
the loans sold. The proceeds include cash and other assets received in the
transaction (primarily MSRs) less any liabilities incurred (i.e.,
representations and warranty provisions). The reported gain or loss is the
difference between the proceeds from the sale of the security or mortgage loan
pool and its allocated cost. The amount of gain on sale is therefore influenced
by the values of the MSRs and retained interest recorded at the time of sale.
See "-Retained Interest Valuation" below for additional information.
If in a transfer of financial assets in exchange for cash or other consideration
(other than beneficial interests in transferred assets), Doral Financial has not
surrendered control over the transferred assets according to the provisions of
Statement of Financial Accounting Standard ("SFAS") No. 140 "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities "
("SFAS 140"), Doral Financial accounts for the transfer as a secured borrowing
(loan payable) with a pledge of collateral.
Retained Interest Valuation
In the past, Doral Financial's sale and securitization activities generally
resulted in the recording of one or two types of retained interests; MSRs and
IOs. During 2008, the Company's sale and securitization activities resulted in
the recording of only one type of retained interest; MSRs. MSRs represent the
estimated present value of the normal servicing fees (net of related servicing
costs) expected to be received on a loan being serviced over the expected term
of the loan. MSRs entitle Doral Financial to a future stream of cash flows based
on the outstanding principal balance of the loans serviced and the contractual
servicing fee. The annual servicing fees generally range between 25 and 50 basis
points, less, in certain cases, any corresponding guarantee fee. In addition,
MSRs may entitle Doral Financial, depending on the contract language, to
ancillary income including late charges, float income, and prepayment penalties
net of the appropriate expenses incurred for performing the servicing functions.
In certain instances, the Company also services loans with no contractual
servicing fee. The servicing asset or liability associated with such loans is
evaluated based on ancillary income, including float, late fees, prepayment
penalties and costs. MSRs are classified as servicing assets in Doral
Financial's Consolidated Statements of Financial Condition. Any servicing
liability recognized is included as part of accrued expenses and other
liabilities in Doral Financial's Consolidated Statements of Financial Condition.
Unlike U.S. Treasury and agency mortgage-backed securities, the fair value of
MSRs and IOs cannot be readily determined because they are not traded in active
securities markets. Doral Financial engages third party specialists to assist
with its valuation of the Company's entire servicing portfolio (governmental,
conforming and non-conforming portfolios). The fair value of the MSRs is
determined based on a combination of market information on trading activity
(MSRs trades and broker valuations), benchmarking of servicing assets (valuation
surveys) and cash-flow modeling. The valuation of the Company's MSRs incorporate
two sets of assumptions: (1) market derived assumptions for discount rates,
servicing costs, escrow earnings rate, float earnings rate and cost of funds and
(2) market derived assumptions adjusted for the Company's loan characteristics
and portfolio behavior, for escrow balances, delinquencies and foreclosures,
late fees, prepayments and prepayment penalties. For the year ended December 31,
2008, the MSRs fair value amounted to $42.6 million, which represents a value
decline of $21.8 million compared to December 31, 2007.
The Company, upon remeasurement of the MSRs at fair value in accordance with
SFAS No. 156 "Accounting for Servicing of Financial Assets", recorded a
cumulative effect adjustment of $0.9 million to
retained earnings (net of tax) on January 1, 2007 for the difference between the
fair value and the carrying amount to bring the December 31, 2006 MSR balance to
the fair value.
Prior to the adoption of SFAS No. 156 in 2007, impairment charges were
recognized through a valuation allowance for each individual stratum of
servicing assets. The valuation allowance was adjusted to reflect the amount, if
any, by which the cost basis of the servicing asset for a given stratum of loans
being serviced exceeded its fair value. Any fair value in excess of the cost
basis of the servicing asset for a given stratum was not recognized.
Other-than-temporary impairment, if any, was recognized as a direct write-down
of the servicing asset, and the valuation allowance was applied to reduce the
cost basis of the servicing asset.
The amortization of the MSRs was based on an income forecast cash-flow method.
The income forecast method was based on the forecasted cash flows determined by
the third-party market valuation and the amortization was calculated by applying
to the carrying amount of the MSRs the ratio of the cash flows projected for the
current period to total remaining forecasted cash flow.
The Company's MSR values experienced a reduction of over 24% during 2008. The
. . .
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