This financial discussion contains an analysis of the consolidated financial position and consolidated results of operations of Doral Financial Corporation and its wholly-owned subsidiaries (the "Company") and should be read in conjunction with the consolidated financial statements, notes and tables included elsewhere in this report.
In addition to the information contained in this Form 10-Q, readers should consider the description of the Company's business contained in Item 1 of the Company's Form 10-K for the year ended December 31, 2008. While not all inclusive, Items 1 and 1A of the Form 10-K disclose additional information about the business of the Company, risk factors, many beyond the Company's control, and further provide discussion of the operating results, financial condition and credit, market and liquidity risks than that which is presented in the narrative and tables included herein.
OVERVIEW OF RESULTS OF OPERATIONS
Net income for the quarter ended June 30, 2009 amounted to $8.2 million, compared to a net income of $1.6 million for the comparable 2008 period. Doral Financial's performance for the second quarter of 2009, compared to the corresponding 2008 quarter, resulted from (1) a $6.8 million decrease in net interest income due to the compression of net interest margin and increasing non-performing loans in a declining interest rate and credit environment and slightly lower interest earning assets (2) a $5.8 million decrease in non-interest income due principally to other-than-temporary impairment ("OTTI") charges related to the investment portfolio; offset by (3) a decrease in normal non-interest expenses of $4.3 million offset by the one-time deposit insurance special assessment of $4.2 million; and (4) by the recognition of an income tax benefit of $12.7 million, compared to an income tax expense of $5.8 million for the corresponding 2008 period.
The significant events affecting the Company's financial results for the quarter ended June 30, 2009 included the following:
• On May 7, 2009, the Company announced the commencement of an offer to exchange a stated amount of its shares of common stock and a cash payment in exchange for a limited number of its shares of outstanding preferred stock. The transaction was settled on June 11, 2009 and resulted in the retirement of $105.6 million in preferred stock and an increase in common equity of $100.6 million.

• Net income attributable to common shareholders for the second quarter of 2009 of $14.5 million, resulted in a diluted earnings per share of $0.27, compared to a net loss attributable to common shareholders for the corresponding 2008 period of $6.7 million, or a diluted loss per share of $0.12. The $0.39 improvement in earnings per share was due to net income attributable to common shareholders of $5.2 million before the effect of preferred stock conversion, which resulted in $0.10 per share for the quarter, and to the results of the preferred stock conversion effected in June of 2009 of $0.17 per share.

• Net interest income for the second quarter of 2009 was $42.1 million, compared to $48.9 million for the comparable period in 2008. The decrease of $6.8 million in net interest income for 2009, compared to 2008, resulted from a reduction in interest income of $21.1 million, partially offset by a reduction in interest expense of $14.3 million. The reduction in net interest income resulted from (a) a 0.70% reduction in yield on assets reflecting the lower market interest rate environment, and (b) the $367.2 million decrease in average interest earning assets, particularly $1.2 billion floating rate securities sold in May 2009, offset by growth in loans, mortgage backed securities, and other investment securities. The decrease in interest expense resulted from a 0.62% decrease in yield on liabilities primarily reflected in lower costs of deposits and certain loans payable combined with slightly lower average interest-bearing liabilities. Average interest-earning assets decreased from $9.7 billion for the second quarter of 2008 to $9.4 billion for the corresponding 2009 period, while the average interest-bearing liabilities decreased from $8.6 billion to $8.5 billion, respectively. The reduction in leverage, combined

with a decline in interest expense, resulted in a contraction of net interest margin from 2.02% in the second quarter of 2008 to 1.80% in the corresponding 2009 period.

• Doral Financial's provision for loan and lease losses for the quarter ended June 30, 2009 amounted to $10.1 million, compared to $10.7 million for the corresponding 2008 period. Second quarter results were impacted by the effects of continuing deterioration of Puerto Rico economy on the residential real estate market, causing lower home absorption rates on new construction, increased defaults on existing mortgages and weakening economic situation of existing borrowers. An increase in the provision for the residential mortgage portfolio of $3.1 million was offset by decreases of $1.6 million and $2.3 million in the provision for loan and lease losses of the commercial and construction (including land) portfolios, respectively.

• Non-interest income for the second quarter of 2009 was $19.1 million, compared to $24.9 million for the corresponding period in 2008. The decrease in non-interest income of $5.8 million for the second quarter of 2009, compared to the same period in 2008, resulted from $6.8 million other-than-temporary impairment realized on investment securities in the 2009 second quarter and a $5.2 million gain recognized in the second quarter of 2008 from the redemption of shares of VISA, Inc., pursuant to their global restructuring agreement. These decreases were partially offset by a gain on investment securities of $4.8 million related to the sale of approximately $1.2 billion of its floating rate securities and lower losses on trading activities of $2.1 million.

• Non-interest expense for the second quarter of 2009 was $55.5 million, compared to $55.6 million for the corresponding period in 2008. Although total non-interest expenses for the second quarter of 2009 remained flat compared to 2008 the results were impacted by decreases in operating expenses for compensation and benefits, advertising, occupancy and depreciation and amortization expenses, largely offset by: (i) an increase of $4.2 million related to the FDIC special assessment expense during the quarter; and (ii) an increase of $1.1 million in EDP expenses.

• An income tax benefit of $12.7 million for the second quarter of 2009 was related to a net release of unrecognized tax benefits of $15.5 million. The release of unrecognized tax benefits was due to the expiration of the statute of limitations and was net of an accrual for unrecognized tax benefits of $3.6 million.

• The Company reported other comprehensive losses of approximately $4.2 million for the second quarter of 2009 compared to $42.7 million for the corresponding 2008 period. The Company's other comprehensive loss for the second quarter of 2009 resulted principally from the reduction in value of securities in its available for sale investment portfolio. As of June 30, 2009, the Company's accumulated other comprehensive loss (net of income tax benefit) totaled $140.2 million, compared to $123.2 million as of December 31, 2008.

• Doral Financial's loan production for the second quarter of 2009 was $291.9 million, compared to $383.3 million for the comparable 2008 period, a decrease of approximately 24%. The decrease in Doral Financial's loan production for the second quarter of 2009 reflects the reduction in Puerto Rico real estate purchase and mortgage lending activity caused by the end of the Puerto Rico government tax incentive program for the purchase of new homes, changes in laws and regulations and to the general economic conditions in Puerto Rico.

• Total assets as of June 30, 2009 amounted to $9.8 billion compared to $10.1 billion as of December 31, 2008. A decrease of $569.5 million in the Company's securities portfolio was partially offset by increases in cash and due from banks of $81.1 million and money market investments of $46.0 million. Total liabilities were $8.9 billion at June 30, 2009, compared to $9.2 billion at December 31, 2008. Total liabilities declined due to a decrease of $338.5 million in deposits driven by a decrease of $448.0 million in brokered deposits offset by an increase in money markets of $141.6 million, and a decrease of $131.3 million in securities sold under agreements to repurchase that was partially offset by an increase of $205.4 million in other short-term borrowings.

• Non-performing assets as of June 30, 2009 were $889.8 million, an increase of $110.6 million since December 31, 2008. Non-performing loans (which are included in non-performing assets) as of June 30, 2009 were $805.7 million, and increase of $88.0 million since December 31, 2008. However, non-performing assets have increased only $7.6 million from the March 31, 2009 non-performing asset balance of $882.2 million, and non-performing loans decreased $6.1 million from the March 31, 2009 non-performing loan balance of $811.8 million.

The following table sets forth certain selected financial data as of the dates indicated and for the periods indicated. This information should be read in conjunction with the Company's financial statements and the related notes thereto.

TABLE A
SELECTED FINANCIAL DATA

                                                       QUARTER ENDED                        SIX MONTH PERIODS ENDED
                                                          JUNE 30,                                 JUNE 30,
(Dollars in thousands)                            2009                2008                 2009                 2008
Selected Income Statement Data:
Interest income                               $    114,578        $    135,646         $    231,072         $    263,754
Interest expense                                    72,488              86,791              152,912              175,855

Net interest income                                 42,090              48,855               78,160               87,899
Provision for loan and lease losses                 10,133              10,683               33,758               15,469

Net interest income after provision for
loan and lease losses                               31,957              38,172               44,402               72,430
Total non-interest income                           19,131              24,895               20,714               42,274
Non-interest expenses                               55,526              55,626              115,952              110,189

(Loss) income before income taxes                   (4,438 )             7,441              (50,836 )              4,515
Income tax (benefit) expense (1)                   (12,654 )             5,799              (12,762 )              5,171

Net income (loss)                             $      8,216        $      1,642         $    (38,074 )       $       (656 )

Net income (loss) attributable to common
shareholders                                  $     14,524        $     (6,683 )       $    (40,091 )       $    (17,306 )


Net income (loss) per common share(2)         $       0.27        $      (0.12 )       $      (0.74 )       $      (0.32 )


Cash Dividends Declared, Preferred Stock      $      3,061        $      8,325         $     11,386         $     16,650
Book Value Per Common Share                   $       6.34        $      12.20         $       6.34         $      12.20
Weighted - Average Common Shares
Outstanding                                     54,679,097          53,810,110           54,247,004           53,810,110
Common shares outstanding at end of
period                                          57,764,002          53,810,110           57,764,002           53,810,110

Selected Balance Sheet Data at Period
End:
Total investment securities                   $  3,229,443        $  3,501,462         $  3,229,443         $  3,501,462
Total loans, net(3)                              5,548,370           5,484,414            5,548,370            5,484,414
Servicing assets, net                              112,869             145,527              112,869              145,527
Total assets                                     9,754,438          10,449,871            9,754,438           10,449,871
Deposit accounts                                 4,064,257           4,330,728            4,064,257            4,330,728
Total borrowings                                 4,540,328           4,588,802            4,540,328            4,588,802
Total liabilities                                8,920,535           9,220,384            8,920,535            9,220,384
Preferred stock                                    467,641             573,250              467,641              573,250
Common stock                                           578                 538                  578                  538
Stockholders' equity                               833,903           1,229,487              833,903            1,229,487
Selected Average Balance Sheet Data for
Period End:
Total interest-earning assets                    9,353,177           9,720,382            9,396,168            9,230,712
Total assets                                    10,061,918          10,470,986           10,042,917           10,015,366
Total interest-bearing liabilities               8,500,380           8,643,916            8,542,163            8,115,766
Preferred equity                                   550,039             573,250              561,581              573,250
Total stockholders' equity                         791,424           1,231,371              822,182            1,247,732
Operating Data:
Loan production                               $    291,940        $    383,309         $    534,278         $    755,383
Loan servicing portfolio(4)                      9,065,032           9,680,896            9,065,032            9,680,896
Selected Financial Ratios(5)
Performance:
Net interest margin                                   1.80 %              2.02 %               1.68 %               1.91 %
Return on average assets                              0.33 %              0.06 %              (0.76 )%             (0.01 )%
Return on average common equity(5)(6)                 8.57 %             (4.08 )%            (38.27 )%             (5.16 )%
Capital:
Leverage ratio                                        8.16 %              9.47 %               8.16 %               9.47 %
Tier 1 risk-based capital ratio                      13.32 %             15.65 %              13.32 %              15.65 %
Total risk-based capital ratio                       15.19 %             17.00 %              15.19 %              17.00 %
Other ratios:
Average common equity to average assets               2.40 %              6.29 %               2.59 %               6.73 %
Tier 1 common equity to risk-weighted
assets                                                6.36 %              6.34 %               6.36 %               6.34 %

(1) See Note 22 of the consolidated financial statements for an explanation of the computation of income tax benefit.

(2) For the quarters and six month periods ended June 30, 2009 and 2008, net income
(loss) per common share represents the basic and diluted earnings
(loss) per common share, respectively, for each of the periods presented.

(3) Includes loans held for sale.

(4) Represents the total portfolio of loans serviced for third parties. Excludes
$4.3 billion
and
$3.8 billion
of mortgage
loans owned
by Doral
Financial at
June 30, 2009
and 2008,
respectively.

(5) Average balances are computed on a daily basis.

(6) Excludes $9.4 million of effect of conversion of preferred stock.

SUBSEQUENT EVENTS
For a description of subsequent events, please refer to Note 31 of the accompanying Consolidated Financial Statements included 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 ("GAAP") 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 June 30, 2009. 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.
RECENT ACCOUNTING PRONOUNCEMENTS
For a description of recent accounting pronouncements, please refer to Note 2 of the accompanying Consolidated Financial Statements included in this Quarterly Report on Form 10-Q.
RESULTS OF OPERATIONS FOR THE QUARTERS AND SIX MONTH PERIODS ENDED JUNE 30, 2009 AND 2008
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 and higher net interest income in periods of declining short-term interest rates. Please refer to "Risk Management" below for additional information on the Company's exposure to interest rate risk.
Net interest income for the quarter ended June 30, 2009 totaled $42.1 million, compared to $48.9 million for the corresponding 2008 period, a decrease of $6.8 million, or 14%. The decrease in net interest income for second quarter of 2009, compared to the corresponding period in 2008, resulted from a reduction in interest income of $21.1 million, partially offset by a reduction in interest expense of $14.3 million. The reduction in interest income was principally related to (i) a reduction of $4.7 million in interest income of loans primarily related to the increase in delinquencies in the Company's loan portfolio; (ii) a decrease of $11.1 million in interest income on investment securities associated with a reduction of $816.1 million in the average balance of investment securities as a result of a reduction of $0.5 billion associated to the termination of repurchase financing arrangements and the sale of collateral associated with such financing arrangements with Lehman Brothers, Inc. ("LBI");
(iii) a decrease of $2.7 million in interest income of mortgage-backed securities resulted from the effect of lower market interest rates on the Company's floating rate investment security portfolio, and (iv) a reduction of $2.4 million in the interest income

of other interest-earning assets resulting from a decrease of $322.9 million in the average balance of other interest-earning assets from the use of these instruments to finance the purchase of securities associated with the Company's plan to replace its earning assets ("Asset Replacement Program").
The decrease in interest income was partially offset by a decrease in interest expense. Interest expense for the quarter ended June 30, 2009 decreased by $14.3 million, or 16%, compared to the corresponding 2008 period. The decrease in interest expense was driven by (i) a reduction of $6.4 million in interest expense of deposits related to a decrease of $209.1 million in the average balance of deposits, due to the repositioning of the Company's deposit products, driven by the run-off of brokered deposits and the general decline in interest rates; and (ii) reductions of $4.6 million in the interest expense on securities sold under agreement to repurchase, $1.6 million in interest expense on advances from FHLB and $2.0 million in interest expense on loans payable associated to a reduction related to the general decline in interest rates and lower borrowing costs under lines of credit with the Federal Home Loan Bank and an auction of term funds to depository institutions granted by the Federal Reserve under the Term Auction Facility ("TAF") which increased its average balance to $647.9 million for the quarter ended June 30, 2009, when compared to the corresponding 2008 period.
Average interest-earning assets decreased from $9.7 billion for the second quarter of 2008 to $9.4 billion for the corresponding 2009 period, while the average interest-bearing liabilities decreased from $8.6 billion to $8.5 billion, respectively. The reduction in leverage, combined with a decline in interest expense, resulted in a contraction of the net interest margin from 2.02% in the second quarter of 2008 to 1.80% in the corresponding 2009 period. Net interest income for the six month period ended June 30, 2009 totaled $78.2 million, compared to $87.9 million for the corresponding 2008 period, a decrease of $9.7 million, or 11%. The decrease in net interest income for the six month period ended June 30, 2009, compared to the corresponding 2008 period, resulted from a reduction in interest income of $32.7 million, partially offset by a reduction in interest expense of $22.9 million. The reduction in interest income was principally related to (i) a reduction of $8.5 million in interest income on loans primarily related to the increase in delinquencies in the Company's loan portfolio between periods of $131.5 million; (ii) a decrease of $21.0 million in interest income on investment securities associated with a reduction of $737.8 million in the average balance of investment securities as a result of a reduction of $0.5 billion associated to the termination of repurchase financing arrangements and the sale of collateral associated with such financing arrangements with LBI, partially offset by an increase of $5.6 million in interest income on mortgage backed securities as a result of an increase in the average balance of these securities of $1.3 billion; and (iii) a decrease of $8.6 million in the interest income on other interest-earning assets resulting from a decrease of $487.2 million in the average balance of other interest-earning assets related to the use of these instruments to finance the purchase of securities associated with the Company's plan to replace its earning assets ("Asset Replacement Program").
The decrease in interest income was partially offset by a decrease in interest expense. Interest expense for the six month period ended June 30, 2009 decreased by $22.9 million, or 13%, compared to the corresponding 2008 period. The decrease in interest expense was driven by (i) a reduction of $10.8 million in interest expense on deposits related to the repositioning of the Company's deposits products, driven by the run-off of brokered deposits and the general decline in interest rates; and (ii) reductions of $5.7 million in the interest expense on securities sold under agreement to repurchase, $2.8 million in interest expense on advances from FHLB and $4.2 million in interest expense on loans payable associated to a reduction associated with the general decline in interest rates and lower borrowing costs under lines of credit with the Federal Home Loan Bank and an auction of term funds to depository institutions granted by the Federal Reserve under TAF which increased is average balance to $629.6 million for the six month period ended June 30, 2009, when compared to the corresponding 2008 period.
Average interest-earning assets increased from $9.2 billion for the year ended June 30, 2008 to $9.4 billion for the corresponding 2009 period, while the average interest-bearing liabilities increased from $8.1 billion to $8.5 billion, respectively. The increase in leverage, combined with an increase in interest expense, resulted in a contraction of the net interest margin from 1.91% for the six month period ended June 30, 2008 to 1.68% for the corresponding 2009 period.
The following tables present, for the periods indicated, Doral Financial's average balance sheet, the total dollar amount of interest income from its average interest-earning assets and the related yields, as well as the interest expense on its average interest-bearing liabilities, expressed in both dollars and rates, and the net interest margin and spread. These tables do not reflect any effect of income taxes. Average balances are based on average daily balances.

TABLE B
AVERAGE BALANCE SHEET AND SUMMARY OF NET INTEREST INCOME

                                                                         QUARTER ENDED JUNE 30,
                                                     2009                                                     2008
                                 AVERAGE                              AVERAGE             AVERAGE                              AVERAGE
(Dollars in thousands)           BALANCE           INTEREST          YIELD/RATE           BALANCE           INTEREST          YIELD/RATE
ASSETS:
Interest-earning assets:
Total loans(1)(2)              $  5,667,466        $  81,245                5.75 %      $  5,553,218        $  85,910                6.22 %
Mortgage-backed
securities                        2,977,412           27,256                3.67 %         2,316,989           29,936                5.20 %
Interest-only strips
("IOs")                              48,964            1,575               12.90 %            51,817            1,756               13.63 %
Investment securities               360,725            2,765                3.07 %         1,176,813           13,912                4.75 %
Other interest-earning
assets                              298,610            1,737                2.33 %           621,545            4,132                2.67 %


Total interest-earning
assets/interest income            9,353,177        $ 114,578                4.91 %         9,720,382        $ 135,646                5.61 %


Total
non-interest-earning
assets                              708,741                                                  750,604

Total assets                   $ 10,061,918                                             $ 10,470,986

LIABILITIES AND
STOCKHOLDERS' EQUITY:
Interest-bearing
liabilities:
Deposits                       $  3,842,363        $  30,872                3.22 %      $  4,051,419        $  37,268                3.70 %
Repurchase agreements             1,785,233           17,481                3.93 %         2,181,718           22,091                4.07 %
Advances from FHLB                1,591,938           15,988                4.03 %         1,745,374           17,549                4.04 %
Other short-term
borrowings                          647,912              406                0.25 %                 -                -                   -
. . .