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DRL > SEC Filings for DRL > Form 10-Q on 5-Nov-2013All Recent SEC Filings

Show all filings for DORAL FINANCIAL CORP

Form 10-Q for DORAL FINANCIAL CORP


5-Nov-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, as amended. In addition, Doral Financial may make forward-looking statements in its press releases, other filings with the Securities and Exchange Commission or in other public or shareholder communications and its senior management may make forward-looking statements orally to analysts, investors, the media and others.

These forward-looking statements may relate to the Company's financial condition, results of operations, plans, prospects, objectives, future performance and business, including, but not limited to, statements with respect to the adequacy of the allowance for loan and lease losses, delinquency trends, market risk and the impact of general economic conditions, interest rate changes, capital markets conditions, capital adequacy and liquidity, and the effect of legal or regulatory proceedings, tax legislation and tax rules, deferred tax assets and related reserves, compliance and regulatory matters and new accounting standards and guidance on the Company's financial condition and results of operations. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts, but instead represent Doral Financial's current expectations regarding future events. Such forward-looking statements may be generally identified by the use of words or phrases such as "would be," "will allow," "intends to," "will likely result," "are expected to," "will continue," "is anticipated," "estimate," "project," "believe," "expect," "predict," "forecast," "anticipate," "plan," "outlook," "target," "goal," and similar expressions and future conditional verbs such as "would," "should," "could," "might," "can" or "may" or similar expressions.

Doral Financial cautions readers not to place undue reliance on any of these forward-looking statements since they speak only as of the date made and represent Doral Financial's expectations of future conditions or results and are not guarantees of future performance. The Company does not undertake and specifically disclaims any obligation to update any forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of those statements, other than as required by law, including the requirements of applicable securities laws.

Forward-looking statements are, by their nature, subject to risks and uncertainties and changes in circumstances, many of which are beyond Doral Financial's control. While there is no assurance that any list of risks and uncertainties or risk factors is complete, below are certain important factors (including our management's ability to identify and manage these and other risks) that could cause actual results to differ materially from those contained in any forward-looking statement:

the continued recessionary conditions of the Puerto Rico economy and any deterioration in the performance of the United States economy and capital markets that adversely affect the general economy, housing prices and absorption, the job market, consumer confidence and spending habits leading to, among other things, (i) a further deterioration in the credit quality of our loans and other assets, (ii) decreased demand for our products and services and lower revenue and earnings, (iii) reduction in our interest margins, and (iv) decreased availability and increased pricing of our funding sources, including brokered certificates of deposit;

the weakness of the Puerto Rico and United States real estate markets and of the Puerto Rico and United States consumer and commercial credit sectors and its impact on the credit quality of our loans and other assets which have contributed and may continue to contribute to, among other things, an increase in our non-performing loans, charge-offs and loan loss provisions and may subject the Company to further risk from loan defaults and foreclosures;

uncertainty about whether Doral Financial and Doral Bank will be able to fully comply with the terms and conditions of the written agreement dated September 11, 2012 (the "Written Agreement") that Doral Financial entered into with the Federal Reserve Bank of New York ("FRBNY") and the consent order dated August 8, 2012 (the "Consent Order") that Doral Bank entered into with the Federal Deposit Insurance Corporation ("FDIC") and the Office of the Commissioner of Financial Institutions of Puerto Rico (the "Office of the Commissioner");

uncertainty as to whether the FRBNY, FDIC and/or the Office of the Commissioner will continue to allow us to diversify our business operations through the development of our banking operations in New York and Florida;

the operating and other conditions imposed by the FDIC and the Office of the Commissioner under the Consent Order and by the FRBNY under the Written Agreement, which may lead to, among other things, an increase in our charge-offs, loan loss provisions, and compliance costs, and an increased risk of being subject to additional regulatory actions, as well as additional actions resulting from future regular annual safety and soundness and compliance examinations by these federal and state regulators;


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our reliance on brokered certificates of deposit and our ability to obtain, on a periodic basis, approval from the FDIC to issue, renew or roll-over brokered certificates of deposit to fund operations and provide liquidity in accordance with the terms of the Consent Order;

uncertainty as to what additional regulatory actions the FRBNY, FDIC and/or the Office of the Commissioner may take against us if we fail to comply with the Written Agreement, the Consent Order or any other operating condition imposed by any such regulator or if any such regulator determines our financial, operating or regulatory condition has significantly deteriorated;

a credit default by the Commonwealth of Puerto Rico or any of its public corporations or other instrumentalities, and recent and/or future downgrades of the long-term debt ratings of the United States and the Commonwealth of Puerto Rico, which could adversely affect economic conditions in the United States and the Commonwealth of Puerto Rico;

a decline in the market value and estimated cash flows of our mortgage-backed securities and other assets may result in the recognition of other-than-temporary impairment of such assets under generally accepted accounting principles in the United States of America;

uncertainty about the tax and other revenue raising measures recently adopted by the Puerto Rico government in response to its fiscal situation and the impact of such measures on different sectors of the Puerto Rico economy;

uncertainty about the effectiveness of the various actions undertaken to stimulate the United States economy and stabilize the United States financial markets, and the impact of such actions on our business, financial condition and results of operations;

the effect of recently adopted regulatory capital standards applicable to banks and bank holding companies, including the final Basel III requirements and their implementation through rulemaking by the Federal Reserve and the FDIC, including requirements to hold higher levels of regulatory capital and meet higher regulatory capital ratios as a result of final Basel III or other capital standards, and our ability to generate capital internally or raise new capital on favorable terms if required under such capital standards;

the extent of our success in our loan modification efforts, as well as the effects of regulatory requirements or guidance regarding loan modifications or changes in such requirements or guidance;

changes in interest rates, which may result from changes in the fiscal and monetary policy of the federal government, and the potential impact of such changes in interest rates on our net interest income and the value of our loans and investments;

the commercial soundness of our various counterparties of financing and other securities transactions, which could lead to possible losses when the collateral held by us to secure the obligations of the counterparty is not sufficient or to possible delays or losses in recovering any excess collateral belonging to us held by the counterparty;

higher credit losses because of federal or state legislation or regulatory action that either: (i) reduces the amount that our borrowers are required to pay us, or (ii) limits our ability to foreclose on properties or collateral or makes foreclosures less economically feasible;

developments in the regulatory and legal environment for public companies and financial services companies in the United States (including Puerto Rico) as a result of, among other things, the adoption of the Dodd-Frank Wall Street Reform and Consumer Protection Act and the regulations adopted and to be adopted thereunder by various federal and state securities and banking regulatory agencies, and the impact of such developments on our business, business practices, capital requirements and costs of operations;

the exposure of Doral Financial, as originator of residential mortgage loans, sponsor of residential mortgage loan securitization transactions, or servicer of such loans or such transactions, or in other capacities, to government sponsored enterprises, investors, mortgage insurers or other third parties as a result of representations and warranties made in connection with the transfer or securitization of such loans;

residential mortgage borrower performance different than that estimated in the cash flow forecasts for troubled debt restructured loans;


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the risk of possible failure or circumvention of our controls, practices and procedures, including those designed to protect our networks, systems, computers and data from attack, damage or unauthorized access, and the risk that our risk management policies and/or processes may be inadequate;

an increase in our non-interest expense as a result of increases in our FDIC assessments brought about by: (i) additional increases in FDIC deposit insurance premiums and/or special assessments by the FDIC to replenish its insurance fund, or (ii) additional deterioration in our FDIC assessment rating;

changes in our accounting policies or in accounting standards, and changes in how accounting standards are interpreted or applied;

an adverse change in our ability to attract new clients and retain existing clients;

general competitive factors and industry consolidation;

the strategies adopted by the FDIC and the three banks, who purchased in April 2010 three other failed banks in Puerto Rico, in connection with the resolution of the residential, construction and commercial real estate loans acquired in connection with those "forced bank sales," which may adversely affect real estate values in Puerto Rico;

potential adverse outcome in the legal or regulatory actions or proceedings described in Part I, Item 3 "Legal Proceedings" in the 2012 Annual Report on Form 10-K, which was filed with the SEC on March 13, 2013, as updated from time to time in the Company's quarterly and other reports filed with the SEC (including this Quarterly Report on Form 10-Q); and

the other risks and uncertainties detailed in Part I, Item 1A "Risk Factors" in the 2012 Annual Report on Form 10-K, which was filed with the SEC on March 13, 2013, as updated from time to time in the Company's quarterly and other reports filed with the SEC (including this Quarterly Report on Form 10-Q).


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EXECUTIVE SUMMARY

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 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 Annual Report on Form 10-K for the year ended December 31, 2012, which was filed with the SEC on March 13, 2013. While not all inclusive, Items 1 and 1A of the Form 10-K and this Form 10-Q disclose additional information about the business of the Company, risk factors, many beyond the Company's control, and provides additional detail and discussion of the operating results, financial condition and credit, market and liquidity risks beyond that which is presented in the narrative and tables included herein.

According to the most recent information published by the Puerto Rico government, the Puerto Rico economy has contracted by approximately 13.4% from the beginning of fiscal year 2007 to the end of fiscal year 2013. The sustained recessionary economic conditions in Puerto Rico are the primary contributing factor to the Company having a high level of non-performing loans and has caused the Company to change its business strategies over time. In 2007, the Company suspended the extension of any new construction loans and land loans in Puerto Rico. In 2008, the Company suspended new commercial lending activities in Puerto Rico as well, focusing on servicing its loans to existing commercial customers. In 2009, the Company further altered its strategy by significantly increasing mortgage loan underwriting standards for loans originated for Puerto Rico borrowers. Despite these actions the Company's non-performing loans increased as a result of defaults by previous existing customers. In response to the economic difficulties of the Company's customers, in 2010 the Company initiated programs to modify the credit terms of a significant number of Puerto Rico residential mortgage and commercial borrowers as a means to optimize the performance of our borrowers and the Company. The Company continues to focus on rationalizing the revenue and expense opportunities available in an economically stressed Puerto Rico. As part of our strategy to return the Company to a safe and sound condition in Puerto Rico, the Company re-embarked in 2009 on expanding its U.S. based funding sources and commercial lending to U.S. businesses in order to diversify risk and generate income.

The Company expects that the conditions which have driven the adoption of its current business strategies to continue to affect the Company's risk profile and earnings into the foreseeable future. Evolving conditions may also present new operational and strategic challenges to the Company. The continuing weakness in the economy in Puerto Rico is expected to continue to adversely affect the quality of the Company's Puerto Rico home mortgage, commercial real estate, and construction and land portfolios, as well as its ability to generate new quality home mortgage loans - the most significant part of the Company's business. The Company anticipates that its operating capabilities will continue to be restricted by the consent order with the FDIC and the Office of the Commissioner, and the Written Agreement with the Federal Reserve Bank of New York, and that compliance with the consent order and the Written Agreement will cause the Company's operating costs to increase. The Company's operations will also be negatively affected by the continuing consolidation of other banks in the Puerto Rico market, as these banks, by virtue of their larger size, have greater access to capital and customers than the Company, and the ability to adopt competitive strategies that are adverse to the interests of the Company.

Regarding the benefits of the Company's strategy to develop U.S. funding and lending opportunities, at September 30, 2013, $2.6 billion of the Company's $6.3 billion gross loans receivable, or 41.62%, are to U.S. operating businesses and individuals for business purposes. Funding sources specific to its U.S. businesses, specifically deposits, borrowings and collateralized loan obligations, aggregated to $2.3 billion as of September 30, 2013, with the remainder of the assets funded by the general funding sources available to Doral Bank. The U.S. based commercial loans have lower defaults than the Company's Puerto Rico commercial loan portfolio. As a result, of the $29.1 million loss before income taxes, the Company's U.S. business contributed $40.7 million in income before income taxes over the first nine months of 2013, compared to income before income taxes of $26.8 million from Puerto Rico Growth. The income before income taxes from the U.S. and Puerto Rico Growth operations were offset by a loss before income taxes of $60.3 million, $29.0 million and $7.3 million from Recovery, Corporate and Treasury operations, respectively.

The preparation of financial statements and other financial information in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts. These estimates and assumptions include management's estimates affecting the allowance for loan and lease losses, including the provision for loan and lease losses, the conditions under which a loan or security is determined to be accounted for as non-performing, the conditions under which a non-performing loan is returned to accrual status, the circumstances under which a loan is determined to be a TDR, the circumstances under which a TDR is no longer reported as a TDR, the valuation of interest only strips and mortgage servicing rights, when a loan is determined to be of such little value it is charged-off, when a security is considered to


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be other than temporarily impaired and the credit loss charged to income, the collectability of other receivables, the estimate of income tax expense and payable and the fair values of financial assets and liabilities. Each of these factors requires subjective judgment and those judgments have a significant impact on the Company's reported results of operations and disclosures. In 2012, the Company changed its loss provision assumptions to better reflect the ongoing economic and regulatory environment in which it operates in Puerto Rico. Each of the identified factors, as well as others not identified, where management is making subjective judgments because the accounting does not relate to actual cash gain or loss, but is estimated future financial effects, can positively or negatively affect reported earnings. See "Critical Accounting Policies" below.

OVERVIEW OF RESULTS OF OPERATIONS

Net loss for the three months ended September 30, 2013 totaled $7.5 million, compared to a net loss of $32.5 million for the comparable 2012 period. The Company's net loss decreased $25.1 million, due to a decrease of $18.0 million in the PLLL, a decrease of $5.1 million in non-interest expense, a decrease of $1.6 million in income tax expense and an increase of $1.4 million in net interest income, partially offset by a decrease in non-interest income of $1.0 million.

The Company's financial results and condition for the three months ended September 30, 2013 included the following:

Net interest income for the three months ended September 30, 2013 was $57.6 million, compared to $56.2 million for the corresponding period in 2012. The $1.4 million increase in net interest income for 2013, compared to 2012, was due to a decrease of $2.1 million in interest expense, partially offset by a decrease of $0.7 million in interest income. Interest expense decreased as securities sold under repurchase agreements have matured and are not being replaced. Additionally, older certificates of deposit are maturing and are being replaced by similar duration contracts at lower rates. For the three months ended September 30, 2013, interest income on MBS decreased when compared to the same period in 2012, as the average balance of these securities decreased due to sales occurring during the later part of 2012. This decrease in interest income was partially offset by a slightly higher interest income from the loans portfolio.

The provision for loan and lease losses for the three months ended September 30, 2013 was $16.4 million, reflecting a decrease of $18.0 million when compared to the $34.4 million provision for the corresponding 2012 period. The decrease in the PLLL is mostly related to: (i) enhancements in the assumptions of the model; and (ii) a decrease of $24.3 million in charge-offs recorded for the three months ended September 30, 2013 when compared to the same period in 2012.

Non-interest income for the three months ended September 30, 2013 was $18.6 million, a decrease of $1.0 million compared to non-interest income of $19.6 million for the corresponding 2012 period. The decrease in non-interest income for the three months ended September 30, 2013, compared to the same period in 2012, resulted largely from: (i) a decrease of $10.6 million in net gain on loans securitized and sold and capitalization of mortgage servicing assets, mostly related to a decrease of $13.0 million in gains on sales of securities held for trading; (ii) a decrease of $2.0 million in net gain on sale of investment securities available for sale due to sales of approximately $152.2 million during the three months ended September 30, 2012; and (iii) a decrease of $0.6 million in commissions, fees and other income, mostly attributable to the insurance business. These decreases were partially offset by: (i) an increase of $7.1 million in mortgage loan servicing income, mostly related to an improvement of $6.4 million in the mark-to-market of the servicing asset; (ii) an increase of $3.3 million in the net gain
(loss) on trading assets and derivatives, primarily due to an improvement of $4.7 million in the loss on hedging derivatives, partially offset by a decrease of $1.2 million in the IOs fair value;
(iii) an increase of $1.1 million related to the mark-to-market on loans held for sale at fair value; and (iv) a decrease of approximately $0.7 million in the loss on early repayment of debt.

Non-interest expense for the three months ended September 30, 2013 was $68.4 million, compared to $73.5 million for the corresponding period in 2012. The $5.1 million decrease in non-interest expense for the three months ended September 30, 2013, compared to the same period in 2012, was due largely to: (i) decreases of $4.1 million in foreclosure and other credit related expenses mostly due to recoverable expenses that the Company is now requiring the borrower to reimburse; (ii) a decrease of $4.0 million in other real estate owned expenses, mostly related to a decrease in the provision for OREO losses; and (iii) a decrease of $1.2 million in advertising expenses, related to reduction in the mortgage business related advertising and in the institutional and community advertisement. These decreases were partially offset by:
(i) an increase of $5.7 million in compensation and benefits mostly related to additional headcount in our U.S and loan administration and review functions; (ii) an increase of $0.9 million in professional fees, mostly related to legal fees related to ongoing litigation; and
(iii) an increase of $0.6 million in taxes, other than payroll, mostly related to a new volume of business tax in the PR operations.


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Income tax benefit was $1.0 million for the three months ended September 30, 2013, compared to an income tax expense of $0.5 million for the corresponding period in 2012 mostly due to a revaluation of the Company's deferred tax asset in light of the new legislation approved by the Commonwealth of Puerto Rico on June 30, 2013.

Net loss attributable to common shareholders for the three months ended September 30, 2013 totaled $9.9 million, or a loss of $1.49 per common share, compared to net loss attributable to common shareholders for the corresponding 2012 period of $35.0 million, or a loss of $5.44 per common share.

The Company's loan production for the three months ended September 30, 2013 was $583.1 million, a decrease of $188.0 million, or 24.38%, when compared to the loan production of $771.1 million for the three months ended September 30, 2012. Major components of the decrease in loan production include $111.0 million in residential mortgage loans, $100.0 million and $51.4 million in commercial real estate loans and commercial & industrial loans originated in the US, respectively, partially offset by an increase of $74.2 million in construction development loans originated in the US. The decrease in the Company's PR residential mortgage loan origination is a reflection of the overall decrease in the refinancing activity in PR. The decrease in the US loan production is mostly related to a $111.0 million refinancing that occurred during the three months ended September 30, 2012.

Assets as of September 30, 2013 totaled $8.6 billion compared to $8.5 billion as of December 31, 2012, with an increase of $90.4 million primarily related to an increase of $160.4 million in total loans, net mostly related to the US portfolio; an increase of $13.0 million in mortgage servicing advances; and an increase of $14.4 million in real estate held for sale, net. These increases were partially offset by decreases in: (i) cash and due from banks and restricted cash of $32.4 million; (ii) total investment securities of $46.9 million;
(iii) other assets of $14.3 million; and (iv) accounts receivable of $6.4 million.

Total deposits of $5.0 billion as of September 30, 2013 increased $351.0 million, or 7.58%, from deposits of $4.6 billion as of December 31, 2012, mostly due to increased deposits in Doral's US branch network.

Non-performing loans, excluding FHA/VA loans guaranteed by the U.S. government, as of September 30, 2013 totaled $717.4 million, a decrease of $25.3 million, or 3.4% from December 31, 2012. The decrease in NPLs during the nine months ended September 30, 2013 is primarily related to $141.8 million in loans that were cured, $69.9 million in write-downs, and $36.2 million of loans transferred to OREO, partially offset by an increase of $222.6 million in new non-performing loans.


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Table A - Selected Financial Data



                                                       Three months ended                    Nine months ended
                                                         September 30,                         September 30,
(In thousands, except for share data)               2013               2012               2013               2012
Selected Income Statement Data:
Interest income                                  $    91,634        $    92,360        $   270,810        $   276,137
Interest expense                                      34,005             36,122            101,910            112,388

Net interest income                                   57,629             56,238            168,900            163,749
Provision for loan and lease losses                   16,395             34,413             40,654            154,803

Net interest income after provision for loan
and lease losses                                      41,234             21,825            128,246              8,946
. . .
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