UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2008

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANG ACT OF 1934

For the transition period from                      to                     

Oriental Financial Group Inc.

Incorporated in the Commonwealth of Puerto Rico,		IRS Employer Identification No. 66-0538893

Principal Executive Offices:
997 San Roberto Street
Oriental Center 10th Floor
Professional Offices Park
San Juan, Puerto Rico 00926
Telephone Number: (787) 771-6800

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ     No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer   o (Do not check if a smaller reporting company)		Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o     No þ

24,293,671 common shares ($1.00 par value per share)
outstanding as of October 31, 2008

 

 

TABLE OF CONTENTS

		Page
Part I FINANCIAL INFORMATION:
Item 1 Financial Statements
Unaudited consolidated statements of financial condition at September 30, 2008 and December 31, 2007			1
Unaudited consolidated statements of operations for the quarters and nine-month periods ended September 30, 2008 and 2007			2
Unaudited consolidated statements of changes in stockholders’ equity for the nine-month periods ended September 30, 2008 and 2007			3
Unaudited consolidated statements of comprehensive income for the quarters and nine-month periods ended September 30, 2008 and 2007			3
Unaudited consolidated statements of cash flows for the nine-month periods ended September 30, 2008 and 2007			4
Notes to unaudited consolidated financial statements			5
Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations			24
Item 3 Quantitative and Qualitative Disclosures About Market Risk			42
Item 4 Controls and Procedures			45
PART II OTHER INFORMATION:
Item 1 Legal Proceedings			46
Item 1A Risk Factors			46
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds			46
Item 3 Defaults Upon Senior Securities			46
Item 4 Submissions of Matters to a Vote of Security Holders			46
Item 5 Other Information			46
Item 6 Exhibits			46
Signatures			47
Certifications			48
EX-31.1
EX-31.2
EX-32.1
EX-32.2

FORWARD-LOOKING STATEMENTS

When used in this Form 10-Q or future filings by Oriental Financial Group Inc. (the “Group”) with the Securities and Exchange Commission (the “SEC”), in the Group’s press releases or other public or shareholder communications, or in oral statements made with the approval of an authorized executive officer, the words or phrases “would be,” “will allow,” “intends to,” “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimated,” “project,” “believe,” “should” or similar expressions are intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.

The future results of the Group could be affected by subsequent events and could differ materially from those expressed in forward-looking statements. If future events and actual performance differ from the Group’s assumptions, the actual results could vary significantly from the performance projected in the forward-looking statements.

The Group wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made and are based on management’s current expectations, and to advise readers that various factors, including local, regional and national economic conditions, substantial changes in levels of market interest rates, credit and other risks of lending and investment activities, competitive, and regulatory factors, legislative changes and accounting pronouncements, could affect the Group’s financial performance and could cause the Group’s actual results for future periods to differ materially from those anticipated or projected. The Group 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 such statements.

PART — I FINANCIAL INFORMATION

ITEM — I FINANCIAL STATEMENTS

     UNAUDITED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

     SEPTEMBER 30, 2008 AND DECEMBER 31, 2007

     (In thousands, except share data)

		September 30,				December 31,
		2008				2007
ASSETS
Cash and due from banks		$	40,382			$	88,983
Investments:
Trading securities, at fair value with amortized cost of $1,078 (December 31, 2007 - $1,103)			1,061				1,122
Investment securities available-for-sale, at fair value with amortized cost of $3,403,608 (December 31, 2007 - $3,063,763)
Securities pledged that can be repledged			3,169,863				2,903,078
Other investment securities			137,957				166,204
Total investment securities available-for-sale			3,307,820				3,069,282
Investment securities held-to-maturity, at amortized cost with fair value of $1,171,853 (December 31, 2007 - $1,478,112)
Securities pledged that can be repledged			1,121,370				1,348,159
Other investment securities			70,301				144,728
Total investment securities held-to-maturity			1,191,671				1,492,887
Federal Home Loan Bank (FHLB) stock, at cost			19,812				20,658
Other investments			150				1,661
Total investments			4,520,514				4,585,610
Securities sold but not yet delivered			4,857				—
Loans:
Mortgage loans held-for-sale, at lower of cost or market			31,152				16,672
Loans receivable, net of allowance for loan losses of $12,466 (December 31, 2007 - $10,161)			1,188,686				1,162,894
Total loans, net			1,219,838				1,179,566
Accrued interest receivable			38,104				52,315
Premises and equipment, net			20,911				21,779
Deferred tax asset, net			22,577				10,362
Foreclosed real estate			8,220				4,207
Investment in equity indexed options			13,548				40,709
Other assets			25,715				16,324
Total assets		$	5,914,666			$	5,999,855
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits:
Demand deposits		$	452,071			$	119,152
Savings accounts			59,250				387,790
Certificates of deposit			1,006,468				739,478
Total deposits			1,517,789				1,246,420
Borrowings:
Federal funds purchased and other short term borrowings			41,026				27,460
Securities sold under agreements to repurchase			3,770,755				3,861,411
Advances from FHLB			281,724				331,898
Subordinated capital notes			36,083				36,083
Total borrowings			4,129,588				4,256,852
Securities purchased but not yet received			—				111,431
Accrued expenses and other liabilities			25,271				25,691
Total liabilities			5,672,648				5,640,394
Stockholders’ equity:
Preferred stock, $1 par value; 5,000,000 shares authorized; $25 liquidation value; 1,340,000 shares of Series A and 1,380,000 shares of Series B issued and outstanding			68,000				68,000
Common stock, $1 par value; 40,000,000 shares authorized; 25,737,837 shares issued; 24,293,432 shares outstanding (December 31, 2007-25,555,575; 24,120,771)			25,738				25,557
Additional paid-in capital			212,511				210,073
Legal surplus			40,573				40,573
Retained earnings			17,868				45,296
Treasury stock, at cost 1,444,405 shares (December 31, 2007 - 1,436,426 shares)			(17,142	)			(17,023	)
Accumulated other comprehensive loss, net of tax of $5,317 (December 31, 2007 - $2,166)			(105,530	)			(13,015	)
Total stockholders’ equity			242,018				359,461
Total liabilities and stockholders’ equity		$	5,914,666			$	5,999,855

See notes to unaudited consolidated financial statements.

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE QUARTERS AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2008 AND 2007
(In thousands, except per share data)

										Nine-Month Period Ended
		Quarter Ended September 30,								September 30,
		2008				2007				2008				2007
Interest income:
Loans		$	19,971			$	21,699			$	59,481			$	65,862
Mortgage-backed securities			47,040				28,480				134,306				79,246
Investment securities and other			17,733				24,747				58,216				62,118
Total interest income			84,744				74,926				252,003				207,226
Interest expense:
Deposits			12,202				13,561				36,746				39,409
Securities sold under agreements to repurchase			40,456				37,405				120,904				106,739
Advances from FHLB, term notes and other borrowings			3,505				3,539				11,042				8,055
Subordinated capital notes			540				771				1,776				2,295
Total interest expense			56,703				55,276				170,468				156,498
Net interest income			28,041				19,650				81,535				50,728
Provision for loan losses			1,950				1,614				5,580				4,064
Net interest income after provision for loan losses			26,091				18,036				75,955				46,664
Non-interest income (loss):
Financial service revenues			3,756				3,737				12,496				12,629
Banking service revenues			1,406				1,862				4,328				6,001
Investment banking revenues			200				113				950				113
Mortgage banking activities			910				1,010				2,461				1,242
Net gain (loss) on:
Sale of securities available-for-sale			386				—				9,908				358
Other than temporary impairments			(58,804	)			—				(58,804	)			—
Derivatives			(5,522	)			154				(13,247	)			8,538
Trading securities			(31	)			(2	)			(32	)			—
Other investments			16				297				132				1,083
Foreclosed real estate			58				(59	)			(452	)			8
Other			609				22				608				88
Total non-interest income (loss), net			(57,016	)			7,134				(41,652	)			30,060
Non-interest expenses:
Compensation and employee benefits			7,742				7,561				23,281				21,222
Occupancy and equipment			3,561				3,045				10,213				9,381
Professional and service fees			2,457				1,543				6,604				5,316
Advertising and business promotion			847				1,069				2,757				2,980
Directors and investor relations			273				308				854				1,608
Loan servicing expenses			352				349				1,022				1,412
Taxes, other than payroll and income taxes			644				607				1,862				1,543
Electronic banking charges			428				431				1,242				1,346
Clearing and wrap fees expenses			294				321				901				997
Communication			314				354				964				1,001
Insurance			618				210				1,799				638
Printing, postage, stationery and supplies			214				177				736				568
Other			453				547				1,772				1,815
Total non-interest expenses			18,197				16,522				54,007				49,827
Income (loss) before income taxes			(49,122	)			8,648				(19,704	)			26,897
Income tax expense (benefit)			(4,226	)			196				(6,083	)			1,007
Net income (loss)			(44,896	)			8,452				(13,621	)			25,890
Less: Dividends on preferred stock			(1,200	)			(1,200	)			(3,601	)			(3,601	)
Income available (loss) to common shareholders		$	(46,096	)		$	7,252			$	(17,222	)		$	22,289
Income (loss) per common share:
Basic		$	(1.90	)		$	0.30			$	(0.71	)		$	0.91
Diluted		$	(1.89	)		$	0.30			$	(0.71	)		$	0.91
Average common shares outstanding			24,292				24,230				24,249				24,396
Average potential common shares-options			82				31				100				110
Average diluted common shares outstanding			24,374				24,261				24,349				24,506
Cash dividends per share of common stock		$	0.14			$	0.14			$	0.42			$	0.42

See notes to unaudited consolidated financial statements.

UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2008 AND 2007
(In thousands)

		Nine-Month Period Ended
		September 30,
CHANGES IN STOCKHOLDERS’ EQUITY:		2008				2007
Preferred stock:
Balance at beginning and end of period		$	68,000			$	68,000
Common stock:
Balance at beginning of period			25,557				25,431
Stock options exercised			181				125
Balance at end of period			25,738				25,556
Additional paid-in capital:
Balance at beginning of period			210,073				209,033
Stock-based compensation expense			444				30
Stock options exercised			1,994				943
Balance at end of period			212,511				210,006
Legal surplus:
Balance at beginning of period			40,573				36,245
Transfer from retained earnings			—				3,053
Balance at end of period			40,573				39,298
Retained earnings:
Balance at beginning of period			45,296				26,772
Net income (loss)			(13,621	)			25,890
Cash dividends declared on common stock			(10,206	)			(10,235	)
Cash dividends declared on preferred stock			(3,601	)			(3,601	)
Transfer to legal surplus			—				(3,053	)
Balance at end of period			17,868				35,773
Treasury stock:
Balance at beginning of period			(17,023	)			(12,956	)
Stock used to match defined contribution plan 1165(e)			116				244
Stock purchased			(235	)			(4,330	)
Balance at end of period			(17,142	)			(17,042	)
Accumulated other comprehensive loss, net of tax:
Balance at beginning of period			(13,015	)			(16,099	)
Other comprehensive loss, net of tax			(92,515	)			(3,697	)
Balance at end of period			(105,530	)			(19,796	)
Total stockholders’ equity		$	242,018			$	341,795

UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE QUARTERS AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2008 AND 2007
(In thousands)

										Nine-Month Period Ended
		Quarter Ended September 30,								September 30,
COMPREHENSIVE INCOME		2008				2007				2008				2007
Net income (loss)		$	(44,896	)		$	8,452			$	(13,621	)		$	25,890
Other comprehensive income (loss), net of tax:
Unrealized gain (loss) on securities available-for-sale			(49,336	)			32,039				(129,021	)			5,943
Realized gain on investment securities available-for-sale included in net income			(386	)			—				(9,908	)			(358	)
Other than temporary impairment			38,932				—				38,932				—
Gain on derivatives designated as cash flow hedges included in net income			—				—				—				(773	)
Gain from termination of cash flow hedging			—				—				—				(8,225	)
Income tax effect related to unrealized loss on securities available-for-sale			915				(4,023	)			7,482				(284	)
Other comprehensive income (loss) for the period			(9,875	)			28,016				(92,515	)			(3,697	)
Comprehensive income (loss)		$	(54,771	)		$	36,468			$	(106,136	)		$	22,193

See notes to unaudited consolidated financial statements.

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2008 AND 2007
(In thousands)

		Nine-Month Period Ended September
		30,
		2008				2007
Cash flows from operating activities:
Net income (loss)		$	(13,621	)		$	25,890
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Amortization of deferred loan origination fees, net of costs			(315	)			(852	)
Amortization of premiums, net of accretion of discounts			971				6,150
Depreciation and amortization of premises and equipment			4,021				4,094
Deferred income tax benefit			(4,732	)			(270	)
Equity in earnings of investment in limited liability partnership			—				(279	)
Provision for loan losses			5,580				4,064
Compensation expense in the form of common stock used to match defined contribution plan 1165(e)			116				244
Stock-based compensation			444				30
(Gain) loss on:
Sale of securities available-for-sale			(9,908	)			(1,205	)
Other than temporary impairments			58,804				—
Mortgage banking activities			(2,461	)			(589	)
Derivatives			13,247				(8,521	)
Foreclosed real estate			452				20
Sale of premises and equipment			1				9
Originations and purchases of loans held-for-sale			(99,372	)			(96,683	)
Proceeds from sale of loans held-for-sale			36,920				43,591
Net decrease (increase) in:
Trading securities			61				2
Accrued interest receivable			14,211				(5,222	)
Other assets			(9,391	)			(8,700	)
Net increase (decrease) in:
Accrued interest on deposits and borrowings			1,572				6,649
Other liabilities			(960	)			5,804
Net cash used in operating activities			(4,360	)			(25,774	)
Cash flows from investing activities:
Purchases of:
Investment securities available-for-sale			(2,912,220	)			(1,983,147	)
Investment securities held-to-maturity			—				(143,843	)
Other investments			—				(515	)
Equity options			(11,796	)			(9,504	)
FHLB stock			(4,112	)			(36,379	)
Maturities and redemptions of:
Investment securities available-for-sale			1,441,945				127,047
Investment securities held-to-maturity			281,337				555,924
Other investments			1,511				42,163
FHLB stock			12,642				28,598
Proceeds from sales of:
Investment securities available-for-sale			1,035,000				23,879
Foreclosed real estate			2,501				2,216
Premises and equipment			55				—
Loan production:
Origination and purchase of loans, excluding loans held-for-sale			(127,440	)			(149,043	)
Principal repayment of loans			90,313				169,992
Additions to premises and equipment			(3,209	)			(4,085	)
Net cash used in investing activities			(193,473	)			(1,376,697	)
Cash flows from financing activities:
Net increase (decrease) in:
Deposits			295,431				38,041
Securities sold under agreements to repurchase			(90,023	)			1,254,365
Federal funds purchased and other short term borrowings			13,566				13,678
Maturity of term note			—				(15,000	)
Proceeds from:
Advances from FHLB			1,103,650				3,822,420
Repayments of advances from FHLB			(1,153,650	)			(3,658,120	)
Exercise of stock options			2,175				1,068
Repurchase of treasury stock			(235	)			(4,330	)
Termination of derivative instrument			(7,875	)			—
Dividend paid on common and preferred stock			(13,807	)			(13,836	)
Net cash provided by financing activities			149,232				1,438,286
Net change in cash and due from banks			(48,601	)			35,815
Cash and due from banks at beginning of period			88,983				34,070
Cash and due from banks at end of period		$	40,382			$	69,885
Supplemental Cash Flow Disclosure and Schedule of Noncash Activities:
Interest paid		$	168,895			$	149,389
Income tax paid		$	54			$	—
Mortgage loans securitized into mortgage-backed securities		$	49,537			$	42,677
Securities sold but not yet delivered		$	4,857			$	45,866
Transfer from loans to foreclosed real estate		$	6,966			$	1,710

See notes to unaudited consolidated financial statements.

Notes to Unaudited Consolidated Financial Statements

NOTE 1 — BASIS OF PRESENTATION

The accounting and reporting policies of Oriental Financial Group Inc. (the “Group” or “Oriental”) conform with U.S. generally accepted accounting principles (“GAAP”) and to financial services industry practices.

The unaudited consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). In the opinion of management, these consolidated financial statements include all adjustments necessary, all of which are of normal recurring nature, to present fairly the consolidated statement of financial condition as of September 30, 2008, and December 31, 2007, and the consolidated results of operations and cash flows for the quarters and nine-month periods ended September 30, 2008 and 2007. All significant intercompany balances and transactions have been eliminated in the accompanying unaudited consolidated financial statements. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such SEC rules and regulations. Management believes that the disclosures made are adequate to make the information presented not misleading. The results of operations and cash flows for the nine-month periods ended September 30, 2008 and 2007 are not necessarily indicative of the results to be expected for the full year. For further information, refer to the consolidated financial statements and footnotes thereto for the year ended December 31, 2007, included in the Group’s 2007 annual report on Form 10-K.

Nature of Operations

The Group is a publicly-owned financial holding company incorporated under the laws of the Commonwealth of Puerto Rico. It has four direct subsidiaries, Oriental Bank and Trust (the “Bank”), Oriental Financial Services Corp. (“Oriental Financial Services”), Oriental Insurance, Inc. (“Oriental Insurance”) and Caribbean Pension Consultants, Inc., which is located in Boca Raton, Florida. The Group also has two special purpose entities, Oriental Financial (PR) Statutory Trust I (the “Statutory Trust I”, presently inactive) and Oriental Financial (PR) Statutory Trust II (the “Statutory Trust II”). Through these subsidiaries and its divisions, the Group provides a wide range of financial services such as mortgage, commercial and consumer lending, financial planning, insurance sales, money management and investment banking and brokerage services, as well as corporate and individual trust services. Note 9 to the unconsolidated financial statements presents further information about the operations of the Group’s business segments.

The main offices of the Group and its subsidiaries are located in San Juan, Puerto Rico. The Group is subject to examination, regulation and periodic reporting under the U.S. Bank Holding Company Act of 1956, as amended, which is administered by the Board of Governors of the Federal Reserve System.

The Bank operates through 23 financial centers located throughout Puerto Rico and is subject to the supervision, examination and regulation of the Office of the Commissioner of Financial Institutions of Puerto Rico (“OCIF”) and the Federal Deposit Insurance Corporation (“FDIC”). The Bank offers banking services such as commercial and consumer lending, saving and time deposit products, financial planning, and corporate and individual trust services, and capitalizes on its commercial banking network to provide mortgage lending products to its clients. Oriental International Bank Inc. (“OIB”), a wholly-owned subsidiary of the Bank, operates as an international banking entity (“IBE”) pursuant to the International Banking Center Regulatory Act of Puerto Rico, as amended. OIB offers the Bank certain Puerto Rico tax advantages. OIB activities are limited under Puerto Rico law to persons and assets/liabilities located outside of Puerto Rico.

Oriental Financial Services is subject to the supervision, examination and regulation of the Financial Industry Regulatory Authority (“FINRA”), the SEC, and the OCIF. Oriental Insurance is subject to the supervision, examination and regulation of the Office of the Commissioner of Insurance of Puerto Rico.

The Group’s mortgage banking activities are conducted through a division of the Bank, and also through its mortgage lending subsidiary, Oriental Mortgage Corporation. The mortgage banking activities primarily consist of the origination and purchase of residential mortgage loans for the Group’s own portfolio and from time to time, if the conditions so warrant, the Group may engage in the sale of such loans to other financial institutions in the secondary market. The Group originates Federal Housing Administration (“FHA”)-insured and Veterans Administration (“VA”)-guaranteed mortgages that are primarily securitized for issuance of Government National Mortgage Association (“GNMA”) mortgage-backed securities which can be resold to individual or institutional investors in the secondary market. Conventional loans that meet the underwriting requirements for sale or exchange under standard Federal National Mortgage Association (the “FNMA”) or the Federal Home Loan Mortgage Corporation (the “FHLMC”) programs are referred to as conforming mortgage loans and are also securitized for issuance of FNMA or FHLMC mortgage-backed securities. The Group is an approved seller of FNMA, as well as

FHLMC, mortgage loans for issuance of FNMA and FHLMC mortgage-backed securities. The Group is also an approved issuer of GNMA mortgage-backed securities. The Group continues to outsource the servicing of the GNMA, FNMA and FHLMC pools that it issues and of its mortgage loan portfolio.

In January 2008, the Group entered into an exclusive alliance with Primerica Financial Services, Inc. (“Primerica”), a wholly-owned subsidiary of Citigroup, in which the Group is the supplier of a mortgage platform and related services for Primerica in its program to market home loans to its clients in Puerto Rico.

Significant Accounting Policies

The unaudited consolidated financial statements of the Group are prepared in accordance with GAAP and with the general practices within the financial services industry. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Group believes that, of its significant accounting policies, the following may involve a higher degree of judgment and complexity.

Allowance for Loan Losses

The Group follows a systematic methodology to establish and evaluate the adequacy of the allowance for loan losses to provide for inherent losses in the loan portfolio. This methodology includes the consideration of factors such as economic conditions, portfolio risk characteristics, prior loss experience, and results of periodic credit reviews of individual loans. The provision for loan losses charged to current operations is based on such methodology. Loan losses are charged and recoveries are credited to the allowance for loan losses.

Larger commercial loans that exhibit potential or observed credit weaknesses are subject to individual review and grading. Where appropriate, allowances are allocated to individual loans based on management’s estimate of the borrower’s ability to repay the loan given the availability of collateral, other sources of cash flow and legal options available to the Group.

Included in the review of individual loans are those that are impaired, as provided in the Statement of Financial Accounting Standards (“SFAS”) No. 114, “Accounting by Creditors for Impairment of a Loan-an amendment of FASB Statements No. 5 and 15” (“SFAS 114”). A loan is considered impaired when, based on current information and events, it is probable that the Group will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, or as a practical expedient, at the observable market price of the loan or the fair value of the collateral, if the loan is collateral dependent. Loans are individually evaluated for impairment, except large groups of small balance homogeneous loans that are collectively evaluated for impairment under the provisions of SFAS No. 5, “Accounting for Contingencies” (“SFAS 5”), as amended, and loans that are recorded at fair value or at the lower of cost or market. The Group measures for impairment all commercial loans over $250,000 and over 90-days past-due. The portfolios of mortgage and consumer loans are considered homogeneous, and are evaluated collectively for impairment.

The Group, using a rating system, applies an overall allowance percentage to each loan portfolio category based on historical credit losses adjusted for current conditions and trends. This delinquency-based calculation is the starting point for management’s determination of the required level of the allowance for loan losses. Other data considered in this determination includes: the overall historical loss trends and other information including underwriting standards and economic trends.

Loan loss ratios and credit risk categories are updated quarterly and are applied in the context of GAAP and the importance of depository institutions having prudent, conservative, but not excessive loan allowances that fall within an acceptable range of estimated losses. While management uses current available information in estimating possible loan losses, factors beyond the Group’s control such as those affecting general economic conditions may require future changes to the allowance.

Financial Instruments

Certain financial instruments including derivatives, trading securities and investment securities available-for-sale are recorded at fair value and unrealized gains and losses are recorded in other comprehensive income or as part of non-interest income, as appropriate. Fair values are based on listed market prices, if available. If listed market prices are not available, fair value is determined based on other relevant factors, including price quotations for similar instruments. The fair values of certain derivative contracts are derived from pricing models that consider current market and contractual prices for the underlying financial instruments as well as time value and yield curve or volatility factors underlying the positions.

SFAS No. 157, “Fair Value Measurements” (“SFAS 157”), establishes a fair value hierarchy that prioritizes the inputs of valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy under SFAS 157 are described below:

Basis of Fair Value Measurement

Level 1-		Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

Level 2-		Quoted prices in markets that are not considered to be active or financial instruments for which all significant inputs are observable, either directly or indirectly;

Level 3-		Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.

A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. For further details regarding the Group’s investment securities and fair value measurements, refer to Note 2 and Note 8, respectively, of the unaudited consolidated financial statements.

Impairment of Investment Securities

The Group evaluates its securities available-for-sale and held-to-maturity for impairment. An impairment charge in the unaudited consolidated statements of operations is recognized when the decline in the fair value of investments below their cost basis is judged to be other-than-temporary. The Group considers various factors in determining whether it should recognize an impairment charge, including, but not limited to, the length of time and extent to which the fair value has been less than its cost basis, and the Group’s ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery in fair value. For debt securities, the Group also considers, among other factors, the issuer’s repayment ability on its debt obligations, its cash and capital generation ability and the performance of the underlying collateral.

At September 30, 2008, the Group determined that an other than temporary impairment existed on the following securities: an ALT A Hybrid ARM collateralized mortgage obligation purchased in late 2006 (the “ALT A CMO”), and certain collateralized debt obligations purchased in mid 2007 (the “CDOs”). For further details regarding the Group’s investment securities and the determination of an other-than-temporary impairment, refer to Note 2 of the unaudited consolidated financial statements.

Income Taxes

In preparing the unconsolidated financial statements, the Group is required to estimate income taxes. This involves an estimate of current income tax expense together with an assessment of temporary differences resulting from differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The determination of current income tax expense involves estimates and assumptions that require the Group to assume certain positions based on its interpretation of current tax laws and regulations. Changes in assumptions affecting estimates may be required in the future and estimated tax assets or liabilities may need to be increased or decreased accordingly. The accrual for tax contingencies is adjusted in light of changing facts and circumstances, such as the progress of tax audits, case law and emerging legislation. When particular matters arise, a number of years may elapse before such matters are audited and finally resolved. Favorable resolution of such matters could be recognized as a reduction to the Group’s effective rate in the year of resolution. Unfavorable settlement of any particular issue could increase the effective rate and may require the use of cash in the year of resolution.

The Group maintained an effective tax rate lower than the maximum marginal statutory rate of 39% for 2008 and 2007, mainly due to the interest income arising from investments exempt from Puerto Rico income taxes, net of expenses attributable to the exempt income. Exempt interest relates mostly to interest earned on obligations of the United States and Puerto Rico governments and certain mortgage-backed securities, including securities held by OIB.

The determination of deferred tax expense or benefit is based on changes in the carrying amounts of assets and liabilities that generate temporary differences. The carrying value of the Group’s net deferred tax assets assumes that the Group will be able to generate sufficient future taxable income based on estimates and assumptions. If these estimates and related assumptions change in the future, the Group may be required to record valuation allowances against its deferred tax assets resulting in additional income tax expense in the consolidated statements of operations. Management evaluates the realizability of the deferred tax assets on a regular basis and assesses the need for a valuation allowance. Changes in valuation allowance from period to period are included in the Group’s tax provision in the period of change. As of September 30, 2008, a valuation allowance

of approximately $362,000 was recorded to offset deferred tax asset that the Group believes it is more likely than not would be realized in future periods.

In addition to valuation allowances, the Group establishes accruals for certain effects of tax positions when, despite the belief that Group’s tax return positions are fully supported, the Group believes that certain positions are likely to be challenged. The tax positions accruals are adjusted in light of changing facts and circumstances, such as the progress of tax audits, case law and emerging legislation. The Group’s tax positions accruals are reflected as income tax payable as a component of accrued expenses and other liabilities.

Beginning with the adoption of Financial Accounting Standard Board (“FASB”) Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109”, on January 1, 2007, the Group recognized the effect of income tax positions only if those positions are more likely than not of being sustained. Unrecognized tax benefits are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. Prior to the adoption of FIN 48, the Group recognized the effect of income tax positions only if such positions were probable of being sustained.

On January 13, 2008, $2.4 million in unrecognized tax benefits expired due to the statute of limitations. The Group does not anticipate any other significant changes in unrecognized tax benefits during 2008. The balance of unrecognized tax benefits at September 30, 2008 was $4.0 million (December 31, 2007 — $5.7 million). The tax periods ended June 30, 2004, and 2005, and December 31, 2005, 2006 and 2007, remain subject to examination by the Puerto Rico Department of Treasury.

The Group’s policy to include interest and penalties related to unrecognized tax benefits within the provision for taxes on the unaudited consolidated statements of operations did not change as a result of implementing the provisions of FIN 48. As of the date of adoption of FIN 48, the Group had accrued $1.3 million (September 30, 2008-$1.4 million; December 31, 2007-$1.9 million) for the payment of interest and penalties relating to unrecognized tax benefits.

Equity-Based Compensation Plans

On April 25, 2007, the Board of Directors (the “Board”) adopted the Oriental Financial Group Inc. 2007 Omnibus Performance Incentive Plan (the “Omnibus Plan”), which was subsequently approved by the Group’s stockholders at their annual meeting held on June 27, 2007. The Omnibus Plan provides for equity-based compensation incentives through the grant of stock options, stock appreciation rights, restricted stock, restricted stock units and dividend equivalents, as well as equity-based performance awards.

The purpose of the Omnibus Plan is to provide flexibility to the Group to attract, retain and motivate directors, officers, and key employees through the grant of awards based on performance and to adjust its compensation practices to the best compensation practice and corporate governance trends as they develop from time to time. The Omnibus Plan is further intended to motivate high levels of individual performance coupled with increased shareholder returns. Therefore, awards under the Omnibus Plan (each, an “Award”) are intended to be based upon the recipient’s individual performance, level of responsibility and potential to make significant contributions to the Group. Generally, the Omnibus Plan will terminate as of (a) the date when no more of the Group’s shares of common stock are available for issuance under the Omnibus Plan, or, if earlier, (b) the date the Omnibus Plan is terminated by the Group’s Board.

The Board’s Compensation Committee (the “Committee”), or such other committee as the Board may designate, has full authority to interpret and administer the Omnibus Plan in order to carry out its provisions and purposes. The Committee has the authority to determine those persons eligible to receive an Award and to establish the terms and conditions of any Award. The Committee may delegate, subject to such terms or conditions or guidelines as it shall determine, to any employee or group of employees any portion of its authority and powers under the Omnibus Plan with respect to participants who are not directors or executive officers subject to the reporting requirements under Section 16(a) of the Securities Exchange Act of 1934. Only the Committee may exercise authority in respect of Awards granted to such participants.

The Omnibus Plan replaced and superseded the Oriental Financial Group Inc. 1996, 1998 and 2000 Incentive Stock Option Plans (the “Stock Option Plans”). All outstanding stock options under the Stock Option Plans continue in full force and effect, subject to their original terms and conditions.

Effective July 1, 2005, the Group adopted SFAS No. 123R “Share-Based Payment” (“SFAS 123R”), an amendment of SFAS No. 123 “Accounting for Stock-Based Compensation” using the modified prospective transition method. SFAS 123R requires measurement of the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award with the cost to be recognized over the service period. SFAS No. 123R applies to all awards unvested and granted after this effective date and awards modified, repurchased, or cancelled after that date.

The following assumptions were used in estimating the fair value of the options granted:

		Nine-Month Period Ended
		September 30,
		2008				2007
Weighted Average Assumptions:
Dividend yield			4.64	%			4.55	%
Expected volatility			33.61	%			33.35	%
Risk-free interest rate			4.48	%			4.65	%
Expected life (in years)			8.5				8.5

The expected term of share options granted represents the period of time that share options granted are expected to be outstanding. Expected volatilities are based on historical volatility of the Group’s shares over the most recent period equal to the expected term of the share option.

Recent Accounting Developments:

FASB Staff Position (FSP) No. FAS 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.”

In September 2008, the FASB issued FASB Staff Position No. FAS 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,” (FSP FAS 133-1 and FIN 45-4), that requires additional disclosures for sellers of credit derivative instruments and certain guarantees. This FSP amends FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” by requiring additional disclosures for certain guarantees and credit derivatives sold including: maximum potential amount of future payments, the related fair value, and the current status of the payment/performance risk.

The new disclosure requirements are effective for reporting periods (annual or interim) ending after November 15, 2008. While the Group already provides some of these disclosures, enhancements will be incorporated into the Group’s 2008 annual report on Form 10-K.

FSP No. 157-3 “Determining the Fair Value of a Financial Asset When the Market for that Asset Is Not Active”

In October 2008, the FASB issued FASB Staff Position No. FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active” (“FSP 157-3”). FSP 157-3 clarifies the application of FAS 157 in a market that is not active. The FSP is intended to address the following application issues: (a) how the reporting entity’s own assumptions (that is, expected cash flows and appropriately risk-adjusted discount rates) should be considered when measuring fair value when relevant observable inputs do not exist; (b) how available observable inputs in a market that is not active should be considered when measuring fair value; and (c) how the use of market quotes (for example, broker quotes or pricing services for the same or similar financial assets) should be considered when assessing the relevance of observable and unobservable inputs available to measure fair value. FSP 157-3 is effective on issuance, including prior periods for which financial statements have not been issued. The Group adopted FSP 157-3 for the quarter ended September 30, 2008 and its adoption did not have a material effect on the unaudited consolidated financial statements.

NOTE 2 — INVESTMENT SECURITIES

Money Market Investments

The Group considers as cash equivalents all money market instruments that are not pledged and that have maturities of three months or less at the date of acquisition. At September 30, 2008, and December 31, 2007, cash equivalents included as part of cash and due from banks amounted to $29.1 million and $66.1 million, respectively.

Investment Securities

The amortized cost, gross unrealized gains and losses, fair value, and weighted average yield of the investment securities at September 30, 2008, and December 31, 2007, were as follows:

		September 30, 2008 (In thousands)
						Gross				Gross								Weighted
		Amortized				Unrealized				Unrealized				Fair				Average
		Cost				Gains				Losses				Value				Yield
Available-for-sale
Obligations of US Government sponsored agencies		$	749,285			$	4,292			$	758			$	752,819				5.69	%
Puerto Rico Government and agency obligations			16,582				11				1,000				15,593				5.58	%
Structured credit investments			85,548				—				20,821				64,727				4.89	%
Total investment securities			851,415				4,303				22,579				833,139
FNMA and FHLMC certificates			1,488,476				8,246				8,188				1,488,534				5.79	%
GNMA certificates			77,292				841				155				77,978				5.81	%
Non-agency collateralized mortgage obligations (CMOs)			650,187				—				63,033				587,154				8.63	%
CMOs issued by US Government sponsored agencies			336,238				25				15,248				321,015				5.38	%
Total mortgage-backed-securities and CMOs			2,552,193				9,112				86,624				2,474,681
Total securities available-for-sale			3,403,608				13,415				109,203				3,307,820				6.25	%
Held-to-maturity
Obligations of US Government sponsored agencies			224,857				987				—				225,844				4.78	%
Puerto Rico Government and agency obligations			55,162				—				3,873				51,289				5.29	%
Structured credit investments			76,300				—				15,980				60,320				6.62	%
Total investment securities			356,319				987				19,853				337,453
FNMA and FHLMC certificates			564,918				2,559				4,219				563,258				5.05	%
GNMA certificates			148,874				579				1,534				147,919				5.37	%
CMOs issued by US Government sponsored agencies			121,560				1,933				270				123,223				5.15	%
Total mortgage-backed-securities and CMOs			835,352				5,071				6,023				834,400
Total securities held-to-maturity			1,191,671				6,058				25,876				1,171,853				5.16	%
Total		$	4,595,279			$	19,473			$	135,079			$	4,479,673				5.97	%

		December 31, 2007 (In thousands)
						Gross				Gross								Weighted
		Amortized				Unrealized				Unrealized				Fair				Average
		Cost				Gains				Losses				Value				Yield
Available-for-sale
Obligations of US Government sponsored agencies		$	1,279,977			$	14,933			$	—			$	1,294,910				5.91	%
Puerto Rico Government and agency obligations			18,331				63				937				17,457				5.69	%
Structured credit investments			85,548				—				7,188				78,360				5.46	%
Total investment securities			1,383,856				14,996				8,125				1,390,727
FNMA and FHLMC certificates			998,008				10,681				223				1,008,466				5.85	%
GNMA certificates			48,907				869				216				49,560				5.69	%
Non-agency collateralized mortgage obligations (CMOs)			632,992				42				12,505				620,529				5.49	%
Total mortgage-backed-securities and CMOs			1,679,907				11,592				12,944				1,678,555
Total securities available-for-sale			3,063,763				26,588				21,069				3,069,282				5.78	%
Held-to-maturity
Obligations of US Government sponsored agencies			418,731				902				1,980				417,653				4.92	%
Puerto Rico Government and agency obligations			55,206				—				3,781				51,425				5.29	%
Structured credit investments			96,171				—				11,949				84,222				6.69	%
Total investment securities			570,108				902				17,710				553,300
FNMA and FHLMC certificates			624,267				4,331				3,560				625,038				5.03	%
GNMA certificates			161,647				1,504				1,204				161,947				5.36	%
CMOs issued by US Government sponsored agencies			136,865				1,489				527				137,827				5.14	%
Total mortgage-backed-securities and CMOs			922,779				7,324				5,291				924,812
Total securities held-to-maturity			1,492,887				8,226				23,001				1,478,112				5.16	%
Total		$	4,556,650			$	34,814			$	44,070			$	4,547,394				5.58	%

The amortized cost and fair value of the Group’s investment securities available-for-sale and held-to-maturity at September 30, 2008, by contractual maturity, are shown in the next table. Securities not due on a single contractual maturity date, such as mortgage-backed securities and collateralized mortgage obligations, are classified in the period of final contractual maturity. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

		(In thousands)
		Available-for-sale								Held-to-maturity
		Amortized								Amortized
		Cost				Fair Value				Cost				Fair Value
Investment Securities
Due within 1 year		$	—			$	—			$	75,000			$	75,431
Due after 1 to 5 years			—				—				50,000				50,423
Due after 5 to 10 years			358,892				343,276				40,128				40,128
Due after 10 years			492,523				489,863				191,191				171,471
			851,415				833,139				356,319				337,453
Mortgage-backed securities and CMOs
Due within 1 year			27				28				—				—
Due after 1 to 5 years			584				609				—				—
Due after 5 to 10 years			—				—				94,751				92,882
Due after 10 years			2,551,582				2,474,044				740,601				741,518
			2,552,193				2,474,681				835,352				834,400
		$	3,403,608			$	3,307,820			$	1,191,671			$	1,171,853

In keeping with the Group’s investment strategy, during the nine-month periods ended September 30, 2008 and 2007, there were certain sales of available-for-sale securities because the Group felt at the time of such sales that gains could be realized while at the same time having good opportunities to invest the proceeds in other investment securities with attractive yields and terms that would allow the Group to continue to protect its net interest margin. Proceeds from the sale of investment securities available-for-sale during the nine-month periods ended September 30, 2008 and 2007, totaled $1.035 billion and $23.9 million, respectively. Realized gains on those sales during the

nine-month periods ended September 30, 2008 and 2007, were $9.9 million and $358,000, respectively. There were no realized losse on those sales during the nine-month periods ended September 30, 2008 and 2007.

The table below presents an analysis of the gross realized gains and losses by category for the nine-month periods ended September 30, 2008 and 2007:

Nine-month period ended September 30, 2008

In thousands

		Original								Sale				Sale Book
Description		Face Value				Original Cost				Proceeds				Value				Gains				Losses
Gain on sale of securities available-for-sale Investment securities
Puerto Rico Government and agency obligations		$	1,830			$	1,843			$	1,862			$	1,804			$	58			$	—
Obligations of U.S. Government sponsored agencies			709,300				708,957				718,291				709,070				9,221				—
Total investment securities			711,130				710,800				720,153				710,874				9,279				—
Mortgage-backed securities and CMOs
FNMA and FHLMC certificates			311,170				311,356				259,549				259,074				475				—
GNMA certificates			45,920				47,319				45,494				45,340				154				—
Total mortgage-backed securities and CMOs			357,090				358,675				305,043				304,414				629				—
		$	1,068,220			$	1,069,475			$	1,025,196			$	1,015,288			$	9,908			$	—