Unassociated Document

10-Q 1 v056779_10q.htm Unassociated Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10 - Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2006

Commission File Number 000-50872

EUROBANCSHARES, INC.

(Exact name of registrant as specified in its charter)

Commonwealth of Puerto Rico		66-0608955
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

270 Muñoz Rivera Avenue, San Juan, Puerto Rico 00918

(Address of principal executive offices, including zip code)

(787) 751-7340

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (i) 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 (ii) has been subject to such filing requirements for the past 90 days.

Yes x No o

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

Large accelerated filer o Accelerated filer x Non- accelerated filer 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 x

The number of shares outstanding of the issuer’s Common Stock as of November 9, 2006, was 19,123,821 shares.

EUROBANCSHARES, INC.

INDEX

	PAGE
PART I - FINANCIAL INFORMATION		1
ITEM 1. FINANCIAL STATEMENTS		1
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.		21
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		51
ITEM 4. CONTROLS AND PROCEDURES		51
PART II - OTHER INFORMATION		52
ITEM 1. LEGAL PROCEEDINGS		52
ITEM 1A. RISK FACTORS		52
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS		53
ITEM 3. DEFAULTS UPON SENIOR SECURITIES		53
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS		53
ITEM 5. OTHER INFORMATION		53
ITEM 6. EXHIBITS		54

PART I - FINANCIAL INFORMATION

ITEM 1. Financial Statements

EUROBANCSHARES, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(Unaudited)

September 30, 2006 and December 31, 2005

	September 30,			December 31,
Assets	2006			2005
Cash and due from banks	$	19,852,364		$	20,993,485
Interest bearing deposits		20,285,235			20,773,171
Securities purchased under agreements to resell		44,607,872			54,132,673
Investment securities available for sale:
Pledged securities with creditors’ right to repledge		322,505,014			399,365,589
Other securities available for sale		291,556,161			227,714,687
Investment securities held to maturity:
Pledged securities with creditors’ right to repledge		38,661,919			41,718,249
Other securities held to maturity		661,365			752,535
Other investments		11,238,850			10,652,000
Loans held for sale		1,559,099			936,281
Loans, net of allowance for loan and lease losses of $18,399,672 in 2006
and $18,188,130 in 2005		1,687,115,765			1,558,071,526
Accrued interest receivable		15,940,351			14,979,784
Customers’ liability on acceptances		1,577,148			501,195
Premises and equipment, net		14,385,460			11,167,981
Other assets		31,031,312			29,523,653
Total assets	$	2,500,977,915		$	2,391,282,809
Liabilities and Stockholders’ Equity
Deposits:
Noninterest bearing	$	128,405,877		$	146,637,966
Interest bearing		1,616,843,560			1,587,490,180
Total deposits		1,745,249,437			1,734,128,146
Securities sold under agreements to repurchase		501,100,354			419,859,750
Acceptances outstanding		1,577,148			501,195
Advances from Federal Home Loan Bank		8,720,432			8,758,626
Notes payable to Statutory Trusts		46,393,000			46,393,000
Other borrowings		—			700,175
Accrued interest payable		16,285,778			9,263,493
Accrued expenses and other liabilities		11,378,089			6,711,389
		2,330,704,238			2,226,315,774
Stockholders’ equity:
Preferred stock:
Preferred stock Series A, $0.01 par value. Authorized 20,000,000
shares; issued and outstanding 430,537 in 2006 and 2005		4,305			4,305
Capital paid in excess of par value		10,759,120			10,759,120
Common stock:
Common stock, $0.01 par value. Authorized 150,000,000
shares; issued: 19,777,536 shares in 2006 and 19,564,086 shares in
2005; outstanding: 19,123,821shares in 2006 and 19,398,848 in 2005		197,775			195,641
Capital paid in excess of par value		106,541,293			105,508,402
Retained earnings:
Reserve fund		7,477,541			6,528,519
Undivided profits		60,845,418			54,348,750
Treasury stock, 653,715 shares at cost in 2006
and 165,238 shares at cost in 2005		(7,410,711	)		(1,946,052	)
Accumulated other comprehensive loss		(8,141,064	)		(10,431,650	)
Total stockholders’ equity		170,273,677			164,967,035
Total liabilities and stockholders’ equity	$	2,500,977,915		$	2,391,282,809

See accompanying notes to condensed consolidated financial statements.

EUROBANCSHARES, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Income

(Unaudited)

For the three and nine-month periods ended September 30, 2006 and 2005

	Three Months Ended September 30,						Nine Months Ended September 30,
	2006			2005			2006		2005
Interest income:
Loans, including fees	$	33,602,070		$	27,873,828		$	95,523,851	$	78,961,729
Investment securities:
Available for sale		7,174,180			6,033,995			21,041,188		15,216,986
Held to maturity		439,515			461,395			1,345,837		1,404,723
Interest bearing deposits, securities purchased
under agreements to resell, and other		633,292			344,567			1,535,692		816,639
Total interest income		41,849,057			34,713,785			119,446,568		96,400,077
Interest expense:
Deposits		17,730,807			11,595,153			49,013,326		31,605,610
Securities sold under agreements to repurchase,
notes payable, and other		7,584,739			6,027,523			19,451,835		14,187,024
Total interest expense		25,315,546			17,622,676			68,465,161		45,792,634
Net interest income		16,533,511			17,091,109			50,981,407		50,607,443
Provision for loan and lease losses		4,849,000			3,015,000			11,629,000		6,340,000
Net interest income after provision for loan
and lease losses		11,684,511			14,076,109			39,352,407		44,267,443
Noninterest income:
Service charges – fees and other		2,155,924			2,324,679			6,228,010		6,701,742
Net loss on non-hedging derivatives		—			—			—		(943,782	)
Net loss on sale of securities		—			—			—		(230,017	)
Net (loss) gain on sale of repossessed assets and on disposition of other assets		(510,980	)		(256,306	)		200,768		(515,355	)
Gain on sale of loans		133,431			399,598			262,470		922,330
Total noninterest income		1,778,375			2,467,971			6,691,248		5,934,918
Noninterest expense:
Salaries and employee benefits		4,535,978			3,459,495			14,012,230		10,792,665
Occupancy		2,587,193			2,055,623			7,087,081		6,103,477
Professional services		966,790			924,811			3,154,810		2,787,087
Insurance		293,349			256,330			794,427		807,943
Promotional		323,538			175,342			840,593		537,901
Other		2,813,905			2,458,366			7,216,039		6,439,479
Total noninterest expense		11,520,753			9,329,967			33,105,180		27,468,552
Income before income taxes		1,942,133			7,214,113			12,938,475		22,733,809
Provision for income taxes		494,556			2,417,003			4,935,712		7,876,818
Net income	$	1,447,577		$	4,797,110		$	8,002,763	$	14,856,991

Basic earnings per share	$	0.07		$	0.24		$	0.39	$	0.73

Diluted earnings per share	$	0.06		$	0.23		$	0.38	$	0.70

See accompanying notes to condensed consolidated financial statements.

EUROBANCSHARES, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Changes in Stockholders’ Equity

(Unaudited)

For the nine-month ended September 30, 2006 and 2005

	2006			2005
Preferred stock:
Balance at beginning of period	$	4,305		$	4,305
Issuance of preferred stock		—			—
Balance at end of period		4,305			4,305
Capital paid in excess of par value – preferred stock:
Balance at beginning of period		10,759,120			10,759,120
Issuance of preferred stock		—			—
Balance at end of period		10,759,120			10,759,120
Common stock:
Balance at beginning of period		195,641			195,641
Issuance of common stock		2,134			—
Balance at end of period		197,775			195,641
Capital paid in excess of par value – common stock:
Balance at beginning of period		105,508,402			105,408,402
Issuance of common stock		877,630			—
Compensation expense – stock options		155,261			—
Reversal of initial public offering expenses		—			100,000
Balance at end of period		106,541,293			105,508,402
Reserve fund:
Balance at beginning of period		6,528,519			4,721,756
Transfer from undivided profits		949,022			1,597,585
Balance at end of period		7,477,541			6,319,341
Undivided profits:
Balance at beginning of period		54,348,750			40,369,955
Net income		8,002,763			14,856,991
Preferred stock dividends		(557,073	)		(557,073	)
Transfer to reserve fund		(949,022	)		(1,597,585	)
Balance at end of period		60,845,418			53,072,288
Treasury stock
Balance at beginning of period		(1,946,052	)		—
Purchase of common stock		(5,464,659	)		—
Balance at end of period		(7,410,711	)		—
Accumulated other comprehensive loss, net of taxes:
Balance at beginning of period		(10,431,650	)		(3,157,491	)
Unrealized net gain (loss) on investment securities available for sale		2,290,586			(4,888,104	)
Balance at end of period		(8,141,064	)		(8,045,595	)
Total stockholders’ equity	$	170,273,677		$	167,813,502

See accompanying notes to condensed consolidated financial statements.

EUROBANCSHARES, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive Income

(Unaudited)

For the three and nine months ended September 30, 2006 and 2005

	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2006		2005			2006		2005

Net income	$	1,447,577	$	4,797,110		$	8,002,763	$	14,856,991
Other comprehensive income (loss), net of tax:
Unrealized net income (loss) on investment securities available for sale		8,992,184		(5,319,589	)		2,290,586		(4,888,104	)
Comprehensive income (loss)	$	10,439,761	$	(522,479	)	$	10,293,349	$	9,968,887

See accompanying notes to condensed consolidated financial statements.

EUROBANCSHARES, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(Unaudited)

For the nine-month periods ended September 30, 2006 and 2005

	2006			2005
Cash flows from operating activities:
Net income	$	8,002,763		$	14,856,991
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		2,889,449			3,571,067
Provision for loan and lease losses		11,629,000			6,340,000
Stock-based employee compensation		155,260			—
Deferred tax (benefit) provision		(989,878	)		6,355,918
Net loss non-hedging derivatives		—			943,782
Net loss on sale of securities		—			230,017
Net gain on sale of loans		(262,470	)		(922,330	)
Net (gain) loss on sale of other real estate, repossessed assets and on disposition of other assets		(200,768	)		515,355
Net amortization of premiums and accretion of discount on investment securities		737,405			4,006,509
Increase (decrease) in deferred loan origination costs, net		1,907,848			(847,535	)
Origination of loans held for sale		(9,385,151	)		(17,548,080	)
Proceeds from sale of loans held for sale		9,647,622			17,758,473
Increase in accrued interest receivable		(960,567	)		(3,233,984	)
Net decrease (increase) in other assets		9,605,545			(1,703,259	)
Increase in accrued interest payable, accrued expenses, and other liabilities		12,140,784			2,268,635
Net cash provided by operating activities		44,916,842			32,591,559
Cash flows from investing activities:
Net decrease (increase) in securities purchased under agreements to resell		9,524,801			(1,291,201	)
Net decrease in interest-bearing deposits		487,936			301,945
Proceeds from sale of investment securities available for sale		—			39,988,612
Purchases of investment securities available for sale		(87,452,819	)		(276,713,557	)
Proceeds from principal payments and maturities of investment securities available for sale		102,142,098			97,093,210
Purchases of investments securities held to maturity		—			(4,591,400	)
Proceeds from principal payments, maturities, and calls of investment securities held to maturity		3,030,505			6,680,862
Purchases of other investments		(1,175,400	)		—
Proceeds from principal payments, maturities, and calls of other investments		586,300			—
Net increase in loans		(155,184,771	)		(184,344,951	)
Proceeds from sale of loans		—			29,962,303
Proceeds from sale of other real estate, repossessed assets and on disposition of other assets		418,337			722,458
Capital expenditures		(4,915,552	)		(1,663,455	)
Net cash used in investing activities		(132,538,565	)		(293,855,174	)
Cash flows from financing activities:
Net increase in deposits		11,121,291			172,788,952
Increase in securities sold under agreements to repurchase and other borrowings		80,540,429			93,119,844
Repayment of Federal Home Loan Bank Advances		(38,194	)		(32,557	)
Dividends paid to preferred stockholders		(558,030	)		(573,167	)
Purchase of common stock		(5,464,659	)		—
Net proceeds from exercise of stock options		879,765			—
Net cash provided by financing activities		86,480,602			265,303,072
Net (decrease) increase in cash and cash equivalents		(1,141,121	)		4,039,457
Cash and cash equivalents beginning balance		20,993,485			18,597,116
Cash and cash equivalents ending balance	$	19,852,364		$	22,636,573

Supplemental disclosure of cash flow information:
Cash paid during the year:
Interest	$	61,442,876		$	42,819,696
Income taxes		3,842,541			1,021,756

Noncash transactions:
Other real estate and repossessed assets acquired through foreclosure of loans		35,889,424			22,376,971
Finance of other real estate and repossessed assets acquired through foreclosure of loans		21,308,558			14,158,755
Change in fair value of available-for-sale securities, net of taxes		(2,290,586	)		5,463,504

See accompanying notes to condensed consolidated financial statements.

EUROBANCSHARES, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

1.	Nature of Operations and Basis of Presentation

EuroBancshares, Inc. (the Company or EuroBancshares) was incorporated on November 21, 2001, under the laws of the Commonwealth of Puerto Rico to engage, for profit, in any lawful acts or businesses and serve as the holding company for Eurobank (the Bank). As a financial holding company, the Company is subject to the provisions of the Bank Holding Company Act, and to the supervision and regulation by the board of governors of the Federal Reserve System.

The unaudited condensed consolidated financial statements include the accounts of the Company and its subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation. These statements are, in the opinion of management, a fair presentation of the financial position and results for the periods presented. These financial statements are unaudited but, in the opinion of management, include all necessary adjustments, all of which are of a normal recurring nature, for a fair presentation of such financial statements.

The presentation of the condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amount of revenue and expenses during the reporting periods. These estimates are based on information available as of the date of the condensed consolidated financial statements. Therefore, actual results could differ from those estimates.

Certain information and note disclosures normally included in the financial statements prepared in accordance with generally accepted accounting principles in the United States of America have been condensed or omitted from these statements pursuant to rules and regulations of the Securities and Exchange Commission (SEC) and, accordingly, these financial statements should be read in conjunction with the audited consolidated financial statements of the Company for the year ended December 31, 2005. The results of operations for the nine months period ended September 30, 2006 are not necessarily indicative of the results to be expected for the full year.

2.	Recent Accounting Pronouncements

In September 2006 the Financial Accounting Standards Board (FASB) issued SFAS 157, Fair Value Measurements. This statement provides the generally accepted accounting principles (GAAP) definition for fair value, the framework for measurements and additional disclosures. The main focus of SFAS 157 is to correct the inconsistency in the definition of fair value and to provide guidance for applying the GAAP definition. This statement applies under other accounting pronouncements that require fair value measurements; however this statement does not require any new fair value measurements. The definition provided in this statement clarifies that the price to be used is the price that would be received by selling the asset or paid to transfer liability instead of the price to acquire the asset or received to assume the liability. This statement applies prospectively and is effective for financials statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company believes that the impact would not be material to the financial statements.

In September 2006, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 108 ("SAB 108"). This bulleting address the methodologies used by registrants to consider the effects of prior year’s misstatements when quantifying misstatements in the current year financial statements. SAB 108 compares the diversity in practice among registrants and expresses SEC staff views regarding the process by which misstatements in financial statements are evaluated for purposes of determining whether financial statement restatement is necessary. SAB108 is effective for fiscal years ending after November 15, 2006, and early application is encouraged. The Company is reviewing the provisions of this recently-issued bulletin to determine the impact on the financial statements, if any.

The Financial Accounting Standard Board Interpretation (FIN) No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109” was issued on June 2006. This Interpretation provides the guides for the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109 (FAS 109), Accounting for Income Taxes. This Interpretation correct the deficiency of FAS 109 to prescribe a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 addresses the diversity that exists in the practice by defining a criterion that an individual tax position must meet for any part of the benefit of that position to be recognized in an enterprise’s financial statements. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. This interpretation is effective for fiscal years beginning after December 15, 2006. The Company believes that the impact would not be material to the financial statements.

(Continued)

EUROBANCSHARES, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

In April 2006 the Financial Accounting Standards Board (FASB) has published Final FASB Staff Position (FSP) No. 46(R)-6, Determining the Variability to Be Considered in Applying FASB Interpretation No. 46(R), to stipulate that when applying FASB Interpretation (FIN) No. 46(R), Consolidation of Variable Interest Entities, to an entity, an analysis of the entity's design should determine the variability to be considered. The requirements in this FSP distinguish between contracts or arrangements that create variability in an entity and those that are exposed to or reduce that variability. Specifically, a reporting enterprise should determine the entity's variability by analyzing the nature of the risks in the entity, determining the purposes for which the entity was created, and determining the variability created by the risks in the entity, which the entity is designed to create and pass along to its interest holders. Once the variability to be considered is determined, the reporting enterprise can measure the amount of variability, as well as determine which interests are designed to absorb that variability. FSP No. FIN 46(R)-6 applies prospectively to all entities with which an enterprise first becomes involved, and to all entities previously required to be analyzed under FIN No. 46(R), beginning the first day of the first reporting period beginning after June 15, 2006. The Company believes that the impact would not be material to the financial statements.

The Statement of Financial Accounting Standards (SFAS) No. 156, Accounting for Servicing of Financial Assets was issued on March 2006. This Statement amends SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, with respect to the accounting for separately recognized servicing assets and servicing liabilities. This Statement requires that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. Under this Statement, an entity can elect subsequent amortization method or fair value measurement of its servicing assets and servicing liabilities by class, thus simplifying its accounting and providing for income statement recognition of the potential offsetting changes in fair value of the servicing assets, servicing liabilities, and related derivative instruments. An entity that elects to subsequently measure servicing assets and servicing liabilities at fair value is expected to recognize declines in fair value of the servicing assets and servicing liabilities more consistently than by reporting other-than-temporary impairments. SFAS No. 156 allows the recognition for servicing rights with an accounting method similar to fair-value hedge accounting, but without the effort and system cost needed to identify effective hedging instruments and document hedging relationships. This Statement becomes effective as of the beginning of the fiscal year that begins after September 15, 2006. The Company believes that the impact would not be material to the financial statements.

In February 2006 the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments. This Statement amends FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities. Also amends SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities by the elimination of the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. This Statement eliminates the exemption from applying SFAS No. 133 to interests in securitized financial assets so that similar instruments are accounted for similarly regardless of the form of the instruments. This Statement also allows electing fair value measurement at acquisition, at issuance, or when a previously recognized financial instrument is subject to a re-measurement (new basis) event, on an instrument-by-instrument basis, in cases in which a derivative would otherwise have to be bifurcated. SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Company believes that the impact would not be material to the financial statements.

3. Earnings Per Share

Basic earnings per share represent income available to common stockholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options and are determined using the treasury stock method.

(Continued)

EUROBANCSHARES, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The computation of earnings per share is presented below:

	Three months ended September 30,						Nine months ended September 30,
	2006			2005			2006			2005
Income before preferred stock dividends	$	1,447,577		$	4,797,110		$	8,002,763		$	14,856,991
Preferred stock dividend		(187,732	)		(187,732	)		(557,073	)		(557,073	)
Income available to common shareholders	$	1,259,845		$	4,609,378		$	7,445,690		$	14,299,918
Weighted average number of common shares
outstanding applicable to basic EPS		19,118,191			19,564,086			19,248,639			19,564,086
Effect of dilutive securities		349,487			739,395			473,115			756,534
Adjusted weighted average number of common
shares outstanding applicable to diluted earnings
per share		19,467,678			20,303,481			19,721,754			20,320,620
Net income per share:
Basic	$	0.07		$	0.24		$	0.39		$	0.73
Diluted	$	0.06		$	0.23		$	0.38		$	0.70

Options to purchase 96,200 shares of common stock at $14.17 per share and 113,500 shares of common stock at $21.00 were outstanding during 2006, but were not included in the computation of diluted earning per share because the options’ exercise prices were greater than the average market price of the common shares. The options, which expire on February 29, 2016 and February 27, 2010, respectively, were outstanding at the end of the third quarter of 2006.

During the third quarter of 2005 options to purchase 125,000 shares of common stock at $21.00 were outstanding but were not included in the computation of diluted earning per share because the options’ exercise price was greater than the average market price of the common shares. The options, which expire on February 27, 2010, were outstanding at the end of the third quarter of 2005.

(Continued)

EUROBANCSHARES, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

4. Investment Securities Available for Sale

Investment securities available for sale and related contractual maturities as of September 30, 2006 and December 31, 2005 are as follows:

	2006
	Amortized		Gross unrealized		Gross unrealized			Fair
	cost		gains		losses			value
Commonwealth of Puerto
Rico obligations:
Less than one year	$	3,070,916	$	—	$	(44,816	)	$	3,026,100
One through five years		1,656,021		2,133		(5,002	)		1,653,152
Five through ten years		5,200,899		91,054		—			5,291,953
Federal Farm Credit Bonds
Less than one year		30,315,847		—		(290,286	)		30,025,561
One through five years		19,994,039		—		(235,779	)		19,758,260
Federal Home Loan Bank notes:
Less than one year		51,881,850		—		(693,834	)		51,188,016
One through five years		102,039,890		—		(1,829,051	)		100,210,839
Five to ten years		8,162,951		12,900		—			8,175,851
Federal National Mortgage
Association notes:
One through five years		12,473,202		9,766		(55,506	)		12,427,462
Five through ten years		10,000,000		101,500		—			10,101,500
Mortgage-backed securities		377,404,022		658,069		(5,859,610	)		372,202,481
Total	$	622,199,637	$	875,422	$	(9,013,884	)	$	614,061,175

	2005
	Amortized		Gross unrealized		Gross unrealized			Fair
	cost		gains		losses			value
Commonwealth of Puerto
Rico obligations:
Less than one year	$	3,115,000	$	–	$	(15,238	)	$	3,099,762
One through five years		3,131,244		2,786		(63,239	)		3,070,791
Five to ten years		631,112		5,912		(340	)		636,684
More than ten years		1,025,000		5,742		(16,957	)		1,013,785
Federal Farm Credit Bonds:
One through five years		50,299,967		–		(614,219	)		49,685,748
Federal Home Loan Bank notes:
Less than one year		22,141,963		–		(247,259	)		21,894,704
One through five years		147,974,882		–		(2,866,421	)		145,108,461
Federal National Mortgage
Association notes:
Less than one year		4,999,830		–		(3,590	)		4,996,240
One through five years		2,474,558		–		(60,980	)		2,413,578
Federal Home Loan Mortgage
Corporation notes:
Less than one year		3,001,070		–		(18,344	)		2,982,726
Mortgage-backed securities		398,713,782		391,108		(6,927,093	)		392,177,797
Total	$	637,508,408	$	405,548	$	(10,833,680	)	$	627,080,276

Contractual maturities on certain investment securities available for sale could differ from actual maturities since certain issuers have the right to call or prepay these securities.

(Continued)

EUROBANCSHARES, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

At September 30, 2006 and December 31, 2005, no investments that are payable from and secured by the same source of revenue or taxing authority, other than the U.S. government and U.S. agencies exceed 10% of stockholders’ equity.

During the nine-months period ended September 30, 2006 there were no sales of investments securities available for sale. During the year ended December 31, 2005 proceeds from the sale of investment securities available for sale were approximately $84,976,000, resulting in net losses of approximately $301,000.

Gross unrealized losses on investment securities available for sale and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2006, were as follows:

	Less than 12 months					12 months or more					Total
	Unrealized			Fair		Unrealized			Fair		Unrealized			Fair
	losses			value		losses			value		losses			value
U.S. agency debt securities	$	(96,440	)	$	9,903,560	$	(3,008,016	)	$	193,705,178	$	(3,104,456	)	$	203,608,738
State and municipal obligations		(3,909	)		777,112		(45,909	)		3,450,007		(49,818	)		4,227,119
Mortgage-backed securities		(265,411	)		44,706,246		(5,594,199	)		254,696,467		(5,859,610	)		299,402,713
	$	(365,760	)	$	55,386,918	$	(8,648,124	)	$	451,851,652	$	(9,013,884	)	$	507,238,570

U.S. Agency Debt Securities - The unrealized losses on investments in U.S. agency debt securities were caused by interest rate increases. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investment. Because the Company has the ability and intent to hold these investments until a market price recovery or maturity, these investments are not considered other-than-temporarily impaired.

Mortgage-Backed Securities - The unrealized losses on investments in mortgage-backed securities were caused by interest rate increases. The contractual cash flows of these securities are guaranteed by a United States government sponsored enterprise. It is expected that the securities would not be settled at a price less than the amortized cost of the investment. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Company has the ability and intent to hold these investments until a market price recovery or maturity, these investments are not considered other-than-temporarily impaired.

5. Investment Securities Held to Maturity

Investment securities held to maturity as of September 30, 2006 and December 31, 2005 are as follows:

	2006
	Amortized		Gross unrealized		Gross unrealized			Fair
	cost		gains		losses			value

Federal Home Loan Bank Notes	$	3,306,828	$	—	$	(90,749	)	$	3,216,079
Mortgage-backed securities		36,016,456		—		(899,666	)		35,116,790
Total	$	39,323,284	$	—	$	(990,415	)	$	38,332,869

	2005
	Amortized		Gross unrealized		Gross unrealized			Fair
	cost		gains		losses			value
Federal Home Loan Bank Notes	$	3,762,677	$	–	$	(99,441	)	$	3,663,236
Mortgage-backed securities		38,708,107		–		(959,804	)		37,748,303
Total	$	42,470,784	$	–	$	(1,059,245	)	$	41,411,539

Contractual maturities on certain investment securities held to maturity could differ from actual maturities since certain issuers have right to call or prepay these securities.

(Continued)

EUROBANCSHARES, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

There were no sales of investment securities held to maturity during the nine-month period ended September 30, 2006 and during the year ended December 31, 2005.

All gross unrealized losses on investment securities held to maturity and the fair value of the related securities have been in a continuous unrealized loss position as of September 30, 2006, for a period of twelve months or more.

6. Other Investments

Other investments at September 30, 2006 and December 31, 2005 consist of the following:

	2006		2005
FHLB stock, at cost	$	9,858,600	$	9,269,500
Investment in statutory trusts		1,380,250		1,382,500
Other investments	$	11,238,850	$	10,652,000

(Continued)

EUROBANCSHARES, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

7. Loans and allowance for loan and lease losses

A summary of the Company’s loan portfolio at September 30, 2006 and December 31, 2005 is as follows:

	2006			2005
Commercial and industrial secured by real estate	$	708,657,950		$	612,375,601
Other commercial and industrial		288,498,791			272,005,403
Construction secured by real estate		104,537,645			82,468,171
Other construction		956,197			200,000
Mortgage		69,884,493			44,841,330
Consumer secured by real estate		799,546			905,774
Other consumer		61,902,912			63,979,725
Lease financing contracts		458,683,351			487,863,247
Overdrafts		7,334,589			5,336,117
		1,701,255,474			1,569,975,368
Deferred loan costs, net		5,533,676			7,441,524
Unearned finance charges		(1,273,713	)		(1,157,236	)
Allowance for loan and lease losses		(18,399,672	)		(18,188,130	)
Loans, net	$	1,687,115,765		$	1,558,071,526

The following is a summary of information pertaining to impaired loans at September 30, 2006 and December 31, 2005:

	2006		2005
Impaired loans with related allowance	$	11,131,000	$	7,071,000
Impaired loans that did not require allowance		17,314,000		12,493,000
Total impaired loans	$	28,445,000	$	19,564,000
Allowance for impaired loans	$	2,208,000	$	590,000

No additional funds are committed to be advanced in connection with impaired loans.

Loans that the accrual of interest has been discontinued amounted to $33,927,122 at September 30, 2006 and $27,702,796 at December 31, 2005, which contains individually classified impaired loans that are included on the table above. If these loans had been accruing interest, the additional interest income realized would have been approximately $2,629,000 and $1,630,000 for the nine months period ended September 30, 2006, and 2005, respectively.

Commercial and industrial loans with principal outstanding balance amounting to approximately $2,076,000 as of September 30, 2006, are guaranteed by the U.S. government through the Small Business Administration at percentages varying from 75% to 90%. As of September 30, 2006, industrial loans with a principal outstanding balance of approximately $1,403,000 were guaranteed by the U.S. government through the U.S. Department of Agriculture at percentages varying from 80% to 90%.

(Continued)

The following analysis summarizes the changes in the allowance for loan and lease losses for the nine months periods ended September 30:

	2006			2005
Balance, beginning of period	$	18,188,130		$	19,038,836
Provision for loan and lease losses		11,629,000			6,340,000
Loans and leases charged-off		(13,573,162	)		(12,385,602	)
Recoveries		2,155,704			2,272,383
Balance, end of period	$	18,399,672		$	15,265,617

8. Other Assets

Other assets at September 30, 2006 and December 31, 2005 consist of the following:

	2006		2005
Deferred tax assets, net	$	5,685,142	$	5,070,074
Merchant credit card items in process of collection		1,069,314		2,716,699
Auto insurance claims receivable on repossessed vehicles		1,354,129		1,074,175
Accounts receivable		1,351,280		1,361,958
Other real estate, net		3,762,895		1,542,369
Other repossessed assets, net of valuation allowance of
$1,250,805 and $1,216,087 at September 30, 2006 and
December 31, 2005, respectively		9,988,750		7,974,665
Servicing assets, net		1,075,868		2,414,348
Prepaid expenses, deposits and other assets		6,743,934		7,369,365
	$	31,031,312	$	29,523,653

Other repossessed assets are presented net of valuation allowance for losses. The following analysis summarizes the changes in the allowance for losses for the nine-month periods ended September 30:

	2006			2005
Balance, beginning of period	$	1,216,087		$	1,493,305
Provision for losses changed to operations		1,047,400			466,000
Net charge-offs		(1,012,682	)		(592,679	)
Balance, end of period	$	1,250,805		$	1,366,626

(Continued)

EUROBANCSHARES, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

9. Deposits

Total deposits as of September 30, 2006 and December 31, 2005 consisted of the following:

	2006		2005
Non interest bearing deposits	$	128,405,877	$	146,637,966

Interest bearing deposits:
NOW & Money Market		70,124,101		70,961,689
Savings		165,532,066		223,664,685
Brokered Deposits		1,066,827,571		967,206,187
Regular CD's & IRAS		104,122,896		121,950,012
Jumbo CD's		210,236,926		203,707,607
		1,616,843,560		1,587,490,180
Total Deposits	$	1,745,249,437	$	1,734,128,146

10. Advances from Federal Home Loan Bank

At September 30, 2006, the Company owes several advances to the FHLB as follows:

Maturity	Interest rate			2006
2006		5.40	%		7,000,000
2007		5.20	%		1,200,000
2014		4.38	%		520,432
				$	8,720,432

Interest rates are fixed for the term of each advance and are payable on the first business day of the following month when the original maturity of the note exceeds twelve months. In notes with original terms of twelve months or less, interest is paid at maturity. Interest payments for the nine-month periods ended September 30, 2006 and 2005 amounted to approximately $863,000 and $378,000, respectively. These notes are secured by approximately $17,395,000 in securities and $30,000,000 in mortgage loans as of September 30, 2006. The collateral secures the outstanding $8,720,432 advances and provides additional capacity for borrowing needs.

11. Derivative Financial Instruments

Interest-rate swaps involve the exchange of fixed and floating interest-rate payments without an exchange of the underlying principal. Net interest settlements of interest-rate swaps are recorded as an adjustment to interest income or interest expense of the hedged item. The Company’s principal objective in holding interest-rate swap agreements is the management of interest-rate risk and related changes in the fair value or cash flows of assets and liabilities. The Company’s policy is that each swap contract be specifically tied to assets or liabilities with the objective of transforming the interest rate characteristics of the instrument.

(Continued)

EUROBANCSHARES, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

As of September 30, 2006, the Company had the following derivative financial instruments outstanding:

	Notional
	amount		Fair value			Net gain (loss)
Libor-Rate interest rate swaps	$	30,800,000	$	(1,380,195	)	$	(2,981	)(1)

(1) Net gain recognized from fair value hedging ineffectiveness during the nine-month period

At September 30, 2006, the Bank had interest rate swap agreements, designated as fair value hedge, which converted $29.1 million of fixed rate time deposit to variable rate time deposits of which $10.4 million will mature between 2010 and 2013 and $18.7 million with maturity between 2018 and 2023 but with semi-annual call options which match call options on the swaps.

12. Notes Payable to Statutory Trusts

On December 18, 2001, Eurobank Statutory Trust I (Trust) issued $25,000,000 of floating rate Trust Preferred Capital Securities Series 1 due in 2031 with a liquidation amount of $1,000 per security, with option to redeem in five years. Distributions payable on each capital security is payable at an annual rate equal to 5.60% beginning on (and including) the date of original issuance and ending on (but excluding) March 18, 2002, and at an annual rate for each successive period equal to the three-month LIBOR, plus 3.60% with a ceiling rate of 12.50%. The capital securities of the Trust are fully and unconditionally guaranteed by EuroBancshares. EuroBancshares then issued $25,774,000 of floating rate junior subordinated deferrable interest debentures to the Trust due in 2031. The terms of the debentures, which comprise substantially all of the assets of the Trust, are the same as the terms of the capital securities issued by the Trust. These debentures are fully and unconditionally guaranteed by the Bank. The Bank subsequently issued an unsecured promissory note to EuroBancshares for the issued amount and at an annual rate equal to that being paid on the Trust Preferred Capital Securities Series 1 due in 2031.

On December 19, 2002, Eurobank Statutory Trust II (Trust II) issued $20,000,000 of floating rate Trust Preferred Capital Securities due in 2032 with a liquidation amount of $1,000 per security, with option to redeem in five years. Distributions payable on each capital security will be payable at an annual rate equal to 4.66% beginning on (and including) the date of original issuance and ending on (but excluding) March 26, 2003, and at an annual rate for each successive period equal to the three-month LIBOR plus 3.25% with a ceiling rate of 11.75%. The capital securities of the Trust II are fully and unconditionally guaranteed by EuroBancshares. The Company then issued $20,619,000 of floating rate junior subordinated deferrable interest debentures to the Trust II due in 2032. The terms of the debentures, which comprise substantially all of the assets of the Trust II, are the same as the terms of the capital securities issued by the Trust II. These debentures are fully and unconditionally guaranteed by the Bank. The Bank subsequently issued an unsecured promissory note to EuroBancshares for the issued amount and at an annual rate equal to that being paid on the Trust Preferred Capital Securities due in 2032.

Prior to FASB Interpretation (FIN) No. 46R, the statutory trusts described above, were considered subsidiaries of the Company. As a result of the adoption of FIN No. 46R, the Company deconsolidated these statutory trusts effective December 31, 2003. The junior subordinated debentures issued by the Company to the statutory trusts, totaling $46,393,000 are reflected in the Company’s consolidated balance sheets under the caption of “notes payable to statutory trusts”. The Company records interest expense on the notes payable to statutory trusts in the consolidated statements of income and included in the caption of other investments in the consolidated balance sheets, the common securities issued by the statutory trusts.

Interest expense on notes payable to statutory trusts amounted to approximately $2,968,000 and $2,290,000 for the nine months period ended September 30, 2006 and 2005, respectively.

(Continued)

EUROBANCSHARES, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The Federal Reserve Board indicated in supervisory letter SR 03-13 (the Supervisory Letter), dated July 2, 2003, that trust preferred securities will be treated as Tier 1 capital until notice is given of the contrary. The Supervisory Letter also indicates that the Federal Reserve will review the regulatory implications of any accounting treatment changes and will provide further guidance if necessary or warranted.

On March 1, 2005 the Federal Reserve Board adopted the final rule that allows the continued limited inclusion of trust-preferred securities in the tier 1 capital of bank holding companies (BHCs). Under the final rule, trust preferred securities and other restricted core capital elements would be subject to stricter quantitative limits. The Federal Reserve Board’s final rule limits restricted core capital elements to 25% of all core capital elements, net of goodwill less any associated deferred tax liability. Internationally active BHCs, defined as those with consolidated assets greater than $250 billion or on-balance-sheet foreign exposure greater than $10 billion, will be subject to a 15% limit. But they may include qualifying mandatory convertible preferred securities up to the generally applicable 25% limit. Amounts of restricted core capital elements in excess of these limits generally may be included in Tier 2 capital. The final rule provides a five-year transition period, ending March 31, 2009, for application of the quantitative limits. The Company believes that impact would not be material to the financial statements.

13. Commitments and Contingencies

The Company is involved as plaintiff or defendant in a variety of routine litigation incidental to the normal course of business. Management believe, based on the opinion of legal counsel, that it has adequate defense or insurance protection with respect to such litigations and that any losses there from, whether or not insured, would not have a material adverse effect on the results of operations or financial position of the Company.

14. Sale of Receivable and Servicing Assets

During the nine month period ended September 30, 2006 the Company sold to third parties approximately $9.6 millions of mortgage loans. The Company surrendered control of the mortgage loans receivables, including servicing rights, as defined by SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities, and accounted for these transactions as a sale. No sales of receivables were completed on any other portfolio during 2006; accordingly, no new servicing assets were recorded. In the first and third quarter of the year 2005, the Company sold to a third party lease financing contracts with carrying values of approximately $14.9 million and $15.0 million, respectively. In these sales, the Company retained servicing responsibilities and servicing assets of $626,285 and $672,565 were recognized, respectively. The Company surrendered control of the lease financing receivables, as defined by SFAS No. 140, and accounted for these transactions as sales and recognized net gains of approximately $365,000 and $348,000, respectively. Under the terms of the transactions, the Company has limited recourse obligations to repurchase defaulted leases up to 5% of the outstanding aggregate principal balance of all leases sold at repossession date for the first quarter sale and of all leases sold as of the cut-off date for the third quarter sale. As of September 30, 2006 and December 31, 2005, total amount accrued on books related to recourse liability amounted to approximately $381,000 and $547,000, respectively.

15. Stock Transactions

As of September 30, 2006 the Company had purchased 652,027 shares under the stock repurchase program approved by the board of directors on October 2005, and on November 2005 recorded 1,688 shares as treasury stock as a result of a payment in lieu of foreclosure from a former borrower. There were no additional purchases of shares as of November 9, 2006. Under the terms of the stock repurchase program, the Company is authorized to acquire shares of its common stock for an aggregate purchase price of up to $10 million in open market purchases, block trades and privately negotiated transactions over a period of one year.

(Continued)

EUROBANCSHARES, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The Company issued 213,450 of common stock shares during the nine-month period ended September 30, 2006, through stock options exercised as follows:

Number of shares	Exercise price		Grant date		Exercise date

150,000	$	3.33		February 28, 2001		February 27, 2006
16,450		4.50		February 26, 2002		June 30, 2006
20,000		5.00		March 15, 2003		June 30, 2006
20,000		8.13		February 23, 2004		June 30, 2006
4,000		5.00		March 15, 2003		September 13, 2006
3,000		8.13		February 23, 2004		September 13, 2006
213,450

During 2005, the Company had repurchased a total of 163,550 shares under the approved program, and on November 2005 recorded 1,688 shares as treasury stock as a result of a payment in lieu of foreclosure from a former borrower.

16. Stock Option Plan

The stockholders of EuroBancshares approved the 2005 Stock Option Plan at the annual meeting held at the main office of the Company on May 12, 2005. The 2005 Stock Option Plan has reserved 700,000 shares of our common stock for issuance pursuant to the stock options. Once the 2005 Stock Options Plan was approved, no further options were available to acquire shares under the 2002 Stock Option Plan. The outstanding options as of September 30, 2006 include options granted under the 2002 and 2005 Stock Option Plan and a stock option plan held by the Bank until the reorganization.

All officers and directors of EuroBancshares are eligible under the Plan, provided, however, that stock options shall not be exercisable by an optionee who is the owner of 5% or more of the issued and outstanding shares of the Company or in exercising the stock options would become the owner of 5% or more of the issued and outstanding shares of the Company, unless the optionee obtains the approvals required from the appropriate regulatory agencies to hold shares in excess of such percent. Any eligible person may hold more than one option at a time.

The compensation committee, appointed by the board of directors, has absolute discretion to select which of the eligible persons will be granted stock options, the number of shares of the Company’s common stock subject to such options, whether stock appreciation rights will be granted for such options, and generally, to determine the terms and conditions of such options in accordance to the provisions of the Plan.

On March 1, 2006, the Company granted to its Directors and Executive Officers, a total of 98,700 options, under the established 2005 stock option plan. Of these options, 16,000 stock options were granted to Directors and were vested immediately. The remaining 82,700 stock options were granted to employees vesting in five equal annual installments beginning on March 1, 2007. These options have an exercise price of $14.17 and are exercisable within ten years after the grant date at the discretion of the optionee.

All options granted prior to December 31, 2005, were fully vested at grant date and are exercisable within five years after the grant date at the discretion of the optionee.

(Continued)

EUROBANCSHARES, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

A summary of the status of stock options under the Plans and changes during the nine-month periods ended September 30, 2006 and 2005 are as follows:

	2006					2005
				Weighted average				Weighted average
	Shares			exercise price		Shares		exercise price
Options outstanding January 1		1,216,312		$	6.84		1,091,312	$	5.22
Granted		98,700			14.17		125,000		21.00
Exercised		(213,450	)		4.12		—		—
Forfeited		(17,000	)		17.72		—		—
Options outstanding		1,084,562		$	7.89		1,216,312	$	6.84

The weighted-average grant date fair value of share options granted during the nine-month periods ended September 30, 2006 and 2005 was $5.65 and $7.23, respectively. Cash received from share option exercised during the nine-month period ended September 30, 2006 amounted to $879,765, none in 2005. There were forfeitures of 17,000 of the outstanding options with a weighted average price of $17.72 per option during the nine-month period ended September 30, 2006 related to the termination of employees. There were no forfeitures of outstanding options during the nine-month period ended September 30, 2005.

The following is a summary of outstanding and exercisable options under the Plans at September 30, 2006:

Range of exercise price per share	Outstanding options		Weighted-average exercise price of outstanding options		Weighted-average remaining term (years) of outstanding options		Exercisable options		Weighted-average exercise price of exercisable options		Weighted-average remaining term (years) of exercisable options
$4.50-$8.13		874,862	$	5.48		1.34		874,862	$	5.48		1.34
14.17-21.00		209,700		17.87		6.17		127,500		20.25		4.07
$4.50-$21.00		1,084,562	$	7.87		2.28		1,002,362	$	7.36		1.69

As of September 30, 2006, the Company had 82,200 non-vested options with a weighted average grant date fair value of $5.65. There were no non-vested outstanding options at September 30, 2005.

The fair value of the options granted was estimated on the date of the grants using the Black-Sholes Option Pricing Model. 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 Company’s shares and the average volatility of similar and comparable entities due to the short period of public history of the Company’s shares in comparison with the expected term of share options. Also, expected volatilities consider other factors, such as expected changes in volatility arising from planned changes in the Company’s operations. The assumptions used for the grants issued were:

	2006			2005
Expected life of options (in years)		6.50			5.00
Expected volatility		39.28	%		40.09	%
Expected dividends		0.00	%		0.00	%
Risk-free rate		4.60	%		4.00	%

As of September 30, 2006, the Company recorded a compensation expense of $155,260 for the vested portion of the options granted on March 1, 2006. The options granted during 2005 approximated the fair value of the Company’s common stock at the date of issuance; accordingly no compensation expense has been recorded.

(Continued)

EUROBANCSHARES, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

At September 30, 2006 there was approximately $403,000 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Plan. That cost is expected to be recognized over a weighted average period of 4.42 years.

During 2006 the Company adopted the provisions of SFAS 123R. Previously it followed the intrinsic value method. The following table illustrates the effects of this change for the period ended September 30, 2006:

	As reported (SFAS 123R)		Previous method (intrinsic value)
Income before taxes	$	12,938,475	$	13,093,735
Net income		8,002,763		8,158,023
Earnings per share, basic		0.39		0.40
Earnings per share, diluted		0.38		0.39
Cash flows from operating activities		44,916,842		44,916,842
Cash flows from financing activities		86,480,602		86,480,602

The following table illustrates the effect on net income if the fair value based method had been applied to all outstanding stock-based compensation for the nine-month period ended September 30, 2005:

	2005
Net income, as reported	$	14,856,991
Deduct total stock-based employee compensation expense,
determined under fair value based method for all awards		904,368
Pro forma net income	$	13,952,623
Earnings per share:
Basic – as reported	$	0.73
Basic – pro forma		0.69
Diluted – as reported		0.70
Diluted – pro forma		0.66

17.

Regulatory Matters

The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. If capital ratios fall below the levels necessary to be considered “well-capitalized” under current regulatory guidelines, the Company could be restricted in using brokered deposits as a short-term funding source. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.

Quantitative measures established by regulations to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier I Capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I Capital (as defined) to average assets (Leverage) (as defined). Management believes, as of September 30, 2006 and December 31, 2005, that the Company and the Bank met all capital adequacy requirements to which they are subject.

(Continued)

EUROBANCSHARES, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier I risk-based and Tier I Leverage ratios as set forth in the following tables. There are no conditions or events since the notification that management believes have changed the institution’s capital category. The Company’s and the Bank’s actual capital amounts and ratios as of September 30, 2006 are also presented in the table.

At September 30, 2006 and December 31, 2005, required and actual regulatory capital amounts and ratios are as follow (dollars in thousands):

	2006
											Well
	Required					Actual					capitalized
	Amount		Ratio			Amount		Ratio			ratio
Total Capital (to risk-weighted
assets):
Consolidated	$	151,943		8.00	%	$	242,049		12.74	%		N/A
Eurobank		152,030		8.00	%		198,395		10.44	%		>10.00	%
Tier I Capital (to risk-weighted
assets):
Consolidated		75,971		4.00	%		223,307		11.76	%		N/A
Eurobank		76,015		4.00	%		159,653		8.40	%		>6.00	%
Tier I Capital (to average assets):
Consolidated		99,056		4.00	%		223,307		9.02	%		N/A
Eurobank		99,013		4.00	%		159,653		6.45	%		>5.00	%

	2005
											Well
	Required					Actual					capitalized
	amount		Ratio			amount		Ratio			ratio
Total Capital (to risk-weighted
assets):
Consolidated	$	141,479		8.00	%	$	238,570		13.49	%		N/A
Eurobank		141,836		8.00	%		190,070		10.72	%		>10.00	%
Tier I Capital (to risk-weighted
assets):
Consolidated		70,740		4.00	%		220,157		12.45	%		N/A
Eurobank		70,918		4.00	%		151,657		8.55	%		>6.00	%
Tier I Capital (to average assets):
Consolidated		94,199		4.00	%		220,157		9.35	%		N/A
Eurobank		94,172		4.00	%		151,657		6.44	%		>5.00	%

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis presents our consolidated financial condition and results of operations for the nine months ended September 30, 2006 and 2005. The discussion should be read in conjunction with our financial statements and the notes related thereto which appear elsewhere in this Quarterly Report on Form 10-Q.

Statements contained in this report that are not purely historical are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, including our expectations, intentions, beliefs, or strategies regarding the future. Any statements in this document about expectations, beliefs, plans, objectives, assumptions or future events or performance are not historical facts and are forward-looking statements. These statements are often, but not always, made through the use of words or phrases such as “may,” “should,” “could,” “predict,” “potential,” “believe,” “will likely result,” “expect,” “will continue,” “anticipate,” “seek,” “estimate,” “intend,” “plan,” “projection,” “would” and “outlook,” and similar expressions. Accordingly, these statements involve estimates, assumptions and uncertainties, which could cause actual results to differ materially from those expressed in them. Any forward-looking statements are qualified in their entirety by reference to the factors discussed throughout this document. All forward-looking statements concerning economic conditions, rates of growth, rates of income or values as may be included in this document are based on information available to us on the dates noted, and we assume no obligation to update any such forward-looking statements. It is important to note that our actual results may differ materially from those in such forward-looking statements due to fluctuations in interest rates, inflation, government regulations, economic conditions, customer disintermediation and competitive product and pricing pressures in the geographic and business areas in which we conduct operations, including our plans, objectives, expectations and intentions and other factors discussed under the section entitled “Risk Factors,” in our most recent Annual Report on Form 10-K and Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on March 16, 2006 and August 9, 2006, respectively, including the following:

if a significant number of our clients fail to perform under their loans, our business, profitability, and financial condition would be adversely affected;

our current level of interest rate spread may decline in the future, and any material reduction in our interest spread could have a material impact on our business and profitability;

the modification of the Federal Reserve Board’s current position on the capital treatment of our junior subordinated debt and trust preferred securities could have a material adverse effect on our financial condition and results of operations;

adverse changes in domestic or global economic conditions, especially in the Commonwealth of Puerto Rico, could have a material adverse effect on our business, growth, and profitability;

we could be liable for breaches of security in our online banking services, and fear of security breaches could limit the growth of our online services;

maintaining or increasing our market share depends on market acceptance and regulatory approval of new products and services;

significant reliance on loans secured by real estate may increase our vulnerability to downturns in the Puerto Rico real estate market and other variables impacting the value of real estate;

if we fail to retain our key employees, growth and profitability could be adversely affected;

we may be unable to manage our future growth;

we have no current intentions of paying cash dividends on common stock;

increases in our allowance for loan and lease losses could materially adversely affect our earnings;

our directors and executive officers beneficially own a significant portion of our outstanding common stock;

the market for our common stock is limited, and potentially subject to volatile changes in price;

we face substantial competition in our primary market area;

we are subject to significant government regulation and legislation that increases the cost of doing business and inhibits our ability to compete;

we could be negatively impacted by downturns in the Puerto Rican economy;

the long term effects of Puerto Rico’s two-weeks government shutdown during May 2006 in an effort to address the Island’s budgetary problems will take time to evaluate;

the proportion of core and non-core funding contrast sharply with that of the mainland and in recent days contributed to a sharp increase in funding costs; and

we rely heavily on short-term funding sources, such as brokered deposits, which access could be restricted if our capital ratios fall below the levels necessary to be considered “well-capitalized” under current regulatory guidelines.

These factors and the risk factors referred in our most recent Annual Report on Form 10-K and Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on March 16, 2006 and August 9, 2006, respectively, could cause actual results or outcomes to differ materially from those expressed in any forward-looking statements made by us, and you should not place undue reliance on any such forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made and we do not undertake any obligation to update any forward-looking statement or statements to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for us to predict which will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

Executive Overview

Introduction

We are a diversified financial holding company headquartered in San Juan, Puerto Rico, offering a broad array of financial services through our wholly owned banking subsidiary, Eurobank, and our wholly owned insurance agency subsidiary, EuroSeguros, Inc. As of September 30, 2006, we had, on a consolidated basis, total assets of $2.5 billion, net loans and leases of $1.7 billion, total deposits of $1.7 billion, and stockholders’ equity of $170.3 million. We currently operate through a network of 23 branch offices located throughout Puerto Rico.

Over the past three years, we have experienced significant balance sheet growth. Our management team has implemented a strategy of building our core banking franchise by focusing on commercial loans, business transaction accounts and acquisitions. We believe that this strategy will increase recurring revenue streams, enhance profitability, broaden our product and service offerings and continue to build stockholder value.

Key Performance Indicators at September 30, 2006

We believe the following were key indicators of our performance and results of operations through the third quarter of 2006:

our total assets increased to $2.501 billion, or by 6.12% on an annualized basis, at the end of the third quarter of 2006, from $2.391 billion at the end of 2005;

our total loans grew to $1.689 billion at the end of the third quarter of 2006, representing an increase of 11.09% on an annualized basis, from $1.559 million at the end of 2005;

our nonperforming assets increased to $65.9 million, or by $62.61% on an annualized basis, at the end of the third quarter of 2006, from $45.8 million at the end of 2005;

our total revenue grew to $43.6 million in the third quarter of 2006, representing an increase of 17.34%, from $37.2 million in the same period of 2005;

our net interest margin and spread on a fully taxable equivalent basis decreased to 2.73% and 2.19% for the third quarter of 2006, respectively, compared to 3.14% and 2.73%, respectively, for the same period in 2005;

our provision for loan and lease losses grew to $4.8 million in the third quarter of 2006, representing an increase of 60.83%, from $3.0 million in the same period of 2005;

our total noninterest expense grew to $11.5 million in the third quarter of 2006, representing an increase of 23.48%, from $9.3 million in the same period of 2005; and

our effective tax rate decreased to 25.46% in the third quarter of 2006, from 33.50% in the same period of 2005.

These items, as well as other factors, contributed to the decrease in net income for the third quarter of 2006 to $1.4 million from $ 4.8 million for the same period in 2005, or $0.06 per common share as compared to $0.23 per common share for the same period in 2005, assuming dilution, and are discussed in further detail throughout this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of this Quarterly Report on Form 10-Q.

Critical Accounting Policies

This discussion and analysis of our financial condition and results of operations is based upon our financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of these consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions. The following is a description of our significant accounting policies used in the preparation of the accompanying consolidated financial statements.

Loans and Allowance for Loan and Lease Losses

Loans that management has the intent and ability to hold for the foreseeable future, or until maturity or payoff, are reported at their outstanding unpaid principal balances adjusted by any charge-offs, unearned finance charges, allowance for loan and lease losses, and net deferred nonrefundable fees or costs on origination. The allowance for loan and lease losses is an estimate to provide for probable collection losses in our loan and lease portfolio. The allowance for loan and lease losses amounted to $18.4 million, $18.2 million and $15.3 million as of September 30, 2006, December 31, 2005 and September 30, 2005, respectively. Losses charged to the allowance amounted to $13.6 million for the nine months ended September 30, 2006 compared to $12.4 million for the same period in 2005. Recoveries were credited to the allowance in the amounts of $2.2 and $2.3 for those same periods, respectively.

We follow a consistent procedural discipline and account for loan and lease loss contingencies in accordance with Statement of Financial Accounting Standards (SFAS) No. 5, Accounting for Contingencies, and SFAS No. 114, Accounting by Creditors for Impairment of a Loan (“SFAS No. 114”), as amended by SFAS No. 118, Accounting by Creditors for Impairment of a Loan — Income Recognition and Disclosures.

To mitigate any difference between estimates and actual results relative to the determination of the allowance for loan and lease losses, our loan review department is specifically charged with reviewing monthly delinquency reports to determine if additional reserves are necessary. Delinquency reports and analysis of the allowance for loan and lease losses are also provided to senior management and the Board of Directors on a monthly basis.

The loan review department evaluates significant changes in delinquency with regard to a particular loan portfolio to determine the potential for continuing trends. Portfolio performance is also monitored through the monthly calculation of the percentage of non-performing loans to the total portfolio outstanding. A significant change in this percentage may trigger a review of the portfolio and eventually, could lead to additional reserves. We also track the ratio of net charge-offs to total portfolio outstanding.

Our methodology for the determination of the adequacy of the allowance for loan and lease losses for impaired loans is based on classifications of loans and leases into various categories and the application of SFAS No. 114. For non-classified loans, the estimated allowance is based on historical loss experiences as adjusted for changes in trends and conditions on an annual basis. While our allowance for loan and lease losses is established in different portfolio components, we maintain an allowance that we believe is sufficient to absorb all credit losses inherent in our portfolio.

As a result of increasing loss ratios experienced in the later part of 2005, particularly with the Company’s auto lease portfolio, during the quarter ended March 31, 2006, we made some revisions to our methodology for the determination of the allowance for loan and lease losses to provide for more structured and timely monitoring of changes in loss trends and conditions. Additionally, new reports and analyses have been incorporated into our control process over such determination.

With the exception of the commercial loans pool and loans secured by real estate with a 60% or lower loan-to-value, loans that are more than 90 days delinquent result in an additional reserve. When commercial loans become 90 days delinquent, each is subjected to full review by the loan review officer including, but not limited to, a review of financial statements, repayment ability and collateral held. Depending on the findings, our allowance may be increased. In connection with this review, the loan review officer will determine what economic factors may have led to the change in the client’s ability to service the obligation, and this in turn may result in an additional review of a particular sector of the economy. For additional information relating to how each portion of the allowance for loan and lease losses is determined, see the section of this discussion and analysis captioned “Allowance for Loan and Lease Losses.”

We believe that our allowance for loan and lease losses is adequate; however, regulatory agencies, including the Commissioner of Financial Institutions of Puerto Rico and the Federal Deposit Insurance Corporation, as an integral part of their examination process, periodically review our allowance for loan and lease losses and may from time to time require us to reclassify our loans and leases or make additional provisions to our allowance for loan and lease losses.

Servicing Assets

We have no contracts to service loans for others, except for servicing rights retained on lease sales. The total cost of loans or leases to be sold with servicing assets retained is allocated to the servicing assets and the loans or leases (without the servicing assets), based on their relative fair values. Servicing assets are amortized in proportion to, and over the period of, estimated net servicing income. In addition, we assess capitalized servicing assets for impairment based on the fair value of those assets.

To estimate the fair value of servicing assets we use an independent third party to consider prices for similar assets and the present value of expected future cash flows associated with the servicing assets calculated using assumptions that market participants would use in estimating future servicing income and expense, including discount rates, anticipated prepayment and credit loss rates. For purposes of evaluating and measuring impairment of capitalized servicing assets, we evaluate separately servicing retained for each loan portfolio sold. The amount of impairment recognized, if any, is the amount by which the capitalized servicing assets exceed its estimated fair value. Impairment is recognized through a valuation allowance with changes included in net income for the period in which the change occurs. The key assumptions we utilized in measuring the servicing assets at the dates the sales were completed during the year ended December 31, 2005, were as follows: March 23, 2005: prepayment rate of 15.12%; weighted average life of 3.68 years; and a discount rate of 8.15%; September 29, 2005: prepayment rate of 17.16%; weighted average life of 3.51 years; and a discount rate of 8.83%; and September 30, 2005: prepayment rate of 17.16%; weighted average life of 3.46 years; and a discount rate of 9.43%. There was no sale of lease financing contracts during the first nine months of 2006. Impairment analyses were performed in June 2006 and December 2005 by an independent third party and it was determined that there was no impairment, respectively. Net servicing assets are included as part of other assets in the balance sheets. Servicing assets recorded amounted to $1.1 million, $2.4 million and $3.0 million as of September 30, 2006, December 31, 2005, and September 30, 2005, respectively.

Other Real Estate Owned and Repossessed Assets

Other real estate owned, or OREO, and repossessed assets, normally obtained through foreclosure or other workout situations, are initially recorded at the lower of net realizable value or book value at the date of foreclosure, establishing a new cost basis. Any resulting loss is charged to the allowance for loan and lease losses. Appraisals of other real estate properties and valuations of repossessed assets are made periodically after their acquisition, as necessary. Additional declines in value after acquisition, if any, are charged to current operations. Other real estate owned amounted to $3.8 million, $1.5 million, and $3.0 million as of September 30, 2006, December 31, 2005 and September 30, 2005, respectively.

Other repossessed assets amounted to $10.0 million, $8.0 million and $7.2 million as of September 30, 2006, December 31, 2005 and September 30, 2005, respectively. Other repossessed assets are mainly comprised of vehicles from our leasing operation.

During the first quarter of 2006, we made certain refinements to our methodology for estimating net realizable value of vehicles upon repossession. We feel these improvements in our estimation procedures, together with revisions in the determination of the allowance for automobile lease losses, will result in more timely recognition of losses in our automobile lease portfolio and better valuation of our repossessed vehicles.

During the third quarter of 2006, we increased the valuation allowance of repossessed vehicles in an effort to expedite the disposition of slow moving inventory. This new strategy resulted from management’s decision of being more aggressive on the disposition of these units in the future in an effort to reduced the build-up of the inventory.

We monitor the total loss ratio on sale of repossessed assets, which is determined by dividing the sum of net charge offs, declines in value, repairs and the gain or loss on sale by the book value of repossessed assets sold. The total loss ratio on sale of repossessed vehicles was 26.6% and 23.2% for the third quarter and first nine months of 2006, respectively, compared to 19.5% and 17.2% for those same periods in 2005. The increase in our total loss ratio on the sale of repossessed vehicles for the third quarter and first nine months of 2006 compared to the same periods in 2005 was mainly due to the portfolio deterioration and to the sale of damaged units previously charged-off as part of our strategy to aggressively dispose of deteriorated repossessed vehicles.

For the third quarter and first nine months of 2006, the total loss on sale of repossessed equipment was $377,000 and $347,000, respectively, compared to a total gain of $37,000 and total loss of $96,000 for the same periods in 2005. The increase in the total loss on sale of repossessed equipment during the third quarter and first nine months of 2006 was due to the sale of damaged equipment previously charged-off as part of our strategy to aggressively dispose of deteriorated repossessed equipment.

We also monitor the ratio of total loss on the leasing business to the average balance of our leasing portfolio. This ratio is determined by dividing the sum of annualized net charge offs, declines in value, repairs and the gain or loss on sale during the period by the average balance of the leasing portfolio. The annualized total loss ratio on the leasing business was 2.72% and 2.29% for the third quarter and first nine months of 2006, respectively, compared to 1.90% and 1.55% for those same periods in 2005. The increase in our total loss on the leases business during the first nine months of 2006 compared to the same period in 2005 was mainly due to the combined effect of portfolio deterioration and a decrease in our lease portfolio to $458.7 million as of September 30, 2006, from $487.9 million at the end of fiscal 2005. We have been closely monitoring the lease portfolio and have tightened underwriting standards in order to manage delinquencies and possible future losses.

For the third quarter and first nine months of 2006, the total loss ratio on sale of repossessed boats was 37.9% and 39.7%, respectively, compared to 12.1% and 44.1% for the same periods in 2005. The boat financing portfolio amounted to $38.3 million as of September 30, 2006. The decrease in the total loss ratio on sale of repossessed boats during the first nine months of 2006 when compared to the same period in 2005 was mainly due to the sale of five high profile boats, which resulted in lower losses for the nine-month period ended September 30, 2006.

Results of Operations as of and for the Nine months ended September 30, 2006 and 2005

Net Interest Income and Net Interest Margin

Net interest income is the difference between interest income, principally from loan, lease and investment securities portfolios, and interest expense, principally on customer deposits and borrowings. Net interest income is our principal source of earnings. Changes in net interest income result from changes in volume, spread and margin. Volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities. Spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. Margin refers to net interest income divided by average interest-earning assets, and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities.

Net interest income decreased by 3.26%, or $558,000, to $16.5 million and increased by 0.74%, or $374,000, to $51.0 million in the third quarter and first nine months of 2006, respectively, from $17.1 million and $50.6 million in the same periods of 2005. The changes in the net interest income resulted from the combined effect of net increases in volumes and rates, but mainly to increased rates during the third quarter of 2006 and increased volumes during the first nine months of 2006, still impacted by increased rates in interest-bearing liabilities, as shown on the table on page 29.

Total interest income increased by 20.55% to $41.8 million for the third quarter of 2006, compared to $34.7 million for the same period in 2005. Total interest income for the nine months ended September 30, 2006 increased by 23.91% to $119.4 million, compared to $96.4 million for the same period last year. These increases were due to the combined effect of increases in average interest-earning assets and higher yields resulting from increased interest rates during 2006. Our average interest-earning assets increased by $128.4 million (5.71%) and by $210.7 million (9.94%) to $2.4 billion and $2.3 billion in the third quarter and first nine months of 2006, respectively, compared to $2.2 billion and $ 2.1 billion for the same periods in prior year. Average net loans increased by $158.6 million (10.51%) and $170.6 million (11.75%) to $1.7 billion and $1.6 billion in the third quarter and first nine months of 2006, respectively, compared to $1.5 billion for each same period in prior year. These increases resulted from organic growth. During the nine-month period ended September 30, 2006, we benefited from the higher average balances of loans and the higher interest rate environment.

Total interest expense increased by 43.65% to $25.3 million in the third quarter of 2006, compared to $17.6 million in the same period of 2005. Total interest expense for the nine months ended September 30, 2006 was $68.5 million, compared to $45.8 million in the same period last year. These increases resulted from the combined effect of higher volumes of interest-bearing liabilities and the higher cost of funds during 2006, mainly on brokered deposits, jumbo deposits, and other borrowings. Average interest-bearing liabilities increased by 6.32% and 10.84% to $2.1 billion in the third quarter and first nine months of 2006, respectively, compared to $2.0 billion and $1.9 billion in the same periods of 2005. The average interest rate we paid for interest-bearing liabilities for the third quarter and first nine months of 2006 increased to 5.47% and 5.02%, respectively, from 3.97% and 3.63% for same periods in 2005.

Net interest margin and spread on a fully taxable equivalent basis decreased to 2.73% and 2.19% for the third quarter of 2006, respectively, compared to 3.14% and 2.73% for the same period in 2005. For the first nine months of 2006, net interest margin and spread on a fully taxable equivalent basis decreased to 2.95% and 2.44%, respectively, compared to 3.31% and 2.91% for the same period in 2005. These declines in margin and spread were primarily caused by the rising short-term interest rates and an inverted yield curve, which caused borrowing costs to increase at a faster rate than the yield on earning-assets, and to the fact that the increase in average deposits has been substantially in brokered deposits, a higher cost category.

The following tables set forth, for the periods indicated, our average balances of assets, liabilities and stockholders’ equity, in addition to the major components of net interest income and our net interest margin. Net loans and leases shown on these tables include nonaccrual loans although interest accrued but not collected on these loans is placed in nonaccrual status and reversed against interest income.

	For the Quarter Ended September 30,
	2006							2005
	Average Balance		Interest		Average Rate/ Yield⁽¹⁾			Average Balance		Interest		Average Rate/ Yield⁽¹⁾
	(Dollars in thousands)

ASSETS:
Interest-earning assets:
Net loans and leases⁽²⁾	$	1,667,880	$	33,602		8.15	%	$	1,509,234	$	27,874		7.46	%
Securities of U.S. government agencies⁽³⁾		607,218		6,919		6.55			652,808		5,951		5.16
Other investment securities⁽³⁾		46,667		581		7.03			43,273		460		5.80
Puerto Rico government obligations⁽³⁾		9,850		113		6.58			8,406		84		5.66
Securities purchased under agreements to resell and federal funds sold		35,444		482		5.69			30,105		295		4.77
Interest-earning deposits		11,293		152		5.38			6,153		50		3.25
Total interest-earning assets	$	2,378,352	$	41,849		7.66	%	$	2,249,979	$	34,714		6.70	%
Total noninterest-earning assets		83,817							80,084
TOTAL ASSETS	$	2,462,169						$	2,330,063

LIABILITIES AND STOCKHOLDERS’ EQUITY:
Interest-bearing liabilities:
Money market deposits	$	23,791	$	141		2.39	%	$	39,578	$	205		2.09	%
NOW deposits		48,838		291		2.39			47,290		216		1.83
Savings deposits		172,836		1,013		2.35			247,900		1,439		2.32
Time certificates of deposit in denominations of $100,000 or more		1,242,217		15,225		5.33			912,218		8,613		3.99
Other time deposits		109,847		1,060		3.87			142,046		1,122		3.16
Other borrowings		544,248		7,585		7.53			625,465		6,028		5.06
Total interest-bearing liabilities	$	2,141,777	$	25,315		5.47	%	$	2,014,497	$	17,623		3.97	%
Noninterest-bearing liabilities:
Noninterest-bearing deposits		128,918							129,040
Other liabilities		27,177							17,448
Total noninterest-bearing liabilities		156,095							146,488
STOCKHOLDERS’ EQUITY		164,297							169,078
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	2,462,169						$	2,330,063
Net interest income⁽⁴⁾			$	16,534						$	17,091
Net interest spread⁽⁵⁾						2.19	%						2.73	%
Net interest margin⁽⁶⁾						2.73	%						3.14	%

__________

(1) Yields on tax-exempt securities, loans and leases are calculated on a fully taxable equivalent basis assuming a 43.5% and 41.5% tax rate for the quarters ended September 30, 2006 and 2005, respectively.

(2) Loan fees have been included in the calculation of interest income. Loan fees were approximately $668,000 and $295,000 for the quarters ended September 30, 2006 and 2005, respectively. Loans includes nonaccrual loans, which balance as of the periods ended September 30, 2006 and 2005 was $33.9 million and $27.0 million, respectively, and are net of the allowance for loan and lease losses, deferred fees, unearned income, and related direct costs.

(3) Available-for-sale investments are adjusted for unrealized gain or loss.

(4) Net interest income on a tax equivalent basis was $16.3 million and $17.7 million for the quarters ended September 30, 2006 and 2005, respectively.

(5) Represents the average rate earned on interest-earning assets less the average rate paid on interest-bearing liabilities on a fully taxable equivalent basis.

(6) Represents net interest income on a fully taxable equivalent basis as a percentage of average interest-earning assets.

	For the Nine Months Ended September 30,
	2006							2005
	Average Balance		Interest		Average Rate/ Yield⁽¹⁾			Average Balance		Interest		Average Rate/ Yield⁽¹⁾
	(Dollars in thousands)

ASSETS:
Interest-earning assets:
Net loans and leases⁽²⁾	$	1,622,194	$	95,524		7.94	%	$	1,451,570	$	78,962		7.32	%
Securities of U.S. government agencies⁽³⁾		611,881		20,463		6.40			589,550		15,194		4.86
Other investment securities⁽³⁾		44,921		1,623		6.82			36,510		1,157		5.76
Puerto Rico government obligations⁽³⁾		9,256		300		6.20			9,103		272		5.64
Securities purchased under agreements to resell and federal funds sold		35,458		1,249		5.15			26,886		644		3.62
Interest-earning deposits		7,276		287		5.26			6,631		172		3.46
Total interest-earning assets	$	2,330,986	$	119,446		7.46	%	$	2,120,250	$	96,401		6.54	%
Total noninterest-earning assets		79,709							77,798
TOTAL ASSETS	$	2,410,695						$	2,198,048

LIABILITIES AND STOCKHOLDERS’ EQUITY:
Interest-bearing liabilities:
Money market deposits	$	27,164	$	458		2.27	%	$	57,215	$	901		2.12	%
NOW deposits		46,405		774		2.23			48,287		659		1.82
Savings deposits		193,378		3,390		2.34			263,960		4,521		2.28
Time certificates of deposit in denominations of $100,000 or more		1,205,427		41,231		4.97			805,582		21,834		3.80
Other time deposits		117,232		3,160		3.60			161,065		3,691		3.06
Other borrowings		504,246		19,452		6.90			553,045		14,187		4.49
Total interest-bearing liabilities	$	2,093,852	$	68,465		5.02	%	$	1,889,154	$	45,793		3.63	%
Noninterest-bearing liabilities:
Noninterest-bearing deposits		129,046							127,877
Other liabilities		23,634							16,602
Total noninterest-bearing liabilities		152,680							144,479
STOCKHOLDERS’ EQUITY		164,163							164,415
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	2,410,695						$	2,198,048
Net interest income⁽⁴⁾			$	50,981						$	50,608
Net interest spread⁽⁵⁾						2.44	%						2.91	%
Net interest margin⁽⁶⁾						2.95	%						3.31	%

__________

(1) Yields on tax-exempt securities, loans and leases are calculated on a fully taxable equivalent basis assuming a 43.5% and 41.5% tax rate for the nine months periods ended September 30, 2006 and 2005, respectively.

(2) Loan fees have been included in the calculation of interest income. Loan fees were approximately $1.9 million and $391,000 for the nine-month periods ended September 30, 2006 and 2005, respectively. Loans includes nonaccrual loans, which balance as of the periods ended September 30, 2006 and 2005 was $33.9 million and $27.0 million, respectively, and are net of the allowance for loan and lease losses, deferred fees, unearned income, and related direct costs.

(3) Available-for-sale investments are adjusted for unrealized gain or loss.

(4) Net interest income on a tax equivalent basis was $51.6 million and $52.7 million for the first nine months of 2006 and 2005, respectively.

(5) Represents the average rate earned on interest-earning assets less the average rate paid on interest-bearing liabilities on a fully taxable equivalent basis.

(6) Represents net interest income on a fully taxable equivalent basis as a percentage of average interest-earning assets.

The following table sets forth, for the periods indicated, the dollar amount of changes in interest earned and paid for interest-earning assets and interest-bearing liabilities and the amount of change attributable to changes in average daily balances (volume) or changes in average daily interest rates (rate). All changes in interest owed and paid for interest-earning assets and interest-bearing liabilities are attributable to either volume or rate. The impact of changes in the mix of interest-earning assets and interest-bearing liabilities is reflected in our net interest income.

	Three Months Ended September 30, 2006 Over 2005 Increases/(Decreases) Due to Change in									Nine Months Ended September 30, 2006 Over 2005 Increases/(Decreases) Due to Change in
	Volume			Rate			Net			Volume			Rate			Net
	(In thousands)
INTEREST EARNED ON:
Net loans⁽¹⁾	$	2,930		$	2,798		$	5,728		$	9,282		$	7,280		$	16,562
Securities of U.S. government agencies		(416	)		1,384			968			576			4,693			5,269
Other investment securities		36			85			121			267			199			466
Puerto Rico government obligations		14			15			29			5			23			28
Securities purchased under agreements to resell and federal funds sold		52			135			187			205			400			605
Interest-earning time deposits		42			60			102			17			98			115
Total interest-earning assets	$	2,658		$	4,477		$	7,135		$	10,352		$	12,693		$	23,045

INTEREST PAID ON:
Money market deposits	$	(82	)	$	18		$	(64	)	$	(473	)	$	30		$	(443	)
NOW deposits		7			68			75			(26	)		141			115
Savings deposits		(436	)		10			(426	)		(1,209	)		78			(1,131	)
Time certificates of deposit in denominations of $100,000 or more		3,116			3,496			6,612			10,837			8,560			19,397
Other time deposits		(254	)		192			(62	)		(1,004	)		473			(531	)
Other borrowings		(783	)		2,340			1,557			(1,252	)		6,517			5,265
Total interest-bearing liabilities	$	1,568		$	6,124		$	7,692		$	6,873		$	15,799		$	22,672
Net interest income	$	1,090			($1,647	)		($557	)	$	3,479			($3,106	)	$	373

__________

(1) Loan fees have been included in the calculation of interest income. Loan fees were approximately $668,000 and $1.9 million for the third quarter and first nine months of 2006, respectively, compared to $295,000 and $391,000 for the same periods in 2005. Loans includes nonaccrual loans, which balance as of the periods ended September 30, 2006 and 2005 was $33.9 million and $27.0 million, respectively, and are net of the allowance for loan and lease losses, deferred fees, unearned income, and related direct costs.

Provision for Loan and Lease Losses

We determine a provision for loan and lease losses that we consider sufficient to maintain an allowance to absorb probable losses inherent in our portfolio as of the balance sheet date. For additional information concerning this determination, see the section of this discussion and analysis captioned “Allowance for Loan and Lease Losses.”

The provision for loan and lease losses for the quarter ended September 30, 2006 was $4.8 million, or 94.5% of net charge-offs, compared to $3.0 million or 79.5% of net charge-offs for the same quarter in 2005. For the nine months ended September 30, 2006 and 2005, the provision for loan and lease losses was $11.6 million, or 101.9% of net charge-offs, and $6.3 million, or 62.7% of net charge-offs, respectively. The increase in the provision was a direct result of the periodic evaluation of the allowance for possible loan and lease losses, considering the growth in the loan portfolio, net-charge offs, delinquencies and related loss experience. During the third quarter of 2006, the net charge-offs increased to $5.1 million, from $3.8 million in the same period of 2005. Net charge-offs during the first nine months of 2006 increased to $11.4 million, from $10.1 million in the same period in 2005. For more detail on net charge-offs please refer to the “Allowance for Loan and Lease Losses” section herein.

In addition, steady growth in our commercial lending portfolio has dictated continual increases in our provision for loan and lease losses. In the other lending categories, such as consumer lending, residential construction lending and mortgage lending, growth has not been robust. We have experienced deterioration of our leasing portfolio and accordingly, we have been closely monitoring related portfolio losses in connection with determining the allowance for possible loan and lease losses and related provision.

Also, in order to maintain an adequate level of our allowance for loan and lease losses, we monitor our portfolio performance on a monthly basis and determine, if necessary, the additional provision for loan and lease losses. Individual credits that are less than satisfactory or delinquent are reviewed on an ongoing basis to determine whether additional provisions are necessary. We believe existing allowance levels are appropriate.

Noninterest Income

The following tables set forth the various components of our noninterest income for the periods indicated:

	Three Months Ended September 30,
	2006						2005
	(Amount)			(%)			(Amount)			(%)
	(Dollars in thousands)

Service charges and other fees	$	2,156			121.2	%	$	2,325			94.2	%
Gain on sale of loans and leases, net		133			7.5			399			16.2
Gain (loss) on sale of repossessed assets and on disposition of other assets, net		(511	)		(28.7	)		(256	)		(10.4	)

Total noninterest income	$	1,778			100.0	%	$	2,468			100.0	%

	Nine Months Ended September 30,
	2006					2005
	(Amount)		(%)			(Amount)			(%)
	(Dollars in thousands)

Service charges and other fees	$	6,228		93.1	%	$	6,702			113.0	%
Loss on non-hedging derivatives, net		—		—			(944	)		(15.9	)
Gain on sale of loans and leases, net		262		3.9			922			15.5
Loss on sale of securities, net		—		—			(230	)		(3.9	)
Gain (loss) on sale of repossessed assets and on disposition of other assets, net		201		3.0			(515	)		(8.7	)

Total noninterest income	$	6,691		100.0	%	$	5,935			100.0	%

Our total noninterest income for the third quarter and first nine months of 2006 was $1.8 million and $6.7 million, respectively, from $2.5 million and $5.9 million for the same periods in 2005. Noninterest income represented approximately 0.28% and 0.27% of average assets as of September 30, 2006 and 2005, respectively.

Our largest noninterest income source is service charges, primarily on deposit accounts. The service charges and other fees decreased to $2.2 million and $6.2 million in the third quarter and first nine months of September 30, 2006, from $2.3 million and $6.7 million at the same periods in 2005. The decrease in service charges and other fees during the first nine months of 2006 when compared to the same period in 2005 was primarily due to a decrease of approximately $179,000 in trust fees and approximately $265,000 in non-sufficient funds charges on deposits accounts.

Another component of noninterest income for the first nine months of 2005 is the net loss on non-hedging derivatives. Noninterest income reflects a $944,000 loss on non-hedging derivatives, which reflected a $1.1 million charge to earnings in the first quarter of 2005 for net losses on non-hedging derivatives on which hedge accounting had been discontinued, and a $132,000 gain on such derivatives in the second quarter of 2005 resulting from their early termination in April 2005. The derivatives were assumed in connection with the acquisition of The Bank & Trust of Puerto Rico in May 2004.

For the third quarter and first nine months of 2006, gain on sale of loans and leases was $133,000 and $262,000, respectively, compared to $399,000 and $922,000 for the same periods in 2005. This source of noninterest income is derived primarily from the sale of mortgage loans and lease financing contracts. During the third quarter and first nine months of 2006, we sold $4.7 million and $9.6 million in mortgage loans to other financial institutions on a spot loan basis, respectively, compared to $5.6 million and $17.5 million for the same periods in 2005. We did not retain the servicing rights on these mortgage loans and we accounted for this transaction as a sale, resulting in a gain of approximately $133,000 and $262,000 for the third quarter and first nine months of 2006, respectively, compared to $51,000 and $209,000 for those same periods in 2005. In June 2006, we became a Government National Mortgage Association’s issuer. In order to take advantage of this designation, we are increasing our volume of mortgage loans originations and have restructured the mortgage loans department to increase our sales in the secondary market. In the third quarter and first nine months of 2006, our mortgage loan portfolio grew by $9.3 million, or 60.95% on an annualized basis, and by $25.2, or 74.76% on an annualized basis, respectively, from $62.0 million and $45.8 million in the second quarter of 2006 and December 31, 2005, respectively.

In addition, in March and September 2005, we sold lease financing contracts carrying values of $14.9 million and $15.0 million, respectively. We retained servicing responsibilities for the lease financing contracts sold. We surrendered control of the lease financing receivables, as defined by SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities, and accounted for this transaction as sale, recognizing a net gain of approximately $365,000 and $348,000, respectively. These lease contracts were sold on a limited recourse basis. The recourse is limited to a maximum of 5.0% of the outstanding aggregate principal balance at repossession date of all leases sold. While the estimated losses on the limited recourse obligations assumed in the sale of our lease financing contracts is not significant, we established an allowance of $106,000 on March 23, 2005 and $120,000 in September 2005, and have included such estimate in the other liabilities section of our balance sheet as of September 30, 2006 and December 31, 2005. There was no sale of lease financing contracts during the first nine months of 2006.

During the first quarter of 2005, we recognized a $230,000 loss on sale of $40.0 million in U.S. Treasury obligations available for sale, which were sold in an effort to improve the yields of the available for sale securities portfolio. No securities were sold during the first nine months of 2006, the second and third quarters of 2005.

For the third quarter of 2006, we experienced a net loss on sale of repossessed assets and on disposition of other assets of $511,000, compared to a net loss of $256,000 for the same period in 2005. The increase in the loss on sale of repossessed assets during the third quarter of 2006 mainly resulted from higher volumes in sales, although losses per unit during the third quarter of 2006 were lesser than losses in the same quarter of 2005. During the first nine months of 2006, we experienced a net gain on sale of repossessed assets and on disposition of other assets of $201,000, compared to a net loss of $515,000 during the same period in 2005. The increase in gain on sale of repossessed assets during the first nine months of 2006 was mainly due to the sale of a real estate property during the second quarter of 2006, which resulted in a gain of approximately $360,000.

Noninterest Expense

The following tables set forth a summary of noninterest expenses for the periods indicated:

	Three Months Ended September 30,
	2006					2005
	(Amount)		(%)			(Amount)		(%)
	(Dollars in thousands)

Salaries and employee benefits	$	4,536		39.3	%	$	3,459		37.1	%
Occupancy and equipment		2,587		22.5			2,056		22.0
Professional services, including directors’ fees		967		8.4			925		9.9
Office supplies		330		2.9			316		3.4
Other real estate owned and other repossessed assets expenses		1,012		8.8			248		2.7
Promotion and advertising		324		2.8			175		1.9
Lease expenses		157		1.4			248		2.7
Insurance		293		2.5			256		2.7
Municipal and other taxes		420		3.6			409		4.4
Commissions and service fees credit and debit cards		318		2.8			312		3.3
Other noninterest expense		577		5.0			926		9.9
Total noninterest expense	$	11,521		100.0	%	$	9,330		100.0	%

	Nine Months Ended September 30,
	2006					2005
	(Amount)		(%)			(Amount)		(%)
	(Dollars in thousands)
Salaries and employee benefits	$	14,012		42.5	%	$	10,793		39.4	%
Occupancy and equipment		7,087		21.4			6,103		22.2
Professional services, including directors’ fees		3,155		9.5			2,787		10.1
Office supplies		1,023		3.1			917		3.3
Other real estate owned and other repossessed assets expenses		1,742		5.3			822		3.0
Promotion and advertising		841		2.5			538		2.0
Lease expenses		479		1.4			606		2.2
Insurance		794		2.4			808		2.9
Municipal and other taxes		1,237		3.7			1,266		4.6
Commissions and service fees credit and debit cards		997		3.0			1,022		3.7
Other noninterest expense		1,738		5.2			1,807		6.6
Total noninterest expense	$	33,105		100.0	%	$	27,469		100.0	%

Our total noninterest expense increased to $11.5 million and $33.1 million in the third quarter and first nine months of 2006, respectively, compared to $9.3 million and $27.5 million for the same periods in 2005. This represents an increase in noninterest expense of 23.48% and 20.52%, respectively. This increase can be attributed mainly to the expanded personnel and occupancy costs associated with our business growth and the recent opening of two new branches in September and December 2005, respectively; an increase in the valuation allowance of repossessed vehicles in an effort to expedite their disposition in the future; salary increases for year 2005, which were effective in January 2006; and an increase in employee headcount mainly from the restructuring of the mortgage loan department to take advantage of the opportunities available in this area on the Island and also to increase our sales in the secondary market. Noninterest expenses as a percentage of average assets increased to 0.47% and 1.37% in the third quarter and first nine months of 2006, respectively, compared to 0.40% and 1.25% for the same periods in 2005. Our efficiency ratio was 63.83% and 56.77% for the third quarter and first nine months of 2006, respectively, compared to 46.24% and 46.88% for the same periods in 2005. The efficiency ratio is determined by dividing total noninterest expense by an amount equal to net interest income (fully taxable equivalent) plus noninterest income.

We anticipate that the overall volume of our noninterest expense will continue to increase as we grow. However, we remain committed to controlling costs and efficiency and expect to moderate these increases relative to our revenue growth.

Salaries and employee benefits totaled $4.5 million and $14.0 million for the third quarter and first nine months of 2006, respectively, compared to $3.5 million and $10.8 million for the same periods in 2005, representing an increase of 31.14% and 29.82% for the comparable periods. This increase in salaries and employee benefits resulted from the increases in personnel, as previously explained, normal salary increases and related employees’ benefits, and in part to an increase of $155,000 related to stock based compensation expense. Despite the new branch openings and significant asset growth in the past year, we have limited full-time employee growth by making efficient use of existing employees. We had 492 full-time equivalent employees as of September 30, 2006, compared with 472 as of September 30, 2005. Our volume of assets per employee slightly increased to $5.1 million as of September 30, 2006, from $5.0 million for the same period in 2005.

Occupancy and equipment expenses totaled $2.6 million and $7.1 million for the third quarter and first nine months of 2006, respectively, compared to $2.1 million and $6.1 million for the same periods in 2005, representing an increase of 25.83% and 16.12% for the comparable periods. This increase is attributable primarily to the expansion of our branch network and franchise, as mentioned before.

Professional and directors’ fees were $967,000 and $3.2 million, or 8.4% and 9.5% of total noninterest expenses, for the third quarter and first nine months of 2006, respectively, compared to $925,000 and $2.8 million, or 9.9% and 10.1% of total noninterest expenses, for the comparable periods in 2005. The increase in professional and directors’ fees during the third quarter of 2006 when compared to the same period in 2005 was mainly due to an increase in audit fees and brokerage expenses from the trust department. The professional and directors’ fees for the first nine months of 2006 included $300,000 related to additional expenses billed by our former external auditors in connection with year 2005 audit and compliance with the Sarbanes Oxley Act. These additional expenses were recorded during the first quarter of 2006.

Our expenses related to OREO and repossessed assets were $1.0 million and $1.7 million, or 8.8% and 5.3% of total noninterest expenses, for the third quarter and first nine months of 2006, respectively, compared to $248,000 and $822,000, or 2.7% and 3.0% of total noninterest expenses, for the same periods in 2005. This increase was mainly due to the combined effect of an increase in the average number of repossessed vehicles in inventory, which resulted in increased repairs and maintenance expenses, and an increase in the valuation allowance of repossessed vehicles in an effort to expedite their disposition in the future. During the first nine months of 2006, the average number of repossessed vehicles in inventory increased by 65.51% to 523 units, when compared to 316 vehicles for the same period in 2005. Repossessed assets are initially recorded at the lower of net realizable value or book value upon repossession and resulting losses are charged to the allowance for loan and lease losses. These assets are then periodically evaluated and recorded at net realizable value. Any subsequent declines in the net realizable value or other adjustments made to expedite the disposition of these assets are charged to current operations.

Promotion and advertising increased to $324,000 and $841,000 for the third quarter and first nine months of 2006, respectively, compared to $175,000 and $538,000 for the same periods in 2005. This increase was mainly attributable to an advertising campaign as part of the expansion of the mortgage loan department.

Leases expenses decreased to $157,000 and $479,000 for the third quarter and first nine months of 2006, respectively, compared to $248,000 and $606,000 for those same periods in 2005. These expenses are primarily comprised of registration costs on leased vehicles. This decrease was mainly attributable to a reduction of 35.47% in lease portfolio originations.

Insurance expenses were $293,000 and $256,000, or 2.5% and 2.7% of total noninterest expenses, for the third quarter of 2006 and 2005, respectively. For the first nine months of 2006, insurance expenses decreased to $794,000 from $808,000 during the same period in 2005. Although these was a reduction of insurance expenses upon the modifications of the coverage on our repossessed assets’ inventory during the second quarter of 2006, it was basically offset by the increase in the average number of vehicles repossessed during the first nine months of 2006, as previously mentioned.

Municipal and other taxes were $420,000 and $1.2 million for the third quarter and first nine months of 2006, respectively, compared to $409,000 and $1.3 million for the same periods in 2005. The decrease during the first nine months of 2006 was mainly due to the net effect of an increase in our volume of patents’ amortization and the fully amortization during the second quarter of 2005 of patents acquired from The Bank & Trust of Puerto Rico in May 2004.

Other noninterest expenses decreased to $577,000 and $1.7 million for the third quarter and first nine months of 2006, respectively, when compared to $926,000 and $1.8 million for the same periods in 2005. The decrease during the third quarter of 2006 year was mainly attributable to the recording of a provision for losses on other assets of $480,000 related to a boat insurance claim during the third quarter of 2005. Other noninterest expenses are mainly comprised of loan processing and other miscellaneous expenses.

Provision for Income Taxes

Puerto Rico income tax law does not provide for the filing of a consolidated tax return; therefore, the income tax expense reflected in our consolidated income statement is the sum of our income tax expense and the income tax expenses of our individual subsidiaries. Our revenues are generally not subject to U.S. federal income tax.

Income tax expense is the sum of two components: current tax expense and deferred tax expense (benefit). Current tax expense is calculated by applying the statutory tax rate to taxable income. The deferred tax expense (benefit) reflects the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Deferred income tax assets and liabilities represent the tax effects, based on current tax law, of future deductible or taxable amounts attributable to events that have been recognized in our financial statements.

On August 1, 2005, the governor of Puerto Rico approved Law No. 41, which imposed a temporary increase of 2.5% on the taxable income. This additional tax increased the maximum statutory tax rate from 39.0% to 41.5% and is applicable to all corporations and partnerships with taxable income in excess of $20,000 during the taxable years beginning after December 31, 2004 and ending on or before December 31, 2006.

In addition, on May 13, 2006, the governor of Puerto Rico approved and signed Law No. 89, which imposed an additional transitory tax of 2% on taxable income. This tax is applicable to the Banking industry raising the maximum statutory tax rate to 43.5% for taxable year beginning after December 31, 2005 and ending on or before December 31, 2006. This law also states that for taxable years beginning after December 31, 2006, the maximum statutory tax rate will be 39%.

During the third quarter of 2006, income tax expense decreased to $495,000, compared to $2.4 million for the same quarter in 2005. Also, for the nine months ended September 30, 2006, the income tax expense decreased to $4.9 million, compared to $7.9 million for the same period in 2005. The decrease in income tax expense during the nine months ended September 30, 2006 resulted from the net effect of a $12.9 million pre-tax income and a 38.15% effective tax rate, compared to a $22.7 million pre-tax income and a 34.65% effective tax rate for the same period in 2005. In addition, during 2006, the Company purchased at a discount, tax credits in the amount of approximately $3.8 million, resulting in an income tax benefit of $376,000. The increase in the effective tax rate during the nine months ended September 30, 2006 mainly resulted from the increase in taxable income as a percentage of total income and the additional temporary taxes recently approved by the Puerto Rico Legislature, as explained below.

The approval of the additional transitory taxes of 4.5% over the original maximum statutory tax rate of 39% resulted in additional income tax expense of $469,000 for the first nine months of 2006, comprised of an increase in current tax expense of $602,000, and a deferred tax benefit of $133,000.

Our deferred tax provision decreased to a benefit of $548,000 and $614,000 for the third quarter and first nine months of 2006, respectively, compared to an expense of $1.9 million and $6.4 million for the same periods in 2005. This decrease was mainly due to the net effect of: a decrease in the net operating losses consumed during the first nine months of 2006, when compared to the consumption in the same period of 2005 and a decrease in deferred tax liabilities, primarily the servicing assets and deferred loan fees, for the period ended September 30, 2006; affected by the additional tax of 4.5%. At September 30, 2006 and December 31, 2005, we had net deferred tax assets of $5.7 million and $5.1 million as of the end of each period, respectively.

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. We believe it is more likely than not that the benefits of these deductible differences at September 30, 2006 will be realized.

On May 16, 2006, the governor of Puerto Rico approved and signed Law No. 98, the “Law of the 2006’s Extraordinary Tax.” This law imposes a prepaid tax of 5% over the 2005 taxable net income by for profit partnerships and corporations with gross income over $10.0 million. We could use the full payment as a tax credit in the income tax return for the taxable year beginning after December 31, 2005 and the portion not used, if any, could be used in equal portions for up to the next four taxable years. This tax payment resulted in a disbursement of approximately $196,000 during the third quarter of 2006. No income tax expense was recorded since such payment will be used as a tax credit in the 2006’s income tax return.

Financial Condition

Our total assets as of September 30, 2006 were $2.501 billion, compared to $2.391 billion as of December 31, 2005. The increase in our total assets during the first nine months of 2006 was primarily due to the net effect of an increase in loans and leases from current operations and a decrease in investment securities and securities purchased under agreements to resell.

On an annualized basis, our total deposits increased by 0.86% to $1.745 billion as of September 30, 2006, compared to $1.734 billion as of December 31, 2005. The increase in deposits during the first nine months of 2006 was concentrated in brokered deposits, as further explained in the section of this discussion and analysis captioned “Deposits.” Other borrowings increased to $556.2 million as of September 30, 2006, compared to $475.7 million as of December 31, 2005. This increase was mainly concentrated in the securities sold under agreements to repurchase.

As of September 30, 2006, our stockholders’ equity was $170.3 million, compared to $165.0 million as of December 31, 2005. In addition to earnings from operations, stock options exercised and stock repurchases, our stockholders’ equity was also impacted by accumulated other comprehensive losses of $8.1 million and $10.4 million during the first nine months of 2006 and the year 2005, respectively.

Short-Term Investments and Interest-bearing Deposits in Other Financial Institutions

We sell federal funds, purchase securities under agreements to resell, and deposit funds in interest-bearing accounts in other financial institutions to help meet liquidity requirements and provide temporary holdings until the funds can be otherwise deployed or invested. As of September 30, 2006 and December 31, 2005, we had $20.3 and $20.8 million in interest-bearing deposits in other financial institutions, respectively. Also, we had $44.6 million and $54.1 million in purchased securities under agreements to resell for those same periods, respectively. On a fully taxable equivalent basis, the yield on interest-bearing deposits and the purchased securities under agreements to resell was 5.17% and 4.80% for the nine month period ended September 30, 2006 and the year 2005, respectively.

Investment Securities

Our investment portfolio primarily serves as a source of interest income and, secondarily, as a source of liquidity and a management tool for our interest rate sensitivity. We manage our investment portfolio according to a written investment policy implemented by our Asset/Liability Management Committee. Our Board of Directors reviews our investment policy at least annually. Investment balances, including cash equivalents and interest-bearing deposits in other financial institutions, are subject to change over time based on our asset/liability funding needs and our interest rate risk management objectives. Our liquidity levels take into consideration anticipated future cash flows and all available sources of credits and are maintained at levels management believe are appropriate to assure future flexibility in meeting our anticipated funding needs.

Our investment portfolio mainly consists of securities classified as “available-for-sale” and a small portion of securities we intend to hold until maturity, or “held-to-maturity securities.” The carrying values of our available-for-sale securities are adjusted for unrealized gain or loss as a valuation allowance, and any gain or loss is reported on an after-tax basis as a component of other comprehensive income (loss).

The following table presents the composition, book value and fair value of our investment portfolio by major category as of the dates indicated:

	Available-for-Sale				Held-to-Maturity				Total
	Amortized Cost		Estimated Fair Value		Amortized Cost		Estimated Fair Value		Amortized Cost		Estimated Fair Value
	(Dollars in thousands)
September 30, 2006:
U.S. government agencies obligations	$	234,868	$	231,887	$	3,307	$	3,216	$	238,175	$	235,104
Collateralized mortgage obligations		322,185		317,721		30,423		29,673		352,608		347,394
Mortgage-backed securities		55,219		54,481		5,593		5,444		60,812		59,925
State and municipal obligations		9,928		9,971		—		—		9,928		9,971
Other investments		—		—		11,239		11,239		11,239		11,239
Total	$	622,200	$	614,061	$	50,562	$	49,572	$	672,762	$	663,633

December 31, 2005:
U.S. government agencies obligations	$	230,892	$	227,081	$	3,763	$	3,663	$	234,655	$	230,744
Collateralized mortgage obligations		333,154		327,399		32,386		31,590		365,540		358,989
Mortgage-backed securities		65,560		64,779		6,322		6,158		71,882		70,937
State and municipal obligations		7,902		7,821		—		—		7,902		7,821
Other investments		—		—		10,652		10,652		10,652		10,652
Total	$	637,508	$	627,080	$	53,123	$	52,063	$	690,631	$	679,143

During the first nine months of 2006, the investment portfolio decreased by approximately $15.6 million to $664.6 million as of September 30, 2006, from $680.2 million as of December 31, 2005. The change from December 31, 2005 was primarily due to the net effect of:

·	the purchase of $20.0 million in US government agencies obligations, $53.7 million in mortgage backed securities, and $5.0 million of Puerto Rico Agency Notes;

·	prepayments for approximately $77.0 million of mortgage backed securities;

·	a decrease of $7.9 million in US government agencies obligations due to monthly principal prepayments and maturity of FHLB, FNMA & FHLMC obligations and the redemption of FHLB stocks;

·	the maturity of $8.0 million in US government agencies obligations and $3.0 million in Puerto Rico Agency Notes;

·	a decrease of $2.3 million in the unrealized net loss on investment securities available for sale; and

·	a net premium amortization of $737,000.

During the past few years, we positioned our investment portfolio for an increase in interest rates by purchasing mostly investments with maturities or estimated maturities between 1½ to 4 years. During the first half of 2006, we have seen higher interest in the short term of the curve and we have been able to reinvest at higher yields and for maturities or estimated maturities from 2 years to 7 years. We did not purchase any securities during the third quarter of 2006. As of September 30, 2006, after above-mentioned transactions, the estimated average maturity was approximately 3.14 years and the average yield was approximately 4.58%, compared to an estimated average maturity of 2.77 years and to an estimated average yield of 4.26% for December 31, 2005. As of September 30, 2006, investment securities having a carrying value of approximately $612.2 million were pledged to secure borrowings and deposits of public funds and to comply with other pledging requirements.

Investment Portfolio — Maturity and Yields

The following table summarizes the contractual maturity of investment securities held in our investment portfolio and their weighted average yields:

	Nine Months Ended September 30, 2006
	Within One Year					After One but Within Five Years					After Five but Within Ten Years					After Ten Years					Total
	Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield
	(Dollars in thousands)
Investments available-for-sale: (1)(2)
U.S. government agencies obligations	$	81,214		4.12	%	$	132,397		4.32	%	$	18,277		5.65	%	$	—		—	%	$	231,888		4.36	%
Mortgage backed securities(3)		32,249		4.06			15,184		4.69			5,938		5.47			1,111		7.12			54,482		4.45
Collateral mortgage obligations(3)		26,076		4.08			237,348		4.67			54,296		5.12			—		—			317,720		4.70
State & political subdivisions		3,026		3.41			1,653		6.14			5,292		4.71			—		—			9,971		4.55

Total investments available-for-sale	$	142,565		4.08	%	$	386,582		4.56	%	$	83,803		5.24	%	$	1,111		7.12	%	$	614,061		4.55	%

Investments held-to-maturity: (2)
U.S. government agencies obligations	$	—		—	%	$	3,307		3.95	%	$	—		—	%	$	—		—	%	$	3,307		3.95	%
Mortgage backed securities(3)		—		—			—		—			5,593		4.94			—		—			5,593		4.94
Collateral mortgage obligations(3)		—		—			13,765		3.95			16,658		5.19			—		—			30,423		4.63
State & political subdivisions		—		—			—		—			—		—			—		—			—		—

Total investments held-to-maturity	$	—		—	%	$	17,072		3.95	%	$	22,251		5.13	%	$	—		—	%	$	39,323		4.61	%

Other Investments:
FHLB stock		9,859		5.75	%		—		—	%		—		—	%		—		—	%		9,859		5.75	%
Investment in statutory trust		—		—			—		—			—		—			1,380		8.78			1,380		8.78
Total other investments	$	9,859		5.75	%	$	—		—	%	$	—		—	%	$	1,380		8.78	%	$	11,239		6.12	%
Total investments	$	152,424		4.19	%	$	403,654		4.53	%	$	106,054		5.21	%	$	2,491		8.04	%	$	664,623		4.58	%

(1)	Based on estimated fair value.

(2)	Almost all of our income from investments in securities is tax exempt because 99.26% of these securities are held in our IBE’s. The yields shown in the above table are not calculated on a fully taxable equivalent basis.

(3)	Maturities of mortgage-backed securities and collateralized mortgage obligations, or CMOs, are based on anticipated life of the underlying mortgages, not contractual maturities. CMO maturities are based on cash flow (or payment) windows derived from broker market consensus.

Other Investments

For various business purposes, we make investments in earning assets other than the interest-earning securities discussed above. As of September 30, 2006, our investment in other earning assets included $9.9 million in FHLB stock and $1.4 million equity in our statutory trusts. The following table presents the balances of other earning assets as of the dates indicated:

		As of September 30,		As of December 31,
Type		2006		2005
		(In thousands)

Statutory trusts	$	1,380	$	1,382
FHLB stock		9,859		9,270
Total	$	11,239	$	10,652

Loan and Lease Portfolio

Our primary source of income is interest on loans and leases. The following table presents the composition of our loan and lease portfolio by category as of the dates indicated, excluding loans held for sale secured by real estate amounting to $1.6 million and $936,000 as of September 30, 2006 and December 31, 2005, respectively:

		As of September 30,			As of December 31,
		2006			2005
		(In thousands)

Real estate secured	$	779,342		$	658,123
Leases		458,683			487,863
Other commercial and industrial		289,455			272,205
Consumer		61,903			63,980
Real estate - construction		104,538			82,468
Other loans		7,335			5,336
Gross loans and leases	$	1,701,256		$	1,569,975
Plus: Deferred loan costs, net		5,534			7,442
Total loans, including deferred loan costs, net	$	1,706,790		$	1,577,417
Less: Unearned income		(1,274	)		(1,157	)
Total loans, net of unearned income	$	1,705,516		$	1,576,260
Less: Allowance for loan and lease losses		(18,400	)		(18,188	)
Loans, net	$	1,687,116		$	1,558,072

As of September 30, 2006 and December 31, 2005, our total loans and leases, net of unearned income, were $1.706 billion and $1.576 billion, respectively. The increase in our loan and lease volume during the nine months ended September 30, 2006 resulted from the organic growth of our operations. Our total loans and leases, net of unearned income, as a percentage of total assets increased to 68.3% as of September 30, 2006 from 66.0% as of December 31, 2005.

Real estate secured loans, the largest component of our loan and lease portfolio, consist primarily of commercial real estate loans and/or commercial lines of credit that are extended to finance the purchase and/or improvement of commercial real estate and/or businesses thereon or for business working capital purposes. The properties may be either owner-occupied or for investment purposes. Our loan policy adheres to the real estate loan guidelines promulgated by the FDIC in 1993. The policy provides guidelines including, among other things, review of appraised value, limitation on loan-to-value ratio, and minimum cash flow requirements to service debt. Loans secured by real estate equaled $779.3 million and $658.1 million as of September 30, 2006 and December 31, 2005, respectively. The increase of our real estate loans is due to the organic growth of the Bank, as explained before. The percentage of our real estate secured loans in relation to our total loan and lease portfolio, increased to 45.81% as of September 30, 2006, compared to 41.92% at the end of fiscal year 2005.

Lease financing contracts, the second largest component of our loan portfolio, consist of automobile and equipment leases made to individuals and corporate customers. In the last two years, we have deemphasized equipment leasing and focused on automobile leasing. For the first nine months of 2006, approximately 76.39% of our lease financing contracts was for new automobiles, approximately 21.23% were for used automobiles and the remaining 2.38% consisted primarily of construction and medical equipment leases. The volume of our lease financing contracts decreased to $458.7 million as of September 30, 2006, from $487.9 million as of December 31, 2005. This decrease was mainly due to the combined effect of a decrease in the volume of lease financing contracts’ originations and the repayment of the existing portfolio. Lease financing contracts, as a percentage of total loans and leases were 26.96% as of September 30, 2006 and 31.07% at the end of 2005.

On a monthly basis, we review the existing lease portfolio to determine the repayment performance of borrowers displaying subprime lending characteristics. This analysis contemplates the segregation of the lease portfolio in two different categories, sub-prime and prime, based on the characteristics of each borrower. The review includes the segregation of the monthly delinquency report into these categories to compare the percentage of the outstanding balance for each category in different delinquent stratas. For the first nine months of 2006, the analysis revealed there was a similar repayment performance for both categories. This review enables us to have a better monitoring system and control sub-prime borrowers and to reduce risk of repossessions and future losses.

Other commercial and industrial loans include revolving lines of credit as well as term business loans. Other commercial and industrial loans increased to $289.5 million as of September 30, 2006, from $272.2 million as of December 31, 2005. Other commercial and industrial loans as a percentage of total loans were 17.02% as of September 30, 2006, and 17.34% at the end of 2005.

Consumer loans have historically represented a small part of our total loan and lease portfolio. The majority of consumer loans consist of personal installment loans, credit cards, boat loans, and consumer lines of credit. We have consumer loans only to complement our commercial business, and our branch managers do not emphasize these loans. Consumer loans decreased to $61.9 million as of September 30, 2006 from $64.0 million as of December 31, 2005. Consumer loans as a percentage of total loans and leases were 3.64% and 4.08% at September 30, 2006 and December 31, 2005, respectively. Consumer loans as of September 30, 2006 included a boat portfolio of $38.3 million acquired as a result of the acquisition of former BankTrust back in May 2004, $14.2 million in unsecured installment loans, and credit cards and open-end loans for $9.5 million.

Construction loans are not a significant part of our total loan portfolio. Construction loans totaled $104.5 million and $82.5 million as of September 30, 2006 and December 31, 2005, respectively. Construction loans as a percentage of total loans and leases were 6.14% and 5.25% as of September 30, 2006 and December 31, 2005, respectively.

Our loan terms vary according to loan type. Commercial term loans generally have maturities of three to five years, while we generally limit real estate loan maturities to five to eight years. Lines of credit, in general, are extended on an annual basis to businesses that need temporary working capital and/or import/export financing. Leases are offered for terms up to 72 months. The following table shows our maturity distribution of loans and leases, including loans held for sale of $1.6 million, as of September 30, 2006, excluding non-accrual loans amounting to $33.9 million as of the same date. A significant part of our non-consumer loan portfolio is floating rate loans, which comprise both commercial and industrial loans, and commercial real estate loans. By contrast, residential mortgage loans originated by Eurobank are fixed rate. Residential mortgage loans are included in the real estate - secured category in the following table.

	As of September 30, 2006
			Over 1 Year through 5 Years				Over 5 Years
	One Year or Less⁽¹⁾		Fixed Rate		Floating or Adjustable Rate		Fixed Rate		Floating or Adjustable Rate		Total
	(In thousands)

Real estate — construction	$	133,966	$	334	$	9,565	$	566	$	2,512	$	146,943
Real estate — secured		218,546		104,015		242,341		126,864		26,846		718,612
Other commercial and industrial		201,093		20,814		45,732		2,833		13,909		284,381
Consumer		12,508		12,634		1,372		34,230		376		61,120
Leases		9,309		400,427		-		45,222		-		454,958
Other loans		7,134		-		-		-		-		7,134
Total	$	582,556	$	538,224	$	299,010	$	209,715	$	43,643	$	1,673,148

(1) Maturities are based upon contract dates. Demand loans are included in the one year or less category and totaled $408.1 million as of September 30, 2006.

Nonperforming Loans, Leases and Assets

Nonperforming assets consist of loans and leases on nonaccrual status, loans 90 days or more past due and still accruing interest, loans that have been restructured resulting in a reduction or deferral of interest or principal, OREO, and other repossessed assets.

The following table sets forth the amounts of nonperforming assets (net of the portion guaranteed by the United States government) as of the dates indicated:

	As of September 30,			As of December 31,
	2006			2005
	(Dollars in thousands)

Loans contractually past due 90 days or more but still accruing interest	$	18,224		$	8,560
Nonaccrual loans		33,927			27,703
Total nonperforming loans		52,151			36,263
Other real estate owned		3,763			1,542
Other repossessed assets		9,989			7,975
Total nonperforming assets	$	65,903		$	45,780
Nonperforming loans to total loans and leases		3.05	%		2.30	%
Nonperforming assets to total loans and leases plus repossessed property		3.83			2.89
Nonperforming assets to total assets		2.64			1.91

We continually review present and estimated future performance of the loans and leases within our portfolio and risk-rate such loans in accordance with a risk rating system. More specifically, we attempt to reduce the exposure to risks through: (1) reviewing each loan request and renewal individually; (2) utilizing a centralized approval system for loans in excess of $100,000 for secured commercial loans and $50,000 for unsecured commercial loans; (3) strictly adhering to written loan policies; and (4) conducting an independent credit review. In addition, loans based on short-term asset values are monitored on a monthly or quarterly basis. In general, we receive and review financial statements of borrowing customers on an ongoing basis during the term of the relationship and respond to any deterioration noted.

Loans are generally placed on nonaccrual status when they become 90 days past due, unless we believe the loan is adequately collateralized and we are in the process of collection. The nonrecognition of interest income on an accrual basis does not constitute forgiveness of the interest, and collection efforts are continuously pursued. Loans may be restructured by management when a borrower has experienced some change in financial status, resulting in an inability to meet the original repayment terms, and when we believe the borrower will eventually overcome financial difficulties and repay the loan in full.

All interest accrued but not collected for loans and leases that are placed on nonaccrual status or charged-off is reversed against interest income. The interest on these loans is accounted for on a cash basis or cost recovery method, until qualifying for return to accrual status.

The nonperforming loans and leases increased to $52.2 million as of September 30, 2006, from $36.3 million as of December 31, 2005. The ratio of nonperforming loans and leases over total loans and leases increased to 3.05% as of September 30, 2006, from 2.30% as of December 31, 2005. This increase was mainly due to the combined effect of a $9.7 million increase in loans over 90 days past due still accruing interest and an increase of $6.2 million in nonaccrual loans. The increase in loans over 90 days still accruing interest was mainly concentrated in two commercial and construction loans secured by real estate, one for $3.8 million and the other for $2.3 million, with loan-to-values of 32% and 64%, respectively. It is important to point out that our historical losses on commercial and construction loans secured by real estate have been low. The increase in nonaccrual loans was mainly attributable to the combined effect of: an increase of $3.8 million in the commercial loans category, mostly secured by real estate; an increase of $1.5 million in the marine loans category, basically resulting from 15 loans classified as nonaccrual during the third quarter of 2006; and an increase of $1.2 million in lease financing contracts classified as nonaccrual loans. The increase in the commercial loans category included: two loans amounting to $1.6 million granted to different companies which are secured by real estate with loan-to-values of 71% and 84%, respectively; and other three loans amounting to $1.5 million granted to a construction company, for which real estate collateral is held for approximately 50% of the total debt and proceeds from specific assignments of construction contracts shall repay the remaining balance. At September 30, 2006, nonaccrual loans acquired from BankTrust amounted to $2.7 million, compared to $2.6 million as of December 31, 2005. We believe all loans and leases, with which we have serious doubts as to collectibility, are classified within the category of nonperforming loans and leases and are appropriately reserved.

OREO consists of properties acquired by foreclosure or similar means and that management intends to offer for sale. Other repossessed assets are comprised primarily of repossessed automobiles subject to lease contracts and boats. OREO and repossessed assets are initially recorded at the lower of net realizable value or book value. Any resulting loss is charged to the allowance for loan and lease losses. An appraisal of OREO and valuations of repossessed assets are made periodically after a property is acquired, and a comparison between the appraised value and the carrying value is performed. Additional declines in value after acquisition, if any, are charged to current operations. Gains or losses on disposition of OREO and repossessed assets, and related operating income and maintenance expenses, are included in current operations.

As of September 30, 2006, our OREO consisted of 26 properties with an aggregate value of $3.8 million, as compared to 13 properties with an aggregate value of $1.5 million as of December 31, 2005. During the first nine months of 2006, we repossessed 17 properties with an aggregate value of $4.8 million and sold 4 properties with an aggregate value of $2.6 million. In the third quarter of 2006, five properties with an aggregate value of $1.1 million were repossessed, of which four were related to a single credit facility. No repossessed properties were sold during the third quarter of 2006.

Other repossessed assets as of September 30, 2006 and December 31, 2005 were $10.0 million and $8.0 million, respectively. The increase in other repossessed assets was mainly due to the net effect of: an increase of $3.1 million in repossessed vehicles, and a decrease of $856,000 and $204,000 in repossessed boats and equipment, respectively. Even though the number of repossessed vehicles increased during the first nine months of 2006 when compared to the same period in 2005, the net increase during the nine months ended September 30, 2006, in term of units, was lower as sales of repossessed assets also increased for the first nine months of 2006 as compared to the same period in 2005. Total repossessed and sold vehicles during the first nine months of 2006 were 1,374 and 1,165, respectively, compared to 1,014 and 794 in the same period in 2005. We continue monitoring this inventory very closely and taking measures to prevent further deterioration and expedite its disposition. We have relocated our repossessed vehicles to a more accessible location in order to give them more exposure in an effort to increase sales to the public.

Together with OREO, the ratio of nonperforming assets as a percentage of total loans and leases plus repossessed property increased to 3.83% as of September 30, 2006, from 2.89% as of December 31, 2005.

Allowance for Loan and Lease Losses

We have established an allowance for loan and lease losses to provide for loans and leases in our portfolio that may not be repaid in their entirety. The allowance is based on our regular, monthly assessments of the probable estimated losses inherent in the loan and lease portfolio. Our methodology for measuring the appropriate level of the allowance relies on several key elements, which include the formula described below and specific allowances for identified problem loans and leases and portfolio segments.

When analyzing the adequacy of our allowance, our portfolio is segmented into as many components as practical. Although the evaluation of the adequacy of our allowance focuses on loans and leases and pools of similar loans and leases, no part of our allowance is segregated for, or allocated to, any particular asset or group of assets. Our allowance is available to absorb all credit losses inherent in our portfolio.

Each component would normally have similar characteristics, such as classification, type of loan or lease, industry or collateral. As needed, we separately analyze the following components of our portfolio and provide for them in our allowance:

·	credit quality;

·	sufficiency of credit and collateral documentation;

·	proper lien perfection;

·	appropriate approval by the loan officer and the loan committees;

·	adherence to any loan agreement covenants; and

·	compliance with internal policies and procedures and laws and regulations.

The general portion of our allowance is calculated by applying loss factors to all categories of loans and leases outstanding in our portfolio. We use historic loss rates determined over a period of years, which on an annual basis, are adjusted to reflect any current conditions that are expected to result in loss recognition. Factors that we consider include, but are not limited to:

·	effects of any changes in lending policies and procedures, including those for underwriting, collection, charge-offs, and recoveries;

·	changes in the experience, ability and depth of our lending management and staff;

·	concentrations of credit that might affect loss experience across one or more components of the portfolio;

·	levels of, and trends in, delinquencies and nonaccruals; and

·	national and local economic business trends and conditions.

The resulting loss factors are then multiplied against the current period’s balance of loans outstanding to derive an estimated loss. Rates for each pool are based on those factors management believes are applicable to that pool. When applied to a pool of loans or leases, the adjusted historical loss rate is a measure of the total inherent losses in the portfolio that would have been estimated if each individual loan or lease had been reviewed.

As a result of increasing loss ratios experienced in the later part of 2005, particularly with the Company’s auto lease portfolio, during the first quarter of 2006 we made some revisions to our methodology for the determination of the allowance for loan and lease losses to provide for more structured and timely monitoring of changes in loss trends and conditions. Additionally, new reports and analyses have been incorporated into our control process over such determination. In addition, as part of these revisions, we have also made some refinements to our methodology for estimating net realizable value of vehicles upon repossession. We feel these revisions will result in more timely recognition of losses in our automobile lease portfolio and better valuation of our repossessed vehicles.

In August 2006, we incorporated a new component to the evaluation of the adequacy of the allowance. This new component serves as a management tool to measure the probable effect that the following current internal and external environmental factors could have on the historical loss factors currently in use:

·	levels of and trends in delinquencies and impaired loans;

·	levels of and trends in charge-offs and recoveries;

·	trends in volume and terms of loans;

·	effects of any changes in risk selection and underwriting standards, and other changes in lending policies, procedures and practices;

·	experience, ability, and depth of lending management and other relevant staff;

·	national and local economic trends and conditions;

·	industry conditions; and

·	effects of changes in credit concentrations.

On a quarterly basis, a risk percentage is assigned to each environmental factor based on our judgment of the implied risk over each loan category. The result of our assumptions is then applied to the current period’s balance of loans outstanding to derive the probable effect these current internal and external environmental factors could have over the general portion of our allowance. The net allowance resulting from this procedure is included as an additional component in the evaluation of the adequacy of our allowance.

In addition to our general portfolio allowances, specific allowances are established in cases where management has identified significant conditions or circumstances related to a credit that management believes indicate a high probability that a loss will be incurred. This amount is determined following a consistent procedural discipline in accordance with Statement of Financial Accounting Standards (SFAS) No. 114, Accounting by Creditors for Impairment of a Loan (“SFAS No. 114”),as amended by SFAS No. 118, Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures.

Through periodic management review at branch and executive level and utilization of internal delinquency processes, both portfolios and individual loans and leases are monitored on an ongoing basis. When considered appropriate, a specific allowance will be considered on individual loan or lease accounts. A review is generally conducted of all the conditions surrounding any particular account such as the borrower’s character, existing and potential financial condition, realizable value of collateral, prospects for additional collateral and payment record. As a result, the loss potential is determined and specific allowances may be established. The level of allowance will vary depending on the analysis but we utilize the same classification categories as federal regulators, which result in varying amounts of reserve depending on loss potential.

As mentioned above, our methodology for the determination of the adequacy of the allowance for loan and lease losses for impaired loans is based on classifications of loans and leases into various categories and the application of SFAS No. 114, as amended. For non-classified loans, the estimated allowance is based on historical loss experiences as adjusted for changes in trends and conditions on an annual basis. In addition, on a quarterly basis, the estimated allowance for non-classified loans is adjusted for the probable effect that current environmental factors could have on the historical loss factors currently in use. While our allowance for loan and lease losses is established in different portfolio components, we maintain an allowance that we believe is sufficient to absorb all credit losses inherent in our portfolio.

Although our management believes that the allowance for loan and lease losses is adequate to absorb probable losses on existing loans and leases that may become uncollectible, there can be no assurance that our allowance will prove sufficient to cover actual loan and lease losses in the future. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the adequacy of our allowance for loan and lease losses. Such agencies may require us to make additional provisions to the allowance based upon their judgments about information available to them at the time of their examinations.

The table below summarizes, for the periods indicated, loan and lease balances at the end of each period, the daily averages during the period, changes in the allowance for loan and lease losses arising from loans and leases charged-off, recoveries on loans and leases previously charged-off, and additions to the allowance, and certain ratios related to the allowance for loan and lease losses:

		Nine Months Ended September 30,		Year Ended December 31,
		2006		2005
		(Dollars in thousands)

Average total loans and leases outstanding during period	$	1,641,923	$	1,487,850
Total loans and leases outstanding at end of period, including loans held for sale		1,707,075		1,577,196
Allowance for loan and lease losses:
Allowance at beginning of period		18,188		19,039
Charge-offs:
Real estate — secured		576		-
Commercial and industrial		2,393		4,848
Consumer		1,407		2,600
Leases		9,100		8,991
Other loans		97		150
Total charge-offs		13,573		16,589

		Nine Months Ended September 30,			Year Ended December 31,
		2006			2005
		(Dollars in thousands)
Recoveries:
Real estate — secured		—			-
Commercial and industrial		512			486
Consumer		318			256
Leases		1,310			2,210
Other loans		16			11
Total recoveries		2,156			2,963
Net loan and lease charge-offs		11,417			13,626
Provision for loan and lease losses		11,629			12,775
Allowance at end of period	$	18,400		$	18,188
Ratios:
Net loan and lease charge-offs to average total loans⁽¹⁾		0.93	%		0.92	%
Allowance for loan and lease losses to total loans at end of period		1.08			1.15
Net loan and lease charge-offs to allowance for loan losses at end of period⁽¹⁾		82.73			74.92
Net loan and lease charge-offs to provision for loan and lease losses		98.18			106.66

(1) Annualized as of September 30, 2006.

The allowance for loan and lease losses increased by 1.2%, or $212,000 to $18.4 million at September 30, 2006, compared to $18.2 million at December 31, 2005. The allowance for loan and lease losses as a percentage of total loans and leases decreased to 1.08% at September 30, 2006 from 1.15% at December 31, 2005. However, the loan portfolio growth during the first nine months of 2006 has been mostly concentrated in commercial loans secured by real estate, on which the risk of loss is lesser than in the other loan categories. We consider that the allowance for loan and lease losses, which is 1.08% of total loans and leases at September 30, 2006, is adequate to absorb probable losses in the portfolio.

On a quarterly basis, we have the practice of effecting partial charge-off on all lease finance contracts that are over 120 days past due. This is done based on our historical lease loss experience. For the nine months ended on September 30, 2006 and year 2005, we used a historical loss ratio in auto lease finance contracts of approximately 20.0% and 15.0%, respectively. Accordingly, all lease finance contracts that are over 120 days past due at the end of the quarter are partially charged-off. For the first nine months of 2006 and 2005, $1.7 million and $1.2 was charged off for this purpose, respectively.

Also, except for leases in a payment plan, bankruptcy or other legal proceedings, we have the practice of charging-off our lease finance contracts that are over 365 days past due. This full charge-off is made on a quarterly basis. Accordingly, most of our lease finance contracts that are over 365 days past due at the end of the quarter are fully charged-off. For the first nine months of 2006 and 2005, $577,000 and $1.1 million was charged off for this purpose, respectively.

Annualized net charge-offs as a percentage of average loans were 0.93% for the first nine months of 2006, compared to 0.91% and 0.92% for the fourth quarter and first nine months of 2005, respectively. Increase shown when comparing the first nine months of 2006 with the same period in 2005 was mainly due to the net effect of the deterioration of our lease portfolio and an increase in the average total loans net of unearned outstanding during 2006.

Net charge-offs as a percentage of provision for loan and lease losses decreased to 98.18% as of September 30, 2006, from 106.66% at December 31, 2005. This decrease was mainly due to the combined effect of an increase in our provision for loan and lease losses to account for the loss trends in the leasing portfolio, as previously mentioned, and to the fact that part of the net charge-offs for year 2005 were related to loans acquired from The Bank & Trust of Puerto Rico in May 2004, in which adequate allowances were also required and accordingly, additional provision was not considered necessary to replenish the reduction in the allowance. The increase in net charge-offs on commercial loans secured by real estate was mainly related to previously classified loans.

Nonearning Assets

Premises, leasehold improvements and equipment, net of accumulated depreciation and amortization, totaled $14.4 million at September 30, 2006 and $11.2 million at December 31, 2005. We have no definitive agreements regarding acquisition or disposition of owned or leased facilities and, for the near-term future, we do not expect significant changes in our total occupancy expense.

Deposits

Deposits are our primary source of funds. Average deposits for the third quarter and first nine months of 2006 were $1.726 billion and $1.719 billion, respectively, compared to $1.505 billion for the year 2005. The increase in average deposits during the first nine months of 2006 was mainly concentrated in brokered deposits. The continuous asset growth of financial institutions on the Island and the reduction of local funding sources, in part due to the elimination of the Section 936 of the US Internal Revenue Code, have generated a fierce competition for core deposits on the Island. During 2006, the fierce competition for local deposits made brokered deposits an attractive funding alternative, resulting in lower funding costs when compared to the unusually higher rates offered locally for time deposits. We decided to pursue the use of the brokered deposits alternative to control the continuous increase in our funding cost. The following table sets forth, for the periods indicated, the distribution of our average deposit account balances and average cost of funds on each category of deposits:

	Nine Months Ended September 30,								Year Ended December 31,
	2006								2005
	Average Balance		Percent of Deposits			Average Rate			Average Balance		Percent of Deposits			Average Rate

	(Dollars in thousands)
Noninterest-bearing demand deposits	$	129,046		7.51	%		-	%	$	129,676		8.62	%		-	%
Money market deposits		27,164		1.58			2.25			51,787		3.44			2.10
NOW deposits		46,405		2.70			2.22			46,421		3.09			1.85
Savings deposits		193,378		11.25			2.34			254,923		16.94			2.30
Time certificates of deposit in denominations of $100,000 or more		202,667		11.79			4.14			202,099		13.43			3.24
Brokered certificates of deposits in denominations of $100,000 or more		1,002,760		58.35			4.65			666,955		44.33			3.87
Other time deposits		117,232		6.82			3.59			152,787		10.15			3.10
Total deposits	$	1,718,652		100.00	%				$	1,504,648		100.00	%

Total deposits at September 30, 2006 and December 31, 2005 were $1.745 billion and $1.734 million, respectively, representing an increase of $11.1 million, or 0.86% on an annualized basis, in the first nine months of 2006. The following table presents the composition of our deposits by category as of the dates indicated:

		As of September 30, 2006		As of December 31, 2005
		(In thousands)
Interest bearing deposits:
NOW and money market	$	70,124	$	70,962
Savings		165,532		223,665
Brokered certificates of deposits in denominations of less than $100,000		1,114		2,972
Brokered certificates of deposits in denominations of $100,000 or more		1,065,714		964,233
Time certificates of deposits in denominations of $100,000 or more		210,236		203,708
Other time deposits		104,123		121,950
Total interest bearing deposits	$	1,616,843	$	1,587,490
Plus: non interest bearing deposits		128,406		146,638
Total deposits	$	1,745,249	$	1,734,128

In addition to the deposits we generate locally, we have also accepted brokered deposits to fund asset growth. The decrease in NOW and money market accounts, savings accounts, and other time deposits in denominations of less than $100,000 was mainly due to the fierce competition for core deposits on the Island. Accordingly, we increased brokered deposits to $1.067 billion and $967.2 million as of September 30, 2006 and December 31, 2005, respectively. Most of our brokered deposits have maturities of one to seven years. Because brokered deposits are generally more volatile and interest rate sensitive than other sources of funds, management closely monitors growth in this category.

The following table sets forth the amount and maturities of the time deposits of $100,000 or more as of the dates indicated:

	September 30, 2006		December 31, 2005
	(In thousands)
Three months or less	$	507,178	$	421,582
Over three months through six months		302,797		250,982
Over six months through 12 months		168,183		184,880
Over 12 months		297,793		310,497
Total	$	1,275,950	$	1,167,941

Other Sources of Funds

Securities Sold Under Agreements to Repurchase

To support our asset base, we sell securities subject to obligations to repurchase to securities dealers and the FHLB. These repurchase transactions generally have maturities of one month to less than five years. The following table summarizes certain information with respect to securities under agreements to repurchase for the third quarter of 2006 and the year ended December 31, 2005:

	Three Months Ended September 30, 2006			Year Ended December 31, 2005
	(Dollars in thousands)

Balance at period-end	$	501,100		$	419,860
Average monthly aggregate balance outstanding during the period		488,467			489,110
Maximum aggregate balance outstanding at any month-end		501,182			614,650
Weighted average interest rate for the period		5.26	%		3.33	%
Weighted average interest rate at period-end		5.29	%		4.25	%

FHLB Advances

Although deposits and repurchase agreements are the primary source of funds for our lending and investment activities and for general business purposes, we may obtain advances from the Federal Home Loan Bank of New York as an alternative source of liquidity. The following table provides a summary of FHLB advances for the third quarter of 2006 and the year ended December 31, 2005:

	Three Months Ended September 30, 2006			Year Ended December 31, 2005
	(Dollars in thousands)

Balance at period-end	$	8,720		$	8,759
Average monthly aggregate balance outstanding during the period		8,725			10,059
Maximum aggregate balance outstanding at any month-end		121,292			10,404
Weighted average interest rate for the period		5.44	%		4.93	%
Weighted average interest rate at period-end		5.30	%		5.37	%

Notes Payable to Statutory Trusts

For more detail on notes payable to statutory trusts please refer to “Note 12 - Notes Payable to Statutory Trusts” of the condensed consolidated financial statements included herein.

Capital Resources and Capital Adequacy Requirements

We are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can trigger regulatory actions that could have a material adverse effect on our business, financial condition, results of operations, cash flows and/or future prospects. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that rely on quantitative measures of our assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. Our capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

We monitor compliance with bank regulatory capital requirements, focusing primarily on the risk-based capital guidelines. Under the risk-based capital method of capital measurement, the ratio computed is dependent on the amount and composition of assets recorded on the balance sheet and the amount and composition of off-balance sheet items, in addition to the level of capital. Generally, Tier 1 capital includes common stockholders’ equity our Series A Preferred Stock, our junior subordinated debentures (subject to certain limitations) less goodwill. Total capital represents Tier 1 plus the allowance for loan and lease losses (subject to certain limits).

In the past three years, our primary sources of capital have been internally generated operating income through retained earnings, our initial public offering, and a private placement. As of September 30, 2006 and December 31, 2005, total stockholders’ equity was $170.3 million and $165.0 million, respectively.

We are not aware of any material trends that could materially affect our capital resources other than those described in the section entitled “Risk Factors,” in our most recent Annual Report on Form 10-K and Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on March 16, 2006 and August 9, 2006, respectively.

As of September 30, 2006, we and Eurobank both qualified as “well-capitalized” institutions under the regulatory framework for prompt corrective action. However, if our capital ratios fall below the levels necessary to be considered “well-capitalized” under current regulatory guidelines, we could be restricted in using brokered deposits as a short-term funding source. The following table presents the regulatory standards for well-capitalized institutions, compared to our capital ratios for Eurobank as of the dates specified:

Actual

For Minimum Capital

Adequacy Purposes

To Be Well Capitalized

Under Prompt Corrective

Action Provision

Amount Is

Ratio Is

Amount

Must Be

Ratio

Must Be

Amount

Must Be

Ratio

Must Be

(Dollars in thousands)

As of September 30, 2006:

Total Capital (to Risk Weighted Assets)

EuroBancshares, Inc

242,049

12.74

≥ $151,943

≥ 8.00

N/A

Eurobank.

198,395

10.44

≥ 152,030

≥ 8.00

≥ 190,038

≥ 10.00

Tier 1 Capital (to Risk Weighted Assets)

EuroBancshares, Inc

223,307

11.76

≥ 75,971

≥ 4.00

N/A

Eurobank

159,653

8.40

≥ 76,015

≥ 4.00

≥ 114,023

≥ 6.00

Leverage (to average assets)

EuroBancshares, Inc

223,307

9.02

≥ 99,056

≥ 4.00

N/A

Eurobank

159,653

6.45

≥ 99,013

≥ 4.00

≥ 123,767

≥ 5.00

As of December 31, 2005:

Total Capital (to Risk Weighted Assets)

EuroBancshares, Inc

238,570

13.49

≥ $141,479

≥ 8.00

N/A

Eurobank.

190,070

10.72

≥ 141,836

≥ 8.00

≥ 177,295

≥ 10.00

Tier 1 Capital (to Risk Weighted Assets)

EuroBancshares, Inc

220,157

12.45

≥ 70,740

≥ 4.00

N/A

Eurobank

151,657

8.55

≥ 70,918

≥ 4.00

≥ 106,377

≥ 6.00

Leverage (to average assets)

EuroBancshares, Inc

220,157

9.35

≥ 94,199

≥ 4.00

N/A

Eurobank

151,657

6.44

≥ 94,172

≥ 4.00

≥ 117,714

≥ 5.00

Liquidity Management

Maintenance of adequate core liquidity requires that sufficient resources be available at all times to meet our cash flow requirements. Liquidity in a banking institution is required primarily to provide for deposit withdrawals and the credit needs of customers and to take advantage of investment opportunities as they arise. Liquidity management involves our ability to convert assets into cash or cash equivalents without incurring significant loss, and to raise cash or maintain funds without incurring excessive additional cost. For this purpose the bank choose to maintain a minimum target liquidity referred as “Core Basis Surplus” and defined as the portion of the bank’s funds maintained in short term investments and other marketable assets, less the liabilities portions secured by any of these assets to cover a portion of time deposits maturing in 30 days and a portion of the non-maturity deposits, expressed as a percentage of total assets. This Core Basis Surplus number generally should be positive, but it may vary as our Asset and Liability Committee decides to maintain relatively large or small liquidity coverage, depending on its estimates of the general business climate, its expectations regarding the future course of interest rates in the near term, and the bank's current financial position. Two additional factors that will impact the magnitude of the Core Basic Surplus target are: 1) the available borrowing capacity at the Federal Home Loan Bank (FHLB), as represented by qualifying loans on the balance sheet that are not part of the calculation, and 2) unused brokered time deposits’ capacity relative to the bank’s related policy limit on acceptable levels of these deposits. For this reason, current FHLB advance and brokered time deposits availability are part of the bank's liquidity presentation. Our liquid assets as of September 30, 2006 and December 31, 2005 totaled approximately $232.2 million and $318.5 million, respectively. Our Core Basis Surplus liquidity level was 6.3% and 10.1% as of the same periods, respectively.

As a secondary source of liquidity, we rely on advances from the FHLB to supplement our supply of lendable funds and to meet deposit withdrawal requirements. Advances from the FHLB are typically secured by qualified residential and commercial mortgage loans, and investment securities. Advances are made pursuant to several different programs. Each credit program has its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based either on a fixed percentage of an institution’s net worth or on the FHLB’s assessment of the institution’s creditworthiness. Other funding alternatives available are local and United States conventional and brokered time deposits, unsecured lines of credit with correspondent banks, borrowing lines with brokers and the Federal Reserve Bank of New York. In order to participate in the broker time deposits market, we must be categorized as “well capitalized” under the regulatory framework for prompt corrective action unless we obtain a waiver from the Federal Deposit Insurance Corporation. Restrictions on our ability to participate in this market could place limitations on our growth strategy or could result in our participation in other more expensive funding sources. Our expansion strategies will have to be reviewed to reflect the possible limitation to funding sources and changes in cost structures. We do not foresee any changes in our capital ratios that would restrict our ability to participate in the brokered deposit market. Our target Core Basis Surplus liquidity ratio established in our Asset/Liability Management Policy is 0.0% or a “positive surplus”. Our liquidity demands are not seasonal and all trends have been stable over the last three years. We are not aware of any trends or demands, commitments, events or uncertainties that will result in or that are reasonably likely to materially impair our liquidity. Generally, financial institutions determine their target liquidity ratios internally, based on the composition of their liquidity assets and their ability to participate in different funding markets that can provide the required liquidity. In addition, the local market has characteristics, which make it impossible to compare our liquidity needs and sources to the liquidity needs and sources of our peers in the rest of the nation. After careful analysis of the diversity of liquidity sources available to us, our asset quality and the historic stability of our core deposits, we have determined that our target liquidity ratio is adequate.

In addition to the normal influx of liquidity from core deposit growth, together with repayments and maturities of loans and investments, we utilize brokered and out-of-market certificates of deposit, FHLB borrowings and broker-dealer repurchase agreements to meet our liquidity needs. The FHLB borrowings are collateralized by first mortgage residential loans, selected investment securities and FHLB stock. Pre-approved repurchase agreement availability with major brokers and banks totaled $314.8 million at September 30, 2006, subject to acceptable unpledged marketable securities available for sale. In addition, Eurobank is able to borrow from the Federal Reserve Bank using securities as collateral. Eurobank also maintains pre-approved clean overnight borrowing lines at various correspondent banks, which provided additional short-term borrowing capacity of $22.5 million at September 30, 2006.

Our net cash inflows from operating activities for the nine months ended September 30, 2006 were $44.9 million. During the first nine months of 2006 the net operating cash inflows were primarily provided by the combined effect of a decrease in other assets, an increase in accrued interest, expenses and other liabilities, and proceeds from sale of loans held for sale.

During 2005, asset growth was funded primarily with growth in deposits, mainly in brokered deposits, which increased $455.2 million. During 2005, cash inflows from operating activities exceeded cash outflows by $44.1 million.

Our net cash outflows from investing activities for the nine months ended September 30, 2006 and the year 2005 were $132.5 million and $319.6 million, respectively. The net investing cash outflows experienced during the first nine months of 2006 were mainly due to a net increase in loans. For 2005, the higher net investing cash outflows were primarily due to growth in the investment securities portfolio, which provided additional collateral in that year to support wholesale funding increases.

Our net cash inflows from financing activities for the nine months ended September 30, 2006 and the year 2005 were $86.5 million and $277.9 million, respectively. During the first nine months of 2006, the net financing cash outflows were primarily provided by an increase in repurchase agreements and deposits. During 2005, the net financing cash inflows were primarily provided by the net increase in deposits.

Quantitative and Qualitative Disclosure About Market Risks

Interest rate risk is the most significant market risk affecting us. Other types of market risk, such as foreign currency risk and commodity price risk, do not arise in the normal course of our business activities. Interest rate risk can be defined as the exposure to a movement in interest rates that could have an adverse effect on our net interest income or the market value of our financial instruments. The ongoing monitoring and management of this risk is an important component of our asset and liability management process, which is governed by policies established by Eurobank’s Board of Directors and carried out by Eurobank’s Asset/Liability Management Committee. The Asset/Liability Management Committee’s objectives are to manage our exposure to interest rate risk over both the one year planning cycle and the longer term strategic horizon and, at the same time, to provide a stable and steadily increasing flow of net interest income. Interest rate risk management activities include establishing guidelines for tenor and repricing characteristics of new business flow, the maturity ladder of wholesale funding, investment security purchase and sale strategies and mortgage loan sales, as well as derivative financial instruments. Eurobank may enter into interest rate swap agreements, in which it exchanges the periodic payments, based on a notional amount and agreed-upon fixed and variable interest rates. At September 30, 2006, the Bank had interest rate swap agreements which converted $29.1 million of fixed rate time deposits to variable rate time deposits of which $10.4 million will mature in 2010 and 2013 and $18.7 million with maturity between 2018 and 2023 but with semi-annual call options which match call options on the swaps. For more detail on derivative financial instruments please refer to “Note 11 - Derivative Financial Instruments” of the condensed consolidated financial statements included herein.

Our primary measurement of interest rate risk is earnings at risk, which is determined through computerized simulation modeling. The primary simulation model assumes a static balance sheet, using the balances, rates, maturities and repricing characteristics of all of the Bank’s existing assets and liabilities, including off-balance sheet financial instruments. Net interest income is computed by the model assuming market rates remaining unchanged and compares those results to other interest rate scenarios with changes in the magnitude, timing and relationship between various interest rates. At September 30, 2006, we modeled rising and declining interest rate simulations in 100 basis point increments over two years. The impact of imbedded options in such products as callable and mortgage-backed securities, real estate mortgage loans and callable borrowings were considered. Changes in net interest income in the rising and declining rate scenarios are then measured against the net interest income in the rates unchanged scenario. The Asset/Liability Management Committee utilizes the results of the model to quantify the estimated exposure of net interest income to sustained interest rate changes and to understand the level of risk/volatility given a range of reasonable and plausible interest rate scenarios. In this context, the core interest rate risk analysis examines the balance sheet under rates up/down scenarios that are neither too modest nor too extreme. All rate changes are “ramped” over a 12 month horizon based upon a parallel yield curve shift and maintained at those levels over the remainder of the simulation horizon. Using this approach, we are able to obtain results that illustrate the effect that both a gradual change of rates (year1) and a rate shock (year 2 and beyond) has on margin expectations.

In the September 30, 2006 simulation, our model indicated no exposure in the level of net interest income to gradual rising rates “ramped” for the first 12-month period, but an exposure in the level of net interest income to a rate shock of rising rates for the second 12-month period. This is caused by the effect of the volume of our commercial and industrial loans variable rate portfolio and our decision to maintain the maturity of repurchase agreements and brokered deposits, our primary funding source, from 30 days to 1 ½ year. The hypothetical rate scenarios consider a change of 100 and 200 basis points during two years. The decreasing rate scenarios have a floor of 200 basis points. At September 30, 2006, the net interest income at risk for year one in the 100 basis point falling rate scenario was calculated at $3,000, or 0.0% lower than the net interest income in the rates unchanged scenario, and $384,000, or 0.52%, lower than the net interest income in the rates unchanged scenario at the September 30, 2006 simulation with a 200 basis point decrease. The net interest income at risk for year two in the 100 basis point falling rate scenario was calculated at $274,000, or 0.36% higher than the net interest income in the rates unchanged scenario, and $1.1 million, or 1.39%, lower than the net interest income in the rates unchanged scenario at the September 30, 2006 simulation with a 200 basis point decrease. At September 30, 2006, the net interest income for year one in the 100 basis point rising rate scenario was calculated to be $546,000, or 0.73%, higher than the net interest income in the rates unchanged scenario, and $1.0 million, or 1.39%, higher than the net interest income in the rate unchanged scenario at the September 30, 2006 simulation with a 200 basis point increase. The net interest income at risk for year two in the 100 basis point rising rate scenario was calculated at $28,000, or 0.04% higher than the net interest income in the rates unchanged scenario, and $319,000, or 0.42%, lower than the net interest income in the rates unchanged scenario at the September 30, 2006 simulation with a 200 basis point increase. These exposures are well within our policy guidelines of 15.0% and 25.0% for 100 and 200 basis points changes in rate scenarios. Computation of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan and security prepayments, deposit run-offs and pricing and reinvestment strategies and should not be relied upon as indicative of actual results. Further, the computations do not contemplate any actions we may take in response to changes in interest rates. We cannot assure you that our actual net interest income would increase or decrease by the amounts computed by the simulations. The following table indicates the estimated impact on net interest income under various interest rate scenarios as of September 30, 2006:

	Change in Future Net Interest Income Gradual Raising Rate Scenario - Year 1
	At September 30, 2006
Change in Interest Rates	Dollar Change			Percentage Change
	(Dollars in thousands)
+200 basis points over year 1	$	1,039			1.39	%
+100 basis points over year 1		546			0.73
- 100 basis points over year 1		(3	)		0.00
- 200 basis points over year 1		(384	)		(0.52	)

	Change in Future Net Interest Income Rate Shock Scenario - Year 2
	At September 30, 2006
Change in Interest Rates	Dollar Change			Percentage Change
	(Dollars in thousands)
+200 basis points over year 2	$	(319	)		(0.42	)%
+100 basis points over year 2		28			0.04
- 100 basis points over year 2		274			0.36
- 200 basis points over year 2		(1,060	)		(1.39	)

We also monitor the repricing terms of our assets and liabilities through gap matrix reports for the rates in unchanged, rising and falling interest rate scenarios. The reports illustrate, at designated time frames, the dollar amount of assets and liabilities maturing or repricing.

The following table sets forth, on a stand-alone basis, Eurobank’s amounts of interest-earning assets, interest-bearing liabilities and the nominal amount of interest rate swaps outstanding at September 30, 2006, which we anticipate, based upon certain assumptions, to reprice or mature in each of the future time periods shown. The projected repricing of assets and liabilities anticipates prepayments and scheduled rate adjustments, as well as contractual maturities under an interest rate unchanged scenario within the selected time intervals. While we believe such assumptions are reasonable, we cannot assure you that assumed repricing rates will approximate our actual future deposit activity.

	As of September 30, 2006 Volumes Subject to Repricing Within
	0-1 Days			2-180 Days			181-365 Days			1-3 Years			Over 3 Years			Non-Interest Sensitive		Total
	(Dollars in thousands)
Assets:
Short-term investments and federal funds sold	$	44,608		$	20,285		$	—		$	—		$	—		$	—	$	64,893
Investment securities and FHLB/ Federal Reserve Bank stock		—			87,933			93,174			260,545			221,591			—		663,243
Loans		—			962,136			85,266			314,509			326,764			—		1,688,675
Fixed and other assets		—			—			—			—			—			84,167		84,167
Total assets	$	44,608		$	1,070,354		$	178,440		$	575,054		$	548,355		$	84,167	$	2,500,978

Liabilities and Stockholders’ Equity:
Interest-bearing checking, savings and money market accounts		—			23,901			—			—			341,260			—		365,161
Certificates of deposit		—			857,475			195,877			193,960			134,153			—		1,381,465
Borrowed funds					473,327			7,527			13,614			60,352			—		554,820
Other liabilities		—			—			—			—			—			29,258		29,258
Total swaps		—			30,800			—			(10,800	)		(20,000	)		—		—
Stockholders’ equity		—			10,763			—			—			—			159,511		170,274
Total liabilities and stockholders’ equity	$	—		$	1,396,266		$	203,404		$	196,774		$	515,765		$	188,769	$	2,500,978
Period gap	$	44,608			(325,912	)		(24,964	)	$	378,280			32,590
Cumulative gap	$	44,608			(281,304	)		(306,268	)	$	72,012		$	104,602
Period gap to total assets		1.78	%		(13.03	)%		(1.00	)%		15.13	%		1.30	%
Cumulative gap to total assets		1.78	%		(11.25	)%		(12.25	)%		2.88	%		4.18	%
Cumulative interest-earning assets to cumulative interest-bearing liabilities		N/A			79.85	%		80.85	%		104.01	%		104.52	%

Certain shortcomings are inherent in the method of analysis presented in the gap table. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. Additionally, certain assets, such as adjustable-rate loans, have features that restrict changes in interest rates, both on a short-term basis and over the life of the asset. More importantly, changes in interest rates, prepayments and early withdrawal levels may deviate significantly from those assumed in the calculations in the table. As a result of these shortcomings, we focus more on earnings at risk simulation modeling than on gap analysis. Even though the gap analysis reflects a ratio of cumulative gap to total assets within acceptable limits, the earnings at risk simulation modeling is considered by management to be more informative in forecasting future income at risk.

Finally, we also monitor core funding utilization in each interest rate scenario as well as market value of equity. These measures are used to evaluate long-term interest rate risk beyond the two-year planning horizon.

Aggregate Contractual Obligations

The following table represents our on and off-balance sheet aggregate contractual obligations, other than deposit liabilities, to make future payments to third parties as of the date specified:

	As of September 30, 2006
	Less than One Year		One Year to Three Years		Over Three Years to Five Years		Over Five Years
	(In thousands)
FHLB advances	$	8,200	$	—	$	—	$	520
Notes payable to statutory trusts		—		—		—		46,393
Operating leases		1,995		2,784		2,339		11,631
Total	$	10,195		2,784		2,339		58,544

Off-Balance Sheet Arrangements

During the ordinary course of business, we provide various forms of credit lines to meet the financing needs of our customers. These commitments, which have a term of less than one year, represent a credit risk and are not represented in any form on our balance sheets.

As of September 30, 2006 and December 31, 2005, we had commitments to extend credit of $317.6 million and $265.3 million, respectively. These commitments included standby letters of credit of $7.9 and $7.0 million, for September 30, 2006 and December 31, 2005, respectively, and commercial letters of credit $1.3 million for those same periods.

The effect on our revenues, expenses, cash flows and liquidity of the unused portions of these commitments cannot reasonably be predicted because there is no guarantee that the lines of credit will be used.

Recent Accounting Pronouncements

For more detail on recent accounting pronouncements please refer to “Note 2 - Recent Accounting Pronouncements” of the condensed consolidated financial statements included herein.

Recent Developments

On December 18, 2001, Eurobank Statutory Trust I, one of our non-banking subsidiaries, issued $25.0 million in floating rate Trust Preferred Securities due in 2031, with an option to redeem in five years. We have submitted a notice to our trustee of our intent to redeem the trust preferred securities on December 18, 2006. Unamortized placements costs as of that date in the amount of approximately $626,000 will be written-off on that same date.

The interest on these capital securities is payable at an annual rate equal to the three-month LIBOR, plus 3.60% with a ceiling rate of 12.50%. Assuming a rate of 8.99%, the actual rate to be paid over these capital securities up to December 17, 2006, such redemption could represent savings of approximately $2.2 million in interest expense on notes payable to statutory trusts for fiscal year 2007.

ITEM 3. Quantitative and Qualitative Disclosures about Market Risk

The information contained in the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations” as set forth in Part I, Item 2 of this Quarterly Report on Form 10-Q is incorporated herein by reference.

ITEM 4. Controls and Procedures

(a) Disclosure Controls and Procedures. We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives and in reaching a reasonable level of assurance our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As of September 30, 2006, we carried out an evaluation, under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our "disclosure controls and procedures," as such term is defined under Exchange Act Rule 13a-15(e). We previously reported that as of December 31, 2005, we had identified a material weakness in our internal control over financial reporting related to determining the allowance for loan and lease losses. While we have made progress in remediating the deficiencies in our internal control over financial reporting related to determining the allowance for loan and lease losses, there has been an insufficient period of time to determine whether the implemented processes are operating effectively. Based on this evaluation, our chief executive officer and chief financial officer concluded that, as of September 30, 2006, such disclosure controls and procedures were not effective to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.

(b) Changes in Internal Control Over Financial Reporting. There were no changes in our internal controls over financial reporting during the quarter ended September 30, 2006 that materially affected, or were reasonably likely to materially affect, our internal controls over financial reporting.

PART II - OTHER INFORMATION

ITEM 1. Legal Proceedings

From time to time, we and our subsidiaries are engaged in legal proceedings in the ordinary course of business, none of which are currently considered to have a material impact on our financial position or results of operation.

ITEM 1A. Risk Factors

The recent economic and government budget crisis in Puerto Rico could adversely affect our business, financial condition, results of operations, cash flows and/or future prospects.

Between May 1 and May 17, 2006, Puerto Rico experienced a partial government shutdown caused by the inability of the Legislature and Governor to agree on a budget, which resulted in an estimated $740 million budget shortfall. This government shutdown forced the closure of approximately 43 public agencies, including Puerto Rico’s public schools, leaving an estimated 90,000 government employees out of work. In response to this economic crisis, several bills were approved by the Puerto Rico legislature to impose additional taxes, some of which were applicable to the banking industry, resulting in an increase in our effective tax rate. For more information relating to additional taxes imposed to the banking industry, see the section captioned “Provision for Income Taxes” in Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Quarterly Report on Form 10-Q.

On May 17, 2006, the Puerto Rico Legislature reached an agreement on the retail sales tax rate that was approved in July 2006 and the Government Development Bank for Puerto Rico granted a loan of up to $741 million to the Puerto Rico Department of the Treasury to cover payroll and operational expenses of the Central Government. In addition, the Government Development Bank for Puerto Rico authorized the issuance of $675 million in General Obligation Bonds, of which $173 million benefits the municipalities for public works and infrastructure, and $316 million covers anticipations authorized for these public works. As per the Government Development Bank for Puerto Rico, this millionaire investment will have an immediate effect on the local economy.

In July 2006, the Commonwealth of Puerto Rico enacted legislation authorizing a new retail sales tax of 7%. The new retail tax of 7% sales tax is comprised of a 1.5% municipal tax, which some municipalities started collecting in July 2006, and a 5.5% central government tax scheduled to begin collection on November 15, 2006. In addition, this legislation allows the Governor to institute an additional retail sales tax of 1% after January 2007 if certain one-time tax measures relating to capital gains, dividends, and stock options do not generate $1 billion by December 2006. This additional retail sales tax of 1% will remain in effect until it has generated, along with the one-time measures, a total of $1 billion in collection of taxes. This legislation also abrogates the existing 6.6% general excise tax on imported goods and moderately reduces individual income taxes. The sales tax is expected to be more efficient and less prone to evasion than the previous excise tax and income tax systems.

In addition, the legislation mandates the establishment of measures to limit spending and a controlled budget plan for fiscal 2007. These measures include a significant reduction in debt service due to the 1% of sales tax designated for debt service and restructuring of debt transactions, as well as a millionaire reduction in non-debt service expenses by planned savings in the health and education areas.

On June 30, 2006, the Puerto Rico Planning Board (the “Planning Board”) revised its growth forecasts for fiscal years 2006 and 2007. According to the revision, the Planning Board estimated the Puerto Rico’s Gross National Product (GNP) growth rates for fiscal years 2006 and 2007 in 1.2% and 0.6% in real terms for the base case scenario, respectively, compared to 2.2% and 2.5% the Planning Board forecasted in January 2006 for those same periods.

In July 2006, Standard and Poor’s and Moody’s Investor Services (“Moody’s”) removed the Commonwealth of Puerto Rico general obligations and public debt from their “Watchlists.” As per the Government Development Bank for Puerto Rico, their determination reflects the recent passage of legislation authorizing a retail sales tax and mandating spending controls, as well as a balanced budget for the current fiscal year.

Although these actions could represent an affirmative attempt to address the government’s prolonged trend of budget and borrowings deficits, certain sectors believe the revenue yield of the sales tax could be lower than previously expected because of tax exemptions included in the law. Also, these sectors believe the government's plan to reduce expenditures heavily depends on debt restructuring and health and education cuts, which could be in an early phase of development.

An economic downturn, such as this, could contribute to the deterioration of the quality of our loan and corporate bond portfolios. During an economic downturn, affected borrowers may be less likely to repay interest and principal on their loans or bonds as scheduled. Moreover, the value of real estate or other collateral that secures the loans and bonds could be adversely affected by an economic downturn. This would cause the number of foreclosures to increase and, therefore, decrease our ability to recover losses on such properties and assets.

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2005, which could materially affect our business, financial condition, results of operations, cash flows and/or future prospects. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition, results of operations, cash flows and/or future prospects.

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

ITEM 3. Defaults Upon Senior Securities

None.

ITEM 4. Submission of Matters to a Vote of Security Holders

None.

ITEM 5. Other Information

Not applicable.

ITEM 6. Exhibits

Exhibit Number		Description of Exhibit
31.1		Rule 13a-14(a) Certification of Chief Executive Officer.

31.2		Rule 13a-14(a) Certification of Chief Financial Officer.

32.1		Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

SIGNATURES

Pursuant to the requirements of the Securities Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.


	EUROBANCSHARES, INC.

Date: November 9, 2006	By:	/s/ Rafael Arrillaga Torréns, Jr.
		Rafael Arrillaga Torréns, Jr. Chairman of the Board, President and Chief Executive Officer


Date: November 9, 2006	By:	/s/ Yadira R. Mercado
		Yadira R. Mercado Chief Financial Officer