SECTION 3: EX-13.1 (EX-13.1)

Financial Review and

Supplementary Information

Management’s Discussion and Analysis of Financial Condition and Results of Operations	2
Statistical Summaries	98
Financial Statements
Management’s Report to Stockholders	103
Report of Independent Registered Public Accounting Firm	104
Consolidated Statements of Condition as of December 31, 2012 and 2011	105
Consolidated Statements of Operations for the years ended December 31, 2012, 2011 and 2010	106
Consolidated Statements of Cash Flows for the years ended December 31, 2012, 2011 and 2010	109
Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2012, 2011 and 2010	108
Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2012, 2011 and 2010	107
Notes to Consolidated Financial Statements	110

Management’s Discussion and

Analysis of Financial Condition

and Results of Operations

Forward-Looking Statements	3
Overview	3
Critical Accounting Policies / Estimates	11
Statement of Operations Analysis	25
Net Interest Income	25
Provision for Loan Losses	29
Non-Interest Income	30
Operating Expenses	32
Income Taxes	34
Fourth Quarter Results	35
Reportable Segment Results	36
Statement of Financial Condition Analysis	40
Assets	40
Deposits and Borrowings	45
Stockholders’ Equity	46
Regulatory Capital	47
Off-Balance Sheet Arrangements and Other Commitments	50
Contractual Obligations and Commercial Commitments	50
Guarantees	51
Risk Management	55
Market / Interest Rate Risk	57
Liquidity	64
Credit Risk Management and Loan Quality	70
Enterprise Risk and Operational Risk Management	95
Adoption of New Accounting Standards and Issued But Not Yet Adopted Accounting Standards	95
Statistical Summaries	98
Statements of Condition	98
Statements of Operations	99
Average Balance Sheet and Summary of Net Interest Income	100
Quarterly Financial Data	102

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The following Management’s Discussion and Analysis (“MD&A”) provides information which management believes is necessary for understanding the financial performance of Popular, Inc. and its subsidiaries (the “Corporation” or “Popular”). All accompanying tables, consolidated financial statements, and corresponding notes included in this “Financial Review and Supplementary Information - 2012 Annual Report” (“the report”) should be considered an integral part of this MD&A.

FORWARD-LOOKING STATEMENTS

The information included in this report contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements may relate to the Corporation’s financial condition, results of operations, plans, objectives, future performance and business, including, but not limited to, statements with respect to expected earnings levels, the adequacy of the allowance for loan losses, delinquency trends, market risk and the impact of interest rate changes, capital market conditions, capital adequacy and liquidity, and the effect of legal proceedings and new accounting standards on the Corporation’s financial condition and results of operations. All statements contained herein that are not clearly historical in nature are forward-looking, and the words “anticipate,” “believe,” “continues,” “expect,” “estimate,” “intend,” “project” and similar expressions and future or conditional verbs such as “will,” “would,” “should,” “could,” “might,” “can,” “may,” or similar expressions are generally intended to identify forward-looking statements.

Forward-looking statements are not guarantees of future performance, are based on management’s current expectations and, by their nature, involve certain risks, uncertainties, estimates and assumptions by management that are difficult to predict. Various factors, some of which are beyond the Corporation’s control, could cause actual results to differ materially from those expressed in, or implied by, such forward-looking statements. Factors that might cause such a difference include, but are not limited to, the rate of growth in the economy and employment levels, as well as general business and economic conditions; changes in interest rates, as well as the magnitude of such changes; the fiscal and monetary policies of the federal government and its agencies; changes in federal bank regulatory and supervisory policies, including required levels of capital; the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Financial Reform Act) on the Corporation’s businesses, business practices and costs of operations; the relative strength or weakness of the consumer and commercial credit sectors and of the real estate markets in Puerto Rico and the other markets in which borrowers are located; the performance of the stock and bond markets; competition in the financial services industry; additional Federal Deposit Insurance Corporation (“FDIC”) assessments; and possible legislative, tax or regulatory changes. Other possible events or factors that could cause results or performance to differ materially from those expressed in such forward-looking statements include the following: negative economic conditions that adversely affect the general economy, housing prices, the job market, consumer confidence and spending habits which may affect, among other things, the level of non-performing assets, charge-offs and provision expense; changes in interest rates and market liquidity, which may reduce interest margins, impact funding sources and affect the ability to originate and distribute financial products in the primary and secondary markets; adverse movements and volatility in debt and equity capital markets; changes in market rates and prices, which may adversely impact the value of financial assets and liabilities; liabilities resulting from litigation and regulatory investigations; changes in accounting standards, rules and interpretations; increased competition; the Corporation’s ability to grow its core businesses; decisions to downsize, sell or close units or otherwise change the business mix of the Corporation; and management’s ability to identify and manage these and other risks. Moreover, the outcome of legal proceedings is inherently uncertain and depends on judicial interpretations of law and the findings of regulators, judges and juries.

All forward-looking statements included in this report are based upon information available to the Corporation as of the date of this report, and other than as required by law, including the requirements of applicable securities laws, management assumes no obligation to update or revise any such forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements.

The description of the Corporation’s business and risk factors contained in Item 1 and 1A of its Form 10-K for the year ended December 31, 2012 discusses additional information about the business of the Corporation and the material risk factors that, in addition to the other information in this report, readers should consider.

OVERVIEW

The Corporation is a diversified, publicly-owned financial holding company subject to the supervision and regulation of the Board of Governors of the Federal Reserve System. The Corporation has operations in Puerto Rico, the United States (“U.S.”) mainland, and the U.S. and British Virgin Islands. In Puerto Rico, the Corporation provides retail and commercial banking services through its principal banking subsidiary, Banco Popular de Puerto Rico (“BPPR”), as well as mortgage loans, investment banking, broker-dealer, auto and equipment leasing and financing, and insurance services through specialized subsidiaries. Effective December 31, 2012, Popular Mortgage, which was a wholly-owned subsidiary of BPPR prior to that date, was merged with and into BPPR as part of an internal reorganization.

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The Corporation’s mortgage origination business will continue to be conducted under the brand name Popular Mortgage. In the U.S. mainland, the Corporation operates Banco Popular North America (“BPNA”), including its wholly-owned subsidiary E-LOAN. BPNA focuses efforts and resources on the core community banking business. BPNA operates branches in New York, California, Illinois, New Jersey and Florida. E-LOAN markets deposit accounts under its name for the benefit of BPNA. As part of the rebranding of the BPNA franchise, all of its branches operate under a new name, Popular Community Bank. Note 41 to the consolidated financial statements presents information about the Corporation’s business segments.

The Corporation has several investments which accounts for under the equity method. These include the 48.5% interest in EVERTEC, a 20% interest in Centro Financiero BHD and our 24.9% interest in PRLP 2011 Holdings LLP, among other investments in limited partnerships which mainly hold investment securities. EVERTEC provides transaction processing services throughout the Caribbean and Latin America, including servicing many of the Corporation’s system infrastructures and transaction processing businesses. Centro Financiero BHD is a diversified financial services institution operating in the Dominican Republic. PRLP 2011 Holdings LLP is a joint venture to which the Corporation sold construction and commercial loans, most of which were non-performing, with a fair value of $148 million during the year 2011. For the year ended December 31, 2012, the Corporation recorded approximately $20.7 million in earnings from these investments on an aggregate basis. The carrying amounts of these investments as of December 31, 2012 were $246.8 million. Refer to Note 16 to the consolidated financial statements for additional information of the Corporation’s investments at equity.

The Corporation’s net income for the year ended December 31, 2012 amounted to $245.3 million, compared with net income of $151.3 million and $137.4 million for 2011 and 2010, respectively. The results for 2012 reflect an income tax benefit of $72.9 million related to reduction of the deferred tax liability on the estimated gains for tax purposes related to the loans acquired from Westernbank as a result of the closing agreement with the Puerto Rico Department of Treasury, which established that these would be taxed at a capital gain rate. Also, the results from 2012 reflect a benefit of approximately $26.9 million from the Corporation’s share of a tax benefit from a grant received by EVERTEC from the Puerto Rico Government. During 2011, the Corporation recorded an income tax expense of $103.3 million as a result of the reduction in the marginal tax rate, which was partially offset by a benefit of $53.6 million recorded as a result of a closing agreement with the Puerto Rico Department of Treasury, which deferred the deduction of charge-offs taken during 2009 and 2010 until the years 2013-2016. The results for 2010 include a $640.8 million gain on the sale of a majority interest in EVERTEC. Table 1 provides selected financial data for the past five years. For purposes of the discussions, assets subject to loss sharing agreements with the FDIC, including loans and other real estate owned, are referred to as “covered assets” or “covered loans” since the Corporation expects to be reimbursed for 80% of any future losses on those assets, subject to the terms of the FDIC loss sharing agreements.

During 2012, the Corporation maintained a strong net interest margin, produced solid and stable top line income throughout the challenging credit cycle, and reflected a reduction in its provision for loan losses. For 2012, top line income, defined as net interest income plus non-interest income, remained strong at $1.8 billion, while the provision for loan losses declined by $166.8 million, compared with 2011. Substantial efforts to bring down the cost of deposits helped maintain a strong net interest margin, on a taxable equivalent basis, of 4.47% for the year 2012.

In Puerto Rico, the credit environment appears to be stabilizing although credit costs remain high, but there has been improvement in some of the Corporation’s Puerto Rico loan portfolios during 2012, which contributed to a decline in the provision for loan losses in the BPPR reportable segment of $130.7 million compared with the year 2011. The improvement is the result of lower level of non-performing loans and improved credit performance. Current conditions in Puerto Rico make loan growth a challenge. However, the Corporation has seen growth in the mortgage lending sector. The Corporation experienced an increase in residential mortgage loan originations during 2012, when compared with 2011. The increase in mortgage loan origination volumes reflect the benefit of a low interest rate environment, the HARP and FHA Streamline programs and the housing incentives in P.R. which helped increase volumes during 2012. Also, the Corporation benefited from its strong position in the mortgage sector, having the highest market share in Puerto Rico. Credit management has remained a primary area of focus in the BPPR reportable segment, principally in the commercial, construction and mortgage lending areas.

The Corporation’s U.S. mainland operations were profitable during 2012 with net interest income benefiting from lower funding costs in the midst of improving credit conditions. The improved credit performance of BPNA resulted in a reduction in the provision for loan losses of $36.4 million for 2012, when compared to the previous year. The U.S. operations have followed the general credit trends on the mainland demonstrating progressive improvement. Furthermore, the successful disposition of OREOs contributed to reduced operating expenses. Management remains focused on increasing BPNA’s customer base, as it continues its strategy to transition from a mainly Hispanic-focused bank to a more broad-based community bank. The biggest challenge for the BPNA reportable segment is achieving healthy loan growth in the markets it serves at an adequate risk-adjusted return.

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Table 1 - Selected Financial Data
	Year ended December 31,
(Dollars in thousands, except per common share data)	2012			2011			2010			2009			2008
CONDENSED STATEMENTS OF OPERATIONS
Interest income	$	1,751,705		$	1,937,501		$	1,948,246		$	1,854,997		$	2,274,123
Interest expense		379,086			505,509			653,381			753,744			994,919
Net interest income		1,372,619			1,431,992			1,294,865			1,101,253			1,279,204
Provision for loan losses:
Non-covered loans		334,102			430,085			1,011,880			1,405,807			991,384
Covered loans		74,839			145,635			-			-			-
Non-interest income		466,342			560,277			1,288,193			896,501			829,974
Operating expenses		1,211,148			1,150,297			1,325,547			1,154,196			1,336,728
Income tax (benefit) expense		(26,403)			114,927			108,230			(8,302)			461,534
Income (loss) from continuing operations		245,275			151,325			137,401			(553,947)			(680,468)
Loss from discontinued operations, net of tax		-			-			-			(19,972)			(563,435)
Net income (loss)	$	245,275		$	151,325		$	137,401		$	(573,919)		$	(1,243,903)
Net income (loss) applicable to common stock	$	241,552		$	147,602		$	(54,576)		$	97,377		$	(1,279,200)
PER COMMON SHARE DATA[1]
Net income (loss) - basic and diluted:
From continuing operations	$	2.35		$	1.44		$	(0.62)		$	2.88		$	(25.46)
From discontinued operations		-			-			-			(0.49)			(20.05)
Total	$	2.35		$	1.44		$	(0.62)		$	2.39		$	(45.51)
Dividends declared	$	-		$	-		$	-		$	0.20		$	4.80
Book value		39.35			37.71			36.67			38.91			63.29
Market price		20.79			13.90			31.40			22.60			51.60
Outstanding shares:
Average - basic		102,429,755			102,179,393			88,515,404			40,822,950			28,107,920
Average - assuming dilution		102,653,610			102,289,496			88,515,404			40,822,950			28,107,920
End of period		103,169,806			102,590,457			102,272,780			63,954,011			28,200,471
AVERAGE BALANCES
Net loans [2]	$	24,845,494		$	25,617,767		$	25,821,778		$	24,836,067		$	26,471,616
Earning assets		31,569,702			32,931,332			34,154,021			34,083,406			36,026,077
Total assets		36,264,031			38,066,268			38,378,966			36,569,370			40,924,017
Deposits		26,903,933			27,503,391			26,650,497			26,828,209			27,464,279
Borrowings		4,415,624			5,846,874			7,448,021			5,832,896			7,378,438
Total stockholders’ equity		3,843,652			3,732,836			3,259,167			2,852,065			3,358,295
PERIOD END BALANCES
Net loans[2]	$	25,093,632		$	25,314,392		$	26,458,855		$	23,803,909		$	26,268,931
Allowance for loan losses		730,607			815,308			793,225			1,261,204			882,807
Earning assets		31,906,198			32,441,983			33,507,582			32,340,967			36,146,389
Total assets		36,507,535			37,348,432			38,814,998			34,736,325			38,882,769
Deposits		27,000,613			27,942,127			26,762,200			25,924,894			27,550,205
Borrowings		4,430,673			4,293,669			6,946,955			5,288,748			6,943,305
Total stockholders’ equity		4,110,000			3,918,753			3,800,531			2,538,817			3,268,364
SELECTED RATIOS
Net interest margin (taxable equivalent basis)		4.47	%		4.47	%		3.82	%		3.47	%		3.81	%
Return on average total assets		0.68			0.40			0.36			(1.57)			(3.04)
Return on average common stockholders’ equity		6.37			4.01			4.37			(32.95)			(44.47)
Tier I Capital to risk-adjusted assets		17.35			15.97			14.52			9.81			10.81
Total Capital to risk-adjusted assets		18.63			17.25			15.79			11.13			12.08

[1] Per share data is based on the average number of shares outstanding during the periods, except for the book value and market price which are based on the information at the end of the periods. All per share data has been adjusted to retroactively reflect the 1-for-10 reverse stock split effected on May 29, 2012.

[2] Includes loans held-for-sale and covered loans.

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During 2012, the Corporation strived to mitigate the decline in earning assets amid challenging economic conditions in Puerto Rico, its principal market. The BPPR reportable segment’s non-covered loans held-in-portfolio increased by $392 million from December 31, 2011 to the same date in 2012, as a result of higher origination volumes and the purchase of high quality loans. Mortgage loan originations for the BPPR reportable segment totalled $1.5 billion, an increase of $272 million from 2011. Also, during 2012, the BPPR reportable segment purchased $265 million (unpaid principal balance) in consumer loans. Furthermore, the U.S. reportable segment recorded mortgage loan purchases of approximately $486 million during 2012, while it did not purchase mortgage loans in 2011.

During the first half of 2011, the Corporation completed two bulk purchases of residential mortgage loans from a Puerto Rico financial institution, adding $518 million in performing mortgage loans to its portfolio. In August 2011, the Corporation completed the purchase of Citibank’s AAdvantage co-branded credit card portfolio in Puerto Rico and the U.S. Virgin Islands, which represented approximately $131 million in balances. In addition, BPPR entered into an agreement with American Airlines, Inc. to become the exclusive issuer of AAdvantage co-branded credit cards in those two regions. Also, during 2011 the Corporation executed sales of $457 million (unpaid principal balance) non-performing mortgage loans at BPNA and $358 million in unpaid principal balance of construction and commercial real estate loans at BPPR as part of its de-risking strategy.

The year 2010 was one of several accomplishments for the Corporation that contributed to the Corporation’s profitability and de-risking in 2011. In an effort to position the Corporation for its participation in an FDIC-assisted transaction in Puerto Rico, during 2010 the Corporation enhanced its capital position with an equity offering in which it raised $1.15 billion of new common equity capital. This capital raise, along with the after-tax gain of $531.0 million, net of transaction costs, on the sale of a 51% interest in EVERTEC, substantially strengthened the Corporation’s capital ratios, placing it in a position to participate in the consolidation of the Puerto Rico banking market and to pursue strategies to improve the credit quality of its loan portfolio. Furthermore, the Westernbank FDIC-assisted transaction proved to be an important strategic move that further solidified the Corporation’s leadership position in Puerto Rico amid a contracting market and has contributed with a positive financial impact. Apart from expanding its client base, the covered assets have boosted the Corporation’s net interest margin and other revenues. The yield on covered loans approximated 7.44% and 8.95% for the years ended December 31, 2012 and 2011, respectively. Table 2 provides a summary of the gross revenues derived from the assets acquired in the FDIC-assisted transaction during 2012, 2011 and 2010.

Table 2 - Financial Information - Westernbank FDIC-Assisted Transaction

	Year ended December 31,
(In thousands)	2012			2011			2010
Interest income:
Interest income on covered loans, except for discount accretion on ASC 310-20 covered loans	$	301,441		$	375,595		$	223,271
Discount accretion on ASC 310-20 covered loans		-			37,083			79,825
Total interest income on covered loans		301,441			412,678			303,096
FDIC loss share (expense) income :
(Amortization) accretion of loss share indemnification asset		(129,676	)		(10,855	)		73,487
80% mirror accounting on credit impairment losses[1]		58,187			110,457			-
80% mirror accounting on reimbursable expenses		29,234			5,093			-
80% mirror accounting on discount accretion for loans and unfunded commitments accounted for under ASC 310-20		(969	)		(33,221	)		(95,383)
Change in true-up payment obligation		(13,178	)		(6,304	)		(3,855)
Other		191			1,621			-
Total FDIC loss share (expense) income		(56,211	)		66,791			(25,751)
Fair value change in equity appreciation instrument		-			8,323			42,555
Amortization of contingent liability on unfunded commitments (included in other operating income)		1,211			4,487			39,404
Total revenues		246,441			492,279			359,304
Provision for loan losses		74,839			145,635			-
Total revenues less provision for loan losses	$	171,602		$	346,644		$	359,304

[1] Reductions in expected cash flows for ASC 310-30 loans, which may impact the provision for loan losses, may consider reductions in both principal and interest cash flow expectations. The amount covered under the FDIC loss sharing agreements for interest not collected from borrowers is limited under the agreements (approximately 90 days); accordingly, these amounts are not subject fully to the 80% mirror accounting.

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Average balances
	Year ended December 31,
(In millions)		2012		2011
Covered loans	$	4,051	$	4,613
FDIC loss share asset		1,680		2,177
Note issued to the FDIC		-		1,382

Interest income on covered loans for the year 2012 amounted to $301.4 million vs. $412.7 million in 2011, reflecting a yield of 7.44% vs. 8.95%, for each year respectively. This portfolio, due to its nature, should continue to decline as scheduled payments are received and workout arrangements are made. The yield variance was impacted by the fact that the interest income for 2011 includes $37.1 million of discount accretion related to covered loans accounted for under ASC 310-20. As previously mentioned, this discount was fully accreted into earnings during 2011. Also, during 2011, resolutions of certain large commercial loan relationships caused the unamortized discount to be recognized into income for one pool and increased the accretable yield to be recognized over a short period of time for another pool. Interest income for the year 2010 reflected only eight months of income vs. a full year of earnings for the year 2011.

The FDIC loss share reflected an expense of $56.2 million for 2012, compared to an income of $66.8 million for 2011. This was the result of a lower provision for loan losses on covered loans by $70.8 million and higher amortization of the FDIC loss share asset due to a decrease in expected losses, partially offset by the favorable mirror accounting on expenses reimbursable from the FDIC and discount accretion on loans and unfunded commitments subject to ASC 310-20 since the discount on these loans had been fully accreted by the end of the third quarter of 2011.

The decrease in the provision for loan losses for covered loans from 2011 to 2012 was mostly driven by certain commercial and construction loan pools accounted for under ASC 310-30 which reflected lower expected loss estimates and reductions in the specific reserves of certain commercial loan relationships accounted for under ASC 310-20. The covered loan portfolio did not require an allowance for loan losses at December 31, 2010.

Although the reduction in estimated loan losses increases the accretable yield to be recognized over the life of the loans, it also has the effect of lowering the realizable value of the loss share asset since the Corporation would receive lower FDIC payments under the loss share agreements. This is reflected in the increased amortization of the loss share asset for 2012. This is also reflected in the increase in the fair value of the true-up payment obligation. The change in the amortization of the loss share asset from 2010 to 2011 also reflected lower estimated losses from year to year.

The discussion that follows provides highlights of the Corporation’s results of operations for the year ended December 31, 2012 compared to the results of operations of 2011. It also provides some highlights with respect to the Corporation’s financial condition, credit quality, capital and liquidity. Table 3 presents a five-year summary of the components of net income (loss) as a percentage of average total assets.

Table 3 - Components of Net Income (Loss) as a Percentage of Average Total Assets
	2012			2011			2010			2009			2008
Net interest income		3.79	%		3.76	%		3.38	%		3.01	%		3.13	%
Provision for loan losses		(1.13	)		(1.51	)		(2.64	)		(3.84	)		(2.42	)
Net gain on sale and valuation adjustments of investment securities		-			0.03			0.01			0.60			0.17
Net gain (loss) on sale of loans, including adjustments to indemnity reserves, and valuation adjustments on loans held-for-sale		0.08			(0.01	)		(0.15	)		(0.10	)		0.01
Trading account (loss) profit		(0.05	)		0.01			0.04			0.11			0.11
FDIC loss share (expense) income		(0.16	)		0.18			(0.07	)		-			-
Fair value change in equity appreciation instrument		-			0.02			0.11			-			-
Gain on sale of processing and technology business		-			-			1.67			-			-
Other non-interest income		1.42			1.24			1.74			1.84			1.74
Total net interest income and non-interest income, net of provision for loan losses		3.95			3.72			4.09			1.62			2.74
Operating expenses		(3.34	)		(3.02	)		(3.45	)		(3.16	)		(3.27	)
Income (loss) from continuing operations before income tax		0.61			0.70			0.64			(1.54	)		(0.53	)
Income tax benefit (expense)		0.07			(0.30	)		(0.28	)		0.02			(1.13	)
Income (loss) from continuing operations		0.68			0.40			0.36			(1.52	)		(1.66	)
Loss from discontinued operations, net of tax		-			-			-			(0.05	)		(1.38	)
Net income (loss)		0.68	%		0.40	%		0.36	%		(1.57	)%		(3.04	)%

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Net interest income on a taxable equivalent basis for the year ended December 31, 2012 amounted to $1.4 billion, a decrease of $64.0 million, compared with 2011. The net interest margin on a taxable equivalent basis remained flat at 4.47% for the years ended December 31, 2012 and 2011. Although there was a decrease in the yield of interest earning assets, this was offset by the decrease in cost of funds. Refer to the Net Interest Income section of this MD&A for a discussion of the major variances in net interest income, including yields and costs.

The provision for loan losses for the year ended December 31, 2012 decreased by $166.8 million, or 29%, compared with 2011, which was the net result of a decrease in the provision for non-covered loans of $96.0 million, coupled with a decrease in the provision for loan losses on covered loans of $70.8 million. The allowance for loan losses was 2.96% of non-covered loans held-in-portfolio at December 31, 2012, compared with 3.35% at December 31, 2011. Total net charge-offs for 2012 decreased $61.1 million, compared with 2011. The reduction in the allowance for loan losses for non-covered loans at December 31, 2012, compared with 2011, was mostly attributable to a lower portfolio balance and net charge-offs from the commercial and construction loan portfolios, and an improvement in the credit quality performance of the Corporation’s consumer loan portfolios, partially offset by higher specific reserve requirements on the mortgage loan portfolio. Year-over-year, total non-performing assets decreased by $364 million, driven by resolution of non-performing loans and a reduction in non-performing construction loans, offset in part by an increase in other real estate owned. The Corporation’s non-covered, non-performing loans held-in-portfolio decreased by $313 million from December 31, 2011 to the same date in 2012, reaching $1.4 billion or 6.79% of total non-covered loans held-in-portfolio at December 31, 2012, compared to 8.44% for the same date in 2011. The decrease in non-performing loans held-in-portfolio was reflected in the commercial, construction and residential mortgage loan portfolios of the BPPR reportable segment.

The provision for the Puerto Rico reportable segment for the year ended December 31, 2012 decreased by $130.3 million from the year 2011, driven mainly by a lower provision in the covered portfolio. The provision for the covered portfolio was lower by $70.8 million and reflected lower expected losses in loans accounted by ASC Subtopic 310-30, mainly in commercial and construction loan pools. The provision for the non-covered portfolio decreased by $59.5 million, mainly driven by lower net charge offs and lower allowance for loan losses in the commercial and construction portfolios. This was offset by higher allowance levels for the mortgage loan portfolio due to specific reserves for restructured loans. The BPNA reportable segment reflected lower provisions for the year ended December 31, 2012, compared to 2011 by $36.5 million. This was principally as a result of lower net charge-offs mainly from the legacy, commercial and consumer loan portfolios due to improved credit performance.

Refer to the Provision for Loan Losses and Credit Risk Management and Loan Quality section of this MD&A for information on the allowance for loan losses, non-performing assets, troubled debt restructurings, net charge-offs and credit quality metrics.

Non-interest income for the year ended December 31, 2012 amounted to $466.3 million, a decrease of $93.9 million, compared with 2011, mainly due to the FDIC loss share expense. The FDIC loss share reflected an expense of $56.2 million for 2012, compared to an income of $66.8 million for 2011. This was the result of a lower provision for loan losses on covered loans and higher amortization of the loss share asset due to a decrease in expected losses, partially offset by the favorable mirror accounting on expenses reimbursable from the FDIC and discount accretion on loans subject to ASC 310-20 and unfunded commitments. Non-interest income for the year ended December 31, 2010 was $1.3 billion. The results for 2010 reflected a $640.8 million gain on the sale of the 51% interest in EVERTEC. Refer to the Non-Interest Income section of this MD&A for a table that provides a breakdown of the different categories of non-interest income.

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Total operating expenses for the year 2012 amounted to $1.2 billion, an increase of $60.9 million, when compared with the previous year. The increase was reflected in the Puerto Rico operations. Higher operating expenses in the Puerto Rico reportable segment were principally due to a loss on early extinguishment of structured repos of approximately $25.0 million; higher professional fees and other operating expenses of $16.0 million and $17.2 million, respectively, some of which are collection and credit related costs reimbursable by the FDIC; and an increase of $14.9 million in OREO expenses due mainly to subsequent fair value adjustments. The U.S. reportable segment reflected a decrease in operating expenses of approximately $11.6 million, principally due to lower OREO expenses due to realized gains on sales of foreclosed properties. Refer to the Operating Expenses section of this MD&A for additional explanations on the major variances in the different categories of operating expenses.

For the year 2012, the Corporation recorded an income tax benefit of $26.4 million, compared to an income tax expense of $114.9 million for the year 2011. During the second quarter of 2012, the Corporation recorded a benefit of $72.9 million, as a reduction of the deferred tax liability on the estimated gains for tax purposes related to the loans acquired from Westernbank, pursuant to a closing agreement with the Puerto Rico Department of Treasury by which these will be taxed at capital gain rates. During 2011, the Corporation recorded an income tax expense of $103.3 million and a decrease in the net deferred tax assets of the Puerto Rico operations resulting from the reduction in the marginal tax rate from 39% to 30% as a result of the enactment of a new Internal Revenue Code in Puerto Rico. This expense in 2011 was partially offset by a tax benefit of $53.6 million recorded in June 2011 for the recognition of certain tax benefits not previously recorded during 2009 (the benefit of reduced tax rates for capital gains) and 2010 (the benefit of the tax-exempt income) as a result of a closing agreement with the Puerto Rico Treasury Department, which also established that the deductions for charge offs during 2009 and 2010 could be deferred until 2013-2016. Refer to the Income Taxes section in this MD&A and Note 39 to the consolidated financial statements for information on the private ruling issued by the Puerto Rico Department of the Treasury to the Corporation, as well as other detailed information such as the changes in the tax rate.

Total assets amounted to $36.5 billion at December 31, 2012, compared with $37.3 billion at December 31, 2011, a decrease of $0.8 billion. Total earning assets at December 31, 2012 amounted to $31.9 billion, a decrease of $0.5 billion, or 1.5%, compared with December 31, 2011.

Total loans, including loans held-for-sale and covered loans, decreased $221 million from December 31, 2011 to the same date in 2012, principally in commercial loans, partially offset by higher volume of mortgage and consumer loans held-in-portfolio. The decrease was principally in the Puerto Rico operations, mainly in the covered loans by $593 million, offset by the increase in the non-covered portfolio of $381 million driven primarily by mortgage loans. The Corporation’s U.S. mainland operations experienced a reduction in total loans of $12 million, reflecting decreases in legacy loans, offset by increased volume of mortgage loans. The decline in total loans was mainly due to portfolio run-off, loan sales, charge-offs and reclassifications to repossessed properties as part of foreclosure proceedings, coupled with low new loan demand in certain loan segments.

Refer to Table 18 in the Statement of Financial Condition Analysis section of this MD&A for the percentage allocation of the composition of the Corporation’s financing to total assets. Deposits amounted to $27.0 billion at December 31, 2012, compared with $27.9 billion at December 31, 2011. Table 19 presents a breakdown of deposits by major categories. The decrease in deposits was mostly associated with lower volume of brokered and time deposits, partially offset by higher volume of savings and demand deposits. The decrease in brokered and time deposits was part of the Corporation’s strategy to replace these with lower cost advances from the Federal Home Loan Bank of New York. The Corporation’s borrowings amounted to $4.4 billion at December 31, 2012, compared with $4.3 billion at December 31, 2011.

Stockholders’ equity amounted to $4.1 billion at December 31, 2012, compared with $3.9 billion at December 31, 2011. The Corporation continues to be well-capitalized at December 31, 2012. The Corporation’s regulatory capital ratios improved from December 31, 2011 to December 31, 2012. The Tier 1 risk-based capital and Tier 1 common equity to risk-weighted assets stood at 17.35% and 13.18%, respectively, at December 31, 2012, compared with 15.97% and 12.10%, respectively, at December 31, 2011. The improvement in the Corporation’s regulatory capital ratios from the end of 2011 to December 31, 2012 was principally due to a reduction in assets, changes in balance sheet composition including the increase in assets with lower risk-weightings such as mortgage loans, and internal capital generation from earnings.

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In summary, 2012 was a solid year during which the Corporation sustained its strong net interest margin, reflected lower provision for loan losses and reported operational profits. As mentioned above, the Corporation remains over the well-capitalized levels at the end of 2012. The covered loans portfolio has provided better than expected results reflecting lower estimated losses, driving lower provisions. The Corporation’s leading position in the Puerto Rico market has allowed it to benefit from the improved loan demand in certain sectors. During 2012, there were notable reductions in the levels of non-performing assets, reflecting the continuous efforts to resolve non-performing loans.

Key transactions during the past years, including the reorganization of the U.S. operations to exit high-risk businesses, the acquisition of assets of Westernbank on the FDIC-assisted transaction and the acquisition of Citibank’s retail business in Puerto Rico, strengthened the Corporation’s financial position. The capital raise and sale of EVERTEC positioned the Corporation to participate in the FDIC-assisted transaction.

Operationally, the Corporation is a smaller organization than it was a few years ago. The Corporation is now focused on its core banking business both in Puerto Rico and the U.S. mainland. Heading into 2013, management expects the Puerto Rico economy to remain flat and the U.S. mainland economy to grow moderately.

Moving forward, in Puerto Rico, the Corporation also expects to continue pursuing resolution and sales of non-performing loans, further enhance loss-mitigation areas, redesign processes and consolidate branches to achieve greater efficiencies and continue to identify opportunities to add lower-risk assets that can be managed within the existing business platforms. In the U.S. mainland, the Corporation expects to solidify the trend of improving credit quality by continuing the run-off or disposition of discontinued portfolios, actively managing the existing classified portfolio, and identifying new asset growth in selected loan categories. Also, going forward, BPNA plans to continue improving its client mix, maximizing the value of the rebranding, achieving growth in targeted loan portfolios both organically and through asset acquisitions and continue enhancing its retail network and products offerings.

For further discussion of operating results, financial condition and business risks refer to the narrative and tables included herein.

The shares of the Corporation’s common stock are traded on the NASDAQ Global Select Market under the symbol BPOP. Table 4 shows the Corporation’s common stock performance on a quarterly basis during the last five years.

Table 4 - Common Stock Performance

	Market Price				Cash Dividends		Book Value		Dividend			Price/ Earnings			Market/Book
	High		Low		Declared per Share		Per Share		Yield [1]			Ratio			Ratio
2012							$	39.35		N.M.			8.85	x		52.83         %
4th quarter	$	20.90	$	17.42	$	-
3rd quarter		18.74		13.55		-
2nd quarter		21.20		13.58		-
1st quarter		23.00		14.30		-
2011								37.71		N.M.			9.65			36.86
4th quarter	$	19.00	$	11.15	$	-
3rd quarter		28.30		13.70		-
2nd quarter		32.40		26.30		-
1st quarter		35.33		28.70		-
2010								36.67		N.M.			(50.65)			85.63
4th quarter	$	31.40	$	27.01	$	-
3rd quarter		29.50		24.50		-
2nd quarter		40.20		26.40		-
1st quarter		29.10		17.50		-
2009								38.91		2.55	%		9.46			58.08
4th quarter	$	28.00	$	21.20	$	-
3rd quarter		28.30		10.40		-
2nd quarter		36.60		21.90		-
1st quarter		55.20		14.70		0.20
2008								63.29		6.17			(1.13)			81.53
4th quarter	$	86.10	$	49.00	$	0.80
3rd quarter		111.70		51.20		0.80
2nd quarter		130.60		65.90		1.60
1st quarter		140.70		89.00		1.60

[1] Based on the average high and low market price for the four quarters.

Note: All per share data has been adjusted to retroactively reflect the 1-for-10 reverse stock split effected on May 29, 2012.

N.M. – Not meaningful.

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CRITICAL ACCOUNTING POLICIES / ESTIMATES

The accounting and reporting policies followed by the Corporation and its subsidiaries conform with generally accepted accounting principles (“GAAP”) in the United States of America and general practices within the financial services industry. The Corporation’s significant accounting policies are described in detail in Note 2 to the consolidated financial statements and should be read in conjunction with this section.

Critical accounting policies require management to make estimates and assumptions, which involve significant judgment about the effect of matters that are inherently uncertain and that involve a high degree of subjectivity. These estimates are made under facts and circumstances at a point in time and changes in those facts and circumstances could produce actual results that differ from those estimates. The following MD&A section is a summary of what management considers the Corporation’s critical accounting policies / estimates.

Fair Value Measurement of Financial Instruments

The Corporation measures fair value as required by ASC Subtopic 820-10 “Fair Value Measurements and Disclosures”, which defines fair value as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Corporation currently measures at fair value on a recurring basis its trading assets, available-for-sale securities, derivatives, mortgage servicing rights and contingent consideration. Occasionally, the Corporation may be required to record at fair value other assets on a nonrecurring basis, such as loans held-for-sale, impaired loans held-in-portfolio that are collateral dependent and certain other assets. These nonrecurring fair value adjustments typically result from the application of lower of cost or fair value accounting or write-downs of individual assets.

The Corporation categorizes its assets and liabilities measured at fair value under the three-level hierarchy. The level within the hierarchy is based on whether the inputs to the valuation methodology used for fair value measurement are observable. The hierarchy is broken down into three levels based on the reliability of inputs as follows:

• Level 1 - Unadjusted quoted prices in active markets for identical assets or liabilities that the Corporation has the ability to access at the measurement date. No significant degree of judgment for these valuations is needed, as they are based on quoted prices that are readily available in an active market.

• Level 2 - Quoted prices other than those included in Level 1 that are observable either directly or indirectly. Level 2 inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, and other inputs that are observable or that can be corroborated by observable market data for substantially the full term of the financial instrument.

• Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value measurement of the financial asset or liability. Unobservable inputs reflect the Corporation’s own assumptions about what market participants would use to price the asset or liability, including assumptions about risk. The inputs are developed based on the best available information, which might include the Corporation’s own data such as internally-developed models and discounted cash flow analyses.

The Corporation requires the use of observable inputs when available, in order to minimize the use of unobservable inputs to determine fair value. The inputs or methodologies used for valuing securities are not necessarily an indication of the risk associated with investing on those securities. The amount of judgment involved in estimating the fair value of a financial instrument depends

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upon the availability of quoted market prices or observable market parameters. In addition, it may be affected by other factors such as the type of instrument, the liquidity of the market for the instrument, transparency around the inputs to the valuation, as well as the contractual characteristics of the instrument.

If listed prices or quotes are not available, the Corporation employs valuation models that primarily use market-based inputs including yield curves, interest rate curves, volatilities, credit curves, and discount, prepayment and delinquency rates, among other considerations. When market observable data is not available, the valuation of financial instruments becomes more subjective and involves substantial judgment. The need to use unobservable inputs generally results from diminished observability of both actual trades and assumptions resulting from the lack of market liquidity for those types of loans or securities. When fair values are estimated based on modeling techniques such as discounted cash flow models, the Corporation uses assumptions such as interest rates, prepayment speeds, default rates, loss severity rates and discount rates. Valuation adjustments are limited to those necessary to ensure that the financial instrument’s fair value is adequately representative of the price that would be received or paid in the marketplace.

The fair value measurements and disclosures guidance in ASC Subtopic 820-10 also addresses measuring fair value in situations where markets are inactive and transactions are not orderly. Transactions or quoted prices for assets and liabilities may not be determinative of fair value when transactions are not orderly and thus may require adjustments to estimate fair value. Price quotes based on transactions that are not orderly should be given little, if any, weight in measuring fair value. Price quotes based upon transactions that are orderly shall be considered in determining fair value and the weight given is based on facts and circumstances. If sufficient information is not available to determine if price quotes are based upon orderly transactions, less weight should be given to the price quote relative to other transactions that are known to be orderly.

The lack of liquidity is incorporated into the fair value measurement based on the type of asset measured and the valuation methodology used. An illiquid market is one in which little or no observable activity has occurred or one that lacks willing buyers or willing sellers. Discounted cash flow techniques incorporate forecasting of expected cash flows discounted at appropriate market discount rates which reflect the lack of liquidity in the market which a market participant would consider. Broker quotes used for fair value measurements inherently reflect any lack of liquidity in the market since they represent an exit price from the perspective of the market participants.

Management believes that fair values are reasonable and consistent with the fair value measurement guidance based on the Corporation’s internal validation procedure and consistency of the processes followed, which include obtaining market quotes when possible or using valuation techniques that incorporate market-based inputs.

Refer to Note 31 to the consolidated financial statements for information on the Corporation’s fair value measurement disclosures required by the applicable accounting standard. At December 31, 2012, approximately $ 5.4 billion, or 97%, of the assets measured at fair value on a recurring basis used market-based or market-derived valuation methodology and, therefore, were classified as Level 1 or Level 2. The majority of instruments measured at fair value were classified as Level 2, including U.S. Treasury securities, obligations of U.S. Government sponsored entities, obligations of Puerto Rico, States and political subdivisions, most mortgage-backed securities (“MBS”) and collateralized mortgage obligations (“CMOs”), and derivative instruments. U.S. Treasury securities were valued based on yields that were interpolated from the constant maturity treasury curve. Obligations of U.S. Government sponsored entities were priced based on an active exchange market and on quoted prices for similar securities. Obligations of Puerto Rico, States and political subdivisions were valued based on trades, bid price or spread, two sided markets, quotes, benchmark curves, market data feeds, discount and capital rates and trustee reports. MBS and CMOs were priced based on a bond’s theoretical value from similar bonds defined by credit quality and market sector. Refer to the Derivatives section below for a description of the valuation techniques used to value these derivative instruments.

The remaining 3% of assets measured at fair value on a recurring basis at December 31, 2012 were classified as Level 3 since their valuation methodology considered significant unobservable inputs. The financial assets measured as Level 3 included mostly Puerto Rico tax-exempt GNMA mortgage-backed securities and mortgage servicing rights (“MSRs”). GNMA tax exempt mortgage-backed securities are priced using a local demand price matrix prepared from local dealer quotes, and other local investments such as corporate securities and local mutual funds which are priced by local dealers. MSRs, on the other hand, are priced internally using a discounted cash flow model which considers servicing fees, portfolio characteristics, prepayment assumptions, delinquency rates, late charges, other ancillary revenues, cost to service and other economic factors. Additionally, the Corporation reported $ 104 million of financial assets that were measured at fair value on a nonrecurring basis at December 31, 2012, all of which were classified as Level 3 in the hierarchy.

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Broker quotes used for fair value measurements inherently reflect any lack of liquidity in the market since they represent an exit price from the perspective of the market participants. Financial assets that were fair valued using broker quotes amounted to $ 40 million at December 31, 2012, of which $ 20 million were Level 3 assets and $ 20 million were Level 2 assets. Level 3 assets consisted principally of tax-exempt GNMA mortgage-backed securities. Fair value for these securities was based on an internally-prepared matrix derived from an average of two indicative local broker quotes. The main input used in the matrix pricing was non-binding local broker quotes obtained from limited trade activity. Therefore, these securities were classified as Level 3.

There were $2 million in transfers from Level 2 to Level 3 and $7 million in transfers from Level 3 to Level 2 for financial instruments measured at fair value on a recurring basis during the year ended December 31, 2012. The transfers from Level 2 to Level 3 of trading mortgage-backed securities were the result of a change in valuation technique to a matrix pricing model, based on indicative prices provided by brokers. The transfers from Level 3 to Level 2 of trading mortgage-backed securities resulted from observable market data becoming available for these securities. There were no transfers in and/or out of Level 2 and Level 3 for financial instruments measured at fair value on a recurring basis during the year ended December 31, 2011. There were $198 million in transfers from Level 3 to Level 2 for financial instruments measured at fair value on a recurring basis during the year ended December 31, 2010. These transfers of certain exempt FNMA and GNMA mortgage-backed securities were the result of a change in valuation methodology from an internally-developed matrix pricing to pricing them based on a bond’s theoretical value from similar bonds defined by credit quality and market sector. Their fair value incorporates an option adjusted spread. Pursuant to the Corporation’s policy, these transfers were recognized as of the end of the reporting period. There were no transfers in and/or out of Level 1 during 2012, 2011, and 2010.

Trading Account Securities and Investment Securities Available-for-Sale

The majority of the values for trading account securities and investment securities available-for-sale are obtained from third-party pricing services and are validated with alternate pricing sources when available. Securities not priced by a secondary pricing source are documented and validated internally according to their significance to the Corporation’s financial statements. Management has established materiality thresholds according to the investment class to monitor and investigate material deviations in prices obtained from the primary pricing service provider and the secondary pricing source used as support for the valuation results. During the year ended December 31, 2012, the Corporation did not adjust any prices obtained from pricing service providers or broker dealers.

Inputs are evaluated to ascertain that they consider current market conditions, including the relative liquidity of the market. When a market quote for a specific security is not available, the pricing service provider generally uses observable data to derive an exit price for the instrument, such as benchmark yield curves and trade data for similar products. To the extent trading data is not available, the pricing service provider relies on specific information including dialogue with brokers, buy side clients, credit ratings, spreads to established benchmarks and transactions on similar securities, to draw correlations based on the characteristics of the evaluated instrument. If for any reason the pricing service provider cannot observe data required to feed its model, it discontinues pricing the instrument. During the year ended December 31, 2012, none of the Corporation’s investment securities were subject to pricing discontinuance by the pricing service providers. The pricing methodology and approach of our primary pricing service providers is concluded to be consistent with the fair value measurement guidance.

Furthermore, management assesses the fair value of its portfolio of investment securities at least on a quarterly basis, which includes analyzing changes in fair value that have resulted in losses that may be considered other-than-temporary. Factors considered include, for example, the nature of the investment, severity and duration of possible impairments, industry reports, sector credit ratings, economic environment, creditworthiness of the issuers and any guarantees.

Securities are classified in the fair value hierarchy according to product type, characteristics and market liquidity. At the end of each period, management assesses the valuation hierarchy for each asset or liability measured. The fair value measurement analysis performed by the Corporation includes validation procedures and review of market changes, pricing methodology, assumption and level hierarchy changes, and evaluation of distressed transactions.

At December 31, 2012, the Corporation’s portfolio of trading and investment securities available-for-sale amounted to $ 5.4 billion and represented 96% of the Corporation’s assets measured at fair value on a recurring basis. At December 31, 2012, net unrealized gains on the trading and available-for-sale investment securities portfolios approximated $16 million and $ 172 million, respectively. Fair values for most of the Corporation’s trading and investment securities available-for-sale were classified as Level 2. Trading and investment securities available-for-sale classified as Level 3, which were the securities that involved the highest degree of judgment, represent less than 1% of the Corporation’s total portfolio of trading and investment securities available-for-sale.

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Mortgage Servicing Rights

Mortgage servicing rights (“MSRs”), which amounted to $ 154 million at December 31, 2012, and are primarily related to residential mortgage loans originated in Puerto Rico, do not trade in an active, open market with readily observable prices. Fair value is estimated based upon discounted net cash flows calculated from a combination of loan level data and market assumptions. The valuation model combines loans with common characteristics that impact servicing cash flows (e.g. investor, remittance cycle, interest rate, product type, etc.) in order to project net cash flows. Market valuation assumptions include prepayment speeds, discount rate, cost to service, escrow account earnings, and contractual servicing fee income, among other considerations. Prepayment speeds are derived from market data that is more relevant to the U.S. mainland loan portfolios and, thus, are adjusted for the Corporation’s loan characteristics and portfolio behavior since prepayment rates in Puerto Rico have been historically lower. Other assumptions are, in the most part, directly obtained from third-party providers. Disclosure of two of the key economic assumptions used to measure MSRs, which are prepayment speed and discount rate, and a sensitivity analysis to adverse changes to these assumptions, is included in Note 13 to the consolidated financial statements.

Derivatives

Derivatives, such as interest rate swaps, interest rate caps and indexed options, are traded in over-the-counter active markets. These derivatives are indexed to an observable interest rate benchmark, such as LIBOR or equity indexes, and are priced using an income approach based on present value and option pricing models using observable inputs. Other derivatives are liquid and have quoted prices, such as forward contracts or “to be announced securities” (“TBAs”). All of these derivatives held by the Corporation were classified as Level 2. Valuations of derivative assets and liabilities reflect the values associated with counterparty risk and nonperformance risk, respectively. The non-performance risk, which measures the Corporation’s own credit risk, is determined using internally-developed models that consider the net realizable value of the collateral posted, remaining term, and the creditworthiness or credit standing of the Corporation. The counterparty risk is also determined using internally-developed models which incorporate the creditworthiness of the entity that bears the risk, net realizable value of the collateral received, and available public data or internally-developed data to determine their probability of default. To manage the level of credit risk, the Corporation employs procedures for credit approvals and credit limits, monitors the counterparties’ credit condition, enters into master netting agreements whenever possible and, when appropriate, requests additional collateral. During the year ended December 31, 2012, inclusion of credit risk in the fair value of the derivatives resulted in a net gain of $2.9 million recorded in the other operating income and interest expense captions of the consolidated statement of operations, which consisted of a loss of $0.5 million resulting from the Corporation’s own credit standing adjustment and a gain of $3.4 million from the assessment of the counterparties’ credit risk.

Contingent consideration liability

The fair value of the true-up payment obligation (contingent consideration) to the FDIC as it relates to the Westernbank FDIC-assisted transaction amounted to $112 million at December 31, 2012. The fair value was estimated using projected cash flows related to the loss sharing agreements at the true-up measurement date, taking into consideration the intrinsic loss estimate, asset premium/discount, cumulative shared loss payments, and the cumulative servicing amount related to the loan portfolio. Refer to Note 4 to the consolidated financial statements for a description of the true-up payment formula. The true-up payment obligation was discounted using a term rate consistent with the time remaining until the payment is due. The discount rate was an estimate of the sum of the risk-free benchmark rate for the term remaining before the true-up payment is due and a risk premium to account for the credit risk profile of BPPR. The risk premium was calculated based on a 12-month trailing average spread of the yields on corporate bonds with credit ratings similar to BPPR.

Loans held-in-portfolio considered impaired under ASC Section 310-10-35 that are collateral dependent

The impairment is measured based on the fair value of the collateral, which is derived from appraisals that take into consideration prices in observed transactions involving similar assets in similar locations, size and supply and demand. The challenging conditions of the housing markets continue to affect the market activity related to real estate properties. These collateral dependent impaired loans are classified as Level 3 and are reported as a nonrecurring fair value measurement.

Loans measured at fair value pursuant to lower of cost or fair value adjustments

Loans measured at fair value on a nonrecurring basis pursuant to lower of cost or fair value were priced based on secondary market prices and discounted cash flow models which incorporate internally-developed assumptions for prepayments and credit loss estimates. These loans are classified as Level 3.

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Other real estate owned and other foreclosed assets

Other real estate owned includes real estate properties securing mortgage, consumer, and commercial loans. Other foreclosed assets include automobiles securing auto loans. The fair value of foreclosed assets may be determined using an external appraisal, broker price opinion, internal valuation or binding offer. The majority of these foreclosed assets is classified as Level 3 since they are subject to internal adjustments and reported as a nonrecurring fair value measurement.

Loans and Allowance for Loan Losses

Interest on loans is accrued and recorded as interest income based upon the principal amount outstanding.

Non-accrual loans are those loans on which the accrual of interest is discontinued. When a loan is placed on non-accrual status, all previously accrued and unpaid interest is charged against income and the loan is accounted for either on a cash-basis method or on the cost-recovery method. Loans designated as non-accruing are returned to accrual status when the Corporation expects repayment of the remaining contractual principal and interest. The determination as to the ultimate collectability of the loan’s balance may involve management’s judgment in the evaluation of the borrower’s financial condition and prospects for repayment.

Refer to the MD&A section titled Credit Risk Management and Loan Quality, particularly the Non-performing assets sub-section, for a detailed description of the Corporation’s non-accruing and charge-off policies by major loan categories.

One of the most critical and complex accounting estimates is associated with the determination of the allowance for loan losses. The provision for loan losses charged to current operations is based on this determination. The Corporation’s assessment of the allowance for loan losses is determined in accordance with accounting guidance, specifically guidance of loss contingencies in ASC Subtopic 450-20 and loan impairment guidance in ASC Section 310-10-35.

The accounting guidance provides for the recognition of a loss allowance for groups of homogeneous loans. The determination for general reserves of the allowance for loan losses includes the following principal factors:

• Historical net loss rates (including losses from impaired loans) by loan type and by legal entity adjusted for recent net charge-off trends and environmental factors. The base net loss rates are based on the moving average of annualized net charge-offs computed over a 36-month historical loss window for the commercial and construction loan portfolios, and an 18-month period for the consumer and mortgage loan portfolios.

• Net charge-off trend factors are applied to adjust the base loss rates based on recent loss trends. The Corporation applies a trend factor when base losses are below recent loss trends. Currently, the trend factor is based on the last 12 months of losses for the commercial, construction and legacy loan portfolios and 6 months of losses for the consumer and mortgage loan portfolios. The trend factor accounts for inherent imprecision and the “lagging perspective” in base loss rates. The trend factor replaces the base-loss period when it is higher than base loss up to a determined cap.

• Environmental factors, which include credit and macroeconomic indicators such as employment, price index and construction permits, were adopted to account for current market conditions that are likely to cause estimated credit losses to differ from historical losses. The Corporation reflects the effect of these environmental factors on each loan group as an adjustment that, as appropriate, increases or decreases the historical loss rate applied to each group. Environmental factors provide updated perspective on credit and economic conditions. Correlation and regression analyses are used to select and weight these indicators.

During the first quarter of 2012, in order to better reflect current market conditions, management revised the estimation process for evaluating the adequacy of the general reserve component of the allowance for loan losses for the Corporation’s commercial and construction loan portfolios. The change in the methodology is described in the paragraphs below. The net effect of these changes in the first quarter amounted to a $24.8 million reduction in the Corporation’s allowance for loan losses, resulting from a reduction of $40.5 million due to the enhancements to the allowance for loan losses methodology, offset in part by a $15.7 million increase in environmental factor reserves due to the Corporation’s decision to monitor recent trends in its commercial loan portfolio at the BPPR reportable segment that although improving, continue to warrant additional scrutiny.

Management made the following principal changes to the methodology during the first quarter of 2012:

• Established a more granular stratification of the commercial loan portfolios to enhance the homogeneity of the loan classes. Previously, the Corporation used loan groupings for commercial loan portfolios based on business lines and collateral types (secured / unsecured loans). As part of the loan segregation, management evaluated the risk profiles

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of the loan portfolio, recent and historical credit and loss trends, current and expected portfolio behavior and economic indicators. The revised groupings consider product types (construction, commercial multifamily, commercial & industrial, non-owner occupied commercial real estate (“CRE”) and owner occupied CRE) and business lines for each of the Corporation’s reportable segments, BPPR and BPNA. In addition, the Corporation established a legacy portfolio at the BPNA reportable segment, comprised of commercial loans, construction loans and commercial lease financings related to certain lending products exited by the Corporation as part of restructuring efforts carried out in prior years.

The refinement in the loan groupings resulted in a decrease to the allowance for loan losses of $7.9 million at March 31, 2012, which consisted of a $9.7 million reduction related to the BPNA reportable segment, partially offset by an increase of $1.8 million related to the BPPR reportable segment.

• Increased the historical look-back period for determining the loss trend factor. The Corporation increased the look-back period for assessing recent trends applicable to the determination of commercial, construction and legacy loan net charge-offs from 6 months to 12 months.

Previously, the Corporation used a trend factor based on 6 months of net charge-offs as it aligned the estimation of inherent losses for the Corporation’s commercial and construction loan portfolios with deteriorating trends.

Given the current overall commercial and construction credit quality improvements noted on recent periods in terms of loss trends, non-performing loan balances and non-performing loan inflows, management concluded that a 12-month look-back period for the trend factor aligns the Corporation’s allowance for loan losses methodology to current credit quality trends.

The increase in the historical look-back period for determining the loss trend factor resulted in a decrease to the allowance for loan losses of $28.1 million at March 31, 2012, of which $24.0 million related to the BPPR reportable segment and $4.1 million to the BPNA reportable segment.

There were additional enhancements to the allowance for loan losses methodology which accounted for a reduction to the allowance for loan losses of $4.5 million at March 31, 2012, of which $3.9 million related to the BPNA reportable segment and $0.6 million to the BPPR reportable segment. This reduction related to loan portfolios with minimal or zero loss history.

There were no changes in the methodology for environmental factor reserves. There were no changes to the allowance for loan losses methodology for the Corporation’s consumer and mortgage loan portfolios during the first quarter of 2012.

According to the accounting guidance criteria for specific impairment of a loan, the Corporation defines as impaired loans those commercial and construction borrowers with outstanding debt of $1 million or more and with interest and/or principal 90 days or more past due. Also, specific commercial borrowers with outstanding debt of $1 million or over are deemed impaired when, based on current information and events, management considers that it is probable that the debtor would be unable to pay all amounts due according to the contractual terms of the loan agreement. Commercial and construction loans that originally met the Corporation’s threshold for impairment identification in a prior period, but due to charge-offs or payments are currently below the $1 million threshold and are still 90 days past due, except for TDRs, are accounted for under the Corporation’s general reserve methodology. Although the accounting codification guidance for specific impairment of a loan excludes large groups of smaller balance homogeneous loans that are collectively evaluated for impairment (e.g. mortgage and consumer loans), it specifically requires that loan modifications considered troubled debt restructurings (“TDRs”) be analyzed under its provisions. An allowance for loan impairment is recognized to the extent that the carrying value of an impaired loan exceeds the present value of the expected future cash flows discounted at the loan’s effective rate, the observable market price of the loan, if available, or the fair value of the collateral if the loan is collateral dependent.

The fair value of the collateral on commercial and construction loans is generally obtained from appraisals or evaluations. The Corporation periodically requires updated appraisal reports for loans that are considered impaired. The frequency of updated appraisals depends on total debt outstanding and type of collateral. Currently, for commercial and construction loans secured by real estate, if the borrower’s total debt is equal to or greater than $1 million, the appraisal is updated annually. If the borrower’s total debt is less than $1 million, the appraisal is updated at least every two years.

As a general procedure, the Corporation internally reviews appraisals as part of the underwriting and approval process and also for credits considered impaired following certain materiality benchmarks. Appraisals may be adjusted due to their age, property conditions, geographical area or general market conditions. The adjustments applied are based upon internal information, like other appraisals and/or loss severity information that can provide historical trends in the real estate market. Discount rates used may change from time-to-time based on management’s estimates. Refer to the Credit Risk Management and Loan Quality section of this MD&A for more detailed information on the Corporation’s collateral value estimation for other real estate.

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The Corporation’s management evaluates the adequacy of the allowance for loan losses on a quarterly basis following a systematic methodology in order to provide for known and inherent risks in the loan portfolio. In developing its assessment of the adequacy of the allowance for loan losses, the Corporation must rely on estimates and exercise judgment regarding matters where the ultimate outcome is unknown such as economic developments affecting specific customers, industries or markets. Other factors that can affect management’s estimates are the years of historical data to include when estimating losses, the level of volatility of losses in a specific portfolio, changes in underwriting standards, financial accounting standards and loan impairment measurement, among others. Changes in the financial condition of individual borrowers, in economic conditions, in historical loss experience and in the condition of the various markets in which collateral may be sold may all affect the required level of the allowance for loan losses. Consequently, the business, financial condition, liquidity, capital and results of operations could also be affected.

The collateral dependent method is generally used for the impairment determination on commercial and construction loans since the expected realizable value of the loan is based upon the proceeds received from the liquidation of the collateral property. For commercial properties, the “as is” value or the “income approach” value is used depending on the financial condition of the subject borrower and/or the nature of the subject collateral. In most cases, impaired commercial loans do not have reliable or sustainable cash flow to use the discounted cash flow valuation method. On construction loans, “as developed” collateral values are used when the loan is originated since the assumption is that the cash flow of the property once leased or sold will provide sufficient funds to repay the loan. In the case of many impaired construction loans, the “as developed” collateral value is also used since completing the project reflects the best exit strategy in terms of potential loss reduction. In these cases, the costs to complete are considered as part of the impairment determination. As a general rule, the appraisal valuation used by the Corporation for impaired construction loans is based on discounted value to a single purchaser, discounted sell out or “as is” depending on the condition and status of the project and the performance of the same.

A restructuring constitutes a TDR when the Corporation separately concludes that both of the following conditions exist: (i) the restructuring constitutes a concession and (ii) the debtor is experiencing financial difficulties. The concessions stem from an agreement between the creditor and the debtor or are imposed by law or a court. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection. A concession has been granted when, as a result of the restructuring, the Corporation does not expect to collect all amounts due, including interest accrued at the original contract rate. If the payment of principal is dependent on the value of collateral, the current value of the collateral is taken into consideration in determining the amount of principal to be collected; therefore, all factors that changed are considered to determine if a concession was granted, including the change in the fair value of the underlying collateral that may be used to repay the loan. In addition, in order to expedite the resolution of delinquent construction and commercial loans, the Corporation routinely enters into liquidation agreements with borrowers and guarantors through the regular legal process, bankruptcy procedures and in certain occasions, out of Court transactions. These liquidation agreements, in general, contemplate the following conditions: (1) consent to judgment by the borrowers and guarantors; (2) acknowledgement by the borrower of debt, its liquidity and maturity; (3) acknowledgement of the default payments. The contractual interest rate is not reduced and continues to accrue during the term of the agreement. At the end of the period, borrower is obligated to remit all amounts due or be subject to the Corporation’s exercise of its foreclosure rights and further collection efforts. Likewise, the borrower’s failure to make stipulated payments will grant the Corporation the ability to exercise its foreclosure rights. This strategy procures to expedite the foreclosure process, resulting in a more effective and efficient collection process. Although in general, these liquidation agreements do not contemplate the forgiveness of principal or interest as debtor is required to cover all outstanding amounts when the agreement becomes due, it could be construed that the Corporation has granted a concession by temporarily accepting a payment schedule that is different from the contractual payment schedule. Accordingly, loans under this program are considered TDRs.

Classification of loan modifications as TDRs involves a degree of judgment. Indicators that the debtor is experiencing financial difficulties which are considered include: (i) the borrower is currently in default on any of its debt or it is probable that the borrower would be in payment default on any of its debt in the foreseeable future without the modification; (ii) the borrower has declared or is in the process of declaring bankruptcy; (iii) there is significant doubt as to whether the borrower will continue to be a going concern; (iv) the borrower has securities that have been delisted, are in the process of being delisted, or are under threat of being delisted from an exchange; (v) based on estimates and projections that only encompass the borrower’s current business capabilities, it is forecasted that the entity-specific cash flows will be insufficient to service the debt (both interest and principal) in accordance with the contractual terms of the existing agreement through maturity; and (vi) absent the current modification, the borrower cannot obtain funds from sources other than the existing creditors at an effective interest rate equal to the current market interest rate for

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similar debt for a non-troubled debtor. The identification of TDRs is critical in the determination of the adequacy of the allowance for loan losses. Loans classified as TDRs are excluded from TDR status if performance under the restructured terms exists for a reasonable period (at least twelve months of sustained performance) and the loan yields a market rate.

For mortgage loans that are modified with regard to payment terms and which constitute TDRs, the discounted cash flow value method is used as the impairment valuation is more appropriately calculated based on the ongoing cash flow from the individuals rather than the liquidation of the asset. The computations give consideration to probability of default and loss-given-foreclosure on the related estimated cash flows. For consumer loans deemed TDRs, the Corporation also uses a discounted cash flow value methodology, but currently does not incorporate a default rate assumption pre- or post-modification.

Refer to Note 11 to the consolidated financial statements for disclosures on the impact of adopting ASU 2011-02 and to Note 3 for a general description of the ASU 2011-02 guidance.

Acquisition Accounting for Covered Loans and Related Indemnification Asset

The Corporation accounted for the Westernbank FDIC-assisted transaction under the accounting guidance of ASC Topic No. 805, Business Combinations, which requires the use of the purchase method of accounting. All identifiable assets and liabilities acquired were initially recorded at fair value. No allowance for loan losses related to the acquired loans was recorded on the acquisition date as the fair value of the loans acquired incorporated assumptions regarding credit risk. Loans acquired were recorded at fair value in accordance with the fair value methodology prescribed in ASC Topic 820, exclusive of the shared-loss agreements with the FDIC. These fair value estimates associated with the loans included estimates related to expected prepayments and the amount and timing of expected principal, interest and other cash flows.

Because the FDIC has agreed to reimburse the Corporation for losses related to the acquired loans in the Westernbank FDIC-assisted transaction, subject to certain provisions specified in the agreements, an indemnification asset was recorded at fair value at the acquisition date. The indemnification asset was recognized at the same time as the indemnified loans, and is measured on the same basis, subject to collectability or contractual limitations. The loss share indemnification asset on the acquisition date reflected the reimbursements expected to be received from the FDIC, using an appropriate discount rate, which reflected counterparty credit risk and other uncertainties.

Refer to Note 4 for a description of the FDIC-assisted transaction and the terms of the loss share agreements.

The initial valuation of these loans and related indemnification asset required management to make subjective judgments concerning estimates about how the acquired loans would perform in the future using valuation methods, including discounted cash flow analyses and independent third-party appraisals. Factors that may significantly affect the initial valuation included, among others, market-based and industry data related to expected changes in interest rates, assumptions related to probability and severity of credit losses, estimated timing of credit losses including the timing of foreclosure and liquidation of collateral, expected prepayment rates, required or anticipated loan modifications, unfunded loan commitments, the specific terms and provisions of any loss share agreements, and specific industry and market conditions that may impact discount rates and independent third-party appraisals.

The Corporation applied the guidance of ASC 310-30 to all loans acquired in the Westernbank FDICE-assisted transaction (including loans that do not meet the scope of ASC 310-30), except for credit cards and revolving lines of credit. ASC 310-30 provides two specific criteria that have to be met in order for a loan to be within its scope: (1) credit deterioration on the loan from its inception until the acquisition date and (2) that it is probable that not all of the contractual cash flows will be collected on the loan. Once in the scope of ASC 310-30, the credit portion of the fair value discount on an acquired loan cannot be accreted into income until the acquirer has assessed that it expects to receive more cash flows on the loan than initially anticipated.

Acquired loans that meet the definition of nonaccrual status fall within the Corporation’s definition of impaired loans under ASC 310-30. It is possible that performing loans would not meet criteria number 1 above related to evidence of credit deterioration since the date of loan origination, and therefore not fall within the scope of ASC 310-30. Based on the fair value determined for the acquired portfolio, acquired loans that did not meet the Corporation’s definition of non-accrual status also resulted in the recognition of a significant discount attributable to credit quality.

Given the significant discount related to credit in the valuation of the Westernbank acquired portfolio, the Corporation considered two possible options for the performing loans (1) accrete the entire fair value discount (including the credit portion) using the interest method over the life of the loan in accordance with ASC 310-20; or (2) analogize to ASC 310-30 and only accrete the portion of the fair value discount unrelated to credit.

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Pursuant to an AICPA letter dated December 18, 2009, the AICPA summarized the SEC Staff’s view regarding the accounting in subsequent periods for discount accretion associated with loan receivables acquired in a business combination or asset purchase. Regarding the accounting for such loan receivables, in the absence of further standard setting, the AICPA understands that the SEC Staff would not object to an accounting policy based on contractual cash flows (Option 1 - ASC 310-20 approach) or an accounting policy based on expected cash flows (Option 2 - ASC 310-30 approach). As such, the Corporation considered the two allowable options as follows:

— Option 1 - Since the credit portion of the fair value discount is associated with an expectation of cash flows that an acquirer does not expect to receive over the life of the loan, it does not appear appropriate to accrete that portion over the life of the loan as doing so could eventually overstate the acquirer’s expected value of the loan and ultimately result in recognizing income (i.e. through the accretion of the yield) on a portion of the loan it does not expect to receive. Therefore, the Corporation does not believe this is an appropriate method to apply.

— Option 2 – The Corporation believes analogizing to ASC 310-30 is the more appropriate option to follow in accounting for the credit portion of the fair value discount. By doing so, the loan is only being accreted up to the value that the acquirer expected to receive at acquisition of the loan.

Based on the above, the Corporation elected Option 2 – the ASC 310-30 approach to the outstanding balance for all the acquired loans in the Westernbank FDIC-assisted transaction with the exception of revolving lines of credit with active privileges as of the acquisition date, which are explicitly scoped out by the ASC 310-30 accounting guidance. New advances / draws after the acquisition date under existing credit lines that did not have revolving privileges as of the acquisition date, particularly for construction loans, will effectively be treated as a “new” loan for accounting purposes and accounted for under the provisions of ASC 310-20, resulting in a hybrid accounting for the overall construction loan balance.

Management used judgment in evaluating factors impacting expected cash flows and probable loss assumptions, including the quality of the loan portfolio, portfolio concentrations, distressed economic conditions in Puerto Rico, quality of underwriting standards of the acquired institution, reductions in collateral real estate values, and material weaknesses disclosed by the acquired institution, including matters related to credit quality review and appraisal report review.

At April 30, 2010, the acquired loans accounted for pursuant to ASC 310-30 by the Corporation totaled $4.9 billion which represented undiscounted unpaid contractually-required principal and interest balances of $9.9 billion reduced by a discount of $5.0 billion resulting from acquisition date fair value adjustments. The non-accretable discount on loans accounted for under ASC 310-30 amounted to $3.4 billion or approximately 68% of the total discount, thus indicating a significant amount of expected credit losses on the acquired portfolios.

Pursuant to ASC 310-20-15-5, the Corporation aggregated loans acquired in the FDIC-assisted transaction into pools with common risk characteristics for purposes of applying the recognition, measurement and disclosure provisions of this subtopic. Each loan pool is accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows. Characteristics considered in pooling loans in the Westernbank FDIC-assisted transaction included loan type, interest rate type, accruing status, amortization type, rate index and source type. Once the pools are defined, the Corporation maintains the integrity of the pool of multiple loans accounted for as a single asset.

Under ASC Subtopic 310-30, the difference between the undiscounted cash flows expected at acquisition and the fair value of the loans, or the “accretable yield,” is recognized as interest income using the effective yield method over the estimated life of the loan if the timing and amount of the future cash flows of the pool is reasonably estimable. The non-accretable difference represents the difference between contractually required principal and interest and the cash flows expected to be collected. Subsequent to the acquisition date, increases in cash flows over those expected at the acquisition date are recognized as interest income prospectively as an adjustment to accretable yield over the loan’s or pool’s remaining life. Decreases in expected cash flows after the acquisition date are recognized by recording an allowance for loan losses.

The fair value discount of lines of credit with revolving privileges that are accounted for pursuant to the guidance of ASC Subtopic 310-20, represented the difference between the contractually required loan payment receivable in excess of the initial investment in the loan. Any cash flows collected in excess of the carrying amount of the loan are recognized in earnings at the time of collection. The carrying amount of lines of credit with revolving privileges, which are accounted pursuant to the guidance of ASC Subtopic 310-20, are subject to periodic review to determine the need for recognizing an allowance for loan losses.

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The FDIC loss share indemnification asset for loss share agreements is measured separately from the related covered assets as it is not contractually embedded in the assets and is not transferable with the assets should the assets be sold.

The FDIC loss share indemnification asset is recognized on the same basis as the assets subject to loss share protection, except that the amortization / accretion terms differ for each asset. For covered loans accounted for pursuant to ASC Subtopic 310-30, decreases in expected reimbursements from the FDIC due to improvements in expected cash flows to be received from borrowers are recognized in non-interest income prospectively over the life of the FDIC loss sharing agreements. For covered loans accounted for under ASC Subtopic 310-20, as the loan discount recorded as of the acquisition date was accreted into income, a reduction of the related indemnification asset was recorded as a reduction in non-interest income. Increases in expected reimbursements from the FDIC are recognized in non-interest income in the same period that the allowance for credit losses for the related loans is recognized.

Over the life of the acquired loans that are accounted under ASC Subtopic 310-30, the Corporation continues to estimate cash flows expected to be collected on individual loans or on pools of loans sharing common risk characteristics. The Corporation evaluates at each balance sheet date whether the present value of its loans determined using the effective interest rates has decreased based on revised estimated cash flows and if so, recognizes a provision for loan loss in its consolidated statement of operations and an allowance for loan losses in its consolidated statement of financial condition. For any increases in cash flows expected to be collected from borrowers, the Corporation adjusts the amount of accretable yield recognized on the loans on a prospective basis over the loan’s or pool’s remaining life.

The evaluation of estimated cash flows expected to be collected subsequent to acquisition on loans accounted pursuant to ASC Subtopic 310-30 and inherent losses on loans accounted pursuant to ASC Subtopic 310-20 require the continued usage of key assumptions and estimates. Given the current economic environment, the Corporation must apply judgment to develop its estimates of cash flows considering the impact of home price and property value changes, changing loss severities and prepayment speeds. Decreases in the expected cash flows for ASC Subtopic 310-30 loans and decreases in the net realizable value of ASC Subtopic 310-20 loans will generally result in a charge to the provision for credit losses resulting in an increase to the allowance for loan losses. These estimates are particularly sensitive to changes in loan credit quality.

The amount that the Corporation realizes on the covered loans and related indemnification assets could differ materially from the carrying value reflected in these financial statements, based upon the timing and amount of collections on the acquired loans in future periods. The Corporation’s losses on these assets may be mitigated to the extent covered under the specific terms and provisions of the loss share agreements.

Refer to Notes 4 and 12 to the consolidated financial statements for further discussions on the Westernbank FDIC-assisted transaction and loans acquired.

Income Taxes

Income taxes are accounted for using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized based on the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis, and attributable to operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply in the years in which the temporary differences are expected to be recovered or paid. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in earnings in the period when the changes are enacted.

The calculation of periodic income taxes is complex and requires the use of estimates and judgments. The Corporation has recorded two accruals for income taxes: (i) the net estimated amount currently due or to be received from taxing jurisdictions, including any reserve for potential examination issues, and (ii) a deferred income tax that represents the estimated impact of temporary differences between how the Corporation recognizes assets and liabilities under accounting principles generally accepted in the United States (GAAP), and how such assets and liabilities are recognized under the tax code. Differences in the actual outcome of these future tax consequences could impact the Corporation’s financial position or its results of operations. In estimating taxes, management assesses the relative merits and risks of the appropriate tax treatment of transactions taking into consideration statutory, judicial and regulatory guidance.

A deferred tax asset should be reduced by a valuation allowance if based on the weight of all available evidence, it is more likely than not (a likelihood of more than 50%) that some portion or the entire deferred tax asset will not be realized. The valuation

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allowance should be sufficient to reduce the deferred tax asset to the amount that is more likely than not to be realized. The determination of whether a deferred tax asset is realizable is based on weighting all available evidence, including both positive and negative evidence. The realization of deferred tax assets, including carryforwards and deductible temporary differences, depends upon the existence of sufficient taxable income of the same character during the carryback or carryforward period. The realization of deferred tax assets requires the consideration of all sources of taxable income available to realize the deferred tax asset, including the future reversal of existing temporary differences, future taxable income exclusive of reversing temporary differences and carryforwards, taxable income in carryback years and tax-planning strategies.

The Corporation’s U.S. mainland operations are in a cumulative loss position for the three-year period ended December 31, 2012, taking into account taxable income adjusted by temporary differences. For purposes of assessing the realization of the deferred tax assets in the U.S. mainland operations, this cumulative taxable loss position is considered significant negative evidence, which evaluated along with all sources of taxable income available to realize the deferred tax asset, has caused management to conclude that it is more-likely-than-not that the Corporation will not be able to fully realize the deferred tax assets in the future, considering solely the criteria of ASC Topic 740. Management will reassess the realization of the deferred tax assets based on the criteria of the applicable accounting pronouncement each reporting period. At December 31, 2012, the Corporation recorded a full valuation allowance of approximately $1.3 billion on the deferred tax assets of the Corporation’s U.S. operations. To the extent that the financial results of the U.S. operations improve and the deferred tax asset becomes realizable, the Corporation will be able to reduce the valuation allowance through earnings.

At December 31, 2012, the Corporation had net deferred tax assets related to its Puerto Rico operations amounting to $558 million. The Corporation’s Puerto Rico banking operation is no longer in a cumulative loss position. This operation shows a cumulative income position for the three-year period ended December 31, 2012 taking into account taxable income exclusive of reversing temporary differences (adjusted taxable income). The sustained profitability during years 2011 and 2012 is considered a strong piece of objectively verifiable positive evidence for the evaluation of the deferred tax asset valuation allowance. Based on this evidence and its estimated adjusted taxable income for future years, the Corporation has concluded that it is more likely than not that the net deferred tax asset of the Puerto Rico operations will be realized.

Changes in the Corporation’s estimates can occur due to changes in tax rates, new business strategies, newly enacted guidance, and resolution of issues with taxing authorities regarding previously taken tax positions. Such changes could affect the amount of accrued taxes. The current income tax payable for 2012 has been paid during the year in accordance with estimated tax payments rules. Any remaining payment will not have any significant impact on liquidity and capital resources.

The valuation of deferred tax assets requires judgment in assessing the likely future tax consequences of events that have been recognized in the financial statements or tax returns and future profitability. The accounting for deferred tax consequences represents management’s best estimate of those future events. Changes in management’s current estimates, due to unanticipated events, could have a material impact on the Corporation’s financial condition and results of operations.

The Corporation establishes tax liabilities or reduces tax assets for uncertain tax positions when, despite its assessment that its tax return positions are appropriate and supportable under local tax law, the Corporation believes it may not succeed in realizing the tax benefit of certain positions if challenged. In evaluating a tax position, the Corporation determines whether it is more-likely-than-not that the position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The Corporation’s estimate of the ultimate tax liability contains assumptions based on past experiences, and judgments about potential actions by taxing jurisdictions as well as judgments about the likely outcome of issues that have been raised by taxing jurisdictions. The tax position is measured as the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. The Corporation evaluates these uncertain tax positions each quarter and adjusts the related tax liabilities or assets in light of changing facts and circumstances, such as the progress of a tax audit or the expiration of a statute of limitations. The Corporation believes the estimates and assumptions used to support its evaluation of uncertain tax positions are reasonable.

The amount of unrecognized tax benefits, including accrued interest, at December 31, 2012 amounted to $16.9 million. Refer to Note 39 to the consolidated financial statements for further information on this subject matter. The Corporation anticipates a reduction in the total amount of unrecognized tax benefits within the next 12 months, which could amount to approximately $10 million.

The amount of unrecognized tax benefits may increase or decrease in the future for various reasons including adding amounts for current tax year positions, expiration of open income tax returns due to the statutes of limitation, changes in management’s judgment about the level of uncertainty, status of examinations, litigation and legislative activity and the addition or elimination of

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uncertain tax positions. Although the outcome of tax audits is uncertain, the Corporation believes that adequate amounts of tax, interest and penalties have been provided for any adjustments that are expected to result from open years. From time to time, the Corporation is audited by various federal, state and local authorities regarding income tax matters. Although management believes its approach in determining the appropriate tax treatment is supportable and in accordance with the accounting standards, it is possible that the final tax authority will take a tax position that is different than the tax position reflected in the Corporation’s income tax provision and other tax reserves. As each audit is conducted, adjustments, if any, are appropriately recorded in the consolidated financial statement in the period determined. Such differences could have an adverse effect on the Corporation’s income tax provision or benefit, or other tax reserves, in the reporting period in which such determination is made and, consequently, on the Corporation’s results of operations, financial position and / or cash flows for such period.

Goodwill

The Corporation’s goodwill and other identifiable intangible assets having an indefinite useful life are tested for impairment. Intangibles with indefinite lives are evaluated for impairment at least annually, and on a more frequent basis, if events or circumstances indicate impairment could have taken place. Such events could include, among others, a significant adverse change in the business climate, an adverse action by a regulator, an unanticipated change in the competitive environment and a decision to change the operations or dispose of a reporting unit.

Under applicable accounting standards, goodwill impairment analysis is a two-step test. The first step of the goodwill impairment test involves comparing the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired; however, if the carrying amount of the reporting unit exceeds its fair value, the second step must be performed. The second step involves calculating an implied fair value of goodwill for each reporting unit for which the first step indicated possible impairment. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination, which is the excess of the fair value of the reporting unit, as determined in the first step, over the aggregate fair values of the individual assets, liabilities and identifiable intangibles (including any unrecognized intangible assets, such as unrecognized core deposits and trademark) as if the reporting unit was being acquired in a business combination and the fair value of the reporting unit was the price paid to acquire the reporting unit. The Corporation estimates the fair values of the assets and liabilities of a reporting unit, consistent with the requirements of the fair value measurements accounting standard, which defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value of the assets and liabilities reflects market conditions, thus volatility in prices could have a material impact on the determination of the implied fair value of the reporting unit goodwill at the impairment test date. The adjustments to measure the assets, liabilities and intangibles at fair value are for the purpose of measuring the implied fair value of goodwill and such adjustments are not reflected in the consolidated statement of condition. If the implied fair value of goodwill exceeds the goodwill assigned to the reporting unit, there is no impairment. If the goodwill assigned to a reporting unit exceeds the implied fair value of the goodwill, an impairment charge is recorded for the excess. An impairment loss recognized cannot exceed the amount of goodwill assigned to a reporting unit, and the loss establishes a new basis in the goodwill. Subsequent reversal of goodwill impairment losses is not permitted under applicable accounting standards.

At December 31, 2012, goodwill amounted to $648 million. Note 17 to the consolidated financial statements provides the assignment of goodwill by reportable segment and the Corporate group.

The Corporation performed the annual goodwill impairment evaluation for the entire organization during the third quarter of 2012 using July 31, 2012 as the annual evaluation date. The reporting units utilized for this evaluation were those that are one level below the business segments, which are the legal entities within the reportable segment. The Corporation follows push-down accounting, as such all goodwill is assigned to the reporting units when carrying out a business combination.

In determining the fair value of a reporting unit, the Corporation generally uses a combination of methods, including market price multiples of comparable companies and transactions, as well as discounted cash flow analysis. Management evaluates the particular circumstances of each reporting unit in order to determine the most appropriate valuation methodology. The Corporation evaluates the results obtained under each valuation methodology to identify and understand the key value drivers in order to ascertain that the results obtained are reasonable and appropriate under the circumstances. Elements considered include current market and economic conditions, developments in specific lines of business, and any particular features in the individual reporting units.

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The computations require management to make estimates and assumptions. Critical assumptions that are used as part of these evaluations include:

• a selection of comparable publicly traded companies, based on nature of business, location and size;

• a selection of comparable acquisition and capital raising transactions;

• the discount rate applied to future earnings, based on an estimate of the cost of equity;

• the potential future earnings of the reporting unit; and

• the market growth and new business assumptions.

For purposes of the market comparable approach, valuations were determined by calculating average price multiples of relevant value drivers from a group of companies that are comparable to the reporting unit being analyzed and applying those price multiples to the value drivers of the reporting unit. Multiples used are minority based multiples and thus, no control premium adjustment is made to the comparable companies market multiples. While the market price multiple is not an assumption, a presumption that it provides an indicator of the value of the reporting unit is inherent in the valuation. The determination of the market comparables also involves a degree of judgment.

For purposes of the discounted cash flows (“DCF”) approach, the valuation is based on estimated future cash flows. The financial projections used in the DCF valuation analysis for each reporting unit are based on the most recent (as of the valuation date) financial projections presented to the Corporation’s Asset / Liability Management Committee (“ALCO”). The growth assumptions included in these projections are based on management’s expectations for each reporting unit’s financial prospects considering economic and industry conditions as well as particular plans of each entity (i.e. restructuring plans, de-leveraging, etc.). The cost of equity used to discount the cash flows was calculated using the Ibbotson Build-Up Method and ranged from 11.93% to 18.38% for the 2012 analysis. The Ibbotson Build-Up Method builds up a cost of equity starting with the rate of return of a “risk-free” asset (20-year U.S. Treasury note) and adds to it additional risk elements such as equity risk premium, size premium and industry risk premium. The resulting discount rates were analyzed in terms of reasonability given the current market conditions and adjustments were made when necessary.

For BPNA, the only reporting unit that failed Step 1, the Corporation determined the fair value of Step 1 utilizing a DCF approach and a market value approach. The market value approach is based on a combination of price multiples from comparable companies and multiples from capital raising transactions of comparable companies. The market multiples used included “price to book” and “price to tangible book”. The Step 1 fair value for BPNA under both valuation approaches (market and DCF) was below the carrying amount of its equity book value as of the valuation date (July 31, 2011), requiring the completion of Step 2. In accordance with accounting standards, the Corporation performed a valuation of all assets and liabilities of BPNA, including any recognized and unrecognized intangible assets, to determine the fair value of BPNA’s net assets. To complete Step 2, the Corporation subtracted from BPNA’s Step 1 fair value, the determined fair value of the net assets to arrive at the implied fair value of goodwill. The results of the Step 2 indicated that the implied fair value of goodwill exceeded the goodwill carrying value of $402 million at July 31, 2012 resulting in no goodwill impairment. The reduction in BPNA’s Step 1 fair value was offset by a reduction in the fair value of its net assets, resulting in an implied fair value of goodwill that exceeds the recorded book value of goodwill.

The analysis of the results for Step 2 indicates that the reduction in the fair value of the reporting unit was mainly attributed to the deteriorated fair value of the loan portfolios and not to the fair value of the reporting unit as a going concern. The current negative performance of the reporting unit is principally related to deteriorated credit quality in its loan portfolio, which is consistent with the results of the Step 2 analysis. The fair value determined for BPNA’s loan portfolio in the July 31, 2012 annual test represented a discount of 18.2%, compared with 28.0% at July 31, 2011. The discount is mainly attributed to market participant’s expected rate of returns, which affected the market discount on the commercial and construction loan portfolios of BPNA.

If the Step 1 fair value of BPNA declines further in the future without a corresponding decrease in the fair value of its net assets or if loan discounts improve without a corresponding increase in the Step 1 fair value, the Corporation may be required to record a goodwill impairment charge. The Corporation engaged a third-party valuator to assist management in the annual evaluation of BPNA’s goodwill (including Step 1 and Step 2) as well as BPNA’s loan portfolios as of the July 31, 2012 valuation date. Management discussed the methodologies, assumptions and results supporting the relevant values for conclusions and determined they were reasonable.

For the BPPR reporting unit, the average reporting unit estimated fair value calculated in Step 1 using all valuation methodologies exceeded BPPR’s equity value by approximately $222 million or 9% in the July 31, 2012 annual test as compared with

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approximately $472 million or 20% at July 31, 2011. This result indicates there would be no indication of impairment on the goodwill recorded in BPPR at July 31, 2012. For the BPNA reporting unit, the estimated implied fair value of goodwill calculated in Step 2 exceeded BPNA’s goodwill carrying value by approximately $338 million or 46% as compared to approximately $701 million or 64% at July 31, 2011. The reduction in the excess of the implied fair value of goodwill over its carrying amount for BPNA is due to the improvement credit quality of its loan portfolio.

Furthermore, as part of the analyses, management performed a reconciliation of the aggregate fair values determined for the reporting units to the market capitalization of Popular, Inc. concluding that the fair value results determined for the reporting units in the July 31, 2012 annual assessment were reasonable.

The goodwill impairment evaluation process requires the Corporation to make estimates and assumptions with regard to the fair value of the reporting units. Actual values may differ significantly from these estimates. Such differences could result in future impairment of goodwill that would, in turn, negatively impact the Corporation’s results of operations and the reporting units where the goodwill is recorded. Declines in the Corporation’s market capitalization could increase the risk of goodwill impairment in the future.

Management monitors events or changes in circumstances between annual tests to determine if these events or changes in circumstances are indicative of possible impairment.

Pension and Postretirement Benefit Obligations

The Corporation provides pension and restoration benefit plans for certain employees of various subsidiaries. The Corporation also provides certain health care benefits for retired employees of BPPR. The non-contributory defined pension and benefit restoration plans (“the Plans”) are frozen with regards to all future benefit accruals.

The estimated benefit costs and obligations of the pension and postretirement benefit plans are impacted by the use of subjective assumptions, which can materially affect recorded amounts, including expected returns on plan assets, discount rates, termination rates, retirement rates and health care trend rates. Management applies judgment in the determination of these factors, which normally undergo evaluation against current industry practice and the actual experience of the Corporation. The Corporation uses an independent actuarial firm for assistance in the determination of the pension and postretirement benefit costs and obligations. Detailed information on the Plans and related valuation assumptions are included in Note 33 to the consolidated financial statements.

The Corporation periodically reviews its assumption for the long-term expected return on pension plan assets. The Plans’ assets fair value at December 31, 2012 was $656.1 million. The expected return on plan assets is determined by considering various factors, including a total fund return estimate based on a weighted-average of estimated returns for each asset class in the plan. Asset class returns are estimated using current and projected economic and market factors such as real rates of return, inflation, credit spreads, equity risk premiums and excess return expectations.

As part of the review, the Corporation’s independent consulting actuaries performed an analysis of expected returns based on the plan’s asset allocation at January 1, 2013. This analysis is reviewed by the Corporation and used as a tool to develop expected rates of return, together with other data. This forecast reflects the actuarial firm’s view of expected long-term rates of return for each significant asset class or economic indicator; for example, 8.8% for large cap stocks, 3.5% for fixed-income securities, 9.0% for small cap stocks and 2.2% inflation at January 1, 2013. A range of expected investment returns is developed, and this range relies both on forecasts and on broad-market historical benchmarks for expected returns, correlations, and volatilities for each asset class.

As a consequence of recent reviews, the Corporation reduced its expected return on plan assets for year 2013 from 7.60% to 7.25%. The 7.60% and 8.00% had been used as the expected rate of return in 2012 and 2011, respectively. Since the expected return assumption is on a long-term basis, it is not materially impacted by the yearly fluctuations (either positive or negative) in the actual return on assets. However, if the actual return on assets performs below management’s expectations for a continued period of time, this could eventually result in the reduction of the expected return on assets percentage assumption.

During the fourth quarter of 2011, the Corporation offered a Voluntary Retirement Program (“VRP”) to all participants eligible for retirement under the Plans, excluding senior management. The VRP provided for an additional benefit of one-year of base pay, payable either as a lump-sum payment from the Plans on February 1, 2012, or as an increase in monthly pension payments on their elected pension benefit commencement date.

Pension expense for the Plans amounted to $13.2 million in 2012. The total pension expense included a credit of $41.3 million for the expected return on assets.

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Pension expense is sensitive to changes in the expected return on assets. For example, decreasing the expected rate of return for 2013 from 7.25% to 7.00% would increase the projected 2013 expense for the Banco Popular de Puerto Rico Retirement Plan, the Corporation’s largest plan, by approximately $1.5 million.

The Corporation accounts for the underfunded status of its pension and postretirement benefit plans as a liability, with an offset, net of tax, in accumulated other comprehensive income or loss. The determination of the fair value of pension plan obligations involves judgment, and any changes in those estimates could impact the Corporation’s consolidated statement of financial condition. The valuation of pension plan obligations is discussed above. Management believes that the fair value estimates of the pension plan assets are reasonable given that the plan assets are managed, in the most part, by the fiduciary division of BPPR, which is subject to periodic audit verifications. Also, the composition of the plan assets, as disclosed in Note 33 of the consolidated financial statements, is primarily in equity and debt securities, which have readily determinable quoted market prices.

The Corporation uses the Tower’s Watson RATE: Link (10/90) Model to discount the expected program cash flows of the plans as a guide in the selection of the discount rate. The Corporation used a discount rate of 3.80% to determine the benefit obligation at December 31, 2012, compared with 4.40% at December 31, 2011.

A 50 basis point decrease in the assumed discount rate of 3.80% as of the beginning of 2013 would increase the projected 2013 expense for the Banco Popular de Puerto Rico Retirement Plan by approximately $2.8 million. The change would not affect the minimum required contribution to the Plan.

The Corporation also provides a postretirement health care benefit plan for certain employees of BPPR. This plan was unfunded (no assets were held by the plan) at December 31, 2012. The Corporation had an accrual for postretirement benefit costs of $183.6 million at December 31, 2012. Assumed health care trend rates may have significant effects on the amounts reported for the health care plan. Note 33 to the consolidated financial statements provides information on the assumed rates considered by the Corporation and on the sensitivity that a one-percentage point change in the assumed rate may have on specified cost components and the postretirement benefit obligation of the Corporation.

STATEMENT OF OPERATIONS ANALYSIS

Net Interest Income

Net interest income is the Corporation’s primary source of earnings with 75% of total revenues (defined as net interest income plus non-interest income) for 2012 compared to 72% in 2011. The Corporation’s main source of income is subject to volatility derived from several risk factors which include market driven events, changes in volumes and repricing characteristics of assets and liabilities, as well as strategic decisions made by the Corporation’s management. Net interest income on a taxable equivalent basis for the year ended December 31, 2012 resulted in a decrease of $64 million when compared with the same period in 2011.

The average key index rates for the years 2010 through 2012 were as follows:

	2012		2011		2010
Prime rate		3.25%		3.25%		3.25%
Fed funds rate		0.14		0.11		0.18
3-month LIBOR		0.42		0.34		0.34
3-month Treasury Bill		0.08		0.05		0.13
10-year Treasury		1.74		2.76		3.19
FNMA 30-year		3.07		4.11		3.95

Interest earning assets include the investment securities and loans that are exempt from income tax, principally in Puerto Rico. The main sources of tax-exempt interest income are certain investments in obligations of the U.S. Government, its agencies and sponsored entities, and certain obligations of the Commonwealth of Puerto Rico and its agencies. Assets held by the Corporation’s international banking entities had a temporary 5% tax rate that ended in December, 2011. To facilitate the comparison of all interest related to these assets, the interest income has been converted to a taxable equivalent basis, using the applicable statutory income tax rates at each period, in the subsidiaries that have the benefit. The taxable equivalent computation considers the interest

25

expense disallowance required by the Puerto Rico tax law. Under this law, the exempt interest can be deducted up to the amount of taxable income. The decrease in taxable equivalent adjustment for 2012 is mainly related to lower exempt income due to renewal of cash flows in lower yielding securities, higher premium amortization and a lower volume of investment securities.

Average outstanding securities balances are based upon amortized cost excluding any unrealized gains or losses on securities available-for-sale. Non-accrual loans have been included in the respective average loans and leases categories. Loan fees collected and costs incurred in the origination of loans are deferred and amortized over the term of the loan as an adjustment to interest yield. Prepayment penalties, late fees collected and the amortization of premiums / discounts on purchased loans are also included as part of the loan yield. Interest income for the period ended December 31, 2012 included a favorable impact, excluding the discount accretion on covered loans accounted for under ASC 310-30, of $19.2 million, related to those items, compared to a favorable impact of $21.4 million for the same period in 2011 and $19.1 million in 2010. The $2.2 million reduction from 2011 to 2012 resulted in part from higher amortization of premiums related to mortgage loans purchased. The discount accretion on covered loans accounted for under ASC 310-20 (revolving lines) was fully accreted in the third quarter of 2011 and totaled $37.1 million.

Tables 5 and 6 present the different components of the Corporation’s net interest income, on a taxable equivalent basis, for the year ended December 31, 2012, as compared with the same period in 2011, segregated by major categories of interest earning assets and interest bearing liabilities.

Net interest margin, on a taxable equivalent basis, remained flat at 4.47% for the years ended December 31, 2012 and 2011. Although the net interest margin did not change from year to year, there were several factors that affected its composition as detailed below:

• a decrease in the yield of investments in part due to higher premium amortization related to mortgage backed securities as a result of higher prepayment activity and renewal of cash inflows in lower yielding collateralized mortgage obligations;

• a lower proportion and lower yield of covered loans. This portfolio, due to its nature, will continue to decline as scheduled payments are received and workout arrangements are made. The yield variance was impacted by the fact that the interest income for 2011 includes $37.1 million of discount accretion related to covered loans accounted for under ASC 310-20. As previously mentioned, this discount was fully accreted into earnings during 2011. Also, during 2011, resolutions of certain large commercial loan relationships caused the unamortized discount to be recognized into income for one pool and increased the accretable yield to be recognized over a short period of time for another pool. The accretion generated by the amortization of the discount for covered loans accounted for under ASC 310-20 as well as the transactions occurring within these two ASC 310-30 pools contributed to the high yield exhibited by the covered loan portfolio during 2011; and

• a decrease in the yield of mortgage loans due to acquisitions made, mainly in the US, of high quality loans, which generally carry a lower rate, originations in a lower rate environment, reversal of interest for delinquent loans, and non-performing loans repurchased under credit recourse agreements.

The above variances were partially offset by the following factors which affected positively the Corporation’s net interest margin:

• higher yield in the non-covered construction portfolio as a result of a lower proportion of non-performing loans;

• decrease of 35 basis points in the cost of interest bearing deposits, driven by management actions to reduce deposit costs; and

• lower cost of short-term borrowings resulting from the cancellation, during the quarter ended June 30, 2012, of $350 million in repurchase agreements with an average cost of 4.36% and replacing them with lower cost Federal Home Loan Bank advances.

Average earning assets decreased $1.4 billion when compared with 2011. This reduction was distributed between both investments and loans categories. The average loans volume decreased by approximately $772 million, principally in the categories of non-covered and covered commercial loans. This reduction occurred in both Puerto Rico and U.S markets. Lower origination activity, resolution of non-performing loans and charge-offs continue to impact the portfolio balance. In addition, the covered loan portfolio continues its normal amortization which contributes to the reduction in loan balances. For a detailed movement of covered loans refer to Note 10 of this Annual Report. The increase in the mortgage loans category resulted from strong originations within the Puerto Rico market as well as acquisitions made during the year by BPNA. The Corporation is pursuing its strategy of acquiring high

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quality assets to mitigate the reduction in the loan portfolio. The consumer loans category also benefitted from this strategy as $225 million of portfolio purchases at the end of June 2012 contributed to the increase in the average balance of this category. In addition, the reduction in the average balance of investment securities reflects maturities and prepayment activity within the mortgage related investments. The average balance of borrowings decreased by $1.4 billion mostly due to the repayment, at the end of 2011, of the note issued to the FDIC.

The increase in the net interest margin, on a taxable equivalent basis, from 3.82% in 2010 to 4.47% in 2011 was driven mostly by:

• a higher proportion of covered loans when compared to 2010. This was mainly due to the covered loan portfolio being outstanding for the full year in 2011 vs. eight months during 2010. This portfolio, due to its nature, carries a higher yield than the other loan portfolios. This impact is included in the line item “Covered loans” in Table 6;

• a decrease of 40 basis points in the cost of interest bearing deposits, driven by management actions to reduce deposit costs as well as renewing brokered certificates of deposits at a lower cost due to the low rate environment; and

• a higher yield in the investments category by 26 basis points. This increase was the result of the combination of maturities of lower yielding investments as well as a higher taxable equivalent benefit for 2011.

The above variances were partially offset by the following factors which affected negatively the Corporation’s net interest margin:

• excess liquidity invested in money market investments with the Federal Reserve earning a low interest rate, which reduced the yield on earning assets;

• a lower yield in both the commercial and construction portfolios. This reduction can be attributed to the level of non-performing loans within the portfolio; and

• the FDIC loss share indemnification asset of $1.9 billion at December 31, 2011, which is a non-interest earning asset being funded throughout the year with interest bearing liabilities, mainly a combination of the FDIC note at a 2.50% annual fixed interest rate and brokered certificates of deposits. The FDIC note was repaid as of December 31, 2011. The accretion of the FDIC loss share indemnification asset is recorded in non-interest income.

The increase in the taxable equivalent adjustment for 2011 was mainly the result of a change in BPPR’s tax position when compared to 2010. During 2011, BPPR was able to deduct tax exempt income, net of the related interest expense. BPPR’s net interest income for 2010 did not include a tax benefit related to exempt income due to its tax position at that time.

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Table 5 - Net Interest Income - Taxable Equivalent Basis

Year ended December 31,
Average volume						Average yields / costs							Interest						Variance attributable to
2012		2011		Variance		2012		2011		Variance			2012		2011		Variance		Rate		Volume
($ in millions)													(In thousands)
$	1,051	$	1,152	$	(101)		0.35 %		0.31 %		0.04 %	Money market investments	$	3,704	$	3,597	$	107	$	206	$	(99)
	5,227		5,494		(267)		3.45		4.05		(0.60)	Investment securities		180,243		222,465		(42,222)		(28,147)		(14,075)
	446		667		(221)		5.81		5.82		(0.01)	Trading securities		25,909		38,850		(12,941)		(76)		(12,865)
	6,724		7,313		(589)		3.12		3.62		(0.50)	Total money market, investment and trading securities		209,856		264,912		(55,056)		(28,017)		(27,039)
												Loans:
	10,226		10,889		(663)		4.95		5.06		(0.11)	Commercial		506,127		551,252		(45,125)		(12,105)		(33,020)
	459		731		(272)		3.61		1.48		2.13	Construction		16,597		10,801		5,796		11,001		(5,205)
	545		577		(32)		8.62		8.81		(0.19)	Leasing		46,960		50,867		(3,907)		(1,121)		(2,786)
	5,817		5,154		663		5.58		6.06		(0.48)	Mortgage		324,574		312,348		12,226		(25,994)		38,220
	3,749		3,654		95		10.22		10.30		(0.08)	Consumer		383,003		376,158		6,845		(3,484)		10,329
	20,796		21,005		(209)		6.14		6.20		(0.06)	Sub-total loans		1,277,261		1,301,426		(24,165)		(31,703)		7,538
	4,050		4,613		(563)		7.44		8.95		(1.51)	Covered loans		301,441		412,678		(111,237)		(63,177)		(48,060)
	24,846		25,618		(772)		6.35		6.69		(0.34)	Total loans		1,578,702		1,714,104		(135,402)		(94,880)		(40,522)
$	31,570	$	32,931	$	(1,361)		5.67 %		6.01 %		(0.34)%	Total earning assets	$	1,788,558	$	1,979,016	$	(190,458)	$	(122,897)	$	(67,561)
												Interest bearing deposits:
$	5,555	$	5,204	$	351		0.44 %		0.60 %		(0.16)%	NOW and money market [1]	$	24,576	$	30,994	$	(6,418)	$	(8,445)	$	2,027
	6,571		6,321		250		0.33		0.59		(0.26)	Savings		21,727		37,537		(15,810)		(17,383)		1,573
	9,421		10,920		(1,499)		1.46		1.84		(0.38)	Time deposits		137,786		200,956		(63,170)		(38,344)		(24,826)
	21,547		22,445		(898)		0.85		1.20		(0.35)	Total deposits		184,089		269,487		(85,398)		(64,172)		(21,226)
	2,565		2,630		(65)		1.82		2.10		(0.28)	Short-term borrowings		46,805		55,258		(8,453)		3,013		(11,466)
	-		1,382		(1,382)		-		2.33		(2.33)	FDIC note		-		32,161		(32,161)		-		(32,161)
	484		456		28		15.92		15.89		0.03	TARP funds [2]		76,977		72,520		4,457		127		4,330
	1,367		1,379		(12)		5.21		5.52		(0.31)	Other medium and long-term debt		71,215		76,083		(4,868)		(2,223)		(2,645)
	25,963		28,292		(2,329)		1.46		1.79		(0.33)	Total interest bearing liabilities		379,086		505,509		(126,423)		(63,255)		(63,168)
	5,357		5,058		299							Non-interest bearing demand deposits
	250		(419)		669							Other sources of funds
$	31,570	$	32,931	$	(1,361)		1.20 %		1.54 %		(0.34)%	Total source of funds		379,086		505,509		(126,423)		(63,255)		(63,168)
							4.47 %		4.47 %		- %	Net interest margin
												Net interest income on a taxable equivalent basis	$	1,409,472	$	1,473,507	$	(64,035)	$	(59,642)	$	(4,393)
							4.21 %		4.22 %		(0.01)%	Net interest spread
												Taxable equivalent adjustment		36,853		41,515		(4,662)
												Net interest income	$	1,372,619	$	1,431,992	$	(59,373)

Note: The changes that are not due solely to volume or rate are allocated to volume and rate based on the proportion of the change in each category.

[1] Includes interest bearing demand deposits corresponding to certain government entities in Puerto Rico.

[2] Junior subordinated deferrable interest debentures held by the U.S. Treasury.

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Table 6 - Analysis of Levels & Yields on a Taxable Equivalent Basis

Year ended December 31,
Average volume						Average yields / costs							Interest						Variance attributable to
2011		2010		Variance		2011		2010		Variance			2011		2010		Variance		Rate		Volume
($ in millions)													(In thousands)
$	1,152	$	1,539	$	(387)		0.31 %		0.35 %		(0.04)%	Money market investments	$	3,597	$	5,384	$	(1,787)	$	(610)	$	(1,177)
	5,494		6,300		(806)		4.05		3.79		0.26	Investment securities		222,465		238,654		(16,189)		19,324		(35,513)
	667		493		174		5.82		6.55		(0.73)	Trading securities		38,850		32,333		6,517		(3,896)		10,413
	7,313		8,332		(1,019)		3.62		3.32		0.30	Total money market, investment and trading securities		264,912		276,371		(11,459)		14,818		(26,277)
												Loans:
	10,889		11,889		(1,000)		5.06		5.17		(0.11)	Commercial		551,252		614,187		(62,935)		(12,085)		(50,850)
	731		1,458		(727)		1.48		2.03		(0.55)	Construction		10,801		29,539		(18,738)		(6,605)		(12,133)
	577		629		(52)		8.81		8.77		0.04	Leasing		50,867		55,144		(4,277)		283		(4,560)
	5,154		4,627		527		6.06		6.02		0.04	Mortgage		312,348		278,339		34,009		2,138		31,871
	3,654		3,854		(200)		10.30		10.40		(0.10)	Consumer		376,158		400,662		(24,504)		(8,947)		(15,557)
	21,005		22,457		(1,452)		6.20		6.14		0.06	Sub-total loans		1,301,426		1,377,871		(76,445)		(25,216)		(51,229)
	4,613		3,365		1,248		8.95		9.01		(0.06)	Covered loans		412,678		303,096		109,582		(1,702)		111,284
	25,618		25,822		(204)		6.69		6.51		0.18	Total loans		1,714,104		1,680,967		33,137		(26,918)		60,055
$	32,931	$	34,154	$	(1,223)		6.01 %		5.73 %		0.28 %	Total earning assets	$	1,979,016	$	1,957,338	$	21,678	$	(12,100)	$	33,778
												Interest bearing deposits:
$	5,204	$	4,981	$	223		0.60 %		0.80 %		(0.20)%	NOW and money market [1]	$	30,994	$	39,776	$	(8,782)	$	(10,113)	$	1,331
	6,321		5,970		351		0.59		0.90		(0.31)	Savings		37,537		54,021		(16,484)		(19,907)		3,423
	10,920		10,967		(47)		1.84		2.34		(0.50)	Time deposits		200,956		257,084		(56,128)		(53,031)		(3,097)
	22,445		21,918		527		1.20		1.60		(0.40)	Total deposits		269,487		350,881		(81,394)		(83,051)		1,657
	2,630		2,401		229		2.10		2.51		(0.41)	Short-term borrowings		55,258		60,278		(5,020)		(8,658)		3,638
	1,382		2,753		(1,371)		2.33		2.13		0.20	FDIC note		32,161		58,521		(26,360)		5,114		(31,474)
	456		434		22		15.89		15.84		0.05	TARP funds [2]		72,520		68,694		3,826		196		3,630
	1,379		1,860		(481)		5.52		6.18		(0.66)	Other medium and long-term debt		76,083		115,007		(38,924)		5,093		(44,017)
	28,292		29,366		(1,074)		1.79		2.22		(0.43)	Total interest bearing liabilities		505,509		653,381		(147,872)		(81,306)		(66,566)
	5,058		4,732		326							Non-interest bearing demand deposits
	(419)		56		(475)							Other sources of funds
$	32,931	$	34,154	$	(1,223)		1.54 %		1.91 %		(0.37)%	Total source of funds		505,509		653,381		(147,872)		(81,306)		(66,566)
							4.47 %		3.82 %		0.65 %	Net interest margin
												Net interest income on a taxable equivalent basis	$	1,473,507	$	1,303,957	$	169,550	$	69,206	$	100,344
							4.22 %		3.51 %		0.71 %	Net interest spread
												Taxable equivalent adjustment		41,515		9,092		32,423
												Net interest income	$	1,431,992	$	1,294,865	$	137,127

Note: The changes that are not due solely to volume or rate are allocated to volume and rate based on the proportion of the change in each category.

[1] Includes interest bearing demand deposits corresponding to certain government entities in Puerto Rico.

[2] Junior subordinated deferrable interest debentures held by the U.S. Treasury.

Provision for Loan Losses

The provision for loan losses amounted to $408.9 million, or 83% of net charge-offs, for the year ended December 31, 2012, compared with $575.7 million, or 104%, respectively, for 2011, and $1.0 billion, or 88%, respectively, for 2010. The provision for loan losses for non-covered loans decreased by $96.0 million, or 22%, from 2011 to 2012 and by $581.8 million, or 57%, from 2010 to 2011. The provision for loan losses for covered loans decreased by $70.8 million, or 49%, from 2011 to 2012 but increased by $145.6 million from 2010 to 2011.

The decrease in the provision for loan losses for non-covered loans from 2011 to 2012 was mainly driven by continued credit quality improvements in all loan categories, except mortgage loans. Net charge-offs declined by $131.3 million in all loan categories, except

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in mortgage loans which increased by $30.1 million principally related revisions to the charge-off policy during the first quarter of 2012, coupled with the continued impact of weak economic conditions in the real estate market of Puerto Rico. The general allowance decreased by $121 million mainly driven by the improvements in credit quality and lower underlying loss trends, partially offset by an increase in the specific allowance of $52 million. The increase in the specific allowance, particularly in the BPPR segment, was primarily attributed to an increase in the specific allowance for mortgage loans reflecting the intensification of the loss mitigation efforts. In the other hand, the decrease in the provision for loan losses for covered loans from 2011 to 2012 was mostly driven by certain commercial and construction loan pools accounted for under ASC Subtopic 310-30 which reflected lower expected loss estimates and reductions in the specific reserves of certain commercial loan relationships accounted for under ASC Subtopic 310-20.

The decrease in the provision for loan losses for non-covered loans from 2010 to 2011 was driven by the following factors: (i) a $176.0 million charge taken in 2010 to provide for the difference between the book value and the estimated fair value of the BPPR commercial and construction loans and the BPNA non-conventional mortgage loans transferred to loans held-for-sale, (ii) a lower level of problem loans in the commercial and construction loan portfolio balances classified as held-for-investment, (iii) the running-off of the BPNA non-conventional mortgage loan portfolio and (iv) the continued improvement in the credit quality performance of the Corporation’s consumer loan portfolios. Overall, reductions in net charge-offs, which decreased by $597.9 million compared to 2010, were reflected in all loan categories and segments, except in mortgage loans at the BPPR reportable segment, which increased by $5.9 million. In the other hand, the increase in the provision for loan losses for covered loans from 2010 to 2011 was primarily due to reductions in expected cash flows on certain pools accounted for pursuant to ASC 310-30 and to two particular credit relationships accounted for pursuant to ASC 310-20 which required specific reserves of $28.2 million, of which $10.9 million were charged-off during the fourth quarter of 2011. The covered loan portfolio did not require an allowance for loan losses at December 31, 2010.

Refer to the Credit Risk Management and Loan Quality section for a detailed analysis of net charge-offs, non-performing assets, the allowance for loan losses and selected loan losses statistics.

Non-Interest Income

Refer to Table 7 for a breakdown of non-interest income by major categories for the past five years.

Table 7 - Non-Interest Income

	Years ended December 31,
(In thousands)	2012			2011			2010			2009			2008
Service charges on deposit accounts	$	183,026		$	184,940		$	195,803		$	213,493		$	206,957
Other service fees:
Debit card fees		36,787			49,459			100,639			110,040			108,274
Credit card fees and discounts		57,551			49,049			84,786			94,636			107,713
Insurance fees		53,825			54,390			49,768			50,132			50,417
Processing fees		6,330			6,839			45,055			55,005			51,731
Sale and administration of investment products		37,766			34,388			37,783			34,134			34,373
Mortgage servicing fees, net of fair value adjustments		30,770			12,098			24,801			15,086			25,987
Trust fees		16,353			15,333			14,217			12,455			12,099
Check cashing fees		244			339			408			588			512
Other fees		16,919			17,825			20,047			22,111			25,057
Total other services fees		256,545			239,720			377,504			394,187			416,163
Net (loss) gain on sale and valuation adjustments of investment securities		(1,707	)		10,844			3,992			219,546			69,716
Trading account (loss) profit		(17,682	)		5,897			16,404			39,740			43,645
Net gain on sale of loans, including valuation adjustments on loans held-for-sale		48,765			30,891			15,874			5,151			26,256
Adjustments (expense) to indemnity reserves on loans sold		(21,198	)		(33,068	)		(72,013	)		(40,211	)		(20,238)
FDIC loss share (expense) income		(56,211	)		66,791			(25,751	)		-			-
Fair value change in equity appreciation instrument		-			8,323			42,555			-			-
Gain on sale of processing and technology business		-			-			640,802			-			-
Other operating income		74,804			45,939			93,023			64,595			87,475
Total non-interest income	$	466,342		$	560,277		$	1,288,193		$	896,501		$	829,974

30

The decrease in non-interest income for the year ended December 31, 2012, when compared with the previous year, was mainly impacted by the following factors:

• unfavorable variance in net (loss) gain on sale and valuation adjustments of investment securities of $12.6 million due to the $8.5 million gain on the sale of $234 million in FHLB notes during the third quarter of 2011 and to the $2.8 million gain on the sale of a limited partnership interest in real estate limited partnerships owning property qualifying for low-income housing tax credits by BPNA during the fourth quarter of 2011;

• unfavorable variance in trading account (loss) profit of $23.6 million mainly driven by lower unrealized gains on outstanding mortgage-backed securities in the P.R. operations due to lower market prices on a lower volume of outstanding pools, partially offset by lower realized losses on derivatives at BPPR;

• unfavorable variance in FDIC loss share (expense) income of $123.0 million. This unfavorable variance was mainly the result of higher amortization of the FDIC loss share asset due to a decrease in expected losses and a reduction in the provision for loan losses on covered loans, partially offset by a favorable impact from the mirror accounting on the 80% FDIC coverage for reimbursable loan-related expenses on covered loans and a favorable impact on the mirror accounting for the discount accretion on loans and unfunded commitments accounted for under ASC Subtopic 310-20 since the discount on these loans had been fully accreted by the end of the third quarter of 2011. Refer to Table 2 for a breakdown of FDIC loss share (expense) income by major categories.

• unfavorable variance on the fair value of the equity appreciation instrument issued to the FDIC as part of the Westernbank FDIC-assisted transaction of $8.3 million since the results for 2011 included the positive impact of valuing the instrument which expired in May 2011.

These unfavorable variances for the year ended December 31, 2012, when compared with the previous year, were partially offset by the following positive factors:

• higher other service fees by $16.8 million due to lower unfavorable fair value adjustments on mortgage servicing rights, higher credit card fees mainly due to higher interchange income from credit card portfolio acquisitions and higher membership fees from the credit card portfolio acquired in August 2011, partially offset by lower debit card fees mostly from lower interchange income driven by the Durbin Amendment of the Dodd-Frank Act that began to take effect on October 1, 2011;

• higher net gain on sale of loans, including valuation adjustments on loans held-for-sale, by $17.9 million. The favorable variance in net gain on sale of loans was principally due to higher gains on securitization transactions in the BPPR reportable segment by $52.8 million. This favorable variance was partially offset by higher unfavorable valuation adjustments on loans held-for-sale of approximately $20.1 million principally related to $27.3 million in valuation adjustments recorded during the second quarter of 2012 on commercial and construction loans held-for-sale in the BPPR reportable segment as a result of revised appraisals and market indicators;

• lower unfavorable adjustments recorded to indemnity reserves on loans sold by $11.9 million mainly as a result of improvements in delinquency trends of mortgage loans serviced subject to credit recourse as well as a declining portfolio since the Corporation is no longer selling loans subject to credit recourse; and

• higher other operating income by $28.9 million principally due to higher net earnings on investments accounted for under the equity method by $38.7 million (net of intra-entity eliminations). This was mainly attributed to $31.6 million of income recorded during the fourth quarter of 2012 related to the Corporation’s proportionate share of a tax benefit from a tax grant received by EVERTEC from the Puerto Rico Government; partially offset by the gain of $20.6 million on the sale of the equity interest in CONTADO during the first quarter of 2011.

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For the year ended December 31, 2011, non-interest income decreased by $727.9 million, or 57%, when compared to 2010, principally due to the gain on sale of the 51% ownership interest in the Corporation’s processing and technology business, EVERTEC, during 2010 of $640.8 million. In addition, other service fees declined by $137.8 million principally due to lower credit and debit card fees, mainly as a result of transferring the merchant banking business to EVERTEC as part of the aforementioned sale of those operations during 2010. There was also an unfavorable impact in the fair value of the equity appreciation instrument issued to the FDIC as part of the Westernbank FDIC-assisted transaction of $34.2 million since the instrument expired on May 7, 2011. Also, other operating income decreased by $47.1 million mainly due to $23.4 million in higher losses (net of intra-entity eliminations) from the retained ownership interest in EVERTEC and $34.9 million in lower accretion of the contingent liability for unfunded lending commitments recorded as part of the FDIC-assisted transaction on revolving lines with maturities of one year or less, partially offset by the gain of $20.6 million on the sale of the equity interest in CONTADO during 2011. These unfavorable variances were partially offset by the following factors: lower unfavorable adjustments related to indemnity reserves on loans sold by $38.9 million due to lower unfavorable representation and warranty adjustments in both the P.R. and U.S. operations by $5.8 million and $22.1 million, respectively, and lower credit recourse adjustments in the BPPR reportable segment by $10.1 million; and a favorable variance in FDIC loss share (expense) income by $92.5 million mainly driven by the recording of provision for loan losses on covered loans during 2011 and the impact of lower discount accretion on the loans and contingent liability for unfunded commitments, partially offset by higher amortization of the FDIC loss share asset due to a decrease in expected losses on covered loans.

Operating Expenses

Table 8 provides a breakdown of operating expenses by major categories.

Table 8 - Operating Expenses

	Year ended December 31,
(In thousands)	2012		2011		2010		2009			2008
Personnel costs:
Salaries		$   301,965		$    305,018		$    352,139		$    364,529			$    421,134
Commissions, incentives and other bonuses		54,702		44,421		53,837		43,840			61,745
Pension, postretirement and medical insurance		66,976		62,219		61,294		81,372			56,481
Other personnel costs, including payroll taxes		42,059		41,712		46,928		43,522			69,105
Total personnel costs		465,702		453,370		514,198		533,263			608,465
Net occupancy expenses		100,452		102,319		116,203		111,035			120,456
Equipment expenses		45,290		43,840		85,851		101,530			111,478
Other taxes		50,120		51,885		50,608		52,605			52,799
Professional fees:
Collections, appraisals and other credit related fees		46,658		34,241		27,081		21,675			21,413
Programming, processing and other technology services		102,222		96,699		45,685		31,286			35,830
Other professional fees		63,010		64,002		93,339		58,326			63,902
Total professional fees		211,890		194,942		166,105		111,287			121,145
Communications		26,834		27,115		38,905		46,264			51,386
Business promotion		61,576		55,067		46,671		38,872			62,731
Impairment losses on long-lived assets		-		-		-		1,545			13,491
FDIC deposit insurance		85,697		93,728		67,644		76,796			15,037
Loss (gain) on early extinguishment of debt		25,196		8,693		38,787		(78,300	)		-
Other real estate owned (OREO) expenses		23,520		21,778		46,789		25,800			12,158
Other operating expenses:
Credit and debit card processing, volume, interchange and other expenses		19,729		17,539		40,574		43,806			45,326
Transportation and travel		6,582		7,012		7,769		8,796			12,751
Printing and supplies		4,615		5,273		9,302		11,093			14,450
Operational losses		24,465		13,239		19,018		13,649			16,399
All other		49,408		44,843		67,950		46,673			54,667
Total other operating expenses		104,799		87,906		144,613		124,017			143,593
Goodwill and trademark impairment losses		-		-		-		-			12,480
Amortization of intangibles		10,072		9,654		9,173		9,482			11,509
Total operating expenses		$ 1,211,148		$  1,150,297		$  1,325,547		$  1,154,196			$  1,336,728
Personnel costs to average assets		1.28%		1.19%		1.34%		1.46%			1.54%
Operating expenses to average assets		3.34		3.02		3.45		3.16			3.39
Employees (full-time equivalent)		8,072		8,329		8,277		9,407			10,387
Average assets per employee (in millions)		$4.49		$4.57		$4.64		$3.89			$3.80

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Operating expenses for the year ended December 31, 2012 increased by $60.9 million, or 5%, when compared with the year ended December 31, 2011. The increase in operating expenses was impacted by the following variances:

• an increase in personnel costs of $12.3 million, principally reflected in the following categories:

^¡  higher incentives, commissions and other bonuses by $10.3 million mainly due to higher annual incentives programs, branch sales incentives, retail commissions and other performance incentives; and

^¡  higher medical insurance expenses by $5.8 million due to higher claims activity and revised premiums during 2012.

• an increase in professional fees of $16.9 million driven primarily by higher collection, appraisals and other credit related fees by $12.4 million, mainly in the BPPR reportable segment. Some of these expenses are reimbursable by the FDIC since they are covered under the loss sharing agreements;

• an increase in business promotion expenses of $6.5 million mainly driven by higher costs from the credit card rewards programs, higher expenses related to institutional advertising campaigns, and the expenses related to mobile banking applications;

• higher loss on extinguishment of debt by $16.5 million as a result of the prepayment expense of $25 million recorded during the second quarter of 2012 which was related to the early termination of repurchase agreements of $350 million with original contractual maturities between March 2014 and May of 2014, partially offset by $8 million in prepayment penalties recorded during the first quarter of 2011 on the repayment of $100 million in medium-term notes; and

• an increase in the category of other operating expenses of $16.9 million mainly due to higher tax, insurance advances, properties maintenance and repair expenses, and other costs associated with the collection efforts of the Westernbank covered loan portfolio by $10.5 million. Under the loss sharing agreements, 80% of certain expenses are reimbursable by the FDIC and although the related expenses are reflected in this category, the 80% offset to these expenses is recorded in the income statement category of FDIC loss share income (expense) in non-interest income.

The above variances were partially offset by a decrease in the FDIC deposit insurance expense of $8.0 million mainly driven by revisions in the deposit insurance premium calculation and efficiencies achieved from the internal reorganization of Popular Mortgage into BPPR during the fourth quarter of 2012.

Total operating expenses for the year 2011 declined by $175.3 million, or 13%, when compared with 2010. The main driver for the decrease pertained to EVERTEC’s operating expenses in 2010, prior to the sale of the 51% interest in EVERTEC during 2010. The decrease was principally reflected in personnel costs by $60.8 million, net occupancy expenses by $13.9 million, equipment expenses by $42.0 million and communication expenses by $11.8 million. Also contributing to the decrease in operating expenses for the year ended December 31, 2011 when compared with the previous year, were a lower loss on extinguishment of debt by $38.8 million, lower other real estate owned expenses by $25.0 million and a decline in credit and debit card processing, volume and interchange expenses of $25.1 million. These favorable variances were partially offset by an increase in professional fees of $28.8 million, primarily due to system application processing and hosting services provided by EVERTEC to the Corporation’s subsidiaries, which were eliminated during consolidation prior to the 51% ownership sale of EVERTEC. There was also an increase in business promotion expenses of $8.4 million, mainly due to advertising expenses and higher FDIC deposit insurance assessments during 2011 by $26.1 million mainly due to the change in the assessment computation for BPPR in the second quarter of 2011. Also, operating expenses for the year ended December 31, 2011 included approximately $15.6 million in pension costs related to employees that were eligible and elected to participate in the voluntary retirement program of 2011. A total of 369 employees retired effective February 1, 2012.

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INCOME TAXES

Income tax benefit amounted to $26.4 million for the year December 31, 2012, compared with an income tax expense of $114.9 million for the previous year. The decrease in income tax expense was due to lower income recognized by the P.R. operations during the year ended December 31, 2012 compared to year ended December 31, 2011. Furthermore, on January 1, 2011, the Governor of Puerto Rico signed Act Number 1 (Internal Revenue Code for a New Puerto Rico) which, among the most significant changes applicable to corporations, was the reduction in the marginal tax rate from 39% to 30%. Consequently, as a result of this reduction in rate, the Corporation recognized during the first quarter of 2011 income tax expense of $103.3 million and a corresponding reduction in the net deferred tax assets of the Puerto Rico operations.

Additionally, an income tax benefit of $72.9 million was recorded during 2012 related to the reduction of the deferred tax liability on the estimated gains for tax purposes related to the loans acquired from Westernbank (the “Acquired Loans”) as a result of a Closing Agreement signed by the Corporation and P.R. Department of the Treasury. Under this agreement, both parties agreed that the Acquired Loans are a capital asset and any gain resulting from such loans will be taxed at the capital gain rate of 15% instead of the ordinary income tax rate of 30%, thus reducing the deferred tax liability on the estimated gain and recognizing an income tax benefit for accounting purposes.

During the year ended December 31, 2011, a tax benefit of $53.6 million was recorded for the recovery of certain tax benefits not previously recorded during years 2009 (the benefit of reduced tax rates for capital gains) and 2010 (the benefit of the exempt income) as a result of a Closing Agreement signed by the Corporation and the P.R. Treasury in June 2011. Under this agreement, both parties agreed that for tax purposes the deductions related to certain charge-offs recorded on the financial statements of Popular for the years 2009 and 2010 could be deferred until 2013,2014,2015 and 2016. In addition, as a result of the 2011 Closing Agreement, the Corporation recorded a tax benefit of $11.9 million related to the tax benefits of the exempt income for the first six months of 2011.

Income tax expense for the year ended December 31, 2011 was $114.9 million, compared with an income tax expense of $108.2 million for 2010. The increase in income tax expense was mainly due to the recognition during 2011 of $103.3 million in income tax expense as a result of the reduction in the marginal tax rate as explained above partly offset by the tax benefit of $53.6 million, recorded as a result of the Closing Agreement signed by the Corporation and the P.R. Treasury in June 2011. Additionally, this increase was offset by lower income before taxes on the Puerto Rico operations mostly because of the gain on the sale of 51% interest in Evertec that took place during 2010. The gain was calculated at the preferential tax rate of 25%.

The Corporation’s net deferred tax assets at December 31, 2012 amounted to $531 million (net of the valuation allowance of $1.3 billion) compared to $405 million at December 31, 2011. Note 39 to the consolidated financial statements provides the composition of the net deferred tax assets as of such dates. All of the net deferred tax assets at December 31, 2012 pertain to the Puerto Rico operations. Of the amount related to the U.S. operations, without considering the valuation allowance, $1.1 billion is attributable to net operating losses of such operations.

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The components of income tax (benefit) expense for the years ended December 31, 2012, 2011 and 2010 are included in the following table.

Table 9 – Components of Income Tax (Benefit) Expense

	2012					2011					2010
(In thousands)	Amount		% of pre-tax income			Amount		% of pre-tax income			Amount			% of pre-tax     income
Computed income tax at statutory rates		$      65,662		30	%		$        79,876		30	%		$        100,586			41 %
Benefit of net tax exempt interest income		(25,540)		(12)			(31,379)		(12)			(7,799)			(3)
Effect of income subject to preferential tax rate [1]		(78,132)		(36)			(1,852)		(1)			(143,844	)		(59)
Deferred tax asset valuation allowance		166		-			7,192		3			143,754			59
Non-deductible expenses		23,093		11			21,756		8			28,130			11
Difference in tax rates due to multiple jurisdictions		(6,034)		(3)			(8,555)		(3)			13,908			6
Initial adjustment in deferred tax due to change in tax rate		-		-			103,287		39			-			-
Recognition of tax benefits from previous years [2]		-		-			(53,615)		(20)			-			-
Unrecognized tax benefits		(8,985)		(4)			(5,160)		(2)			-			-
Others		3,367		2			3,377		1			(26,505)			(11)
Income tax (benefit) expense		$     (26,403)		(12	)%		$      114,927		43	%		$        108,230			44 %

[1] Includes the impact of the Closing Agreement with the P.R. Treasury signed in June 2012 and income from investments in subsidiaries subject to preferential tax rates.

[2] Represents the impact of the Ruling and Closing Agreement with the P.R. Treasury signed in June 2011.

The full valuation allowance in the Corporation’s U.S. operations was recorded in the year 2008 in consideration of the requirements of ASC 740. Refer to the Critical Accounting Policies / Estimates section of this MD&A for information on the requirements of ASC 740. The Corporation’s U.S. mainland operations are in a cumulative loss position for the three-year period ended December 31, 2012 taking into account taxable income adjusted by temporary differences. For purposes of assessing the realization of the deferred tax assets in the U.S. mainland, this cumulative taxable loss position, along with the evaluation of all sources of taxable income available to realize the deferred tax asset, has caused management to conclude that it is more likely than not that the Corporation will not be able to fully realize the deferred tax assets in the future, considering solely the criteria of ASC 740.

The Corporation’s Puerto Rico Banking operation is no longer in a cumulative loss position. This operation shows a cumulative income position for the three-year period ended December 31, 2012 taking into account taxable income exclusive of reversing temporary differences (adjusted taxable income). The sustained profitability during the years 2011 and 2012 is considered a strong piece of objectively verifiable positive evidence for the evaluation of the deferred tax valuation allowance. Based on this evidence and its estimated adjusted taxable income for future years, the Corporation has concluded that it is more likely than not that the net deferred tax asset of the Puerto Rico operations will be realized.

Management will reassess the realization of the deferred tax assets based on the criteria of ASC 740 each reporting period. To the extent that the financial results of the U.S. operations improve and the deferred tax asset becomes realizable, the Corporation will be able to reduce the valuation allowance through earnings.

Refer to Note 39 to the consolidated financial statements for additional information on income taxes.

Fourth Quarter Results

The Corporation recognized net income of $83.9 million for the quarter ended December 31, 2012, compared with $3.0 million for the same quarter of 2011. The variance in the quarterly results was mainly driven by a reduction in the provision for loan losses of $97.0 million.

Net interest income for the fourth quarter of 2012 amounted to $350.4 million, compared with $344.8 million for the fourth quarter of 2011. The increase in net interest income was primarily due to a higher volume of mortgage loans, a higher volume and yield of consumer loans, and a reduction in the cost of deposits and repurchase agreements.

The provision for loan losses amounted to $82.8 million or 73% of net charge-offs for the quarter ended December 31, 2012, compared to $179.8 million or 131% of net charge-offs for the fourth quarter of 2011. There was a decrease of $37.7 million in the provision for loan losses on non-covered loans and $59.3 million in the provision for loan losses on covered loans. The decrease in the provision for loan losses on non-covered loans was mainly due to reductions in the general reserves as a result of improvements in credit quality and lower underlying loss trends. This favorable variance was partially offset by increases in the specific reserves of

35

the mortgage loan portfolio. The decrease in the provision for loan losses on covered loans was driven by reversals to provision expense for certain construction pools accounted for under ASC Subtopic 310-30 and a reduction in the specific reserve of certain commercial loan relationships accounted for under ASC Subtopic 310-20.

Non-interest income amounted to $133.0 million for the quarter ended December 31, 2012, compared with $149.4 million for the same quarter in 2011. The decrease in non-interest income was mainly due to an unfavorable variance in FDIC loss share (expense) income of $54.3 million principally due to a release of allowance for loan and lease losses during the fourth quarter of 2012 and higher amortization of the loss share asset due to lower expected losses. In addition, there was an unfavorable variance in trading account (loss) gain of $8.6 million related to higher unrealized losses on trading mortgage-backed securities and higher realized losses on derivatives. These unfavorable variances were partially offset by higher gains on sales of loans, net of valuation adjustments on loans held-for-sale, by $14.1 million as a result of higher gains on securitization transactions at BPPR, and higher other operating income by $34.5 million mostly due to $31.6 million of income recorded from the Corporation’s interest in EVERTEC during the fourth quarter of 2012 related to its proportionate share of a tax benefit from a tax grant received by EVERTEC from the Puerto Rico Government.

Operating expenses totaled $296.7 million for the quarter ended December 31, 2012, compared with $311.1 million for the same quarter in the previous year. There were lower personnel costs by $8.2 million mainly due to the $15.6 million charge during the fourth quarter of 2011 related to the voluntary retirement program, partially offset by an increase in the amortization of pension costs resulting from a decrease in the discount rate and in the expected return of plan assets, and an increase in incentive compensation and medical insurance expenses. In addition, there was a decrease in FDIC deposit insurance expenses of $11.4 million due to revisions in the deposit insurance premium calculation and efficiencies achieved from the internal reorganization of Popular Mortgage into BPPR during the fourth quarter of 2012. Also, there were lower OREO expenses by $8.8 million driven mainly by higher gains on sales of commercial properties in the U.S. mainland and a decrease in fair value adjustments for commercial properties in BPPR. These favorable variances were partially offset by higher professional fees by $8.2 million due to appraisal and programming costs, processing fees, and other technology costs related to services from EVERTEC; and higher other operating expenses by $6.7 million mainly due to a higher provision for operational losses in the Puerto Rico and U.S. operations, partially offset by lower charges to increase the reserve for unfunded lending commitments in the Puerto Rico operations.

Income tax expense amounted to $19.9 million for the quarter ended December 31, 2012, compared with $0.3 million for the same quarter of 2011. The variance was primarily due to higher income recognized by the Puerto Rico operations during the fourth quarter of 2012 compared with the same period of 2011, including higher income from the Corporation’s investment in EVERTEC’s parent company.

REPORTABLE SEGMENT RESULTS

The Corporation’s reportable segments for managerial reporting purposes consist of Banco Popular de Puerto Rico and Banco Popular North America. A Corporate group has been defined to support the reportable segments. For managerial reporting purposes, the costs incurred by the Corporate group are not allocated to the reportable segments.

For a description of the Corporation’s reportable segments, including additional financial information and the underlying management accounting process, refer to Note 41 to the consolidated financial statements.

 The Corporate group reported a net loss of $91.9 million for the year ended December 31, 2012, compared with net loss of $110.8 million for the year ended December 31, 2011. The favorable variance in the results for the Corporate group was the net effect of higher income, net of intra-entity eliminations, from the equity interest in EVERTEC; and prepayment penalties incurred in 2011 on the early cancellation of medium-term notes, partially offset by a gain recognized during the year ended December 31, 2011 from the sale of its equity investment in CONTADO.

Highlights on the earnings results for the reportable segments are discussed below.

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Banco Popular de Puerto Rico

The Banco Popular de Puerto Rico reportable segment’s net income amounted to $290.8 million for the year ended December 31, 2012, compared with $231.5 million for the year ended December 31, 2011. The principal factors that contributed to the variance in the financial results included the following:

• lower net interest income by $42.2 million, or 3%, mostly due to a reduction in interest income from the covered loan portfolio by $111.2 million resulting from $37.1 million discount accretion recognized during the year ended December 31, 2011 on revolving lines of credit accounted for pursuant to ASC 310-20, and from a lower average balance of covered loans by $563 million. Also, a reduction of approximately $794 million in the average volume of money market, investment and trading securities resulted in a lower interest income of $48.3 million. The unfavorable impact resulting from these reductions was partially offset by a $63.6 million reduction in deposit costs or 35 basis points and $44.4 million in the cost of borrowings mostly associated with the prepayment during 2011 of the note issued to the FDIC. The net interest margin was 5.06% for the year ended December 31, 2012, compared to 5.02% for 2011;

• lower provision for loan losses by $130.7 million, or 27%, due to the decrease in the provision for loan losses on the covered loan portfolio of $70.8 million, or 49% and $59.9 million, or 18% in the provision for loan losses on the non-covered loan portfolio. The provision for loan losses for the non-covered portfolio reflected lower net charge-offs by $40.9 million and reductions in the allowance for loan losses, mainly driven by the commercial and consumer portfolios, as a result of continued improvement in credit trends. These reductions were more than offset by higher allowance levels for the mortgage loan portfolio prompted by higher loss trends and higher specific reserves for loans restructured under the Corporation’s loss mitigation program. The decrease in the provision for loan losses on covered loans was mainly driven by a lower provision on loans accounted for under ASC Subtopic 310-30 as certain pools, principally commercial and construction loan pools, reflected higher increases in expected loss estimates for 2011 when compared with the revisions in expected loss estimates for 2012;

• lower non-interest income by $86.4 million, or 18%, mainly due to FDIC loss share expense of $56.2 million recognized for the year ended December 31, 2012, compared with FDIC loss share income of $66.8 million for the same period previous year. Refer to Table 2 for components of this variance. The decrease in non-interest income was also due to an unfavorable variance of $23.8 million in trading account (loss) profit resulting from lower unrealized gains on outstanding mortgage-backed securities due to lower market prices on a lower volume of outstanding pools, partially offset by lower realized losses on derivatives. Also, the decrease was due to unfavorable variances of $21.2 million in valuation adjustments on loans held-for-sale, and the $8.5 million gain on the sale of $234 million in FHLB notes during the third quarter of 2011. These unfavorable variances were partially offset by an increase in gain on sale of loans by $40.7 million mainly due to higher gains on securitization transactions by $52.8 million, partially offset by the gain of $17.4 million on the sale of construction and commercial real estate loans to a joint venture during the third quarter of 2011. Also there was a favorable variance of $20.7 million in other service fees due to lower unfavorable fair value adjustments on mortgage servicing rights, higher credit card fees mainly due to higher interchange income from credit card portfolio acquisitions and higher membership fees from the credit card portfolio, partially offset by lower debit card fees mostly from lower interchange income driven by the Durbin Amendment of the Dodd-Frank Act that began to take effect on October 1, 2011. In addition, there were lower adjustments by $18.6 million to increase the indemnity reserve on loans serviced and higher other operating income by $9.6 million mainly due to $7.8 million income from the equity investment in PRLP 2011 Holdings, LLC during 2012;

• higher operating expenses by $82.9 million, or 9%, mainly due to an increase of $24.5 million in loss on early extinguishment of debt, primarily related to the cancellation of $350 million in outstanding repurchase agreements during the second quarter of 2012; an increase of $17.7 million in other operating expenses mostly due to costs associated with the collection efforts of the covered loan portfolio, of which 80% is reimbursed by the FDIC; an increase in OREO expenses of $14.9 million mainly related to higher subsequent fair value adjustments on commercial, construction and mortgage properties; and an increase of $16.0 million in professional fees mostly due to appraisal expenses and loan collection efforts, some of which are reimbursable by the FDIC. Also there were unfavorable variances of $7.2 million in personnel costs due to higher incentive and other compensation, net periodic pension costs, medical insurance costs, post retirement health benefits, among other factors; and $5.8 million in business promotion expense mostly from credit card reward programs and other retail product promotional campaigns; and

• lower income tax expense by $140.1 million, mainly due to $103.3 million in income tax expense recognized during the first quarter of 2011 with a corresponding reduction in the Puerto Rico Corporation’s net deferred tax asset as a result of the reduction in the marginal corporate income tax rate due to the Puerto Rico tax reform. The favorable variance was also attributable to a tax benefit of $72.9 million recognized in 2012 resulting from a Closing Agreement with the P.R. Treasury Department related to the tax treatment of the loans acquired in the Westernbank FDIC-assisted transaction,

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compared with a tax benefit of $53.6 million recognized in 2011 resulting from a Closing Agreement with the P.R. Treasury Department for the recognition of certain tax benefits not previously recorded during years 2009 (the benefit of reduced tax rates for capital gains) and 2010 (the benefit of the exempt income). The decrease in income tax expense was also due to lower income in the Corporation’s Puerto Rico operations compared to 2011.

The main factors that contributed to the variance in the financial results for the year ended December 31, 2011, when compared with 2010, included the following:

• higher net interest income by $144.8 million, or 13%, mostly due to interest income from covered loans which increased by $109.6 million. Other favorable variances included reduced deposit and borrowing cost, and greater volume of mortgage loans. The net interest margin was 5.02% for the year ended December 31, 2011, compared with 4.43% for the year 2010;

• lower provision for loan losses by $122.4 million, or 20%, mostly due to the decrease in the provision for loan losses on the non-covered loan portfolio of $268.0 million, partially offset by an increase of $145.6 million related to the covered loan portfolio. The decline on the provision for loan losses for non-covered loans was mainly driven by lower levels of commercial, construction and consumer net charge-offs, coupled with an improved outlook in net charge-offs for the consumer loan portfolio due to better macro-economic indicators. These improvements were partially offset by provisioning requirements for consumer and mortgage loans restructured under loss mitigation programs that are considered troubled debt restructurings and require to be analyzed for specific reserves under ASC Section 310-10-35. The decrease in net charge-offs was in part because of the charge-offs taken in December 2010 on the commercial and construction loans reclassified to held-for-sale. Also, the decrease in net charge-offs of the BPPR construction loan portfolio was principally because a substantial portion of the portfolio was classified as held-for-sale. The decline consumer loan net charge-offs reflects some signs of more stable credit performance in the personal and auto loan portfolios. These favorable variances were partially offset by the recording of a provision for loan losses on the covered loans during the year 2011, principally due to reductions in expected cash flows of certain loans accounted for pursuant to ASC 310-30 and two particular credit relationships accounted for pursuant to ASC 310-20. Refer to the Credit Risk Management and Loan Quality section of this MD&A for certain quality indicators and further explanations;

• higher non-interest income by $40.2 million, or 9%, which included an increase in FDIC loss share income of $92.5 million, higher gains on sale of loans, net of valuation adjustments on loans held-for-sale, of $8.9 million, and lower adjustments to indemnity reserves on loans serviced by $16.0 million. These favorable variances were partially offset by lower fair value adjustment on the equity appreciation instrument by $34.2 million, lower amortization of the contingent liability on unfunded commitments of Westernbank by $34.9 million, lower trading account profits by $10.5 million, lower service charges on deposit accounts by $2.3 million and other service fees by $2.9 million. The latter was principally due to a reduction in credit and debit card fees and unfavorable adjustments in the fair value of servicing rights, offset in part by higher insurance agency fees and revenues for the sale and administration of investment products. Refer to Table 2 for detailed amounts on the Westernbank-related items.

• higher operating expenses by $29.7 million, or 3%, mainly due to increase in personnel costs by $4.5 million, mostly pension and postretirement benefit costs by $9.8 million, and professional fees by $13.5 million primarily for consulting, legal and credit related services, such as appraisals. Also, there was higher business promotion expense by $6.3 million related to credit card programs and advertising, other operating taxes by $4.2 million related mostly to personal property taxes, and higher FDIC deposit insurance by $31.9 million. These unfavorable variances were partially offset by lower equipment, net occupancy, and communication expenses, as well as a reduction in provision for unfunded lending commitments and the subsequent fair value adjustments in other real estate properties; and

• higher income tax expense by $92.7 million, mainly due to an increase in income before tax. Also, during the first quarter of 2011, an adjustment to income tax expense was made to reduce the net deferred tax asset of the Puerto Rico operations as a result of the reduction in the marginal rate from 39% to 30%. These variances were partially offset by a tax benefit of $53.6 million for the recognition of certain tax benefits not previously recorded during years 2009 and 2010 and by higher benefit on net exempt interest income.

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Banco Popular North America

For the year ended December 31, 2012, the reportable segment of Banco Popular North America reported net income of $46.0 million, compared with $29.9 million for the year ended December 31, 2011. The principal factors that contributed to the variance in the financial results included the following:

• lower net interest income by $13.9 million, or 5%, which was primarily the effect of lower average volume by $527 million in the loan portfolio, partially offset by higher volume of investment securities and lower deposit balances. The BPNA reportable segment’s net interest margin was 3.60% for 2012, compared with 3.64% for 2011;

• lower provision for loan losses by $36.4 million, or 41%, principally as a result of lower net charge-offs by $90.6 million mainly from the legacy, commercial and consumer loan portfolios due to improved credit performance. These favorable variances were partly offset by a lower allowance for loan losses release for 2011. In addition, the first quarter of 2011 included a $13.8 million benefit due to improved pricing from the sale of the non-conventional mortgage loan portfolio. Refer to the Credit Risk Management and Loan Quality section of this MD&A for certain quality indicators and further explanations corresponding to the BPNA reportable segment;

• lower non-interest income by $18.0 million, or 24%, mostly due to higher adjustments to indemnity reserves by $6.8 million; lower gains on sale of securities by $4.1 million mainly due to the $2.8 million gain on the sale of a limited partnership interest in real estate limited partnerships owning property qualifying for low-income housing tax credits during the fourth quarter of 2011; lower other service fees by $3.9 million, mostly related to debit card fees due to the effect of the Durbin Amendment of the Dodd-Frank Act; lower service charges on deposits by $2.5 million; and lower gains on sales of mortgage loans by $3.7 million; and

• lower operating expenses by $11.6 million, or 5%, mainly due to a decrease in OREO expenses of $13.2 million related to higher gains on the sale of commercial real estate properties and lower FDIC insurance assessment by $5.1 million. These favorable variances were partially offset by increases of $4.3 million in personnel costs mainly due to higher headcount, benefit accruals and medical insurance costs, and $2.3 million in other operating expenses mostly due to higher operational losses.

The main factors that contributed to the variance in the financial results for the year ended December 31, 2011, when compared with 2010, included the following:

• lower net interest income by $14.4 million, or 5%, principally as a result of lower earning assets primarily due to loan pay downs, sales, and charge-offs. This negative variance was partially offset by deleveraging of the balance sheet and lower deposit cost. The BPNA reportable segment’s net interest margin was 3.64% for 2011, compared with 3.32% for 2010;

• lower provision for loan losses by $313.8 million, or 78% of net charge-offs, principally driven by improvements in credit performance, lower loan balances, primarily in the commercial loan portfolio, and decreases in net charge-offs in all loan categories. Refer to the Credit Risk Management and Loan Quality section of this MD&A for certain quality indicators and further explanations corresponding to the BPNA reportable segment;

• higher non-interest income by $20.3 million, or 37%, principally due to lower adjustments to representation and warranty reserves of $22.1 million as E-LOAN has negotiated settlements with certain major counterparties who have agreed to release the Corporation from any future claims, and higher gains on the sale of loans, net of valuation adjustments, by $5.9 million, partially offset by lower service charges on deposit accounts by $8.5 million; and

• lower operating expenses by $49.9 million, or 17%, mainly due to lower prepayment penalties on early extinguishment of debt by $21.9 million, lower FDIC deposit insurance amortization by $5.9 million and lower professional fees by $7.0 million, including legal fees, armored car expenses, appraisal fees and computer service fees. In addition, there were lower other real estate property expenses and also lower net occupancy and equipment expenses mainly due to fewer branches. In addition, the results for 2010 included a settlement loss on the termination of the BPNA pension plan of $4.2 million.

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STATEMENT OF FINANCIAL CONDITION ANALYSIS

Assets

Refer to the consolidated financial statements included in this 2012 Annual Report for the Corporation’s consolidated statements of financial condition at December 31, 2012 and December 31, 2011. Also, refer to the Statistical Summary 2008-2012 in this MD&A for condensed statements of financial condition for the past five years. At December 31, 2012, the Corporation’s total assets were $36.5 billion, compared with $37.3 billion at December 31, 2011.

Money market, trading and investment securities

Money market investments amounted to $1.1 billion at December 31, 2012, compared with $1.4 billion at the same date in 2011. The decrease from the end of 2011 to 2012 was mainly due to a decrease of $210 million in time deposits with other banks, principally in balances at the Federal Reserve Bank of New York.

Trading account securities amounted to $315 million at December 31, 2012, compared with $436 million at December 31, 2011. The decrease in trading account securities was principally due to Puerto Rico government bonds (GDB Senior Notes 2011) and Puerto Rico Infrastructure Financing Authority bonds (PRIFA) purchased by Popular Securities in December 2011, that were sold to retail clients in January 2012. Refer to the Market / Interest Rate Risk section of this MD&A included in the Risk Management section for a table that provides a breakdown of the trading portfolio by security type.

Table 10 provides a breakdown of the Corporation’s portfolio of investment securities available-for-sale (“AFS”) and held-to-maturity (“HTM”) on a combined basis at December 31, 2012 and 2011. Notes 8 and 9 to the consolidated financial statements provide additional information with respect to the Corporation’s investment securities AFS and HTM.

Table 10 - AFS and HTM Securities

(In millions)	2012		2011
U.S. Treasury securities	$	37.2	$	38.7
Obligations of U.S. government sponsored entities		1,096.3		985.5
Obligations of Puerto Rico, States and political subdivisions		171.2		157.7
Collateralized mortgage obligations		2,369.7		1,755.6
Mortgage-backed securities		1,483.1		2,139.6
Equity securities		7.4		6.9
Other		62.1		51.2
Total AFS and HTM investment securities	$	5,227.0	$	5,135.2

The investment securities portfolio consists primarily of highly liquid and rated securities. The increase in investment securities from December 31, 2011 to December 31, 2012 was mainly related to purchases of collateralized mortgage obligations, principally in the form of U.S. Government agency-issued collateralized mortgage obligations, partially offset by a reduction in mortgage-backed securities, due to maturities and prepayments.

At December 31, 2012, there were investment securities available-for-sale and held-to-maturity with a fair value of $357 million in an unrealized loss position of $2 million, compared with securities of $210 million with unrealized losses of $9 million at December 31, 2011. Management performed its quarterly analysis of all debt securities in an unrealized loss position at December 31, 2012 and concluded that no individual debt security was other-than-temporarily impaired as of such date. At December 31, 2012, the Corporation does not have the intent to sell debt securities in an unrealized loss position and it is not more-likely-than-not that the Corporation will have to sell those investment securities prior to recovery of their amortized cost basis.

Loans

Refer to Table 11 for a breakdown of the Corporation’s loan portfolio, the principal category of earning assets. Loans covered under the FDIC loss sharing agreements are presented in a separate line item in Table 11. The risks on covered loans are significantly different as a result of the loss protection provided by the FDIC.

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Table 11 - Loans Ending Balances

	At December 31,
(in thousands)	2012		2011		2010		2009		2008 [2]
Loans not covered under FDIC loss sharing agreements:
Commercial	$	9,858,202	$	9,973,327	$	10,570,502	$	11,448,204	$	12,148,082
Construction		252,857		239,939		340,556		1,349,942		1,709,186
Legacy[1]		384,217		648,409		1,013,484		1,647,117		2,043,499
Lease financing		540,523		548,706		572,787		618,797		714,188
Mortgage		6,078,507		5,518,460		4,524,722		4,603,246		4,469,134
Consumer		3,868,886		3,673,755		3,705,984		4,045,807		4,648,784
Total non-covered loans held-in-portfolio		20,983,192		20,602,596		20,728,035		23,713,113		25,732,873
Loans covered under FDIC loss sharing agreements:
Commercial		2,244,647		2,512,742		2,767,181		-		-
Construction		361,396		546,826		640,492		-		-
Mortgage		1,076,730		1,172,954		1,259,459		-		-
Consumer		73,199		116,181		169,750		-		-
Loans covered under FDIC loss sharing agreements		3,755,972		4,348,703		4,836,882		-		-
Total loans held-in-portfolio		24,739,164		24,951,299		25,564,917		23,713,113		25,732,873
Loans held-for-sale:
Commercial		16,047		25,730		60,528		972		365,728
Construction		78,140		236,045		412,744		-		-
Legacy[1]		2,080		468		-		1,925		-
Mortgage		258,201		100,850		420,666		87,899		170,330
Total loans held-for-sale		354,468		363,093		893,938		90,796		536,058
Total loans	$	25,093,632	$	25,314,392	$	26,458,855	$	23,803,909	$	26,268,931
[1] The legacy portfolio is comprised of commercial loans, construction loans and lease financings related to certain lending products exited by the Corporation as part of restructuring efforts carried out in prior years at the BPNA reportable segment. [2] Loans disclosed exclude the discontinued operations of PFH.

In general, the changes in most loan categories generally reflect soft loan demand, the impact of loan charge-offs, portfolio runoff of the exited loan origination channels at the BPNA reportable segment and the resolution of non-performing loans. The decreases were partially offset by mortgage and consumer loan growth, mostly due to loans origination, in part, by government incentives in the housing market, loans acquisitions, and mortgage loans repurchases under recourse agreements in Puerto Rico.

The explanations for loan portfolio variances discussed below exclude the impact of the covered loans.

The decrease in commercial loans held-in-portfolio from December 31, 2011 to December 31, 2012 was reflected in the BPPR reportable segment which decreased by $174 million, partially offset by an increase on $59 million in the BPNA reportable segment. The decrease in the BPPR reportable segment was principally the result of overall portfolio runoff, loan net charge-offs by $145 million during 2012 and the cancellation and repayment of certain commercial lines of credit. The increase in the BPNA reportable segment was principally due to new originations, offset by portfolio runoff of the discontinued lending business, loan amortization, the sale of loans, and the impact of net charge-offs during 2012

Construction loans held-in-portfolio increased $13 million from December 31, 2011 to December 31, 2012. The BPPR reportable segment increased $51 million due to new notes, while BPNA segment decreased $38 million due loan sales of approximately $32 million during 2012.

Commercial and construction loans held-for-sale loans decreased $10 million and $158 million, respectively, from December 31, 2011 to the end of 2012. The decrease in commercial loans was reflected in the BPPR and BPNA reportable segments by $5 million in each reportable segment. The decrease in construction loans was $150 million in the BPPR segment and $8 million in the BPNA segment. These decreases were impacted by lower new loan origination activity, portfolio run-off associated with exited origination channels in the U.S. operations and loan sales.

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The BPNA legacy portfolio, which is comprised of commercial loans, construction loans and lease financings related to certain lending products exited by the Corporation as part of restructuring efforts carried out in prior years at the BPNA reportable segment, declined mostly due to the run-off status of this portfolio and the effect of net charge-offs of $16 million for the year ended December 31, 2012.

The decline in the lease financing portfolio from December 31, 2011 to the same date in 2012 was experienced in the BPPR reportable segments by approximately $8 million. The decrease at the BPPR reportable segment was mainly due to a slowdown in originations due to economic conditions in Puerto Rico. BPNA reportable segment is no longer originating lease financing and as such, the outstanding portfolio in those operations is running off and its part of the legacy loan portfolio.

The increase in mortgage loans held-in-portfolio was reflected in both reportable segments, BPPR and BPNA segments. BPNA reportable segment increased $301 million or 36% from the balances at December 31, 2011, while the BPPR reportable segment increased $259 million or 6%. The increase in the BPPR segment was principally associated to loan repurchases and loans originations. During 2012, mortgage originations amounted to $1.5 billion, an increase of 21% when compared to the originations during 2011. Partially offsetting these increases, were net charge-offs of $57 million during 2012 in the BPPR segment. The increase in BPNA segment was also related to loan purchases of approximately $486 million, partially offset by net charge-offs of $15 million during 2012.

The portfolio of mortgage loans held-for-sale increased $157 million from December 31, 2011 to December 31, 2012. The increase was principally at the BPPR reportable segment mostly due to loans originated and purchased held with the purpose of executing agency securitizations in the secondary markets.

The increase in consumer loans held-in-portfolio from December 31, 2011 to December 31, 2012 of $195 million was reflected in the BPPR reportable segment which experienced an increase of $264 million, mostly due to the acquisition of $260 million (unpaid principal balance) during 2012, out of which $225 million were purchased during the second quarter of 2012. The BPNA reportable segment decreased $69 million as a result of the runoff status of the portfolio at exited lines of business, including E-LOAN. Net charge-offs for the BPPR segment was $90 million and $36 million for the BPNA reportable segment.

Covered loans were initially recorded at fair value. Their carrying value approximated $3.8 billion at December 31, 2012, of which approximately 60% pertained to commercial loans, 9% to construction loans, 29% to mortgage loans and 2% to consumer loans. Note 10 to the consolidated financial statements presents the carrying amount of the covered loans broken down by major loan type categories and the activity in the carrying amounts of loans accounted for pursuant to ASC 310-30. A substantial amount of the covered loans, or approximately $3.5 billion of their carrying value at December 31, 2012, was accounted for under ASC Subtopic 310-30. The reduction was principally the result of loan collections and to charge-offs amounting to $47 million for the year ended December 31, 2012, partially offset by the accretion on the loans, which increases their carrying value. Tables 12 and 13 provide the activity in the carrying amount and outstanding discount on the covered loans accounted for under ASC 310-30. The outstanding accretable discount has been impacted by increases in cash flow expectations on the loan pools based on quarterly revisions of the portfolio. The increase in the accretable discount is recognized as interest income using the effective yield method over the estimated life in each applicable loan pool.

FDIC loss share asset

As indicated in the Critical Accounting Policies / Estimates section of this MD&A, the Corporation recorded the FDIC loss share asset, measured separately from the covered loans, as part of the Westernbank FDIC-assisted transaction. Based on the accounting guidance in ASC Topic 805, at each reporting date subsequent to the initial recording of the indemnification asset, the Corporation measures the indemnification asset on the same basis as the covered loans and assesses its collectability.

The amount to be ultimately collected for the indemnification asset is dependent upon the performance of the underlying covered assets, the passage of time, claims submitted to the FDIC and the Corporation’s compliance with the terms of the loss sharing agreements. Refer to Note 12 to the consolidated financial statements for additional information on the FDIC loss share agreements.

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Table 12 - Activity in the Carrying Amount of Covered Loans Accounted for Under ASC 310-30

		Years ended December 31,
(In thousands)		2012		2011
Beginning balance	$		4,036,471	$	4,539,928
Accretion			280,596		352,401
Collections / charge-offs			(825,308)		(855,858)
Ending balance	$		3,491,759	$	4,036,471
Allowance for loan losses (ALLL)			(95,407)		(83,477)
Ending balance, net of ALLL	$		3,396,352	$	3,952,994

Table 13 - Activity in the Outstanding Accretable Discount on Covered Loans Accounted for Under ASC 310-30

	Years ended December 31,
(In thousands)	2012		2011
Beginning balance	$	1,470,259	$	1,331,108
Accretion [1]		(280,596)		(352,401)
Change in expected cash flows		262,006		491,552
Ending balance	$	1,451,669	$	1,470,259

[1] Positive to earnings, which is included in interest income.

The loan discount accretion in 2012 and 2011, which is recorded in interest income, resulted principally from accelerated cash payments collected from a number of large borrowers, for some of which the Corporation had estimated significantly higher losses. These cash flows resulted in a faster recognition of the corresponding loan pool’s accretable yield.

Although the reduction in estimated loan losses increases the accretable yield to be recognized over the life of the loans, it also has the effect of lowering the realizable value of the loss share asset since the Corporation would receive lower FDIC payments under the loss share agreements.

Table 14 sets forth the activity in the FDIC loss share asset for the years ended December 31, 2012, 2011 and 2010.

Table 14 - Activity of Loss Share Asset

	Year ended December 31,
(In thousands)	2012		2011		2010
Balance at beginning of year	$	1,915,128	$	2,410,219	$	-
FDIC loss share indemnification asset recorded at business combination		-		-		2,425,929
(Amortization) accretion of loss share indemnification asset		(129,676)		(10,855)		73,487
Credit impairment losses to be covered under loss sharing agreements		58,187		110,457		-
Reimbursable expenses to be covered under loss sharing agreements		29,234		5,093		-
Decrease due to reciprocal accounting on the discount accretion for loans and unfunded commitments accounted for under ASC Subtopic 310-20		(969)		(33,221)		(95,383)
Payments received from FDIC under loss sharing agreements		(462,016)		(561,111)		-
Other adjustments attributable to FDIC loss sharing agreements		(10,790)		(5,454)		6,186
Balance at end of period	$	1,399,098	$	1,915,128	$	2,410,219

The FDIC loss share indemnification asset is recognized on the same basis as the assets subject to the loss share protection from the FDIC, except that the amortization / accretion terms differ. Decreases in expected reimbursements from the FDIC due to improvements in expected cash flows to be received from borrowers, as compared with the initial estimates, are recognized as a reduction to non-interest income prospectively over the life of the loss share agreements. This is because the indemnification asset balance is being reduced to the expected reimbursement amount from the FDIC. Table 15 presents the activity associated with the outstanding balance of the FDIC loss share asset amortization (or negative discount) for the periods presented.

Table 15 - Activity in the Remaining FDIC Loss Share Asset Amortization (Discount)

	Year ended December 31,
(In thousands)	2012		2011		2010
Balance at beginning of period [1]	$	117,916	$	(139,283)	$	(212,770)
(Amortization of negative discount) accretion of discount [2]		(129,676)		(10,855)		73,487
Impact of lower projected losses		153,560		268,054		-
Balance at end of period	$	141,800	$	117,916	$	(139,283)

[1] Positive balance represents negative discount (debit to assets), while a negative balance represents a discount (credit to assets).

[2] Amortization results in a negative impact to non-interest income, while a positive balance results in a positive impact to non-interest income, particularly FDIC loss share income / expense.

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While the Corporation was originally accreting to the future value of the loss share indemnity asset, the lowered loss estimates in mid-2011 required the Corporation to amortize the loss share asset to its currently lower expected collectible balance, thus resulting in negative accretion. Due to the shorter life of the indemnity asset compared with the expected life of the covered loans, this negative accretion temporarily offsets the benefit of higher cash flows accounted through the accretable yield on the loans.

Other real estate owned

Other real estate represents real estate property received in satisfaction of debt. Aggressive collection of non-performing loans and a slowdown in OREO sales have led to an increase in the amount of other real estate owned from $282 million at December 31, 2011 to $406 million at December 31, 2012. Table 16 provides the activity in other real estate for the years ended December 31, 2012 and 2011. The amounts included as “covered other real estate” are partially sheltered by the FDIC loss sharing agreements.

Table 16 - Other Real Estate Owned (“OREO”) Activity

	For the year ended December 31, 2012
(In thousands)	Non-covered   OREO   Commercial/ Construction		Non-covered       OREO       Mortgage		Covered   OREO   Commercial/ Construction		Covered         OREO         Mortgage		Total
Balance at beginning of period		$ 90,230		$ 82,267		$  77,776		$  31,359		$  281,632
Write-downs in value		(13,727)		(10,823)		(7,466)		(767)		(32,783)
Additions		110,947		108,312		60,920		23,195		303,374
Sales		(51,422)		(46,091)		(32,022)		(13,122)		(142,657)
Other adjustments		(166)		(2,683)		190		(1,005)		(3,664)
Ending balance		$  135,862		$  130,982		$ 99,398		$ 39,660		$ 405,902

	For the year ended December 31, 2011
(In thousands)	Non-covered   OREO   Commercial/ Construction		Non-covered       OREO       Mortgage		Covered   OREO   Commercial/ Construction		Covered         OREO         Mortgage		Total
Balance at beginning of period		$ 87,283		$ 74,213		$ 41,153		$ 16,412		$ 219,061
Write-downs in value		(15,576)		(3,032)		(4,095)		(220)		(22,923)
Additions		78,064		77,543		54,898		23,421		233,926
Sales		(59,537)		(65,115)		(13,829)		(8,184)		(146,665)
Other adjustments		(4)		(1,342)		(351)		(70)		(1,767)
Ending balance		$ 90,230		$ 82,267		$ 77,776		$ 31,359		$ 281,632

Other assets

Table 17 provides a breakdown of the principal categories that comprise the caption of “Other assets” in the consolidated statements of financial condition at December 31, 2012 and 2011.

Table 17 - Other Assets

(In thousands)	2012		2011		Change
Net deferred tax assets (net of valuation allowance)	$	541,499	$	429,691	$	111,808
Investments under the equity method		246,776		313,152		(66,376)
Bank-owned life insurance program		233,475		238,077		(4,602)
Prepaid FDIC insurance assessment		27,533		58,082		(30,549)
Prepaid taxes		88,360		17,441		70,919
Other prepaid expenses		60,626		59,894		732
Derivative assets		41,925		61,886		(19,961)
Trades receivables from brokers and counterparties		137,542		69,535