10-K 1 g02793e10vk.htm DORAL FINANCIAL CORPORATION DORAL FINANCIAL CORPORATION
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-K
ANNUAL REPORT
PURSUANT TO SECTIONS 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
     
(Mark One)    
þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
    For the Fiscal Year Ended December 31, 2005
 
OR
 
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File No. 0-17224
Doral Financial Corporation
(Exact name of registrant as specified in its charter)
 
     
Puerto Rico   66-0312162
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. employer
identification no.)
 
1451 Franklin D. Roosevelt Avenue
San Juan, Puerto Rico
(Address of principal executive offices)
  00920-2717
(Zip Code)
Registrant’s telephone number, including area code:
(787) 474-6700
Securities registered pursuant to Section 12(b) of the Act:
     
Title of Each Class   Name of Each Exchange on Which Registered
     
Common Stock, $1 par value   New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
Title of Each Class
7% Noncumulative Monthly Income Preferred Stock, Series A
8.35% Noncumulative Monthly Income Preferred Stock, Series B
7.25% Noncumulative Monthly Income Preferred Stock, Series C
     Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes o         No þ
     Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.    Yes o         No þ
     Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes o         No þ
     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    o
     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ         Accelerated filer o         Non-accelerated filer o
     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes o         No þ
     State the aggregate market value of the voting and non-voting common equity held by nonaffiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter.
     $1,559,197,980, approximately, based on the last sale price of $16.54 per share on the New York Stock Exchange on June 30, 2005 (the last business day of the registrant’s most recently completed second fiscal quarter). For the purposes of the foregoing calculation only, all directors and executive officers of the registrant and certain related parties of such persons have been deemed affiliates.
     Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date: 107,948,236 shares as of July 31, 2006.
 
 


 

DORAL FINANCIAL CORPORATION
2005 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
               
        Page
         
 FORWARD-LOOKING STATEMENTS     1  
 PART I     2  
     Business     2  
     Risk Factors     30  
     Unresolved Staff Comments     36  
     Properties     36  
     Legal Proceedings     37  
     Submission of Matters to a Vote of Security Holders     39  
 PART II     39  
     Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities     39  
     Selected Financial Data     41  
     Management’s Discussion and Analysis of Financial Condition and Results of Operations     45  
     Quantitative and Qualitative Disclosures About Market Risk     109  
     Financial Statements and Supplementary Data     109  
     Changes in and Disagreements with Accountants on Accounting and Financial Disclosure     110  
     Controls and Procedures     110  
     Other Information     116  
 PART III     117  
     Directors and Executive Officers of the Registrant     117  
     Executive Compensation     123  
     Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters     132  
     Certain Relationships and Related Transactions     135  
     Principal Accountant Fees and Services     138  
 PART IV     138  
     Exhibits and Financial Statement Schedules     138  
 EX-3.2 BYLAWS OF DORAL FINANCIAL CORPORATION
 EX-10.8 EMPLOYMENT AGREEMENT
 EX-10.9 EMPLOYMENT AGREEMENT
 EX-10.10 EMPLOYMENT AGREEMENT
 EX-10.11 EMPLOYMENT AGREEMENT
 EX-12.1 COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
 EX-12.2 COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
 EX-21 LIST OF DORAL FINANCIAL'S SUBSIDIARIES
 EX-31.1 SECTION 302 CERTIFICATION OF THE CEO
 EX-31.2 SECTION 302 CERTIFICATION OF THE CFO
 EX-32.1 SECTION 906 CERTIFICATION OF THE CEO
 EX-32.2 SECTION 906 CERTIFICATION OF THE CFO

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EXPLANATORY NOTE
      As a result of the delay in completing Doral Financial’s amended Annual Report on Form 10-K for the year ended December 31, 2004, which included the restatement of the Company’s audited financial statements for the years ended December 31, 2004, 2003 and 2002, and the unaudited selected quarterly financial information for each of the four quarters of 2004, 2003 and 2002, and the Quarterly Reports on Form 10-Q for the fiscal quarters ended March 31, 2005, June 30, 2005 and September 30, 2005, Doral Financial was unable to timely file with the Securities and Exchange Commission (“SEC”) this Annual Report on Form 10-K and its Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2006. As soon as practicable following the filing of this Annual Report on Form 10-K, the Company will file its Quarterly Report on Form 10-Q for the quarter ended March 31, 2006. For information regarding the restatement of Doral Financial’s previously issued financial statements, see the Company’s amended Annual Report on Form 10-K for the year ended December 31, 2004 that was filed with the SEC on February 27, 2006.
FORWARD-LOOKING STATEMENTS
      This Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. In addition, Doral Financial may make forward-looking statements in its press releases or in other public or shareholder communications and its senior management may make forward-looking statements orally to analysts, investors, the media and others. These “forward-looking statements” are identified by the use of words or phrases such as “would be,” “will allow,” “intends to,” “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “project” or similar expressions.
      Doral Financial cautions readers not to place undue reliance on any of these forward-looking statements since they speak only as of the date made and represent Doral Financial’s expectations of future conditions or results and are not guarantees of future performance. Forward-looking statements involve inherent risks and uncertainties. A number of important factors could cause actual results to differ materially from those contained in any forward-looking statement. Such factors include, but are not limited to, the following:
  •  Doral Financial’s ability to attract new clients and retain existing clients;
 
  •  Doral Financial’s ability to retain and attract key employees;
 
  •  Doral Financial’s ability to successfully implement new business strategies;
 
  •  potential adverse effects to Doral Financial’s financial condition, results of operations or prospects resulting from any required adjustments to prior period financial statements;
 
  •  risks associated with the effects of global, national and regional economic and political conditions, including with respect to fluctuations in interest rates;
 
  •  risks arising from worsening economic conditions in Puerto Rico;
 
  •  potential adverse developments in connection with the ongoing inquiry of the SEC or the grand jury investigation by the U.S. Attorney’s Office for the Southern District of New York;
 
  •  potential adverse developments from ongoing enforcement actions by bank regulatory agencies;
 
  •  potential adverse developments in connection with ongoing shareholder litigation against the Company;
 
  •  risks associated with the Company’s inability to prepare and timely file financial statements;
 
  •  risks arising from the downgrade and potential further downgrades in the credit ratings of the Company’s securities;

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  •  risks arising from material weaknesses in the Company’s internal control over financial reporting; and
 
  •  developments from changes in the regulatory and legal environment for financial services companies in Puerto Rico and the United States.
      The Company does not undertake and specifically disclaims any obligation to update any forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of those statements.
PART I
Item 1. Business.
GENERAL
      Doral Financial is a diversified financial services company engaged in mortgage banking, banking (including thrift operations), institutional securities operations and insurance agency activities. Doral Financial’s activities are principally conducted in Puerto Rico and in the New York City metropolitan area. As of December 31, 2005, Doral Financial had consolidated assets of approximately $17.3 billion and consolidated stockholders’ equity of approximately $1.1 billion.
      Doral Financial’s principal strategy is to further develop its core mortgage banking business while continuing to diversify it service and product offerings especially those that have natural synergies with its mortgage related businesses. Doral Financial seeks to leverage its base of over 500,000 customer accounts, to cross-sell other financial services including banking and insurance products. As of December 31, 2005, Doral Bank, FSB (“Doral Bank — NY”), a federal savings bank, operated ten branches in the New York City metropolitan area.
      Doral Financial seeks to maximize its volume of loan originations by emphasizing quality customer service and by maintaining an extensive system of retail mortgage origination branches in Puerto Rico. Doral Financial strives to increase its servicing portfolio primarily through internal loan originations and supplements these originations with purchases of loans with the related servicing rights as well as bulk purchases of mortgage servicing rights from third parties.
      Doral Financial obtains net interest income by holding mortgage-backed securities, primarily Puerto Rico tax-exempt mortgage-backed securities backed by Puerto Rico mortgages and guaranteed by the Government National Mortgage Association, or GNMA securities, for longer periods prior to sale than most U.S. mortgage banking companies. This strategy reduces Doral Financial’s overall effective tax rate. Doral Financial’s banking subsidiaries also seek to increase net interest income by funding and holding for investment loans and investment securities, consisting primarily of residential mortgage loans, mortgage-backed securities and United States government and agency obligations. Doral Financial also operates an international banking entity subsidiary that invests in assets that generate investment income that is generally not subject to income taxation for Puerto Rico or U.S. income tax purposes.
      Doral Bank, Doral Financial’s Puerto Rico-based banking subsidiary (“Doral Bank — PR”), has opened 20 branches between 2000 and 2005. As of December 31, 2005, Doral Bank — PR operated 42 branches in Puerto Rico, concentrated in the greater San Juan metropolitan area and the Island’s northeast region. Many of the recently opened branches are larger in physical size than typical Doral Bank — PR branches and are referred to as Doral Financial Centers. Doral Bank — PR subleases space in these centers to affiliates thereby allowing clients to obtain bank loan and deposit products from Doral Bank — PR, residential mortgage loans from one of Doral Financial’s mortgage banking units, insurance products through Doral Insurance Agency, Inc., and securities services through representatives of UBS Financial Services Incorporated of Puerto Rico (“UBS Financial Services”) located at the branch under an agreement with Doral Bank — PR.
      See “— Recent Significant Events” below for certain changes to the Company’s business strategy.

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      Doral Financial was founded in 1972 under the laws of the Commonwealth of Puerto Rico. Doral Financial’s principal executive offices are located at 1451 Franklin D. Roosevelt Avenue, San Juan, Puerto Rico, and its main telephone number is (787) 474-6700.
Recent Significant Events
      Since April 2005, Doral Financial has focused substantial time and attention responding to various legal, financial and operational challenges resulting from the restatement of the Company’s financial statements for periods between 2000 and 2004. These challenges have included:
  •  The commencement of a formal investigation by the SEC into the matters surrounding the restatement, and the receipt of a grand jury document subpoena from the U.S. Attorney’s Office for the Southern District of New York;
 
  •  The initiation of numerous private lawsuits, including purported class action lawsuits alleging violations of federal securities laws and shareholders derivative actions alleging among other things breach of fiduciary duties owed to the Company;
 
  •  The delisting of the Company’s 7% Noncumulative Monthly Income Preferred Stock, Series A, 8.35% Noncumulative Monthly Income Preferred Stock, Series B and 7.25% Noncumulative Monthly Income Preferred Stock, Series C from The Nasdaq Stock Market;
 
  •  The downgrade of the Company’s credit ratings by Standard & Poor’s Rating Services, a division of The McGraw-Hill Companies, Inc. (“S&P”), Moody’s Investors Service (“Moody’s”) and Fitch Ratings, Ltd., a subsidiary of Fimalac, S.A. (“Fitch”);
 
  •  The identification of various material weaknesses in the Company’s internal control over financial reporting;
 
  •  The inability by the Company to timely file its annual and quarterly reports with the SEC and to comply with its reporting obligations under the indentures for its publicly-traded senior notes as a result of the restatement process;
 
  •  The unavailability to the Company of traditional funding sources, including the local financial institution market for the sale of non-conforming mortgage loans and the unsecured bank and public debt markets;
 
  •  The receipt on February 9, 2006 of a notification from the Office of Thrift Supervision (the “OTS”), directing Doral Bank — NY, Doral Financial’s New York-based savings bank, until further notice, not to pay any dividend, extend credit to Doral Financial, purchase assets or enter into similar transactions, without the prior written consent of the OTS; and
 
  •  The entry, on March 17, 2006, by the Company and its principal Puerto Rico Banking subsidiary, Doral Bank — PR, into consent orders with the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation (“FDIC”) and the Commissioner of Financial Institutions of Puerto Rico (“Office of the Commissioner”). (For a detailed description of these orders, please refer to Part I, Item 3. Legal Proceedings in this Annual Report on Form 10-K.)
      Although Doral Financial continues to face challenges related to the restatement, it has made substantial progress in addressing many significant obstacles, including:
  •  The filing with the SEC in February 2006 of the Company’s amended Annual Report on Form 10-K for the fiscal year ended December 31, 2004, including audited restated financial statements for the years ended December 31, 2004, 2003 and 2002;
 
  •  The conclusion of an independent investigation relating to the Company by Latham & Watkins LLP, outside counsel to the independent directors and the Audit Committee of the Board of Directors;

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  •  The design and on-going implementation of a remediation program, under the oversight of the Audit Committee of the Board of Directors and management, to address the material weaknesses in the Company’s internal control over financial reporting and enhance the Company’s corporate governance (For additional information regarding this program, see “Remediation of Material Weaknesses” under Part II, Item 9A. Controls and Procedures in this Annual Report on Form 10-K);
 
  •  The election of John A. Ward, III, as non-executive Chairman of the Board of Directors, in July 2005;
 
  •  The appointment of a new senior management team, as further described below;
 
  •  The implementation since the second half of 2005 of a new process to improve the Company’s interest rate risk management practices (For additional information regarding this new process, see “Risk Management” under Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in this Annual Report on Form 10-K.);
 
  •  The filing with the SEC in May 2006 of the Company’s Quarterly Reports on Form 10-Q for the quarters ended March 31, 2005, June 30, 2005 and September 30, 2005;
 
  •  The redemption in whole of the Company’s $75 million 7.84% Senior Notes due October 10, 2006 and the successful completion of a consent solicitation pursuant to which bondholders under the Company’s senior indenture agreed to temporarily forbear their right to declare an event of default as a result of the Company’s failure to timely file its quarterly reports on Form 10-Q for the first three quarters of 2005, in February 2006;
 
  •  The suspension of the quarterly dividend on the Company’s common stock since the second quarter of 2006, as a prudent capital management decision designed to preserve and strengthen the Company’s capital;
 
  •  The restructuring of certain prior non-conforming mortgage loan transfers to local financial institutions, which in certain cases had been originally recorded as sales but were subsequently characterized as secured borrowings, as further described below;
 
  •  Sales, commencing during the fourth quarter of 2005 and for the first time in more than 10-years, of non-conforming mortgage loans to major U.S. mortgage dealers for future securitization and sale into the U.S. asset-backed securities market;
 
  •  The design of a new business plan for the Company, as further described below; and
 
  •  The commencement of a major reengineering project, with the assistance of Proudfoot Consulting, designed to substantially reduce non-interest expenses and to make the Company’s operations more efficient, as further described below.
      Doral Financial has been engaged in discussions with the staff of the SEC regarding a possible resolution to its investigation of the Company’s restatement, and has reserved $25 million in its consolidated financial statements for the year ended December 31, 2005 in connection with a potential settlement of the SEC’s investigation of the Company. Any settlement is subject to acceptance and authorization by the Commission. There can be no assurance that the Company’s efforts to resolve the SEC’s investigation with respect to the Company will be successful, or that the amount reserved will be sufficient, and the Company cannot predict the timing or the final terms of any settlement.
      Doral Financial continues to cooperate with the SEC and the U.S. Attorney’s Office for the Southern District of New York, as they continue with their investigations. In addition, the Company is complying with the terms of the consent orders with Board of Governors of the Federal Reserve System, the FDIC and the Commissioner of Financial Institutions of Puerto Rico.
      Doral Financial encourages you to read the discussions contained in Part I, Item 1A. Risk Factors, Part I, Item 3. Legal Proceedings, Part II, Item 7. Management’s Discussion and Analysis of Financial

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Condition and Results of Operations and Part II, Item 9A. Control and Procedures in this Annual Report on Form 10-K, which highlight some of these and other risks and uncertainties to Doral Financial.
      Changes in Senior Management. There have been significant senior management changes at Doral Financial since the beginning of the restatement process. The following key officers have been appointed to senior management positions:
  •  Effective immediately after the filing of this Annual Report, Mr. Glen Wakeman will be appointed as Chief Executive Officer of the Company, replacing John A. Ward, III who had been acting as Chief Executive Officer on an interim basis since September 2005. Since May 30, 2006, Mr. Wakeman has been acting as President and Chief Operating Officer of the Company. Mr. Ward will continue to serve as non-executive Chairman of the Board of Directors. Mr. Wakeman is a 20-year veteran of General Electric Company (“GE”) with a strong background in global consumer finance. Most recently, he was Chief Executive Officer of GE’s Consumer Finance Latin America business. This business, which he started in 1998 for GE, now operates in nine countries and has over 15,000 employees. At GE, Mr. Wakeman was the recipient of GE’s “Heroes of Growth” award for exhibiting excellence in growth leadership.
 
  •  On March 27, 2006, Mr. Lidio Soriano was appointed as Chief Financial Officer of the Company. Mr. Soriano had been serving as Chief Financial Officer on an interim basis since August 2005. Prior to his appointment as interim Chief Financial Officer, Mr. Soriano served as Senior Vice President and Risk Management Director of the Company since January 2005. From June 2004 until January 2005, Mr. Soriano served as President of Doral Money, a New York based subsidiary of Doral Bank — PR, specializing in commercial and construction mortgage lending. Before joining the Company, Mr. Soriano was Vice President in charge of the mortgage division of Citibank’s Puerto Rico operations.
 
  •  In August 2005, Mr. Julio Micheo was appointed as Treasurer of the Company. Mr. Micheo had served as Executive Vice President and Head of Funds Management Group for the Company since January 2005. Prior to that position, Mr. Micheo was President of Doral Securities, the broker dealer subsidiary of the Company.
      These appointments follow the decision of the Board of Directors, in August 2005, to ask for and accept the resignations of Salomón Levis, former chief executive officer and former member of the board, Mario S. Levis, former treasurer, and David Levis, former director emeritus from their positions at Doral Financial and to terminate the employment of Ricardo Meléndez, former chief financial officer, after Mr. Meléndez’s refusal to tender his resignation.
      In addition, on January 31, 2006, Zoila Levis retired from her positions as Chief Operating Officer and President of the Company.
      Restructuring of Certain Prior Mortgage Loan Transfers. Doral Financial has been and continues to be engaged in negotiations with several local financial institutions to restructure certain prior non-conforming mortgage loan transfers, which in certain cases had been originally recorded as sales but were subsequently characterized as secured borrowings. The negotiations are being conducted primarily for the purpose of improving the Company’s capital ratios and clarifying the parties’ rights and obligations and contemplate a number of different alternatives. These alternatives include the negotiation of loan documentation for transactions recharacterized by Doral Financial as secured borrowings, the sale into the market of mortgage loans that are included in Doral Financial’s balance sheet following the recharacterization of transactions, the repurchase of loans from counterparties and the sale of Interest-Only Strips (“IOs”) to counterparties owning the underlying mortgages.
      As part of these negotiations, on April 19, 2006 Doral Financial entered into an agreement with Banco Santander Puerto Rico (“BSPR”), a wholly-owned subsidiary of Santander Bancorp, pursuant to which Doral Financial agreed to acquire from BSPR approximately $617 million of mortgage loans previously sold by Doral Financial to BSPR during 2004 and the first quarter of 2005. This transaction closed in two parts on May 15 and May 16, 2006. Substantially all the mortgage loans purchased from

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BSPR were resold to a U.S. financial institution on a servicing retained basis on the same date of the purchase. No IOs were created by Doral Financial as part of the subsequent sale of the mortgage loans.
      Under the original sale agreements with BSPR, Doral Financial was required to pay BSPR a floating pass-through rate tied to the London Interbank Offered Rate (“LIBOR”). Doral Financial also retained a call option which granted it a right to repurchase the mortgage loans at par if the floating pass-though rate was equal or exceeded the weighted-average interest rate on the underlying mortgages. The sale treatment for these transactions was not revised as part of the Company’s restatement of its financial statements for the five year period ended December 31, 2004. However, during the first quarter of 2006, as a result of the continued rise in short-term interest rates the floating pass-through rate exceeded the weighted average interest rate on the underlying mortgages, causing the Company’s call right to become exercisable. Under accounting rules, because the call right became exercisable at the option of Doral Financial, approximately $613 million of mortgage loans had to be brought back on Doral Financial’s balance sheet during the first quarter of 2006.
      On May 25, 2006, Doral Financial entered into a series of credit agreements with FirstBank Puerto Rico (“FirstBank”), a wholly-owned subsidiary of First Bancorp, to document as secured borrowings the loan transfers between the parties that prior to the restatement had been accounted for as sales. The aggregate amount of the borrowings documented under the credit agreements was approximately $2.9 billion. The borrowings accrue interest at a floating rate based on a spread over the applicable 90-day LIBOR subject to a cap and are subject to amortization schedules tied to the scheduled amortizations of the underlying mortgage loans subject to a maximum maturity of 10 years. The borrowings are subject to mandatory prepayments as a result of actual prepayments on, or sales of, the underlying mortgage loans, and the Company may prepay the borrowings at any time, without premium or penalty. On May 30, 2006, Doral Financial sold to a U.S. financial institution on a servicing retained basis approximately $2.4 billion of the loans securing these borrowings and reduced the outstanding principal balance of the borrowings to $450 million. No IOs were created by Doral Financial as part of the subsequent sale of the mortgage loans.
      On June 30, 2006, Doral Financial entered into an agreement with Westernbank Puerto Rico (“Westernbank”), a wholly owned subsidiary of W Holding Company, Inc., to restructure all outstanding mortgage loan sale transactions between the parties. As of May 31, 2006, the unpaid principal balance of all mortgage loans previously sold by Doral Financial to Westernbank was approximately $954 million.
      Pursuant to the agreement, Doral Financial agreed to transfer to Westernbank its retained interest on the mortgage loans, which was equal to the excess of the weighted-average interest rate on the mortgage loans over the floating pass-through rate payable to Westernbank. As a result, Doral Financial will no longer pay Westernbank a floating pass-through rate, which as of the date of the agreement, exceeded the weighted average coupon with respect to certain mortgage loan pools. In addition, Doral Financial and Westernbank entered into a master servicing agreement pursuant to which Doral Financial will continue servicing the mortgage loans in exchange for an annual servicing fee of 25 basis points of the unpaid principal balance of the mortgage loans. Doral Financial also agreed to repurchase from Westernbank at par any mortgage loans that were 90 or more days delinquent as of May 31, 2006.
      Under the original sale agreements with Westernbank, Doral Financial was required to pay Westernbank a floating pass-through rate tied to LIBOR. Doral Financial also had certain limited recourse obligations with respect to delinquent mortgage loans (generally the obligation to repurchase up to 15% of the principal amount of the mortgage loans sold) and retained a call option to repurchase the mortgage loans at par if the floating pass-through rate equaled or exceeded the weighted-average interest rate on the underlying mortgages. In connection with the restructuring agreement, Westernbank agreed to discharge and terminate in full Doral Financial’s recourse obligations under the original mortgage sale agreements (except for obligations with respect to certain representations and warranties made in the original mortgage sale agreements, which will survive for a six month period following the closing of the restructuring agreement).

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      New Business Strategy. The Company has designed changes to its business strategies that are principally intended to produce revenues and earnings streams that are more stable and transparent. Among the changes in business strategies are the following:
  •  retention of more loans in portfolio to increase net interest income;
 
  •  diversification of loan product offerings;
 
  •  continued emphasis on fee income;
 
  •  diversification of loan sale and securitization channels for mortgage loans and a better balance between cash gains and non-cash gains on mortgage loan sales; and
 
  •  more efficient product delivery systems.
Emphasis on Lending Activities and Retention of a Greater Portion of Loan Production
      In the past, Doral Financial strived to sell a significant portion of its internal mortgage loan production. Management has made an evaluation of its business strategy and has made a decision to evolve into a more traditional lending institution with less emphasis on trading and investment activities. Management believes that lending activities and the retention of a greater proportion of the loans originated through these activities will provide a more stable stream of income for the Company and reduce the Company’s exposure to interest rate risk associated with trading and investment activities. Management, therefore, intends to retain a significant amount of its future internal loan originations in order to increase its net interest income, subject to liquidity needs and interest rate risk considerations. As part of this strategy, the Company is in the process of strengthening its credit underwriting procedures. Most of the loans retained will be retained in the Company’s banking subsidiaries and funded primarily through retail deposits, brokered deposits, and Federal Home Loan Bank of New York advances. The Company is also considering ways of consolidating some of its lending activities into Doral Bank — PR, its principal banking subsidiary. This would increase operational efficiency and facilitate the funding of lending activities.
Diversification of Loan Product Offerings
      As the Company evolves into a more traditional lending institution it intends to expand the loan products offered by its banking subsidiaries. While the Company has diversified its revenues by entering into the banking business, its banking subsidiaries have primarily originated residential mortgage loans. In recent years, Doral Financial’s banking subsidiaries have increased their origination of commercial loans and construction loans secured by real property. The Company will seek to leverage its customer relations with mortgage clients to cross sell a number of different consumer loan products and financial services.
Continued Emphasis on Fee Income
      The Company intends to increase the fee income it earns from its insurance agency activities, as well as from other banking and financial services. The Company intends to increase this fee income by further penetrating its mortgage banking client base (it currently acts as agent for insurance products with respect to approximately 80% of the mortgage loans it services), offering a greater variety of insurance products to its client base and earning a larger portion of the insurance premiums paid by its clients by acting as a general agent and eliminating the portion of the premium payable to co-agents. The Company is also considering making wholesale purchases of insurance agency portfolios and purchasing of one or more insurance agencies, as well as seeking alliances with strategic partners. The Company will also strive to increase fee income from traditional banking products and services. The Company believes that it can increase insurance and banking fees without significantly increasing recurring general and administrative expenses.

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Diversification of Loan Sale Outlets
      For that portion of its loan originations that it intends to continue selling, the Company will seek to diversify its loan sale channels and will look to enter into new sale and securitization transactions with FNMA, FHLMC, U.S. investment banking firms and local financial institutions. As part of this strategy, the Company will seek to reduce sales of mortgage loans with recourse. In fact, all of Doral Financial’s mortgage loan sale transactions since the third quarter of 2005 and until the date of this Annual Report have been on a non-recourse basis. The Company will seek loan channels that allow it to maintain a more balanced mix between cash gains and non-cash gains in the form of fixed rate IOs and MSRs. The Company made sales during the first half of 2005 that have produced cash gains and higher MSRs by negotiating a higher contractual servicing fee. Also, during the fourth quarter of 2005 and for the first time in more than 10-years, the Company sold loans to a major U.S. mortgage dealer for future securitization and sale into the U.S. asset-backed securities market. The Company has made additional loan sales to U.S. mortgage dealers during the first half of 2006. The diversification of loan sales channels is an important step towards ensuring the profitability and liquidity of the Company.
      The Company will also work closely with FNMA, FHLMC and investment banking firms to develop new securitization channels that do not expose the Company to the volatility and risks associated with floating rate IOs. The Company does not expect to enter into new sales of loans with the retention of floating rate IOs. During 2005, all outstanding commitments to sell mortgage loans to local financial institutions that would give rise to the creation of IOs were terminated.
More Efficient Product Delivery Systems
      The Company understands that it has now created an effective branch system through the most important markets in Puerto Rico and is now carefully examining the profitability of existing branches. This process may result in the consolidation or elimination of branches that are considered unprofitable or duplicative. While the Company may open additional branches in strategic locations, it intends to use technology to provide product and service delivery systems that are less expensive to build and operate than traditional branches.
      Reengineering and Cost Reduction Program. Over the last five years, the Company’s expenses have grown at a compounded average growth rate of 16%. The growth in expenses was partly a result of the rapid expansion of the Company’s banking and mortgage franchises. The Company has commenced a reengineering and cost reduction program that includes the following key elements:
  •  outsourcing certain information technology and back office functions;
 
  •  reengineering and consolidating mortgage banking back office processes;
 
  •  optimizing mortgage and banking locations;
 
  •  leveraging existing capacities; and
 
  •  promulgating cost discipline across all business units.
      The measures have resulted in a substantial reduction in headcount, which has been reduced from 2,522 as of December 31, 2005 to 1,866 as of June 15, 2006. The Company estimates that beginning in 2007 this program will result in annualized cost savings of at least $50 million and will allow the Company to improve its efficiency ratio. Because of the severance benefits offered to displaced employees there will not be a significant financial benefit in 2006 from the reduction in headcount.
Mortgage Banking Business
      Doral Financial has historically conducted its mortgage banking activities in Puerto Rico through its four mortgage banking units — HF Mortgage Bankers, an operating division at the parent company level, Doral Mortgage Corporation, Centro Hipotecario de Puerto Rico, Inc. and Sana Mortgage Corporation. On the mainland United States, Doral Financial conducts its mortgage banking activities through its

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subsidiary, Doral Money, Inc. Doral Financial operates 56 mortgage banking offices in Puerto Rico and one office on the mainland United States. During the second quarter of 2006, Doral Financial, made a strategic decision to consolidate its mortgage banking activities into its two principal mortgage banking units — HF Mortgage Bankers and Doral Mortgage Corporation in order to achieve operational efficiency and strengthen its two principal brands.
Mortgage Loan Origination
      Mortgage Loan Products. Doral Financial is an approved seller/servicer for the Federal Home Loan Mortgage Corporation (“FHLMC”) and the Federal National Mortgage Association (“FNMA”), an approved issuer for the Government National Mortgage Association (“GNMA”) and an approved servicer under the GNMA, FNMA and FHLMC mortgage-backed securities programs. Doral Financial is also qualified to originate mortgage loans insured by the Federal Housing Administration (“FHA”) or guaranteed by the Veterans Administration (“VA”) or by the Rural Housing Service (“RHS”).
      Doral Financial offers a variety of mortgage loan products that are designed to meet consumer needs and competitive conditions. Doral Financial has traditionally emphasized 15- to 30-year fixed rate first mortgage loans secured by single family residences. Doral Financial generally classifies mortgage loans between those that are guaranteed or insured by the FHA, VA or RHS and those that are not. The latter type loans are referred to as conventional loans. Conventional loans that meet the underwriting requirements for sale or exchange under standard FNMA or FHLMC programs are referred to as conforming loans, while those that do not are referred to as non-conforming loans.
      Doral Financial’s current principal mortgage loan products are summarized below:
        FHA and VA loans. These are 15- to 30-year first mortgage loans that qualify for the insurance program of FHA or the guarantee programs of VA. As of December 31, 2005, the maximum loan amount for a VA loan was $333,700 and for FHA loans the maximum loan amount ranged from $200,160 to $247,000, for a one-family dwelling and, depending on the location of the mortgaged property, could go as high as $390,000, for a four-family dwelling.
 
        RHS loans. These are 30-year first mortgage loans made to low income individuals that qualify for the guarantee program of RHS. As of December 31, 2005, the maximum loan amount for an RHS loan was based on an income table which is revised periodically.
 
        Conforming conventional loans. These are loans that satisfy the underwriting criteria for standard sale or exchange programs of FNMA or FHLMC. As of December 31, 2005, the maximum loan amount for conforming conventional loans was $359,650, for a one-family dwelling.
 
        Non-conforming loans. These are conventional mortgage loans that do not qualify for sale or exchange under the standard programs of FNMA or FHLMC. These loans do not qualify for such programs primarily because of more flexible requirements for income verification or credit history, and loan amounts that exceed those permitted by FNMA or FHLMC. Doral Financial uses its own credit system to evaluate these loans and generally requires lower loan-to-value ratios and higher borrower equity.
 
        Second mortgage loans. Doral Financial has traditionally offered loans secured by second mortgage liens on single family residences as part of its non-conforming loan products.
 
        Other mortgage loans. Doral Financial’s mortgage banking units also originate construction loans for owner occupied single family residences and real estate development projects, as well as land loans and loans secured by income producing residential, multi-family and commercial properties. However, most construction loans for real estate development projects are originated by Doral Bank — PR. See “Banking Activities.”
      For additional information on Doral Financial’s mortgage loan originations, refer to Table H — Loan Production included in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section in this report.

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Mortgage Origination Channels
      Doral Financial’s strategy is to increase the size of its mortgage servicing portfolio primarily by internal originations through its retail branch network. Doral Financial supplements retail originations with wholesale originations that include purchases of loans with the related servicing rights from third parties and referrals from mortgage brokers. Doral Financial maintains specialized units for the origination of construction loans and loans to finance purchases of residences in new housing developments. The principal origination channels of Doral Financial’s mortgage banking units are summarized below.
        Retail branch network. Doral Financial operates 56 mortgage banking offices in Puerto Rico and one branch office in the mainland United States. Customers are sought through aggressive advertising campaigns in local newspapers, as well as television, direct mail and telemarketing campaigns. Doral Financial emphasizes quality customer service and offers extended operating hours to accommodate the needs of customers. Doral Financial’s mortgage banking units also target the realtor community by emphasizing the same quality of service provided to customers.
 
        New housing unit. In Puerto Rico, Doral Financial maintains a separate unit that works closely with residential housing developers and specializes in originating mortgage loans to finance the purchase of homes in newly developed housing projects. During the year ended December 31, 2005, Doral Financial originated approximately $563 million of mortgage loans to finance the purchase of homes within new housing projects, compared to $539 million for the year ended December 31, 2004.
 
        Wholesale activities. Doral Financial purchases mortgage loans from other mortgage bankers in Puerto Rico consisting primarily of conventional mortgage loans. For the years ended December 31, 2005 and 2004, total loan purchases amounted to approximately $483.1 million and $606.5 million, respectively. In the past, Doral Financial has also purchased conforming mortgage loans on a wholesale basis from a U.S. financial institution without the related servicing rights. Such wholesale purchases amounted to $2.0 billion and $2.3 billion for 2005 and 2004, respectively. These loans were generally securitized into FNMA or FHLMC securities and sold into the market. During the third quarter of 2005, Doral Financial made the determination to terminate its program of purchasing loans in bulk without the associated servicing rights.
 
        New York multi-family and commercial real estate lending subsidiary. During 1998, Doral Financial established Doral Money, Inc., a lending subsidiary in the New York City metropolitan area that specializes in originating mortgage loans secured by income producing multi-family residential and commercial properties, including bridge loans and loans to finance the rehabilitation of multi-family residential buildings. During the years ended December 31, 2005 and 2004, this subsidiary originated approximately $60 million and $42 million, respectively, of mortgage loans, consisting principally of this type of mortgage product.
 
        Construction loans. Construction loans on residential housing developments are primarily originated by a specialized unit within the HF Mortgage Bankers Division and by Doral Bank — PR. See “Banking Activities.”
      For more information on Doral Financial’s loan origination channels, refer to Table I — Loan Origination Sources in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section in this report.
Loan Underwriting
      Doral Financial’s underwriting standards comply with the relevant guidelines set forth by HUD, VA, FNMA, FHLMC, federal and Puerto Rico banking regulatory authorities, private mortgage investment conduits and private mortgage insurers, as applicable.
      In connection with the changes to Doral Financial’s business strategies, the Company’s current management determined that Doral Financial’s underwriting procedures and controls were not sufficiently robust or effective to enable the Company to fully benefit from the U.S. institutional secondary market for

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non-conforming loans or consistent with the Company’s goals of retaining a greater portion of loan production and improving the quality of its loan portfolio. Accordingly, Doral Financial’s current management, with the assistance of outside experts, is in the process of reviewing and improving the Company’s loan application and underwriting procedures and controls.
      The maximum loan-to-value ratio on conventional mortgages generally does not exceed 80%, including, in the case of second mortgages, the amount of any first mortgage. The Company also offers certain loan products with higher loan-to-value ratios ranging up to 100% for certain new home purchase transactions. Non-conforming loans, other than jumbo loans to finance home purchases, generally have a loan-to-value ratio below 80%.
Loan Servicing
      When Doral Financial sells originated or purchased mortgage loans, it generally retains the right to service such loans and to receive the associated servicing fees. Doral Financial’s principal source of servicing rights has traditionally been its mortgage loan production. Doral Financial also seeks to purchase servicing rights in bulk when it can identify attractive opportunities.
      Servicing rights represent a contractual right and not a beneficial ownership interest in the underlying mortgage loans. Failure to service the loans in accordance with contract requirements may lead to a termination of the servicing rights and the loss of future servicing fees. In general, Doral Financial’s servicing agreements are terminable by the investors for cause. To date, there has been no termination of servicing rights by any mortgage loan owner because of the failure by Doral Financial to service loans in accordance with its contractual obligations. In certain instances, the Company also services loans with no contractual servicing fee. The servicing asset or liability associated with such loans is evaluated based on ancillary income, float, late fees, prepayment penalties and costs.
      Doral Financial’s mortgage loan servicing portfolio is subject to reduction by reason of normal amortization, prepayments and foreclosure of outstanding mortgage loans. Additionally, Doral Financial may sell mortgage loan servicing rights from time to time to other institutions if market conditions are favorable. Refer to Table J — Mortgage Loan Servicing in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section in this report for detailed information on the composition and movement of Doral Financial’s mortgage loan servicing portfolio.
      The degree of risk associated with a mortgage loan servicing portfolio is largely dependent on the extent to which the servicing portfolio is non-recourse or recourse. In non-recourse servicing, the principal credit risk to the servicer is the cost of temporary advances of funds. In recourse servicing, the servicer agrees to share credit risk with the owner of the mortgage loans such as FNMA or FHLMC or with a private investor, insurer or guarantor. Losses on recourse servicing occur primarily when foreclosure sale proceeds of the property underlying a defaulted mortgage loan are less than the outstanding principal balance and accrued interest of such mortgage loan and the cost of holding and disposing of the underlying property. Doral Financial has often sold non-conforming loans on a partial recourse basis. For additional information regarding recourse obligations, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Off-Balance Sheet Activities.”
      In the ordinary course of business, Doral Financial makes certain representations and warranties to purchasers and insurers of mortgage loans and to the purchasers of servicing rights. In connection with certain purchases of servicing rights, Doral Financial may have a liability exposure as a guarantor to the representations and warranties of third party originators. If a loan defaults and there has been a breach of representations and warranties, Doral Financial may become liable for the unpaid principal and interest on defaulted loans. In such a case, Doral Financial may be required to repurchase the mortgage loan and bear any subsequent loss related to the loan. To date, the impact on earnings of loans repurchased as a result of borrower misrepresentations has not been material.
      There is a market in Puerto Rico for servicing rights, which are generally valued in relation to the present value of the expected cash income stream generated by the servicing rights. However, the fair

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values of servicing rights cannot be determined with precision because they are not traded in a liquid secondary market. Among the factors which influence the value of a servicing portfolio are servicing fee rates, loan balances, loan types, loan interest rates, expected average life of underlying loans (which may be reduced through foreclosure or prepayment), the value of escrow balances, delinquency and foreclosure experience, servicing costs, servicing termination rights of permanent investors, and any recourse provisions.
Sale of Loans and Securitization Activities
      Residential Mortgage Loans. Doral Financial customarily sells or securitizes a significant portion of the residential mortgage loans that it originates and purchases. As described below, Doral Financial utilizes various channels to sell its mortgage products. Doral Financial issues GNMA-guaranteed mortgage-backed securities, which involve the packaging of FHA loans, RHS loans or VA loans into pools of $1 million or more for sale primarily to broker-dealers and other institutional investors. During the years ended December 31, 2005 and 2004, Doral Financial issued approximately $322 million and $411 million, respectively, in GNMA-guaranteed mortgage-backed securities.
      Conforming conventional loans are generally either sold directly to FNMA, FHLMC or private investors for cash, or are grouped into pools of $1 million or more in aggregate principal balance and exchanged for FNMA or FHLMC-issued mortgage-backed securities, which Doral Financial sells to broker-dealers. In connection with such exchanges, Doral Financial pays guarantee fees to FNMA and FHLMC. The issuance of mortgage-backed securities provides Doral Financial with flexibility in selling the mortgage loans that it originates or purchases and also provides income by increasing the value and marketability of such loans. For the years ended December 31, 2005 and 2004, Doral Financial securitized approximately $1.0 billion and $491.8 million, respectively, of loans into FNMA and FHLMC mortgage-backed securities. In addition, for the years ended December 31, 2005 and 2004, Doral Financial sold approximately $317.1 million and $425.3 million, respectively, of loans through the FNMA and FHLMC cash window program.
      In the past, the Company generally sold mortgage loans that did not conform to GNMA, FNMA or FHLMC requirements (non-conforming loans) in bulk to local financial institutions or to FNMA or FHLMC and other financial institutions in negotiated transactions. Doral Financial’s bulk sales historically have operated very similar to securitization transactions because when Doral Financial sells a pool of loans to an investor it retains the servicing rights and agrees to pay the purchaser a specified pass-through rate for the entire pool, which is below the weighted-average coupon of the underlying mortgage loans. Any amounts received on the mortgages above the pass-through rate are retained by Doral Financial. The pass-through rate paid to the investors may be a fixed rate, but more often is a variable rate generally based on a spread over the three-month LIBOR. The present value of the future cash flows retained by Doral Financial above any contractual servicing fees are recognized on Doral Financial’s financial statements as IOs.
      The fair values assigned to the IOs and the mortgage servicing rights reduce the carrying amount of the loan sold. The gain realized on the sale of the loan is determined by the difference between the sales price for the loan and its carrying amount. See “Management’s Discussion Analysis of Financial Condition and Results of Operations — Critical Accounting Policies” for a more detailed discussion of the impact of IOs on Doral Financial’s consolidated financial statements.
      Doral Financial’s non-conforming loan sales have been generally made on a limited recourse basis. As of December 31, 2005 and 2004, Doral Financial was servicing mortgage loans with an aggregate principal amount of $2.4 billion and $1.8 billion, respectively, on a recourse basis. As of December 31, 2005 and 2004, Doral Financial’s maximum contractual exposure relating to its portfolio of loans sold with recourse, including recourse obligations to FNMA and FHLMC, was approximately $1.8 billion and $884.8 million, respectively. As of December 31, 2005 and 2004, Doral Financial recognized an estimated recourse liability of $17.2 million and $11.4 million, respectively, to absorb potential losses from such recourse arrangements.
      Commencing in the fourth quarter of 2005 and continuing throughout 2006, the Company began selling non-conforming loans to major financial institutions in the mainland United States on a non-

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recourse basis. The Company will seek to continue to diversify secondary market outlets for its non-conforming loan products both in the mainland United States and Puerto Rico. See “— Recent Significant Events” above for additional information regarding certain changes to the Company’s business strategy.
Puerto Rico Secondary Mortgage Market and Favorable Tax Treatment
      In general, the Puerto Rico market for mortgage-backed securities is an extension of the United States market with respect to pricing, rating of investment instruments, and other matters. However, Doral Financial has benefited historically from certain tax incentives provided to Puerto Rico residents to invest in FHA and VA loans and GNMA securities backed by such loans.
      Under the Puerto Rico Internal Revenue Code of 1994 (the “PR Code”), the interest received on FHA and VA loans used to finance the original purchase of newly constructed housing in Puerto Rico and mortgage-backed securities backed by such loans is exempt from Puerto Rico income taxes. This favorable tax treatment allows Doral Financial to sell tax-exempt Puerto Rico GNMA mortgage-backed securities to local investors at higher prices than those at which comparable instruments trade in the mainland United States, and also to reduce its effective tax rate through the receipt of tax-exempt interest.
Banking Activities
      Doral Financial is engaged in commercial banking activities in Puerto Rico through its subsidiary, Doral Bank — PR. As of December 31, 2005, Doral Bank — PR operated through 42 branches in Puerto Rico. Doral Bank — PR offers a variety of mortgage products similar to those offered by Doral Financial’s mortgage banking units. Doral Bank — PR’s lending activities are concentrated primarily on the origination of residential mortgage loans and are closely integrated with Doral Financial’s mortgage banking units as described below. Residential mortgage loans originated by Doral Bank — PR are usually sold through Doral Financial’s mortgage banking units. As of December 31, 2005, Doral Bank — PR had a portfolio of mortgage loans held-for-sale of approximately $1.2 billion, which includes mortgage loans held-for-sale by Doral Bank — PR’s wholly-owned subsidiaries, Doral Money and Doral International. As of December 31, 2005, Doral Bank — PR had loans classified as loans receivable of approximately $2.1 billion of which $872.3 million consisted of loans secured by residential mortgages. Doral Bank — PR is also actively involved in originating construction loans to finance the construction of residential home developments and commercial real estate projects. Doral Bank — PR is also actively engaged in granting commercial loans secured by real estate collateral.
      Doral Bank — PR’s mortgage origination activities are closely integrated with Doral Financial’s mortgage banking units through a Master Loan Production Agreement. Under this agreement, Doral Financial’s mortgage banking units have agreed to assist Doral Bank — PR meet its stated mortgage loan production goals by, among other things, (i) advertising, promoting and marketing to the general public; (ii) interviewing prospective borrowers and conducting the initial processing of loan applications, consistent with Doral Bank — PR’s underwriting guidelines; and (iii) providing personnel and facilities with respect to the execution of loan agreements. Doral Bank — PR independently underwrites all loans closed through the Master Loan Production Agreement. In the future, Doral Bank — PR may determine to engage in direct mortgage loan originations through its branch network.
      Doral Bank — PR is also a party to a Master Servicing and Collection Agreement (the “Master Servicing Agreement”) with Doral Financial’s mortgage banking units, whereby these units have agreed to service all of Doral Bank — PR’s loans originated after the date of the Master Servicing Agreement. Under the terms of the Master Servicing Agreements, Doral Financial is entitled to receive a servicing fee, net of guarantee fees, ranging from 25 to 44 basis points of the outstanding principal amount of the loans being serviced. Doral Bank — PR, however, retains the right to terminate Doral Financial’s servicing rights, without cause, upon notice to Doral Financial.
      Doral Financial is also engaged in the banking business in the New York City metropolitan area through its federal savings bank subsidiary, Doral Bank — NY. Doral Bank — NY offers retail banking services and products and currently operates ten branch locations in the New York City metropolitan area.

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To date, Doral Bank — NY has focused its lending activities on loans secured by multi-family apartment buildings and commercial properties located in the New York City metropolitan area, as well as on taxi medallion loans. Doral Bank — NY also purchases conforming residential loans without the related servicing rights from financial institutions.
      Doral Bank — NY is a party to Master Loan Production, and Master Servicing and Collection Agreements with Doral Financial’s mortgage banking units similar to those in effect for Doral Bank — PR.
      In addition to originating residential mortgage loans, construction loans and commercial loans secured by multi-family buildings, Doral Bank — PR and Doral Bank — NY also originate consumer loans, unsecured commercial loans and loans secured by undeveloped real property. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Loans Receivable,” below for detailed information regarding Doral Financial’s portfolio of loans receivable.
      Doral Bank — PR and Doral Bank — NY complement their lending activities by earning fee income, collecting service charges for deposit accounts and other traditional banking services, as well as through trading activities through its international banking entity subsidiary, in the case of Doral Bank — PR. See “Other Investment Activities” below.
      For detailed information regarding the deposit accounts of Doral Financial’s banking subsidiaries please refer to the “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources” in this Form 10-K.
Institutional Securities Operations
      Doral Financial is involved in the securities business through Doral Securities, Inc., a broker-dealer firm registered with the SEC and a member of the National Association of Securities Dealers, Inc. (the “NASD”). Doral Securities provides institutional brokerage, financial advisory and investment banking services. During 2002, Doral Financial sold its retail securities brokerage business to UBS Financial Services. As part of the transaction, UBS Financial Services agreed to provide retail securities services in selected Doral Financial bank branch locations and to pay Doral Financial a base rent plus a portion of all commissions earned with respect to sales of securities at these locations.
      Following the sale of its retail unit, Doral Securities has concentrated its efforts on sales to institutional clients as well as investment banking services in both the public and private capital markets. During 2003, Doral Securities also began asset management services by acting as a co-investment manager to a local fixed income investment company. Doral Securities also earns interest revenues by acting as an intermediary between borrowers, including Doral Financial, and lenders of funds utilizing repurchase and reverse repurchase agreements.
      As part of the Company’s expense reduction efforts, during the fourth quarter of 2005, the Company further reduced its institutional securities operations by terminating its institutional sales and investment banking services. Doral Securities is currently conducting certain asset management activities and maintains a small portion of the Company’s trading securities portfolio. The Company is currently considering the future viability of this operation.
Other Investment Activities
      As a result of Doral Financial’s mortgage securitization activities, Doral Financial maintains a substantial portfolio of mortgage-backed securities classified as held-for-trading. Doral Financial also invests in securities that are classified either as available-for-sale or held-to-maturity. In addition, Doral Financial operates an international banking entity subsidiary. Under Puerto Rico law, Doral Financial’s international banking entity subsidiary is generally not subject to Puerto Rico income taxation on the interest earned on the securities held by it or on the gains from the sale of securities held by it. Because Doral Financial and its Puerto Rico subsidiaries, including its international banking entity subsidiary, are considered foreign corporations for U.S. income tax purposes they generally are not subject to U.S. income tax on the interest earned on such securities.

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      Refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Investment and Trading Activities” and to Notes 5, 6, 7 and 8 to Doral Financial’s consolidated financial statements for more detailed information on Doral Financial’s investment activities.
Insurance Agency Activities
      Taking advantage of the cross-marketing opportunities provided by financial modernization legislation, during 2000, Doral Financial entered the insurance agency business in Puerto Rico. Doral Insurance Agency currently earns commissions by acting as agent in connection with the issuance of insurance policies by unaffiliated insurance companies. During 2005, 2004 and 2003, Doral Insurance Agency produced insurance fees and commissions of $12.4 million, $11.9 million and $7.9 million, respectively. Doral Insurance Agency anticipates continued growth as it expands the products and services it provides and continues to cross market its services to Doral Financial’s existing customer base.
Puerto Rico Income Taxes
      On August 1, 2005 the Government of Puerto Rico approved legislation that imposed a special transitory income tax of 2.5% to certain corporations, including Doral Financial and its subsidiaries in Puerto Rico. The actual statutory income tax rate of 39% increased to 41.5%. This law is effective for taxable years beginning after December 31, 2004 and ending on or before December 31, 2006. Under the PR Code, corporations are not permitted to file consolidated returns with their subsidiaries and affiliates. Doral Financial is entitled to a 100% dividend received deduction on dividends received from Doral Bank — PR, Doral Mortgage or any other Puerto Rico subsidiary subject to tax under the PR Code.
      In computing its interest expense deduction, Doral Financial’s interest deduction will be reduced in the same proportion that its average exempt obligations (including FHA and VA loans and GNMA securities) bear to its average total assets. Therefore, to the extent that Doral Financial holds FHA loans or VA loans and other tax exempt obligations, part of its interest expense may be disallowed for tax purposes.
      On August 22, 2004, local legislation was enacted to provide a temporary reduction in the long-term capital gain tax rates. The law amended the PR Code to reduce the long-term capital gain tax rates by fifty percent for transactions occurring from July 1, 2004, through June 30, 2005. The maximum long-term capital gain tax rate applicable to gains on sale of property located in Puerto Rico during this period was reduced to 6.25% from 12.5% for corporations and partnerships. To take advantage of this reduction, during the second quarter of 2005, the Company completed an intercompany sale of approximately $39.9 million in IOs (based on the valuation methodology used prior to the restatement) to accelerate the realization of long-term capital gains that had been deferred for tax purposes. The value, after making all relevant adjustments as a result of the restatement, approximates $15.6 million. The sale yielded a tax benefit of $2.6 million.
      Doral Financial’s international banking entity subsidiary is generally not subject to Puerto Rico income taxes on interest earned on, or gain realized from the sale of, non-Puerto Rico assets including certain U.S. government and agency securities. The results of Doral Financial for the years ended December 31, 2004 and 2003 include the results of Doral Overseas, an international banking entity organized as a division at the parent company level. In connection with local legislation enacted on January 8, 2004, designed to encourage international banking entities to operate as separate legal entities rather than operating divisions, effective March 31, 2004, Doral Financial phased out the operations of Doral Overseas. The investing activities previously carried out by Doral Overseas are now conducted by Doral International, Inc., an international banking entity and a wholly-owned subsidiary of Doral Bank — PR.
United States Income Taxes
      Except for Doral Bank — NY and Doral Money, Doral Financial and its subsidiaries are corporations organized under the laws of Puerto Rico. Accordingly, Doral Financial and its Puerto Rico subsidiaries are generally only required to pay United States income tax on their income, if any, derived from the active

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conduct of a trade or business within the United States (excluding Puerto Rico) or from certain investment income earned from United States sources. Doral Bank — NY and Doral Money are subject to both federal and state income taxes on the income derived from their operations in the United States.
Employees
      At January 31, 2006, Doral Financial employed 2,317 persons, of which 2,192 were employed in Puerto Rico. Of these, 1,225 were employed in mortgage banking, with 727 involved in loan production and sale activities and 204 involved in loan servicing activities. As of such date, Doral Financial’s banking, broker-dealer and insurance agency operations employed 1,080, one, and 11 employees, respectively. None of Doral Financial’s employees are represented by a labor union and Doral Financial considers its employee relations to be good.
Segment Disclosure
      For information regarding Doral Financial’s operating segments, please refer to Note 33 to Doral Financial’s consolidated financial statements “Segment Information” and the information provided under the caption “Operating Segments” in the Management’s Discussion and Analysis of Financial Condition and Results of Operation in this Form 10-K.
      Puerto Rico is the principal market for Doral Financial. Doral Financial’s Puerto Rico based operations accounted for 97% of Doral Financial’s consolidated assets as of December 31, 2005 and 94% of Doral Financial’s consolidated revenues for the year then ended. Approximately, 95% of total loan originations were secured by real estate properties located in Puerto Rico. The following table sets forth the geographic composition of Doral Financial’s loan originations:
                         
    December 31,
     
    2005   2004   2003
             
Puerto Rico
    95%       97%       97%  
United States
    5%       3%       3%  
Market Area and Competition
      Puerto Rico is Doral Financial’s primary service area. The competition in Puerto Rico for the origination of mortgages loans is substantial. Competition comes not only from other mortgage bankers but also from major commercial banks, including affiliates of banks headquartered in the United States, Spain and Canada. Doral Financial competes principally by offering loans with competitive features, by emphasizing the quality of its service and pricing its range of products at competitive rates.
The Commonwealth of Puerto Rico, USA
      General. Puerto Rico, the fourth largest and most economically developed of the Caribbean islands, is located approximately 1,600 miles southeast of New York, New York and 1,000 miles southeast of Miami, Florida. The average flying time from New York City is approximately 31/2 hours and from Miami, Florida 21/2 hours. Puerto Rico is approximately 100 miles long and 35 miles wide. According to the United States Census Bureau, the population of Puerto Rico was 3.8 million in 2000. The Puerto Rico Planning Board estimates that the San Juan metropolitan area has a population in excess of 1.0 million. The Caribbean region has a population of over 30 million located in more than 25 principal islands.
      Relationship of Puerto Rico with the United States. Puerto Rico has been under the jurisdiction of the United States since 1898. The United States and Puerto Rico share a common defense, market and currency. As a U.S. commonwealth, Puerto Rico exercises virtually the same control over its internal affairs as a state government does. There is a federal district court in Puerto Rico and most federal laws are applicable to Puerto Rico. The U.S. postal service operates in Puerto Rico in the same manner as in the mainland United States. The people of Puerto Rico are citizens of the United States, but do not vote in national elections and are represented in Congress by a Resident Commissioner who has a voice in the

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House of Representatives, but only limited voting rights. Most federal taxes, except those such as social security taxes which are imposed by mutual consent, are not levied in Puerto Rico. No federal income tax is collected from Puerto Rico residents on ordinary income earned from sources within Puerto Rico, except for federal employees who are subject to taxes on their salaries.
      The Economy. The economy of Puerto Rico is closely integrated with that of the mainland United States. During the fiscal year ended June 30, 2005, approximately 83% of Puerto Rico’s exports went to the United States mainland, which was also the source of approximately 50% of Puerto Rico’s imports. Factors affecting the Unites States economy usually have a significant impact on the performance of Puerto Rico’s economy. These include exports, direct investment, the amount of federal transfer payments, the level of interest rates, the level of oil prices, the rate of inflation, and tourist expenditures. In the past, the economy of Puerto Rico has generally followed economic trends in the overall United States economy. However, in recent years economic growth in Puerto Rico has lagged behind growth in the United States.
      The economy of Puerto Rico is dominated by the manufacturing and service sectors. The manufacturing sector has experienced a basic change over the years as a result of increased emphasis on higher wage, high technology industries such as pharmaceuticals, biotechnology, electronics, computers, microprocessors, professional and scientific instruments, and certain high technology machinery and equipment. The service sector also plays a major role in the economy. It ranks second only to manufacturing in contribution to the gross domestic product and leads all sectors in providing employment. In recent years, the service sector has experienced significant growth.
      Gross product increased from $44.0 billion (in current dollars) for fiscal 2001 to $53.4 billion (in current dollars) for fiscal 2005. Since fiscal 1985, personal income per capita has increased consistently each fiscal year. In fiscal 2005, personal income per capita was $12,502. Average employment increased from 1,144,120 in fiscal 2001 to 1,237,593 for fiscal 2005, an increase of 8.2%. Unemployment, although a relatively low historical levels, remains above the Unites States average. The average unemployment rate decreased from 11.4% in fiscal 2004 to 10.6% in fiscal 2005. The unemployment rate for the first nine months of fiscal year 2006 was 11.2%, an increase from 10.4% for the same period of fiscal year 2005.
      Future growth in the Puerto Rico economy will depend on several factors including the condition of the United States economy, the relative stability in the price of oil imports, the exchange value of the U.S. dollar and the level of interest rates and changes to existing tax incentive legislation as discussed below. Currently, after a number of downward revisions reflecting a deterioration in several key economic indicators, the Puerto Rico Planning Board forecasts an increase in the real gross national product of 1.2% for the fiscal year ended June 30, 2006 and of 0.6%. for the fiscal year ending June 30, 2007. Among the variables contributing to the Planning Board’s reductions in forecasts are the persistent high levels of oil prices, the upward trend in short-term interest rates, the depreciation of the dollar (which affects the value of imports from foreign countries, which account for approximately 50% of total imports to Puerto Rico), and the deceleration of public investment due to the Commonwealth’s budget deficits (which could further reduce activity in construction and other sectors).
      The Small Business Job Protection Act, which was signed into law on August 20, 1996, provided for the repeal of Section 936 of the Internal Revenue Code over a ten year phase-out period for corporations with operations in Puerto Rico as of August 1995. Section 936 has traditionally provided tax incentives for U.S. corporations to invest in Puerto Rico. In addition, the Act eliminated the tax credit for corporations that established operations in Puerto Rico after October 1995. The elimination of the benefits of Section 936, without the substitution of another fiscal incentive to attract investment to Puerto Rico, could have an adverse effect on the future growth of the Puerto Rico economy. At this point, Doral Financial cannot predict the long-term impact of the repeal of Section 936 on the economy of Puerto Rico.
Current Fiscal Situation
      During 2005 and 2006, the Commonwealth of Puerto Rico considered several alternatives for a comprehensive tax and fiscal reform. On July 4, 2006, the Puerto Rico legislature approved legislation

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amending the PR Code to provide, among other things, for a general sales and use tax of 5.5%, a municipal sales and use tax of 1.5% and certain tax relief measures to be implemented as part of the tax reform. Although the tax and fiscal reforms have been adopted, there is no assurance that such measures will generate the projected revenues or savings. It is impossible for the Company to predict the impact that current fiscal situation of the Commonwealth will have on the Puerto Rico economy and thus on Doral Financial’s results of operations.
      Ratings of Commonwealth of Puerto Rico Obligations. In May 2005, Moody’s and S&P announced downgrades to the Commonwealth’s general obligation debt rating. Moody’s and S&P lowered their respective ratings on the Commonwealth’s general obligation debt from “Baa1” to “Baa2” and from “A-” to “BBB.” Among the reasons given by the rating agencies for the reduction in the ratings were the concern for the Commonwealth’s financial performance, particularly the structural imbalance in its budget, the low funding ratio of the Employees Retirement System of the Commonwealth and its instrumentalities, the uncertainty surrounding the approval of a budget for fiscal year 2006 and the availability of additional recurring revenue sources. For more information relating to the rating downgrades please refer to www.moodys.com and www.standardandpoors.com.
      On March 22, 2006, S&P placed the Commonwealth’s rating on CreditWatch with negative implications as a result of the Commonwealth’s anticipated budget deficit for fiscal year 2006, slow progress on tax and fiscal reform and the apparent political impasse regarding these measures. S&P has indicated that it may take further rating action. On July 20, 2006, S&P affirmed its “BBB” general obligation debt rating and removed the ratings from CreditWatch with negative implications. The rating outlook for the general obligation debt remains negative.
      On February 24, 2006, Moody’s placed the Commonwealth’s general obligation rating of “Baa2” on its Watchlist for review and possible downgrade. Moody’s also placed on its Watchlist all other bonds issued by various Commonwealth instrumentalities whose credit is directly or indirectly linked to that of the Commonwealth. On May 2, 2006, Moody’s issued a report in response to the partial shutdown of the Commonwealth’s government. In the report, Moody’s stated that a prolonged political stalemate with respect to the resolution of the Commonwealth’s budget deficit for fiscal year 2006 will have negative ratings implications.
      On May 8, 2006, Moody’s downgraded the Commonwealth’s general obligation and appropriation bond ratings from “Baa2” to “Baa3” and from “Baa3” to “Ba1,” respectively, and kept the ratings on Watchlist for possible further downgrade. Moody’s action reflected the Commonwealth’s strained financial condition, ongoing political conflict and lack of agreement regarding the measures necessary to end the government’s multi-year trend of financial deterioration. On July 21, 2006, Moody’s removed the Commonwealth’s general obligation and appropriation bond ratings from Watchlist. The rating outlook for the Commonwealth’s general obligation and appropriation bond remains negative.
REGULATION AND SUPERVISION
Mortgage Banking Business
      Doral Financial’s mortgage banking business is subject to the rules and regulations of FHA, VA, RHS, FNMA, FHLMC, HUD and GNMA with respect to the origination, processing, selling and servicing of mortgage loans and the issuance and sale of mortgage-backed securities. Those rules and regulations, among other things, prohibit discrimination and establish underwriting guidelines which include provisions for inspections and appraisals, require credit reports on prospective borrowers and fix maximum loan amounts, and with respect to VA loans, fix maximum interest rates. Moreover, lenders such as Doral Financial are required annually to submit to FHA, VA, RHS, FNMA, FHLMC, GNMA and HUD audited financial statements, and each regulatory entity has its own financial requirements. Doral Financial’s affairs are also subject to supervision and examination by FHA, VA, RHS, FNMA, FHLMC, GNMA and HUD at all times to assure compliance with the applicable regulations, policies and procedures. Mortgage origination activities are subject to, among others, the Equal Credit Opportunity Act,

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Federal Truth-in-Lending Act, the Real Estate Settlement Procedures Act and the regulations promulgated thereunder which, among other things, prohibit discrimination and require the disclosure of certain basic information to mortgagors concerning credit terms and settlement costs. Doral Financial is also subject to regulation by the Office of the Commissioner, with respect to, among other things, licensing requirements and maximum origination fees on certain types of mortgage loan products. Although Doral Financial believes that it is in compliance in all material respects with applicable federal and Puerto Rico laws, rules and regulations, there can be no assurance that more restrictive laws or rules will not be adopted in the future, which could make compliance more difficult or expensive, restrict Doral Financial’s ability to originate or sell mortgage loans or sell mortgage-backed securities, further limit or restrict the amount of interest and other fees earned from the origination of loans, or otherwise adversely affect the business or prospects of Doral Financial.
      Each of Doral Financial’s mortgage banking units that operate in Puerto Rico is licensed by the Office of the Commissioner as a mortgage banking institution. Such authorization to act as a mortgage banking institution must be renewed as of January 1 of each year. In the past, Doral Financial and its subsidiaries have not had any difficulty in renewing its authorization to act as a mortgage banking institution and management is unaware of any existing practices, conditions or violations which would result in Doral Financial being unable to receive such authorization in the future. Doral Financial’s operations in the mainland United States are subject to regulation by state regulators in the states in which it conducts business.
      Section 5 of the Puerto Rico Mortgage Banking Institutions Law (the “Mortgage Banking Law”) requires the prior approval of the Office of the Commissioner for the acquisition of control of any mortgage banking institution licensed under the Mortgage Banking Law. For purposes of the Mortgage Banking Law, the term “control” means the power to direct or influence decisively, directly or indirectly, the management or policies of a mortgage banking institution. The Mortgage Banking Law provides that a transaction that results in the holding of less than 10% of the outstanding voting securities of a mortgage banking institution shall not be considered a change of control. Pursuant to Section 5 of the Mortgage Banking Law, upon receipt of notice of a proposed transaction that may result in a change of control, the Office of the Commissioner is obligated to make such inquiries as it deems necessary to review the transaction. Under the Mortgage Banking Law, the determination of the Office of the Commissioner whether or not to authorize a proposed change of control is final and non-appealable.
Banking Operation
Federal Regulation
General
      Doral Financial is a bank holding company subject to supervision and regulation by the Board of Governors of the Federal Reserve System (the “Federal Reserve”) under the Bank Holding Company Act of 1956 (the “BHC Act”), as amended by the Gramm-Leach-Bliley Act of 1999 (the “Gramm-Leach-Bliley Act”). As a bank holding company that has elected to be treated as a financial holding company under the Gramm-Leach-Bliley Act, Doral Financial’s activities and those of its banking and non-banking subsidiaries are limited to activities that are financial in nature. See “Financial Modernization Legislation” for a description of recent legislation expanding the powers of financial holding companies. Under the BHC Act, Doral Financial may not, directly or indirectly, acquire the ownership or control of more than 5% of any class of voting shares of a bank or another bank holding company, without the prior approval of the Federal Reserve.
      Doral Bank — PR is subject to supervision and examination by applicable federal and state banking agencies, including the FDIC and the Office of the Commissioner. Doral Bank — NY is subject to supervision and examination by the OTS and the FDIC. Doral Financial’s banking subsidiaries are subject to requirements and restrictions under federal and state law, including requirements to maintain reserves against deposits, restrictions on the types and amounts of loans that may be granted and the interest that may be charged thereon, and limitations on the types of other investments that may be made and the

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types of services that may be offered. Various consumer laws and regulations also affect the operations of Doral Financial’s banking subsidiaries. In addition to the impact of regulation, commercial and savings banks are affected significantly by the actions of the Federal Reserve as it attempts to control the money supply and credit availability in order to influence the economy.
      On March 17, 2006, the Company and its principal Puerto Rico Banking subsidiary, Doral Bank — PR, entered into consent orders with the Board of Governors of the Federal Reserve System, the FDIC and the Office of the Commissioner. For a detailed description of these orders, please refer to Part  I, Item 3. Legal Proceedings, in this Form 10-K.
      Doral Financial’s banking subsidiaries are subject to certain regulations promulgated by the Federal Reserve including, without limitations, Regulation B (Equal Credit Opportunity Act), Regulation DD (The Truth in Savings Act), Regulation E (Electronic Funds Transfer Act), Regulation F (Limits on Exposure to Other Banks), Regulation Z (Truth-in-Lending Act), Regulation CC (Expedited Funds Availability Act), Regulation X (Real Estate Settlement Procedures Act), Regulation BB (Community Reinvestment Act) and Regulation C (Home Mortgage Disclosure Act).
Holding Company Structure
      Doral Bank — PR and Doral Bank — NY, as well as any other insured depository institution subsidiary organized by Doral Financial in the future, are subject to restrictions under federal law that govern certain transactions with Doral Financial or other non-banking subsidiaries of Doral Financial, whether in the form of loans, other extensions of credit, investments or asset purchases and sales. Such transactions by any depository institution subsidiary with Doral Financial, or with any one of Doral Financial’s non-banking subsidiaries, are limited in amount to 10% of the depository institution’s capital stock and surplus and, with respect to all of its non-banking subsidiaries, to an aggregate of 20% of the transferring institution’s capital stock and surplus. Furthermore, such loans and extensions of credit by the depository institution subsidiary are required to be secured in specified amounts and must be at market rates and on terms and conditions that are consistent with safe and sound banking practices. All other transactions between Doral Financial or any of its non-banking subsidiaries and any of the depository institution subsidiaries, while not subject to quantitative or collateral requirements, are subject to the requirement that they be on terms and conditions no less favorable to the banking subsidiary than would be available to unaffiliated third parties.
      Under Federal Reserve policy, a bank holding company such as Doral Financial is expected to act as a source of financial strength to each of its subsidiary banks and to commit resources to support each such subsidiary bank. This support may be required at times when, absent such policy, the bank holding company might not otherwise provide such support. In addition, any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary depository institution will be assumed by the bankruptcy trustee and entitled to a priority of payment.
      Because Doral Financial is a bank holding company, its right to participate in the assets of any subsidiary upon the latter’s liquidation or reorganization will be subject to the prior claims of the subsidiary’s creditors (including depositors in the case of depository institution subsidiaries) except to the extent that Doral Financial may itself be a creditor with recognized claims against the subsidiary.
      Under the Federal Deposit Insurance Act (the “FDIA”), a depository institution (which term includes both commercial banks and savings banks), the deposits of which are insured by the FDIC, can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with (i) the default of a commonly controlled FDIC-insured depository institution, or (ii) any assistance provided by the FDIC to any commonly controlled FDIC-insured depository institution “in danger of default.” “Default” is defined generally as the appointment of a conservator or a receiver and “in danger of default” is defined generally as the existence of certain conditions indicating that a default is likely to

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occur in the absence of regulatory assistance. In some circumstances (depending upon the amount of the loss or anticipated loss suffered by the FDIC), cross-guarantee liability may result in the ultimate failure or insolvency of one or more insured depository institutions in a holding company structure. Any obligation or liability owned by a subsidiary depository institution to its parent company is subordinated to the subsidiary bank’s cross-guarantee liability with respect to commonly controlled insured depository institutions.
Financial Modernization Legislation
      Doral Financial has elected to be treated as a financial holding company as permitted by the Gramm-Leach-Bliley Act. Under the Gramm-Leach-Bliley Act, bank holding companies, such as Doral Financial, all of whose depository institutions are “well capitalized” and “well managed,” as defined in the BHC Act, and which obtain satisfactory Community Reinvestment Act ratings, may elect to be treated as financial holding companies (“FHCs”). FHCs are permitted to engage in a broader spectrum of activities than those permitted to other bank holding companies. FHCs can engage in any activities that are “financial” in nature, including insurance underwriting and brokerage, and underwriting and dealing in securities without a revenue limit or other limits applicable to foreign securities affiliates (which include Puerto Rico securities affiliates for these purposes).
      Subject to certain limitations, under new merchant banking rules, FHCs are also permitted to make investments in companies that engage in activities that are not financial in nature without regard to the existing 5% limit for domestic investments and 20% limit for overseas (including Puerto Rico) investments applicable to bank holding companies that are not FHCs.
      Under the Gramm-Leach-Bliley Act, if Doral Financial fails to meet the requirements for being an FHC and is unable to correct such deficiencies within certain prescribed time periods, the Federal Reserve could require Doral Financial to divest control of its depository institution subsidiaries or alternatively to cease conducting activities that are not permissible for bank holding companies that are not FHCs.
      The Gramm-Leach-Bliley Act also modified other laws, including laws related to financial privacy and community reinvestment. The new financial privacy provisions generally prohibit financial institutions, including Doral Financial’s mortgage banking and banking subsidiaries from disclosing non-public personal financial information to third parties unless customers have the opportunity to “opt out” of the disclosure.
Capital Adequacy
      Under the Federal Reserve’s risk-based capital guidelines for bank holding companies, the minimum guidelines for the ratio of qualifying total capital (“Total Capital”) to risk-weighted assets (including certain off-balance sheet items, such as standby letters of credit) is 8%. At least half of the Total Capital is to be comprised of common equity, retained earnings, minority interests in unconsolidated subsidiaries, noncumulative perpetual preferred stock and a limited amount of cumulative perpetual preferred stock, in the case of a bank holding company, less goodwill and certain other intangible assets discussed below (“Tier 1 Capital”). The remainder may consist of a limited amount of subordinated debt, other preferred stock, certain other instruments and a limited amount of loan and lease loss reserves (“Tier 2 Capital”).
      The Federal Reserve has adopted regulations that require most intangibles, including core deposit intangibles, to be deducted from Tier l Capital. The regulations, however, permit the inclusion of a limited amount of intangibles related to readily marketable mortgage servicing rights and purchased credit card relationships and include a “grandfather” provision permitting the continued inclusion of certain existing intangibles.
      In addition, the Federal Reserve has established minimum leverage ratio guidelines for bank holding companies. These guidelines provide for a minimum ratio of Tier 1 Capital to total assets, less goodwill and certain other intangible assets discussed below (the “Leverage Ratio”) of 3% for bank holding companies that have the highest regulatory rating or have implemented the Federal Reserve’s market risk capital measure. All other bank holding companies are required to maintain a minimum Leverage Ratio of

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4%. The guidelines also provide that banking organizations experiencing significant internal growth or making acquisitions are expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. Furthermore, the guidelines indicate that the Federal Reserve will continue to consider a “tangible Tier 1 Leverage Ratio” and other indicia of capital strength in evaluating proposals for expansion or new activities. The tangible Tier 1 leverage ratio is the ratio of a banking organization’s Tier 1 Capital, less all intangibles, to average total assets, less all intangibles.
      The U.S. federal bank regulatory agencies’ risk-capital guidelines are based upon the 1988 capital accord of the Basel Committee on Banking Supervision (the “BCS”). The BCS is a committee comprised by central bank governors and bank supervisor authorities of the Group of Ten countries (G10). The BCS is in charge of developing broad policy guidelines used by each country’s supervisor to determine its own supervisory guidelines. In June 26, 2004 (subsequently amended in November 2005), the BSC released a proposal to replace the 1988 capital accord with a new set of guidelines. The new Basel Accord would, among other things, set capital requirements for operational risk and refine the existing capital requirements for credit risk and market risk exposures. The 1988 capital accord does not include a separate capital requirement for operational risk, which is defined under the proposed accord as the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events.
      On September 30, 2005, the U.S. banking regulators delayed the U.S. implementation of Basel II by one year. The current U.S. implementation timetable consists of parallel calculations under the current regulatory capital regime (Basel I) and Basel II, starting January 1, 2008, and an implementation transition period, starting January 1, 2009 through year-end 2011 or possibly later. The U.S. regulators have also reserved the right to change how Basel II is applied in the U.S., and retain the existing Prompt Corrective Action and leverage capital requirements applicable to U.S. banking organizations. The new timetable, clarifications, and other proposals will be set forth in a notice of proposed rulemaking (NPR), which the U.S. banking regulators are expected to issue during 2006.
      Doral Financial is closely monitoring the implementation process of the new accord and planning to comply with its requirements. Doral Financial expects that a new capital accord will eventually be adopted by the BCS and enforced by the federal banking agencies. At this time, Doral Financial cannot predict the timing and final form of the United States rules implementing the new capital accord and their impact on the Company. The new capital requirements that may arise out of a new Basel Accord may increase the minimum capital requirements applicable to Doral Financial and its subsidiaries.
      The FDIC and the OTS have established regulatory capital requirements for state non-member insured banks and federal savings banks, such as Doral Bank — PR and Doral Bank — NY, respectively, that are substantially similar to those adopted by the Federal Reserve for bank holding companies.
      Set forth below are Doral Financial’s, Doral Bank — PR’s and Doral Bank — NY’s capital ratios at December 31, 2005, based on existing Federal Reserve, FDIC and OTS guidelines.
                                 
        Banking Subsidiaries
         
            Well
            Capitalized
    Doral Financial   Doral Bank — PR   Doral Bank — NY   Minimum
                 
Total capital ratio (total capital to risk weighted assets)
    12.7 %     19.9 %     17.2 %     10.0 %
Tier 1 capital ratio (Tier 1 capital to risk weighted assets)
    11.7 %     19.1 %     16.7 %     6.0 %
Leverage ratio(1)
    5.5 %     6.3 %     9.5 %     5.0 %
 
(1)  Tier 1 capital to average assets in the case of Doral Financial and Doral Bank — PR and Tier 1 Capital to adjusted total assets in the case of Doral Bank — NY.

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      As of December 31, 2005, Doral Financial, Doral Bank — PR and Doral Bank — NY were in compliance with all the regulatory capital requirements that were applicable to them as a financial holding company, state non-member bank and federal savings bank, respectively. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Regulatory Capital Ratios” for additional information regarding Doral Financial’s regulatory capital ratios.
      Failure to meet capital guidelines could subject a bank holding company or an insured bank to a variety of enforcement remedies, including, with respect to an insured bank or savings bank, the termination of deposit insurance by the FDIC, and to certain restrictions on its business. See “FDICIA” below.
FDICIA
      Under the Federal Deposit Insurance Corporation Improvement Act of 1991 and the regulations promulgated thereunder (“FDICIA”), federal banking regulators must take prompt corrective action with respect to depository institutions that do not meet minimum capital requirements. FDICIA and the regulations thereunder, establish five capital tiers: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized.” A depository institution is deemed to be well capitalized if it maintains a Leverage Ratio of at least 5%, a risk-based Tier 1 capital ratio of at least 6% and a risk-based Total Capital ratio of at least 10%, and is not subject to any written agreement or regulatory directive to meet a specific capital level. A depository institution is deemed to be adequately capitalized if it is not well capitalized but maintains a Leverage Ratio of at least 4% (or at least 3% if given the highest regulatory rating and not experiencing or anticipating significant growth), a risk based Tier l capital ratio of at least 4% and a risk-based Total Capital ratio of at least 8%. A depository institution is deemed to be undercapitalized if it fails to meet the standards for adequately capitalized institutions (unless it is deemed to be significantly or critically undercapitalized). An institution is deemed to be significantly undercapitalized if it has a Leverage Ratio of less than 3%, a risk-based Tier 1 capital ratio of less than 3% or a risk-based Total Capital ratio of less than 6%. An institution is deemed to be critically undercapitalized if it has tangible equity equal to 2% or less of total assets. A depository institution may be deemed to be in a capitalization category that is lower than is indicated by its actual capital position if it receives a less than satisfactory examination rating in any one of four categories.
      At December 31, 2005, Doral Financial’s banking subsidiaries were well capitalized. Doral Financial’s, Doral Bank — PR’s and Doral Bank — NY’s capital category, as determined by applying the prompt corrective action provisions of FDICIA, may not constitute an accurate representation of the overall financial condition or prospects of Doral Financial, Doral Bank — PR or Doral Bank — NY, and should be considered in conjunction with other available information regarding the institution’s financial condition and results of operations.
      FDICIA generally prohibits a depository institution from making any capital distribution (including payment of a dividend) or paying any management fee to its holding company if the depository institution would thereafter be undercapitalized. Undercapitalized depository institutions are subject to restrictions on borrowing from the Federal Reserve System. In addition, undercapitalized depository institutions are subject to growth limitations and are required to submit capital restoration plans. A depository institution’s holding company must guarantee the capital plan, up to an amount equal to the lesser of 5% of the depository institution’s assets at the time it becomes undercapitalized or the amount of the capital deficiency when the institution fails to comply with the plan. The federal banking agencies may not accept a capital plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution’s capital. If a depository institution fails to submit an acceptable plan, it is treated as if it were significantly undercapitalized. Significantly undercapitalized depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets and cessation of receipt of deposits from correspondent banks. Critically undercapitalized depository institutions are subject to appointment of a receiver or conservator.

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      The capital-based prompt corrective action provisions of FDICIA and their implementing regulations apply to FDIC-insured depository institutions such as Doral Bank — PR and Doral Bank — NY, but they are not directly applicable to bank holding companies, such as Doral Financial, which control such institutions. However, federal banking agencies have indicated that, in regulating bank holding companies, they may take appropriate action at the holding company level based on their assessment of the effectiveness of supervisory actions imposed upon subsidiary insured depository institutions pursuant to such provisions and regulations.
Interstate Banking Legislation
      Effective June 1, 1997, the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “Riegle-Neal Act”) amended the FDIA and certain other statutes to permit state and national banks with different home states to merge across state lines, with the approval of the appropriate federal banking agency, unless the home state of a participating bank had passed legislation prior to May 31, 1997, expressly prohibiting interstate mergers. Under the Riegle-Neal Act amendments, once a state or national bank has established branches in a state, that bank may establish and acquire additional branches at any location in the state at which any bank involved in the interstate merger transaction could have established or acquired branches under applicable federal or state law. If a state opts out of interstate branching within the specified time period, no bank in any other state may establish a branch in the state which has opted out, whether through an acquisition or de novo.
      For purposes of the Riegle-Neal Act amendments to the FDIA, Doral Bank — PR is treated as a state bank and is subject to the same restrictions on interstate branching as other state banks. However, for purposes of the International Banking Act (the “IBA”), Doral Bank — PR is considered to be a foreign bank and may branch interstate by merger or de novo to the same extent as a domestic bank in Doral Bank — PR’s home state. Because Doral Bank — PR does not currently operate in the mainland United States, it has not designated a “home state” for purposes of the IBA. It is not yet possible to determine how these statutes will be harmonized, with respect either to which federal agency will approve interstate transactions or with respect to which “home state” determination rules will apply.
      As a federal savings bank, Doral Bank — NY is subject to the branching regulations promulgated by the OTS. Such regulations allow Doral Bank — NY to branch on an interstate basis without geographic limitations.
Federal Legislative Initiatives
      Various other legislation affecting depository institutions and bank holding companies is from time to time introduced in Congress. Doral Financial cannot determine the ultimate effect that such potential legislation, if enacted, or implementing regulations, would have upon Doral Financial’s financial condition or results of operations.
      On October 22, 2004, the President of the United States, George W. Bush, signed into law the American Jobs Creation Act of 2004, which lowers the withholding tax rate imposed on distributions of U.S. sourced dividends to a corporation organized under the laws of the Commonwealth of Puerto Rico from 30% to 10%. The new legislation which lowered the withholding tax rate to 10% is not expected to have an impact on Doral Financial’s earnings in the foreseeable future.
Dividend Restrictions
      The payment of dividends to Doral Financial by its banking subsidiaries may be affected by regulatory requirements and policies, such as the maintenance of adequate capital. If, in the opinion of the applicable regulatory authority, a depository institution under its jurisdiction is engaged in, or is about to engage in, an unsafe or unsound practice (that, depending on the financial condition of the depository institution, could include the payment of dividends), such authority may require, after notice and hearing, that such depository institution cease and desist from such practice. The Federal Reserve has issued a policy statement that provides that insured banks and bank holding companies should generally pay dividends

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only out of current operating earnings. In addition, all insured depository institutions are subject to the capital-based limitations required by FDICIA. See “— FDICIA.”
      On February 9, 2006, the OTS notified Doral Bank — NY that, until further notice, it could not pay any dividends to Doral Financial without the prior written approval of the OTS. Since its organization in October 1999, Doral Bank — NY has never paid a dividend to Doral Financial.
      On March 17, 2006, Doral Financial and its principal Puerto Rico Banking subsidiary, Doral Bank — PR, entered into consent orders with the Federal Reserve, the FDIC and the Office of the Commissioner. The mutually agreed upon orders prohibit Doral Bank — PR from paying dividends to Doral Financial, and prohibit Doral Financial from paying dividends to its common and preferred shareholders, without obtaining prior written approval from the FDIC and Federal Reserve. Historically, Doral Financial has not depended on dividends from its banking subsidiaries to support its operation.
      See “Regulation and Supervision — Banking Operations — Puerto Rico Regulation” for a description of certain restrictions on Doral Bank — PR’s ability to pay dividends under Puerto Rico law. See “Regulation and Supervision — Banking Operations — Savings Bank Regulation,” for a description of certain restrictions on Doral Bank — NY’s ability to pay dividends under OTS regulations.
FDIC Insurance Assessments
      The deposits of Doral Bank — PR and Doral Bank — NY are insured by the Savings Association Insurance Fund (“SAIF”) administered by the FDIC and, accordingly, the banking subsidiaries are subject to FDIC deposit insurance assessments.
      Pursuant to FDICIA, the FDIC has adopted a risk-based assessment system, under which the assessment rate for an insured depository institution varies according to the level of risk incurred in its activities. An institution’s risk category is based partly upon whether the institution is well capitalized, adequately capitalized or less than adequately capitalized. Each insured depository institution is also assigned to one of the following “supervisory subgroups”: “A,” “B” or “C.” Group “A” institutions are financially sound institutions with only a few minor weaknesses; group “B” institutions are those that demonstrate weaknesses that, if not corrected, could result in significant deterioration; and group “C” institutions are those for which there is a substantial probability that the FDIC will suffer a loss in connection with the institution, unless effective action is taken to correct the areas of weakness.
      Currently premiums related to deposits assessed by both the Bank Insurance Fund (“BIF”) and the SAIF are to be assessed at a rate of between 0 cents and 27 cents per $100.00 of deposits. Because of favorable loss experience, well capitalized and well managed banks, including Doral Bank — PR, have in recent years paid no premiums for FDIC insurance. In the future, even well capitalized and well managed banks may be required to pay premiums on deposit insurance. It is not possible to determine when any such premiums will become assessable or the level of such premiums.
      As a result of the Federal Deposit Insurance Reform Act of 2005, the FDIC will use a risk-based assessment system to determine assessment rates to be paid by member institutions such as the Bank. Until new regulations are issued with respect to that system, FDIC assessments will continue to range from zero cents to 27 cents per $100 of insured deposits based upon the level of an institution’s capital as well the degree of supervisory concern over the institution.
      The Deposit Insurance Funds Act of 1996 also separated the Financing Corporation (“FICO”) assessment to service the interest on its bond obligations from the BIF and SAIF assessments. The amount assessed on individual institutions by the FICO is in addition to the amount, if any, paid for deposit insurance according to the FDIC’s risk-related assessment rate schedules. The current FICO annual assessment rate is 1.44 cents per $100 of deposits. As of December 31, 2005, Doral Bank — PR and Doral Bank — NY had a deposit base of approximately $3.9 billion and $379.6 million, respectively (consisting entirely of SAIF assessment deposits).

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Brokered Deposits
      FDIC regulations adopted under FDICIA govern the receipt of brokered deposits. Under these regulations, a bank cannot accept, roll over or renew brokered deposits (which term is defined also to include any deposit with an interest rate more than 75 basis points above prevailing rates) unless (i) it is well capitalized or (ii) it is adequately capitalized and receives a waiver from the FDIC. A bank that is adequately capitalized may not pay an interest rate on any deposits in excess of 75 basis points over certain prevailing market rates specified by regulation. There are no such restrictions on a bank that is well capitalized. Doral Financial does not believe the brokered deposits regulation has had or will have a material effect on the funding or liquidity of its banking subsidiaries, which are currently well capitalized institutions.
      As of December 31, 2005, Doral Bank — PR and Doral Bank — NY had a total of approximately $1.9 billion and $17.0 million, respectively, of brokered deposits, compared to approximately $1.3 billion and $30.5 million, respectively, as of December 31, 2004. Doral Bank — PR and Doral Bank — NY use brokered deposits as a source of inexpensive long-term funding.
USA Patriot Act of 2001
      On October 26, 2001, the President of the United States signed into law a comprehensive anti-terrorism legislation known as the USA PATRIOT Act of 2001 (the “USA Patriot Act”). Title III of the USA Patriot Act substantially broadened the scope of U.S. anti-money laundering laws and regulations by imposing significant new compliance and due diligence obligations, creating new crimes and penalties and expanding the extra-territorial jurisdiction of the United States.
      The U.S. Treasury Department (“Treasury”) has issued a number of regulations implementing the USA Patriot Act that apply certain of its requirements to financial institutions, including Doral Financial’s banking subsidiaries. The regulations impose new obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing.
      Failure of a financial institution to comply with the USA Patriot Act’s requirements could have serious legal and reputational consequences for the institution. Doral Financial believes that the cost of compliance with Title III of the USA Patriot Act is not likely to be material to Doral Financial.
Puerto Rico Regulation
General
      As a commercial bank organized under the laws of the Commonwealth of Puerto Rico, Doral Bank — PR is subject to supervision, examination and regulation by the Office of the Commissioner, pursuant to the Puerto Rico Banking Act of 1933, as amended (the “Banking Law”).
      Section 27 of the Banking Law requires that at least 10% of the yearly net income of Doral Bank — PR be credited annually to a reserve fund until such fund equals 100% of total paid-in capital (preferred and common). As of December 31, 2005, Doral Bank — PR’s reserve fund complied with the legal requirement.
      Section 27 of the Banking Law also provides that when a bank suffers a loss, the loss must first be charged against retained earnings, and the balance, if any, must be charged against the reserve fund. If the balance of the reserve fund is not sufficient to cover the loss, the difference shall be charged against the capital account of the bank and no dividend may be declared until the capital has been restored to its original amount and the reserve fund to 20% of the original capital of the institution. This reserve fund is reflected on Doral Financial’s consolidated financial statements as “Legal Surplus.”
      Section 16 of the Banking Law requires every bank to maintain a reserve requirement which shall not be less than 20% of its demand liabilities, other than government deposits (federal, state and municipal)

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secured by actual collateral. The Office of the Commissioner can, by regulation, increase the reserve requirement to 30% of demand deposits.
      Section 17 of the Banking Law generally permits Doral Bank — PR to make loans on an unsecured basis to any one person, firm, partnership or corporation, up to an aggregate amount of 15% of the paid-in capital and reserve fund of the bank and of such other components as the Office of Commissioner may permit from time to time. The Office of the Commissioner has permitted up to 50% of retained earnings. As of December 31, 2005, the legal lending limit for Doral Bank — PR under this provision based solely on its paid-in capital and reserve fund was approximately $65.2 million. If such loans are secured by collateral worth at least 25% more than the amount of the loan, the aggregate maximum amount may reach one third of the paid-in capital of the bank, plus its reserve fund and such other components as the Office of Commissioner may permit from time to time. As of December 31, 2005, the lending limit for loans secured by collateral worth at least 25% more than the amount of the loan was $145.0 million. There are no restrictions under Section 17 on the amount of loans that are wholly secured by bonds, securities and other evidences of indebtedness of the Government of the United States or the Commonwealth, or by current debt bonds, not in default, of municipalities or instrumentalities of the Commonwealth.
      As a result of the independent investigation conducted in connection with the restatement, certain mortgage loans transfers that were previously reported as purchases of residential mortgage loans are now reflected for accounting and financial reporting purposes as commercial loans secured by mortgages. The impact of such recharacterization on applicable loan to one borrower limitations is not clear. Accordingly, Doral Bank — PR requested an administrative ruling from the Office of the Commissioner providing it with a temporary waiver from compliance with the loans-to-one-borrower limitations to the extent applicable. As of the date of the filing of this Annual Report on Form 10-K, the Company had not received a response from the Office of the Commissioner.
      Section 14 of the Banking Law authorizes Doral Bank — PR to conduct certain financial and related activities directly or through subsidiaries, including finance leasing of personal property, making and servicing mortgage loans and operating a small-loan company. Doral Bank — PR currently operates three subsidiaries, Doral Money, Inc., which engages in mortgage banking activities in the mainland United States, Doral International, Inc., which is licensed as an international banking entity under the International Banking Center Regulatory Act of Puerto Rico, and CB, LLC, a Puerto Rico limited liability company organized in connection with the receipt, in lieu of foreclosure, of the real property securing an interim construction loan and the Company’s decision to continue the development of the residential housing project on a temporary basis.
      The Finance Board, which is a part of the Office of the Commissioner, but also includes as its members the Secretary of the Treasury, the Secretary of Commerce, the Secretary of Consumer Affairs, the President of the Planning Board, and the President of the Government Development Bank for Puerto Rico, has the authority to regulate the maximum interest rates and finance charges that may be charged on loans to individuals and unincorporated businesses in the Commonwealth. The current regulations of the Finance Board provide that the applicable interest rate on loans to individuals and unincorporated businesses is to be determined by free competition. The Finance Board also has the authority to regulate the maximum finance charges on retail installment sales contracts and credit cards. Currently, there is no maximum rate set for installment sales contracts or credit cards.
      On March 17, 2006, Doral Financial and its principal Puerto Rico Banking subsidiary, Doral Bank — PR, entered into consent orders with the Board of Governors of the Federal Reserve System, the FDIC and the Office of the Commissioner. The mutually agreed upon orders require Doral Financial and Doral Bank — PR to conduct reviews of their mortgage portfolios, and to submit plans regarding the maintenance of capital adequacy and liquidity. The consent orders also prohibit Doral Financial and any of its non-banking affiliates, directly or indirectly, to enter into, participate, or in any other manner engage in any covered transactions with its subsidiary banks, Doral Bank — PR and Doral Bank — NY.

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Savings Bank Regulation
      As a federal savings bank, Doral Bank — NY’s investments, borrowings, lending, issuance of securities, establishment of branch offices and all other aspects of its operations are subject to the jurisdiction of the OTS.
      Doral Bank — NY’s payment of dividends is subject to the limitations of the capital distribution regulation promulgated by the OTS. The OTS’ regulation determines a savings bank’s ability to pay dividends, make stock repurchases, or make other types of capital distributions, according to the institution’s capital position. The rule establishes amounts of capital distributions that institutions can make after providing notice to the OTS, without constituting an unsafe or unsound practice. Institutions that do not meet their capital requirements can make distributions only with the prior approval of the OTS.
      For savings banks such as Doral Bank — NY that meet all applicable capital requirements may make a distribution without an application in an amount equal to the sum of (i) the current year’s net income and (ii) the retained net income (net income less capital distributions) from the preceding two years; so long as the association continues to satisfy applicable capital requirements after the distribution. If such distribution would cause Doral Bank — NY to fall below the well-capitalized requirement, a prior 30-day notice to the OTS is required.
      OTS regulations generally permit Doral Bank — NY to make total loans and extensions of credit to one borrower up to 15% of its unimpaired capital and surplus. As of December 31, 2005, the legal lending limit for Doral Bank — NY under this regulation was approximately $9.1 million. Doral Bank — NY’s legal lending limit may be increased by an additional 10% of its unimpaired capital and surplus if such additional extension of credit is fully secured by readily marketable collateral having a market value as determined by reliable and continuously available price quotations. Doral Bank — NY’s expanded aggregate legal lending limit under this provision was approximately $15.1 million as of December 31, 2005.
      On February 9, 2006, the OTS notified Doral Bank — NY that, until further notice, it could not pay any dividend to Doral Financial without the prior approval of the OTS. The OTS also directed Doral Bank — NY not to make any extensions of credit to Doral Financial, purchases of assets or similar transactions, without the prior written consent of the OTS. Since its organization in 1999, Doral Bank — NY has never paid a dividend or made an extension of credit to Doral Financial or purchased any assets from Doral Financial.
Certain Regulatory Restrictions on Investments in Common Stock
      Because of Doral Financial’s status as a bank holding company, owners of Doral Financial’s common stock are subject to certain restrictions and disclosure obligations under various federal laws, including the BHC Act. Regulations pursuant to the BHC Act generally require prior Federal Reserve approval for an acquisition of control of an insured institution (as defined) or holding company thereof by any person (or persons acting in concert). Control is deemed to exist if, among other things, a person (or persons acting in concert) acquires more than 25% of any class of voting stock of an insured institution or holding company thereof. Control is presumed to exist subject to rebuttal, if a person (or persons acting in concert) acquires more than 10% of any class of voting stock and either (i) the company has registered securities under Section 12 of the Securities Exchange Act of 1934, or (ii) no person will own, control or hold the power to vote a greater percentage of that class of voting securities immediately after the transaction. The concept of acting in concert is very broad and also is subject to certain rebuttable presumptions, including among others, that relatives, business partners, management officials, affiliates and others are presumed to be acting in concert with each other and their businesses.
      Section 12 of the Banking Law requires the prior approval of the Office of the Commissioner with respect to a transfer of voting stock of a bank that results in a change of control of the bank. Under Section 12, a change of control is presumed to occur if a person or group of persons acting in concert, directly or indirectly, acquires more than 5% of the outstanding voting capital stock of the bank. The

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Office of the Commissioner has interpreted the restrictions of Section 12 as applying to acquisitions of voting securities of entities controlling a bank, such as a bank holding company. Under the Banking Law, the determination of the Office of the Commissioner whether to approve a change of control filing is final and non-appealable.
      The provisions of the Mortgage Banking Law also require regulatory approval for the acquisition of more than 10% of Doral Financial’s outstanding voting securities. See “— Regulation and Supervision — Mortgage Banking Business.”
      The above regulatory restrictions relating to investment in Doral Financial may have the effect of discouraging takeover attempts against Doral Financial and may limit the ability of persons, other than Doral Financial directors duly authorized by Doral Financial’s board of directors, to solicit or exercise proxies, or otherwise exercise voting rights, in connection with matters submitted to a vote of Doral Financial’s stockholders.
Broker-Dealer Operations
      Doral Securities is registered as a broker-dealer with the SEC and the Office of the Commissioner, and is also a member of the NASD. As a registered broker-dealer, it is subject to regulation by the SEC, the NASD and the Office of the Commissioner in matters relating to the conduct of its securities business, including record keeping and reporting requirements, supervision and licensing of employees and obligations to customers. In particular, Doral Securities is subject to the SEC’s net capital rules, which specify minimum net capital requirements for registered broker-dealers and are designed to ensure that broker-dealers maintain adequate regulatory capital in relation to their liabilities and the size of their customer business.
Insurance Operations
      Doral Insurance Agency is registered as a corporate agent and general agency with the Office of the Commissioner of Insurance of Puerto Rico (the “Commissioner of Insurance”). Doral Insurance Agency is subject to regulation by the Commissioner of Insurance relating to, among other things, licensing of employees, sales practices, charging of commissions and obligations to customers.
Availability on Website
      Doral Financial’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, are available free of charge, through its website, http://www.doralfinancial.com, as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. In addition, Doral Financial makes available on its website under the heading Corporate Governance its: (i) Code of Business Conduct and Ethics; (ii) Corporate Governance Guidelines; (iii) Information Disclosure Policy; and (iv) the charters of the Audit, Compensation, Corporate Governance and Nominating, and Risk Policy committees, and also intends to disclose any amendments to its code of ethics, or waivers of the code of ethics on behalf of its Chief Executive Officer, Chief Financial Officer and Chief Accounting Officer, on its website or by writing to the Corporate Secretary at 1451 F.D. Roosevelt Avenue, San Juan, Puerto Rico 00920-2717.
      The public may read and copy any materials Doral Financial files with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. In addition, the public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at its website (http://www.sec.gov).

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Item 1A. Risk Factors.
      Some of the factors that could cause Doral Financial’s actual results for future periods to differ materially from those anticipated are discussed below.
Risks Relating to the Restatement Process
Doral Financial has restated its financial statements.
      Doral Financial may continue to suffer adverse effects from the restatement of its previously issued financial statements that were included in its annual report on Form 10-K for the year ended December 31, 2004, as amended (the “2004 Form 10-K”). In the 2004 Form 10-K, Doral Financial restated its previously reported financial statements for the years ended December 31, 2004, 2003, 2002, and the unaudited selected quarterly financial information for each of the four quarters of 2004, 2003 and 2002.
      As a result of these matters, Doral Financial may become subject to fines, settlements, judgments or other penalties or damages in its ongoing SEC investigation or regulatory actions or civil litigation. Any of these matters may also contribute to further ratings downgrades, negative publicity and difficulties in attracting and retaining key clients, employees and management personnel.
Doral Financial is subject to ongoing regulatory investigations by the SEC and the U.S. Attorney’s Office for the Southern District of New York, which could require it to pay substantial fines or penalties.
      On October 25, 2005, Doral Financial announced that the SEC was conducting a formal investigation into the April 19, 2005 announcement that the Company would restate its financial statements and the underlying issues addressed in that announcement. A formal investigation enables the SEC to issue subpoenas for witnesses and documents, including third parties outside the Company. As part of the formal investigation, the Company has received a subpoena from the SEC seeking the production of documents principally regarding the restatement and related financial reporting matters and the terms of certain transactions with local financial institutions. Doral Financial has also received a Grand Jury subpoena from the U.S. Attorney’s Office for the Southern District of New York regarding the production of certain documents, including financial statements and corporate, auditing and accounting records prepared during the period relating to the restatement of Doral Financial’s financial statements.
      Doral Financial cannot predict when these investigations will be completed or what the results of these investigations will be. The effects and results of these or other investigations may have a material adverse effect on Doral Financial’s business, results of operations, financial condition and liquidity. Adverse developments related to such investigations, including any expansion of their scope, could negatively impact the Company and could divert efforts and attention of its management team from Doral Financial’s ordinary business operations. Doral Financial may be required to pay material fines, judgments or settlements or suffer other penalties, each of which could have a material adverse effect on its business, results of operations, financial condition and liquidity. These investigations may adversely affect Doral Financial’s ability to obtain, and/or increase the cost of obtaining, directors’ and officers’ liability insurance and/or other types of insurance, which could have a material adverse effect on Doral Financial’s businesses, results of operations and financial condition. In addition, the findings of these investigations may affect the course of the civil litigation pending against Doral Financial, which are more fully described below.
Significant legal proceedings could adversely affect Doral Financial’s results of operations.
      In addition to being subject to litigation in the ordinary course of business, Doral Financial is a party to several legal and regulatory proceedings relating to the restatement. See Part I, Item 3. Legal Proceedings in this Form 10-K. Doral Financial cannot predict at this time the outcome of these proceedings or estimate the potential costs related to the proceedings. It is possible that the Company may

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be required to pay substantial judgments or settlements that could have a material adverse effect on the Company’s business, results of operations, financial condition or liquidity. In addition, the expenses incurred in connection with these proceedings (including substantial fees of lawyers and other professional advisors and potential obligations to indemnify officers and directors who may be parties to such actions) could have an adverse effect on the Company’s cash position.
Doral Financial and its banking subsidiaries are subject to the supervision and regulation of various banking regulators and have entered into consent orders with these regulators. These regulators could take action against the Company or its banking subsidiaries.
      As a regulated financial services firm, Doral Financial’s good standing with its regulators is of fundamental importance to the continuation and growth of its businesses. Doral Financial is subject to supervision and regulation by the Board of Governors of the Federal Reserve, Doral Bank — PR is subject to supervision and regulation by the FDIC and the Office of the Commissioner and Doral Bank — NY is subject to supervision and regulation by the OTS and the FDIC. Doral Financial is a bank holding company that qualifies as a financial holding company. As such, Doral Financial is permitted to engage in a broader spectrum of activities than those permitted to bank holding companies that are not financial holding companies. To continue to qualify as a financial holding company, each of Doral Financial’s banking subsidiaries must continue to qualify as “well capitalized” and “well managed.” As of December 31, 2005, Doral Financial and its banking subsidiaries continued to satisfy all applicable capital guidelines. This, however, does not prevent banking regulators from taking adverse actions against Doral Financial or its banking subsidiaries as a result of the restatement or related internal control matters. If Doral Financial were not to continue to qualify as a financial holding company, it might be required to discontinue certain securities and insurance activities and may be prohibited from engaging in new activities without prior regulatory approval.
      Doral Financial is responding to inquiries and requests for documents from the Federal Reserve and the other banking regulators of the Company and its subsidiaries regarding the issues arising from the restatement and related internal-control matters. Federal banking regulators, in the performance of their supervisory and enforcement duties, have significant discretion and power to initiate enforcement actions for violations of laws and regulations and unsafe or unsound practices. The enforcement powers available to federal banking regulators include, among other things, the ability to assess civil monetary penalties, to issue cease-and-desist or removal orders, to require written agreements and to initiate injunctive actions. As discussed in Part I, Item 3. Legal Proceedings, Doral Financial and Doral Bank — PR entered into consent orders with the Federal Reserve, the FDIC and the Office of the Commissioner, which, among other things, prohibit the Company’s banking subsidiaries from paying dividends to the parent company, and prohibit Doral Financial from paying dividends to its common and preferred shareholders, without regulatory approval. Doral Financial cannot predict whether any of these banking regulators will take any further action with respect to Doral Financial or its banking subsidiaries, or, if any such further action were taken, whether such action would have a material adverse effect on Doral Financial.
Recent downgrades in Doral Financial’s credit ratings will increase Doral Financial’s borrowing costs and may lessen Doral Financial’s ability to compete in certain business.
      Following Doral Financial’s announcement of the need to restate its financial statements, the major rating agencies downgraded Doral Financial’s ratings in a series of actions. S&P lowered the long-term senior debt and counterparty ratings of Doral Financial from ‘BBB-’ to ‘B+’ and placed the ratings on Credit Watch Negative. Moody’s lowered Doral Financial’s long term senior debt rating from ‘Baa2’ to ‘B1’ and placed the ratings on outlook of credit negative. Fitch lowered Doral Financial’s long-term senior debt rating from ‘BBB+’ to ‘BB-’ and placed the ratings on Rating Watch Negative. These or further downgrades may adversely affect Doral Financial’s ability to access capital and will likely result in more stringent covenants and higher interest rates under the terms of any future indebtedness.
      Doral Financial relies on external sources of financing to fund its operations. The cost and availability of unsecured financing are generally related to the issuer’s debt ratings. The recent downgrades and any future downgrades in Doral Financial’s debt ratings will increase Doral Financial’s borrowing costs and

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margin requirements and therefore adversely affect Doral Financial’s liquidity and results of operations and the Company’s ability to refinance existing debt.
      These debt and financial strength ratings are current opinions of the rating agencies. As such, they may be changed, suspended or withdrawn at any time by the rating agencies as a result of changes in, or unavailability of, information or based on other circumstances. Ratings may also be withdrawn at the request of Doral Financial’s management. These ratings actions have affected and will continue to affect Doral Financial’s business and results of operations in a number of ways.
Doral Financial’s failure to comply with certain reporting covenants under its public debt indentures may result in the acceleration of its public debt securities and other debt arrangements.
      Under its senior debt indenture, Doral Financial is required to timely file its periodic reports with the trustee. As a result of the restatement, Doral Financial has not yet filed its quarterly reports on Form 10-Q for the fiscal quarters ended March 31, 2006 and June 30, 2006.
      The failure to file the reports becomes a default with respect to any series under the indenture that would allow the required percentage of holders of a series of debt securities to deliver a notice of default to the trustee or the Company. After receipt of any notice of default, the Company would have a 90-day grace period to cure the default before it became an event of default under the senior debt indenture. As of the date of this Annual Report on Form 10-K, Doral Financial has not received a notice of default with respect to its reports for the first two quarters of 2006 and expects to file such reports before any failure to file could become an event of default.
      If Doral Financial, however, failed to cure a filing default within those 90 days after receipt of that notice of default, the trustee or such holders will have the right to accelerate the maturity of the relevant series of debt securities. This would trigger the cross-acceleration provisions under the other series of debt securities issued under its senior indenture. If such an acceleration were to occur, Doral Financial may be unable to meet its payment obligations. There can be no assurance that under such circumstances Doral Financial would be able to refinance its debt, whether through the capital markets or otherwise, on commercially reasonable terms, or at all.
Management has identified several material weaknesses in Doral Financial’s internal control over financial reporting.
      Doral Financial’s management has concluded that the Company’s internal control over financial reporting was not effective at December 31, 2005 as a result of several material weaknesses included in this report on Form 10-K. As a result, this report includes an adverse opinion from PricewaterhouseCoopers LLP, the Company’s independent registered public accounting firm, on Doral Financial’s internal control over financial reporting. Each material weakness results in more than a remote likelihood that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected. The Company’s ability to file its periodic reports with the SEC in a timely manner may also be adversely affected by the existence of ineffective controls.
      A discussion of the material weaknesses that have been identified by management can be found in Item 9A of Part II of this Annual Report on Form 10-K. While remediation of these weaknesses has begun, Doral Financial has not yet fully implemented its plan for remedying the identified material weaknesses, and there can be no assurance as to when the remediation plan will be fully implemented or that it will be effective. Remediation work continues through and may extend beyond 2006.
Doral Financial does not expect to be able to access the public capital markets until all of its filings with the SEC are up to date.
      Doral Financial anticipates that, once it is current in its filings with the SEC, it, depending on market conditions, may be able to access the Rule 144A market. However, Doral Financial will be unable to access the U.S. public securities markets until it has filed and the SEC has declared effective a new registration statement or post-effective amendments to existing registration statements under the Securities

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Act of 1933. Depending on the SEC’s review of these filings, this process may take several months or longer.
      Until Doral Financial is current in its SEC filings, a holder of restricted securities within the meaning of Rule 144 of the Securities Act will be unable to sell such securities in reliance on Rule 144, unless such holder has held such securities for at least two years and is not an “affiliate” of Doral Financial for purposes of the U.S. federal securities laws.
There is a lack of public disclosure concerning Doral Financial.
      Doral Financial has not yet filed with the SEC its quarterly report on Form 10-Q for the fiscal quarter ended March 31, 2006. The Company expects to file this report as soon as practicable after the date of this Annual Report on Form 10-K. Until the Doral Financial files this quarterly report, there will be limited public information available concerning the Company’s more recent results of operations and financial condition. The absence of more recent financial information may have a number of adverse effects on Doral Financial and its securities, including a decrease in the market price of the Company’s securities and an increase in the volatility of such market price.
Doral Financial may fail to attract and retain key employees and management personnel.
      Doral Financial’s success has been and will continue to be influenced by its ability to attract and retain key employees and management personnel, including senior and middle management. Doral Financial’s ability to attract and retain key employees and management personnel may be adversely affected as a result of the restatement and related risks and uncertainties.
Risks Relating to Doral Financial’s Business
Fluctuations in interest rates may negatively impact Doral Financial’s business.
      Interest rate risk is the primary market risk affecting Doral Financial. Changes in interest rates can adversely affect the following areas of its business:
  •  the number of mortgage loans it originates and purchases;
 
  •  the net interest income it earns on loans and securities;
 
  •  its gain on the sale of loans;
 
  •  the value of its securities holdings; and
 
  •  the value of its servicing asset and IOs.
      Significant increases in interest rates reduce demand for mortgage loan originations and refinancing. Higher interest rates increase the cost of mortgage loans to consumers and therefore reduce consumer demand for mortgage loans. Reduced demand for mortgage loans negatively impacts Doral Financial’s profits because it results in lower loan originations by Doral Financial and lower mortgage origination income. Demand for refinance loans is generally more sensitive to increases in interest rates.
      Significant changes in interest rates reduce net interest income. Doral Financial is liability sensitive (on average the liabilities mature sooner than the assets) and thus significant increases in short-term interest rates reduce net interest income, which is the most important component of Doral Financial’s earnings. Net interest income is the difference between the interest received by Doral Financial on its interest-earning assets and the interest paid on its borrowings. Most of Doral Financial’s interest-earning assets, like its mortgage loans and mortgage-backed securities, are long-term assets with fixed interest rates. In contrast, most of Doral Financial’s borrowings are short-term. When interest rates rise, Doral Financial must pay more in interest on its borrowings while the interest earned on its assets does not rise as quickly. This causes profits to decrease. This adverse impact on earnings is higher when the slope of the yield curve flattens, that is, when short-term interest rates increase more than long-term rates.

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      Significant increases in interest rates may reduce the value of Doral Financial mortgage loans, securitiesholdings and floating rate IOs. Significant increases in interest rates may reduce the value of Doral Financial’s financial assets and may have an adverse impact on its earnings and financial condition. Doral Financial owns a substantial portfolio of mortgage loans, mortgage-backed securities and other debt securities with fixed interest rates. The market value of an obligation with a fixed interest rate generally decreases when prevailing interest rates rise. In addition, most of Doral Financial’s IOs are related to mortgage pools in which the pass-through rates payable to investors is a floating rate based on a spread over the three-month LIBOR. Accordingly, significant unexpected increases in short-term interest rates reduce the spread received on Doral Financial’s IOs and adversely affect its value. For mortgage loan sales contracts that are not subject to interest rate caps, to the extent that the interest rate payable to investors on the mortgage loans underlying the floating rate IOs exceeds the weighted-average coupon on such mortgage loans, the change in fair value of the Company’s IOs may exceed the carrying value of the IOs, creating a liability instead of an asset. Doral Financial must recognize decreases in the value of the IOs against its current period earnings.
      Significant reductions in interest rates may adversely affect the value of Doral Financials servicing assets. Significant decreases in long-term interest rates lead to increases in the prepayment of mortgages by borrowers, which may reduce the value of Doral Financial’s servicing assets. Doral Financial’s servicing assets represent the estimated present value of the normal servicing fees (net of related servicing costs) Doral Financial expects to receive on the mortgages it services over their expected term. If prepayments increase above expected levels, the value of Doral Financial’s servicing assets will decrease because the amount of future fees expected to be received by Doral Financial from the servicing assets will decrease.
Doral Financial must identify and satisfy the requirements of new loan sale channels for its non-conforming mortgage loan production.
      Prior to the announcement that it would have to restate its financial statements, Doral Financial historically sold a significant portion of its non-conforming loan production to local financial institutions at relatively high gain on sale margins through the creation of floating rate IOs. Because of the uncertainty surrounding the restatement process, the Company has not been able to sell its non-conforming loan production in the local market and, in the fourth quarter of 2005, began selling non-conforming loans to U.S. financial institutions, on a non-recourse basis, in transactions that did not involve the creation of IOs and resulted in a significantly lower gain on sale margin. While Doral Financial is seeking to broaden sales channels for its non-conforming mortgage loan production, it anticipates that these new sales channels will continue to result in considerably lower gain on sales margins compared to those obtained in past sales in the local Puerto Rico market, thereby adversely affecting its profitability. In addition, these new channels require that the Company adopt and maintain more stringent underwriting and pricing criteria, which has affected and may continue to affect the Company’s share of Puerto Rico’s loan production.
Doral Financial is exposed to credit risks from mortgage loans held pending sale and mortgage loans that have been sold subject to recourse arrangements.
      Doral Financial is generally at risk for mortgage loan defaults from the time it funds a loan until the time the loan is sold or securitized into a mortgage-backed security. Doral Financial also often retains, through recourse arrangements, part of the credit risk on sales of mortgage loans that do not qualify for GNMA, FNMA or FHLMC sale or exchange programs and consequently may suffer losses on these loans. Doral Financial suffers losses on these loans when the proceeds from a foreclosure sale of the property underlying a defaulted mortgage loan are less than the outstanding principal balance of the loan and the costs of holding and disposing of the related property.
Doral Financial is subject to default risk in connection with the loans it originates for its own portfolio.
      Doral Financial is subject to the risk of loss from loan defaults and foreclosures with respect to the loans originated for its own portfolio, including those loans originated by its banking subsidiaries for investment. Doral Financial establishes provisions for loan and lease losses, which are charged to

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operations, in order to maintain its allowance for loans and lease losses at a level which management deems to be appropriate based upon management’s assessment of prior loss experience, the volume and type of lending being conducted, industry standards, past due loans, general economic conditions in its market and other factors related to the collectibility of the loan portfolio. Although Doral Financial’s management utilizes its best judgment in providing for loan losses, there can be no assurance that management has accurately estimated the level of probable loan losses or that Doral Financial will not have to increase its provisions for loan and lease losses in the future as a result of future increases in non-performing loans or for other reasons beyond its control. Any such increases in Doral Financial’s provisions for loan and lease losses could have a material adverse impact on Doral Financial’s future financial condition and results of operations.
Increases in Doral Financial’s originations of construction and commercial loans have increased Doral Financial’s credit risks.
      Doral Financial’s increase in originations of construction loans and mortgage loans secured by income producing residential buildings and commercial properties through its banking subsidiaries has increased the credit risks to which Doral Financial is exposed. These types of loans involve greater credit risks than residential mortgage loans because they are larger in size, concentrate more risk in a single borrower and are generally more sensitive to economic conditions. The properties securing these loans are also harder to dispose of in foreclosure.
Doral Financial is exposed to greater risk because its business is concentrated in Puerto Rico.
      Doral Financial’s business activities and credit exposure are concentrated in Puerto Rico. Consequently, its financial condition and results of operations are highly dependent on economic conditions in Puerto Rico. Adverse political or economic developments, decreases in housing values or natural disasters, such as hurricanes, could result in a downturn in loan originations, an increase in the level of nonperforming assets, an increase in the rate of foreclosure loss on mortgage loans and a reduction in the value of Doral Financial’s loans and loan servicing portfolio. These factors could materially and adversely affect Doral Financial’s condition and results of operations.
      During 2006, a number of key economic indicators suggest that the Puerto Rican economy is suffering a slowdown, as a result of, among other things, the persistent high levels of oil prices, the upward trend in short-term interest rates, the depreciation of the dollar and the deceleration of public investment due to the Commonwealth’s current fiscal situation. In particular, the increase in short-term interest rates and the reduction in public investment are expected to have an adverse effect in construction activity, which has been a key contributor to economic growth in recent years. Some of these factors are also adversely affecting housing affordability.
Doral Financial is subject to risks in servicing loans for others.
      Doral Financial’s profitability may also be adversely affected by mortgage loan delinquencies and defaults on mortgage loans that it services for third parties. Under many of its servicing contracts, Doral Financial must advance all or part of the scheduled payments to the owner of an outstanding mortgage loan, even when mortgage loan payments are delinquent. In addition, in order to protect their liens on mortgaged properties, owners of mortgage loans usually require that Doral Financial, as servicer, pay mortgage and hazard insurance and tax payments on schedule even if sufficient escrow funds are not available. Doral Financial generally recovers its advances from the mortgage owner or from liquidation proceeds when the mortgage loan is foreclosed. However, in the interim, Doral Financial must absorb the cost of the funds it advances during the time the advance is outstanding. Doral Financial must also bear the increased costs of attempting to collect on delinquent and defaulted mortgage loans. In addition, if a default is not cured, the mortgage loan will be canceled as part of the foreclosure proceedings and Doral Financial will not receive any future servicing income with respect to that loan.

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Competition with other financial institutions could adversely affect the profitability of Doral Financial’s operations.
      Doral Financial faces significant competition from other financial institutions, many of which have significantly greater assets, capital and other resources. As a result, many of Doral Financial’s competitors have advantages in conducting certain businesses and providing certain services. This competitive environment could force Doral Financial to increase the rates it offers on deposits or lower the rates it charges on loans and, consequently, could adversely affect the profitability of Doral Financial’s operations.
Changes in statutes and regulations could adversely affect Doral Financial.
      As a financial institution, Doral Financial is subject to extensive federal and local governmental supervision and regulation. Any change in regulation, whether by applicable regulators or as a result of legislation enacted by the United States Congress or by the applicable local legislatures, could have a substantial impact on Doral Financial’s operations and profitability.
Item 1B. Unresolved Staff Comments.
      None.
Item 2. Properties.
      Doral Financial maintained its principal administrative and executive offices in an office building known as the Doral Financial Plaza, located at 1451 F.D. Roosevelt Avenue in San Juan, Puerto Rico. The Doral Financial Plaza is owned in fee simple by Doral Properties, Inc., a wholly-owned subsidiary of Doral Financial, and has approximately 200,000 square feet of office and administrative space. The cost of the building, related improvements and land was approximately $51.3 million. The building is subject to a mortgage in the amount of $42.8 million.
      Doral Bank — PR maintains its administrative offices on three floors in a commercial office condominium known as the Doral Bank Plaza, located at 33 Resolution Street in San Juan, Puerto Rico adjacent to the Doral Financial Plaza. The three floors are owned in fee simple by Doral Bank. Two floors consist of approximately 18,176 square feet per floor and one consists of approximately 18,523 square feet. The aggregate cost of the three floors was approximately $14.0 million.
      Doral Financial also leases administrative office spaces at the following locations:
         
Location   Business Activity
     
279 F.D. Roosevelt Avenue(1)
       
Hato Rey, Puerto Rico
    Mortgage Banking  
 
305 F.D. Roosevelt Avenue(1)
       
Hato Rey, Puerto Rico
    Mortgage Banking  
 
387 Park Avenue South(2)
    Federal Savings Bank/  
New York, New York
    Mortgage Banking  
 
(1)  Retail mortgage banking branch also located here.
 
(2)  Federal Savings Bank and retail mortgage banking branch also located here.
      In addition to the administrative offices listed above, Doral Financial maintains 56 retail mortgage banking branches in Puerto Rico and one in the New York metropolitan area, 42 commercial banking branches in Puerto Rico, one broker-dealer branch in Puerto Rico and one insurance agency branch in Puerto Rico, all except for nine of which are leased, and 10 retail branches for its thrift operation in the New York City metropolitan area, all of which are leased. Doral Financial considers that its properties are generally in good condition, are well maintained and are generally suitable and adequate to carry on Doral Financial’s business.

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Item 3. Legal Proceedings.
      Doral Financial and its subsidiaries are defendants in various lawsuits arising in the ordinary course of business. In the opinion of Doral Financial’s management, except as described below, the pending and threatened legal proceedings of which management is aware will not have a material adverse effect on the financial condition or results of operations of Doral Financial.
      During 2005, Doral Financial became subject to various legal proceedings, including regulatory and judicial investigations and civil litigation, arising as a result of the Company’s restatement.
Lawsuits
      Class Action Lawsuits. Following the announcement of the restatement, Doral Financial and certain of its officers and directors and former officers and directors, were named as defendants in eighteen purported class action lawsuits filed between April 20, 2005 and June 14, 2005, alleging violations of federal securities laws. Sixteen of these actions were filed in the U.S. District Court for the Southern District of New York and two were filed in the U.S. District Court for the District of Puerto Rico. These lawsuits, brought on behalf of shareholders who purchased Doral Financial securities as early as May 15, 2000 and as late as May 26, 2005, allege primarily that the defendants engaged in securities fraud by disseminating materially false and misleading statements during the class period, failing to disclose material information concerning the valuation of the Company’s IOs, and misleading investors as to Doral’s vulnerability to interest rate increases. The two actions not initially filed in the U.S. District Court for the Southern District of New York have been transferred there by the Judicial Panel on Multi-District Litigation for coordinated or consolidated pretrial proceedings with the actions previously filed there before Judge Richard Owen.
      On February 8, 2006, Judge Owen entered an order appointing the West Virginia Investment Management Board as lead plaintiff and approving the selection of Lerach Coughlin Stoia Geller Rudman & Robbins LLP as lead plaintiffs’ counsel. On June 22, 2006, the lead plaintiff filed a consolidated amended complaint alleging securities fraud during the period between March 15, 2000 and October 25, 2005, based on allegations similar to those noted above, as well as based on the reversal of certain transactions entered into by Doral Financial with other Puerto Rico financial institutions and on weaknesses in Doral Financial’s control environment as described in the Company’s amended annual report on Form 10-K/ A for 2004. The consolidated amended complaint seeks unspecified compensatory damages (including interest), costs and expenses, and injunctive relief. The deadline for defendants to respond to the amended complaint is currently September 15, 2006.
      Shareholder Derivative Lawsuits. Certain officers and directors and former officers and directors of the Company were also named as defendants in four shareholder derivative actions filed in the U.S. District Court for the Southern District of New York between June 2, 2005 and June 13, 2005. A fifth derivative lawsuit was filed in New York state court and was subsequently removed to the U.S. District Court for the Southern District of New York. These derivative actions purport to bring claims on behalf of the Company based principally on allegations that Doral Financial’s officers and directors allowed Doral Financial to use inadequate procedures and financial controls in connection with the Company’s financial statements and made misstatements to the public concerning the Company’s financial controls and financial performance. Two derivative lawsuits have been voluntarily dismissed by plaintiffs. The three remaining derivative actions are pending before Judge Owen and have been consolidated with the class actions during pretrial proceedings. The relief sought in these derivative actions includes contribution in respect of the securities actions, unspecified compensatory damages on behalf of Doral Financial, disgorgement of defendants’ profits and compensation, equitable and/or injunctive relief, costs and other expenses. On April 27, 2006, Judge Owen appointed Rosenbaum Capital, LLC as lead derivative plaintiff and the law firm of Federman & Sherwood as lead derivative plaintiffs’ counsel. On June 21, 2006, Judge Owen stayed the derivative actions pending disposition of motions to dismiss the securities class action and established a deadline of 45 days after final disposition of such motions for the filing of the consolidated amended complaint.

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      Other Lawsuits. On June 21, 2005, a lawsuit was filed against Doral Financial and certain of its officers and directors and former officers and directors in the U.S. District Court for the District of Puerto Rico. Between June 29, 2005 and August 30, 2005, plaintiff filed three amended complaints. The suit as amended concerns a divorce settlement entered by the former Chairman and chief executive officer of Doral Financial and also alleges, among other things, violations of federal securities laws, Racketeer Influenced and Corrupt Organizations (RICO) Act violations, as well as fraud and breach of contract under Puerto Rico law, some of which are stated in the alternative as derivative claims on behalf of Doral Financial. Plaintiff seeks an award of damages, costs, and expenses. All defendants have moved to dismiss the complaint as amended, and such motions have not been decided.
      In addition, on October 14, 2005, the Company, a director and certain former officers and directors of the Company were named as defendants in an action brought by an individual plaintiff filed in the U.S. District Court for the Southern District of New York, alleging violations of federal securities laws and various Kentucky state laws similar to those alleged in the class action lawsuits. Plaintiff seeks compensatory damages in the amount of $292,000 for losses the plaintiff allegedly incurred in connection with Doral Financial securities purchased between January 19, 2005 and March 18, 2005, as well as unspecified punitive damages, interest, costs and other expenses. This action is at a very early stage, is pending before Judge Owen and has been consolidated with the class and derivative actions for pretrial proceedings.
      Doral Financial cannot predict the outcome of the lawsuits described above and is unable to ascertain the ultimate aggregate amount of monetary liability or financial impact to Doral Financial of these lawsuits. Accordingly, no reserve is being established in Doral Financial’s financial statements at this time. Doral Financial cannot determine whether these lawsuits will, individually or collectively, have a material adverse effect on the business, results of operations, financial condition and liquidity of Doral Financial.
Other Legal Matters
      On April 19, 2005, the SEC informed Doral Financial that it is conducting an inquiry into Doral Financial’s accounting and disclosure practices related to the April 19, 2005 announcement that it would restate its financial results, and the underlying issues related to the restatement. Subsequently, the SEC issued a formal order of investigation in connection with the previously announced informal inquiry into the Company’s restatement of its consolidated financial statements. The Company is cooperating with the SEC in connection with this investigation.
      Doral Financial has been engaged in discussions with the staff of the SEC regarding a possible resolution to its investigation of the Company’s restatement, and has reserved $25 million in its consolidated financial statements for the year ended December 31, 2005 in connection with a potential settlement of the SEC’s investigation of the Company. Any settlement is subject to acceptance and authorization by the Commission. There can be no assurance that the Company’s efforts to resolve the SEC’s investigation with respect to the Company will be successful, or that the amount reserved will be sufficient, and the Company cannot predict the timing or the final terms of any settlement.
      On August 24, 2005, the U.S. Attorney’s Office for the Southern District of New York served Doral Financial with a grand jury subpoena seeking the production of certain documents relating to issues arising from the restatement, including financial statements and corporate, auditing and accounting records prepared during the period January 1, 2000 to the date of the subpoena. Doral Financial is cooperating with the U.S. Attorney’s Office in this matter, including by producing documents and other information in response to the subpoena.
      On March 17, 2006, Doral Financial and its principal Puerto Rico banking subsidiary, Doral Bank — PR, entered into consent orders with the Federal Reserve, the FDIC and the Office of the Commissioner. The mutually agreed upon orders require Doral Financial and Doral Bank — PR to conduct reviews of their mortgage portfolios, and to submit plans regarding the maintenance of capital adequacy and liquidity. No fines or monetary penalties were assessed against Doral Financial or Doral Bank — PR under the orders.

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      Under the terms of the consent order with the FDIC and the Office of the Commissioner, Doral Bank — PR may not pay a dividend or extend credit to, or enter into certain asset purchase and sale transactions with Doral Financial or its subsidiaries, without the prior consent of the FDIC and the Office of the Commissioner.
      The consent order with the Federal Reserve contains similar restrictions on Doral Financial from obtaining extensions of credit from, or entering into certain asset purchase and sale transactions with, Doral Bank — PR, without the prior approval of the Federal Reserve. The consent order also restricts Doral Financial from paying dividends on its capital stock without the prior written approval of the Federal Reserve. Doral Financial is required to request permission for the payment of dividends on its common stock and preferred stock not less than 30 days (five days in the case of the first request following the effective date of the order) prior to a proposed dividend declaration date.
      Doral Financial cannot predict the outcome of the matters described above and is unable to ascertain the ultimate aggregate amount of monetary liability or financial impact to Doral Financial of these matters. Except with respect to the SEC’s investigation, no reserve is being established in Doral Financial’s financial statements at this time. Doral Financial cannot determine whether these actions, suits, claims and proceedings will, individually or collectively, have a material adverse effect on the business, results of operations, financial condition and liquidity of Doral Financial.
Item 4. Submission of Matters to a Vote of Security Holders.
      Not applicable.
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
      Doral Financial’s common stock, $1.00 par value (the “Common Stock”), is traded and quoted on the New York Stock Exchange (“NYSE”) under the symbol “DRL.”
      The table below sets forth, for the calendar quarters indicated, the high and low closing sales prices and the cash dividends declared on the Common Stock during such periods.
                                 
        Price Range    
    Calendar       Dividends
Year   Quarter   High   Low   Per Share
                 
2005
    4th     $ 12.760     $ 8.000     $ 0.080  
      3rd       16.760       13.070       0.180  
      2nd       21.750       11.520       0.180  
      1st       49.450       21.500       0.180  
 
2004
    4th     $ 49.250     $ 39.790     $ 0.180  
      3rd       42.880       34.480       0.150  
      2nd       35.630       30.880       0.150  
      1st       35.420       29.870       0.120  
      As of July 31, 2006, the approximate number of record holders of Doral Financial’s Common Stock was 458, which does not include beneficial owners whose shares are held in record names of brokers and nominees. The last sales price for the Common Stock as quoted on the NYSE on such date was $5.12 per share.
      Doral Financial has three outstanding series of nonconvertible preferred stock: 7.25% noncumulative monthly income preferred stock, Series C (liquidation preference $25 per share); 8.35% noncumulative monthly income preferred stock, Series B (liquidation preference $25 per share); and 7% noncumulative

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monthly income preferred stock, Series A (liquidation preference $50 per share) (collectively, the “Preferred Stock”).
      During 2003, Doral Financial issued 1,380,000 shares of its 4.75% perpetual cumulative convertible preferred stock (“the convertible preferred stock”) having a liquidation preference of $250 per share in a private offering to qualified institutional buyers pursuant to Rule 144A. Each share of the convertible preferred stock is currently convertible into 6.2856 shares of common stock, subject to adjustment under specific conditions. The convertible preferred stock ranks on parity with Doral Financial’s other outstanding preferred stock with respect to dividend rights and rights upon liquidation, winding up or dissolution.
      The terms of Doral Financial’s preferred stock do not permit Doral Financial to declare, set apart or pay any dividends or make any other distribution of assets, or redeem, purchase, set apart or otherwise acquire shares of the Doral Financial’s common stock, or any other class of Doral Financial’s stock ranking junior to the preferred stock, unless all accrued and unpaid dividends on the preferred stock and any parity stock, at the time those dividends are payable, have been paid and the full dividend on the preferred stock for the current dividend period is contemporaneously declared and paid or set aside for payment. The terms of the preferred stock provide that if Doral Financial is unable to pay in full dividends on the preferred stock and other shares of stock of equal rank as to the payment of dividends, all dividends declared upon the preferred stock and such other shares of stock be declared pro rata.
      On April 25, 2006, Doral Financial announced that, as a prudent capital management decision designed to preserve and strengthen the Company’s capital, the Board of Directors had suspended the quarterly dividend on the Company’s common stock.
      Doral Financial’s ability to pay dividends in the future is limited by various regulatory requirements and policies of bank regulatory agencies having jurisdiction over Doral Financial and its banking subsidiaries, its earnings, cash resources and capital needs, general business conditions and other factors deemed relevant by Doral Financial’s Board of Directors.
      On March 17, 2006, the Company and its principal Puerto Rico Banking subsidiary, Doral Bank — PR, entered into consent orders with the Board of Governors of the Federal Reserve System, the FDIC and the Office of the Commissioner.
      Under the terms of the consent order with the FDIC and the Office of the Commissioner, Doral Bank — PR may not pay a dividend or extend credit to, or enter into certain asset purchase and sale transactions with Doral Financial or its subsidiaries, without the prior consent of the FDIC and the Office of the Commissioner. The consent order also restricts Doral Financial from paying dividends on its capital stock without the prior written approval of the Federal Reserve. Doral Financial is required to request permission for the payment of dividends on its common stock and preferred stock not less than 30 days prior to a proposed dividend declaration date.
      On February 9, 2006, the OTS notified Doral Bank — NY that, until further notice, it could not pay any dividend to Doral Financial without prior approval of the OTS. The OTS also directed Doral Bank-NY not to make any extensions of credit to Doral Financial, purchases of assets or similar transactions, without the prior written consent of the OTS.
      Doral Financial did not purchase any of its equity securities during 2004 or 2005.
      The PR Code generally imposes a 10% withholding tax on the amount of any dividends paid by Doral Financial to individuals, whether residents of Puerto Rico or not, trusts, estates, special partnerships and non-resident foreign corporations and partnerships. Prior to the first dividend distribution for the taxable year, individuals who are residents of Puerto Rico may elect to be taxed on the dividends at the regular graduated rates, in which case the special 10% tax will not be withheld from such year’s distributions.
      United States citizens who are not residents of Puerto Rico may also make such an election except that notwithstanding the making of such election, a 10% withholding will still be made on the amount of any dividend distribution unless the individual files with Doral Financial’s transfer agent, prior to the first distribution date for the taxable year, a certificate to the effect that said individual’s gross income from

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sources within Puerto Rico during the taxable year does not exceed $1,300 if single, or $3,000 if married, in which case dividend distributions will not be subject to Puerto Rico income taxes.
      United States income tax law permits a credit against United States income tax liability, subject to certain limitations, for Puerto Rico income taxes paid or deemed paid with respect to such dividends.
      Special United States federal income tax rules apply to distributions received by U.S. citizens on stock of a passive foreign investment company (“PFIC”) as well as amounts retained from the sale or exchange of stock of a PFIC. Based upon certain provisions of the Code and proposed Treasury Regulations promulgated thereunder, Doral Financial understands that it has not been a PFIC for any of its prior taxable years.
      For information regarding securities authorized for issuance under Doral Financial’s stock-based compensation plans, refer to Part III, Item 12. Executive Compensation in this Annual Report on Form 10-K.
Item 6. Selected Financial Data.
      The following table sets for the certain selected consolidated financial data for each of the five years in the period ended December 31, 2005. This information should be read in conjunction with Doral Financial’s consolidated financial statements and related notes thereto.

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    Year Ended December 31,
     
(Dollars in thousands, except for share data)   2005   2004   2003   2002   2001
                     
Selected Income Statement Data:
                                       
 
Interest income
  $ 947,779     $ 722,709     $ 557,705     $ 479,624     $ 444,710  
 
Interest expense
    667,182       385,086       320,246       315,575       336,797  
                               
 
Net interest income
    280,597       337,623       237,459       164,049       107,913  
 
Provision for loan and lease losses
    22,369       10,384       11,579       4,488       2,684  
                               
 
Net interest income after provision for loan and lease losses
    258,228       327,239       225,880       159,561       105,229  
                               
 
Net gain on mortgage loan sales and fees
    52,131       83,585       94,709       70,188       73,048  
 
Investment activities
    (44,204 )     (99,722 )     (23,199 )     84,964       33,537  
 
Servicing income (loss)
    16,715       (18 )     24,486       (7,269 )     (10,093 )
 
Commissions, fees and other income
    37,906       32,333       22,809       18,747       15,231  
                               
 
Total non-interest income
    62,548       16,178       118,805       166,630       111,723  
                               
 
Non-interest expenses
    288,493       214,114       178,631       145,961       128,558  
                               
 
Income before income taxes and cumulative effect of change in accounting principle
    32,283       129,303       166,054       180,230       88,394  
 
Income tax (expense) benefit(1)
    (19,091 )     85,491       (23,916 )     (13,348 )     3,386  
                               
 
Income before cumulative effect of change in accounting principle
    13,192       214,794       142,138       166,882       91,780  
 
Cumulative effect of change in accounting principle, net of tax
                            5,929  
                               
 
Net income
  $ 13,192     $ 214,794     $ 142,138     $ 166,882     $ 97,709  
                               
 
Net (loss) income attributable to common shareholders
  $ (20,107 )   $ 181,495     $ 121,050     $ 153,152     $ 88,301  
                               
 
Cash Dividends Declared:
                                       
 
Common stock
  $ 66,914     $ 64,744     $ 43,218     $ 30,185     $ 21,543  
                               
 
Preferred stock
  $ 33,299     $ 33,299     $ 21,088     $ 13,730     $ 9,408  
                               
Per Common Share Data:
                                       
Basic:
                                       
 
(Loss) income before cumulative effect of change in accounting principle
  $ (0.19 )   $ 1.68     $ 1.12     $ 1.42     $ 0.82  
 
Cumulative effect of change in accounting principle
                            0.06  
                               
 
Net (loss) income
  $ (0.19 )   $ 1.68     $ 1.12     $ 1.42     $ 0.88  
                               
Diluted:
                                       
 
(Loss) income before cumulative effect of change in accounting principle
  $ (0.19 )   $ 1.63     $ 1.10     $ 1.40     $ 0.80  
 
Cumulative effect of change in accounting principle
                            0.06  
                               
 
Net (loss) income
  $ (0.19 )   $ 1.63     $ 1.10     $ 1.40     $ 0.86  
                               
Dividends per common share
  $ 0.62     $ 0.60     $ 0.40     $ 0.28     $ 0.21  
Book value per common share
  $ 5.34     $ 6.59     $ 5.64     $ 5.35     $ 4.21  
Weighted — Average Common Shares Outstanding:
                                       
 
Basic
    107,927,037       107,907,699       107,861,415       107,697,114       100,786,932  
 
Diluted
    107,927,037       111,070,048       110,434,162       109,438,695       102,381,614  
Common shares outstanding at end of period
    107,930,236       107,908,862       107,903,912       107,774,022       107,573,252  
(Continues)
                                       

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    Year Ended December 31,
     
(Dollars in thousands, except for share data)   2005   2004   2003   2002   2001
                     
(Continued)
                                       
Selected Balance Sheet Data:
                                       
 
Cash and cash equivalents
  $ 1,546,502     $ 2,535,726     $ 954,722     $ 1,573,291     $ 594,385  
 
Securities held for trading
    388,676       489,070       494,717       996,508       884,326  
 
Securities available for sale
    4,631,573       4,982,508       2,850,598       862,090       928,179  
 
Securities held to maturity
    2,099,694       2,301,695       1,641,435       960,766       866,503  
 
Total loans(2)
    7,800,155       6,670,206       5,172,223       4,348,148       3,585,681  
 
Servicing assets, net
    150,576       123,586       128,920       96,930       105,688  
 
Total assets
    17,298,749       17,839,376       11,761,548       9,351,082       7,569,956  
 
Deposit accounts
    4,237,269       3,643,080       2,971,272       2,217,211       1,669,909  
 
Securities sold under agreements to repurchase
    6,054,598       6,305,163       3,602,942       2,733,339       2,573,772  
 
Advances from the Federal Home Loan Bank of NY (FHLB)
    969,500       1,294,500       1,206,500       1,311,500       687,500  
 
Loans payable
    3,578,230       3,638,507       2,014,183       1,477,743       1,224,787  
 
Notes payable
    965,621       1,095,977       561,373       563,229       459,543  
 
Total liabilities
    16,148,940       16,554,759       10,579,186       8,546,703       6,992,281  
 
Stockholders’ equity
    1,149,809       1,284,617       1,182,362       804,379       577,675  
Operating Data:
                                       
 
Loan production
  $ 5,480,000     $ 5,466,000     $ 4,901,000     $ 3,707,000     $ 3,335,000  
 
Loan servicing portfolio(3)
    15,728,000       14,264,000       12,690,000       11,242,000       10,006,000  
Selected Financial Ratios:(4)(5)
                                       
 
Return on average assets
    0.07 %     1.50 %     1.37 %     2.00 %     1.40 %
 
Return on average common equity
    (3.04 )%     30.20 %     19.96 %     30.74 %     26.49 %
 
Dividend payout ratio for common stock
    (326.32 )%     36.81 %     36.36 %     20.00 %     24.42 %
 
Average equity to average assets
    6.56 %     8.22 %     8.91 %     8.20 %     6.56 %
 
(1)  See Note 22 of the consolidated financial statements for an explanation of the computation of income tax benefit and expense.
 
(2)  Includes loans held for sale.
 
(3)  Includes $5.9 billion, $5.2 billion, $4.3 billion, $3.1 billion, and $2.4 billion of loans owned by Doral Financial at December 31, 2005, 2004, 2003, 2002 and 2001, respectively, which represented 38%, 37%, 34%, 27% and 24%, respectively, of the total servicing portfolio as of such dates.
 
(4)  Return on Average Assets, Return on Average Common Equity and Dividend Payout Ratio for Common Stock based on income before cumulative effect of a change in accounting principle for 2001 would have been 1.31%, 24.71% and 26.25% respectively.
 
(5)  Average balances are computed on a daily basis.

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      Doral Financial’s ratios of earnings to fixed charges and earnings to fixed charges and preferred stock dividends on a consolidated basis for each of the last five years in the period ended December 31, 2005 are as follows:
                                           
    Year Ended December 31,
     
    2005   2004   2003   2002   2001
                     
Ratio of Earnings to Fixed Charges
                                       
 
Including Interest on Deposits
    1.05 x     1.33 x     1.51 x     1.57 x     1.24 x
 
Excluding Interest on Deposits
    1.06 x     1.42 x     1.66 x     1.72 x     1.30 x
Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends
                                       
 
Including Interest on Deposits
    (A )     1.27 x     1.41 x     1.50 x     1.21 x
 
Excluding Interest on Deposits
    (A )     1.33 x     1.51 x     1.62 x     1.26 x
 
(A) During 2005, earnings were not sufficient to cover preferred dividends and the ratio was less than 1:1. The Company would have had to generate additional earnings of $49.2 million to achieve a ratio of 1:1 in 2005.
      For purposes of computing these consolidated ratios, earnings consist of pre-tax income from continuing operations plus fixed charges and amortization of capitalized interest, less interest capitalized. Fixed charges consist of interest expensed and capitalized, amortization of debt issuance costs, and Doral Financial’s estimate of the interest component of rental expense. Ratios are presented both including and excluding interest on deposits. The term “preferred stock dividends” is the amount of pre-tax earnings that is required to pay dividends on Doral Financial’s outstanding preferred stock.
      The principal balance of Doral Financial’s long-term obligations (excluding deposits) and the aggregate liquidation preference of its outstanding preferred stock on a consolidated basis as of December 31 of each of the last five years ended December 31, 2005 is set forth below.
                                         
    Year Ended December 31,
     
(In thousands)   2005   2004   2003   2002   2001
                     
Long-term obligations
  $ 9,774,714     $ 7,636,373     $ 5,126,788     $ 4,719,603     $ 2,991,578  
Cumulative preferred stock
  $ 345,000     $ 345,000     $ 345,000              
Non-Cumulative preferred stock
  $ 228,250     $ 228,250     $ 228,250     $ 228,250     $ 124,750  

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
      The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help you understand Doral Financial and its subsidiaries. This MD&A is provided as a supplement to and should be read in conjunction with Doral Financial’s consolidated financial statements and the accompanying notes. The MD&A includes the following sections:
        OVERVIEW OF RESULTS OF OPERATIONS: Provides a brief summary of the most significant events and drivers affecting Doral Financial’s results of operations during 2005.
 
        INTERNAL CONTROL OVER FINANCIAL REPORTING: Provides a description of the status of Doral Financial’s internal control over financial reporting. For more detail, see Part II, Item 9A. Controls and Procedures of this Annual Report on Form 10-K.
 
        CRITICAL ACCOUNTING POLICIES: Provides a discussion of Doral Financial’s accounting policies that require critical judgment, assumptions and estimates.
 
        CONSOLIDATED RESULTS: Provides an analysis of the consolidated results of operations for 2005 compared to 2004 and 2004 compared to 2003.
 
        OUT OF PERIOD ADJUSTMENTS: Provides a description and impact of amounts recorded in Doral Financial’s consolidated financial statements which relate to prior periods. The out of period adjustments primarily relate to errors in accounting related to the accrual of interest income and expense on recharacterizated mortgage loan transfers and the forfeiture of unvested stock options, as well as certain other adjustments.
 
        OPERATING SEGMENTS: Provides a description of Doral Financial’s four operating segments and an analysis of the results of operations for each of these segments.
 
        BALANCE SHEET AND OPERATING DATA ANALYSIS: Provides an analysis of the most significant balance sheet items and operational data that impact Doral Financial’s financial statements and business. This section includes a discussion of the Company’s liquidity and capital resources, regulatory capital ratios, off-balance sheet activities and contractual obligations.
 
        RISK MANAGEMENT: Provides an analysis of the most significant risks to which Doral Financial is exposed, specifically those relating to interest rate and market risk, credit risk and operational risks.
 
        MISCELLANEOUS: Provides disclosure about various matters, including changes in accounting standards and recently issued accounting standards.
 
        FUTURE OPERATIONS: Provides a brief discussion of some of the continuing financial, operational and legal challenges faced by the Company following the restatement.
OVERVIEW OF RESULTS OF OPERATIONS
      Doral Financial’s consolidated financial statements for 2005 reflect significantly lower earnings than those reported for 2004. Net income for the year ended December 31, 2005 amounted to $13.2 million, compared to $214.8 million and $142.1 million for 2004 and 2003, respectively. Doral Financial’s 2005 financial performance was principally impacted by (1) a change in tax position from a tax benefit in 2004 to tax expense in 2005, (2) reduced net interest income and gain on sale of mortgage loans due principally to the interest rate environment, (3) a higher provision for loan and lease losses, (4) increased expenses as a result of the Company’s restatement efforts, (5) a significant loss on sale of investment securities and (6) a reserve for a potential settlement of the SEC’s ongoing investigation of the Company. The highlights of the Company’s financial results for the year ended December 31, 2005 included the following:
  •  Net income for the year ended December 31, 2005 was $13.2 million, compared to $214.8 million and $142.1 million for the years ended December 31, 2004 and 2003, respectively. After the payment of preferred stock dividends, there was a net loss attributable to common shareholders of

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  $20.1 million for the year ended December 31, 2005, compared to net income attributable to common shareholders of $181.5 million and $121.1 million for the years ended December 31, 2004 and 2003, respectively.
 
  •  Diluted loss per share for the year ended December 31, 2005 was $0.19, compared to diluted earnings per share of $1.63 and $1.10 for the years ended December 31, 2004 and 2003, respectively.
 
  •  Net interest income for the year ended December 31, 2005 was $280.6 million, compared to $337.6 million and $237.5 million for the years ended December 31, 2004 and 2003, respectively. The decrease in net interest income for 2005 reflects a significant decrease in net interest margin, offset in part by a significant growth in average interest-earning assets, principally loans and mortgage-backed securities (see Tables A and B below for information regarding the Company’s net interest income). The reduction in net interest margin resulted from the flattening of the yield curve. On average, the Company’s interest bearing liabilities, principally wholesale funding and loans payable, re-priced at higher rates than the Company’s interest earning assets.
 
  •  The provision for loan and lease losses for the year ended December 31, 2005 was $22.4 million, compared to $10.4 million and $11.6 million for 2004 and 2003, respectively. The increase in the allowance for loan and lease losses reflects principally an increase in the allowance for the Company’s construction loan portfolio, as well as an increase in the delinquency trends of the overall loans portfolio.
 
  •  Non-interest income for the year ended December 31, 2005 was $62.5 million, compared to $16.2 million and $118.8 million in 2004 and 2003, respectively. The increase in non-interest income, in 2005 compared to 2004, was primarily driven by lower losses on trading activities and higher servicing income, offset in part by lower gain on sales of mortgage loans and investment securities. During the fourth quarter of 2005, the Company, as a measure designed to increase liquidity, as well as to strengthen its capital ratios, sold approximately $1.2 billion of certain lower-yielding securities from its investment portfolio, at a loss of approximately $45.3 million. Lower losses on trading activities during 2005 were principally due to unrealized gains with respect to derivative instruments undertaken for risk management purposes, which were in turn mainly attributable to an increase in long-term interest and swap rates during 2005.
 
  •  Non-interest expenses for the year ended December 31, 2005 was $288.5 million, compared to $214.1 million and $178.6 million for the years ended December 31, 2004 and 2003 respectively, an increase of 35% and 20% respectively. The increase in non-interest expenses was driven by an increase of $29.4 million in professional fees associated with the restatement of the Company’s prior period financial statements and a $25 million reserve created for a potential settlement of the SEC’s ongoing investigation of the Company.
 
  •  Doral Financial has been engaged in discussions with the staff of the SEC regarding a possible resolution to its investigation of the Company’s restatement, and has reserved $25 million in its consolidated financial statements for the year ended December 31, 2005 in connection with a potential settlement of the SEC’s investigation of the Company. Any settlement is subject to acceptance and authorization by the Commission. There can be no assurance that the Company’s efforts to resolve the SEC’s investigation with respect to the Company will be successful, or that the amount reserved will be sufficient, and the Company cannot predict the timing or the final terms of any settlement. Doral Financial has not reserved any amounts in its financial statements in respect of the pending civil lawsuits in connection with its restatement, which are in their early stages.
 
  •  For the year ended December 31, 2005, Doral Financial reported income tax expense of $19.1 million (representing an effective tax rate of 59.1%), as compared to a tax benefit of $85.5 million for 2004. During 2005, the Company’s effective tax rate was adversely affected by an increase in income tax rates in Puerto Rico, net operating losses at certain subsidiaries that could

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  not be used to offset taxable income at other subsidiaries, certain expenses that were not deductible for tax purposes and an increase in the valuation allowance on the Company’s deferred tax assets. During 2004, the Company benefited from a significant inter-company sale of IOs completed for the purpose of taking advantage of a temporary reduction in capital gain tax rates, as well as from the recognition of a deferred tax asset in respect of taxes paid on transfers of IOs based on their value prior to the restatement.

INTERNAL CONTROL OVER FINANCIAL REPORTING
      Over the course of the Company’s restatement of its financial statements for periods between January 1, 2000 and December 31, 2004, the Company’s management identified a number of material weaknesses in its internal control over financial reporting as of December 31, 2004. Although the Company has taken a number of significant actions to remedy the material weakness in its internal controls since the beginning of the restatement process and has remedied some of the most pervasive weaknesses existing as of December 31, 2004, Doral Financial’s management concluded that its internal control over financial reporting remained ineffective as of December 31, 2005 based on the criteria set forth in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). A description of the material weaknesses existing as of December 31, 2005 is included in Part II, Item 9A. Controls and Procedures of this Annual Report on Form 10-K.
      The Company has and continues to develop a plan for remedying all of the identified material weaknesses, and the work will continue through and may extend beyond 2006. As part of this remediation program, the Company is taking steps to add skilled resources to improve controls and increase the reliability of the financial closing process. At present, there can be no assurance as to when the Company will remedy all of the material weaknesses in its internal control over financial reporting.
CRITICAL ACCOUNTING POLICIES
      The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make a number of judgments, estimates and assumptions that affect the reported amount of assets, liabilities, income and expenses in Doral Financial’s consolidated financial statements and accompanying notes. Certain of these estimates are critical to the presentation of Doral Financial’s financial condition since they are particularly sensitive to the Company’s judgment and are highly complex in nature. Doral Financial believes that the judgments, estimates and assumptions used in the preparation of its consolidated financial statements are appropriate given the factual circumstances as of December 31, 2005. However, given the sensitivity of Doral Financial’s consolidated financial statements to these estimates, the use of other judgments, estimates and assumptions could result in material differences in Doral Financial’s results of operations or financial condition.
      Various elements of Doral Financial’s accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. Note 2 to Doral Financial’s consolidated financial statements contains a summary of the most significant accounting policies followed by Doral Financial in the preparation of its financial statements. The accounting policies that have a significant impact on Doral Financial’s statements and that require the most judgment are set forth below.
Fair Value Measurement
      The measurement of fair value is fundamental to the presentation of Doral Financial’s financial condition and results of operations. Fair value is defined under GAAP as the amount at which an instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. GAAP indicates that fair value must be based on observable (for example, quoted) market prices. If observable market prices are not available, the techniques management uses for estimating fair value measurements should incorporate assumptions that individuals in the market would

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use. If that information is not available, then GAAP permits an entity to use its own assumptions, as long as there is no indication that the market would use a different assumption. Doral Financial recognizes many of its financial instruments at fair value in the Consolidated Statements of Financial Condition, with changes in these fair values recognized as gains and losses in the Consolidated Statements of Income or deferred, net of tax, in Accumulated Other Comprehensive Income (“AOCI”).
      Set forth below is a summary of Doral Financial’s sources of fair value for its investment securities, held in the securities held-for-trading and available-for-sale portfolios as well as its derivatives, retained interests and mortgage loans held for sale as of December 31, 2005:
                                 
    Carrying Amount
     
        Prices    
        Provided    
    Prices   by Other   Internal   External
    Actively   External   Valuation   Valuation
(In thousands)   Quoted   Sources   Models   Models
                 
Tax-exempt GNMAs
  $     $ 206,406     $     $  
Collateralized Mortgage Obligations
          5       1,841        
Puerto Rico government obligations
          5,510              
Mortgage-backed and U.S. Treasury and U.S. government sponsored agency securities
    4,624,862       82,327              
Derivative instruments
    846       24,395              
Other investment securities
          23              
IOs
                74,034        
Servicing assets (“MSRs”)
                      150,576  
Mortgage loans held for sale(1)
    5,322,195                    
                         
    $ 9,947,903     $ 318,666     $ 75,875     $ 150,576  
                         
 
(1)  Derived from prices of actively traded mortgage-backed securities.
      Fair value affects Doral Financial’s earnings in a variety of ways. For certain financial instruments that are carried at fair value (such as securities held-for-trading, including IOs and derivative instruments), changes in fair value are recognized in current period earnings as net gain (loss) on securities held-for-trading. For securities available-for-sale, changes in fair value are generally deferred, net of tax, in AOCI, a component of stockholders’ equity. The deferred gains and losses in AOCI, initially measured at fair value, are recognized in earnings over time when the securities are sold or when impairments are recognized. In addition, impairments of mortgage loans held for sale are recognized in earnings through lower-of-cost-or-market valuation adjustments. Finally, impairments or recoveries of MSRs are recognized in earnings through an impairment allowance as part of servicing income.
      The estimation of fair values reflects Doral Financial’s judgment regarding appropriate valuation methods and assumptions. The selection of a method to estimate fair value for each type of financial instrument depends on both the reliability and availability of relevant market data. The amount of judgment involved in estimating the fair value of a financial instrument is affected by a number of factors, such as type of instrument, the liquidity of the markets for the instrument and the contractual characteristics of the instrument.
      For financial instruments with active markets and readily available market prices, Doral Financial estimates fair values based on independent price quotations obtained from third parties, including dealer marks or direct market observations. Dealer quotes are prices that are obtained from third-party dealers that generally make markets in the relevant products. The quoted price is an indication of the price at which the dealer would consider transacting in normal market conditions. Market observable prices are prices that are retrieved from sources in which market trades are executed, such as electronic trading platforms.

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      Certain instruments, such as the Company’s portfolio of IOs, are less actively traded and, therefore, fair value is based on valuation models using market data inputs adjusted by the Company’s particular characteristics, when appropriate. See “Retained Interest Valuation,” below, for additional details.
Gain on Mortgage Loan Sales
      The Company generally securitizes or sells in bulk a significant portion of the residential mortgage loans it originates. FHA and VA loans are generally securitized into GNMA mortgage-backed securities and held as trading securities. After holding these securities for a period of time, Doral Financial sells these securities for cash. Conforming conventional loans are generally sold directly to FNMA, FHLMC or institutional investors or exchanged for FNMA or FHLMC-issued mortgage-backed securities, which Doral Financial sells for cash through broker-dealers. The Company generally attempts to sell mortgage loans that do not conform to GNMA, FNMA or FHLMC requirements (non-conforming loans) in bulk as part of mortgage loan pools to financial institutions or government-sponsored agencies.
      As part of its mortgage loan sale activities, Doral Financial generally retains the right to service the mortgage loans it sells and retain compensation thereon. In connection with the sale of fixed non-conforming mortgage loan pools, Doral Financial may also retain the right to receive any interest payments on such loans above the contractual pass-through rate payable to the investor. In substance, pursuant to these agreements, the Company sells its legal rights to the mortgage loans to the counterparty and enters into agreements that effectively change the cash flow associated with the underlying mortgage loans. Doral Financial determines the gain on sale of a mortgage-backed security or loan pool by allocating the carrying value of the underlying mortgage loans between the mortgage-backed security or mortgage loan pool sold and its retained interests, based on their relative estimated fair values. The reported gain or loss is the difference between the proceeds from the sale of the security or mortgage loan pool and its allocated cost after allocating a portion of the cost to the retained interests, and, in the case of loan sales with recourse provisions, the recourse obligation assumed by the Company.
      Below is a hypothetical example of the operation of this accounting principle based on a sale of loans with recourse with a carrying amount of $48.0 million:
                             
            Allocated
        Percentage of   Carrying
(Dollars in thousands)   Fair Value   Total Fair Value   Amount
             
1.
Allocation of carrying amount based on relative fair values:
                       
 
Loans sold
  $ 47,000       95.5 %   $ 45,840  
 
MSRs
    493       1.0 %     480  
 
IOs
    1,722       3.5 %     1,680  
                   
   
Total
  $ 49,215       100.0 %   $ 48,000  
                   
2.
Gain on sale calculation:
                       
 
Net proceeds from sale of loans
  $ 47,000                  
 
Carrying amount of loans sold
    (45,840 )                
 
Recourse obligation assumed
    (280 )                
                   
   
Gain on sale
  $ 880                  
                   
3.
Doral Financial retains MSRs and IOs with a carrying amount of $480,000 and $1.68 million, respectively, and recognizes a recourse obligation of $280,000. Simultaneously, the allocated carrying amount of the IOs, which are classified as securities held for trading, will be adjusted to its fair value of $1.72 million.
      If in a transfer of financial assets in exchange for cash or other consideration (other than beneficial interests in transferred assets), Doral Financial has not surrendered control over the transferred assets according to the provisions of Statement of Financial Accounting Standard (“SFAS”) No. 140 “Accounting

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for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (“SFAS 140”), Doral Financial accounts for the transfer as a secured borrowing (loan payable) with pledge of collateral.
Retained Interest Valuation
      Doral Financial’s sale and securitization activities generally result in the recording of one or two types of retained interests; MSRs and IOs. MSRs represent the estimated present value of the normal servicing fees (net of related servicing costs) expected to be received on a loan being serviced over the expected term of the loan. MSRs entitle Doral Financial to a future stream of cash flows based on the outstanding principal balance of the loans serviced and the contractual servicing fee. The annual servicing fees generally range between 25 and 50 basis points, and in certain cases, less any corresponding guarantee fee. In addition, MSRs may entitle Doral Financial, depending on the contract language, to ancillary income including late charges, float income, and prepayment penalties net of the appropriate expenses incurred for performing the servicing functions. In certain instances, the Company also services loans with no contractual servicing fee. The servicing asset or liability associated with such loans is evaluated based on ancillary income, including float, late fees, prepayment penalties and costs. MSRs are classified as servicing assets in Doral Financial’s Consolidated Statements of Financial Condition. Any servicing liability recognized is included as part of accrued expenses and other liabilities in Doral Financial’s Consolidated Statements of Financial Condition.
      IOs represent the estimated present value of the cash flows retained by the Company that are generated by the underlying fixed rate mortgages (as adjusted for expected losses and prepayments, as well as by the estimated market value of any embedded cap, if applicable) after subtracting: (1) the interest rate payable to the investor, and (2) a contractual servicing fee. In the past, the Company generally agreed to pay investors a variable pass-through rate based on a spread over the 3-month LIBOR that resets quarterly, while the underlying mortgages generate interest at a fixed rate. Generally, the loans sold under a floating rate arrangement are subject to interest rate caps or calls set at or below the weighted-average coupon (less the servicing fee) on the pools of loans and to a lesser extent based on a spread above the initial contractual pass-through rate at the time of sale, which does not exceed the weighted-average coupon on the loans. As of December 31, 2005, the carrying value of the IOs of $74.0 million is related to $2.2 billion of outstanding principal balance of mortgage loans sold to investors. IOs are classified as securities held for trading in Doral Financial’s Consolidated Statements of Financial Condition. For mortgage loan sale contracts that are not subject to interest rate caps, to the extent that the interest rate payable to investors on the mortgage loans underlying the floating rate IOs exceeds the weighted-average coupon on such mortgage loans, the change in the fair value of the Company’s floating rate IOs may exceed the carrying value of the IOs, creating a liability instead of an asset. Since July 2005, the Company has refrained from arranging loan sales that generated IOs based on variable rates.
      Unlike U.S. Treasury and agency mortgage-backed securities, the fair value of MSRs and IOs cannot be readily determined because they are not traded in active securities markets. Doral Financial determined the initial fair value of its MSRs based on a market valuation received from a third party. The market valuation received for the Company’s entire servicing portfolio (governmental, conforming and non-conforming portfolios), is calculated stratifying the portfolio by predominant risk characteristics — loan type and coupon. Under a market valuation approach, the fair value of the servicing assets is determined based on a combination of market information, such as trading activity, benchmarking of servicing assets and cash flow modeling. Once MSRs have been recorded, they must be periodically evaluated for impairment. Impairment occurs when the current fair value of the MSRs falls below its carrying value. If MSRs are impaired, the impairment is recognized in current period earnings and the carrying value of the MSRs is adjusted through a valuation allowance. If the value of the MSRs subsequently increases, the recovery in value is recognized in current-period earnings and the carrying value of the MSRs is adjusted through a reduction in the valuation allowance. As of December 31, 2005, the MSRs impairment valuation allowance was $6.2 million. Doral Financial has also engaged the same third party to prepare an other-than-temporary impairment analysis to evaluate whether a loss in the value of the MSRs, if any, was

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permanent or not. If impairment is deemed to be other-than-temporary, the valuation allowance is applied to reduce the cost basis of the MSRs.
      The amortization of the MSRs is based on an income forecast cash flow method. The income forecast method is based on the forecasted cash flows determined by the third party market valuation and the amortization is calculated by applying to the carrying amount of the MSRs the ratio of the cash flows projected for the current period to total remaining forecasted cash flow.
      To determine the value of its portfolio of IOs, Doral Financial uses an internal valuation model that takes into consideration changes in interest rates by incorporating an interest rate spread based on implied LIBOR rates derived from the forward yield curve at the date of the valuation. Prepayment assumptions and discount rates incorporated into the valuation model are based on publicly available, independently verifiable market data and statistically derived relationships between the Company’s and U.S. mainland FNMA’s mortgage prepayment experience.
      To determine prepayment assumptions, Doral Financial calculates its prepayment forecasts based on the median of 12 static prepayment forecasts by mortgage-backed securities dealers obtained from Bloomberg. This median is then adjusted using a regression analysis that correlates the prepayment experiences of the Company’s non-conforming loan portfolio with U.S. mainland FNMA mortgages. To establish the adjustment factor between U.S. mainland and the Company’s portfolio, the Company calculates a quarterly constant prepayment rate (“CPR”) for its non-conforming loan portfolio and compares the CPR of each pool to a generic FNMA pool with similar coupon and seasonality. To mitigate risks of misestimating, the Company updates its regression analysis on a quarterly basis as new data become available.
      This methodology resulted in a CPR of 12.17% for 2005, 17.04% for 2004 and 17.82% for 2003. The change in the CPR between 2005 and 2004 was principally attributable to a change in the composition of the Company’s non-conforming loan portfolio (during 2005, the weighted-average coupon of the portfolio was lower than in 2004), as well as to the increase in interest rates, which led to a decrease in forecasted prepayment rates.
      The IO valuation model utilizes a Z-spread approach to calculate discount rates. The Z-spread is the market recognized spread over the swap curve that takes into consideration additional yield requirements based on the risk characteristics of a particular instrument. As a result, the discount rates used by the Company in the valuation of its IOs change as interest rates and the Z-spread change. The Z-spread approach incorporates a premium for prepayment optionality and liquidity risk over the period-end swap curve. Doral Financial obtains the Z-spread from major investment banking firms. This methodology resulted in a discount rate of 10.91% for 2005, 10.50% for 2004 and 9.64% for 2003.
      The valuation model values fixed and floating rate IOs on a contract-by-contract basis. For fixed IOs, the valuation model projects a fixed spread cash flow through the life of the underlying mortgages and applies a discount rate to obtain the present value of the projected cash flows. For the valuation of variable IOs, each contract is segregated into unprotected cash flows and the contract’s embedded optionality (calls, caps and floors). Each component, except embedded calls, is valued independently. For the unprotected cash flows from the IO, the model incorporates widely used financial techniques, such as cubic spline and bootstrapping, to estimate future LIBOR rates. Cubic spline is an interpolation technique used to complete the yields to maturity of the spot swap curve. Using the completed set of yields to maturity developed using cubic spline, the spot rate curve (or zero-coupon curve) is developed utilizing bootstrapping methodology. Once a complete set of spot rates is obtained, the model generates implied forward rates used in the valuation.
      The model uses the Black option formula, a standard financial technique, to value interest rate caps and floors. The Black formula uses as inputs the strike price of the floor or cap, forward LIBOR rates, volatilities and discount rates to estimate value. With respect to the embedded calls, Doral Financial made the determination that due to the characteristics of the portfolio and the expected terms for any sale of such portfolio in the secondary market, its value was not significant. Consequently, the Company has not

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developed a valuation model for embedded calls and the value of such calls, if any, is not included in the Company’s financial statements. As of December 31, 2005 and 2004 the carrying value of IOs reflected in the Consolidated Statements of Financial Condition was $74.0 million and $127.4 million, respectively.
      For IOs, Doral Financial recognizes as interest income (through the life of the IO) the excess of all estimated cash flows attributable to these interests over its recorded balance using the effective yield method in accordance with Emerging Issue Task Force (“EITF”) Issue No. 99-20 “Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets.” Doral Financial recognizes as interest income the excess of the cash collected from the borrowers over the yield payable to investors less a servicing fee (“retained spread”), up to an amount equal to the yield on the IOs that equates the discount rate used in the internal valuation model. Doral Financial accounts for any excess retained spread as amortization to the gross IO capitalized at inception. The Company updates its estimates of expected cash flows periodically and recognizes changes in calculated effective yield on a prospective basis. The following table presents a detail of the cash flows received and the losses on the valuation of Doral Financial’s portfolio of IOs for 2005, 2004 and 2003 based on the internal valuation model:
                         
    Year Ended December 31,
     
(In thousands)   2005   2004   2003
             
Total cash flows received on IO portfolio
  $ 62,639     $ 65,146     $ 54,059  
Amortization of IOs, as offset to cash flows
    (51,785 )     (51,692 )     (40,650 )
                   
Net cash flows recognized as interest income
  $ 10,854     $ 13,454     $ 13,409  
                   
Losses on the IO valuation
  $ (12,523 )   $ (3,137 )   $ (3,877 )
                   
      As discussed above, Doral Financial classifies its IOs as securities held for trading with changes in the fair value recognized in current earnings as a component of net gain (loss) on securities held for trading.
      The following table shows the value sensitivity of Doral Financial’s MSRs and IOs to the key assumptions used to determine their fair values at December 31, 2005:
                 
(Dollars in thousands)   Servicing Assets   Interest-Only Strips
         
Carrying amount of retained interest
  $ 150,576     $ 74,034  
Weighted-average expected life (in years)
    5.4       6.0  
 
Constant Prepayment Rate (weighted-average annual rate)
    14.55 %     12.17 %
Decrease in fair value due to 10% adverse change
  $ (4,791 )   $ (3,290 )
Decrease in fair value due to 20% adverse change
  $ (9,102 )   $ (6,355 )
 
Residual cash flow discount rate (weighted-average annual rate)
    9.74 %     10.91 %
Decrease in fair value due to 10% adverse change
  $ (5,397 )   $ (2,213 )
Decrease in fair value due to 20% adverse change
  $ (10,461 )   $ (4,300 )
      These sensitivities are hypothetical and should be used with caution. This information is furnished to provide the reader with a basis for assessing the sensitivity of the values presented to changes in key assumptions. As the figures indicate, changes in fair value based on a 10% variation in individual assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in this table, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated without changing any other assumption; in reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments), which may magnify or counteract the sensitivities.

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      The following table summarizes the estimated change in the fair value of the Company’s IOs, the constant prepayment rate and the weighted-average expected life under the Company’s valuation model, given several hypothetical instantaneous parallel increases or decreases in the yield curve. For mortgage loan sale contracts that are not subject to interest caps, to the extent that the interest rate payable to investors on the mortgage loans underlying the floating rate IOs exceeds the weighted-average coupon on such mortgage loans, the change in fair value of the Company’s floating rate IOs may exceed the carrying value of the IOs, creating a liability instead of an asset.
                                     
(Dollars in thousands)                
 
    Constant   Weighted-Average    
Change in Yield Curve   Prepayment   Expected Life   Change in Fair    
(Basis Points)   Rate   (Years)   Value of IOs   % Change
                 
  +200       9.98 %     6.8     $ (124,909 )     (168.7 )%
  +100       10.63 %     6.5       (63,368 )     (85.6 )%
  + 50       11.21 %     6.3       (31,561 )     (42.6 )%
  Base       12.17 %     6.0       0       0.0 %
  - 50       14.43 %     5.3       27,628       37.3 %
  -100       17.87 %     4.4       48,651       65.7 %
  -200       25.29 %     3.3       78,793       106.4 %
Valuation of Trading Securities and Derivatives
      Doral Financial’s net gain (loss) on securities held for trading includes gains and losses, whether realized or unrealized, on securities accounted for as held for trading, including IOs, as well as various other financial instruments, including derivative contracts that Doral Financial uses to manage its interest rate risk. Securities held for trading and derivatives are recorded at fair values with increases or decreases in such values reflected in current earnings. The fair value of many of Doral Financial’s trading securities (other than IOs) and derivative instruments is based on dealer quotations from recognized markets and, as such, does not require significant management judgment. For instruments not traded on a recognized market, Doral Financial generally determines fair value by reference to quoted market prices for similar instruments.
      As of December 31, 2005, Doral Financial held $206.4 million in Puerto Rico tax-exempt GNMA securities included in its securities held-for-trading portfolio. Because of their preferential tax status in Puerto Rico, these securities cannot be valued directly by reference to market quotations for U.S. GNMA securities with similar characteristics. Doral Financial determines the fair value of its portfolio of tax-exempt GNMA securities, based on a quotation received by a Puerto Rico broker-dealer.
      Generally, derivatives are financial instruments with little or no initial net investment in comparison to their notional amount and whose value is based on the value of an underlying asset, index, reference rate or other variable. They may be standardized contracts executed through organized exchanges or privately negotiated contractual agreements that can be customized to meet specific needs, including certain commitments to purchase and sell mortgage loans and mortgage-backed securities. The fair value of derivatives is generally reported net by counterparty, provided that a legally enforceable master netting agreement exists. Derivatives in a net asset position are reported as part of securities held for trading, at fair value. Similarly, derivatives in a net liability position are reported as part of accrued expenses and other liabilities, at fair value.
      In the ordinary course of business, the Company’s derivatives are not designated as being in hedge accounting relationships. For those derivatives not designated as an accounting hedge, fair value gains and losses are reported as part of net gain (loss) on securities held for trading in the Consolidated Statements of Income.

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Other Income Recognition Policies
      Interest income on loans is accrued by Doral Financial when earned. Loans are placed on non-accrual status when any portion of principal or interest is more than 90 days past due, or earlier if concern exists as to the ultimate collectibility of principal or interest. When a loan is placed on non-accrual status, all accrued but unpaid interest to date is fully reversed. Such interest, if collected, is credited to income in the period of recovery. Loans return to accrual status when principal and interest become current and are anticipated to be fully collectible.
      Loan origination fees, as well as discount points and certain direct origination costs for mortgage loans held for sale, are initially recorded as an adjustment to the cost of the loan and reflected in Doral Financial’s earnings as part of the net gain on mortgage loans sales and fees when the loan is sold or securitized into a mortgage-backed security. In the case of loans receivable held for investment, such fees and costs are deferred and amortized to income as adjustments to the yield of the loan in accordance with SFAS No. 91 “Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases.”
Allowance for Loan and Lease Losses
      Doral Financial maintains an allowance for loan and lease losses to absorb probable credit-related losses on its loans receivable portfolio. The allowance consists of specific and general components and is based on Doral Financial’s assessment of default probabilities, internal risk ratings (based on borrowers’ financial stability, external credit ratings, management strength, earnings and operating environment), probable loss and recovery rates, and degree of risks inherent in the loans receivable portfolio. The allowance is maintained at a level that Doral Financial considers to be adequate to absorb probable losses. Credit losses are charged and recoveries are credited to the allowance, while increases to the allowance are charged to operations. Unanticipated increases in the allowance for loan and lease losses could adversely impact Doral Financial’s net income in the future.
      Commercial and construction loans over $2.0 million are evaluated individually for impairment. Doral Financial measures impaired loans at their estimated realizable values determined by discounting the expected future cash flows at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral, if the loan is collateral dependent. Loans are considered impaired when, based on management’s evaluation, a borrower will not be able to fulfill its obligation under the original terms of the loan. Loans that are measured at the lower-of-cost-or-market are excluded. Doral Financial performs impairment evaluations of small-balance homogeneous loans (including residential mortgages, consumer, commercial and construction loans under $2.0 million) on a group basis. For such loans, the allowance is determined considering the historical charge-off experience of each loan category and delinquency levels as well as charge-off and delinquency trends and economic data, such as interest rate levels, inflation and the strength of the housing market in the areas where the Company operates.
Estimated Recourse Obligation
      From time to time, the Company sells mortgage loans and mortgage-backed securities subject to recourse provisions. Pursuant to these recourse arrangements, the Company agrees to retain or share the credit risk with the purchaser of such mortgage loans for a specified period or up to a certain percentage of the total amount in loans sold. The Company estimates the fair value of the retained recourse obligation or any liability incurred at the time of sale and includes such obligation with the net proceeds from the sale, resulting in a lower gain on sale recognition. Doral Financial recognizes the fair value of its recourse obligation by estimating the amount that the Company would be required to pay for mortgage insurance from a third party in order to be relieved of its estimated recourse exposure on these loans. The Company believes that this method resulted in an adequate valuation of its recourse allowance as of December 31, 2005, but actual future recourse obligations may be different and a different result may have been obtained if the Company had used another method for estimating this liability, such as one requiring management

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to estimate this liability based on actual historical losses incurred by the Company. As part of its new business strategy, the Company is seeking to reduce the sale of mortgage loans with recourse.
Income Taxes
      The Company recognizes deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of assets and liabilities based on current tax laws. To the extent tax laws change, deferred tax assets and liabilities are adjusted, to the extent necessary, in the period that the tax change is enacted. The Company recognizes income tax benefits when the realization of such benefits is probable. A valuation allowance is recognized for any deferred tax asset which, based on management’s evaluation, is more likely than not (a likelihood of more than 50%) that some portion or the entire deferred tax asset will not be realized.
      Income tax expense includes (a) deferred tax expense or benefit, which represents the net change in the deferred tax assets or liability balance during the year plus any change in the valuation allowance, if any, and (b) current tax expense, which represents the amount of tax currently payable to or credit plus amounts accrued for expected tax deficiencies.
      Investors are encouraged to carefully read this MD&A together with Doral Financial’s consolidated financial statements, including the Notes to the consolidated financial statements.
      As used in this report, references to “the Company” or “Doral Financial” refer to Doral Financial Corporation and its consolidated subsidiaries unless otherwise indicated.
CONSOLIDATED RESULTS
Net Income
      Doral Financial’s net income for the year ended December 31, 2005, amounted to $13.2 million, compared to $214.8 million and $142.1 million for the years ended December 31, 2004 and 2003, respectively. Diluted earnings per common share decreased from $1.63 in 2004 to a diluted loss per common share of $0.19 for 2005. Diluted earnings per common share for 2003 were $1.10.
      2005 compared to 2004. Doral Financial’s consolidated net income decreased by $201.6 million, or 94%, for the year ended December 31, 2005 compared to the same period in 2004. The decrease in consolidated net income was principally attributable to a decrease in net interest income coupled with increases in tax expense and non-interest expenses, which were partially offset by an increase in non-interest income. The decrease in net interest income partially reflects a significant decrease in the Company’s net interest margin as a result of the flattening of the yield curve during 2005. The increase in non-interest expenses was principally due to increases in professional services, driven by expenses associated with the restatement of the Company’s prior period financial statements and to a $25 million reserve for a potential settlement of the SEC’s ongoing investigation of the Company. The increase in non-interest income was principally driven by unrealized gains experienced with respect to derivative instruments undertaken for risk management purposes (See “— Risk Management,” below, for a description of Doral Financial’s interest rate risk management policies and procedures), coupled with increases in net servicing income due to lower impairment charges resulting from a decrease in forecasted mortgage prepayment rates. The increase in non-interest income was partially offset by lower gains on sales of mortgage loans as a result of the Company’s inability to use its traditional secondary market channels to effect non-conforming loan sales because of the uncertainty surrounding the restatement process and a significant loss on sale of investment securities. For the year ended December 31, 2005, Doral Financial reported income tax expense of $19.1 million (representing an effective tax rate of 59.1%), as compared to a tax benefit of $85.5 million for 2004. During 2005, the Company’s effective tax rate was adversely affected by an increase in income tax rates in Puerto Rico, net operating losses at certain subsidiaries that could not be used to offset taxable income at other subsidiaries, certain expenses that were not deductible for tax purposes and an increase in the valuation allowance on the Company’s deferred tax assets. During 2004, the Company benefited from a significant inter-company sale of IOs completed

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for the purpose of taking advantage of a temporary reduction in capital gain tax rates, as well as from the recognition of a deferred tax asset in respect of taxes paid on transfers of IOs based on their value prior to the restatement.
      2004 compared to 2003. Doral Financial’s consolidated net income for the year ended December 31, 2004, increased by $72.7 million, or 51%, compared to the same period in 2003. The increase was principally due to increases in net interest income and the recognition of an income tax benefit, which was partially offset by lower non- interest income. The increase in net interest income for 2004, compared to 2003, was due to a significant increase on the Company’s average balance of interest-earning assets coupled with a slight increase in the Company’s net interest margin (see Table A below for further information). Net income for 2004 includes an income tax benefit of approximately $85.5 million resulting from the implementation of tax planning strategies effected by Doral Financial to take advantage of local legislation that provided a temporary reduction in the long-term capital gain tax rates for transactions occurring between July 1, 2004 and June 30, 2005. The decrease in non-interest income was principally due to the Company’s hedging activities and servicing income. In 2004, Doral Financial’s results of operations were significantly impacted by losses experienced with respect to derivative instruments undertaken for risk management purposes. Net loss on securities held for trading included net losses of $130.5 million with respect to derivative instruments. In the past, Doral Financial’s interest rate risk management program was designed to protect the value of the Company’s assets and income from instantaneous substantial increases in long-term interest rates that could not be absorbed in the normal course of business and was not adequately aligned with the sensitivity of the Company’s balance sheet composition to interest rate changes. As the yield curve flattened during the latter part of 2004, the Company experienced increased losses on the value of its derivatives. Also, the 2004 results included a loss of $7.0 million, which represents the ineffective portion of the fair value hedges related to certain securities available for sale. The results for 2004 were also significantly impacted by increased impairment charges of mortgage servicing assets resulting from a decline in the estimated fair value of the Company’s MSRs. This decline was principally driven by a slight increase in forecasted mortgage prepayments rates during 2004.
Net Interest Income
      Net interest income is the excess of interest earned by Doral Financial on its interest-earning assets over the interest incurred on its interest-bearing liabilities. Doral Financial’s net interest income is subject to interest rate risk due to the repricing and maturity mismatch in the Company’s assets and liabilities. Generally, Doral Financial’s assets have a longer maturity and a later repricing date than its liabilities, which results in lower net interest income in periods of rising short-term interest rates. Refer to “— Risk Management” below for additional information on the Company’s exposure to interest rate risk.
      Net interest income for the years 2005, 2004 and 2003, was $280.6 million, $337.6 million, and $237.5 million, respectively.
      2005 compared to 2004. Doral Financial’s net interest income for the year ended December 31, 2005, decreased by $57.0 million, or 17%, compared to 2004. The decrease in net interest income was due to a significant reduction in the Company’s net interest margin offset in part by significant increases in Doral Financial’s average balance of interest-earning assets. Doral Financial’s net interest spread and margin for the year ended December 31, 2005 were 1.42% and 1.56%, respectively, compared to 2.29% and 2.51%, respectively, for the year ended December 31, 2004. The decrease in net interest rate spread and margin during 2005 was due primarily to the upward trend of short-term interest rates and the flattening of the yield curve. The average rate paid by Doral Financial on its interest-bearing liabilities increased by 78 basis points during 2005, while the average yield earned on its interest-earning assets decreased by 9 basis points, compared to 2004. The decrease in the yield of the Company’s interest-earning assets related primarily to lower yields obtained on loans originated during the period.
      Average interest-earning assets grew by 34% from the year ended December 31, 2004 to the year ended December 31, 2005. The increase in average interest-earning assets, particularly in the loans

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portfolio and mortgage-backed securities, was driven by a strong level of loan originations and the Company’s strategy to increase its interest income by investing in mortgage-backed securities. The increase in the average balance of mortgage-backed securities reflected the Company’s strategy to maximize tax-exempt interest income by holding a significant amount of U.S. GNMAs and U.S. FHLMC/ FNMA mortgage-backed securities at its international banking entity subsidiary. Under Puerto Rico law, the interest earned on such U.S. mortgage-backed securities is tax exempt for Doral Financial’s international banking subsidiary. The increase in the volume of interest-earning assets was funded through a combination of deposits and secured borrowings (including securities sold under repurchase agreements).
      2004 compared to 2003. Doral Financial’s net interest income for the year ended December 31, 2004, increased by $100.2 million, or 42%, compared to the same period in 2003. The increase in net interest income for 2004 compared to 2003 was principally due to an increase in Doral Financial’s average balance of interest-earning assets, particularly in its loans portfolio and investment and mortgage-backed securities, driven by a higher level of originations and the Company’s strategy to increase its tax-exempt income by investing in U.S. Treasury and agency and mortgage-backed securities. The increase in the volume of interest-earning assets was funded through a combination of deposits, secured borrowings, including repurchase agreements, and the issuance of floating rate senior notes. The Company issued an aggregate principal amount of $625.0 million of its floating rate senior notes due July 20, 2007, and $115.0 million of its floating rate senior notes due December 7, 2005, during the third and second quarter of 2004, respectively.

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      The following table presents Doral Financial’s average balance sheet, for the years indicated, the total dollar amount of interest income from its average interest-earning assets and the related yields, as well as the interest expense on its average interest-bearing liabilities expressed in both dollars and rates, and the net interest margin and spread. The table does not reflect any effect of income taxes. Average balances are based on average daily balances.
Table A — Average Balance Sheet and Summary of Net Interest Income
                                                                           
    2005   2004   2003
             
    Average       Average   Average       Average   Average       Average
(Dollars in thousands)   Balance   Interest   Yield/Rate   Balance   Interest   Yield/Rate   Balance   Interest   Yield/Rate
                                     
Assets:
                                                                       
Interest-Earning Assets:
                                                                       
 
Total loans(1)(2)
  $ 7,196,617     $ 496,806       6.90 %   $ 5,534,219     $ 423,908       7.66 %   $ 4,645,744     $ 345,663       7.44 %
 
Mortgage-backed securities
    4,727,622       224,930       4.76 %     2,309,797       103,491       4.48 %     1,263,282       69,111       5.47 %
 
Interest-only strips
    103,767       10,854       10.46 %     132,739       13,454       10.14 %     139,526       13,409       9.61 %
 
Investment securities
    3,578,327       142,601       3.99 %     3,771,387       158,379       4.20 %     2,368,299       113,777       4.80 %
 
Other interest-earning assets
    2,357,348       72,588       3.08 %     1,699,361       23,477       1.38 %     1,310,438       15,745       1.20 %
                                                       
 
Total interest-earning assets/interest income
    17,963,681     $ 947,779       5.28 %     13,447,503     $ 722,709       5.37 %     9,727,289     $ 557,705       5.73 %
                                                       
Total non-interest-earning assets
    854,302                       840,472                       628,481                  
                                                       
Total assets
  $ 18,817,983                     $ 14,287,975                     $ 10,355,770                  
                                                       
 
Liabilities and Stockholders’ Equity:
Interest-Bearing Liabilities:
                                                                       
 
Deposits
  $ 3,841,825     $ 106,164       2.76 %   $ 3,239,996     $ 80,683       2.49 %   $ 2,651,633     $ 71,409       2.69 %
 
Repurchase agreements
    7,179,834       256,542       3.57 %     4,805,381       120,635       2.51 %     2,999,339       90,514       3.02 %
 
Advances from the FHLB
    1,181,804       48,631       4.11 %     1,254,202       49,842       3.97 %     1,250,034       49,164       3.93 %
 
Loans payable
    3,998,461       197,902       4.95 %     2,420,848       88,413       3.65 %     1,710,772       63,320       3.70 %
 
Notes payable
    1,079,831       57,943       5.37 %     768,524       45,513       5.92 %     569,268       45,839       8.05 %
                                                       
 
Total interest-bearing liabilities/interest expense
    17,281,755     $ 667,182       3.86 %     12,488,951     $ 385,086       3.08 %     9,181,046     $ 320,246       3.49 %
                                                       
Total non-interest-bearing liabilities
    302,336                       624,749                       252,323                  
                                                       
Total liabilities
    17,584,091                       13,113,700                       9,433,369                  
Stockholders’ equity
    1,233,892                       1,174,275                       922,401                  
                                                       
Total liabilities and stockholders’ equity
  $ 18,817,983                     $ 14,287,975                     $ 10,355,770                  
                                                       
Net interest-earning assets
  $ 681,926                     $ 958,552                     $ 546,243                  
Net interest income on a non-taxable equivalent basis
          $ 280,597                     $ 337,623                     $ 237,459          
                                                       
Interest rate spread(3)
                    1.42 %                     2.29 %                     2.24 %
                                                       
Interest rate margin(4)
                    1.56 %                     2.51 %                     2.44 %
                                                       
Net interest-earning assets ratio
                    103.95 %                     107.68 %                     105.95 %
                                                       
 
(1)  Average loan balances include the average balance of non-accruing loans, on which interest income is recognized when collected. Also includes the average balance of GNMA defaulted loans for which the Company has an unconditional buy-back option.
 
(2)  Interest income on loans includes $4.9 million, $4.0 million and $3.0 million for 2005, 2004 and 2003, respectively, of income from prepayment penalties related to the Company’s loan portfolio. For 2004, interest income on loans also includes a yield adjustment of $11.3 million related to deferred fees on construction loans repaid prior to maturity.
 
(3)  Interest rate spread represents the difference between Doral Financial’s weighted-average yield on interest-earning assets and the weighted-average rate on interest-bearing liabilities.
 
(4)  Interest rate margin represents net interest income as a percentage of average interest-earning assets.

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     The following table describes the extent to which changes in interest rates and changes in volume of interest-earning assets and interest-bearing liabilities have affected Doral Financial’s interest income and interest expense during the years indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (change in volume multiplied by prior year rate), (ii) changes in rate (change in rate multiplied by current year volume), and (iii) total change in rate and volume. The combined effect of changes in both rate and volume has been allocated in proportion to the absolute dollar amounts of the changes due to rate and volume.
Table B — Net Interest Income Variance Analysis
                                                   
    2005 Compared to 2004   2004 Compared to 2003
         
    Increase/ (Decrease)   Increase/ (Decrease)
    Due to:   Due to:
         
(In thousands)   Volume   Rate   Total   Volume   Rate   Total
                         
Interest Income Variance
                                               
 
Total loans
  $ 127,516     $ (54,618 )   $ 72,898     $ 66,075     $ 12,170     $ 78,245  
 
Mortgage-backed securities
    108,215       13,224       121,439       57,246       (22,866 )     34,380  
 
Interest-only strips
    (2,933 )     333       (2,600 )     (655 )     700       45  
 
Investment securities
    (8,189 )     (7,589 )     (15,778 )     67,260       (22,658 )     44,602  
 
Other interest-earning assets
    9,072       40,039       49,111       4,671       3,061       7,732  
                                     
Total interest income variance
    233,681       (8,611 )     225,070       194,597       (29,593 )     165,004  
                                     
Interest Expense Variance
                                               
 
Deposits
    15,058       10,423       25,481       15,775       (6,501 )     9,274  
 
Repurchase agreements
    59,688       76,219       135,907       54,601       (24,480 )     30,121  
 
Advances from the FHLB
    (2,869 )     1,658       (1,211 )     167       511       678  
 
Loans payable
    57,544       51,945       109,489       26,302       (1,209 )     25,093  
 
Notes payable
    18,384       (5,954 )     12,430       16,042       (16,368 )     (326 )
                                     
Total interest expense variance
    147,805       134,291       282,096       112,887       (48,047 )     64,840  
                                     
Net interest income variance
  $ 85,876     $ (142,902 )   $ (57,026 )   $ 81,710     $ 18,454     $ 100,164  
                                     
Interest Income
      Total interest income for the years 2005, 2004 and 2003, was $947.8 million, $722.7 million and $557.7 million, respectively. The increases in interest income are primarily related to the increase in Doral Financial’s total average balance of interest-earning assets.
      2005 compared to 2004. Interest income increased by approximately $225.1 million, or 31%, for the year ended December 31, 2005 compared to 2004. The increase in interest income during 2005 was primarily related to the increase in Doral Financial’s total average balance of interest-earning assets, which increased from $13.4 billion for the year ended December 31, 2004 to $18.0 billion for 2005. The increase was partially offset by a decrease in the average rate earned by interest-earning assets, which decreased from 5.37% in 2004 to 5.28% for 2005.
      Interest income on loans increased by approximately $72.9 million, or 17%, for the year ended December 31, 2005, compared to 2004. The increase during 2005 reflected an increase in the level of loans held by Doral Financial of approximately 30% compared to 2004, due to the increased volume of loan originations coupled with the Company’s inability to use its traditional secondary market channels to effect non-conforming loan sales. The increase in interest income on loans was partially offset by lower average rate earned on loans and by a higher amount of interest income reversed with respect to loans placed on a non-accrual status. The average rate earned on the Company’s loans decreased by 76 basis points for the

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year ended December 31, 2005, compared to 2004. During the first quarter of 2005, the Company changed its estimate for non-accrual loans as a result of conforming the non-accrual policies of its mortgage banking units to that of its banking subsidiaries, pursuant to which mortgage loans held for sale are placed on non-accrual status after they are delinquent for more than 90 days. The effect of this change was a decrease in interest income of approximately $7.0 million. Prior to 2005, mortgage loans held for sale by Doral Financial’s mortgage banking units were placed on a non-accrual status if they had been delinquent for more than 180 days to the extent that the loan-to-value ratio raised concerns as to ultimate collectibility of the loan.
      Interest income on mortgage-backed securities for the year ended December 31, 2005 increased by approximately $121.4 million, or 117%, compared to the same period in 2004. The result for 2005 reflected an increase in the average balance of mortgage-backed securities, which increased by 105% from 2004 to 2005, coupled with an increase in the average rate earned on mortgage-backed securities of 28 basis points.
      Interest income on IOs for the year ended December 31, 2005 decreased by $2.6 million, or 19%, compared to 2004. The decrease during 2005 resulted from a decrease in the average balance of IOs of approximately 22%, compared to 2004, offset in part by an increase in the average yield of the IOs (which equals the average discount rate used in the internal valuation model) of 32 basis points. The actual cash flow received on Doral Financial’s portfolio of IOs, particularly its floating rate IOs, decreased to $62.6 million for 2005, compared to $65.1 million for 2004. See “Critical Accounting Policies — Retained Interest Valuation” for additional information regarding the cash flows of the IO portfolio.
      Interest income on investment securities decreased by $15.8 million, or 10%, from the year ended December 31, 2004 to the year ended December 31, 2005. The decrease in interest income on investment securities was principally driven by a decrease on the average balance of investment securities, which decreased by 5% from 2004 to 2005 coupled with a decrease in the average yield of 21 basis points.
      Interest income on other interest-earning assets for the year ended December 31, 2005 increased by approximately $49.1 million, or 209% from 2004. Other interest-earning assets consist primarily of fixed income money market investments whose original maturity is less than three months, including overnight deposits, term deposits and reverse repurchase agreements. The increase for the year ended December 31, 2005 reflected an increase of 170 basis points in the average yield on other interest-earning assets due to higher short-term interest rates and an increase in the average balances of money market instruments, principally overnight and term deposits, compared to 2004. The average balance of other interest-earning assets during 2005 increased by $658.0 million, or 39%, compared to 2004.
      2004 compared to 2003. Interest income on loans increased by $78.2 million or 23% during 2004 compared to 2003. The increase reflects primarily an increase in the level of loans held by Doral Financial due to the increased volume of loan originations and purchases. Also, during 2004, the Company recognized a positive yield adjustment of $11.3 million related to deferred fees on construction loans with an aggregate outstanding balance of $71.6 million, which were repaid prior to their stated maturity.
      Interest income on mortgage-backed securities increased by $34.4 million or 50% during 2004, compared to 2003. The results for the year 2004 reflect an increase in the average balance of mortgage-backed securities, which increased from $1.3 billion for 2003 to $2.3 billion for 2004. The higher average balance was offset in part by an increase in amortization of premiums, particularly on U.S. GNMAs, due to higher prepayments experienced on such portfolio during 2004 compared to 2003.
      Interest income on IOs remained stable at $13.5 million during 2004, from $13.4 million for the year 2003. The small increase during 2004 resulted from an increase in the average yield of IOs (which equals the average discount rate used in the internal valuation model), from 9.61% for 2003 to 10.14% for 2004. The increase in the average yield responded to a rise in the yield curve, particularly the short-end. The increase in the average yield of IOs was partially offset by a decrease in the average balance of IOs from $139.5 million for 2003 to $132.7 million for 2004, attributable to increases in short-term interest rates and the flattening of the yield curve, despite a higher volume of loan sales. The actual cash flow received on Doral Financial’s portfolio of IOs, particularly its floating rate IOs, increased to $65.1 million for 2004,

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compared to $54.1 million for 2003. See “Critical Accounting Policies — Retained Interest Valuation” for additional information regarding the cash flows of the IO portfolio.
      Interest income on investment securities increased by $44.6 million or 39% from 2003 to 2004. The average balance of investment securities increased from $2.4 billion for 2003 to $3.8 billion for 2004. The effect of the Company’s higher balance in investment securities on interest income was partially offset by a reduction of 60 basis points in the average yield on these securities for 2004 compared to 2003. These reductions in average yield reflect the downward trend and continued long-term interest low levels since the early part of 2002, and the replacement of higher-yielding securities that were called or matured with lower-yielding current-coupon securities.
      Interest income on other interest-earning assets increased by $7.7 million from 2003 to 2004. The increase for 2004 reflects an increase of 18 basis points in the average yield on other interest-earning assets due to higher short-term interest rates and an increase in the average balance of money market instruments, principally overnight and term deposits. The average balance of other interest-earning assets increased from $1.3 billion for 2003 to $1.7 billion for 2004 as a higher volume of liquid assets was accumulated by the Company in anticipation of rising interest rates.
Interest Expense
      Total interest expense for the years 2005, 2004 and 2003, was $667.2 million, $385.1 million and $320.2 million, respectively. The increases in interest expense were primarily related to the increase in Doral Financial’s total average balance of interest-bearing liabilities coupled with an increase in the average costs of interest-bearing liabilities.
      2005 compared to 2004. Total interest expense for the year ended December 31, 2005 increased by $282.1 million, or 73%, compared to 2004. The increase in interest expense for 2005 was due to an increased volume of borrowings to finance Doral Financial’s loan production and investment activities, coupled with an increase in the average cost of borrowings. The average balance of interest-bearing liabilities during 2005 increased by $4.8 billion, or 38%, compared to 2004, and the average cost of borrowings increased during 2005 by 78 basis points, compared to 2004.
      Interest expense on deposits for the year ended December 31, 2005 increased by $25.5 million, or 32%, compared to 2004. The increase in interest expense on deposits reflects a larger deposit base held at Doral Financial’s banking subsidiaries and an increase in the average cost of deposits. The average balance of deposits during 2005 increased by $601.8 million, or 19%, compared to 2004. The average interest cost on deposits during 2005 increased by 27 basis points, compared to 2004.
      Interest expense related to securities sold under agreements to repurchase for the year ended December 31, 2005 increased by $135.9 million, or 113%, compared to 2004. The increase in interest expense on securities sold under agreements to repurchase during 2005 reflects increased borrowings to finance mortgage-backed securities and other investment securities, as compared to 2004, coupled with higher borrowing costs experienced during 2005. The average balance of borrowings under repurchase agreements for 2005 increased by $2.4 billion, or 49%, compared to 2004. The average cost on securities sold under agreements to repurchase increased by 106 basis points from 2004 to 2005.
      Interest expense on advances from the FHLB for the year ended December 31, 2005 decreased by approximately $1.2 million, or 2%, compared to the same period in 2004. The decrease in FHLB advances interest expense during 2005 reflects a decrease in the average balance of advances from FHLB, partially offset by higher average interest cost.
      Interest expense related to loans payable for the year ended December 31, 2005 increased by approximately 124% compared to 2004. The increase in interest expense on loans payable reflects an increase in the average balance of loan payable couple with an increase in the average cost of loans payable. The average balance of loans payable during 2005 increased by $1.6 billion, or 65%, compared to 2004. The average interest cost on loans payable during 2005 increased by 130 basis points compared to 2004.

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      Interest expense on notes payable for the year ended December 31, 2005 increased by $12.4 million, or 27%, compared to the same period in 2004. The increase in interest expense on notes payable was due to an increase in the average balance of notes payable from $768.5 million for the year ended December 31, 2004 to $1.1 billion for 2005, principally as a result of the issuance after the first quarter of 2004, of an aggregate principal amount of $740.0 million of the Company’s floating rate senior notes with interest tied to 3-month LIBOR. The replacement of high-rate borrowings with borrowings tied to short-term rates caused the average cost of notes payable during 2005 to decrease by 55 basis points.
      2004 compared to 2003. Total interest expense for the year ended December 31, 2004 increased by $64.8 million, or 20%, compared to the same period in 2004. The increase in interest expense for 2004 was due to an increased volume of borrowings to finance Doral Financial’s loan production and investment activities offset partially by a decrease in the average cost of borrowings. The average balance of interest-bearing liabilities increased to $12.5 billion at an average cost of 3.08% for 2004, compared to $9.2 billion at an average cost of 3.49% for 2003.
      Interest expense on deposits amounted to $80.7 million during 2004, an increase of 13% compared to 2003. The increase in interest expense on deposits reflects a larger deposit base held at Doral Financial’s banking subsidiaries that was partly offset by a decrease in the average cost of deposits. The average balance of deposits increased to $3.2 billion for 2004 from $2.7 billion for 2003. The increase in deposits reflects an increase in the volume of brokered deposits and the expansion of Doral Financial’s bank branch network, which increased to 46 branches as of December 31, 2004, compared to 41 branches as of December 31, 2003. The average interest cost on deposits during 2004 decrease by 20 basis points, compared to 2003.
      Interest expense related to securities sold under agreements to repurchase increased by $30.1 million or 33% during 2004 compared to 2003. The increase in interest expense on securities sold under agreements to repurchase during 2004 reflects increased borrowings to finance mortgage-backed securities and other investment securities, compared to 2003, that more than offset lower borrowing costs experienced during 2004. The average balance of borrowings under repurchase agreements for 2004 was $4.8 billion, compared to $3.0 billion for 2003. The average cost on securities sold under agreements to repurchase was 2.51% for 2004, compared to 3.02% for 2003.
      Interest expense on advances from the FHLB increased by approximately $678,000 for 2004, compared to 2003. The increase in interest expense on advances from the FHLB during 2004 reflects an increase in the average cost of advances from the FHLB of 4 basis points compared to 2003. During 2004, Doral Financial relied on deposits, secured borrowings and other sources of borrowings for additional financing. Increased deposits replaced the overall unchanged volume of advances from the FHLB.
      Interest expense on loans payable amounted to $88.4 million for 2004, compared to $63.3 million for 2003, an increase of approximately $25.1 million. The increase in interest expense on loans payable for 2004 was principally due to an increase in the average balance of loans payable from $1.7 billion for 2003 to $2.4 billion for 2004. The average interest rate cost for loans payable during 2004 decreased by 5 basis points compared to 2003. The Company’s loans payable consisted principally of borrowings with local financial institutions tied to short-term interest rates and secured by mortgage loans.
      Interest expense on notes payable was $45.5 million for 2004, compared to $45.8 million for 2003, a decrease of 0.7%. The decrease in interest expense on notes payable was due to a decrease in the average cost of notes payable from 8.05% for 2003 to 5.92% for 2004. The decrease in average cost was partially offset by the increase in the balance of notes payable as a result of the issuance of an aggregate principal amount of $740.0 million of the Company’s floating rate senior notes.
Provision for Loan and Lease Losses
      The provision for loan and lease losses is charged to earnings to bring the total allowance for loan and lease losses to a level considered appropriate by management based on Doral Financial’s historical loss experience, current delinquency rates, known and inherent risks in the loan portfolio, an assessment of

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individual problem loans, the estimated value of the underlying collateral, and an assessment of current economic conditions. While management believes that the current allowance for loan and lease losses is adequate, future additions to the allowance could be necessary if economic conditions change or if credit losses increase substantially from the assumptions used by Doral Financial in determining the allowance for loan and lease losses. Unanticipated increases in the allowance for loan and lease losses could result in reductions in Doral Financial’s net income. As of December 31, 2005, approximately 96% of the Company’s loan portfolio was collateralized by real property, and the amounts due on delinquent loans have historically been recovered through the sale of the property after foreclosure or negotiated settlements with borrowers.
      During 2005, due to worsening macro-economic conditions and increases in the cost of living in Puerto Rico, and delinquency trends in the Company’s loan portfolio, the Company increased its allowance for loan losses for its construction loan portfolio from $12.5 million or 1.99% of the total construction loan portfolio as of December 31, 2004 to $20.7 million or 2.61% as of December 31, 2005. Doral Financial recognized total provisions for loan and lease losses of $22.4 million, $10.4 million and $11.6 million for the years ended December 31, 2005, 2004 and 2003, respectively.
      2005 compared to 2004. Doral Financial provisions for loan and lease losses for the year ended December 31, 2005 increased by $12.0 million, or 115%, compared to 2004. The increase in the provision during 2005 primarily reflects increases to the Company’s provision for construction loans, coupled with changes to Doral Financial’s estimate of probable losses based on recent experience with lines of credit and credit cards compared to 2004. As of December 31, 2005, the allowance for loan and lease losses was 1.70% of total loans receivable compared to 1.33% as of December 31, 2004. Refer to the discussions under “Non-performing assets and allowance for loan and lease losses” and “Credit Risk” for further analysis of the allowance for loan and lease losses and non-performing assets and related ratios.
      During the second quarter of 2005, the Company received, in lieu of foreclosure, the real property securing a $13.5 million interim construction loan. The Company decided that the best strategy to manage its exposure on this loan was to continue the development of the initial phase of the residential housing project. The Company intends to complete the initial phase of the project and sell the residential units on the open market. During the second quarter of 2005, the Company wrote-down the loan to its market value by recognizing a loss of $1.3 million recorded as an increase in its provision for loan losses.
      2004 compared to 2003. During 2003, the Company increased the allowance for loan and lease losses to partially reserve a construction loan with an outstanding balance of $13.5 million that was not considered a non-performing loan as of December 31, 2003, but is reflected as a non-performing loan during 2004. Also, a smaller provision for 2004 resulted from a reduction in consumer loan net charge-offs. As of December 31, 2004, the allowance for loan and lease losses was 1.33% of total loans receivable, compared to 1.05% as of December 31, 2003.

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Non-Interest Income
      Non-interest income consists of net gain on mortgage loans sales and fees, trading activities, net gain on sale of investment securities, servicing income and commissions, fees, and other income.
                             
    For the Year Ended December 31,
     
(In thousands)   2005   2004   2003
             
Non-interest income:
                       
 
Net gain on mortgage loan sales and fees
  $ 52,131     $ 83,585     $ 94,709  
 
Net loss on securities held for trading, including gains and losses on the fair value of IOs
    (3,406 )     (111,678 )     (28,692 )
 
Net (loss) gain on sale of investment securities
    (40,798 )     11,956       5,493  
 
Servicing income (loss), net of amortization and impairment/recovery
    16,715       (18 )     24,486  
 
Commissions, fees and other income
    37,906       32,333       22,809  
                   
   
Total non-interest income
  $ 62,548     $ 16,178     $ 118,805  
                   
      Net Gain on Mortgage Loan Sales and Fees. Set forth below is certain information regarding the Company’s loan sale and securitization activities and resulting IO and MSR capitalization for the years ended December 31, 2005, 2004, and 2003.
                         
    For the Year Ended December 31,
     
(In thousands)   2005   2004   2003
             
Total loan sales and securitizations
  $ 2,686,935     $ 2,531,345     $ 2,308,070  
Total loans sales resulting in the recording of IOs
  $ 732,650     $ 1,063,052     $ 342,560  
IOs capitalized
  $ 10,981     $ 53,624     $ 30,258  
MSRs capitalized
  $ 45,433     $ 27,520     $ 31,690  
      2005 compared to 2004. Net gain from mortgage loan sales and fees decreased by 38% during the year ended December 31, 2005 compared to 2004. The decrease for 2005 was the result of (1) lower gain on sale margins on sales involving floating rate IOs due to lower spreads between the weighted-average coupon of the mortgage loans sold and implied LIBOR rates and (2) a reduction in non-conforming mortgage loan sales involving the creation of IOs. The lower volume of sales was related to the Company inability to use its traditional secondary market channels to effect sales of non-conforming loans to local financial institutions because of the uncertainty surrounding the restatement process. (See Part I, Item 1. Business “— Recent Significant Events” for additional information regarding certain changes to the Company’s business strategy that will impact its future earnings results, particularly its net gain on mortgage loan sales and fees.) See also “Critical Accounting Policies — Gain on Mortgage Loan Sales and Retained Interest Valuation.”
      2004 compared to 2003. Net gain from mortgage loan sales and fees decreased by 12% during 2004 compared to 2003. The decrease in net gain on mortgage loan sales and fees during 2004, notwithstanding a larger volume of sales, especially sales resulting in the recording of IOs, reflects lower gain on sale margins on sales involving floating rate IOs due to increases in short-term interest rates.
      Net (Loss) Gain on Securities Held for Trading. Net (loss) gain on securities held for trading includes gains and losses, whether realized or unrealized, in the market value of Doral Financial’s securities accounted for as held for trading, including IOs, as well as options, futures contracts and other derivative instruments used for interest rate risk management purposes. Set forth below is a summary of the components of the net (loss) gain from securities held for trading for the year ended December 31, 2005, 2004, and 2003.

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Table C — Components of Net (Loss) Gain from Securities Held for Trading
                           
    Year Ended December 31,
     
(In thousands)   2005   2004   2003
             
Net realized gains on sales of securities held for trading
  $ 13,315     $ 18,665     $ 106,813  
Losses on the IO valuation
    (12,523 )     (3,137 )     (3,877 )
Net unrealized (losses) and gains on trading securities, excluding IOs
    (4,530 )     3,259       (6,823 )
Net realized and unrealized gains (losses) on derivative instruments
    332       (130,465 )     (124,805 )
                   
 
Total
  $ (3,406 )   $ (111,678 )   $ (28,692 )
                   
      2005 compared to 2004. Net losses on securities held for trading for the year ended December 31, 2005 decreased by $108.3 million, or 97%, compared to the same period in 2004. The decrease was principally due to decreases in losses on derivative instruments, partially offset by increased losses on the value of the Company’s IOs. In order to manage the Company’s sensitivity to changes in interest rates, Doral Financial generally enters into derivative instruments, including floating-to-fixed interest rate swap agreements. As medium- and long-term rates increased during 2005, the Company experienced an increase in the value of its derivative portfolio, which resulted in realized and unrealized gains for 2005 of $332,000, compared to a loss of $130.5 million in the same period in 2004. During 2004, the Company’s interest rate risk management program was designed to protect the value of the Company’s assets and income from instantaneous substantial increases in long-term interest rates that could not be absorbed in the normal course of business and was not adequately aligned with the sensitivity of the Company’s balance sheet composition to changes in interest rates. During the latter part of 2004 the yield curve continued to flatten and long-term interest rates did not increase as anticipated. Accordingly, the Company experienced significant losses on the value of its derivatives. For an overview of the Company’s new risk management practices, as well as current exposure to changes in interest rates, see “— Risk Management,” below.
      Net losses on the value of the Company’s IO for the period ended December 31, 2005 increased by $9.4 million, compared to the same period in 2004. Higher losses during 2005 were recognized as a result of a 123 basis points decrease in spread, due to a lower weighted-average coupon of the underlying mortgage loans and higher implied LIBOR rates. The average implied 3-month LIBOR rates over the life of the loans, is represented by the 5-year swap rate. The five-year swap rate is used throughout the MD&A as a representative rate for parallel shifts in the yield curve to simplify the presentation of the results. However, expected cash flows of the variable IO and discounting are based on the full swap curve. The weighted-average coupon received on the mortgage loans underlying the Company’s variable IO portfolio decreased 37 basis points from 7.42% as of December 31, 2004 to 7.05% as of December 31, 2005 and the 5-year swap rate increased 86 basis points from 4.02% to 4.88% for such periods. The value of the variable rate IOs is very sensitive to changes in interest rates, particularly to changes in short-term interest rates. As short-term interest rates increase, the value of the Company’s variable rate IOs is adversely affected. This may be offset, to some extent, by a reduction of prepayments and the extension of the asset’s life. Conversely, as short-term interest rates decrease, the fair value of the IOs increases, but this may be partially or fully offset by an acceleration of prepayments and associated reduction of the life of the asset.
      Net realized gains on sales of trading securities for the period ended December 31, 2005 decreased by $5.4 million, or 29%, compared to the same period in 2004. Lower gains in 2005 were recognized as a result of a lower volume of trading activities. During 2005, sales of trading securities were $2.9 billion, compared to $5.0 billion in 2004.
      Net (loss) gain on securities held for trading for 2005 and 2004, also included $4.5 million of net unrealized losses and $3.3 million of net unrealized gains, respectively, on the value of Doral Financial’s securities held for trading, excluding IOs.

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      2004 compared to 2003. During 2004, the Company recognized a net loss on securities held for trading of $111.7 million compared to a net loss of $28.7 million for 2003. The net loss on securities held for trading for 2004 was principally due to losses of $130.5 million with respect to derivative instruments undertaken for risk management purposes, as explained above.
      The net loss on securities held for trading for 2004 included net realized gains on sales of securities of $18.7 million, compared to a gain of $106.8 million for 2004. Lower gains in 2004 were recognized as a result of a lower volume of trading activities coupled with lower gain on sale margins. During 2004, sales of trading securities were $5.0 billion, compared to $11.6 billion in 2003. Increased realized gains on securities held for trading during 2003 reflected an increased volume of trading activities and higher profits, particularly in Doral Financial’s international banking entity subsidiary as well as a gain of approximately $12.2 million on a bulk sale of $250 million of Puerto Rico GNMAs to a local investment company.
      Net gain (loss) on securities held for trading for 2004 and 2003, also included net losses on the value of the Company’s IOs of $3.1 million, compared to losses of $3.9 million for 2003 and $3.3 million of net unrealized gains and $6.8 million of net unrealized losses, respectively, on the value of Doral Financial’s securities held for trading, excluding IOs.
      Net (Loss) Gain on Sale of Investment Securities. Net (loss) gain on sale of investment securities represents the impact on Doral Financial’s income of transactions involving the sale of securities classified as available for sale.
      2005 compared to 2004. For the year ended December 31, 2005 the Company experienced a net loss on sale of investment securities of $40.8 million compared to a gain of $12.0 million for 2004. The net loss during 2005 was principally driven by the Company’s decision to sell $1.2 billion from its available for sale portfolio at a loss of $45.3 million during the fourth quarter of 2005. The Company’s decision was designed as a measure to increase liquidity as well as to strengthen its capital ratios.
      2004 compared to 2003. Net gain on sale of investment securities for the year ended December 31, 2004 increased by $6.5 million compared to the same period in 2003. Increased gains in 2004 were mostly related to increased volume of sales. Increased sales activities resulted in proceeds from sales of securities available for sale of $10.0 billion in 2004, compared to $7.0 billion in 2003. A substantial increase in the volume of sales was realized through Doral Financial’s international banking entity subsidiary. Gain on the sale of securities through the international banking entity subsidiary is tax exempt to Doral Financial.
      Net Servicing Income. Servicing income represents revenues earned for administering mortgage loans for others. The main component of Doral Financial’s servicing income is loan servicing fees, which depend on the type of mortgage loan being serviced. The servicing fees on residential mortgage loans generally range from 0.25% to 0.50%, of the declining outstanding principal amount of the serviced loan. Other components of net servicing income include late charges, prepayment penalties, interest loss, other servicing fees, and amortization and impairment of servicing assets. Set forth below is a summary of the components of net servicing income (loss) for the years ended December 31, 2005, 2004, and 2003.

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Table D — Components of Net Servicing Income (Loss)
                           
    Year Ended December 31,
     
(In thousands)   2005   2004   2003
             
Servicing fees (net of guarantee fees)
  $ 31,330     $ 29,398     $ 28,727  
Late charges
    8,860       7,393       6,958  
Prepayment penalties
    2,502       2,247       2,306  
Interest loss
    (3,551 )     (2,620 )     (2,974 )
Other servicing fees
    438       923       216  
                   
 
Servicing income, gross
    39,579       37,341       35,233  
Amortization and impairment of servicing assets
    (22,864 )     (37,359 )     (10,747 )
                   
 
Servicing income (loss), net
  $ 16,715     $ (18 )   $ 24,486  
                   
      The following table shows the changes in Doral Financial’s mortgage-servicing assets for each of the years shown:
Table E — Capitalization of Mortgage-Servicing Assets
                           
    Year Ended December 31,
     
(In thousands)   2005   2004   2003
             
Balance at beginning of year
  $ 136,024     $ 133,237     $ 125,243  
Capitalization of MSRs
    45,433       27,520       31,690  
Rights purchased
    4,421       4,505       11,047  
Amortization
    (26,846 )     (29,213 )     (34,743 )
Application of valuation allowance to write-down permanently impaired servicing assets
    (2,220 )     (25 )      
                   
 
Balance before valuation allowance at end of year
    156,812       136,024       133,237  
Valuation allowance for temporary impairment
    (6,236 )     (12,438 )     (4,317 )
                   
 
Balance at end of year
  $ 150,576     $ 123,586     $ 128,920  
                   
      2005 compared to 2004. Loan servicing fees, net of guarantee fees, increased by $1.9 million, or 7%, for the year ended December 31, 2005, compared to 2004. The increase in servicing fees, net of guarantee fees, was principally due to an increase in the average servicing portfolio. Doral Financial’s mortgage-servicing portfolio, including its own loan portfolio of $5.9 billion at December 31, 2005 and $5.2 billion at December 31, 2004, was approximately $15.7 billion at December 31, 2005, compared to $14.3 billion at December 31, 2004. Late fees and other servicing-related income for the year ended December 31, 2005 increase by $0.3 million, or 4%, for the year ended December 31, 2005, compared to the same period in 2004. The increase is principally attributable to a higher servicing portfolio, partially offset by a higher servicing interest loss attributable to an increase in the amount of interest paid to investors and not recovered from delinquent loans serviced by the Company.
      For the year ended December 31, 2005, net servicing income amounted to $16.7 million, compared to a servicing loss of $18,000 for 2004. The increase in net servicing income for 2005 was principally the result of reduced impairment charges of mortgage-servicing assets. The decrease in impairment charges was due to a decrease in anticipated mortgage prepayment rates as of December 31, 2005 that led to an increase in the valuation of the Company’s MSRs as of such date. As a result, for 2005, Doral Financial recovered $4.0 million of the Company’s previously recognized impairment valuation allowance.
      2004 compared to 2003. Loan servicing fees, net of guarantee fees, increased by $0.7 million, or 2%, compared to 2003. The increase in servicing fees, net of guarantee fees, was principally due to an increase in the average servicing portfolio. Doral Financial’s mortgage-servicing portfolio, including its own loan

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portfolio of $5.2 billion at December 31, 2004 and $4.3 billion at December 31, 2003, was approximately $14.3 billion at December 31, 2004, compared to $12.7 billion at December 31, 2003. Late fees and other servicing-related income for the year ended December 31, 2004 increased by $1.4 million, or 22%, compared to the same period in 2004. The increase is principally attributed to a higher servicing portfolio.
      For the year ended December 31, 2004, net servicing loss amounted to $18,000, compared to net servicing income of $24.5 million for the same period in 2003. The decrease for 2004 was the result of increased impairment charges of mortgage-servicing assets resulting from a decline in the estimated fair value of the Company’s MSRs. During 2003, the slowdown in anticipated mortgage prepayment rates, coupled with increases in escrow earnings and mortgage rates led to an increase in the valuation of the Company’s MSRs. As a result, in 2003, Doral Financial recovered $24.0 million of the Company’s previously recognized impairment valuation allowance (from $28.3 million as of December 31, 2002 to $4.3 million as of December 31, 2003). During 2004, the slight decrease in mortgage rates caused a slight increase in prepayment projections that resulted in a decrease in the valuation of the Company’s MSRs. As result, in 2004, Doral Financial recognized a net impairment of $8.1 million through a higher impairment valuation allowance.
      Capitalization of MSRs. The value of the servicing asset retained in the sale of a mortgage loan reduces the basis of the mortgage loan and thereby results in increased “Net Gain on Mortgage Loan Sales and Fees” at the time of sale. During 2005, 2004 and 2003, Doral Financial recognized servicing assets of $45.4 million, $27.5 million and $31.7 million, respectively, in connection with the sale of loans to third parties.
      Commissions, Fees and Other Income
      Set forth below is a summary of Doral Financial’s principal sources of commissions, fees and other income for the year ended December 31, 2005, 2004, and 2003:
Table F — Commissions, Fees and Other Income
                           
    Year Ended December 31,
     
(In thousands)   2005   2004   2003
             
Retail banking fees
  $ 17,656     $ 13,578     $ 11,000  
Securities brokerage and asset management fees and commissions
    1,208       1,945       2,993  
Insurance agency commissions
    12,396       11,852       7,910  
Other income
    6,646       4,958       906  
                   
 
Total
  $ 37,906     $ 32,333     $ 22,809  
                   
      Doral Financial’s fees and commissions have increased steadily as Doral Financial’s banking subsidiaries increased their retail branch network and as Doral Financial continues to diversify its sources of revenues by generating additional fees and commissions from insurance agency activities. Currently, Doral Financial is capturing a substantial portion of the insurance policies obtained by borrowers who obtain residential mortgage loans through Doral Financial’s mortgage-banking entities.
      2005 compared to 2004. Commissions, fees and other income for the year ended December 31, 2005 increased by $5.6 million, or 17%, compared to the same period in 2004. The increases were due primarily to increased retail banking fees and commissions. Also during the fourth quarter of 2005 the Company sold on the open market certain residential units related with the development of a residential housing project (see — “Non-Performing Assets and Allowance for Loan and Lease Losses” section below for additional information), which resulted in revenues of approximately $2.2 million included as part of Other Income. Other Income also includes a gain of approximately $2.0 million recognized in 2005 in connection with an early extinguishment of certain securities sold under agreements to repurchase.

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      2004 compared to 2003. Commissions, fees and other income for the year ended December 31, 2004 increased by $9.5 million, or 42%, compared to the same period in 2003. The increases were due primarily to increased commissions and fees earned by Doral Financial’s banking and insurance agency operations. Also during 2004, the Company recognized approximately $3.8 million in penalty fees associated with the repayment of certain construction loans prior to their stated maturity included as part of Other Income.
Non-Interest Expenses
      A summary of non-interest expenses for the years ended December 31, 2005, 2004, and 2003 is provided below.
Table G — Non-Interest Expenses
                           
    Year Ended December 31,
     
(In thousands)   2005   2004   2003
             
Compensation and employee benefits
  $ 90,797     $ 90,284     $ 74,377  
Taxes, other than payroll and income taxes
    10,918       9,363       7,587  
Advertising
    16,588       15,079       15,311  
Professional services — excluding restatement expenses
    15,801       13,711       8,644  
Professional services — restatement expenses
    29,373              
Communication and information systems
    18,553       13,812       13,323  
Occupancy and other office expenses
    31,548       27,242       23,201  
Depreciation and amortization
    20,923       17,683       14,704  
Provision for contingency
    25,000              
Other
    28,992       26,940       21,484  
                   
 
Total non-interest expenses
  $ 288,493     $ 214,114     $ 178,631  
                   
      2005 compared to 2004. Non-interest expense for the year ended December 31, 2005 increased by $74.4 million, or 35%, compared to the same period in 2004. The increase in 2005 was primarily due to increases in professional services related to the restatement and the establishment of a reserve in connection with a potential settlement of the ongoing SEC investigation of the Company. Compensation and employee benefits during 2005 increased by $0.5 million, compared to 2004. The departure of certain former members of senior management during 2005 resulted in the forfeitures of 535,000 unvested stock options. When unvested options are forfeited, any compensation expense previously recognized on the forfeited unvested options is reversed in the period of the forfeiture. The compensation expense associated with forfeited unvested stock options previously recognized and reversed during 2005 amounted to $5.0 million. Excluding the amount with respect to the forfeiture of unvested stock options, compensation and employee benefits during 2005 increased by $5.5 million or 6%, compared to 2004. The increase in compensation and employee benefit was primarily due to increases in the average compensation and related fringe benefits, partially offset by a decrease of 3%, in headcount from 2,598 as of December 31, 2004 to 2,522 employees as of December 31, 2005. In 2006, the Company commenced a major reengineering project with the assistance of Proudfoot Consulting designed to substantially reduce non-interest expenses and to make the Company’s operations more efficient.
      Professional fees for 2005 increased by $31.5 million, compared to the same period in 2004. The increase for 2005 was primarily due to legal, accounting and consulting fees associated with the restatement process and related legal proceedings.
      Occupancy and other office expenses for 2005 increased by $4.3 million, or 16%, compared to the same period in 2004. The increase during 2005 was primarily due to increased costs associated with Doral Financial’s branch network expansion program as well as increased electric, water and other utility costs. As of December 31, 2005, the Company conducts its business through 112 offices within Puerto Rico and New York City, compared to 108 offices as of December 31, 2004.

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      Depreciation and amortization expense during 2005 increased by $3.2 million, or 18%, compared to 2004. The increase in depreciation was principally related to increases in leasehold improvements and the purchase of office furniture and equipment as well as software and hardware, and computer systems upgrades related to the Company’s growth.
      Other expenses for the year ended December 31, 2005 increased by $2.1 million, compared to the same period in 2004. During the fourth quarter of 2005, Doral wrote off goodwill of approximately $4.7 million associated with the acquisition of its subsidiary, Sana Mortgage Corporation, based on management’s analysis of the future profitability and prospects of this subsidiary.
      Doral Financial has been engaged in discussions with the staff of the SEC regarding a possible resolution to its investigation of the Company’s restatement, and has reserved $25 million in its consolidated financial statements for the year ended December 31, 2005 in connection with a potential settlement of the SEC’s investigation of the Company. Any settlement is subject to acceptance and authorization by the Commission. There can be no assurance that the Company’s efforts to resolve the SEC’s investigation with respect to the Company will be successful, or that the amount reserved will be sufficient, and the Company cannot predict the timing or the final terms of any settlement. Doral Financial has not reserved any amounts in its financial statements in respect of the pending civil lawsuits in connection with its restatement, which are in their early stages.
      2004 compared to 2003. Non-interest expense for the year ended December 31, 2004 increased by $35.5 million, or 20%, compared to the same period in 2004. The increase in 2004 was principally due to increases in compensation and employee benefits, professional services, occupancy and other office expenses, and depreciation and amortization. Compensation and employee benefits during 2004 increased by $15.9 million, or 21%, compared to 2003. A significant portion of the increase was associated with the expensing of the fair value of stock options which increased to $9.7 million during 2004, compared to $4.5 million for 2003. The increase in stock based compensation expenses was related to options on 1,560,000 common shares granted to certain former executive officers during the first quarter of 2004. The increase in compensation expense also was attributable to increases in the average compensation and related fringe benefits and increases of 9% for 2004 in headcount, from 2,375 as of December 31, 2003 to 2,598 employees as of December 31, 2004. The increase in headcount was associated with Doral Financial’s continued growth and expansion of its various lending and servicing activities.
      Professional fees for 2004 increased by $5.1 million, compared to the same period in 2003. The increase for 2004 was primarily due to legal, accounting, security and consulting fees associated with the continued expansion of Doral Financial’s business and compliance with the requirements of the Sarbanes-Oxley Act of 2002.
      Occupancy and other office expenses for 2004 increased by $4.0 million, or 17%, compared to the same period in 2003. The increase during 2004 was primarily due to increased costs associated with Doral Financial’s ongoing branch network expansion program and refurbishing of existing bank branches. As of December 31, 2004, the Company conducts its business through 108 offices within Puerto Rico and New York City, compared to 103 offices as of December 31, 2003.
      Depreciation and amortization expense during 2004 increased by $3.0 million, or 20%, compared to same period in 2003. The increase in depreciation was principally related to increases in leasehold improvements and the purchase of office furniture and equipment as well as software and hardware and computer systems upgrades related to the Company’s growth.
      Other expenses increased for the year ended December 31, 2004 by $5.5 million, or 25%, compared to the same period in 2003. The increase for 2004 was primarily related to increases in indirect mortgage loan origination-related expenses, employee-related expenses, custodial fees and other expenses. Increased donations and contributions were effected during 2004 as the Company continued its commitment with the development and support of innovative educational, social and philanthropic programs to assist the communities it serves. The Company’s other expenses for 2004 also included a $5.2 million provision for

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bad debts, principally attributable to servicing advances from the sale of delinquent mortgage loans to third parties, compared to approximately $1.0 million in 2003.
Income Taxes
      Income taxes include Puerto Rico income taxes as well as applicable federal and state taxes. As Puerto Rico corporations, Doral Financial and all of its Puerto Rico subsidiaries are generally required to pay federal income taxes only with respect to their income derived from the active conduct of a trade or business in the United States (excluding Puerto Rico) and certain investment income derived from U.S. assets. Any such tax is creditable, with certain limitations, against Puerto Rico income taxes. Except for the operations of Doral Bank — NY and Doral Money, substantially all of the Company’s operations are conducted through subsidiaries in Puerto Rico. Doral Bank — NY and Doral Money are U.S. corporations and are subject to U.S. income tax on their income derived from all sources.
      Doral Financial enjoys tax-exemption on interest income derived from certain FHA and VA mortgage loans secured by properties located in Puerto Rico and on GNMA securities backed by such mortgage loans. Doral Financial also invests in U.S. Treasury and agency securities that are exempt from Puerto Rico taxation and are not subject to federal income taxation because of the portfolio interest deduction to which Doral Financial is entitled as a foreign corporation. In addition, Doral Financial uses its international banking entity subsidiary to invest in various U.S. securities and U.S. mortgage-backed securities. The interest income and gain on sale, if any, derived from these securities by Doral Financial’s international banking entity subsidiary is exempt from Puerto Rico income taxation and excluded from federal income taxation in the case of interest, on the basis of the portfolio interest deduction, and in the case of capital gains, because the gains are sourced outside the United States.
      Under the PR Code, the statutory corporate tax rates ranges from 12.5% (20% effective July 1, 2005) for capital gain transactions to a maximum of 41.5% for regular income. The PR Code also includes an alternative minimum tax of 22% that applies if the Company’s regular income tax liability is less than the alternative minimum tax requirements. The provision for income taxes of the Company differs from amounts computed by applying the applicable Puerto Rico statutory rate to income before taxes. A reconciliation of the difference follows:
                                                 
    Year Ended December 31,
     
(Dollars in thousands)   2005   2004   2003
             
Income before income taxes
  $ 32,283   $ 129,303   $ 166,054
             
             
                                                   
        % of       % of       % of
        Pre-tax       Pre-tax       Pre-tax
    Amount   Income   Amount   Income   Amount   Income
                         
Tax at maximum statutory rates
  $ (13,397 )     (41.5 )   $ (50,428 )     (39.0 )   $ (64,761 )     (39.0 )
Tax effect of exempt income, net of expense disallowance
    42,229       130.8       48,271       37.3       63,432       38.2  
Net tax benefit (expense) from capital gain transactions
    706       2.2       86,807       67.1       (18,414 )     (11.1 )
Effect of net operating losses not used
    (30,420 )     (94.2 )                        
Deferred tax valuation allowance
    (4,440 )     (13.8 )                        
Non-tax deductible expenses
    (12,311 )     (38.1 )                        
Other, net
    (1,458 )     (4.5 )     841       0.7       (4,173 )     (2.5 )
                                     
 
Income tax (provision) benefit
  $ (19,091 )     (59.1 )   $ 85,491       66.1     $ (23,916 )     (14.4 )
                                     
      2005 compared to 2004. For the year ended December 31, 2005, Doral Financial reported income tax expense of $19.1 million (representing an effective tax rate of 59.1%), as compared to a tax benefit of

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$85.5 million for 2004. During 2005, the Company’s effective tax rate was adversely affected by an increase in income tax rates in Puerto Rico, net operating losses at certain subsidiaries that could not be used to offset taxable income at other subsidiaries, certain expenses that were not deductible for tax purposes and an increase in the valuation allowance on the Company’s deferred tax assets. These factors were offset, in part, by a high proportion of pre-tax income represented by tax exempt income derived from Doral Financial’s international banking entity subsidiary. During 2004, the Company benefited from a significant inter-company sale of IOs completed for the purpose of taking advantage of a temporary reduction in capital gain tax rates, as well as from the recognition of a deferred tax asset in respect of taxes paid on transfers of IOs based on their value prior to the restatement.
      On August 22, 2004, legislation was enacted in Puerto Rico to provide a temporary reduction in the long-term capital gain tax rates. The law amends the PR Code to reduce the long-term capital gain tax rates by fifty percent for transactions occurring from July 1, 2004, through June 30, 2005. The maximum long-term capital gain tax rate applicable to gains on sale of property located in Puerto Rico (as defined in the PR Code) during this period was reduced to 6.25% from 12.5% for corporations and partnerships. To take advantage of this reduction, during the fourth quarter of 2004 and the second quarter of 2005, the Company entered into two separate agreements with the local taxing authorities related to intercompany sales of IOs, which permitted the Company to accelerate the recognition for tax purposes of long-term capital gains of $536.6 million and $39.9 million, respectively, related to IOs created in previous transactions. The value of the IOs at the time of the agreements, after making all relevant adjustments pursuant to the restatement, approximates $49.1 million and $15.6 million, respectively. Refer to Note 1 “— Restatement of Previously Issued Financial Statements” to the Consolidated Financial Statements accompanying the Company’s amended 2004 Annual Report on Form 10-K for additional information. The transactions executed during the second quarter of 2005 and the fourth quarter of 2004 resulted in the recognition of an income tax benefit of approximately $2.6 million and $9.1 million, respectively, representing the difference between the deferred tax liability originally accrued on the IOs at the higher rate and the reduced long-term capital gain rate of 6.25%.
      During 2004, as a result of the correction in the methodology used to determine the fair value of its portfolio of IOs and the recharacterization of certain mortgage loan transfers as secured borrowings, the Company recognized a deferred tax asset and deferred benefit of $190.1 million (before any valuation allowance). This benefit is attributable to the tax effect of the difference between the tax basis of the IOs and their restated book value. The basis differential arises from the fact that Doral Financial paid taxes on the book value of the IOs prior to the restatement, as opposed to the restated value, which would have resulted in a significant lower tax obligation. The Company accounted for this tax benefit pursuant to the guidance in EITF 98-11, “Accounting for Acquired Temporary Differences in Certain Purchase Transactions That Are Not Accounted for as Business Combinations.”
      As a result of the increase in deferred tax assets attributable to the restatement, the Company has evaluated its ability to realize the deferred tax asset and concluded, based on the evidence available, that it is more likely than not that some of the deferred tax assets will not be realized and as a result, established a valuation allowance. This evaluation included an analysis of the inability of the Company to file consolidated tax returns for its Puerto Rico subsidiaries and, therefore, to utilize losses in one of its subsidiaries to offset gains in another subsidiary, as well as an analysis of the likelihood of realizing the deferred tax assets created in the ordinary course of the Company’s operations. At December 31, 2005, the deferred tax asset, net of its valuation allowance of $75.7 million, amounted to approximately $213.2 million.
      Under the PR Code, Doral Financial is not permitted to file consolidated tax returns and, thus, Doral Financial is not able to utilize losses from one subsidiary to offset gains in another subsidiary. During 2005, certain subsidiaries operated at a loss, and based on the forecast of future taxable income, Doral Financial determined that the associated deferred tax asset could not be realized. Specifically for the year ended December 31, 2005, the Company expected that the tax benefit of $30.4 million attributable to losses at certain subsidiaries will not be realized and, as a result, is not being recognized in the financial statements. During 2004, all of Doral Financial’s subsidiaries operated at a profit.

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      During 2005, Doral Financial’s results included non-tax deductible expenses of $29.7 million arising from goodwill impairment and a reserve for a potential settlement of the SEC’s ongoing investigation of the Company.
      During 2005, pre-tax income from Doral Financial’s international banking entity subsidiary amounted to $85.3 million or 264% of total consolidated pre-tax income, compared to $77.8 million or 60% for 2004.
      2004 compared to 2003. In 2004, Doral Financial recognized an income tax benefit of $85.5 million compared to an income tax expense of $23.9 million in 2003. The decrease in tax expense during 2004 reflected higher income from capital gain transactions, including the intercompany sale of IOs, offset by slightly higher proportional income from Doral Financial tax exempt operations.
      Refer to Note 22 to the consolidated financial statements for additional information on income taxes.
OUT OF PERIOD ADJUSTMENTS
      In the fourth quarter of 2005, the Company identified certain errors in its previously reported financial statements. Because these changes are not material to the Company’s financial statements for the periods prior to 2005, to the interim periods in 2005 or to 2005, as a whole, the Company corrected these errors in the fourth quarter of 2005.
      The errors in the Company’s previously reported financial information, and the failure to prevent them or detect them in the Company’s financial reporting process, were largely attributable to ineffective controls, particularly the lack of effective controls over the financial close and reporting process. As part of its remediation program, the Company is taking steps to add skilled resources to improve controls and increase the reliability of its financial closing process. See Part II, Item 9A. Controls and Procedures of this Annual Report on Form 10-K for further information.
Description of Out of Period Adjustments
Accrual of Interest Income and Expense on Recharacterized Loan Transfers:
      As part of the restatement of its financial statements, the Company developed software to process the accounting for the mortgage loan assets and related loans payable resulting from the recharacterization as secured borrowings of certain prior mortgage loan transfers. This system erroneously calculated the interest income and interest expense resulting from those items on a cash basis, rather than on an accrual basis as required by GAAP. This error affected all quarterly and annual periods from 2000 to the present, but the effect was not material in any reporting period.
Forfeiture of Unvested Stock Options:
      During the third quarter of 2005, the Company should have reversed approximately $5.0 million in compensation expense from the forfeiture of unvested stock options resulting from the departure of some of its former senior executives.
Valuation Allowance on Deferred Tax Assets:
      During 2005, the Company erroneously calculated the valuation allowance on deferred tax assets and recorded adjustments to its results for the fourth quarter of 2005. Specifically, the Company failed to consider the appropriate factors in estimating the valuation allowance for its deferred income tax assets. These adjustments relate to errors made during the first three quarters of 2005.
Other Adjustments:
      We identified other items that did not conform to GAAP and recorded adjustments to our results for the fourth quarter of 2005 that relate to previously reported periods. The most significant of these errors relate to the valuation of the Company’s interest-only strips, the capitalization of servicing advances for insurance and taxes on delinquent loans and real estate owned properties and the accounting for foreclosed

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properties. The error in the valuation of the IOs was related to a mistake in gathering the data for calculating the regression factor used to determine prepayment assumptions, and not to an error in the valuation methodology.
Impact of Out of Period Adjustments
      Had these errors been recorded in the proper period, the Company’s net interest income as reported would decrease by $5.2 million for 2005 and by $0.2 million for 2004 and would increase by $2.2 million for 2003. Net income as reported would decrease by $2.0 million (or an increase in net loss per diluted share of $0.02) for 2005 and by $0.6 million for 2004 (or $0.01 per diluted share), and would increase by $1.4 million (or $0.01 per diluted share) for 2003.
      For information about the impact of these out of period adjustments on our fourth quarter results of operations, please refer to Note 34 to Doral Financial’s consolidated financial statements.
OPERATING SEGMENTS
      Doral Financial manages its business as four operating segments: mortgage banking and risk management, banking (including thrift operations), institutional securities operations and insurance agency activities. Refer to Note 33 of Doral Financial’s Notes to the consolidated financial statements for summarized financial information regarding these operating segments. The entire amount of interest expense related to debt incurred at the parent company level is allocated to the mortgage-banking segment. The majority of the Company’s operations are conducted in Puerto Rico. The Company also operates in the mainland United States, principally in the New York City metropolitan area. Refer to Note 33 of Doral Financial’s Notes to the consolidated financial statements for summarized financial information for these operations. All figures shown in this section are based on balances before intersegment eliminations.
      Mortgage Banking and Risk Management. This segment includes a wide range of activities, including the origination, sale, securitization and servicing of mortgage loans; the holding of mortgage-backed securities and other investment securities for sale or investment; and the origination of construction loans and mortgage loans secured by income-producing real estate or unimproved land. This segment also includes the results of most of the Company’s transactions with respect to derivative instruments used for risk management purposes. The mortgage- banking business is carried out primarily in Puerto Rico, and to a lesser extent in New York. Mortgage loan originations in Puerto Rico tend to be less sensitive to interest-rate changes than in the mainland United States because a significant number of loan originations in Puerto Rico are made for debt consolidation purposes rather than interest rate savings. Servicing operations generally perform better when mortgage rates are relatively high and consequently loan prepayments are low.
      The activities in this area are conducted through four mortgage banking units — HF Mortgage Bankers, an operating division within the parent company, Doral Mortgage Corporation, Centro Hipotecario de Puerto Rico, Inc. and Sana Mortgage Corporation (“the Mortgage Subsidiaries”). Results for this segment are significantly impacted by Master Loan Production Agreements entered with Doral Financial’s banking subsidiary in Puerto Rico. Under the terms of the Master Loan Production Agreement, the Mortgage Subsidiaries assist Doral Bank — PR in reaching its loan production goals by advertising to the general public and providing other origination and settlement services. In exchange for these services, Doral Bank — PR remits to the Mortgage Subsidiaries a percentage of the originating fees charged to the borrowers under the mortgage loan agreements. Residential mortgage loans originated by Doral Bank — PR are usually sold through Doral Financial’s mortgage banking units, after an intersegment transaction. Realized losses on the sale of mortgage loans, losses in the value of the IO portfolio and an increased income tax expense, negatively impacted the results of the mortgage banking segment in 2005 compared to 2004 and 2003. This segment experienced a net loss of $62.8 million in 2005, compared to net income of $30.5 million in 2004 (including an income tax benefit of $109.7 million) and a net income of $24.6 million in 2003.

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      Net interest income was $82.9 million in 2005, $138.2 million in 2004, and $98.0 million in 2003. The decrease in net interest income in 2005 was due to a significant reduction in net interest margin coupled with a decrease in the average balance of interest-earning assets for the segment. The increase in net interest income for 2004 was due largely as a result of an increase in the average balance of interest-earning assets and the repayment of an aggregate of approximately $366.5 million of relatively high-rate notes payable and the replacement of such borrowings with lower-cost borrowings. Also during 2004, the Company recognized a yield adjustment on its mortgage-banking segment of $10.0 million related to deferred fees on construction loans that were repaid prior to their stated maturity. Interest rate spread and margin for the mortgage banking and risk management segment for 2005 was 1.22% and 1.32%, respectively, compared to 1.57% and 1.80% for 2004 and 1.66% and 2.02% for 2003. Average balance of interest-earning assets for the segment was $6.3 billion, $7.7 billion, and $4.9 billion for 2005, 2004, and 2003, respectively.
      This segment experienced non-interest income of $28.3 million for 2005, a non-interest loss of $108.8 million for 2004, and non-interest income of $33.0 million for 2003. The increase in non-interest income in 2005 compared to 2004 was primarily due to dividends received from other non-mortgage banking subsidiaries, higher net gain on mortgage loans sales and higher servicing income offset by higher losses on sale of investment securities. The loss during 2004 was related to a reduced net gain on mortgage loans sales and fees, reflecting higher premiums paid on the loans purchased from Doral Bank — PR, coupled with losses sustained on its investment activities. Generally, the mortgage-banking segment realized losses on the loans purchased from its affiliate when the loans are sold (generally at par) to a third party. This loss is offset in consolidated results by realized gains recognized on the banking segment for such transactions. Realized losses of $38.0 million for 2005, $122.1 million for 2004, and $41.2 million for 2003 were recognized in the mortgage-banking segment related to such intercompany loan transactions. Net gains on mortgage loan sales and fees amounted to $15.2 million for 2005, compared to a net loss of $41.8 million for 2004, and a net gain of $52.8 million for 2003. Notwithstanding increases in mortgage banking loan production and higher volume of sales, mortgage loan sales and fees were also lower because of lower margins associated with the reduced valuation of IOs. The reduced margins resulted primarily from increases in short-term interest rates.
      Investment activities losses decreased during 2005 to $42.3 million, compared to a loss of $75.1 million and $51.2 million for 2004 and 2003, respectively. Investment activities were primarily affected by gains sustained with respect to derivative instruments undertaken for risk management purposes of $1.6 million for 2005, compared to losses of $72.9 million and $107.8 million for 2004 and 2003, respectively. Gains with respect to derivative instruments during 2005 were offset by a net loss on the sale of investment securities of $40.6 million during 2005 compared to losses of $7.4 million and gains of $11.4 million for 2004 and 2003, respectively. The net loss during 2005 was principally driven by the Company’s decision to sell $1.2 billion from its available for sale portfolio at a loss of $45.3 million during the fourth quarter of 2005. The Company’s decision was designed as a measure to increase future net interest income and liquidity, as well as to strengthen its capital ratios. Investment activities were also adversely affected by a loss of $12.5 million on the IO valuation for 2005, compared to a loss of $3.1 million for 2004 and a loss of $3.9 million for 2003.
      Net servicing income increased during 2005, driven by decreased amortization and impairment charges of the Company’s servicing assets. The combined amortization and impairment charges for the mortgage-banking segment amounted to $22.8 million during 2005, compared to $37.2 million and $9.1 million during 2004 and 2003, respectively.
      Non-interest expenses for this segment increased to $170.9 million in 2005, compared to $107.5 million in 2004 and $90.7 million in 2003. The increase in non-interest expenses for this segment in 2005 and 2004 was driven by increases in professional fees associated with the restatement process, depreciation and amortization, occupancy and other expenses resulting from the expansion of Doral Financial’s mortgage banking and expenses related to increased lending activities and servicing. Also, the Company’s reserve of $25.0 million established in connection with the potential settlement of the SEC’s ongoing investigation of the Company was recognized in the mortgage-banking segment, as well

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as a goodwill write-off of $4.7 million associated with SANA Mortgage Corporation based on management’s analysis of the future profitability and prospects of this subsidiary.
      The results for the mortgage banking and risk management segment for the years ended December 31, 2004 and 2003, include the results of Doral Overseas, an international banking entity organized as a division at the parent company level. Doral Financial phased out the operations of Doral Overseas, effective March 31, 2004. For the years ended December 31, 2004 and 2003, the operations of Doral Overseas accounted for approximately $804,000 and $28.8 million, respectively, of the total non-interest income, and approximately $755,000 and $5.4 million, respectively, of the total net interest income of the mortgage banking and risk management segment.
      Doral Financial also operates another international banking entity, Doral International, Inc., a wholly owned subsidiary of Doral Bank — PR. The operations of Doral International are included within the banking segment discussed below. Doral Financial has increased the investment activities of Doral International and, accordingly, the diminished contribution from Doral Overseas was counterbalanced to some extent by an increased contribution from Doral International.
      Banking. The banking segment includes Doral Financial’s banking operations in Puerto Rico, currently operating through 42 retail bank branches, and its thrift operations in the New York City metropolitan area, currently operating through 10 branches. The investment activities by Doral Bank — PR through its international banking entity are also included within the banking segment. Doral Financial’s banking subsidiaries offer a variety of loan and deposit products, with an emphasis on residential, construction and commercial real estate-secured mortgage loan products. The mortgage loan origination activity of the banking segment is closely integrated with the mortgage-banking segment. Doral Financial’s banking subsidiaries have entered into master loan production agreements with their mortgage banking affiliates whereby the mortgage banking units help the banking subsidiaries originate loans by advertising to the general public and providing other origination and settlement infrastructures. These arrangements result in reduced expenses by avoiding the costs of maintaining duplicate origination systems. Net income for the banking segment amounted to $97.0 million during 2005, compared to $165.5 million and $108.3 million during 2004 and 2003, respectively.
      Net interest income for the banking segment was $191.2 million for 2005, compared to $181.1 million and $126.0 million for 2004 and 2003, respectively. The increase in net interest income for 2005 and 2004 resulted mainly from significant increases in the amount of interest-earning assets, particularly in mortgage-backed and investment securities held by the banking subsidiaries, driven by the Company’s strategy to increase its tax-exempt income by investing in U.S. GNMAs and U.S. FHLMC/ FNMA mortgage-backed securities, and by holding a significant amount of U.S. Treasury securities at its international banking entity subsidiary, as described in “Consolidated Results.” In 2005, significant decreases in net interest margin partially reduced the results of the segment. Interest rate spread and margin for the banking segment for 2005 was 1.58% and 1.71%, respectively, compared to 1.80% and 1.98% for 2004 and 1.60% and 1.96% for 2003. Total average interest-earning assets for the banking segment for 2005 were $11.2 billion compared to $9.2 billion for 2004 and $6.2 billion for 2003.
      Non-interest income decreased to $56.8 million in 2005, compared to $116.9 million in 2004 and $84.5 million in 2003. The decrease during 2005 reflected decreased gains on sales tied to lower volume of loan sales, mainly to the parent company, as a result of the parent company’s inability to use its traditional secondary market channels in Puerto Rico to effect non-conforming loan sales because of the uncertainty surrounding the restatement process. The increase during 2004 reflected increased gains on sales of mortgage loans tied to the increased volume of loan sales, mainly to the parent company, and the recognition of higher gains on such sales. Gains on mortgage loan sales and fees for this segment were $36.3 million in 2005 compared to $127.9 million in 2004 and $49.1 million in 2003. Investment activities for this segment resulted in a loss of $2.1 million in 2005 compared to a loss of $28.4 million in 2004 and a gain of $24.4 million in 2003. The improve performance in 2005 on investment activities was principally attributable to derivatives undertaken for interest rate risk management purposes. Banking fees and

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commissions also increased considerably during the period, from $11.0 million in 2003 to $13.6 million in 2004 and $17.7 million in 2005, as the Company continued the expansion of its bank branch network.
      Non-interest expenses for this segment increased to $122.2 million in 2005, compared to $105.7 million in 2004 and $84.5 million in 2003. The increase in non-interest expenses during 2005 and 2004 was driven by increases in compensation, professional fees, depreciation and amortization, occupancy and other expenses resulting from the expansion of Doral Bank — PR and Doral Bank — NY banking operations. As of December 31, 2005, the segment had 52 bank branches compared to 46 and 41 branches as of December 31, 2004 and 2003, respectively.
      Institutional Securities Operations. This segment corresponds to the operations of Doral Financial’s institutional broker-dealer subsidiary, Doral Securities, Inc., which is headquartered in San Juan, Puerto Rico. Doral Securities sells securities to institutional customers, provides investment banking services, provides investment management services to a locally based investment company, and to a lesser extent, operates a repurchase lending operation involving short-term extensions of credit secured by highly liquid and marketable securities. During 2004, Doral Securities significantly reduced its repurchase lending operations. Net income for this segment amounted to $2.1 million for 2005, $4.4 million for 2004 and $5.6 million for 2003. The decrease for 2005 was principally related to losses on investment activities. The decrease for 2004 was principally related to a decrease in intercompany agency fees paid by Doral Financial’s other affiliates to Doral Securities and reduced repurchase lending operations with affiliates.
      As part of the Company’s expense reduction efforts, during the fourth quarter of 2005, the Company decided to terminate its institutional sales and investment banking services. Doral Securities is still conducting certain asset management activities and maintains a small portion of the Company’s trading securities portfolio. The Company is currently examining the future viability of this operation.
      Insurance Agency. Doral Financial operates its insurance agency activities through its wholly-owned subsidiary Doral Insurance Agency. Doral Insurance Agency’s principal insurance products are hazard, title and flood insurance, which are sold primarily to Doral Financial’s base of mortgage customers. Doral Insurance Agency is diversifying its range of products to include other forms of insurance products such as auto, life and disability. Net income for this segment amounted to $8.4 million during 2005, compared to $10.9 million for 2004 and to $6.1 million for 2003. The decrease for 2005 was primarily attributable to the Company’s decision in the second quarter of 2005 to transfer the investment portfolio of the mortgage banking subsidiaries and insurance agency operations to the parent company. As a result for the year ended December 2005, net interest income amounted to $2.0 million, compared to $5.3 million and $2.0 million in 2004 and 2003, respectively. During 2005 and 2004, the segment experienced growth in insurance fees and commissions driven by the Company’s strong internal mortgage loan production and the cross-selling of mortgage-related insurance products to its client base. For the year ended December 31, 2005, insurance fees and commissions amounted to $12.4 million, compared to $11.9 million in 2004, and $7.9 million in 2003.

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BALANCE SHEET AND OPERATING DATA ANALYSIS
Loan Production
      Loan production includes loans internally originated by Doral Financial as well as residential mortgage loans purchased from third parties with the related servicing rights. Purchases of mortgage loans from third parties were $483.1 million, $606.5 million, and $496.2 million for the years ended December 31, 2005, 2004 and 2003, respectively. The following table sets forth the number and dollar amount of Doral Financial’s loan production for the years indicated:
Table H — Loan Production
                           
    Year Ended December 31,
     
(Dollars in thousands, except for average initial loan balance)   2005   2004   2003
             
FHA/ VA mortgage loans
                       
 
Number of loans
    3,881       5,116       3,973  
 
Volume of loans
  $ 332,409     $ 446,551     $ 370,904  
 
Percent of total volume
    6 %     8 %     8 %
 
Average initial loan balance
  $ 85,650     $ 87,285     $ 93,356  
Conventional conforming mortgage loans
                       
 
Number of loans
    11,357       7,537       10,459  
 
Volume of loans
  $ 1,355,136     $ 932,085     $ 1,245,989  
 
Percent of total volume
    25 %     17 %     25 %
 
Average initial loan balance
  $ 119,322     $ 123,668     $ 119,131  
Conventional non-conforming mortgage loans(1)
                       
 
Number of loans
    22,294       25,286       18,419  
 
Volume of loans
  $ 2,438,285     $ 2,789,250     $ 2,175,970  
 
Percent of total volume
    44 %     51 %     44 %
 
Average initial loan balance
  $ 109,370     $ 110,308     $ 118,137  
Other(2)
                       
 
Number of loans
    13,956       12,460       8,790  
 
Volume of loans
  $ 1,354,184     $ 1,297,911     $ 1,108,074  
 
Percent of total volume
    25 %     24 %     23 %
                   
Total loans
                       
 
Number of loans
    51,488       50,399       41,641  
                   
 
Volume of loans
  $ 5,480,014     $ 5,465,797     $ 4,900,937  
                   
 
(1)  Includes $224 million, $160 million, and $79 million in second mortgages for the years ended December 31, 2005, 2004 and 2003, respectively.
 
(2)  Consists of construction loans on residential projects, mortgage loans secured by multifamily and commercial properties as well as other commercial, land, and consumer loans.
      A substantial portion of Doral Financial’s total residential mortgage loan originations has consistently been composed of refinancings. For the years ended December 31, 2005, 2004, and 2003, refinancings represented approximately 53%, 55%, and 62%, respectively, of the total dollar volume of internally originated mortgage loans. Doral Financial’s future results could be adversely affected by a significant increase in mortgage interest rates that may reduce refinancing activity. However, the Company believes that refinancing activity in Puerto Rico is less sensitive to interest rate changes than in the mainland United States because a significant number of refinance loans in the Puerto Rico mortgage market are made for debt consolidation purposes rather than interest savings due to lower rates.

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Loan Origination Channels
      In Puerto Rico, Doral Financial relies primarily on its extensive retail mortgage banking and bank branch network to originate loans. It supplements these originations with wholesale purchases from other financial institutions. Purchases generally consist of conventional mortgage loans. Doral Financial also originates consumer, commercial, construction and land loans primarily through its banking subsidiaries. In Puerto Rico, Doral Financial maintains a specialized unit that works closely with housing project developers and originates mortgage loans to finance the acquisition of homes in new residential developments.
      The following table sets forth the sources of Doral Financial’s loan production as a percentage of total loan originations for the years indicated:
Table I — Loan Origination Sources
                                                         
    Year Ended December 31,
     
    2005   2004   2003
             
    Puerto Rico   U.S.   Total   Puerto Rico   U.S.   Total   Total
                             
Retail
    70 %     1 %     71 %     68 %           68 %     70%  
Wholesale(1)
    8 %           8 %     11 %           11 %     10%  
New Housing Developments
    10 %     2 %     12 %     13 %     2 %     15 %     14%  
Multifamily
                                        2%  
Other(2)
    7 %     2 %     9 %     5 %     1 %     6 %     4%  
 
(1)  Refers to purchases of mortgage loans from other financial institutions and mortgage lenders.
 
(2)  Refers to commercial, consumer and land loans originated through the banking subsidiaries and other specialized units.
Mortgage Loan Servicing
      Doral Financial’s principal source of servicing rights has traditionally been sales of loans from its internal mortgage loan production. However, Doral Financial also purchases mortgage loans on a servicing-released basis as well as servicing rights in bulk. During the years ended December 31, 2005, 2004, and 2003, Doral Financial purchased servicing rights to approximately $229.0 million, $266.6 million, and $616.0 million, respectively, in principal amount of mortgage loans. Doral Financial intends to continue growing its mortgage-servicing portfolio by internal loan originations and wholesale purchases of loans with the related servicing rights, but will also continue to consider attractive opportunities for bulk purchases of servicing rights from third parties.

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      The following table sets forth certain information regarding the total mortgage loan-servicing portfolio:
Table J — Mortgage Loan Servicing
                           
    Year Ended December 31,
     
(Dollars in thousands, except for average size of loans prepaid)   2005   2004   2003
             
Composition of Servicing Portfolio at Year End:
                       
GNMA
  $ 2,193,541     $ 2,451,039     $ 2,729,132  
FHLMC/ FNMA
    4,209,561       3,656,712       3,483,173  
Doral Financial grantor trusts
          12,999       37,225  
Other conventional mortgage loans(1)(2)
    9,324,502       8,143,617       6,440,714  
                   
 
Total servicing portfolio
  $ 15,727,604     $ 14,264,367     $ 12,690,244  
                   
Servicing Portfolio Activity:
                       
Beginning servicing portfolio
  $ 14,264,367     $ 12,690,244     $ 11,241,523  
Add:
                       
 
Loans funded and purchased(3)
    4,224,348       4,141,931       3,723,566  
 
Bulk servicing acquired
    229,022       266,638       616,028  
Less:
                       
 
Servicing sales
    15,032       4,029       2,450  
 
Run-off(4)
    2,975,101       2,830,417       2,888,423  
                   
 
Ending servicing portfolio
  $ 15,727,604     $ 14,264,367     $ 12,690,244  
                   
Selected Data Regarding Mortgage Loans Serviced:
                       
Number of loans
    173,956       162,196       150,553  
Weighted-average interest rate
    7.02 %     6.76 %     7.03 %
Weighted-average remaining maturity (months)
    257       258       258  
Weighted-average gross servicing fee rate
    0.3852 %     0.3835 %     0.3873 %
Average-servicing portfolio
  $ 15,168,446     $ 13,558,766     $ 12,057,231  
Principal prepayments
  $ 2,348,000     $ 2,333,000     $ 2,391,000  
Constant prepayment rate
    13 %     15 %     17 %
Average size of loans
  $ 90,411     $ 87,945     $ 84,291  
Servicing assets, net
  $ 150,576     $ 123,586     $ 128,920  
Delinquent Mortgage Loans and Pending Foreclosures at Year End:
                       
60-89 days past due
    1.24 %     1.01 %     1.06 %
90 days or more past due
    1.71 %     1.55 %     1.90 %
                   
 
Total delinquencies excluding foreclosures
    2.95 %     2.56 %     2.96 %
                   
Foreclosures pending
    1.64 %     1.62 %     1.72 %
                   
 
(1)  Includes $5.9 billion, $5.2 billion, and $4.3 billion of loans owned by Doral Financial at December 31, 2005, 2004 and 2003, respectively, which represented 38%, 37%, and 34%, respectively, of the total servicing portfolio as of such dates.
 
(2)  Includes portfolios of $286.1 million, $333.7 million, and $261.4 million at December 31, 2005, 2004 and 2003, respectively, of delinquent FHA/ VA and conventional mortgage loans sold to third parties.
 
(3)  Excludes approximately $1.3 billion, $1.3 billion, and $1.2 billion for the years ended December 31, 2005, 2004 and 2003, respectively, of commercial, consumer, construction and other non-mortgage loans originated by Doral Financial but not considered part of the mortgage-servicing portfolio.
 
(4)  Run-off refers to regular amortization of loans, prepayments and foreclosures.

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     Most of the mortgage loans in Doral Financial’s servicing portfolio are secured by single (one-to-four) family residences located in Puerto Rico. At December 31, 2005, 2004 and 2003 less than 2% of Doral Financial’s mortgage-servicing portfolio was related to mortgages secured by real property located on the U.S. mainland.
      The amount of principal prepayments on mortgage loans serviced by Doral Financial was $2.3 billion, $2.3 billion, and $2.4 billion for the years ended December 31, 2005, 2004 and 2003, respectively. Doral Financial attempts to mitigate the sensitivity of its servicing income to increases in prepayment rates through a strong retail origination network that has permitted Doral Financial to increase the size of its servicing portfolio even during periods of declining interest rates and high prepayments.
Mortgage Loans Held for Sale
      Substantially all of the residential mortgage loans originated by Doral Financial mortgage banking units are classified as held for sale because Doral Financial intends to sell these loans in the ordinary course of its mortgage banking business. Mortgage loans held for sale are carried on Doral Financial’s Consolidated Statements of Financial Condition at the lower of net cost or market value on an aggregate portfolio basis. Market values are determined by reference to market prices for comparable mortgage loans, adjusted by the portfolio credit risk. The amount by which costs exceed market value, if any, is accounted for as a loss during the period in which the change in valuation occurs. Given traditional consumer preferences in Puerto Rico, substantially all of Doral Financial’s residential mortgage loans held for sale are fixed-rate loans. Note 9 to Doral Financial’s consolidated financial statements contains additional information with respect to Doral Financial’s portfolio of mortgage loans held for sale.
      As of December 31, 2005, Doral Financial owned approximately $5.3 billion in mortgage loans held for sale, of which approximately $4.7 billion consisted of residential mortgage loans. This amount includes $3.5 billion of mortgage loans pledged to secure financing agreements with local financial institutions.
      GNMA programs allow financial institutions to buy back individual delinquent mortgage loans that meet certain criteria from the securitized loan pool for which the Company provides servicing. At the Company’s option and without GNMA prior authorization, Doral Financial may repurchase such delinquent loan for an amount equal to 100% of the loan’s remaining principal balance. This buy-back option is considered a conditional option until the delinquency criteria are met, at which time the option becomes unconditional. When the loans backing a GNMA security are initially securitized, the Company treats the transaction as a sale for accounting purposes and the loans are removed from the balance sheet because the conditional nature of the buy-back option means that the Company does not maintain effective control over the loans. When individual loans later meet GNMA’s specified delinquency criteria and are eligible for repurchase, Doral Financial is deemed to have regained effective control over these loans. In such case, for financial reporting purposes, the delinquent GNMA loans are brought back onto the Company’s mortgage loans held for sale portfolio, regardless of whether the Company intends to exercise the buy-back option. An offsetting liability is also recorded. As of December 31, 2005, the mortgage loans held for sale portfolio includes $74.0 million related to GNMA defaulted loans, compared to $71.2 million as of December 31, 2004.
Loans Receivable
      Doral Financial originates mortgage loans secured by income-producing residential and commercial properties, construction loans, land loans, certain residential mortgage loans and other commercial and consumer loans that are held for investment and classified as loans receivable. Loans receivable are originated primarily through Doral Financial’s banking subsidiaries. During 2005 and 2004, the Company experienced significant increases in its commercial loan activity. Commercial loans secured by real estate include $448.0 million and $200.1 million as of December 31, 2005 and 2004, respectively, resulting from mortgage transfers from a local financial institutions that were subsequently recharacterized as commercial loans. Also, during 2004, the Company entered into the auto and equipment finance leasing business

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through Doral Leasing, a division of Doral Bank — PR. A significant portion of Doral Financial’s loans receivable represent loans made to entities or individuals located in Puerto Rico.
      The maximum aggregate amount in unsecured loans that Doral Bank — PR could make to a single borrower under Puerto Rico banking regulations as of December 31, 2005, was approximately $65.2 million. Puerto Rico banking regulations permit larger loans to a single borrower to the extent secured by qualifying collateral. The maximum aggregate amount in loans that Doral Bank — NY could make to a single borrower under the OTS banking regulations as of December 31, 2005, was $9.1 million. Doral Financial’s largest aggregate authorized indebtedness to a single borrower or group of related borrowers as of December 31, 2005, was $448.0 million, and consists principally of loans secured by real estate mortgages that resulted from the recharacterization of certain mortgage loan transfers from a local financial institution as commercial loans secured by mortgages. The impact of such recharacterization on applicable loan-to-one-borrower limitations is not clear. Accordingly, Doral Bank — PR has requested an administrative ruling from the Office of the Commissioner providing a temporary waiver from continued compliance with applicable loan-to-one-borrower limitations with respect to this transaction. As of the date of the filing of this Annual Report on Form 10-K, the Company had not received a response from the Office of the Commissioner. Doral Financial’s largest aggregated indebtedness to a single borrower or a group of borrowers other than the recharacterized secured borrowings mentioned above is $63.3 million.
      The following table sets forth certain information regarding Doral Financial’s loans receivable:
Table K — Loans Receivable, Net
                                           
    As of December 31,
     
(In thousands)   2005   2004   2003   2002   2001
                     
Construction loans
  $ 795,848     $ 629,913     $ 603,909     $ 465,020     $ 358,659  
Residential mortgage loans
    514,164       409,005       529,147       282,059       63,546  
Commercial — secured by real estate
    891,795       568,842       152,016       138,270       123,414  
Consumer — secured by real estate
          320       375       821       870  
Consumer — other
    81,464       70,579       66,516       62,279       39,109  
Lease financing receivable
    44,636       7,488                    
Commercial non-real estate
    142,909       36,848       22,006       13,291       16,874  
Loans on savings deposits
    15,082       9,354       8,769       8,720       10,523  
Land secured
    50,358       51,853       65,818       79,996       46,602  
                               
 
Loans receivable, gross
    2,536,256       1,784,202       1,448,556       1,050,456       659,597  
                               
Less:
                                       
 
Unearned interest and deferred loan fees, net
    (23,252 )     (15,622 )     (21,052 )     (18,777 )     (7,778 )
 
Allowance for loan and lease losses
    (35,044 )     (20,881 )     (14,919 )     (7,364 )     (4,459 )
                               
      (58,296 )     (36,503 )     (35,971 )     (26,141 )     (12,237 )
                               
 
Loans receivable, net
  $ 2,477,960     $ 1,747,699     $ 1,412,585     $ 1,024,315     $ 647,360  
                               

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      The following table sets forth certain information as of December 31, 2005, regarding the dollar amount of Doral Financial’s loans receivable portfolio based on the remaining contractual maturity. Expected maturities may differ from contractual maturities because of prepayments and other market factors. Loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less.
Table L — Loans Receivable by Contractual Maturities
                                   
    As of December 31, 2005
     
    1 Year or   1 to    
(In thousands)   Less   5 Years   Over 5 Years   Total
                 
Construction loans
  $ 515,554     $ 208,628     $ 71,666     $ 795,848  
Residential mortgage loans
    6,954       61,651       445,559       514,164  
Commercial — secured by real estate
    70,364       242,027       579,404       891,795  
Consumer — secured by real estate
                       
Consumer — other
    51,439       29,877       148       81,464  
Lease financing receivable
    18       33,231       11,387       44,636  
Commercial non-real estate
    38,980       102,518       1,411       142,909  
Loans on savings deposits
    8,428       6,626       28       15,082  
Land secured
    30,702       3,709       15,947       50,358  
                         
 
Loans receivable, gross
  $ 722,439     $ 688,267     $ 1,125,550     $ 2,536,256  
                         
      Scheduled contractual amortization of loans receivable does not reflect the expected life of Doral Financial’s loans receivable portfolio. The average life of these loans is substantially less than their contractual terms because of prepayments and, with respect to conventional mortgage loans, due-on-sale clauses, which give Doral Financial the right to declare a conventional mortgage loan immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid. The average life of mortgage loans tends to increase when current mortgage loan rates are higher than rates on existing mortgage loans and, conversely, decrease when current mortgage loan rates are lower than rates on existing mortgage loans. Under the latter circumstance, the weighted-average yield on loans decreases as higher-yielding loans are repaid or refinanced at lower rates.
      The following table sets forth the dollar amount of total loans receivable at December 31, 2005, as shown in the preceding table, which have fixed interest rates or which have floating or adjustable interest rates.
Table M — Loans Receivable by Fixed and Floating or Adjustable Rates
                                   
        Due After One Year    
             
            Floating or    
    1 Year or       Adjustable-    
(In thousands)   Less   Fixed-Rate   Rate   Total
                 
Construction loans
  $ 515,554     $ 118,631     $ 161,663     $ 795,848  
Residential mortgage loans
    6,954       507,210             514,164  
Commercial — secured by real estate
    70,364       364,037       457,394       891,795  
Consumer — secured by real estate
                       
Consumer — other
    51,439       29,938       87       81,464  
Lease financing receivable
    18       44,618             44,636  
Commercial non-real estate
    38,980       103,643       286       142,909  
Loans on savings deposits
    8,428       6,654             15,082  
Land secured
    30,702       19,306       350       50,358  
                         
 
Loans receivable, gross
  $ 722,439     $ 1,194,037     $ 619,780     $ 2,536,256  
                         

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      Doral Financial originates floating or adjustable and fixed interest-rate loans. Unlike its portfolio of residential mortgage loans, which is comprised almost entirely of fixed rate mortgage loans, a significant portion of Doral Financial’s construction, land, and other commercial loans classified as loans receivable carry adjustable rates. At December 31, 2005, 2004 and 2003, approximately 44%, 52%, and 40%, respectively, of Doral Financial’s gross loans receivable were adjustable rate loans. The adjustable rate construction, commercial and land loans have interest rate adjustment limitations and are generally tied to the prime rate, and often provide for a maximum and minimum rate beyond which the applicable interest rate will not fluctuate. Future market factors may affect the correlation of the interest rate adjustment with the rate Doral Financial pays on the different funding sources used to finance these loans. Substantially all construction, commercial and land loans held by Doral Financial are adjustable rate loans maturing, generally, within 10 to 70 months. Note 10 to Doral Financial’s consolidated financial statements contains additional information with respect to Doral Financial’s portfolio of loans receivable.
Investment and Trading Activities
      As part of its mortgage securitization activities, Doral Financial is involved in the purchase and sale of mortgage-backed securities. In the past, Doral Financial also engaged in purchases and sales of whole loans and securities primarily through its international banking entity subsidiary. During the third quarter of 2005, Doral Financial made the determination to terminate its program of purchasing loans in bulk without the associated servicing rights. At December 31, 2005, Doral Financial held securities for trading with a fair market value of $388.7 million, approximately $206.4 million of which consisted of Puerto Rico tax-exempt GNMA securities. These tax-exempt securities are generally held by Doral Financial for longer periods prior to sale in order to maximize the tax-exempt interest received thereon. Securities held for trading are reflected on Doral Financial’s consolidated financial statements at their fair market value with resulting gains or losses included in current period earnings as part of net gain (loss) on securities held for trading. The fair values of Doral Financial’s tax-exempt GNMA securities are based on quotations obtained from local broker-dealers. Refer to “Critical Accounting Policies — Valuation of Trading Securities and Derivatives” for additional information on how Doral Financial determines the fair values of its trading securities.
      As part of its strategy to diversify its revenue sources and maximize net interest income, Doral Financial also invests in securities that are classified as available for sale or held to maturity. As of December 31, 2005, Doral Financial held $4.6 billion of investment securities that were classified as available for sale and reported at fair value based on quoted market prices, with unrealized gains or losses included in stockholders’ equity and reported as accumulated other comprehensive income (loss), net of income tax (expense) benefit in Doral Financial’s consolidated financial statements. Of this amount, approximately 99.97% was held at Doral Financial’s banking subsidiaries. At December 31, 2005, Doral Financial had unrealized losses in AOCI of $125.5 million, compared to unrealized losses of $73.7 million at December 31, 2004 related to its available for sale portfolio. The Company evaluates for impairment its investment securities at least quarterly or earlier if other factors indicative of potential impairment exist. An impairment charge in the consolidated statements of income is recognized when the decline in the fair value of the securities below their cost basis is judged to be other-than-temporary. The Company evaluates for other than temporary impairment in accordance with FASB Staff Position FAS115-1/124-1: “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments,” which requires that the Company considers various factors in determining whether it should recognize an impairment charge, including, but not limited to the length of time and extent to which the fair value has been below cost basis, the expectations for the security’s performance, the creditworthiness of the issuer, and the Company’s intention and ability to hold the security until maturity. The unrealized losses in the Company’s investment securities are almost entirely related to increases in interest rates, which tend to reduce the value of fixed rate securities, and not credit concerns. Most of the Company’s securities are either U.S. government agency or mortgage-backed securities that are highly rated. No individual securities position has unrealized losses in excess of 7.5% of its amortized cost. Moreover, the Company understands that it has adequate liquidity at its banking subsidiaries, where most of the securities are held, to continue to hold these securities. Based on these factors, management has concluded that the existing

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impairments as of December 31, 2005 were temporary and no impairment charge was reported in the Consolidated Statements of Income. See Part I, Item 1. Business “— Recent Significant Events” for discussion of the Company’s future business strategy, which involves an increased emphasis on lending activities and decreased emphasis on investment in securities.
      As of December 31, 2005, Doral Financial held approximately $2.1 billion in securities that are classified as held to maturity and reported at amortized cost.
      The following table summarizes Doral Financial’s securities holdings as of December 31, 2005.
Table N — Investment Securities
                                   
                Total
    Held for   Available for   Held to   Investment
(In thousands)   Trading   Sale   Maturity   Securities
                 
Mortgage-backed securities
  $ 272,712     $ 3,499,130     $ 352,255     $ 4,124,097  
Variable interest-only strips
    72,550                   72,550  
Fixed interest-only strips
    1,484                   1,484  
U.S. Treasury
          1,022,391       675,265       1,697,656  
U.S. government sponsored agency obligation
    11,156       110,052       1,049,619       1,170,827  
Puerto Rico government obligations
    5,510             19,135       24,645  
Other
    25,264             3,420       28,684  
                         
 
Total
  $ 388,676     $ 4,631,573     $ 2,099,694     $ 7,119,943  
                         
      For additional information regarding the composition of Doral Financial’s investment securities, please refer to Notes 5, 6 and 7 of Doral Financial’s consolidated financial statements.
Liquidity and Capital Resources
      Doral Financial has an ongoing need for capital to finance its lending, servicing and investing activities. This need is expected to increase as the volume of its loan originations and investing activity increases. Doral Financial’s cash requirements arise mainly from loan originations and purchases, purchases and holding of securities, repayments of debt upon maturity, payments of operating and interest expenses, servicing advances and loan repurchases pursuant to recourse or warranty obligations.
      Doral Financial’s capital resources and financing costs have been affected by a number of factors as a result of the restatement process, including the downgrade of its credit ratings, its inability to access the capital markets, the decision of a substantial majority of its unsecured creditors not to renew committed credit facilities and the termination of commitments to sell non-conforming mortgage loans in the local market, as well as extraordinary legal, accounting and other expenses. The decrease in Doral Financial’s credit ratings could make it more difficult for Doral Financial to sell non-conforming loans subject to recourse provisions since the purchasers of loans subject to recourse provisions rely in part on the credit of Doral Financial when purchasing such loans. A decrease in recourse sales could adversely affect the liquidity of Doral Financial because the secondary market for non-conforming loans is not as liquid as the secondary market for loans that qualify for the sale or guarantee programs of FHA, VA, FNMA and FHLMC. The decrease in Doral Financial’s credit ratings has and may continue to adversely affect its liquidity because lending institutions have been and may continue to be less inclined to renew or enter into new lending arrangements with Doral Financial or demand higher collateral requirements. In addition, counterparties to repurchase agreements used for funding loan origination activities or to derivative contracts used for interest rate risk management purposes have and could further increase the applicable margin requirements under such agreements.

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      On April 25, 2006, Doral Financial announced that, as a prudent capital management decision designed to preserve and strengthen the Company’s capital, the Board of Directors voted to suspend the quarterly dividend on the Company’s common stock.
      Since the second half of 2005, Doral Financial has relied on deposits, short-term borrowings under FHLB advances and repurchase agreements secured by pledges of its mortgage loans and mortgage-backed securities, sales of mortgage loans in the secondary markets to agencies or U.S. financial institutions as its principal sources of liquidity. During the fourth quarter of 2005, the Company sold approximately $1.2 billion in treasury and mortgage-backed securities in order to improve liquidity and strengthen its capital ratios. As of the date of this Annual Report, Doral Financial expects that it will continue to have adequate liquidity, financing arrangements and capital resources to finance its operations during 2006. The Company’s greatest liquidity challenge will be to refinance $625 million of its floating rates senior notes that mature in July 2007. Doral Financial does not anticipate that it will have sufficient sources of internal liquidity to repay this indebtedness at maturity. Accordingly, it is currently reviewing a number of possible alternatives to refinance this indebtedness. The resolution of the ongoing SEC proceedings and civil class actions may also require the payment of fines, settlements, damages or other amounts, which would place additional demands and stress on Doral Financial’s liquidity.
      Doral Financial has been engaged in discussions with the staff of the SEC regarding a possible resolution to its investigation of the Company’s restatement, and has reserved $25 million in its consolidated financial statements for the year ended December 31, 2005 in connection with a potential settlement of the SEC’s investigation of the Company. Any settlement is subject to acceptance and authorization by the Commission. There can be no assurance that the Company’s efforts to resolve the SEC’s investigation with respect to the Company will be successful, or that the amount reserved will be sufficient, and the Company cannot predict the timing or the final terms of any settlement.
      Banking regulators place restrictions on the ability of Doral Financial’s non-banking operations to rely on the liquidity of its banking subsidiaries. Moreover, on March 17, 2006, the Company and its principal Puerto Rico Banking subsidiary, Doral Bank — PR, entered into consent orders with the Board of Governors of the Federal Reserve System, the FDIC and the Office of the Commissioner, which prohibit the Company’s banking subsidiaries from paying dividends to the parent company, and prohibit Doral Financial from paying dividends to its common and preferred shareholders, without regulatory approval. As a result of Doral Financial’s holding company structure, its deposits and substantially all of its investment securities are held by its banking subsidiaries. For a detailed description of these orders, please refer to Part I, Item 3. Legal Proceedings, in this Form 10-K.
      Servicing agreements relating to the mortgage-backed securities programs of FNMA, FHLMC and GNMA, and to mortgage loans sold to certain other investors, require Doral Financial to advance funds to make scheduled payments of principal, interest, taxes and insurance, if such payments have not been received from the borrowers. While Doral Financial generally recovers funds advanced pursuant to these arrangements within 30 days, it must absorb the cost of the funds it advances during the time the advance is outstanding. At December 31, 2005 and 2004, advances to investors were $43.9 million and $32.5 million, respectively. During the years ended December 31, 2005 and 2004, the monthly average amount of funds advanced by Doral Financial under such servicing agreements was approximately $36.0 million and $26.2 million, respectively. To the extent the mortgage loans underlying Doral Financial’s servicing portfolio experience increased delinquencies, Doral Financial would be required to dedicate additional cash resources to comply with its obligation to advance funds as well as incur additional administrative costs related to increases in collection efforts. In recent years, Doral Financial has sold pools of delinquent FHA and VA and conventional mortgage loans. Under these arrangements, Doral Financial is required to advance the scheduled payments whether or not collected from the underlying borrower. While Doral Financial expects to recover the amounts advanced through foreclosure or, in the case of FHA/ VA loans, under the applicable FHA and VA insurance and guarantee programs, the amounts advanced tend to be greater than normal arrangements because of the delinquent status of the loans. As of December 31, 2005, and 2004, the outstanding principal balance of such delinquent loans was $286.1 million and $333.7 million, respectively, and the aggregate monthly average amount of funds

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advanced by Doral Financial on such delinquent loans was $21.9 million and $26.1 million, respectively. During the year ended December 31, 2004, the Company sold approximately $44.4 million of residential FHA-insured or VA-guaranteed delinquent loans and $67.0 million of conventional residential mortgage loans to third parties. There were no delinquent loan sales in 2005.
      When Doral Financial sells mortgage loans to third parties it generally makes customary representations and warranties regarding the characteristics of the loans sold. To the extent Doral Financial breaches any of these warranties, investors are generally entitled to cause Doral Financial to repurchase the loan subject of the breach.
      In addition to its servicing and warranty obligations, Doral Financial’s loan sale activities include the sale of some non-conforming mortgage loans subject to recourse arrangements that generally require Doral Financial to repurchase or substitute the loans if the loans are 90 days or more past due or otherwise in default up to a specified amount or limited to a period of time after the sale. To the extent the delinquency ratios of the loans sold subject to recourse are greater than anticipated, and Doral Financial is required to repurchase more loans than anticipated, Doral Financial’s liquidity requirements would increase. See “Off-Balance Sheet Activities” for additional information on these arrangements.
      From time to time, Doral Financial also sells or securitizes mortgage loans with FNMA on a partial or full recourse basis. Doral Financial’s contractual agreements with FNMA authorize FNMA to require Doral Financial to post collateral in the form of cash or marketable securities to secure such recourse obligation to the extent Doral Financial does not maintain an investment grade rating. As of December 31, 2005, Doral Financial’s maximum recourse exposure with FNMA amounted to $980.6 million and FNMA required the posting of approximately $45.0 million in cash collateral to secure recourse obligations. While deemed unlikely by Doral Financial, FNMA has the contractual right to request collateral for the full amount of Doral Financial’s recourse obligations. Any such request by FNMA would have a material adverse effect on Doral Financial’s liquidity and business.
      The table below shows Doral Financial’s sources of borrowings and the related average interest rate as of December 31, 2005, and 2004. Refer to Notes 17 and 19 to Doral Financial’s consolidated financial statements for additional information regarding Doral Financial’s repurchase agreements and warehouse lines of credit.
Table O — Sources of Borrowings
                                 
    As of December 31,
     
    2005   2004
         
    Outstanding   Average   Outstanding   Average
(Dollars in thousands)   Balance   Rate   Balance   Rate
                 
Deposits
  $ 4,237,269       2.98 %   $ 3,643,080       2.47 %
Repurchase agreements
    6,054,598       4.08 %     6,305,163       2.73 %
Advances from the FHLB
    969,500       4.08 %     1,294,500       3.98 %
Loans payable
    3,578,230       5.75 %     3,638,507       3.68 %
Notes payable
    965,621       5.86 %     1,095,977       4.38 %
      As of December 31, 2005, Doral Financial had collateralized warehousing, gestation and repurchase agreement lines of credit (including advances from the FHLB-NY) totaling $13.9 billion of which $7.0 billion was outstanding under these facilities at year end. Of the aggregate amount of funding available under Doral Financial’s warehousing and repurchase lines of credit, only approximately $300 million represented committed facilities under which the lender is committed to advance funds subject to compliance with various conditions. The remainder was represented by uncommitted facilities, under which the lender does not have a binding legal obligation to disburse funds to the Company. Until the uncertainty surrounding the restatement process is resolved, it will be more difficult for Doral Financial to obtain committed credit facilities. Committed lines of credit generally require a borrower to comply with various financial covenants and ratios. Failure to comply with any of these covenants permits the

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lender to require immediate repayment of all amounts previously advanced and to stop making further advances to Doral Financial.
      Doral Financial has also obtained liquidity in the capital markets through public and private offerings of its debt securities, although it has not offered debt securities since April 2005 when it announced the decision to restate its financial statements and does not expect to be able to do so until at least after it is current in its SEC filings. For example, on June 7, 2004, Doral Financial sold $115.0 million of its floating rate senior notes due December 7, 2005, and on July 20, 2004, sold $350.0 million of its floating rate senior notes due July 20, 2007. On September 1, 2004, and September 20, 2004, Doral Financial sold an additional $125.0 million and $150.0 million, respectively, of its floating rate senior notes due July 20, 2007. The $740.0 million aggregate principal amount of floating rate senior notes issued during 2004 were sold at an average price to the public of 100.084% of the principal amount thereof, resulting in proceeds to Doral Financial of approximately $739.3 million, after selling commissions but before expenses.
      Under Doral Financial’s repurchase lines of credit and derivative contracts, Doral Financial is required to deposit cash or qualifying securities to meet margin requirements. To the extent that the value of securities previously pledged as collateral declines because of changes in interest rates, Doral Financial will be required to deposit additional cash or securities to meet its margin requirements, thereby adversely affecting its liquidity.
      A considerable amount of Doral Financial’s liquidity is derived from the sale of mortgage loans in the secondary mortgage market. The U.S. (including Puerto Rico) secondary mortgage market is the most liquid in the world in large part because of the sale or guarantee programs maintained by FHA, VA, HUD, FNMA and FHLMC. To the extent these programs are curtailed or the standard for insuring or selling loans under such programs is materially increased, or for any reason Doral Financial failed to qualify for such programs, Doral Financial’s ability to sell mortgage loans, and consequently its liquidity, would be materially adversely affected.
      Doral Financial maintains an investment in MSRs and IOs generated as part of its mortgage sale activities. While the servicing assets and IOs are recorded at the time of sale of the related mortgage loans, the cash related to such retained interest is received over the life of the asset and, therefore, does not generally provide immediate liquidity that is available to Doral Financial to fund its operations or to pay dividends.
      Doral Financial’s banking subsidiaries obtain funding for their lending activities through the receipt of deposits, advances from the FHLB and from other borrowings, such as term notes backed by FHLB-NY letters of credit. As of December 31, 2005, Doral Financial’s banking subsidiaries held approximately $4.2 billion in deposits at an average interest rate of 2.98%. For additional information regarding deposit accounts and advances from the FHLB, see Notes 16 and 18 to Doral Financial’s consolidated financial statements.
      The following table presents the average balance and the annualized average rate paid on each deposit type for the years indicated.
Table P — Average Deposit Balance
                                                   
    Year Ended December 31,
     
    2005   2004   2003
             
    Average   Average   Average   Average   Average   Average
(Dollars in thousands)   Balance   Rate   Balance   Rate   Balance   Rate
                         
Certificates of deposit
  $ 2,248,530       3.56 %   $ 1,829,370       3.15 %   $ 1,535,835       3.50 %
Regular passbook savings
    476,600       2.34 %     416,928       2.27 %     268,990       2.51 %
NOW accounts
    673,755       2.22 %     634,486       2.15 %     497,277       2.19 %
Non-interest bearing
    442,940             359,212             349,531        
                                     
 
Total deposits
  $ 3,841,825       2.76 %   $ 3,239,996       2.49 %   $ 2,651,633       2.69 %
                                     

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      The following table sets forth the maturities of certificates of deposit having principal amounts of $100,000 or more at December 31, 2005.
Table Q — Certificates of Deposit Maturities
           
(In thousands)   Amount
     
Certificates of deposit maturing:
       
 
Three months or less
  $ 276,710  
 
Over three through six months
    305,803  
 
Over six through twelve months
    680,026  
 
Over twelve months
    1,066,638  
       
 
Total
  $ 2,329,177  
       
      As of December 31, 2005 and 2004, Doral Financial’s retail banking subsidiaries had approximately $1.9 billion and $1.3 billion, respectively, in brokered deposits obtained through broker-dealers. Brokered deposits are used by Doral Financial’s banking subsidiaries as a source of long-term funds. Brokered deposits, however, are generally considered a less stable source of funding than core deposits obtained through retail bank branches. Brokered-deposit investors are generally very sensitive to interest rates and will generally move funds from one depository institution to another based on minor differences in rates offered on deposits.
      Doral Financial’s banking subsidiaries, as members of the FHLB-NY, have access to collateralized borrowings from the FHLB-NY up to a maximum of 30% of total assets. Advances and reimbursement obligations with respect to letters of credit must be secured by qualifying assets with a market value of 110% of the advances or reimbursement obligations. At December 31, 2005, Doral Financial’s banking subsidiaries had $969.5 million in outstanding advances from the FHLB-NY at a weighted-average interest rate cost of 4.08%. See Note 18 to Doral Financial’s consolidated financial statements for additional information regarding such advances.
Regulatory Capital Ratios
      As of December 31, 2005, Doral Financial, Doral Bank — PR and Doral Bank — NY were in compliance with all the regulatory capital requirements that were applicable to them as a financial holding company, state non-member bank and federal savings bank, respectively, (i.e., total capital and Tier 1 capital to risk-weighted assets of at least 8% and 4%, respectively, and Tier 1 capital to average assets of at least 4%) to be considered as an adequately capitalized institution. Set forth below are Doral Financial’s, and its banking subsidiaries’ regulatory capital ratios as of December 31, 2005, based on existing Federal Reserve, FDIC and OTS guidelines.
Table R — Regulatory Capital Ratios
                                 
        Banking Subsidiaries
         
            Well-
    Doral   Doral   Doral   Capitalized
    Financial   Bank — PR   Bank — NY   Minimum
                 
Total capital (Total capital to risk-weighted assets)
    12.7 %     19.9 %     17.2 %     10.0 %
Tier 1 capital ratio (Tier 1 capital to risk-weighted assets)
    11.7 %     19.1 %     16.7 %     6.0 %
Leverage ratio(1)
    5.5 %     6.3 %     9.5 %     5.0 %
 
(1)  Tier 1 capital to average assets in the case of Doral Financial and Doral Bank — PR and Tier 1 capital to adjusted total assets in the case of Doral Bank — NY.

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      Doral Financial’s regulatory capital ratios as of December 31, 2005 declined, when compared to 2004, due to significant asset growth that was not accompanied with a proportional capital growth. The higher volume of risk-weighted assets during 2005, which increased by 13% compared to 2004, was principally attributable to significant increases in the Company’s loan portfolios, in particular the commercial and construction, and residential loan portfolios. Also, while the Tier 1 and Total capital ratios have risk weighting components that take into account the low level of risk associated with the Company’s mortgage and securities portfolios, the leverage ratio is significantly lower because it is based on total average assets without any risk weighting. Refer to Note 3 to Doral Financial’s consolidated financial statements for additional information regarding the regulatory capital ratios.
      As of December 31, 2005, Doral Bank — PR and Doral Bank — NY were considered well-capitalized banks for purposes of the prompt corrective action regulations adopted by the FDIC pursuant to the FDICIA. To be considered a well-capitalized institution under the FDIC’s regulations, an institution must maintain a Leverage Ratio of at least 5%, a Tier 1 Capital Ratio of at least 6% and a Total Capital Ratio of at least 10%, and not be subject to any written agreement or directive to meet a specific capital ratio.
      Failure to meet minimum regulatory capital requirements could result in the initiation of certain mandatory and additional discretionary actions by banking regulators against Doral Financial and its banking subsidiaries that, if undertaken, could have a material adverse effect on Doral Financial. Doral Financial anticipates that it will continue to comply with all applicable capital requirements.
      On March 17, 2006, Doral Financial and its principal Puerto Rico Banking subsidiary, Doral Bank — PR, entered into consent orders with the Board of Governors of the Federal Reserve System, the FDIC and the Office of the Commissioner. For a detailed description of these orders, please refer to Part  I, Item 3. Legal Proceedings, in this Form 10-K.
      Doral Securities is subject to regulatory capital requirements imposed by the SEC. At December 31, 2005, Doral Securities was in compliance with its applicable regulatory capital requirement.
Assets and Liabilities
      At December 31, 2005, Doral Financial’s total assets were $17.3 billion, compared to $17.8 billion at December 31, 2004. The slight decrease in total assets for 2005 was primarily due to decreases in cash and cash equivalents and investment securities portfolio, offset in part by increases in the loans portfolio. As of December 31, 2005, cash and money market accounts decreased by approximately $989.2 million compared to 2004, as a result of the Company’s strategy to maximize net interest income by retaining a higher percentage of the Company’s mortgage loan production and extraordinary legal, accounting and other expenses associated with the restatement process. At December 31, 2005, the investment securities portfolio decreased by approximately $667.2 million compared to 2004, as a result of the Company’s strategy to deleverage its investment portfolio. At December 31, 2005 the loans portfolio increased by $1.1 billion, as a result of Doral Financial’s strategy to retain a larger portion of its mortgage loan production to provide the Company with a more stable stream of earnings.
      Total liabilities were $16.1 billion at December 31, 2005, compared to $16.6 billion at December 31, 2004. The funding mix changed in 2005 to more reliance on loans payable and deposits, and less reliance on repurchase agreements and senior notes payable. Borrowings with local financial institutions secured by real estate mortgages increased to $3.5 billion at December 31, 2005, compared to $3.3 billion at December 31, 2004. At December 31, 2005, deposit accounts totaled $4.2 billion, compared to $3.6 billion at December 31, 2004. Due to the Company’s strategy to de-leverage its investment portfolio, at December 31, 2005 funding from repurchase agreements decreased by $250.6 million compared to the balance at December 31, 2004. On December 7, 2005, the Company paid in full $115 million of its floating rate senior note.
      As of December 31, 2005, Doral Financial’s banking subsidiaries had $11.6 billion in assets, including assets of Doral International, an international banking entity and wholly-owned subsidiary of Doral Bank — PR, compared to $11.7 billion at December 31, 2004.

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Off-Balance Sheet Activities
      In the past, the Company normally sold loans that did not qualify for the insurance or guarantee programs of FHA and VA, or the sale or exchange programs of FNMA or FHLMC (“non-conforming loans”) to local financial institutions on a recourse basis pursuant to which Doral Financial retains part of the credit risk associated with such loan after sale. Recourse is generally limited to a period of time (generally from four to seven years) or up to a specified percentage (generally 10% to 15%) of the principal amount of the loans sold. In addition, certain loans are sold to, or securitized through, FNMA and FHLMC on a full or partial recourse basis. As of December 31, 2005, the outstanding principal balance of loans sold subject to recourse was $2.4 billion. As of such date, the maximum contractual exposure in principal amount of loans that Doral Financial would have if all loans subject to recourse defaulted was $1.8 billion (see Table U — Other Commercial Commitments for a breakdown of recourse obligation by expiration period). Doral Financial’s contingent obligation with respect to such recourse provision is not reflected on Doral Financial’s consolidated financial statements, except for a liability of $17.2 million, as of December 31, 2005, for estimated losses from such recourse agreements, which is included as part of “Accrued expenses and other liabilities.” As of December 31, 2005, approximately $96.8 million or 4% of the principal amount in loans sold with recourse were 60 days or more past due, of which $66.2 million were 90 days or more past due.
      Set forth below is a breakdown of Doral Financial’s loans subject to recourse by loan type and weighted-average loan to value ratios as of December 31, 2005.
Table S — Loans Subject to Recourse by Loan Type
                           
            Loans Past Due — Over
            90 Days Without
    Outstanding   Weighted-Average   Insurance, and Loan-
(In thousands)   Balance   Loan to Value   To-Value Over 80%
             
Loan Type:
                       
 
FHA/ VA loans
  $ 19,057       90.1 %   $  
 
Conventional loans
    2,298,917       76.4 %     9,781  
 
Commercial loans
    102,740       79.1 %      
                   
Total
  $ 2,420,714       76.6 %   $ 9,781  
                   
      From time to time, Doral Financial has sold pools of delinquent FHA and VA and conventional mortgage loans, on a servicing retained basis. Following these transactions, the loans are not reflected on Doral Financial’s Consolidated Statements of Financial Condition. Under these arrangements, as part of its servicing responsibilities, Doral Financial is required to advance the scheduled payments of principal and interest whether or not collected from the underlying borrower. For additional information regarding sales of delinquent loans refer to “Liquidity and Capital Resources” above.
      Doral Financial is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments may include commitments to extend credit and sell mortgage-backed securities and loans. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the statement of financial position.
      The contractual amounts of these instruments reflect the extent of involvement Doral Financial has in particular classes of financial instruments. Doral Financial’s exposure to credit losses in the event of nonperformance by the other party to the financial instrument for commitments to extend credit or for forward sales is represented by the contractual amount of these instruments. Doral Financial uses the same credit policies in making these commitments as it does for on-balance sheet instruments. At December 31, 2005, commitments to extend credit and commercial and financial standby letters of credit amounted to approximately $522.1 million and $6.6 million, respectively, and commitments to sell mortgage-backed securities and loans amounted to approximately $186.0 million. Commitments to extend credit are

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agreements to lend to a customer as long as the conditions established in the contract are met. Commitments generally have fixed expiration dates or other termination clauses.
Contractual Obligations and Other Commercial Commitments
      The following tables summarize Doral Financial’s contractual obligations, on the basis of contractual maturity or first call date, whichever is earlier, and other commercial commitments as of December 31, 2005.
Table T — Contractual Obligations
                                           
(In thousands)   Payment Due by Period
     
        Less Than       After
Contractual Obligations(1)   Total   1 Year   1-3 Years   3-5 Years   5 Years
                     
Deposits
  $ 4,237,269     $ 3,083,931     $ 970,876     $ 168,173     $ 14,289  
Repurchase agreements(2)
    6,054,598       2,389,798       2,864,800       800,000        
Advances from the FHLB(2)
    969,500       622,500       297,000       50,000        
Loans payable(3)
    3,578,230       507,555       824,531       621,148       1,624,996  
Notes payable
    965,621       82,760       638,320       1,115       243,426  
Other liabilities
    349,752       345,065       3,687       1,000        
Non-cancelable operating leases
    72,157       8,401       14,675       12,559       36,522  
                               
 
Total Contractual Cash Obligations
  $ 16,227,127     $ 7,040,010     $ 5,613,889     $ 1,653,995     $ 1,919,233  
                               
 
(1)  Amounts included in the table above do not include interest.
 
(2)  Includes $3.4 billion of repurchase agreements with an average rate of 4.03% and $702.5 million in advances from the FHLB-NY with an average rate of 4.09%, which the lenders have the right to call before their contractual maturities. The majority of such repurchase agreements and advances from the FHLB-NY are included in the less than one year category in the above table but have actual contractual maturities ranging from February 2008 to March 2015. They are included on the first call date basis because increases in interest rates over the average rate of the Company’s callable borrowings may induce the lenders to exercise their call right.
 
(3)  Includes $3.5 billion of secured borrowings with local financial institutions, collateralized by real estate mortgage loans at variable interest rates tied to 3-month LIBOR. These loans are not subject to scheduled payments, but are expected to be repaid according to the regular amortization and prepayments of the underlying mortgage loans. For purposes of the table above, the Company used a CPR of 13.02% to estimate the repayments.
Table U — Other Commercial Commitments(1)
                                           
(In thousands)   Amount of Commitment Expiration Per Period
     
    Total Amount   Less Than       After
Other Commercial Commitments   Committed   1 Year   1-3 Years   3-5 Years   5 Years
                     
Commitments to extend credit
  $ 522,094     $ 309,087     $ 209,754     $ 1,964     $ 1,289  
Commitments to sell mortgage-backed securities and loans
    186,035       186,035                    
Commercial and financial standby letters of credit
    6,576       6,576                    
Maximum contractual recourse exposure
    1,769,301       80,341       776,199       544,971       367,790  
                               
 
Total
  $ 2,484,006     $ 582,039     $ 985,953     $ 546,935     $ 369,079  
                               
 
(1)  Refer to “Off-Balance Sheet Activities” for additional information regarding other commercial commitments of Doral Financial.

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RISK MANAGEMENT
      Doral Financial’s business is subject to four broad categories of risks: interest rate risk, credit risk, operational risk and liquidity risk. Doral Financial has adopted policies and procedures which have been designed to identify and manage risks to which the company is exposed specifically those relating to interest rate risk, credit risk, and operational risks.
Interest Rate and Market Risk Management
      Doral Financial’s management has identified interest rate risk as the primary risk facing the Company. Interest rate risk includes the risk that changes in interest rates may adversely affect the value of Doral Financial’s assets and liabilities. Interest rate risk also includes the risk that Doral Financial’s net interest income from its loan and investment portfolio will change in response to changes in interest rates.
      Doral Financial’s risk management policies are designed with the goal of maximizing long-term shareholder value and minimizing the impact of interest rate volatility. These policies are also designed to ensure the maintenance of adequate capitalization, liquidity, and other regulatory requirements. The objectives of Doral Financial’s risk management policies are pursued within the limits established by the Board of Directors of the Company. The Board of Directors has delegated the monitoring of interest rate and market risk to its Risk Policy Committee.
      Doral Financial’s Asset/ Liability Management Committee (“ALCO”) has been created under the authority of the Board of Directors to manage the Company’s interest rate and market risk. The ALCO is primarily responsible for ensuring that Doral Financial operates within the established asset/liability management policy guidelines and procedures. The ALCO reports directly to the Risk Policy Committee of the Board of Directors.
      The ALCO is responsible for:
  •  developing the Company’s asset/liability management and liquidity strategy;
 
  •  recommending for Board approval asset/liability and liquidity risk limits that are consistent with the Company’s policies;
 
  •  overseeing product pricing and volume objectives for customer-related activities;
 
  •  overseeing the Company’s secondary sales activities;
 
  •  monitoring compliance with risk limits and judging adequacy of execution of tactics by the Funds Management Group; and
 
  •  overseeing the maintenance of management information systems that supply, on a timely basis, the information and data necessary for the ALCO to fulfill its role as the Company’s asset/liability manager.
Risk Identification and Measurement
      Doral Financial manages interest rate exposure related to its assets and liabilities on a consolidated basis. Changes in interest rates can affect the volume of Doral Financial’s mortgage loan originations, the net interest income earned on Doral Financial’s portfolio of loans and securities, the amount of gain on sale of loans and the value of Doral Financial’s servicing assets, IOs, and loans and securities holdings.
      Commencing in the second half of 2005, Doral Financial began a process to improve its interest rate risk management practices and it continues to explore ways to improve its practices. This process included measures to better identify the interest rate risk associated with the Company’s assets and liabilities and source of income, and the development of policies and procedures to better manage these risks. The Company currently manages these risks by principally focusing on the following metrics:
  •  Net Interest Income (NII) Sensitivity. In determining the appropriate measure of Doral Financial’s exposure to NII sensitivity, the Company uses simulations to measure the risk of

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  changes in interest rates on the Company’s net interest income. These simulations assume a static balance sheet, in which every maturing asset or liability is reinvested or refunded in the same type of instrument with the same tenor. Simulation modeling includes “what if” analyses to determine the effect of different interest scenarios on Doral Financial’s risk profile and profitability. The primary scenario used for risk measurement purposes is based on instantaneous changes in interest rates across contractual maturities.

    In using these simulations, the Company considers the impact of changes in interest rates on the interest rate spreads between deposits, CD rates, loans, investments, etc. The impact of prepayment rates on loans and mortgage securities, interest rate caps and floors, and other options are also taken into account.
  •  Market Value of Equity. While simulations can adequately assess short term (1-2 years) interest rate risk, Doral Financial does not rely entirely on this analysis to capture and identify the risks associated with longer term re-pricing imbalances. To complement and broaden the risk analysis, the Company uses convexity and duration analysis to measure the sensitivity of the market value of equity (“MVE”) to changes in interest rates. Duration measures the linear change in MVE caused by changes in interest rates; while, convexity measures the non-linear change in MVE caused by changes in interest rates. These two analysis combined provide a better understanding of the sensitivity of MVE to changes in interest rates.
 
  •  Leverage. The Company measures and monitors the Company’s leverage by targeting and setting limits to the following two ratios: (1) Tangible Equity to Tangible Assets, and (2) Risk Based Capital Ratio.
 
  •  Yield curve twist. Under a “normal yield curve,” longer term interest rates are higher than shorter term rates. A change of interest rates by the same amount along all maturities of the curve is called a “parallel shift” in the yield curve, since the shape of the curve stays the same even though rates might be higher or lower across the curve. A change in the yield curve where interest rates change differently for different terms of the curve is called a “twist.” Yield curve twist, also called rotation risk or yield curve risk, is the risk associated with non-parallel rate shifts in the yield curve. These changes in the shape of the yield curve are more commonly known as flattening or steepening. The Company measures MVE sensitivity to yield curve twist by shifting the 3-month LIBOR and 10-year LIBOR rates by 55 and 14 basis points, respectively, in opposite directions. LIBOR rate shifts between the 3-month LIBOR and 10-year LIBOR are interpolated in a linear fashion.
Interest Rate Risk Management Strategies
      Prior to the second half of 2005, the Company’s interest rate risk strategy was designed to protect the value of the Company’s assets and income from instantaneous substantial increases in long-term rates that could not be absorbed in the normal course of business and was not adequately aligned to the sensitivity of the Company’s balance sheet composition to interest rate changes. In implementing this strategy the Company engaged in a substantial volume of short dated derivatives. At December 31, 2004, based on the previous risk management strategy, the Company had outstanding open derivative positions of $72.3 billion. At December 31, 2005, based on the Company’s new risk management strategy, the Company’s outstanding open derivative positions had decreased to $14.6 billion.
      Doral Financial’s current interest rate management strategies is implemented by the ALCO and is designed to reduce volatility of the Company’s net interest income and to protect the market value of equity. While the current strategy will also use a combination of derivatives and balance sheet management, more emphasis will be placed on balance sheet management.
      Net Interest Income Risk. In order to protect net interest income against interest rate risk, the ALCO employs a number of strategies, which are adjusted in relation to prevailing market conditions.

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      Internal balance sheet management practices are designed with the aim of reducing the re-pricing gaps of the Company’s assets and liabilities. These techniques seek longer-term funds through the use of long-term repurchase agreements, FHLB-NY advances and brokered deposits.
      Currently, the Company mainly uses interest rate swaps as part of its interest rate risk management activities. Interest rate swaps represent a mutual agreement to exchange interest rate payments; one party pays fixed rate and the other pays a floating rate. For NII protection, Doral Financial typically pays a fixed rate of interest and receives floating rate of interest.
      Market Value of Equity Hedging Strategies. Due to the composition of Doral Financial’s assets and liabilities, the Company has a positive duration gap (on average the maturity of the Company’s assets is greater than the maturity of its liabilities) which causes the MVE to decrease with increases in interest rates. Management implements duration and convexity strategies in order to bring the Company’s duration gap within the long-term targets established by the Board of Directors.
      Duration Risk. In order to bring duration measures within the long-term target of the Company, management also uses a combination of the internal liabilities management techniques and derivative instruments. Doral Financial primarily uses the following derivatives for such purposes:
  •  Interest Rate Swaps
 
  •  Payor Swaptions
 
  •  Eurodollar Futures
 
  •  Treasury Futures
      Doral Financial also enters into forward commitments to sell mortgaged-backed securities (“MBS”) by setting the price in advance to protect the Company against increases in interest rates and concurrent reductions in the price of MBS.
      Convexity Risk. Convexity is a measure of how much duration changes as interest rates change. For Doral Financial, convexity risks primarily results from mortgage prepayment risk. In order to bring convexity measures within the long-term targets of the Company, management primarily uses a combination of internal balance sheet management and the following derivatives:
  •  Payor Swaptions
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