UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2007

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

For the transition period from                      to                     

Oriental Financial Group Inc.

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

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No o

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

Large Accelerated Filer o     Accelerated Filer þ     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

24,119,149 common shares ($1.00 par value per share)
outstanding as of October 31, 2007

 

 

TABLE OF CONTENTS

		Page
Part I FINANCIAL INFORMATION:
Item 1 Financial Statements
Unaudited consolidated statements of financial condition at September 30, 2007 and December 31, 2006		1
Unaudited consolidated statements of income for the quarters and nine-month periods ended September 30, 2007 and 2006		2
Unaudited consolidated statements of changes in stockholders’ equity for the nine-month periods ended September 30, 2007 and 2006		3
Unaudited consolidated statements of comprehensive income for the quarters and nine-month periods ended September 30, 2007 and 2006		3
Unaudited consolidated statements of cash flows for the nine-month periods ended September 30, 2007 and 2006		4
Notes to unaudited consolidated financial statements		5
Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations		18
Item 3 Quantitative and Qualitative Disclosures About Market Risk		35
Item 4 Controls and Procedures		37
PART II OTHER INFORMATION:
Item 1 Legal Proceedings		37
Item 1A Risk Factors		38
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds		38
Item 3 Defaults Upon Senior Securities		38
Item 4 Submissions of Matters to a Vote of Security Holders		38
Item 5 Other Information		38
Item 6 Exhibits		39
Signatures		40
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

FORWARD-LOOKING STATEMENTS

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

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

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

PART – I FINANCIAL INFORMATION

ITEM – I FINANCIAL STATEMENTS

UNAUDITED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

SEPTEMBER 30, 2007 AND DECEMBER 31, 2006
(In thousands, except share data)

		September 30,				December 31,
		2007				2006
ASSETS
Cash and cash equivalents:
Cash and due from banks		$	12,331			$	15,341
Money market investments			57,554				18,729
Total cash and cash equivalents			69,885				34,070
Investments:
Time deposits with other banks			5,000				5,000
Trading securities, at fair value with amortized cost of $243 (December 31, 2006 - $246)			240				243
Investment securities available-for-sale, at fair value with amortized cost of $2,832,329 (December 31, 2006 – $984,060)
Securities pledged that can be repledged			2,663,438				947,880
Other investment securities			165,733				27,080
Total investment securities available-for-sale			2,829,171				974,960
Investment securities held-to-maturity, at amortized cost with fair value of $1,526,876 (December 31, 2006 – $1,931,720)
Securities pledged that can be repledged			1,415,549				1,814,746
Other investment securities			140,122				152,731
Total investment securities held-to-maturity			1,555,671				1,967,477
Other Investments			1,613				30,949
Federal Home Loan Bank (FHLB) stock, at cost			21,387				13,607
Total investments			4,413,082				2,992,236
Securities sold but not yet delivered			45,866				6,430
Loans:
Mortgage loans held-for-sale, at lower of cost or market			21,607				10,603
Loans receivable, net of allowance for loan losses of $9,055 (December 31, 2006 – $8,016)
			1,175,896				1,201,767
Total loans, net			1,197,503				1,212,370
Accrued interest receivable			33,162				27,940
Premises and equipment, net			20,124				20,153
Deferred tax asset, net			14,136				14,150
Foreclosed real estate			4,349				4,864
Other assets			59,082				59,773
Total assets		$	5,857,189			$	4,371,986
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits:
Demand deposits		$	110,172			$	132,434
Savings accounts			338,128				266,184
Certificates of deposit			821,405				834,370
Total deposits			1,269,705				1,232,988
Borrowings:
Federal funds purchased and other short term borrowings			27,246				13,568
Securities sold under agreements to repurchase			3,809,709				2,535,923
Advances from FHLB			348,114				182,489
Term notes			—				15,000
Subordinated capital notes			36,083				36,083
Total borrowings			4,221,152				2,783,063
Accrued expenses and other liabilities			24,537				19,509
Total liabilities			5,515,394				4,035,560
Commitments and Contingencies
Stockholders’ equity:
Preferred stock, $1 par value; 5,000,000 shares authorized; $25 liquidation value; 1,340,000 shares of Series A and 1,380,000 shares of Series B issued and outstanding			68,000				68,000
Common stock, $1 par value; 40,000,000 shares authorized; 25,555,575 shares issued (December 31, 2006 - 25,430,929 shares)			25,556				25,431
Additional paid-in capital			210,006				209,033
Legal surplus			39,298				36,245
Retained earnings			35,773				26,772
Treasury stock, at cost 1,436,426 shares (December 31, 2006 - 989,405 shares)			(17,042	)			(12,956	)
Accumulated other comprehensive loss, net of tax of $7 (December 31, 2006 - $290)			(19,796	)			(16,099	)
Total stockholders’ equity			341,795				336,426
Total liabilities and stockholders’ equity		$	5,857,189			$	4,371,986

See notes to unaudited consolidated financial statements.

UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
FOR THE QUARTERS AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2007 AND 2006
(In thousands, except per share data)

										Nine-Month Period Ended
		Quarter ended September 30,								September 30,
		2007				2006				2007				2006
Interest income:
Loans		$	21,699			$	20,819			$	65,862			$	55,384
Mortgage-backed securities			28,480				26,030				79,246				74,416
Investment securities and other			24,747				14,016				62,118				43,952
Total interest income			74,926				60,865				207,226				173,752
Interest expense:
Deposits			13,561				11,931				39,409				33,575
Securities sold under agreements to repurchase			37,405				36,035				106,739				93,525
Advances from FHLB, term notes and other borrowings			3,539				2,551				8,055				7,741
Subordinated capital notes			771				1,395				2,295				4,036
Total interest expense			55,276				51,912				156,498				138,877
Net interest income			19,650				8,953				50,728				34,875
Provision for loan losses			1,614				870				4,064				2,918
Net interest income after provision for loan losses			18,036				8,083				46,664				31,957
Non-interest income:
Financial service revenues			3,737				3,986				12,629				11,303
Banking service revenues			1,862				2,025				6,001				6,712
Investment banking revenues			113				592				113				3,153
Mortgage banking activities			1,010				1,122				1,242				2,191
Net gain (loss) on:
Securities available-for-sale			838				2,174				1,205				2,193
Derivatives			154				(1,571	)			8,538				(713	)
Trading securities			(2	)			281				—				303
Income (loss) from other investments			(541	)			928				236				658
Other			(37	)			348				96				558
Total non-interest income, net			7,134				9,885				30,060				26,358
Non-interest expenses:
Compensation and employees’ benefits			7,561				6,241				21,222				18,042
Occupancy and equipment			3,045				2,867				9,381				8,549
Professional and service fees			1,543				1,681				5,316				4,906
Advertising and business promotion			1,069				950				2,980				2,964
Directors and investor relations			308				198				1,608				550
Loan servicing expenses			349				525				1,412				1,490
Taxes, other than payroll and income taxes			607				440				1,543				1,613
Electronic banking charges			431				489				1,346				1,451
Clearing and wrap fees expenses			321				312				997				1,101
Communication			354				419				1,001				1,261
Insurance			210				220				638				652
Printing, postage, stationery and supplies			177				259				568				803
Other			547				544				1,815				1,431
Total non-interest expenses			16,522				15,145				49,827				44,813
Income before income taxes			8,648				2,823				26,897				13,502
Income tax expense			196				446				1,007				557
Net income			8,452				2,377				25,890				12,945
Less: Dividends on preferred stock			(1,200	)			(1,200	)			(3,601	)			(3,601	)
Income available to common shareholders		$	7,252			$	1,177			$	22,289			$	9,344
Income per common share:
Basic		$	0.30			$	0.05			$	0.91			$	0.38
Diluted		$	0.30			$	0.05			$	0.91			$	0.38
Average common shares outstanding			24,230				24,564				24,396				24,600
Average potential common shares-options			31				97				110				124
			24,261				24,661				24,506				24,724
Cash dividends per share of common stock		$	0.14			$	0.14			$	0.42			$	0.42

See notes to unaudited consolidated financial statements.

UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE NINE-MONTH PERIODS ENDED ENDED SEPTEMBER 30, 2007 AND 2006
(In thousands)        

		Nine-Month Period Ended September 30,
CHANGES IN STOCKHOLDERS’ EQUITY:		2007				2006
Preferred stock:
Balance at beginning and end of period		$	68,000			$	68,000
Common stock:
Balance at beginning of period			25,431				25,350
Stock options exercised			125				29
Balance at end of period			25,556				25,379
Additional paid-in capital:
Balance at beginning of period			209,033				208,454
Stock-based compensation expense			30				16
Stock options exercised			943				200
Balance at end of period			210,006				208,670
Legal surplus:
Balance at beginning of period			36,245				35,863
Transfer from retained earnings			3,053				1,660
Balance at end of period			39,298				37,523
Retained earnings:
Balance at beginning of period			26,772				52,340
Net income			25,890				12,945
Cash dividends declared on common stock			(10,235	)			(10,322	)
Cash dividends declared on preferred stock			(3,601	)			(3,601	)
Transfer to legal surplus			(3,053	)			(1,660	)
Balance at end of period			35,773				49,702
Treasury stock:
Balance at beginning of period			(12,956	)			(10,332	)
Stock used to match defined contribution plan 1165(e)			244				171
Stock purchased			(4,330	)			(1,360	)
Balance at end of period			(17,042	)			(11,521	)
Accumulated other comprehensive loss, net of tax:
Balance at beginning of period			(16,099	)			(37,884	)
Other comprehensive income (loss) for the period, net of tax			(3,697	)			11,844
Balance at end of period			(19,796	)			(26,040	)
Total stockholders’ equity		$	341,795			$	351,713

UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE QUARTERS AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2007 AND 2006
(In thousands)

										Nine-Month Period Ended
		Quarter Ended September 30,								September 30,
COMPREHENSIVE INCOME		2007				2006				2007				2006
Net income		$	8,452			$	2,377			$	25,890			$	12,945
Other comprehensive income (loss), net of tax:
Unrealized gain on securities available-for-sale			32,877				25,039				6,790				3,689
Realized gain on investment securities available-for-sale included in net income			(838	)			(2,174	)			(1,205	)			(2,193	)
Unrealized loss on derivatives designated as cash flows hedges arising during the period			—				(18,454	)			—				(432	)
Realized loss (gain) on derivatives designated as cash flow hedges included in net income			—				1,571				(773	)			822
Realized gain on termination of derivatives activities, net			—				10,455				—				10,455
Gain from termination of cash flow hedging			—				—				(8,225	)			—
Income tax effect related to unrealized loss on securities available-for-sale			(4,023	)			(2,067	)			(284	)			(497	)
Other comprehensive income (loss) for the period			28,016				14,370				(3,697	)			11,844
Comprehensive income		$	36,468			$	16,747			$	22,193			$	24,789

See notes to unaudited consolidated financial statements.

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2007 AND 2006
(In thousands)

		Nine-Month Period Ended September 30,
		2007				2006
Cash flows from operating activities:
Net income		$	25,890			$	12,945
Adjustments to reconcile net income to net cash used in operating activities:
Amortization of deferred loan origination fees, net of costs			(852	)			(1,006	)
Amortization of premiums, net of accretion of discounts			6,150				1,317
Depreciation and amortization of premises and equipment			4,094				3,998
Deferred income tax benefit			(270	)			(972	)
Equity in earnings of investment in limited partnership			(279	)			(658	)
Provision for loan losses			4,064				2,918
Common stock used to match defined contribution plan 1165(e)			244				171
Stock-based compensation			30				16
(Gain) loss on:
Sale of securities available-for-sale			(1,205	)			(2,193	)
Mortgage banking activities			(589	)			(2,191	)
Derivatives			(8,521	)			713
Sale of foreclosed real estate			20				(169	)
Sale of premises and equipment			9				(253	)
Originations and purchases of loans held-for-sale			(96,683	)			(62,434	)
Proceeds from sale of loans held-for-sale			43,591				28,963
Net decrease (increase) in:
Trading securities			2				(201	)
Accrued interest receivable			(5,222	)			406
Other assets			(8,700	)			(4,810	)
Net increase (decrease) in:
Accrued interest on deposits and borrowings			6,649				231
Other liabilities			5,804				(993	)
Net cash used in operating activities			(25,774	)			(24,202	)
Cash flows from investing activities:
Net decrease in time deposits with other banks			—				55,000
Purchases of:
Investment securities available-for-sale			(1,983,147	)			(443,229	)
Investment securities held-to-maturity			(143,843	)			(6,500	)
Other Investments			(515	)			—
Equity options			(9,504	)			—
FHLB stock			(36,379	)			—
Maturities and redemptions of:
Investment securities available-for-sale			127,047				26,490
Investment securities held-to-maturity			555,924				170,049
Other investments			42,163				—
FHLB stock			28,598				7,155
Proceeds from sales of:
Investment securities available-for-sale			23,879				380,653
Foreclosed real estate			2,216				2,522
Premises and equipment			—				2,644
Origination and purchase of loans, excluding loans held-for-sale			(149,043	)			(342,782	)
Principal repayment of loans			169,992				63,987
Additions to premises and equipment			(4,085	)			(11,358	)
Net cash used in investing activities			(1,376,697	)			(95,369	)
Cash flows from financing activities:
Net increase (decrease) in:
Deposits			38,041				(3,084	)
Securities sold under agreements to repurchase			1,254,365				262,177
Federal funds purchased			13,678				40,615
Proceeds from:
Advances from FHLB			3,822,420				2,977,225
Exercise of stock options			1,068				229
Repayments of advances from FHLB			(3,658,120	)			(3,125,525	)
Purchase of treasury stocks			(4,330	)			(1,360	)
Maturity of term note			(15,000	)			—
Dividend paid on common and preferred stock			(13,836	)			(13,923	)
Net cash provided by financing activities			1,438,286				136,354
Net change in cash and cash equivalents			35,815				16,783
Cash and cash equivalents at beginning of period			34,070				17,269
Cash and cash equivalents at end of period		$	69,885			$	34,052
Supplemental Cash Flow Disclosure and Schedule of Noncash Activities:
Interest paid		$	149,389			$	142,560
Income taxes paid		$	—			$	82
Mortgage loans securitized into mortgage-backed securities		$	42,677			$	36,023
Securities sold but not yet delivered		$	45,866			$	43,478
Securities purchased but not yet received		$	—			$	42,652
Transfer from loans to foreclosed real estate		$	1,710			$	1,376

See notes to unaudited consolidated financial statements.

ORIENTAL FINANCIAL GROUP INC.

NOTE 1 – BASIS OF PRESENTATION:

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

The unaudited consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). In the opinion of management, these consolidated financial statements include all adjustments necessary, all of which are of normal recurring nature, to present fairly the consolidated statement of financial condition as of September 30, 2007 and December 31, 2006, and the consolidated results of operations and cash flows for the nine-month periods ended September 30, 2007 and 2006. All significant intercompany balances and transactions have been eliminated in the accompanying unaudited consolidated financial statements. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such SEC rules and regulations. Management believes that the disclosures made are adequate to make the information presented not misleading. The results of operations and cash flows for the nine-month periods ended September 30, 2007 and 2006 are not necessarily indicative of the results to be expected for the full year. For further information, refer to the consolidated financial statements and footnotes thereto for the year ended December 31, 2006, included in the Group’s 2006 annual report on Form 10-K.

Nature of Operations

The Group is a diversified, publicly-owned financial holding company incorporated on June 14, 1996 under the laws of the Commonwealth of Puerto Rico. It has four wholly-owned subsidiaries, Oriental Bank and Trust (the “Bank”), Oriental Financial Services Corp. (“Oriental Financial Services”), Oriental Insurance, Inc. (“Oriental Insurance”), and Caribbean Pension Consultants, Inc. (located in Boca Raton, Florida). The Group also has two special purpose entities, Oriental Financial (PR) Statutory Trust I (the “Statutory Trust I”) and Oriental Financial (PR) Statutory Trust II (the “Statutory Trust II”). Through these subsidiaries and its divisions, the Group provides comprehensive financial services to its clients through a complete range of banking and financial solutions, including mortgage, commercial and consumer lending, financial planning, insurance sales, money management and investment banking and brokerage services, as well as corporate and individual trust services. Note 9 to the unaudited consolidated financial statements present further information about the operations of the Group’s business segments.

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

The Bank operates through twenty-four branches located throughout Puerto Rico and is subject to the supervision, examination and regulation of the Office of the Commissioner of Financial Institutions of Puerto Rico (“OCIF”) and the Federal Deposit Insurance Corporation (“FDIC”). The Bank offers banking services such as commercial and consumer lending, saving and time deposit products, financial planning, and corporate and individual trust services, and capitalizes on its commercial banking network to provide mortgage lending products to its clients. The Bank operates an international banking entity (“IBE”) pursuant to the International Banking Center Regulatory Act of Puerto Rico, as amended (the “IBE Act”): Oriental International Bank Inc., which is a wholly-owned subsidiary of the Bank. The IBE offers the Bank certain Puerto Rico tax advantages and its services are limited under Puerto Rico law to persons and assets/liabilities located outside of Puerto Rico. The Group previously had another IBE, which was liquidated on May 31, 2007, after obtaining all the corresponding regulatory approvals.

Oriental Financial Services is subject to the supervision, examination and regulation of the National Association of Securities Dealers, Inc., (now the Financial Industry Regulatory Authority), the SEC, and the OCIF. Oriental Insurance is subject to the supervision, examination and regulation of the Office of the Commissioner of Insurance of Puerto Rico.

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

Federal Home Loan Mortgage Corporation (the “FHLMC”) programs are referred to as conforming mortgage loans and are also securitized for issuance of FNMA or FHLMC mortgage-backed securities. In 2006, and after FNMA’s approval for the Group to sell FNMA-conforming conventional mortgage loans directly in the secondary market, the Group became an approved seller of FNMA, as well as FHLMC, mortgage loans for issuance of FNMA and FHLMC mortgage-backed securities. The Group is also an approved issuer of GNMA mortgage-backed securities. The Group continues to outsource the servicing of the GNMA, FNMA and FHLMC pools that it issues and of its mortgage loan portfolio.

Significant Accounting Policies

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

Allowance for Loan Losses

The allowance for loan losses is established through a provision for loan losses based on probable losses that are estimated to occur. Loan losses are charged against the allowance when the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The Group follows a systematic methodology to establish and evaluate the adequacy of the allowance for loan losses. This methodology consists of several key elements. The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.

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

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

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

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

Financial Instruments

Certain financial instruments including derivatives, trading securities and investment securities available-for-sale are recorded at fair value and unrealized gains and losses are recorded in other comprehensive income or as part of non-interest income, as appropriate. Fair values are based on listed market prices, if available. If

listed market prices are not available, fair value is determined based on other relevant factors, including price quotations for similar instruments. The fair values of certain derivative contracts are derived from pricing models that consider current market and contractual prices for the underlying financial instruments as well as time value and yield curve or volatility factors underlying the positions.

Impairment of Investment Securities

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

Income Taxes

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

The Group maintained an effective tax rate lower than the maximum marginal statutory rate of 39% and 43.5% as of September 30, 2007 and 2006, respectively, mainly due to the interest income arising from investments exempt from Puerto Rico income taxes, net of expenses attributable to the exempt income. Exempt interest relates mostly to interest earned on obligations of the United States and Puerto Rico governments and certain mortgage-backed securities, including securities held by the Bank’s international banking entity.

The determination of deferred tax expense or benefit is based on changes in the carrying amounts of assets and liabilities that generate temporary differences. The carrying value of the Group’s net deferred tax assets assumes that the Group will be able to generate sufficient future taxable income based on estimates and assumptions. If these estimates and related assumptions change in the future, the Group may be required to record valuation allowances against its deferred tax assets resulting in additional income tax expense in the consolidated statements of income.

Management evaluates the realizability of the deferred tax assets on a regular basis and assesses the need for a valuation allowance. A valuation allowance is established when management believes that it is more likely than not that some portion of its deferred tax assets will not be realized. Changes in valuation allowance from period to period are included in the Group’s tax provision in the period of change. As of September 30, 2007, a valuation allowance of approximately $4.3 million was recorded to offset deferred tax assets from loss carry forwards that the Group believes it may not realize in future periods.

Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the projections of future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Group will realize the benefits of these deductible differences, net of the existing valuation allowances at September 30, 2007. The amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carry forward period are reduced.

Effective at the beginning of the first quarter of 2007, the Group adopted the provisions of Financial Accounting Standard Board (“FASB”) Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes–an interpretation of FASB Statement No. 109.” FIN 48 contains a two-step approach to recognizing and measuring uncertain tax positions accounted for in accordance with SFAS No. 109, “Accounting for Income Taxes.” The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement.

The total amount of gross unrecognized tax benefits as of the date of adoption that would affect the effective tax rate was $5.7 million. The Group classifies unrecognized tax benefits in income taxes payable. No adjustments resulted by the implementation of FIN 48. These gross unrecognized tax benefits would affect the effective tax rate if realized.

The Group’s policy to include interest and penalties related to unrecognized tax benefits within the provision for taxes on the consolidated statements of income did not change as a result of implementing the provisions of FIN 48. As of the date of adoption of FIN 48, the Group had accrued $1.3 million for the payment of interest and penalties relating to unrecognized tax benefits. The Group does not anticipate significant changes in unrecognized tax benefits during 2007.

Equity-Based Compensation Plans

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

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

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

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

The Group recorded approximately $30,000 and $16,000 during the nine-month periods ended September 30, 2007 and 2006, respectively, related to compensation expense for options issued under the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123R “Share-Based Payment” (“SFAS 123R”). The remaining unrecognized compensation cost related to unvested awards as of September 30, 2007, was approximately $436,000 and the weighted average period of time over which this cost will be recognized is approximately 7 years.

The average fair value of each option granted during the nine-month periods ended September 30, 2007 and 2006 was $3.09 and $3.95, respectively. The average fair value of each option granted was estimated at the date of the grant using the Black-Scholes option pricing model. The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no restrictions and are fully transferable and negotiable in a free trading market. Black-Scholes does not consider the employment, transfer or vesting restrictions that are inherent in the Group’s employee options. Use of an option valuation model, as required by GAAP, includes highly subjective assumptions based on long-term predictions, including the expected stock price volatility and average life of each option grant.

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

		Nine-Month Period Ended
		September 30,
		2007				2006
Weighted Average Assumptions:
Dividend yield			4.55	%			3.92	%
Expected volatility			33.35	%			34.32	%
Risk-free interest rate			4.65	%			4.18	%
Expected life (in years)			8.5				8.5

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

NOTE 2 – INVESTMENT SECURITIES:

The amortized cost, gross unrealized gains and losses, fair value, and weighted average yield of the investment securities as of September 30, 2007 and December 31, 2006, were as follows:

		September 30, 2007 (In thousands)
						Gross				Gross								Weighted
		Amortized				Unrealized				Unrealized				Fair				Average
		Cost				Gains				Losses				Value				Yield
Available-for-sale
Obligations of US Government sponsored agencies		$	1,119,366			$	3,943			$	15			$	1,123,294				5.88	%
Puerto Rico Government and agency obligations			18,311				57				1,237				17,131				5.69	%
Other investment securities			86,000				—				2,555				83,445				5.69	%
Total investment securities			1,223,677				4,000				3,807				1,223,870
FNMA and FHLMC certificates			907,686				2,281				2,195				907,772				5.89	%
GNMA certificates			55,505				444				325				55,624				5.72	%
Pass-through collateralized mortgage obligations (CMO’s)			645,461				48				3,604				641,905				5.48	%
Total mortgage-backed-securities and CMO’s			1,608,652				2,773				6,124				1,605,301
Total securities available-for-sale			2,832,329				6,773				9,931				2,829,171				5.79	%
Held-to-maturity
Obligations of US Government sponsored agencies			468,724				17				6,580				462,161				4.85	%
Puerto Rico Government and agency obligations			55,238				—				4,422				50,816				5.29	%
Other investment securities			81,170				—				2,535				78,635				7.04	%
Total investment securities			605,132				17				13,537				591,612
FNMA and FHLMC certificates			641,739				246				12,462				629,523				5.05	%
GNMA certificates			166,568				70				2,904				163,734				5.38	%
Collateralized mortgage obligations (CMO's) issued by US Government sponsored agencies			142,232				588				813				142,007				5.14	%
Total mortgage-backed-securities and CMO’s			950,539				904				16,179				935,264
Total securities held-to-maturity			1,555,671				921				29,716				1,526,876				5.15	%
Total		$	4,388,000			$	7,694			$	39,647			$	4,356,047				5.56	%

		December 31, 2006 (In thousands)
						Gross				Gross								Weighted
		Amortized				Unrealized				Unrealized				Fair				Average
		Cost				Gains				Losses				Value				Yield
Available-for-sale
Puerto Rico Government and agency obligations		$	20,254			$	64			$	872			$	19,446				5.68	%
Other investment securities			50,598				520				2,347				48,771				6.11	%
Total investment securities			70,852				584				3,219				68,217
FNMA and FHLMC certificates			150,099				—				1,506				148,593				5.45	%
GNMA certificates			40,690				408				235				40,863				5.61	%
Pass-through collateralized mortgage obligations (CMOs)			722,419				7				5,139				717,287				5.48	%
Total mortgage-backed-securities and CMO’s			913,208				415				6,880				906,743
Total securities available-for-sale			984,060				999				10,099				974,960				5.52	%
Held-to-maturity
US Treasury securities			15,022				—				127				14,895				2.71	%
Obligations of US Government sponsored agencies			848,400				7				17,529				830,878				3.85	%
Puerto Rico Government and agency obligations			55,262				—				3,961				51,301				5.29	%
Total investment securities			918,684				7				21,617				897,074
FNMA and FHLMC certificates			713,171				628				11,529				702,270				5.04	%
GNMA certificates			182,874				215				2,176				180,913				5.35	%
Collateralized mortgage obligations (CMO's) issued by US Government sponsored agencies			152,748				18				1,303				151,463				5.13	%
Total mortgage-backed-securities and CMO’s			1,048,793				861				15,008				1,034,646
Total securities held-to-maturity			1,967,477				868				36,625				1,931,720				4.55	%
Total		$	2,951,537			$	1,867			$	46,724			$	2,906,680				4.87	%

The amortized cost and fair value of the Group’s investment securities available-for-sale and held-to-maturity at September 30, 2007, by contractual maturity, are shown in the next table. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

		(In thousands)
		Available-for-sale								Held-to-maturity
		Amortized								Amortized
		Cost				Fair Value				Cost				Fair Value
Investment securities
Due within 1 year		$	19,366			$	19,351			$	24,997			$	24,881
Due after 1 to 5 years			—				—				187,378				185,968
Due after 5 to 10 years			1,064,525				1,065,787				216,499				209,857
Due after 10 years			139,786				138,732				176,258				170,906
			1,223,677				1,223,870				605,132				591,612
Mortgage-backed securities
Due after 1 to 5 years			939				973				—				—
Due after 10 years			1,607,713				1,604,328				950,539				935,264
			1,608,652				1,605,301				950,539				935,264
		$	2,832,329			$	2,829,171			$	1,555,671			$	1,526,876

Securities not due on a single contractual maturity date, such as collateralized mortgage obligations, are classified in the period of final contractual maturity. The expected maturities of collateralized mortgage obligations and certain other securities may differ from their contractual maturities because they may be subject to prepayments or may be called by the issuer.

Proceeds from the sale of investment securities available-for-sale during the nine-month periods ended September 30, 2007 and 2006, totaled $23.9 million and $380.7 million, respectively. Realized gains on those sales during the nine-month period ended September 30, 2007 were $1.2 million, while gross realized gains and losses on those sales during the corresponding 2006 nine-month period were $4.7 million and $2.6 million, respectively. The following table shows the Group’s gross unrealized losses and fair value of investment securities available-for-sale and held-to-maturity, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at September 30, 2007.

Available-for-sale
(In thousands)

		Less than 12 months
		Amortized				Unrealized				Fair
		Cost				Loss				Value
Obligations of U.S. government entities		$	19,366			$	15			$	19,351
Puerto Rico Government and agency obligations			1,996				376				1,620
Mortgage-backed securities and CMO’s			802,826				5,863				796,963
Other investment securities			86,000				2,555				83,445
			910,188				8,809				901,379

		12 months or more
		Amortized				Unrealized				Fair
		Cost				Loss				Value
Puerto Rico Government and agency obligations			14,135				861				13,274
Mortgage-backed securities and CMO’s			8,195				261				7,934
			22,330				1,122				21,208

		Total
		Amortized				Unrealized				Fair
		Cost				Loss				Value
Obligations of U.S. government entities		$	19,366			$	15			$	19,351
Puerto Rico Government and agency obligations			16,131				1,237				14,894
Mortgage-backed securities and CMO’s			811,021				6,124				804,897
Other investment securities			86,000				2,555				83,445
		$	932,518			$	9,931			$	922,587

Held-to-maturity
(In thousands)

		Less than 12 months
		Amortized				Unrealized				Fair
		Cost				Loss				Value
Obligations of U.S government sponsored entities		$	49,999			$	2,154			$	47,845
Puerto Rico Government and agency obligations			4,270				61				4,209
Mortgage-backed securities and CMO’s			343,365				3,489				339,876
Other investment securities			71,970				2,535				69,435
			469,604				8,239				461,365

		12 months or more
		Amortized				Unrealized				Fair
		Cost				Loss				Value
Obligations of U.S government sponsored entities			412,225				4,426				407,799
Puerto Rico Government and agency obligations			50,968				4,361				46,607
Mortgage-backed securities and CMO’s			435,766				12,690				423,076
			898,959				21,477				877,482

		Total
		Amortized				Unrealized				Fair
		Cost				Loss				Value
Obligations of U.S government sponsored entities			462,224				6,580				455,644
Puerto Rico Government and agency obligations			55,238				4,422				50,816
Mortgage-backed securities and CMO’s			779,131				16,179				762,952
Other investment securities			71,970				2,535				69,435
		$	1,368,563			$	29,716			$	1,338,847