UNITED STATES SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

Commission File Number 000-27377

W HOLDING COMPANY, INC.

19 West McKinley Street
Mayagüez, Puerto Rico 00681
(Address of Principal Executive Offices) (Zip Code)

(787) 834-8000
(Registrant’s Telephone Number Including Area Code)

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 l934 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 NOo

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12-b-2 of the Exchange Act).

As of April 30, 2005, there were 164,037,228 shares outstanding of the Registrant’s Common Stock, $1.00 par value.

W HOLDING COMPANY, INC. AND SUBSIDIARIES

CONTENTS

Part I. Financial Information

Item I. Financial Statements

W HOLDING COMPANY, INC. AND SUBSIDIARIES

See notes to consolidated financial statements.

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W HOLDING COMPANY, INC. AND SUBSIDIARIES

See notes to consolidated financial statements.

2

W HOLDING COMPANY, INC. AND SUBSIDIARIES

See notes to consolidated financial statements.

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W HOLDING COMPANY, INC. AND SUBSIDIARIES

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W HOLDING COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)

See notes to consolidated financial statements.

(Concluded)

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W HOLDING COMPANY, INC. AND SUBSIDIARIES

1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

W Holding Company, Inc. (the “Company”) is a financial holding company offering a full range of financial services. The business of the Company is conducted primarily through its wholly owned commercial bank subsidiary, Westernbank Puerto Rico (“Westernbank” or the “Bank”). The Company’s other direct subsidiary is Westernbank Insurance Corp. The Company was organized under the laws of the Commonwealth of Puerto Rico in February 1999 to become the bank holding company of Westernbank. Westernbank was founded as a savings institution in 1958 operating in the western and southwestern regions of Puerto Rico, focusing on retail banking and emphasizing long-term fixed-rate residential mortgage loans on one-to-four family residential properties. In 1994, Westernbank changed its charter to become a full-service commercial bank. Westernbank offers a full range of business and consumer financial services, including banking, trust and brokerage services. Westernbank Insurance Corp. is a general insurance agent placing property, casualty, life and disability insurance. The assets, liabilities, revenues and expenses of Westernbank Insurance Corp. at March 31, 2005 and December 31, 2004, and for the three month periods ended March 31, 2005 and 2004, were not significant.

In July 2000, the Company became a financial holding company under the Bank Holding Company Act. As a financial holding company, the Company is permitted to engage in financial related activities, including insurance and securities activities, provided that the Company and its banking subsidiary meet certain regulatory standards.

Westernbank operates through 53 full service branch offices located throughout Puerto Rico, including 33 in the Western and Southwestern regions, 7 in the Northeastern region, 12 in the San Juan Metropolitan area, and one in the Eastern region, and a fully functional banking site in the Internet. Westernbank traditional banking operations include retail operations, such as its branches, including the branches of the Expresso division, together with consumer loans, mortgage loans, commercial loans (excluding the asset-based lending operations), investments (treasury) and deposit products. Besides the traditional banking operations, Westernbank operates through four other divisions: Westernbank International Division, which is an International Banking Entity (“IBE”) under the Puerto Rico Act No. 52 of August 11, 1989, as amended, known as the International Banking Regulatory Act, which offers commercial and related services, and treasury and investment activities outside of Puerto Rico; Westernbank Business Credit, which specializes in commercial business loans secured principally by commercial real estate, accounts receivable, inventory and equipment; Westernbank Trust Division, which offers a full array of trust services; and Expresso of Westernbank, a division which specializes in small, unsecured consumer loans up to $15,000 and real estate collateralized consumer loans up to $150,000 through 19 full-service branches.

Westernbank World Plaza, Inc. (“WWPI”), a wholly owned subsidiary of Westernbank, owns and operates Westernbank World Plaza, a 23-story office building, including its related parking facility, located in Hato Rey, Puerto Rico, the main Puerto Rican business district. Westernbank World Plaza serves as the Company’s San Juan metropolitan area headquarters for Westernbank’s regional commercial lending office and headquarters for the Westernbank Business Credit and Expresso of Westernbank divisions. Westernbank also owns 100% of the voting shares of SRG Net, Inc., a Puerto Rico corporation that operates an electronic funds transfer network. The assets, liabilities, revenues and expenses of SRG Net, Inc. at March 31, 2005 and December 31, 2004, and for the three month periods ended March 31, 2005 and 2004, were not significant.

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The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America (“GAAP”) and banking industry practices (See Note 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – on the Company’s Consolidated Financial Statements as of December 31, 2004 and 2003, and for each of the three years in the period ended December 31, 2004, included in the Company’s Annual Report on Form 10-K). 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, the unaudited Consolidated Financial Statements include all adjustments (which consist of normal recurring accruals) necessary to present fairly the consolidated financial condition as of March 31, 2005 and December 31, 2004, and the results of operations and cash flows for the three months ended March 31, 2005 and 2004. 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 SEC rules and regulations. Management believes that the disclosures made are adequate to make the information presented not misleading. Financial information as of December 31, 2004, has been derived from the audited Consolidated Financial Statements of the Company. The results of operations and cash flows for the three months ended March 31, 2005 and 2004, 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, 2004, included in the Company’s Annual Report on Form 10-K.

Following is a summary of the most recent accounting policies adopted by the Company:

In December 2003, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position (“SOP”) 03-3, Accounting for Certain Loans and Debt Securities Acquired in a Transfer. SOP 03-3 addresses the accounting for acquired loans that show evidence of having deteriorated in terms of credit quality since their origination (i.e. impaired loans). SOP 03-3 requires acquired loans to be recorded at their fair value defined as the present value of future cash flows. SOP 03-3 prohibits the carryover of an allowance for loan losses on certain acquired loans as credit losses are considered in the future cash flows assessment. SOP 03-3 is effective for loans that are acquired in fiscal years beginning after December 15, 2004. SOP 03-3 did not have any effect on the Company’s financial position or results of operations.

In March 2004, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue 03-1, Meaning of Other Than Temporary Impairment (Issue 03-1) for debt and equity securities accounted for under Statement of Financial Accounting Standards (“SFAS”) No. 115, Accounting for Certain Investments in Debt and Equity Securities and cost method investments. The basic model developed by the Task Force in evaluating whether an investment within the scope of Issue 03-1 is other-than-temporarily impaired is as follows: Step 1: Determine whether an investment is impaired. An investment is considered impaired if its fair value is less than its cost. Step 2: Evaluate whether an impairment is other-than-temporary. For equity securities and debt securities that can contractually be prepaid or otherwise settled in such

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a way that the investor would not recover substantially all of its cost, an impairment is presumed to be other-than-temporary unless: the investor has the ability and intent to hold the investment for a reasonable period of time sufficient for a forecasted market price recovery of the investment, and evidence indicating that the cost of the investment is recoverable within a reasonable period of time outweighs evidence to the contrary. For other debt securities, an impairment is deemed other-than-temporary if: the investor does not have the ability and intent to hold the investment until a forecasted market price recovery (may mean until maturity), or it is probable that the investor will be unable to collect all amounts due according to the contractual terms of the debt security. Step 3: If the impairment is other-than-temporary, recognize in earnings an impairment loss equal to the difference between the investment cost and its fair value. The fair value of the investment then becomes the new cost basis of the investment and cannot be adjusted for subsequent recoveries in fair value, unless required by other authoritative literature.

On September 30, 2004, the Financial Accounting Standards Board (“FASB”) issued FSP EITF Issue 03-01-1, which delayed the effective date for the measurement and recognition guidance of an impairment loss that is other-than-temporary (i.e. steps 2 and 3 of the impairment model) contained in paragraphs 10-20 of EITF 03-1. Application of these paragraphs is deferred pending issuance of proposed FSP EITF Issue 03-1a. This delay does not suspend the requirement to recognize other-than-temporary impairments as required by existing authoritative literature. The guidance in paragraphs 6 to 9 of EITF 03-1 (i.e. step 1 of the impairment model), as well as the disclosure requirements in paragraphs 21 and 22 have not been deferred and should be applied based on the transition provisions in EITF 03-1. Based on the composition of the investment portfolio held at March 31, 2005, EITF 03-1 is not expected to have a material effect on the Company’s financial position or results of operations.

In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets – an amendment of APB Opinion No. 29. The guidance in APB Opinion No. 29, Accounting for Nonmonetary Transactions, is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. The guidance in that Opinion, however, included certain exceptions to that principle. This Statement amends Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. This Statement shall be applied prospectively and is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Earlier application is permitted for nonmonetary asset exchanges occurring in fiscal periods beginning after the date of issuance of this Statement. SFAS No. 153 is not expected to have a material effect on the Company’s financial position or results of operations.

In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment, that will require compensation costs related to share-based payment transactions to be recognized in the financial statements. With limited exceptions, the amount of compensation cost will be measured based on the grant-date fair value of the equity or liability instruments issued. In addition, liability awards will be remeasured each reporting period. Compensation cost will be recognized over the period that an employee provides service in exchange for the award. SFAS No. 123(R) replaces FASB Statement No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25,

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Accounting for Stock Issued to Employees. SFAS No. 123(R) will be effective on January 1, 2006, and applies to all awards granted after this effective date and to awards modified, repurchased, or cancelled after that date. The cumulative effect of initially applying this statement, if any, is recognized as of the required effective date. Entities that used the fair-value-based method for either recognition or disclosure under SFAS No. 123 will apply this revised statement using a modified version of prospective application. Under that transition method, for the portion of outstanding awards for which the requisite service has not yet been rendered, compensation cost is recognized on or after the required effective date based on the grant-date fair value of those awards calculated under SFAS No. 123 for either recognition or pro forma disclosures. For periods before the required effective date, those entities may elect to apply a modified version of retrospective application under which financial statements for prior periods are adjusted on a basis consistent with the pro forma disclosures required for those periods by SFAS No. 123. SFAS No. 123(R) is not expected to have a significant effect on the Company’s financial position or results of operations since the Company only has employee stock options and it follows since January 1, 2003 the fair value method under the modified prospective application allowed by the provisions of SFAS No. 148.

2. EARNINGS PER SHARE AND CAPITAL TRANSACTIONS

Basic and diluted earnings per common share for the three months ended March 31, 2005 and 2004, were computed by dividing the net income attributable to common stockholders for such periods by the weighted average number of shares of common stock outstanding during the same periods, as follows:

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On January 3, 2005, the Company issued 401,300 shares of its 2004 Series H preferred stock under an over-allotment option to the underwriter. The preferred shares were issued at a price of $50.00 per share. Proceeds from this issuance of the 2004 Series H preferred stock amounted to $19,433,000, net of $632,000 of issuance costs.

On February 10, 2005, one of the Company’s executive officers exercised 35,113 options under the Company’s 1999 Qualified Option Plan at an exercise price of $2.85 per share.

During the three month period ended March 31, 2005, 16,840 shares of the Company’s convertible preferred stock series A were converted into 58,824 shares of the Company’s common stock.

3. DIVIDENDS DECLARED PER COMMON SHARE

The Company’s Board of Directors has adopted an ongoing policy that provides for the distribution of dividends to common shareholders on the basis of a percentage of the average earnings for the last two preceding years. The same are paid monthly on the 15^th day of each month for stockholders of record as of the last day of the preceding month.

On January 20, 2005, the Company’s board of directors approved an increase in its annual dividend payments to stockholders for 2005 to $0.19 per share. This represents an increase of 32.14% over the dividends paid in 2004.

The Company’s cash dividends per share declared for the three months ended March 31, 2005 and 2004, were as follows:

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4. INVESTMENT SECURITIES

The amortized cost, gross unrealized gains and losses and fair value of investment securities were as follows:

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The amortized cost and fair value of investment securities held to maturity at March 31, 2005, by contractual maturity (excluding mortgage-backed securities) are shown below:

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The Company’s investment portfolio as of March 31, 2005, consisted principally of U.S. Government and agencies obligations, Puerto Rico Government and agencies obligations, and mortgage-backed securities issued or guaranteed by FHLMC, FNMA or GNMA. There were no investment securities other than those referred to above in unrealized loss position as of March 31, 2005. These unrealized losses relate to interest rate changes. Investment securities with prepayment provisions did not have significant unamortized premiums at March 31, 2005. As management has the ability to hold debt securities until maturity, or for the foreseeable future, if classified as available for sale, no declines are deemed to be other-than-temporary at March 31, 2005.

The Company uses certain methods and assumptions in estimating fair values of financial instruments. (See Note 20. FAIR VALUE OF FINANCIAL INSTRUMENTS of the Company’s Consolidated Financial Statements as of December 31, 2004 and 2003, and for each of the three years in the period ended December 31, 2004, included in the Company’s Annual Report on Form 10-K).

Available-for-sale and held-to-maturity securities are reviewed at least quarterly for possible other-than-temporary impairment. The review includes an analysis of the facts and circumstances of each individual investment such as the length of time and the extent to which the fair value has been below cost, the expectation for that security’s performance, the credit worthiness of the issuer and the Company’s intent and ability to hold the security to allow for any anticipated recovery in fair value if classified as available for sale, or to maturity. A decline in value that is considered to be other-than-temporary is recorded as a loss within noninterest income in the consolidated statements of income.

See Note 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES for recent developments on the measurement and recognition guidance on other-than-temporary impairments.

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5. LOANS

The loan portfolio consisted of the following:

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The total investment in impaired commercial and construction loans at March 31, 2005 and December 31, 2004, was $55,159,000 and $54,175,000, respectively. All impaired commercial and construction loans were measured based on the fair value of collateral at March 31, 2005 and December 31, 2004. Impaired commercial and construction loans amounting to $32,675,000 and $29,975,000 at March 31, 2005 and December 31, 2004, respectively, were covered by a valuation allowance of $8,610,000 and $8,412,000, respectively. Impaired commercial and construction loans amounting to $22,484,000 at March 31, 2005, and $24,200,000 at December 31, 2004, did not require a valuation allowance in accordance with SFAS No. 114. The average investment in impaired commercial and construction loans for the three-month periods ended March 31, 2005 and 2004, amounted to $54,157,000 and $47,320,000, respectively. The Company’s policy is to recognize interest income related to impaired loans on a cash basis, when these are over 90 days in arrears on payments of principal or interest. Interest on impaired commercial and construction loans collected and recognized as income for the three-month periods ended March 31, 2005 and 2004, amounted to $743,000 and $619,000, respectively.

6. PLEDGED ASSETS

At March 31, 2005, residential and commercial mortgage loans, investment securities (held to maturity and available for sale) and money market instruments amounting to $612,514,000; $6,516,456,000; and $13,168,000, respectively, were pledged to secure public funds, individual retirement accounts, repurchase agreements, commercial letters of credit, advances and borrowings from the Federal Home Loan Bank and the Federal Reserve Bank of New York, interest rate swap agreements, and to comply with the requirements of the Puerto Rico Treasury Department (for Westernbank International Division). Pledged investment securities amounting to $6,200,017,000 at March 31, 2005, can be repledged.

7. DEPOSITS

Deposits consisted of the following:

The weighted average interest rate of all deposits at March 31, 2005 and December 31, 2004, was approximately 2.85% and 2.75%, respectively.

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8. INCOME TAXES

Under the Puerto Rico Internal Revenue Code (the “Code”), all companies are treated as separate taxable entities and are not entitled to file consolidated tax returns. The Company, Westernbank, Westernbank Insurance Corp. and SRG Net, Inc. are subject to Puerto Rico regular income tax or alternative minimum tax (“AMT”) on income earned from all sources. The AMT is payable if it exceeds regular income tax. The excess of AMT over regular income tax paid in any one year may be used to offset regular income tax in future years, subject to certain limitations.

Westernbank World Plaza, Inc., a wholly owned subsidiary of Westernbank, elected to be treated as a special partnership under the Code; accordingly, its taxable income or deductible loss is included in the taxable income of Westernbank.

The Code provides a dividend received deduction of 100%, on dividends received from wholly owned subsidiaries subject to income taxation in Puerto Rico. The income on certain investments is exempt for income tax purposes. Also, Westernbank International division operates as an International Banking Entity (“IBE”) under the International Banking Regulatory Act. Under Puerto Rico tax law, an IBE can hold non-Puerto Rico assets, and earn interest on these assets, as well as generate fee income outside of Puerto Rico on a tax-exempt basis under certain circumstances. As a result of the above, the Company’s effective tax rate is substantially below the statutory rate.

Pursuant to the provisions of Act No. 13 of January 8, 2004 (the “Act”), for taxable years commencing after June 30, 2003, the net income earned by an IBE that operates as a unit of a bank under the Puerto Rico Banking Law, will be considered taxable and subject to income taxes at the current tax rates in the amount by which the IBE taxable income exceeds 40% in the first applicable taxable year (2004), 30% in the second year (2005) and 20% thereafter, of the taxable income of Westernbank, including its IBE taxable income. Westernbank’s IBE carries on its books a significant amount of securities which are, irrespective of the IBE status, tax exempt by law. Moreover, the Act provides that IBE’s operating as subsidiaries will continue to be exempt from the payment of income taxes. Management estimated that the provisions of the Act did not have an effect on the Company’s financial position at March 31, 2005 and December 31, 2004, or the results of operations for the three month periods ended March 31, 2005 and 2004.

The Puerto Rico Treasury Department recently submitted to the Governor of Puerto Rico a draft of a proposal to impose a transitory additional income tax of 4% on net interest income, as defined, applicable to Puerto Rico financial institutions. This transitory additional tax, if approved, is expected to be in effect for two years. The proposal excludes from the definition of net interest income, exempt interest earned from obligations of the United States , of any state or territory of the United States or political subdivision, the District of Columbia, the Commonwealth of Puerto Rico or any instrumentality or political subdivision; including all interest expense allocable to such exempt interest income.

The proposal is subject to review and approval by the Governor and the Puerto Rico Legislature. There is no assurance that this proposal will be approved or changes made before it is signed into law. This proposal, based on year 2004 actual results of operations and the distribution of taxable and exempt interest income for such year, would have resulted in approximately $8.1 million in additional income tax for year 2004, or an estimated increase of approximately 4% in our annual effective tax rate. The final impact of this proposal will depend on the final bill, if approved, and the actual distribution of taxable and exempt income in each applicable year.

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A reconciliation of the provision for income taxes computed by applying the Puerto Rico income tax statutory rate to the tax provision as reported for the three months ended March 31, 2005 and 2004, is as follows:

Deferred income tax assets, net as of March 31, 2005 and December 31, 2004, consisted of the following:

Realization of deferred tax assets is dependent on generating sufficient future taxable income or capital gains. The amount of the deferred tax assets considered realizable could be reduced in the near term if estimates of future taxable income or capital gains are not met.

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9. OFF-BALANCE SHEET ACTIVITIES

In the normal course of business, the Company becomes a party to credit related financial instruments with off-balance sheet risk to meet the financing needs of its customers. These financial instruments include commitments to extend credit and commercial letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated statements of financial condition. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, commitments under credit card arrangements, commercial letters of credit and commitments to purchase loans is represented by the contractual notional amount of those instruments, which do not necessarily represent the amounts potentially subject to risk. In addition, the measurement of the risks associated with these instruments is meaningful only when all related and offsetting transactions are identified. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of credit, is based on management’s credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income producing commercial properties.

Commercial letters of credit are conditional commitments issued by the Company on behalf of a customer authorizing a third party to draw drafts on the Company up to a stipulated amount and with specified terms and conditions.

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The contract amount of financial instruments, whose amounts represent credit risk at March 31, 2005 and December 31, 2004, was as follows:

Such commitments will be funded in the normal course of business from the Company’s principal sources of funds.

10.	ON-BALANCE SHEET DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

Derivative Financial Instruments

The Company maintains an overall interest rate risk management strategy that incorporates the use of derivative instruments to minimize significant unplanned fluctuations in earnings and cash flows caused by interest rate volatility. The Company’s interest rate risk management strategy may involve modifying the re-pricing characteristics of certain assets and liabilities so that changes in interest rates do not adversely affect the net interest margin and cash flows. Derivative instruments that the Company may use as part of its interest rate risk management strategy include interest rate swaps and indexed options. These transactions involve both credit and market risk. The notional amounts are amounts on which calculations, payments and the value of the derivative are based. Notional amounts do not represent direct credit exposures. Direct credit exposure is limited to the net difference between the calculated amounts to be received and paid, if any. Such difference, which represents the fair value of the derivative, is reflected on the Company’s statements of financial condition as derivative assets and derivative liabilities.

The Company is exposed to credit-related losses in the event of nonperformance by the counterparties to these agreements. The Company controls the credit risk of its financial contracts through credit approvals, limits and monitoring procedures, and does not expect any counterparties to fail their obligations. The Company deals only with primary dealers.

Derivative instruments are generally negotiated over-the-counter (“OTC”) contracts. Negotiated OTC derivatives are generally entered into between two counterparties that negotiate specific agreement terms, including the underlying instrument, amount, exercise price and maturity.

The Company enters into interest-rate swap contracts in managing its interest rate exposure. Interest-rate swap contracts generally involve the exchange of fixed and floating-rate interest payment obligations without the exchange of the underlying principal amounts. Entering into

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interest-rate swap contracts involves not only the risk of dealing with counterparties and their ability to meet the terms of the contracts, but also the interest rate risk associated with unmatched positions. Interest rate swaps are the most common type of derivative contracts that the Company utilizes.

Indexed options are contracts that the Company enters into in order to receive the average appreciation of the month end value of the Standard & Poor’s 500 Composite Stock Index over a specified period in exchange for the payment of a premium when the contract is initiated. The credit risk inherent in the indexed options is the risk that the exchange party may default.

Fair Value Hedging Instruments

The Company currently utilizes interest rate swaps to convert its fixed-rate certificates of deposit or firm commitments to originate certificates of deposit (liabilities) to a variable rate. By entering into the swap, the principal amount of the hedged item would remain unchanged but the interest payment streams would change. These swaps mature between one to twenty years with a right by the counterparty to call them after the first anniversary. The Company has an identical right to call the certificates of deposit. Decisions to convert fixed-rate certificates of deposits or firm commitments to originate certificates of deposit (liabilities) to variable rate are made primarily by consideration of the asset/liability mix of the Company, the desired asset/liability sensitivity and by interest rate levels.

The notional amount of the interest rate swaps used to hedge the fixed rate certificates of deposit and the firm commitments to originate certificates of deposit amounted to $625,924,000 and $778,105,000 at March 31, 2005 and December 31, 2004, respectively. Firm commitments to originate certificates of deposit at December 31, 2004, amounted to $20,000,000. No firm commitments were outstanding at March 31, 2005. At March 31, 2005, the fair value of these derivatives qualifying for fair value hedge represented an unrealized net loss of $17.6 million, which was recorded as “Accrued expenses and other liabilities”, before right to offset effect, and as a decrease to the hedged “Deposits” in the accompanying consolidated statements of financial condition. At December 31, 2004, the fair value of these derivatives qualifying for fair value hedge represented an unrealized net loss of $13.0 million, which was recorded as “Accrued expenses and other liabilities”, before right to offset effect, and as a decrease to the hedged “Deposits” of $12.9 million and as an increase in “Other assets” of $101,000 in the accompanying consolidated statements of financial condition. The right to offset effect of $5.9 million and $4.3 million was recorded at March 31, 2005 and December 31, 2004, respectively, as a decrease in “Other assets” and “Accrued expenses and other liabilities” in the accompanying consolidated statements of financial condition.

The Company purchases fixed rate residential mortgage loans for its portfolio. Fixed rate loans expose the Company to variability in their fair value due to changes in the level of interest rates. Management believes that it is prudent to limit the variability in the fair value of a portion of its fixed rate loan portfolio. It is the Company’s objective to hedge the change in fair value of fixed rate mortgage loans at coverage levels that are appropriate, given the anticipated or existing interest rate levels and other market considerations, as well as the relationship of changes in this asset to other assets of the Company. To meet this objective, the Company enters into contracts to purchase fixed rate residential mortgage loans with a third party. The third party agreed to provide the Company a return at a floating rate of interest (three month LIBOR plus a spread)

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even though the contractual terms of the loans are fixed rate in nature. This provision is effectively an interest rate swap (balance guarantee swap). Since the contracts meet with the sale accounting provisions of SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, SFAS No. 133 and related interpretations, these interest rate swaps are accounted for separately. Since the hedged item and the hedging instrument have identical critical terms, no ineffectiveness is assumed and the fair value changes in the interest rate swaps are recorded as changes in the value of both the interest rate swaps and the mortgage loans. At March 31, 2005 and December 31, 2004, the notional amount of these interest rate swaps which equals the principal balance of the mortgage loans amounted to $977,864,000 and $600,848,000, respectively; the weighted average receive floating rate at period end was 4.35% and 3.65%, respectively; the weighted average pay fixed rate at period end was 6.90% and 7.39%, respectively; and the floating rate spread ranged from 120 to 165 basis points.

At March 31, 2005 and December 31, 2004, the fair value of these derivatives qualifying for fair value hedge represented an unrealized loss of $19.9 million and $23.9 million, respectively, which was recorded as “Accrued expenses and other liabilities” and as an increase to “Loans” in the accompanying consolidated statements of financial condition.

Derivative Instruments not Designated as Hedge

The Company offers its customers certificates of deposit which contain an embedded derivative tied to the performance of the Standard & Poor’s 500 Composite Stock Index that is bifurcated from the host deposit and recognized in the consolidated statements of financial condition in accordance with SFAS No. 133. At the end of five years, the depositor will receive a specified percent of the average increase of the month-end value of the stock index. If such index decreases, the depositor receives the principal without any interest. The Company uses option and interest rate swap agreements with major broker dealer companies to manage its exposure to the stock market. Under the option agreements, the Company will receive the average increase in the month-end value of the index in exchange for the payment of a premium when the contract is initiated. Under the terms of the swap agreements, the Company also will receive the average increase in the month-end value of the index in exchange for a quarterly fixed interest cost. Since the embedded derivative instrument on the certificates of deposit and the option and interest rate swap agreements do not qualify for hedge accounting, these derivative instruments are marked to market through earnings.

Information pertaining to the notional amounts of the Company’s derivative instruments not designated as hedge as of March 31, 2005 and December 31, 2004, was as follows:

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At March 31, 2005, the fair value of derivatives not qualifying as a hedge represented an unrealized net gain of $23.3 million and was recorded as part of “Other assets” of $10.9 million, as a reduction of “Deposits” of $12.8 million and as part of “Accrued expenses and other liabilities” of $422,000, in the accompanying consolidated statements of financial condition.

At December 31, 2004, the fair value of derivatives not qualifying as a hedge represented an unrealized net gain of $26.4 million and was recorded as part of “Other assets” of $12.1 million, as a reduction of “Deposits” of $14.5 million and as part of “Accrued expenses and other liabilities” of $254,000, in the accompanying consolidated statements of financial condition.

Other Derivative Instruments Information

A summary of the types of swaps used, excluding those used to manage exposure to the stock market and to the variability in the fair value of fixed rate residential mortgage loans, and their terms at March 31, 2005 and December 31, 2004, follows:

The changes in notional amount of swaps outstanding during the three months ended March 31, 2005, follows:

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At March 31, 2005, the maturities of interest rate swaps, embedded options and purchased options by year were as follows:

Swap agreements amounting to $574,000,000 at March 31, 2005, provide the counterparties the option to cancel the swap agreements on any interest payment date after the first anniversary (matching the call option that the Company has purchased on hedged certificates of deposit). During the three months ended March 31, 2005, various counterparties of swap agreements exercised their option to cancel their swaps and immediately, the Company exercised its option to call the hedged certificates of deposit. No gains or losses resulted from above cancellations.

At March 31, 2005, the carrying value of the specific collateral held by the counterparties consisted of money market instruments of $13,168,000.

11. STOCK OPTION PLANS

The Company has two stock option plans, the 1999 Qualified Stock Option Plan (the “1999 Qualified Option Plan”) and the 1999 Nonqualified Stock Option Plan (the “1999 Nonqualified Option Plan”), for the benefit of employees of the Company and its subsidiaries. These plans offer to key officers, directors and employees an opportunity to purchase shares of the Company’s common stock. Under the 1999 Qualified Option Plan, options for up to 14,747,670 shares (as adjusted) of common stock can be granted. Also, options for up to 14,747,670 shares (as adjusted) of common stock, reduced by any share issued under the 1999 Qualified Option Plan can be granted under the 1999 Nonqualified Option Plan. The option price for both plans is determined at the grant date. Both plans will remain in effect for a term of 10 years. The Board of Directors has sole authority and absolute discretion as to the number of stock options to be granted, their vesting rights, and the options’ exercise price. The options become fully exercisable after five years following the grant date. The Plans provide for a proportionate adjustment in the exercise price and the number of shares that can be purchased in the event of a stock split, reclassification of stock and a merger or reorganization.

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The Company has only three exercise prices for options granted, all of them granted at three different dates. The following table summarizes the exercise prices and the weighted average remaining contractual life of the options outstanding at March 31, 2005:

Effective January 1, 2003, the Company changed the method of accounting for employee stock options from the intrinsic value method to the fair value method. Under the modified prospective method selected by the Company under the provisions of SFAS No. 148, compensation cost to be recognized in future years is the same that would have been recognized if the recognition provisions of FASB No. 123 had been applied from its original effective date. Results prior to 2003 were not restated. Compensation expense of stock options granted to employees for the three month periods ended March 31, 2005 and 2004, was $116,000 and $224,000, respectively.

On February 10, 2005, one of the Company’s executive officers exercised 35,113 options under the Company’s 1999 Qualified Option Plan at an exercise price of $2.85 per share. No options were granted during the three month period ended March 31, 2005.

12. SEGMENT INFORMATION

The Company’s management monitors and manages the financial performance of two reportable business segments, the traditional banking operations of Westernbank Puerto Rico and the activities of the division known as Westernbank International. Other operations of the Company not reportable in either segment include Westernbank Business Credit Division, which specializes in asset-based commercial business lending; Westernbank Trust Division, which offers trust services; SRG Net, Inc., which operates an electronic funds transfer network; Westernbank Insurance Corp., which operates a general insurance agency; Westernbank World Plaza, Inc., which operates the Westernbank World Plaza, a 23-story office building located in Hato Rey, Puerto Rico; and the transactions of the parent company only, which mainly consist of other income related to the equity in the net income of its two wholly owned subsidiaries.

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Management determined the reportable segments based on the internal reporting used to evaluate performance and to assess where to allocate resources. Other factors such as the Company’s organizational structure by divisions, nature of the products, distribution channels, and the economic characteristics of the products were also considered in the determination of the reportable segments. The Company evaluates performance based on net interest income and other income. Operating expenses and the provision for income taxes are analyzed on a combined basis.

Westernbank Puerto Rico’s traditional banking operations consist of Westernbank’s retail operations, such as its branches, including the branches of the Expresso division, together with consumer loans, mortgage loans, commercial loans (excluding the asset-based lending operations), investments (treasury) and deposit products. Consumer loans include loans such as personal, collateralized personal loans, credit cards, and small loans. Commercial products consist of commercial loans including commercial real estate, unsecured commercial and construction loans.

Westernbank International operates as an IBE under the International Banking Regulatory Act. Westernbank International’s business activities consist of commercial banking and related services, and treasury and investment activities outside of Puerto Rico. As of March 31, 2005 and December 31, 2004, and for the periods then ended, substantially all of Westernbank International’s business activities consisted of investment in securities and loans. Loans outstanding at March 31, 2005 and December 31, 2004, amounted to $150,665,000 and $122,723,000, respectively.

Intersegment sales and transfers, if any, are accounted for as if the sales or transfers were to third parties, that is, at current market prices. The accounting policies of the segments are the same as those described in the summary of significant accounting policies of the Company’ Consolidated Financial Statements as of December 31, 2004 and 2003, and for each of the three years in the period ended December 31, 2004, included in the Company’s Annual Report on Form 10-K.

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The financial information presented below was derived from the internal management accounting system and does not necessarily represent each segment’s financial condition and results of operations as if these were independent entities.