W HOLDING CO INC (WBPRP) - Description of business

Company Description
" -->ITEM 1. BUSINESSGENERAL     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 December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006, 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.     At December 31, 2006, the Company had total assets of $17.15 billion, a loan portfolio-net of $8.64 billion, an investment portfolio of $7.03 billion, excluding short-term money market instruments of $971.6 million, deposits of $9.34 billion, borrowings of $6.48 billion and stockholders’ equity of $1.23 billion. The Company has improved its efficiency ratio from 40.66% in 2002, to 34.94% for the year ended December 31, 2006.     Westernbank is the second largest commercial bank in Puerto Rico, based on total assets at December 31, 2006. Westernbank operates through a network of 56 bank branches (including 20 Expresso of Westernbank branches) located throughout Puerto Rico, including 33 in the Western and Southwestern regions, 14 in the San Juan metropolitan area, 7 in the Northeastern region, and 2 in the Eastern region, and a website on the Internet. Westernbank’s deposits, excluding Individual Retirement Accounts (IRAs), are insured by the Deposit Insurance Fund (“DIF”), which is administered by the FDIC, up to $100,000 per depositor. IRAs are insured by DIF up to $250,000 per depositor. 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 five 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 Center Regulatory Act, which offers commercial banking 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; Expresso ofWesternbank, a division which specializes in small, unsecured consumer loans up to $15,000 and real estate collateralized consumer loans up to $150,000 and Westernbank International Trade Services, established during the first quarter of year 2006, a division which specializes in international trade products and services. Westernbank owns 100% of the voting shares of Westernbank World Plaza, Inc., which 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 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 December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006, were not significant. Westernbank also owns 100% of the issued and outstanding common stock of Westernbank Financial Center Corp. (“WFCC”). WFCC was incorporated under the laws of the State of Florida to carry commercial lending and other related activities in the United States of America. WFCC commenced operations in February 2007.     Westernbank seeks to differentiate itself from other banks by focusing on customer relationships and personalized service, offering customers direct access to senior management. As part of this strategy, Westernbank strives to make fast and effective decisions locally. Westernbank’s branches offer modern facilities with advanced technology and remain open to customers for longer hours compared to many other local banks, with a number of branches offering both Saturday and Sunday hours. In addition, Westernbank trains its employees to promote an effective and customer-focused sales culture. Westernbank is one of the fastest-growing commercial banks in Puerto Rico, increasing both total assets and loans at an average annual growth rate of over 24.58% for the last five fiscal years. The Company has achieved this growth while consistently maintaining a combined delinquency ratio on all loan portfolios for the categories of 60 days and over below 1.00%.     The Company continues to emphasize growing Westernbank’s commercial loan portfolio through commercial real estate, asset-based, unsecured business and construction lending. As a result, the Company’s asset composition is mainly composed of assets with shorter maturities and greater repricing flexibility. At December 31, 2006, commercial real estate, commercial, industrial and agricultural (“Commercial and C&I”) and construction loans were $6.94 billion or 80.35% (81.65% of which are collateralized by real estate) and consumer loans were $810.0 million or 9.37% (60.59% of which are collateralized by real estate) of the $8.64 billion loan portfolio-net. Investment securities, excluding money market instruments of $971.6 million, totaled $7.03 billion at December 31, 2006. These loans and securities tend to have shorter maturities and reprice faster than traditional residential mortgage loans. The Company also continues to diversify and grow Westernbank’s sources of revenue, while maintaining its status as a secured lender, with approximately 83% of its loans collateralized by real estate as of December 31, 2006.     The Company is focused on the expansion of Westernbank in the San Juan metropolitan area. The Company has opened 14 branches in the San Juan metropolitan area since 1998, including seven Expresso of Westernbank branches in July 2002. In the first quarter of 2002, Westernbank acquired Westernbank World Plaza; a 23-story office building that is the tallest in Puerto Rico’s main business district and now serves as the Company’s San Juan metropolitan area headquarters, the Bank’s regional commercial lending office and the headquarters for Westernbank Business Credit, the Expresso of Westernbank and Westernbank International Trade Services divisions. In addition, the Company continues to build upon its existing platform and further expand its fee-based businesses, including insurance brokerage, trust services and securities brokerage. In March 2005, the Company opened its first mega branch in the eastern region of Puerto Rico, in the town of Humacao and in December 2005, it opened a mega branch in the Condado area in the city of San Juan. In September 2006, the Company opened its newest mega branch in the city of Bayamón.     Commercial lending, including commercial real estate and asset-based lending, unsecured business lending and construction lending, generally carry a greater risk than residential lending because such loans are typically larger in size and more risk is concentrated in a single borrower. In addition, the borrower’s ability to repay a commercial loan or a construction loan depends, in the case of a commercial loan, on the successful operation of the business or the property securing the loan and, in the case of a construction loan, on the successful completion and sale or operation of the project. Substantially all of the Company’s borrowers and properties and other collateral securing the commercial, real estate mortgage and consumer loans are located in Puerto Rico. These loans may be subject to a greater risk of default if the Puerto Rico economy suffers adverse economic, political or business developments, or if natural disasters affect Puerto Rico.     The Company’s financial performance is reported in two primary business segments, the traditional banking operations of Westernbank Puerto Rico and the activities of Westernbank’s division known as Westernbank International. Other operations of the Company, not reportable in either segment, include Westernbank Business Credit Division; Westernbank Trust Division; Westernbank International Trade Services Division; SRG Net, Inc.; Westernbank Insurance Corp.; Westernbank World Plaza, Inc.; 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.     The traditional banking operations of Westernbank Puerto Rico 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. 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’s business activities consist of commercial banking and related services, and treasury and investment activities outside of Puerto Rico. As of December 31, 2006, 2005, and 2004, and for the periods then ended, substantially all of Westernbank International’s business activities consisted of investment in securities of and loans to entities located in the United States of America. At December 31, 2006, Westernbank International had $335.4 million in loans receivable-net of which $109.3 million were foreign loans (see Note 23 to the consolidated financial statements).     Established in 2001, Westernbank Insurance Corp. is a general insurance agent placing property, casualty, life and disability insurance on which it earns commission income. Currently, most of the agency’s volume is derived from two areas — mortgage insurance on residential mortgage loans and credit life insurance for borrowers of personal loans.     The Company and its wholly owned subsidiaries’ executive offices are located at 19 West McKinley Street, Mayagüez, Puerto Rico 00681, and the telephone number is (787) 834-8000. The Company’s Internet address is www.wholding.com. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports are available, without charge, on our website, http://www.wholding.com/InvestorRelations.asp, as soon as reasonably practicable after they are filed electronically with the SEC. Copies are also available, without charge, from W Holding Company, Inc, Corporate Communications and Investor Relations, 19 West McKinley Street, 4 th Floor, Mayagüez, PR 00680.     The information required by Item 101 (b) of Regulation S-K appears in the Company’s Consolidated Financial Statements, and is included herein in Part II, Item 8. See Note 23 to the consolidated financial statements for further information about the Company’s business segments.COMPETITION     The financial services and banking business are highly competitive, and the profitability of the Company will depend principally upon the Company’s ability to continue to compete in its market area as well as to a significant extent upon general economic conditions in its market place. The Company competes with other commercial and non-commercial banks, finance companies, mutual funds, insurance companies, brokerage and investment banking firms, asset-based non-bank lenders and certain other non-financial institutions, including certain governmental organizations which may offer subsidized financing at lower rates than those offered by the Company. The Company has been able to compete effectively with other financial institutions by emphasizing technology and customer service, including local office decision-making on loans, establishing long-term customer relationships and building customer loyalty, and by providing products and services designed to address the specific needs of its customers. Significant deterioration in the local economy or external economic conditions, such as inflation, recession, unemployment, real estate values and other factors beyond the Company’s control, could also substantially impact the Company’s performance. There can be no assurance that future adverse changes in the local economy would not have a material adverse effect on the Company’s consolidated financial condition, results of operations or cash flows.LENDING ACTIVITIES     GENERAL. At December 31, 2006, the Company’s net loans amounted to $8.64 billion or 50.37% of total assets.     The following table sets forth the composition of the Company’s loan portfolio at the dates indicated.                                                                                       At December 31,       2006     2005     2004     2003     2002       Amount     Percent     Amount     Percent     Amount     Percent     Amount     Percent     Amount     Percent       (Dollars in thousands)  Commercial real estate - mortgage (1)   $ 4,945,932       57.2 %   $ 4,260,258       54.5 %   $ 3,154,679       53.3 %   $ 2,261,465       48.3 %   $ 1,647,602       38.9 %Residential real estate - mortgage (2)     1,014,957       11.8       1,298,535       16.6       879,056       14.9       894,007       19.1       844,803       22.5  Construction — mortgage     722,789       8.4       505,760       6.5       328,145       5.5       202,600       4.3       181,266       4.8  Commercial, industrial and agricultural (1)     1,274,236       14.7       1,013,092       13.0       768,604       13.0       524,747       11.2       384,200       15.2  Consumer and others (3) (4)     809,953       9.4       830,384       10.6       866,934       14.6       861,907       18.4       743,600       19.8                                                                                                                                              Total loans     8,767,867       101.5       7,908,029       101.2       5,997,418       101.3       4,744,726       101.3       3,801,471       101.2                                                                                  Allowance for loan losses     (126,844 )     (1.5 )     (92,406 )     (1.2 )     (80,066 )     (1.3 )     (61,608 )     (1.3 )     (47,114 )     (1.2 )                                                                                                                                            Loans — net   $ 8,641,023       100.0 %   $ 7,815,623       100.0 %   $ 5,917,352       100.0 %   $ 4,683,118       100.0 %   $ 3,754,357       100.00 %                                                             (1)   Includes $1.46 billion, $1.26 billion, $831.1 million, $641.1 million and $427.7 million of Westernbank Business Credit division outstanding loans at December 31, 2006, 2005, 2004, 2003 and 2002, respectively.   (2)   Includes fixed and floating interest rate loans to two mortgage originator groups in Puerto Rico mainly secured by mortgages on one-to-four family residential properties as follows: $940.0 million, $1.14 billion, $745.0 million, $750.6 million, and $701.6 million at December 31, 2006, 2005, 2004, 2003 and 2002, respectively.   (3)   Includes $129.0 million, $135.0 million, $144.0 million, $155.6 million and $117.4 million of Expresso of Westernbank division outstanding loans at December 31, 2006, 2005, 2004, 2003 and 2002, respectively.   (4)   Includes $490.7 million, $585.9 million, $585.2 million, $521.6 million and $447.9 million collateralized by real estate at December 31, 2006, 2005, 2004, 2003, 2002, respectively.     Residential real estate — mortgage loans are mainly comprised of loans secured by first mortgages on one-to-four family residential properties. At December 31, 2006, residential and commercial real estate loans included $940.0 million in commercial loans, mainly secured by individual mortgages on one-to-four family residential properties, to two mortgage originator groups in Puerto Rico and $26.0 million of mortgages insured or guaranteed by government agencies of the United States or Puerto Rico.     Westernbank has a significant fixed rate lending concentration with an aggregate unpaid principal balance of $894.0 million in one mortgage originator group in Puerto Rico at December 31, 2006. In addition, Westernbank has outstanding $46.0 million of fixed and floating rate loans to another mortgage originator group in Puerto Rico, for total outstanding loans to mortgage originator groups amounting to $940.0 million at December 31, 2006. These commercial loans are secured by 11,672 individual mortgage loans on residential and commercial real estate with an average principal outstanding balance of $80,534. Westernbank’s historical experience with the mortgage originator groups is that they have paid these loans in accordance with their terms. On March 16, 2006, Westernbank obtained a waiver from the Office of the Commissioner of Financial Institutions of the Commonwealth of Puerto Rico with respect to the statutory limit for individual borrowers (loan to one borrower limit), which allows the Company to retain the above significant commercial loans in its portfolio until these are paid in full.     On June 30, 2006, Westernbank entered into an agreement to restructure the terms of the original transactions of the $894.0 million lending relationship described above. The agreement eliminated the recourse provisions on the underlying loans, terminated the counterparties’ call rights, converted the return from variable to a fixed rate, and resulted in a net compensation of $25.8 million to Westernbank. One of the purposes of that transaction was to give Westernbank the ability to use sale accounting treatment. However, because most of the individual mortgage loans were originally transferred to the ultimate transferor within the mortgage originator group by two of its affiliates, the Company has not been able to obtain persuasive evidence that the transfers of loans from the affiliates to the entity that subsequently transferred the loans to Westernbank met all the criteria for sale accounting under the provisions of SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. As a result, the Company continues to present these transactions as commercial loans secured by real estate mortgages. The net compensation of $25.8 million received by Westernbank in connection with the June 30, 2006 transaction is being amortized over the remaining life of these loans as a yield adjustment.     Westernbank originated $1.87 billion of commercial real estate mortgage loans, including construction loans, during the year ended December 31, 2006. At December 31, 2006, commercial real estate mortgage loans totaled $4.96 billion. In general, commercial real estate mortgage loans are considered by management to be of somewhat greater risk of uncollectibility than residential lending because such loans are typically larger in size and more risk is concentrated in a single borrower. In addition, the borrower’s ability to repay a commercial loan or a construction loan depends, in the case of a commercial loan, on the successful operation of the business or the property securing the loan and,in the case of a construction loan, on the successful completion and sale or operation of the project. Substantially all of the Company’s borrowers and properties and other collateral securing the commercial, real estate mortgage and consumer loans are located in Puerto Rico. These loans may be subject to a greater risk of default if the Puerto Rico economy suffers adverse economic, political or business developments, or if natural disasters affect Puerto Rico. Foreign loans, mainly to entities in Canada and in the United Kingdom, amounted to $109.3 million at December 31, 2006.     The portfolio of Consumer and other loans at December 31, 2006, consisted of consumer loans of $810.0 million, of which $490.7 million are secured by real estate, $282.7 million are unsecured consumer loans (consisting of $104.3 million of Expresso of Westernbank division unsecured loans portfolio, credit card loans of $48.7 million and other consumer loans of $129.7 million) and loans secured by deposits in Westernbank totaling $36.6 million.     During 2006, Westernbank securitized $4.6 million and $4.0 million of residential mortgage loans into Government National Mortgage Association and Fannie Mae participation certificates, respectively, and sold loans amounting to $16.6 million to Fannie Mae. Westernbank continues to service outstanding loans which are securitized and those individually sold to Fannie Mae.     The following table summarizes the contractual maturities of Westernbank’s total loans for the periods indicated at December 31, 2006. Contractual maturities do not necessarily reflect the expected term of a loan, including prepayments.                                                               Maturities                       After one year to five years     After five years       Balance     One year or     Fixed     Variable       Fixed     Variable       outstanding     less     interest     interest     interest     interest       (In thousands)    Commercial real estate — mortgage   $ 4,945,932     $ 1,503,741     $ 349,206     $ 774,960     $ 125,973     $ 2,192,052  Residential real estate — mortgage (1)     1,014,957       8,194       51,921       7       918,186       36,649  Construction — mortgage     722,789       502,411       —       220,378       —       —  Commercial, industrial and agricultural     1,274,236       491,124       17,310       636,541       54,349       74,912  Consumer and others     809,953       135,469       167,245       8,188       82,826       416,225                                        Total   $ 8,767,867     $ 2,640,939     $ 585,682     $ 1,640,074     $ 1,181,334     $ 2,719,838                                       (1)   Includes fixed and floating interest rate loans to two mortgage originator groups in Puerto Rico mainly secured by mortgage on one-to-four familiy residential properties with an outstanding principal balance of $940.0 million at December 31, 2006.     ORIGINATION, PURCHASE AND SALE OF LOANS. Westernbank’s loan originations come from a number of sources. The primary sources for residential loan originations are depositors and walk-in customers. Commercial loan originations come from existing customers as well as through direct solicitation and referrals.     Westernbank originates loans in accordance with written, non-discriminatory underwriting standards and loan origination procedures prescribed in the Board of Directors approved loan policies. Detailed loan applications are obtained to determine the borrower’s repayment ability. Applications are verified through the use of credit reports, financial statements and other confirmation procedures. Property valuations by independent appraisers approved by the Board of Directors are required for mortgage and all real estate loans.     Westernbank’s Senior Credit Committee approval is required for all loans in excess of $20.0 million ($15.0 million in the case of Westernbank Business Credit Division). The Senior Credit Committee also reviews and ratifies all loans from $1.0 million to $20.0 million approved by Westernbank’s regional credit committees. The Senior Credit Committee is composed of a majority of the members of the Company’s Board of Directors and senior lending officers. All loans in excess of $20.0 million ($15.0 million for Westernbank Business Credit Division) approved by the Senior Credit Committee are also reviewed and ratified by the Board of Directors of the Company. All loans in excess of $50.0 million require the approval of the Board of Directors of the Company.     It is Westernbank’s policy to require borrowers to provide title insurance policies certifying or ensuring that Westernbank has a valid first lien on the mortgaged real estate. Borrowers must also obtain hazard insurance policies prior to closing and, when required by the Department of Housing and Urban Development, flood insurance policies. Borrowers may be required to advance funds on a monthly basis together with each payment of principal and interest to a mortgage escrow account from which Westernbank makes disbursements for items such as real estate taxes, hazard insurance premiums and private mortgage insurance premiums as they fall due.     Westernbank originates fixed and adjustable rate residential mortgage loans secured by a first mortgage on the borrower’s real property, payable in monthly installments for terms ranging from ten to forty-five years. Adjustable rates are indexed to specified prime or LIBOR rate. Westernbank’s practice is that its limited production and origination of residential real estate loans are mostly conforming loans, eligible for sale in the secondary market. The loan-to-value ratio at the time of origination on residential mortgages is generally 75%, except that Westernbank may lend up to 90% of the lower of the purchase price or appraised value of residential properties if private mortgage insurance is obtained by the borrower for amounts in excess of 80%.     Westernbank originates primarily variable and adjustable rate commercial business and real estate loans. Westernbank also makes real estate construction loans subject to firm permanent financing commitments. As of December 31, 2006, Westernbank’s Commercial and C&I and construction loan portfolios had a total delinquency ratio, including the categories of 60 days and over, of 0.63% (less than 1%), compared to 0.85% (less than 1%) at December 31, 2005. For further explanation on the delinquency ratio of the Company’s commercial loan portfolio refer to section “NON-PERFORMING LOANS AND FORECLOSED REAL ESTATE HELD FOR SALE”.     Westernbank offers different types of consumer loans in order to provide a full range of financial services to its customers. Within the different types of consumer loans offered by Westernbank, there are various types of secured and unsecured consumer loans with varying amortization schedules. In addition, Westernbank makes fixed-rate residential second mortgage consumer loans. In July 2002, Westernbank launched a banking division focused on offering consumer loans that now has 20 full-service branches, called “Expresso of Westernbank”, denoting the branches’ emphasis on small, unsecured consumer loans up to $15,000 and collateralized consumer loans up to $150,000.     Westernbank offers the service of VISA TM and MasterCard TM credit cards. At December 31, 2006, there were approximately 21,499 outstanding accounts, with an aggregate outstanding balance of $48.7 million and unused credit card lines available of $81.8 million.     In connection with all consumer loans originated, Westernbank’s underwriting standards include a determination of the applicants’ payment history on other debts and an assessment of the ability to meet existing obligations and payments on the proposed loan. As of December 31, 2006, Westernbank’s consumer loan portfolio, including the Expresso of Westernbank loan portfolio, had a total delinquency ratio, including the categories of 60 days and over, of 1.52%, compared to 1.13% at December 31, 2005. The increase in the delinquency ratio from 2005 to 2006 was mainly due to delinquencies in regular consumer loans past due over 90 days which are collateralized by real estate properties.     Westernbank has 83% of its loan portfolio as of December 31, 2006, secured by real estate. Our combined delinquency on all portfolios for the categories of 60 days and over continues to be below 1% for both periods, being 0.66% at December 31, 2006, and 0.72% at December 31, 2005. The improvement in the combined delinquency ratio arises from a reduction in delinquent loans of the Commercial and C&I and construction loan portfolios.     INCOME FROM LENDING ACTIVITIES. Westernbank realizes interest income and fee income from its lending activities. For the most part, interest rates charged by Westernbank on loans depend upon the general interest rate environment, the demand for loans and the availability of funds. Westernbank also receives fees for originating and committing to originate or purchase loans and also charges service fees for the assumption of loans, late payments, inspection of properties, appraisals and other miscellaneous services.     Loan origination and commitment fees vary with the volume and type of loans and commitments made and sold and with competitive conditions in the residential and commercial mortgage markets. Loan origination fees net of related direct loan origination costs are deferred and amortized over the life of the related loans as a yield adjustment using the interest method or a method which approximates the interest method. Commitment fees are also deferred and amortized over the life of the related loans as a yield adjustment. If the commitment expires unexercised, the fee is taken into income.     Westernbank recognizes as separate assets the rights to service mortgage loans for others, regardless of how those servicing rights are acquired and assesses the capitalized mortgage servicing rights for impairment based on the fair value of those rights. Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Fair value is determined using prices for similar assets with similar characteristics. Impairment is recognized through a valuation allowance for an individual servicing right, to the extent that fair value is less than the carrying amount for that right. The total cost of mortgage loans to be sold with servicing rights retained is allocated to the mortgage servicing rights and the loans (without the mortgage servicing rights), based on their relative fair values. Mortgage servicing rights are amortized in proportion to, and over the period of, estimated servicing income. As of December 31, 2006, Westernbank had $3.0 million in mortgage servicing assets.     NON-PERFORMING LOANS AND FORECLOSED REAL ESTATE. When a borrower fails to make a required payment on a loan, Westernbank attempts to cure the deficiency by contacting the borrower. In most cases, deficiencies are cured promptly. If the delinquency exceeds 90 days and is not cured through normal collection procedures, Westernbank will generally institute measures to remedy the default. If a foreclosure action is instituted and the loan is not cured, paid in full or refinanced, the property is sold at a judicial sale at which Westernbank may acquire the property. In the event that the property is sold at a price insufficient to cover the balance of the loan, the debtor remains liable for the deficiency. Thereafter, if Westernbank acquires the property, such acquired property is appraised and included in the foreclosed real estate held for sale account at the fair value at the date of acquisition. Then, this asset is carried at the lower of fair value less estimated costs to sell or cost until the property is sold.     The accrual of interest on loans is discontinued when there is a clear indication that the borrower’s cash flows may not be sufficient to meet payments as they become due, but in no event is it recognized after a borrower is 90 days in arrears on payments of principal or interest. When a loan is placed on nonaccrual status, all previously accrued and unpaid interest is charged against income and the loan is accounted for on the cash method thereafter, until qualifying for return to accrual status. Generally, a loan is returned to accrual status when all delinquent interest and principal payments become current in accordance with the terms of the loan agreement or when the loan is both well secured and in the process of collection and collectibility is no longer doubtful. Consumer loans that have principal and interest payments that have become past due one hundred and twenty days and credit cards and other consumer revolving lines of credit that have principal and interest payments that have become past due one hundred and eighty days are charged-off against the allowance for loan losses.     The following table sets forth information regarding non-performing loans and foreclosed real estate held for sale by the Company at the dates indicated:                                               December 31,       2006     2005     2004     2003     2002       (Dollars in thousands)  Commercial real estate mortgage and commercial, industrial and agricultural loans   $ 154,862     $ 55,585     $ 25,417     $ 24,142     $ 13,567  Residential real estate mortgage and construction loans     1,641       2,125       1,730       2,259       2,026  Consumer loans     9,309       6,288       7,122       4,845       3,812                                Total non-performing loans     165,812       63,998       34,269       31,246       19,405  Foreclosed real estate held for sale     5,917       4,137       3,811       4,082       3,679                                Total non-performing loans and foreclosed real estate held for sale   $ 171,729     $ 68,135     $ 38,080     $ 35,328     $ 23,084                                  Interest that would have been recorded if the loans had not been classified as non-performing   $ 9,052     $ 4,916     $ 3,557     $ 2,500     $ 1,102                                Interest recorded on non-performing loans   $ 4,785     $ 743     $ 243     $ 583     $ 775                                Total non-performing loans as a percentage of total loans at end of period     1.89 %     0.81 %     0.58 %     0.66 %     0.51 %                              Total non-performing loans and foreclosed real estate held for sale as a percentage of total assets at end of period     1.00 %     0.42 %     0.27 %     0.31 %     0.28 %                                   The increase in non-performing loans from year end 2005, to year end 2006 mainly comes from the Company’s Commercial and C&I loan portfolio. Non-performing loans on the Commercial and C&I loan portfolio increased by $99.3 million, when compared to December 31, 2005. The increase is mainly attributed to four loans of the Company’s asset based lending division, with outstanding principal balances of $44.9 million, $40.5 million, $14.2 million and $7.3 million at December 31, 2006. These loans are current and have not missed their payment schedules but have shortfalls in the collaterals and in the financial condition of the borrowers. These loans required valuation allowances as follows: $11.4 million for the $44.9 million loan, $15.2 million for the $40.5 million loan, $4.7 million for the $14.2 million loan and $2.5 million for the $7.3 million loan. During the year ended December 31, 2006, five loans related to one single borrower that were in non-performing status at December 31, 2005, with an aggregate outstanding principal balance of $8.4 million, were collected. Non-performing loans on the consumer loans portfolio increased by $3.0 million or 48.04% at December 31, 2006, when compared to December 31, 2005. Such increase was mainly due to non-performing loans in the regular consumer loans portfolio which are collateralized by real estate. At December 31, 2006, the allowance for possible loan losses was 76.50% of total non-performing loans (reserve coverage).     The increase in non-performing loans from year end 2004, to year end 2005 mainly comes from the Company’s Commercial and C&I loan portfolio. Non-performing loans on the Commercial and C&I loan portfolio increased by $30.2 million, when compared to December 31, 2004. The increase is primarily attributed to one loan of Westernbank Business Credit division originally acquired in the purchased loan portfolio, with an outstanding principal balance of $10.1 million. There is also one borrower with five commercial loans with an aggregate principal balance of $8.4 million, and five other commercial loans with outstanding principal balances between $1.0 million to $3.0 million, with an aggregate outstanding principal balance of $8.2 million. These loans are collateralized with real estate and did not require any valuation allowance. At December 31, 2005, the allowance for possible loan losses was 144.39% of total non-performing loans (reserve coverage).     ALLOWANCE FOR LOAN LOSSES. Westernbank maintains an allowance for loan losses to absorb probable losses inherent in the loan portfolio. The allowance is based on ongoing, quarterly assessments of the probable estimated losses inherent in the loan portfolio, based on evaluations of the collectibility and historical loss experience of loans. The Company follows a systematic methodology to establish and evaluate the adequacy of the allowance for loan losses. This methodology consists of several key elements, which include:     The Formula Allowance. The formula allowance is calculated by applying loss factors to outstanding loans not otherwise covered by specific allowances. Loss factors are based on historical loss experience and may be adjusted for significant factors that, in management’s judgment, reflect the impact of any current condition on loss recognition. Factors that management considers in the analysis include the effect of the national and local economies, trends in the nature and volume of loans (delinquencies, charge-offs, non-accrual and problem loans), asset quality trends, changes in the internal lending policies and credit standards, collection practices, and examination results from bank regulatory agencies and the Company’s internal credit examiners. Loss factors are described as follows:•   Loan loss factors for commercial loans, including construction and land acquisition loans, are based on average loss trends (historical net charge-offs and changes in the specific allowances) for three to five years, as adjusted for management’s expected increase in the loss factors given the significant increase in such loan portfolios over the last few years.    •   Pooled loan loss factors are also based on average loss trends (historical net charge-offs and changes in the specific allowances) for one to three years. Pooled loans are loans that are homogeneous in nature, such as consumer installment, residential mortgage loans and credit cards.     Specific Allowances for Identified Problem Loans and Portfolio Segments. Specific allowances are established and maintained where management has identified significant adverse conditions or circumstances related to a credit or portfolio segment that management believes indicate the probability that a loss has been incurred in excess of the amount determined by the application of the formula allowance. Larger commercial and construction loans that exhibit probable or observed credit weaknesses are subject to individual review. 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 Westernbank.     In addition, the specific allowance incorporates the results of measuring impaired loans as provided in SFAS No. 114, Accounting by Creditors for Impairment of a Loan, as amended. This accounting standard prescribes the measurement methods, income recognition and disclosures concerning impaired loans.     The Unallocated Allowance. An unallocated allowance is established recognizing the estimation risk associated with the formula and specific allowances. It is based upon management’s evaluation of various conditions, the effects of which are not directly measured in determining the formula and specific allowances. These conditions include then-existing general economic and business conditions affecting our key lending areas; credit quality trends, including trends in nonperforming loans expected to result from existing conditions, collateral values, loan volumes and concentrations, seasoning of the loan portfolio, recent loss experience in particular segments of the portfolio, regulatory examination results, and findings of our internal credit examiners. The evaluation of the inherent loss regarding these conditions involves a higher degree of uncertainty because these are not identified with specific problem credits or portfolio segments.     Management assesses these conditions quarterly. If any of these conditions is evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s estimate of the effect of this condition may be reflected as a specific allowance applicable to this credit or portfolio segment. Where any of these conditions is not evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s evaluation of the probable loss concerning this condition is reflected in the unallocated allowance.     The allowance for loan losses is based upon estimates of probable losses inherent in the loan portfolio. The amount actually observed for these losses can vary significantly from the estimated amounts. Our methodology includes several features that are intended to reduce the differences between estimated and actual losses. Historical loss factors for commercial and consumer loans may be adjusted for significant factors that, in management’s judgment, reflect the impact of any current condition on loss recognition. Factors which management considers in the analysis include the effect of the national and local economies, trends in the nature and volume of loans (delinquencies, charge-offs, non-accrual and problem loans), changes in the internal lending policies and credit standards, collection practices, and examination results from bank regulatory agencies and the Bank’s internal credit examiners. Loan loss factors are adjusted quarterly based upon the level of net charge-offs expected by management in the next twelve months, after taking into account historical loss ratios adjusted for current trends. By assessing the probable estimated losses inherent in the loans portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates based upon any more recent information that has become available.     At December 31, 2006, the allowance for loan losses was $126.8 million, consisting of $86.6 million formula allowance (general allowance) and $40.2 million of specific allowance. As of December 31, 2006, the allowance for loan losses equals 1.45% of total loans, compared with an allowance for loan losses at December 31, 2005, of $92.4 million, or 1.17% of total loans.     As of December 31, 2006, there have been no significant changes in estimation methods or assumptions that affected our methodology for assessing the appropriateness of the allowance for loan losses.     The table below presents a reconciliation of changes in the allowance for loan losses for the periods indicated:                                               YEAR ENDED DECEMBER 31,       2006     2005     2004     2003     2002       (Dollars in thousands)    Balance, beginning of year   $ 92,406     $ 80,066     $ 61,608     $ 47,114     $ 38,364                                Loans charged-off:                                        Commercial real estate mortgage and commercial, industrial and agricultural loans (1)     (22,606 )     (8,233 )     (5,433 )     (2,479 )     (3,389 )Residential real estate mortgage and construction loans     (94 )     (121 )     (297 )     (184 )     —  Consumer loans (2)     (12,576 )     (13,809 )     (16,473 )     (12,203 )     (4,576 )                              Total loans charged-off     (35,276 )     (22,163 )     (22,203 )     (14,866 )     (7,965 )                              Recoveries of loans previously charged-off:                                        Commercial real estate mortgage and commercial, industrial and agricultural loans     2,846       1,008       1,844       1,141       584  Residential real estate mortgage and construction loans     66       212       206       372       190  Consumer loans (3)     2,252       2,283       1,920       79