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More From Puerto Rico
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Posted by: Jack Ciesielski 11/11/2005 6:59 AM
A couple of developments - but not much clarity - since the last update on the Puerto Rican bank securitization situation. You'll recall that there are three Puerto Rican institutions being investigated by the SEC for their loan securitization accounting practices: Doral Financial, R&G Financial, and First BanCorporation. Yesterday, all three filed notifications of late filing on their September 10-Qs due to the investigations. All three are audited by PricewaterhouseCoopers - and so is a fourth one involved: Popular, Inc.

On Thursday, Popular filed an S-3 for a stock offering to existing shareholders. This curiosity relating to the trio under investigation emerges in the "risk factors" section of the prospectus:

"We are unable to predict what adverse consequences, if any, or other effects our dealings with Doral Financial Corporation or R&G Financial Corporation, the civil litigation related to Doral or R&G matters or the related investigations could have on us.


As described in our Quarterly Report on Form 10-Q for the quarter ended September 30, 2005 under “Management's Discussion and Analysis of Financial Condition and Results of Operations—Transactions with Doral Financial Corporation” and “—Transactions with R&G Financial Corporation”, Doral Financial Corporation has announced investigations by the Securities and Exchange Commission and the U.S. Attorney's Office for the Southern District of New York and R&G Financial Corporation has announced an investigation by the Securities and Exchange Commission. We have had dealings with both Doral and R&G and we have provided information in connection with, and are continuing to cooperate with, certain of the investigations of these matters. We are unable to predict what adverse consequences, if any, or other effects our dealings with Doral or R&G, the civil litigation related to Doral or R&G matters or the related investigations could have on us."

Well, who could predict the outcome, anyway? Popular apparently is not under investigation; it sounds more like they're being questioned in connection with the investigation of Doral and R&G - perhaps the way DaimlerChrysler was questioned in connection with the SEC's investigation of General Motors and others in connection with pension assumptions. Maybe it's an attempt to corroborate statements made by the companies being investigated.

There's more meat in the Popular third quarter 10-Q. In the section labeled "Transactions with Doral Financial Corporation:"

Doral Announcements. Doral Financial Corporation (“Doral”) has announced that its previously filed financial statements for periods from January 1, 2000 through December 31, 2004 should no longer be relied on and that the financial statements for some or all of the periods included therein should be restated because of issues relating to the methodology used to calculate the fair value of its portfolio of floating rate interest-only strips (“IOs”). On September 22, 2005, Doral estimated that its consolidated stockholders' equity at December 31, 2004, would be reduced, on a pre-tax basis, by approximately $615 million related to corrections to the valuation of its IOs. In addition, on October 25, 2005, Doral announced that it was investigating its mortgage loan sales to local financial institutions. Doral has also announced that the Securities and Exchange Commission is conducting a formal investigation, and that the U.S. Attorney's Office for the Southern District of New York is also conducting an investigation of these matters. Actions have been brought by or on behalf of securities holders of Doral in relation to these matters."

For Popular, so far, so good: Doral's the one being investigated. But in the next paragraph:

"Estimates of Value Provided by Popular Securities. Between October 2002 and December 2004, Popular Securities, Inc., a wholly-owned subsidiary of the Corporation, provided quarterly estimates of the value of portfolios of IOs on behalf of Doral. In accordance with its understanding regarding the engagement, in providing those estimates of value, Popular Securities utilized assumptions provided by Doral that may not have been consistent with the actual terms of the IO portfolios. Doral's Form 10-K for the year ended December 31, 2004 stated that “to determine the fair value of its IO portfolio”, Doral engaged a “party” to provide an “external valuation” that “consists of a cash flow valuation model in which all economic and portfolio assumptions are determined by the preparer”. Popular Securities believes that this characterization is not appropriate if it was meant to apply to Popular Securities' work."

Then what was the purpose of the work done by Popular? It's clear what they say it wasn't for; but it begs the question of what it actually accomplished. There's more:

"Transactions with Doral Relating to Mortgage Loans and IOs. Between 1996 and 2004, BPPR purchased approximately $1.6 billion of mortgage loans from Doral. The remaining balance of these mortgage loans recorded on the Corporation's consolidated statement of condition at September 30, 2005 was $570 million. In the first six months of 2000 the Corporation also sold $200 million of mortgage loans to Doral Bank, a subsidiary of Doral. The Corporation recorded a gain of $2.2 million in the first quarter of 2000 and of $1.9 million in the second quarter of 2000 from the sales of mortgages to Doral Bank. The purchases and sales of loans were often accompanied by separate recourse and other financial arrangements. Between 1996 and 2004, the Corporation purchased $110 million in IOs from Doral. The remaining balance of these IOs recorded on the Corporation's consolidated statement of condition at September 30, 2005 was $42 million. These IOs have been reclassified from investments available-for-sale to loans to Doral because they are accompanied by 100% yield and principal guarantees from Doral and because of the source of the cash flow for payments on the IOs. See Note 3 to the Corporation's financial statements for the quarter ended September 30, 2005. The Corporation has concluded that its previously filed financial statements are fairly stated and that no restatement is necessary."

Nothing malodorous here. In fact, the recharacterization of the IOs purchased from Doral as loans makes more sense than leaving them as IOs, given these facts. On to R&G dealings:

"R&G Announcements. R&G Financial Corporation (“R&G”) has announced that its previously filed financial statements for periods from January 1, 2002 through December 31, 2004 need to be restated and should no longer be relied upon because of issues relating to the methodology used in valuing its portfolio of residual interests retained in securitization transactions. R&G has announced that the Securities and Exchange Commission is conducting a formal investigation of this matter. Actions have been brought by or on behalf of securities holders of R&G in relation to these matters."

No mention of valuation work done for R&G by Popular, as was done for Doral. And in the next paragraph, the deals done with R&G:

"Purchases of Mortgage Loans from R&G. Between 2003 and 2004, BPPR entered into various mortgage purchase transactions with R&G in the amount of $176 million. These purchase transactions had recourse provisions and other financial arrangements. At September 30, 2005, the remaining balance of the mortgage loans purchased from R&G recorded on the Corporation's consolidated statement of condition was $136 million. The Corporation has concluded that its previously filed financial statements are fairly stated and that no restatement is necessary."

Sounds pretty ordinary. What it does show is how widely the SEC is casting its net; so far, the disclosed facts are only teasing investors. And Popular's disclosures raise another puzzle: their accounting for securitizations, so far, has passed muster. Yet it was audited by the same audit firm - PwC -as the other three, from the same San Juan office. Stay tuned.
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