SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

OR

Commission file number: 000-21137

R&G FINANCIAL CORPORATION

(787) 758-2424

(Registrant’s telephone number, including area code)

Indicate by checkmark whether Registrant (a) has filed all reports required to be filed by Section 13 (a) or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such report (s) and (b) has been subject to such filing requirements for at least 90 days.

YES x           NO o

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).
      YES x      NO o

Number of shares of Class B Common Stock outstanding as of September 30, 2004: 29,561,190 (Does not include 21,559,584 Class A Shares of Common Stock which are exchangeable into Class B Shares of Common Stock at the option of the holder.)

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R&G FINANCIAL CORPORATION

INDEX

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PART 1-FINANCIAL INFORMATION

ITEM 1: CONSOLIDATED FINANCIAL STATEMENTS
R&G FINANCIAL CORPORATION

The accompanying notes are an integral part of these statements.

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R&G FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME

The accompanying notes are an integral part of these statements.

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R&G FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

The accompanying notes are an integral part of these statements.

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R&G FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS

The accompanying notes are an integral part of these statements.

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R&G FINANCIAL CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - REPORTING ENTITY AND BASIS OF PRESENTATION

Reporting entity

     The accompanying unaudited consolidated financial statements include the accounts of R&G Financial Corporation (the “Company”), a diversified financial services company, and its wholly-owned subsidiaries, R-G Premier Bank of Puerto Rico (“Premier Bank”), a Puerto Rico commercial bank, R-G Crown Bank (“Crown Bank”), a Florida-based federal savings bank, R&G Mortgage Corp. (“R&G Mortgage”), Puerto Rico’s second largest mortgage banker, R&G International Corp., a Puerto Rico international banking entity, R-G Investments Corporation, a Puerto Rico licensed securities broker-dealer, and Home & Property Insurance Corp., a Puerto Rico insurance agency. The Company, currently in its 32nd year of operations, operates as a financial holding company pursuant to the provisions of the Gramm-Leach-Bliley Act of 1999, and is engaged in banking, mortgage banking, and securities and insurance brokerage through its subsidiaries.

     Premier Bank and Crown Bank provide a full range of banking services, including residential, commercial and personal loans and a variety of deposit products. Premier Bank operates through thirty-two branches located mainly in the northeastern part of the Commonwealth of Puerto Rico. Crown Bank operates in the Orlando and Tampa/St. Petersburg metropolitan areas through fifteen full service branches and six commercial lending offices. Premier Bank also provides private banking and trust and other financial services to its customers. Premier Bank and Crown Bank are subject to the regulations of certain federal and Puerto Rico agencies, and undergo periodic examinations by those regulatory agencies.

     Crown Bank is also engaged in the origination of FHA-insured, VA-guaranteed and privately insured first and second mortgage loans on residential real estate (1 to 4 families) in the States of New York, New Jersey, Connecticut and North Carolina, through its wholly-owned subsidiary, Continental Capital Corporation (“Continental Capital”).

     R&G Mortgage is engaged primarily in the business of originating FHA-insured, VA- guaranteed, and privately insured first and second mortgage loans on residential real estate (1 to 4 families), directly and through its wholly-owned subsidiary, Mortgage Store of Puerto Rico, Inc. R&G Mortgage pools FHA and VA loans into GNMA mortgage-backed securities and collateralized mortgage obligation certificates for sale to investors. After selling the loans, it retains the servicing on the loans. R&G Mortgage is also a FNMA and FHLMC seller-servicer of conventional loans.

     On October 11, 2004, the Company and Crown Bank entered into a purchase and assumption agreement with SouthTrust Bank to acquire 18 SouthTrust branches located in three banking markets in Florida and one banking market in Georgia with deposits and other liabilities totaling approximately $600 million. The acquisition results from the required divestiture of certain SouthTrust branches, together with the assets, deposits and other liabilities of such branches, to facilitate regulatory approval of Wachovia Corporation’s acquisition of SouthTrust Corporation, the parent of SouthTrust Bank. The merger of SouthTrust Corporation and Wachovia Corporation was completed on November 1, 2004. The Company expects to complete this transaction in February 2005 as contemplated by the purchase and assumption agreement.

Basis of presentation

     The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions for Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles. However, in the opinion of management, the accompanying unaudited consolidated financial statements include all adjustments (only consisting of normal recurring accruals) necessary for a fair presentation of the Company’s financial condition as of September 30, 2004 and the results of operations and changes in its cash flows for the three and nine months ended September 30, 2004 and 2003.

     The results of operations for the three and nine month periods ended September 30, 2004 are not necessarily indicative of the results to be expected for the year ending December 31, 2004. The unaudited consolidated financial statements and notes thereto should be read in conjunction with the audited financial statements and notes thereto for the year ended December 31, 2003.

Basis of consolidation

     All significant intercompany balances and transactions have been eliminated in the accompanying unaudited financial statements.

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Cash and due from banks

     Cash and due from banks include certain funds that are subject to withdrawal and usage restrictions. At September 30, 2004, cash and due from banks include approximately $11.8 million pledged as collateral under various agreements of the Company, and approximately $10.4 million deposited with the Federal Reserve Bank to comply with certain reserve maintenance balance requirements.

Reclassifications

Certain reclassifications have been made to the 2003 consolidated financial statements to conform with the 2004 presentation.

Recent accounting pronouncements

Accounting for Derivative Instruments and Hedging Activities

     On July 1, 2003, the Company adopted SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities,” which amends and clarifies financial accounting and reporting for derivative instruments, including certain derivatives instruments embedded in other contracts, and for hedging activities under FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities.” The adoption of this Statement on July 1, 2003 had no significant effect on the consolidated financial condition or results of operations of the Company.

Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity

     On July 1, 2003 the Company adopted SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.” SFAS No. 150 covers a limited number of instruments that are to be classified as liabilities and specifies that such instruments embody obligations of the issuer and that, therefore, the issuer must classify them as liabilities.

     Among the instruments specified by SFAS No. 150, mandatorily redeemable financial instruments had to be classified as liabilities. The Company had $35 million of guaranteed preferred beneficial interest in company junior subordinated deferrable interest debentures (“trust preferred securities”) that had already been classified as other borrowings in its consolidated statements of financial condition as of June 30, 2003 and accordingly, the adoption of this Statement on July 1, 2003 did not have any effect on the Company’s consolidated financial statements.

Accounting for Consolidation of Variable Interest Entities

     In January 2003, the FASB issued FIN 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51” (“FIN 46”). Under FIN 46, entities that would be assessed for consolidation are typically referred to as Special-Purposed Entities (“SPEs”), although non-SPE-type entities may also be subject to the guidance. FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entities residual returns, or both. FIN 46 was effective immediately for variable interest entities created after January 31, 2003. For variable interest entities created prior to February 1, 2003, the provisions of FIN 46 became effective October 1, 2003.

     Under the provisions of FIN 46, effective July 1, 2003, the Company deconsolidated R&G Capital Trust I and II, which had issued trust preferred securities prior to February 1, 2003. As discussed above, the Company had classified its $35 million trust preferred securities as borrowings in its consolidated statements of financial condition prior to such deconsolidation. The primary effect of deconsolidating these trusts was to change the balance sheet classification of the liabilities from guaranteed preferred beneficial interest in company junior subordinated deferrable interest debentures to long-term debt.

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     The Company did not consolidate R&G Capital Trust IV, which in August 2003 issued $15 million in trust preferred securities in a private placement, R&G Capital Trust III, which in October 2003 issued $100 million of trust preferred securities in a public offering, and R&G Capital Trust V, which in March 2004 issued $100 million of trust preferred securities in a public offering.

     On May 6, 2004, the Federal Reserve issued proposed rules that would continue to allow trust preferred securities to be included in Tier I regulatory capital, subject to stricter quantitative and qualitative limits. Currently, trust preferred securities and qualifying perpetual preferred stock are limited in the aggregate to no more than 25% of a bank holding company’s core capital elements. As proposed, the Federal Reserve’s rule would retain trust preferred securities as an element of Tier 1 regulatory capital, but with stricter quantitative limitations following a three-year transition period. Under the proposed rule, as of March 31, 2007, the aggregate amount of trust preferred securities and cumulative perpetual preferred stock, as well as certain additional elements of Tier 1 capital which are identified in the proposed rule, may not exceed 25% of a bank holding company’s Tier 1 capital, net of goodwill. As of the date of this Form 10-Q, the 25% limitation is limited to the aggregate amount of only trust preferred securities and cumulative perpetual preferred stock, and is calculated on a basis that includes goodwill. The Federal Reserve also indicated with respect to its proposal that it expected “internationally active banking organizations” to limit the amount of restricted core capital elements included in Tier 1 capital to 15% of the sum of all core capital elements, net of goodwill. The proposed rules do not clarify what constitutes an “internationally active banking organization.” Both we and other Puerto Rico banks through our trade organization, the Puerto Rico Bankers Association, have asked the Federal Reserve to clarify that for purposes of this rule, Puerto Rico banks are not considered “internationally active banking organizations.” Whether or not this change is addressed in a final rule, the proposed rule, if adopted, would effectively limit the amount of trust preferred securities that may be included in Tier 1 capital.

Accounting for Certain Loans and/or Debt Securities Acquired in a Transfer

     In December 2003, the Accounting Standards Executive Committee issued Statement of Position (SOP) No. 03-3, “Accounting for Certain Loans and/or Debt Securities Acquired in a Transfer.” This SOP addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor’s initial investment in loans or debt securities acquired in a transfer if those differences are attributable to credit quality. This SOP does not apply to loans originated by the entity, and it prohibits both the creating and carryover of valuation allowances in the initial accounting of all loans acquired in a transfer within the scope of this SOP. The prohibition of the carryover applies to purchase of an individual loan, a pool of loans, a group of loans, and loans acquired in a purchase business combination. This SOP is effective for loans acquired in fiscal years beginning after December 15, 2004. Based on presently available information, management believes the adoption of this SOP will not have a significant effect on its consolidated financial statements.

Application of Accounting Principles to Loan Commitments

     On March 9, 2004, the SEC issued Staff Accounting Bulletin 105, “Application of Accounting Principles to Loan Commitments,” (“SAB 105”) to inform registrants of the Staff’s view that the fair value of the recorded loan commitments should not consider the expected future cash flows related to the associated servicing of the future loan. The provisions of SAB 105 must be applied to loan commitments accounted for as derivatives that are entered into after March 31, 2004. The Staff will not object to the application of existing accounting practices to loan commitments accounted for as derivatives that are entered into on or before March 31, 2004, with appropriate disclosures. On April 1, 2004, the Company adopted the provisions of SAB 105. The Company records the value of its mortgage loan commitments at fair market value for mortgages it intends to sell. The Company does not currently include, and was not including, the value of mortgage servicing or any other internally-developed intangible assets in the valuation of its mortgage loan commitments. Therefore, the adoption of SAB 105 did not have an impact on the Company’s financial condition or results of operations.

The Meaning of Other-than-Temporary Impairment and its Application to Certain Investments

     At its March 2004 meetings, the Emerging Issues Task Force (“EITF”) revisited EITF Issue No. 03-1, “The Meaning of Other-than-Temporary Impairment and its Application to Certain Investments” (EITF No. 03-1) regarding the determination of whether an investment is considered impaired, whether the identified impairment is considered other-than-temporary, how to measure other-than-temporary impairment, and how to disclose unrealized losses on investments that are not other-than-temporarily impaired. Adoption of the new measurement requirements has been delayed by the FASB pending reconsideration of implementation guidance relating to debt securities that are impaired solely due to market interest rate fluctuations. The contractual cashflows of the Company’s mortgage-backed securities are guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae. Because a decline in fair value is attributable to changes in interest rates and not credit quality, and because the Company has the ability and intent to hold these investments until a market price recovery or maturity, these investments are not considered other-than-temporarily impaired.

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NOTE 2 — EARNINGS PER SHARE

     Basic earnings per common share are computed by dividing net income (less preferred stock dividends) by the weighted average number of shares of common stock outstanding. The weighted average number of outstanding stock options granted in connection with the Company’s Stock Option Plans (270,388 and 225,450 during the three months ended September 30, 2004 and 2003, respectively, and 261,052 and 223,146 during the nine month periods ended September 30, 2004 and 2003, respectively, after giving effect to stock split paid in January 2004), is included in the weighted average number of shares for purposes of the diluted earnings per share computation. No other adjustments are made to the computation of basic earnings per share to arrive at diluted earnings per share.

The reconciliation of the numerator and denominator of the basic and diluted earnings-per-share follows:

(Dollars in thousands, except per share amounts)

Dividends per share on common stock declared and paid by the Company were as follows:

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NOTE 3 — INVESTMENT AND MORTGAGE-BACKED SECURITIES

          The carrying value and estimated fair value of investment and mortgage-backed securities by category are shown below. The fair value of investment securities is based on quoted market prices and dealer quotes.

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In addition to the investment and mortgage-backed securities pledged on repurchase agreements and reported as pledged assets in the consolidated statements of financial condition, at September 30, 2004 the Company had investment and mortgage-backed securities pledged as collateral on repurchase agreements where the counterparties do not have the right to sell or repledge the assets as follows:

     Prior to the quarter ended September 30, 2004, residual interests retained by the Company on financial assets transfers accounted for as sales were reported by the Company at fair value as interest-only strips (IO’s) and classified as available for sale securities. As of September 30, 2004, the Company has reclassified approximately $80.9 million from its available for sale securities to other assets following the guidance contained in SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities (“SFAS No. 133”). Under SFAS No. 133, such residual interests must be recorded as trading derivatives and reported at fair value, with unrealized marked-to-market gains or losses recorded in results of operations of the Company. A corresponding reclassification of $43.1 million was made as of December 31, 2003 for consistency purposes. Following the guidance contained in SFAS No. 133, the Company recorded a trading loss of approximately $11.5 million related to the trading derivatives. The amount of unrealized gains or losses recorded in other comprehensive income related to the retained interests prior to the quarter ended September 30, 2004 were not material since the level of short-term interest rates had been relatively constant from the time the residual interest were originally recognized. As a result, management has determined that the application of the guidance contained on SFAS No. 133 to prior periods has no material impact on the consolidated financial statements of the Company. For additional information on this matter, see “Management’s Discussion and Analysis — Results of Operations.”

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NOTE 4 — LOANS AND ALLOWANCE FOR LOAN LOSSES

     Loans consist of the following:

     The changes in the allowance for loan losses follow:

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The following table sets forth the amounts and categories of R&G Financial’s non-performing assets at the dates indicated.

During the quarter ended June 30, 2004, the Company sold approximately $28.2 million of non-performing residential mortgage loans on a recourse basis.

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NOTE 5 - SERVICING ASSET

The changes in the servicing asset of the Company follows:

NOTE 6 - DEPOSITS

Deposits are summarized as follows:

Certificates of deposit include $817.7 million and $623.8 million of brokered deposits at September 30, 2004 and December 31, 2003, respectively.

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NOTE 7 - STOCK OPTION PLANS

The Company accounts for the plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations. The Company follows the disclosure only provisions of SFAS No. 123 – “Accounting for Stock-Based Compensation” (SFAS 123) and thus, no compensation cost has been recognized for the Company’s Stock Option Plans. Had compensation cost for the Company’s Stock Option Plans been determined based on the fair value of the options at the grant date consistent with the provisions of SFAS 123, the Company’s net earning and earnings per share for the three and nine month period ended September 30, 2004 would have been reduced to the pro-forma amounts indicated below: