Doral Financial Corporation
Some Early Concerns

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By reinhs
February 28, 2006

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Hi All,
I haven't made it through the whole 10k yet and haven't thought about what I have read so far enough either, but I've seen a few things that worry me.

First, there is a lot of talk about the possibility of not being able to pay dividends in the near term. 1) They can't and won't pay a dividend if it will put their cash below levels they need to maintain for their debt agreements. 2) The regulators can stop them from paying dividends, and halt various types of dealings in general if they smell something fishy. It seems like Doral actually is expecting this. Here's a quote from the 10K...

"In light of the concerns expressed by the banking regulators, Doral Financial expects that the other banking regulators will take action with respect to Doral Financial and Doral Bank PR to require further analysis and plans with respect to their safety and soundness and impose restrictions on the ability of Doral Bank PR to pay dividends or extend credit to, or purchase assets from, Doral Financial and on the ability of Doral Financial to pay dividends. The federal banking regulators may also exercise their enforcement powers to take other actions."

Also, preferred shares get dividends before common shares. My worry of course is two fold. We might lose our dividend, and also what will happen to the stock when and if that does happen.

My other concern isn't really a new one. We worried about it before everything fell apart... Doral turned in a 2004 EPS of $1.63, which was better than several of us had guessed. BUT that included the "special" but valid tax benefit that Doral got in 2004. In 2004 Doral had net income of $214.8M but $85.5M of that was the tax benefit. Without it, EPS would have only been $0.63 per share, which is a nasty drop from the 2003 numbers, which were already down from 2002. Yuck. Part of this was getting clobbered not only on yield curves, but on hedging too. Going forward, since Doral is now being honest with itself, they should be able to hedge better, but how much damage was done in 2005. They list book value per common share at the end of 2004 as $6.59 on page 35, 2005 might make things worse, not better.

There are a lot of other scary points in the first 60 or so pages I've made it through. I'm sure things will be fine long term, but these next few 10Q reports potentially might not be all that pretty. I cheated and looked ahead to page 101 where they say...

"The restatement process has resulted in a number of financial, operational and legal difficulties that had a material adverse effect on Doral Financial Corporation's results of operations for the years ended after December 31, 2005. Earnings for 2005 were adversely impacted by the following factors and are anticipated to be significantly lower than those reported for 2004:
� reduction in mortgage loan sales and related gain on sales, in particular during the second half of 2005, as a result of the inability of the Company to use its traditional sales channels for non-conforming loans to local financial institutions because of the uncertainty surrounding the accounting treatment of sale transactions as well as reduced gain on sale margins resulting from the interest rate environment during 2005;

� reduced net interest income as a result of the continued rise in short-term interest rates and the flattening of the yield curve;
� losses incurred on the sale of lower-yielding investment securities during the fourth quarter of 2005;
� losses on derivatives during the first half of 2005 resulting primarily from delays in properly aligning the Company's risk management practices to the interest rate sensitivity of the Company's financial assets; and
� legal, accounting and other expenses related to the restatement."

We'll see I guess. From other things I've read, it sounds like the damage is done, but not all reported yet (10Q's coming). They have, and are, making the right adjustments. They may run into additional issues with shareholder lawsuits, SEC/Regulatory issues, and debt rating issues. All of these should be taken seriously. I think in the end all will be fine, I'm not so sure all the dust has settled just yet, they REALLY need to get this SEC investigation past them ASAP, but it's not in their control, all they can do is be cooperative. I was entirely hoping today would be the start of a long and continued upward trend, but from what I've read so far I'm not so sure we won't take some more hits. Maybe they won't come until the 10Q reports, or maybe I'm flat wrong.

More later when I've been through the rest of it. Sorry it's not rosy, but it is what it is. Talk to you soon,

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