Income tax expense (benefit) differed from the amounts computed by applying the Puerto Rico income tax rate of 30 percent to pre-tax income as a result of the following:

		Quarters ended
		June 30, 2012				June 30, 2011
(In thousands)		Amount	% of pre-tax income			Amount	% of pre-tax income
Computed income tax at statutory rates	$	(3,646)	30	%	$	21,776	30	%
Net benefit of net tax exempt interest income		(3,739)	31			(15,206)	(21)
Deferred tax asset valuation allowance		(48)	-			3,945	5
Non-deductible expenses		5,726	(47)			5,400	7
Difference in tax rates due to multiple jurisdictions		(1,149)	9			(1,866)	(2)
Recognition of tax benefits from previous years^[1]		-	-			(53,615)	(74)
Effect of income subject to preferential tax rate^[2]		(73,298)	603			(100)	-
State taxes and others		(1,739)	14			1,566	2
Income tax (benefit) expense	$	(77,893)	640	%	$	(38,100)	(53)	%
[1] Represents the impact of the Ruling and Closing Agreement with the P.R. Treasury signed in June 2011.
[2] Includes the impact of the Closing Agreement with the P.R. Treasury signed in June 2012.

		Six months ended
		June 30, 2012				June 30, 2011
(In thousands)		Amount	% of pre-tax income			Amount	% of pre-tax income
Computed income tax at statutory rates	$	15,734	30	%	$	68,984	30	%
Net benefit of net tax exempt interest income		(10,753)	(21)			(17,613)	(8)
Deferred tax asset valuation allowance		1,119	2			(1,360)	(1)
Non-deductible expenses		11,365	22			10,726	5
Difference in tax rates due to multiple jurisdictions		(4,356)	(8)			(4,344)	(2)
Initial adjustment in deferred tax due to change in tax rate		-	-			103,287	45
Recognition of tax benefits from previous years^[1]		-	-			(53,615)	(23)
Effect of income subject to preferential tax rate^[2]		(74,269)	(142)			(332)	-
State taxes and others		(541)	(1)			3,394	1
Income tax (benefit) expense	$	(61,701)	(118)	%	$	109,127	47	%
[1] Represents the impact of the Ruling and Closing Agreement with the P.R. Treasury signed in June 2011.
[2] Includes the impact of the Closing Agreement with the P.R. Treasury signed in June 2012.

The results for the second quarter of 2012 reflect a tax benefit of $72.9 million related to the reduction of the deferred tax liability on the estimated gains for tax purposes related to the loans acquired from Westernbank (the “Acquired Loans”). In June 2012, the Puerto Rico Department of the Treasury (the “P.R. Treasury”) and the Corporation entered into a Closing Agreement (the “Closing Agreement”) to clarify that the Acquired Loans are a capital asset and any gain resulting from such loans will be taxed at the capital gain tax rate of 15% instead of the ordinary income tax rate of 30%, thus reducing the deferred tax liability on the estimated gain and recognizing an income tax benefit for accounting purposes. As part of the Closing Agreement, the Corporation prepaid to the P.R. Treasury the estimated tax of $72.9 million related to these estimated capital gains.

As part of the Closing Agreement, the P.R. Treasury and the Corporation agreed that for tax purposes the deductions related to previously recognized charge-offs originated from the Westernbank FDIC-assisted transaction for the years 2010 through May 2012 will be deferred until years 2017 to 2020. As a result of this aspect of the Closing Agreement, the Corporation made a payment of $45.5 million to the P.R. Treasury and recorded an increase in the deferred tax asset. In June 2012, the Corporation made a total payment to the P.R. Treasury of $132.5 million related to the Closing Agreement.

Additionally, as a result of a private ruling, in June 2011 the P.R. Treasury and the Corporation signed a closing agreement in which both parties agreed that for tax purposes the deductions related to certain charge-offs recorded on the financial statements of the Corporation for the years 2009 and 2010 will be deferred until 2013 through 2016. As a result of the agreement, the Corporation made a payment of $89.4 million to the P.R. Treasury and recorded a tax benefit on its financial statements of $143 million, or $53.6 million net of the payment made to the P.R. Treasury, resulting from the recovery of certain tax benefits not previously recorded during years 2009 (the benefit of reduced tax rates for capital gains) and 2010 (the benefit of exempt income) that were previously unavailable to the Corporation as a result of being in a loss position in such years.

On January 31, 2011, the Governor of Puerto Rico signed into law a new Internal Revenue Code for Puerto Rico (the “2011 Tax Code”) which resulted in a reduction in the Corporation's net deferred tax asset with a corresponding charge to income tax expense of $ 103.3 million due to a reduction in the marginal corporate income tax rate. Under the provisions of the 2011 Tax Code, the maximum marginal corporate income tax rate is 30% for years commenced after December 31, 2010. Prior to the 2011 Tax Code, the maximum marginal corporate income tax rate in Puerto Rico was 39%, which had increased to 40.95% due to a temporary 5% surtax approved in March 2009 for years beginning on January 1, 2009 through December 31, 2011. The 2011 Tax Code, however, eliminated the special 5% surtax on corporations for tax year 2011. The effective tax rate for the Corporation's Puerto Rico banking operations for 2012 is estimated at 20%.

The following table presents the components of the Corporation's deferred tax assets and liabilities.

(In thousands)			June 30, 2012		December 31, 2011
Deferred tax assets:
Tax credits available for carryforward		$	2,447	$	3,459
Net operating loss and other carryforward available			1,194,341		1,174,488
Postretirement and pension benefits			103,059		104,663
Deferred loan origination fees			6,931		6,788
Allowance for loan losses			600,478		605,105
Deferred gains			11,145		11,763
Accelerated depreciation			5,711		5,527
Intercompany deferred gains			4,099		4,344
Other temporary differences			34,019		27,341
	Total gross deferred tax assets		1,962,230		1,943,478
Deferred tax liabilities:
Differences between the assigned values and the tax bases of assets and liabilities
	recognized in purchase business combinations		34,709		32,293
Difference in outside basis between financial and tax reporting on sale of a business			8,155		20,721
FDIC-assisted transaction			28,153		142,000
Unrealized net gain on trading and available-for-sale securities			56,592		73,991
Deferred loan origination costs			4,303		4,277
Other temporary differences			7,345		6,187
	Total gross deferred tax liabilities		139,257		279,469
Valuation allowance			1,260,597		1,259,358
Net deferred tax asset		$	562,376	$	404,651

The net deferred tax asset shown in the table above at June 30, 2012 is reflected in the consolidated statements of financial condition as $573 million in net deferred tax assets (in the “Other assets” caption) (December 31, 2011 - $430 million) and $10 million in deferred tax liabilities in the “Other liabilities” caption (December 31, 2011 - $25 million), reflecting the aggregate deferred tax assets or liabilities of individual tax-paying subsidiaries of the Corporation.

A deferred tax asset should be reduced by a valuation allowance if based on the weight of all available evidence, it is more likely than not (a likelihood of more than 50%) that some portion or the entire deferred tax asset will not be realized. The valuation allowance should be sufficient to reduce the deferred tax asset to the amount that is more likely than not to be realized. The determination of whether a deferred tax asset is realizable is based on weighting all available evidence, including both positive and negative evidence. The realization of deferred tax assets, including carryforwards and deductible temporary differences, depends upon the existence of sufficient taxable income of the same character during the carryback or carryforward period. The analysis considers all sources of taxable income available to realize the deferred tax asset, including the future reversal of existing taxable temporary differences, future taxable income exclusive of reversing temporary differences and carryforwards, taxable income in prior carryback years and tax-planning strategies.

The Corporation's U.S. mainland operations are in a cumulative loss position for the three-year period ended June 30, 2012. For purposes of assessing the realization of the deferred tax assets in the U.S. mainland, this cumulative taxable loss position is considered significant negative evidence and has caused management to conclude that it is more likely than not that the Corporation will not be able to realize the associated deferred tax assets in the future. At June 30, 2012, the Corporation recorded a valuation allowance of approximately $ 1.3 billion on the deferred tax assets of its U.S. operations (December 31, 2011 - $ 1.3 billion).

At June 30, 2012, the Corporation's net deferred tax assets related to its Puerto Rico operations amounted to $588 million. The Corporation's Puerto Rico banking operation is in a cumulative loss position for the three-year period ended June 30, 2012 taking into account taxable income exclusive of temporary differences. This cumulative loss position was mainly due to the performance of the construction and commercial real estate loan portfolios in prior years, including the losses related to the reclassification and sale of certain loans pertaining to those portfolios. The Corporation weights all available positive and negative evidence to assess the realization of the deferred tax asset. Positive evidence assessed included (i) the Corporation's Puerto Rico banking operations very strong earnings history; (ii) consideration that the event causing the cumulative loss position is not a continuing condition of the operations; (iii) new legislation extending the period of carryover of net operating losses to ten years; (iii) unrealized gain on appreciated assets that could be realized to increase taxable income; and (iv) the financial results of the operations showed an improvement in the profitability of the business during 2011 and first two quarters of 2012. Accordingly, there is enough positive evidence to outweigh the negative evidence of the cumulative loss. Based on this evidence, the Corporation has concluded that it is more-likely-than-not that such net deferred tax asset will be realized.

(In millions)		2012		2011
Balance at January 1	$	19.5	$	26.3
Additions for tax positions - January through March		0.7		2.2
Reduction as a result of settlements - January through March		-		(4.4)
Balance at March 31	$	20.2	$	24.1
Additions for tax positions - April through June		-		0.8
Additions for tax positions taken in prior years - April through June		-		2.1
Reduction for tax positions - April through June		(0.2)		-
Reduction for tax positions taken in prior years - April through June		(0.7)		-
Balance at June 30	$	19.3	$	27.0

The accrued interest related to uncertain tax positions approximated $6.4 million at June 30, 2012 (December 31, 2011 - $5.5 million). Management determined that at June 30, 2012 and December 31, 2011, there was no need to accrue for the payment of penalties.

After consideration of the effect on U.S. federal tax of unrecognized U.S. state tax benefits, the total amount of unrecognized tax benefits, including U.S. and Puerto Rico, that if recognized, would affect the Corporation's effective tax rate, was approximately $24.9 million at June 30, 2012 (June 30, 2011 - $33.4 million).

The amount of unrecognized tax benefits may increase or decrease in the future for various reasons including adding amounts for current tax year positions, expiration of open income tax returns due to the statutes of limitation, changes in management's judgment about the level of uncertainty, status of examinations, litigation and legislative activity and the addition or elimination of uncertain tax positions.

The Corporation and its subsidiaries file income tax returns in Puerto Rico, the U.S. federal jurisdiction, various U.S. states and political subdivisions, and foreign jurisdictions. At June 30, 2012, the following years remain subject to examination in the U.S. Federal jurisdiction: 2008 and thereafter; and in the Puerto Rico jurisdiction, 2007 and thereafter. The Corporation anticipates a reduction in the total amount of unrecognized tax benefits within the next 12 months, which could amount to approximately $11 million.

		Quarters ended
		June 30, 2012				June 30, 2011
(In thousands)		Amount	% of pre-tax income			Amount	% of pre-tax income
Computed income tax at statutory rates	$	(3,646)	30	%	$	21,776	30	%
Net benefit of net tax exempt interest income		(3,739)	31			(15,206)	(21)
Deferred tax asset valuation allowance		(48)	-			3,945	5
Non-deductible expenses		5,726	(47)			5,400	7
Difference in tax rates due to multiple jurisdictions		(1,149)	9			(1,866)	(2)
Recognition of tax benefits from previous years^[1]		-	-			(53,615)	(74)
Effect of income subject to preferential tax rate^[2]		(73,298)	603			(100)	-
State taxes and others		(1,739)	14			1,566	2
Income tax (benefit) expense	$	(77,893)	640	%	$	(38,100)	(53)	%
[1] Represents the impact of the Ruling and Closing Agreement with the P.R. Treasury signed in June 2011.
[2] Includes the impact of the Closing Agreement with the P.R. Treasury signed in June 2012.

		Six months ended
		June 30, 2012				June 30, 2011
(In thousands)		Amount	% of pre-tax income			Amount	% of pre-tax income
Computed income tax at statutory rates	$	15,734	30	%	$	68,984	30	%
Net benefit of net tax exempt interest income		(10,753)	(21)			(17,613)	(8)
Deferred tax asset valuation allowance		1,119	2			(1,360)	(1)
Non-deductible expenses		11,365	22			10,726	5
Difference in tax rates due to multiple jurisdictions		(4,356)	(8)			(4,344)	(2)
Initial adjustment in deferred tax due to change in tax rate		-	-			103,287	45
Recognition of tax benefits from previous years^[1]		-	-			(53,615)	(23)
Effect of income subject to preferential tax rate^[2]		(74,269)	(142)			(332)	-
State taxes and others		(541)	(1)			3,394	1
Income tax (benefit) expense	$	(61,701)	(118)	%	$	109,127	47	%
[1] Represents the impact of the Ruling and Closing Agreement with the P.R. Treasury signed in June 2011.
[2] Includes the impact of the Closing Agreement with the P.R. Treasury signed in June 2012.