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
		September 30, 2012				September 30, 2011
(In thousands)		Amount	% of pre-tax income			Amount	% of pre-tax income
Computed income tax at statutory rates	$	18,772	30	%	$	9,921	30	%
Net benefit of net tax exempt interest income		(7,625)	(12)			(7,779)	(23)
Deferred tax asset valuation allowance		1,611	3			1,473	4
Non-deductible expenses		5,817	9			5,475	17
Difference in tax rates due to multiple jurisdictions		(250)	-			(1,542)	(5)
Effect of income subject to preferential tax rate^[1]		7,662	12			(79)	-
Unrecognized tax benefits		(8,985)	(14)			(750)	(2)
Others		(1,618)	(3)			(1,182)	(4)
Income tax expense	$	15,384	25	%	$	5,537	17	%
[1] Includes the adjustment related to the Closing Agreement with the P.R. Treasury signed in June 2012.

		Nine months ended
		September 30, 2012				September 30, 2011
(In thousands)		Amount	% of pre-tax income			Amount	% of pre-tax income
Computed income tax at statutory rates	$	34,505	30	%	$	78,904	30	%
Net benefit of net tax exempt interest income		(18,378)	(16)			(25,392)	(10)
Deferred tax asset valuation allowance		2,730	2			113	-
Non-deductible expenses		17,182	15			16,201	6
Difference in tax rates due to multiple jurisdictions		(4,606)	(4)			(5,884)	(2)
Initial adjustment in deferred tax due to change in tax rate		-	-			103,287	39
Recognition of tax benefits from previous years^[1]		-	-			(53,615)	(20)
Effect of income subject to preferential tax rate^[2]		(66,607)	(58)			(411)	-
Unrecognized tax benefits		(8,985)	(8)			(5,160)	(2)
Others		(2,158)	(1)			6,621	3
Income tax (benefit) expense	$	(46,317)	(40)	%	$	114,664	44	%
[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 as adjusted as of September 30, 2012.

The results for the nine months ended September 30, 2012 reflect a tax benefit of $72.9 million, recorded during the second quarter, 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.

The results for the nine months ended September 30, 2011 reflect an income tax expense of $ 103.3 million due to the effect on the net deferred tax asset of the reduction in the marginal corporate income tax rate from 39% to 30% as a result of the enactment on January 31, 2011 of a new Internal Revenue Code in Puerto Rico. The results also reflect a tax benefit of $53.6 million as a result of a private ruling and a Closing Agreement entered into with the P.R. Treasury. 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 years 2009 and 2010 will be deferred until years 2013 through 2016. The tax benefit arises from the recovery of certain tax benefits not previously recorded during 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 during such years.

The effective tax rate for the Corporation's Puerto Rico banking operations for 2012 is estimated at 15.8%.

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

(In thousands)			September 30, 2012		December 31, 2011
Deferred tax assets:
Tax credits available for carryforward		$	3,633	$	3,459
Net operating loss and other carryforward available			1,195,338		1,174,488
Postretirement and pension benefits			102,796		104,663
Deferred loan origination fees			6,813		6,788
Allowance for loan losses			599,030		605,105
Deferred gains			10,836		11,763
Accelerated depreciation			5,798		5,527
Intercompany deferred gains			3,792		4,344
Other temporary differences			35,972		27,661
	Total gross deferred tax assets		1,964,008		1,943,798
Deferred tax liabilities:
Differences between the assigned values and the tax bases of assets and liabilities
	recognized in purchase business combinations		35,906		32,293
Difference in outside basis between financial and tax reporting on sale of a business			8,155		20,721
FDIC-assisted transaction			57,293		142,000
Unrealized net gain on trading and available-for-sale securities			55,833		73,991
Deferred loan origination costs			3,273		4,277
Other temporary differences			7,252		6,507
	Total gross deferred tax liabilities		167,712		279,789
Valuation allowance			1,261,594		1,259,358
Net deferred tax asset		$	534,702	$	404,651

The net deferred tax asset shown in the table above at September 30, 2012 is reflected in the consolidated statements of financial condition as $546 million in net deferred tax assets (in the “Other assets” caption) (December 31, 2011 - $430 million) and $11 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 September 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 September 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 September 30, 2012, the Corporation's net deferred tax assets related to its Puerto Rico operations amounted to $561 million. The Corporation's Puerto Rico banking operation is in a cumulative loss position for the three-year period ended September 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; (iv) unrealized gain on appreciated assets that could be realized to increase taxable income; and (v) the financial results of the operations showed an improvement in the profitability of the business during 2011 and first three 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
Additions for tax positions - July through September		0.2		0.3
Reduction as a result of lapse of statute of limitations - July through September		(6.3)		(6.0)
Balance at September 30	$	13.2	$	21.3

The accrued interest related to uncertain tax positions approximated $4.1 million at September 30, 2012 (December 31, 2011 - $5.5 million). Management determined that at September 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 $16.4 million at September 30, 2012 (September 30, 2011 - $25.6 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 September 30, 2012, the following years remain subject to examination in the U.S. Federal jurisdiction: 2009 and thereafter; and in the Puerto Rico jurisdiction, 2008 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 $8 million.

		Quarters ended
		September 30, 2012				September 30, 2011
(In thousands)		Amount	% of pre-tax income			Amount	% of pre-tax income
Computed income tax at statutory rates	$	18,772	30	%	$	9,921	30	%
Net benefit of net tax exempt interest income		(7,625)	(12)			(7,779)	(23)
Deferred tax asset valuation allowance		1,611	3			1,473	4
Non-deductible expenses		5,817	9			5,475	17
Difference in tax rates due to multiple jurisdictions		(250)	-			(1,542)	(5)
Effect of income subject to preferential tax rate^[1]		7,662	12			(79)	-
Unrecognized tax benefits		(8,985)	(14)			(750)	(2)
Others		(1,618)	(3)			(1,182)	(4)
Income tax expense	$	15,384	25	%	$	5,537	17	%
[1] Includes the adjustment related to the Closing Agreement with the P.R. Treasury signed in June 2012.

		Nine months ended
		September 30, 2012				September 30, 2011
(In thousands)		Amount	% of pre-tax income			Amount	% of pre-tax income
Computed income tax at statutory rates	$	34,505	30	%	$	78,904	30	%
Net benefit of net tax exempt interest income		(18,378)	(16)			(25,392)	(10)
Deferred tax asset valuation allowance		2,730	2			113	-
Non-deductible expenses		17,182	15			16,201	6
Difference in tax rates due to multiple jurisdictions		(4,606)	(4)			(5,884)	(2)
Initial adjustment in deferred tax due to change in tax rate		-	-			103,287	39
Recognition of tax benefits from previous years^[1]		-	-			(53,615)	(20)
Effect of income subject to preferential tax rate^[2]		(66,607)	(58)			(411)	-
Unrecognized tax benefits		(8,985)	(8)			(5,160)	(2)
Others		(2,158)	(1)			6,621	3
Income tax (benefit) expense	$	(46,317)	(40)	%	$	114,664	44	%
[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 as adjusted as of September 30, 2012.