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Sometimes bounding past Wall Street expectations isn't enough.

On Wednesday, investors fled shares of

Doral Financial


, even though the bank's fourth-quarter earnings of $1.22 a share exceeded the Thomson Financial consensus estimate by 18 cents. Investors were spooked by the potentially low quality of the bank's earnings and the possibility that it is sitting on a derivatives mess.

In early afternoon trading, shares of the Puerto Rico-based mortgage lender were down $5.48, or 11%, to $44. At 2 p.m. EST, more than 6 million shares had changed hands, 15 times the stock's normal trading volume.

The selloff may mark an end of a huge run for tiny Doral. Before today, shares of Doral were up 170% since January 2003, benefiting from the bank's

small but lucrative role as a real estate financier in Puerto Rico.

On the surface, the numbers released late Tuesday looked great. Doral reported earning $150.5 million, or $1.22 a share, compared with $94.7 million, or 76 cents a share, in the year-ago period.

But on closer inspection, Doral's big earnings beat looks a bit hollow. That's because the bank's bottom line was juiced by a $77 million tax benefit stemming from a temporary 50% reduction in Puerto Rico's long-term capital gains rate.

The tax benefit applies to transactions between July 1, 2004, and June 30, 2005.

Doral claims the tax reduction merely offset a $95 million trading loss it incurred on some investment securities the bank uses as part of its strategy to hedge against interest rate fluctuations. The bank says the new law prompted it to "accelerate" the time frame for recording an impairment charge on the value of those securities called interest-only strips.

The bank recorded a $97.5 million pretax impairment charge on the securities as the result of an increase in interest rates, specifically a rise in LIBOR -- the London interbank offered rate, which is frequently used as a rate benchmark.

Doral's Chairman and CEO Salomon Levis, in an email response to a question about the bank's earnings, characterized the tax benefit and the investment loss as events "that wash out the other.'' He said the writedown represents a "conservative" move to better prepare the bank for a further rise in interest rates.

"The stock is down on misinterpretation of a 'one'-time tax benefit and an extraordinary trading loss due to a $97 million impairment charge in the I/O

interest-only strip," the bank said in a statement. "The I/O writedown in the fourth quarter is not related to an issue with the company's hedging program."

But some critics don't see it that way and contend the bank may have revealed a hidden flaw in its use of derivatives to safeguard the value of its investment portfolio from big swings in interest rates.

Derivatives are sophisticated investment contracts used to hedge against the change in value of a stock, bond, commodity or other investment.

Andrew Collins, a bank analyst with Piper Jaffray, in a research note, said the tax benefit "masks'' a derivative shortfall and is an indication that the bank's hedging strategy against interest rates changes may be flawed. Collins said the bank may not be able to rely on a similar tax benefit to offset any future derivatives losses.

Just last week, Collins predicted that the flattening yield curve could be especially damaging to banks such as Doral, which have a "high concentration of securities as a percentage of total assets.'' Collins said these banks are likely to generate "relatively weak'' returns on their securities portfolio, and this undoubtedly will have a negative impact on earnings.

The flattening yield curve poses a danger to banks that rely heavily on the so-called carry trade to generate income. That's because as the spread between short-term and long-term interest rates narrows there's less opportunity for banks to make money. When the divergence between rates was wide, banks were able to borrow money on the cheap and reinvest those dollars in mortgage bonds and other higher-yielding securities.

But rising interest rates can reduce the value of a portfolio of mortgage-backed securities. A bank in this position can add to its woes by failing to hedge itself properly.

Michael Stead, a portfolio manager for River Aire Investment, a small financial services-oriented investment fund, says he fears Doral got "carried away with the carry trade'' and may now pay the price. Stead, a former portfolio manager for Wells Capital Management, had been a big fan of Doral back when the stock was selling in the low $20 range.

But that was before the bank became a bigger player in the derivatives market, he said. He has no position in the stock currently.