Picture Darkens at Doral Financial

It's going from bad to worse for Doral Financial ( DRL), the troubled mortgage lender.

Shares plunged $1.80, or 16%, to $9.25 early Wednesday after the Puerto Rico-based bank said securities regulators launched a formal investigation into accounting irregularities. Doral also said it was slashing its quarterly dividend by 56% to 8 cents.

The stock has been cratering since Doral announced earlier this year that it may have improperly used interest rate-only strips, a special type of security, to hedge its mortgage portfolio. The potential accounting problems with its use of derivatives led the bank to announce in April that it might restate earnings by as much as $600 million.

Over the subsequent months, the bank's problems have only grown. In August, the bank fired its CFO Ricardo Melendez and its longtime CEO Salomon Levis resigned under pressure. The company also announced that federal prosecutors in New York had begun investigating the bank and served a subpoena, seeking documents and audit records from Jan. 1, 2000, to the present.

Now it appears the scope of the accounting issues at Doral extends beyond the use of interest rate-only strips. The bank says the law firm it retained to conduct an internal investigation has found potential problems with the bank's "mortgage loan sales to local financial institutions." Doral says the new area of investigation may impact the accounting treatment of some or all of these transactions as "sales."

It's possible, Doral says, that it may have to reverse the gains it previously had recorded for these mortgage sales.

In light of the new information, Doral says it no longer expects to file its 2004 annual report by Nov. 10.

The series of accounting irregularities and investigations have left Doral's once-pristine reputation on Wall Street in tatters. Doral's had been one of the best-performing bank stocks during the mortgage refinancing boom. The stock was trading around $49 a share at the beginning of the year before tumbling to its recent lows.

Doral, however, is not the only Puerto Rican bank to run into trouble this year.

Also in August, R&G Financial Corp. ousted its CFO. Last month, the CEO and CFO of First BanCorp, Puerto Rico's second-largest bank, resigned. Both banks are also being investigated by the Securities and Exchange Commission.

The investigation of First BanCorp may be related to the new line of inquiry at Doral. A few days ago, the bank said the SEC probe is focusing on "transactions in which First Bank acquired a substantial number of mortgage loans from other Puerto Rican financial institutions."

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