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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(Mark One) |
|
(Mark One)x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2006 OR o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______________to _______________ Commission File Number 0-26996 ý
|
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2004 |
or |
o |
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number 0-26996
|
INVESTORS FINANCIAL SERVICES CORP.
(Exact name of registrant as specified in its charter)
Delaware | | 04-3279817 |
(State or other jurisdiction of
| | (I.R.S Employer |
incorporation or organization) | | (IRS Employer Identification No.) |
200 Clarendon Street
P.O. Box 9130
Boston, Massachusetts |
|
02116
|
(Address of principal executive offices) | | (Zip Code) |
Registrant'sRegistrant’s telephone number, including area code: (617) 937-6700
Securities registered pursuant to Section 12(b) of the Act:
NoneCommon Stock, $.01 Par Value Registered with the NASDAQ Global Select Market
Securities registered pursuant to Section 12(g) of the Act:
None
Common Stock, $.01 Par Value
Series A Junior Preferred Stock Purchase RightsIndicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yeso Nox
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesýx Noo
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant'sregistrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x Accelerated filer oNon-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2)12b-2 of the Act). Yesý No o Nox
The aggregate market value of Common Stockcommon stock held by non-affiliates of the registrant was $2,763,194,519$2,863,941,561 based on the last reported sale price of $43.58$44.90 on The Nasdaq NationalNASDAQ Global Select Market on June 30, 20042006 as reported by Nasdaq.NASDAQ.
As of January 31, 2005,2007, there were 66,666,72265,986,040 shares of Common Stockcommon stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The registrant will file a definitive Proxy Statement pursuant to Regulation 14A within 120 days of the end of the fiscal year ended December 31, 2004.2006. Portions of such Proxy Statement are incorporated by reference in Part III.
PART I
PART I
ITEM 1. BUSINESS.
General
Unless otherwise indicated or unless the context requires otherwise, all references in this Report to "Investors“Investors Financial," "we," "us," "our,"” “we,” “us,” “our,” or similar references mean Investors Financial Services Corp., together with our subsidiaries. "Investors Bank"“Investors Bank” or the "Bank" will be used to mean“Bank” means our subsidiary, Investors Bank & Trust Company, alone.
We provide a broad range of services to financial asset managers, such as mutual fund complexes, investment advisors, hedge funds, family offices, banks and insurance companies. We define these services as core services and value-added services. Our core services include middle office outsourcing, global custody, multicurrency accounting, fund administration and fund administration.middle office outsourcing. Our value-added services include securities lending, foreign exchange, cash management, securities lending, investment advisory, performance measurement, institutional transfer agency, investment advisory services, lines of credit and brokerage and transition management services. At December 31, 2004,2006, we provided services for approximately $1.4$2.2 trillion in net assets, including approximately $236 billion$0.4 trillion of foreign net assets.
Investors Financial Services Corp. is a bank holding company. We were organized as a Delaware corporation in 1995. Our primary operating subsidiary is Investors Bank & Trust Company®Company® which was founded in 1969 as a banking subsidiary of Eaton Vance Corp., an investment management firm. In 1995, we reorganized as a bank holding company, were spun-off to the stockholders of Eaton Vance and completed our initial public offering. We provide our services from offices in Boston, New York, Sacramento, Toronto, Dublin, London, Luxembourg and the Cayman Islands.
On February 4, 2007, we entered into an Agreement and Plan of Merger (the ‘Merger Agreement’) with State Street Corporation (‘State Street’). At the closing of the transaction contemplated by the Merger Agreement, we will merge into State Street and our shareholders will receive 0.906 shares of State Street common stock for each share of our common stock. Each company’s Board of Directors has approved the Merger Agreement. We expect to complete the transaction in the third quarter of 2007, subject to customary closing conditions, including regulatory and shareholder approval.
Overview of the Asset Servicing Industry
Asset managers invest and manage the financial assets entrusted to them. They do so using a broad range of financial products, including mutual funds, alternative investment vehicles, unit investment trusts, separate accounts, variable annuities and other products that pool together money from multiple investors. Asset servicing companies like ours perform various back and middle office services for asset managers and the pooled financial products they sponsor, allowing asset managers to focus on core competencies such as product development and distribution. In addition, asset servicing companies like ours provide non-corethese back office services such as the third-party safekeeping of assets and administrative services that alsoto give investors more confidence in the integrity of their investments. The following discussion sets forth our view of the key drivers in today'stoday’s asset servicing industry.
Historical Financial Asset Growth.Despite the stock market declines of 2000 through 2002, over the past ten years, growth in financial assets under management has remained strong. Factors driving this growth include an aging population, the privatization of retirement systems and the increased popularity of pooled investment products such as mutual funds. The total amount of U.S. financial assets held in mutual funds, life insurance companies, private pension funds and bank personal trust accounts was $15.8$17.5 trillion at December 31, 2003,2005, up from $6.8$7.6 trillion in 1993,1995, a compounded annual growth rate of approximately 9%. Mutual funds, aone of the primary marketmarkets for our services, hold a large portion of the money invested in pooled investment vehicles. The U.S. mutual fund market has grown at a compounded annual growth
rate of approximately 13%12% since 1993,1995, and held almost $7approximately $8.1 trillion in assets
at December 31, 2003.2005. The following table presents U.S. financial assets, including mutual funds (Dollars in billions):
| | December 31, 2003
| | December 31, 1993
| | Compounded
Annual
Growth Rate
| | |
December 31, 2005
| |
December 31, 1995
| | Compounded
Annual
Growth Rate | |
|---|
| U.S. Financial Assets | | | | | | | | | | | | | | | | | | | | |
| Mutual Funds | | $ | 6,896 | | $ | 2,051 | | 13 | % | | | $ | 8,056 | | | | $ | 2,594 | | | | 12 | % | |
| Life Insurance Companies | | 3,823 | | 1,755 | | 8 | | | | 4,351 | | | | 2,064 | | | | 8 | | |
| Private Pension Funds | | 4,194 | | 2,304 | | 6 | | | | 5,120 | | | | 2,899 | | | | 6 | | |
| Bank Personal Trusts and Estates | | 899 | | 661 | | 3 | | |
| | |
| |
| | | | |
| Total | | $ | 15,812 | | $ | 6,771 | | 9 | % | | | $ | 17,527 | | | | $ | 7,557 | | | | 9 | % | |
| | |
| |
| | | | |
Source: Federal Reserve Bank
Consolidation and Outsourcing Trends.Another important factor affecting the asset servicing industry is the consolidation of asset servicing providers. Since the early 1990s, a number of small and mid-size asset servicers have consolidated with larger service providers or divested their asset servicing operations to focus their finite resources on their core businesses. Also, numerous service providers have combined their operations with other companies. This ongoing consolidation has concentrated the industry around a smaller number of service providers and presents us with opportunities for growth as clients react to consolidation and review their relationships with existing providers. In addition, as consolidated financial institutions dispose of businesses that do not fit with their core services, we may see opportunities to acquire those business lines.lines at a reasonable price.
The unique operational philosophy of a particular asset management organization determines its view of asset servicing. The majority of asset managers hire third parties to provide custody services. Some use more than one custodian in an attempt to foster cost reduction through competition. Large asset managers may have enough assets to justify the cost of providing in-house facilities to handle accounting, administration and transfer agency services. Other asset managers generally hire third parties to provide accounting, administration and transfer agency services in addition to custody services. Keeping abreast of developments like regulatory changes, Internetinternet data delivery, and compressed settlement cycles, and complex investment strategies, structures and instruments has forced significant increases in technology spending across the financial services industry. We believe that this increase in spending requirements has accelerated the pace at which asset managers outsource back and middle office operations to asset servicers.
Technology.Information technology is a driving force in the financial services industry. Asset managers are able to create innovative investment products using technological tools including:
·
•- Access to data from world markets as a result of more powerful and affordable information processing power.
•·The ability to send and receive large volumes of information almost instantly through widely dispersed communication networks.
•·Timely on-line access to electronic information on security positions, prices and price shifts that facilitate activities, including on-line currency trading, indexing of assets, real time arbitrage and hedging through the use of derivative securities.
Asset servicers use technology as a competitive tool to deliver precise and functional information to asset managers. Technology also allows asset servicers to offer more value-added services, such as performance measurement. Examples of analytical tools used in performance measurement include reports showing time-weighted return, performance by sector and time-weighted return by sector.
Complex Investment Products.Asset managers create different investment structures in an effort to capture efficiencies and appeal to investors with diverse means, risk tolerances, diversification requirements and time horizons. One innovative example of this is exchange traded funds, or ETFs. ETFs are securities that replicate an index and are traded on a national securities exchange, usuallysuch as the New York Stock Exchange or the American Stock Exchange. Unlike investing in a conventional index mutual fund, investing in an ETF allows investors to buy and sell shares throughout the trading day at market prices. ETFs also offer potential tax efficiencies. According to an industry source,the Investment Company Institute, domestic ETF assets increased 50%34% to approximately $226$397 billion as of November 30, 2006 from approximately $296 billion as of December 31, 2004 from approximately $151 billion as of December 31, 2003.2005.
Alternative investments, including hedge funds, private equity funds, venture capital funds and commodity pools, are another example of complex investment products that have recently experienced dramatic growth. According to an industry consultant,HFMWeek’s latest hedge fund administrator survey, hedge fund assets in particular have grown attotaled approximately $2.1 trillion as of November 30, 2006, which represents an impressive rate for several years and total approximately $1 trillion at the endincrease of 2004.53% as compared to November 30, 2005. Hedge fund assets have increased due to widening interest from institutional investors such as pension plans and endowments, as well as high net worth individuals. These asset pools often feature increasingly sophisticated trading strategies, financial instruments and product structures such as distressed debt, swaps and asset-backed securities that require more specialized operational support than traditional mutual funds.
In addition, a growing number of mutual funds have been structured as multi-class funds or as multi-manager funds in order to address the differing requirements and preferences of potential investors. Multi-class arrangements allow an investment company to sell interests in a single investment portfolio to separate classes of stockholders. Multi-manager funds have two or more investment managers, who may have different investing styles, managing the assets of one fund. Multi-manager funds allow an investor to invest along multiple style linesoffer investors diverse investment styles with a single investment.
Another product innovation is the master-feeder structure. In the master-feeder structure, one or more investment vehicles (the "feeder funds"‘feeder funds’) with identical investment objectives pool their assets in the common portfolio of a separate investment vehicle (the "master fund"‘master fund’). This structure permits each of the feeder funds to be sold to a separate target market or through a different distribution channel. The feeder fund, if it were a stand-alone fund, might not be large enough to support its operating costs. The feeder funds benefit from the economies of scale available to the larger pool of assets invested in the master fund.
International Investing. Asset managers have also expanded their reach in the global marketplace to capitalize on cross-border and multi-national marketing opportunities. This creates demand for asset servicing around the world and particularly for value-added services like foreign exchange. At December 31, 2006, we provided services for approximately $2.2 trillion in net assets, including approximately $0.4 trillion of foreign net assets, which represents an increase of 23% and 33%, respectively, from December 31, 2005.
Our Strategy
We believe that asset servicing companies operate most efficiently when bundling core services such as custody and accounting with value-added services such as foreign exchange and securities lending and foreign exchange.lending. We also believe that efficient integration of these services is critical to both service quality and profitability. The following discussion outlines the key components of our growth strategy.strategy:
Maintain Our Technological Expertise.One of our core strategies is to commit the necessary capital and resources to maintain our technological expertise. The asset servicing industry requires the technological capability to support a wide range of global security types, currencies and complex portfolio structures. Asset servicers must also maintain the telecommunications flexibility to support the diversity of
global communications standards. Technological change creates opportunities for product differentiation and cost reduction.
Our Fund Accounting and Custody Tracking System, or FACTS™FACTS™, is a single integrated technology platform that combines our service offerings into one solution for customers and can accommodate rapid growth in net assets processed. FACTS provides the following functions in a single information system:
•Middle Office Outsourcing
•·Custody
•·Securities movement and control
•·Portfolio accounting
•·Multicurrency general ledger accounting
•·Pricing
•·Net asset value calculation
•· Middle office outsourcing
·Multi-class and multi-manager processing
•·ETF processing
By consolidating these functions, we have eliminated redundancy in data capture and reduced the opportunity for clerical error.
The consolidation of functions available through FACTS allows us to assign a dedicated client team to provide a full suite of services to each account. We believe that this approach helps us to provide high quality service and to maintain better overall relationships with our clients.
The FACTS architecture also enables us to modify the system quickly. Rapid modifications allow us to constantly improve processing quality and efficiency and to implement service innovations for our clients quickly.clients. We believe that the integrated nature of FACTS provides us with a competitive advantage by allowing us to respond quickly to the continuously changing technological demands of the financial services industry. We believe the separate systems used for different tasks by many other asset servicing providers may not provide the same advantages.
Maintain Our Expertise in Complex Products.Another of our core strategies is to maintain our strength in the rapidly growing area of complex investment products. We have developed expertise in servicing ETFs, various alternative investment structures, master-feeder funds and multi-managed funds. BecauseWe are able to respond rapidly to the systems requirements of complex structures since the design of FACTS allows us to effect modifications or enhancements quickly, we are able to respond rapidly to the systems requirements of complex structures.quickly.
Deliver Superior Service.We strive to deliver superior and innovative client service. We believe service quality is the key to maintaining and expanding existing client relationships and to attracting new clients. The consolidation of functions available through FACTS allows us to take an integrated approach to client servicing. We believe this approach is different from that employed by many of our competitors. We dedicate a single operations team to handle all tasks for a particular account or fund.client. In addition, each client is assigned a client manager, independent of the operations team, to anticipate the client'sclient’s needs, to coordinate service delivery and to provide consulting support.
Cross-Sell Our Services.We believe that our strong client relationships provide opportunities to cross-sell value-added services to broaden our customer relationships. Many of our clients manage multiple pools of assets. Once an investment manager becomes a client, we believe that this client is more likely to select us to service more products, provide additional services, or both. If we are engaged to provide services for only certain pools of assets managed by our clients, we strive to expand the
relationship to include more asset pools by providing superior client service. Also, some of our clients engage us to provide the core services ofsuch as global custody and multicurrency accounting, but do
not use us for value-added services likesuch as foreign exchange or cash management. We target expanding these relationships through increasing the number of services provided for each client.
Service Offerings
We provide a broad range of services to financial asset managers, such as mutual fund complexes, investment advisors, hedge funds, family offices, banks and insurance companies. We think of these services in two groupings:groupings, core services and value-added services.services, which are comprised of the following:
| Core Services
| | |
| Value-Added Services
|
|---|
• · | Global Custody | | · | Foreign Exchange |
· | Multicurrency Accounting | | · | Cash Management |
· | Fund Administration | | · | Securities Lending |
· | Middle Office Outsourcing | | • Securities Lending· | Investment Advisory |
• Global Custody | | • Foreign Exchange | · | Performance Measurement |
• Multicurrency Accounting | | • Cash Management |
• Fund Administration | · | • Investment Advisory Services |
| | • Performance Measurement |
| | • Institutional Transfer Agency |
| | • | · | Lines of Credit |
| | • | · | Brokerage and Transition Management Services |
Our value-added services help clients develop and execute their strategies, and evaluate and manage their risks, which we believe provides them with the opportunity to enhance their returns. We strive to maximize the use of our value-added services by our client base.
Fees charged for core services vary from client to client based on the value of assets processed, the number of securities held and the number of portfolio transactions. Generally, fees are billed to our clients monthly in arrears and, upon their approval, charged directly to their account. Fees charged for core services reflect the price sensitivity of the market for such services. Fees charged for value-added services reflect a more favorable pricing environment for us andbecause we can increase activity in these areas without a necessarily proportionate increase in personnel or other resources. We also derive net interest income by investing cash balances that our clients leave on deposit with us. Our share of earnings from these investments is viewed as part of the total compensation that our clients pay us for servicing their assets.
The following is a description of the various services we offer:
Core Services
Middle Office Outsourcing. Middle office outsourcing services represent the tasks that need to be performed for financial asset managers after they have initiated a particular trade to ensure accurate and timely trade processing and communications to any party affected by the trades. We perform some or all of the following functions for our outsourcing clients: trade operations management, settlements, portfolio and fund accounting, fund administration, cash management, reconciliation, corporate actions, tax reclaims and tax filings, performance measurement, broker performance, and vendor data management.
Global Custody.Global custody entails the safekeeping of securities for clients and settlement of portfolio transactions. Our net assets processed have grown from $22 billion at October 31, 1990 to $1.4$2.2 trillion at December 31, 2004.2006. At December 31, 2004,2006, our foreign net assets processed totaled approximately $236 billion.$0.4 trillion.
In order to service our clients worldwide, we have established a network of global subcustodians in almost 100 markets. Since we do not have our own branches in these countries, we are able to operate in the foreign custody arena with minimal fixed costs, while our clients benefit from the ability to use a single custodian, Investors Bank, for all of their international investment needs.
Multicurrency Accounting.Multicurrency accounting entails the daily recordkeeping for each account or investment vehicle, including the calculation of net asset value per share. In addition to providing these services to domestic-based accounts and investment vehicles, we also provide fund accounting services to clients in Europe and Canada, which we continue to view as areas of significant business opportunity.
Fund Administration.Fund administration services include management reporting, regulatory reporting, compliance monitoring, tax accounting and return preparation, partnership administration and chief compliance officer services and support. In addition to these ongoing services, we also provide fund start-up consulting services, which typically include assistance with product definition, service provider selection and fund structuring and registration. We have worked with a number of investment advisors to assist them in the development of new funds and other pooled investment vehicles.
Value-Added Services
Securities Lending.Middle Office Outsourcing. Securities lending involvesMiddle office outsourcing services represent the lendingtasks that need to be performed for financial asset managers after they have initiated a particular trade to ensure accurate and timely trade processing and communications to any party affected by the trades. We perform some or all of clients' securities to brokers and other institutions for a fee. Receipt of securities lending fees improves a client's return on the underlying securities. We act as agentfollowing functions for our clients for both internationalmiddle office outsourcing clients: trade operations management, settlements, portfolio and domestic securities lending services.fund accounting, fund administration, cash management, reconciliation, corporate actions, tax reclaims and tax filings, performance measurement, broker performance and vendor data management.
Value-Added Services
Foreign Exchange.We provide foreign exchange services to facilitate settlement of international securities transactions for funds and other accounts and to convert income payments denominated in a non-base currency to base dollars. By using us rather than a third-party foreign exchange bank to perform these functions, clients can reduce the amount of time spent coordinating currency delivery and monitoring delivery failures and claims.
Cash Management.We provide a number of investment options for cash balances held by our clients. Typically, we have a standing arrangement to sweep client balances into one or more investments, including deposit accounts, short-term funds and repurchase agreements. This allows our clients to conveniently maximize their earnings on idle cash balances.
Securities Lending.Securities lending involves the lending of clients’ securities to brokers and other institutions for a fee. Receipt of securities lending fees improves a client’s return on the underlying securities. We act as agent for our clients for both international and domestic securities lending services.
Investment Advisory Services.Advisory.The Bank acts as the investment advisor to the Merrimac Master Portfolio, an open-end investment management company registered under the Investment Company Act of 1940.1940, as amended (the ‘ICA’). The portfolio currently consists of a series of six master funds in a master-feeder structure. The Merrimac Cash Portfolio, the Merrimac Prime Portfolio and the Merrimac U.S. Government Portfolio are subadvised by Lincoln Capital Fixed IncomeLehman Brothers Asset Management Company, LLC. The Merrimac Treasury Portfolio and the Merrimac Treasury Plus Portfolio are subadvised by M&I Investment Management Corp. The Merrimac Municipal Portfolio is subadvised by ABN AMRO Asset Management (USA) LLC.Inc. At December 31, 2004,2006, the total net assets of the portfolio approximated $6.1$4.5 billion. The portfolio'sportfolio’s master funds serve as investment vehicles for seven domestic feeder funds and two active offshore feeder funds whose shares are sold to institutional investors.
Performance Measurement.Performance measurement services involve the creation of systems and databases that enable asset managers to construct, manage and analyze their portfolios. Services include portfolio profile analysis, portfolio return analysis and customized benchmark construction. Performance measurement uses data already captured by FACTS to calculate statistics and report them to asset managers in a customized format.
Institutional Transfer Agency.Transfer agency encompasses shareholder recordkeeping and communications. We provide these services only to institutional clients with a small number of shareholder accounts or omnibus positions of retail shareholders.
Lines of Credit.We offer credit lines to our clients for the purpose of leveraging portfolios, covering overnight cash shortfalls and other borrowing needs. We do not conduct retail banking operations. At December 31, 2004,2006, we had gross loans outstanding to clients of approximately $135$271 million, which represented approximately 1%2% of our total assets. The interest rates charged on the Bank'sBank’s loans are indexed to either the Prime rate or the Federal Funds rate. We have never had a loan loss. All loans are secured, or may be secured, by marketable securities and virtually all loans to individually managed account customers are due on demand.
Brokerage and Transition Management Services.In 2002, we began offering "introducing broker-dealer"“introducing broker-dealer” services to clients by accepting customer orders, which we have elected to clear through a clearing broker-dealer. The clearing broker-dealer processes and settles customer transactions and maintains detailed customer records. This arrangement allows us to use the back office processing infrastructure of the clearing broker-dealer while earning a commission on trades executed on behalf of clients. Transition management services are designed to assist the process of moving a portfolio from one asset manager to another in as seamless a manner as possible. Components of these services include planning and customizing a strategy for the transition, conducting performance analysis and executing the transition in an efficient, risk-managed fashion. The brokerage services we offer do not include margin accounts, short selling or market making activities.
Sales, Marketing and Client Support
We employ a direct sales staff that targets potential market opportunities, including investment management companies, insurance companies, family offices, banks and investment advisors. Sales personnel are primarily based at our headquarters in Boston, and are given geographic area sales responsibility. We also have sales personnel located in Dublin, Toronto, Luxembourg and London who are responsible for international markets. Included in the sales staff are individuals who are dedicated to marketing services to institutional accounts. Senior managers from all functional areas are directly involved in obtaining new clients, frequently working as a team with a sales professional.
In order to service existing clients, a separate team of client management staffprofessionals based in our Boston, Sacramento, New York, Toronto, Dublin and DublinLondon offices provideprovides dedicated client support. Each client is assigned a client manager responsible for the client'sclient’s overall satisfaction. The client manager is usually a senior professional with extensive industry experience who works with the client on designing new products and specific systems requirements, provides consulting support, anticipates the client'sclient’s needs and coordinates service delivery.
Financial information regarding our geographic reporting can be found in Note 21 of our Notes to Consolidated Financial Statements included in this Report.
Significant Clients
Barclays Global Investors, N.A. ("BGI"(‘BGI’) accounted for approximately 17%18% of our consolidated net operating revenues for the years ended December 31, 2006 and 2005, and approximately 17% for the year ended December 31, 2004 and approximately 16% for the years ended December 31, 2003 and 2002.2004. No client other than BGI accounted for more than 10% of our net operating revenues for the years ended December 31, 2004, 20032006, 2005 and 2002.2004. See Item 1A “Risk Factors—A material portion of our revenue is derived from our relationship with Barclays Global Investors, N.A. (‘BGI’) and related entities.”
Software Systems and Data Center
Our business requires that we provide daily and periodic reports of asset accounting and performance, and provide measurement and analytical data to asset managers on-line on a real timereal-time basis. To help us meet these requirements, our asset servicing operations are supported by sophisticated information
technology. We receive vast amounts of information across a worldwide computer network. That information covers a wide range of global security types and complex portfolio structures in various currencies and must be processed before being used for system-wide updating and reporting.
Our proprietary system, FACTS, is multi-tiered. FACTS uses personal computers linked to mainframe processing by means of local and wide area networks. This configuration combines the best features of each platform. FACTS uses the power and capacity of the mainframe, the data distribution capabilities of the network and the independence of personal computers. The fully functional microcomputer component of FACTS works independently of the mainframe throughout the processing cycle. This minimizes the amount of system-wide delay inherent in data processing. The FACTS configuration also allows for fully distributed processing capabilities within multiple geographic locations in an effective and efficient manner.
The integrated nature of the FACTS architecture allows us to effect modifications and enhancements quickly. Swift modifications and enhancements result in increased processing quality and efficiency for our clients. These modifications and enhancements also help us quickly implement service innovations for our clients. This integrated architecture helps differentiate us from our competitors. Technological enhancements and upgrades are an ongoing part of asset servicing that are necessary for asset administrators to remain competitive and to create information delivery mechanisms that add value to the information available as part of clearing and settling transactions.
Technology also helps us add value to the custody and fund accounting information we gather by processing client assets. We have developed a comprehensive suite of standardized data extracts and reports and created automated interfaces that allow our clients to access the full range of custody and fund accounting data. We have also developed interfaces that allow our clients to connect electronically with our host systems and access data collected from clearance and settlement transactions in multiple currencies. Through these information-sharing tools, we are better equipped to supplement our custody and accounting services with foreign exchange services and asset and transaction reporting and monitoring services. Electronic linkages also position us to respond quickly to client requests.
We use the Internetinternet as a means to communicate with clients and external parties. We also provide secure value-added services to our clients over the Internet.internet. We utilize a secure extranet environment that provides the authentication, access controls, intrusion detection, encryption and firewalls needed to ensure the protection of client information and assets. Internet-based applications provide our clients with secure electronic access to their data as well as flexible ad-hoc data query and reporting tools.
Our mainframe processing and mainframe disaster recovery capability is provided by Electronic Data Systems ("EDS"(‘EDS’), located in Plano, Texas. During the summer of 2004, we signed an agreement withIn addition, International Business Machines ("IBM"(‘IBM’), located in Armonk, New York. Under this agreement, IBMYork, provides support for our network and hardware environments and our help desk services. By outsourcing these infrastructure support functions, we can focus our resources on systems development and minimize our capital investment in large-scale computer equipment. EDS and IBM offer us state-of-the-art computer products and services, access to which we could not otherwise afford, while removing the risk of product obsolescence. Due to their large and diverse customer bases, EDS and IBM can invest in the latest computer technology and spread the related costs over multiple users. We also receive the benefit of the continuing investment by EDS and IBM in their computer hardware. Under both contracts we are billed monthly for services provided by EDS or IBM on an as-used basis in accordance with a predetermined pricing schedule for specific products and services. Our current agreement with EDS is scheduled to expire on December 31, 2005.2008. Our current agreement with IBM is scheduled to expire on June 30, 2011.
Each year we target spending approximately 18-20% of our consolidated net operating revenue on technology. Because of our relationships with EDS and IBM and our system architecture, we are able to devote the majority of our technology investments to development, rather than support or infrastructure.
9
Our trust processing services are provided by SEI Investments Company ("SEI"(‘SEI’), located in Oaks, Pennsylvania. SEI is a global provider of asset management and investment technology solutions. We
pay SEI certain monthly service fees based upon usage. Our current agreement with SEI is scheduled to expire on December 31, 2009.
Investors Bank maintains a comprehensive Business Continuity Plan ("BCP"(‘BCP’). The program has been developed to comply with guidelines issued by various regulatory and industry bodies such as the Federal Financial Institutions Examination Council ("FFIEC"(‘FFIEC’). The planning process begins with a business impact analysis which isolates critical business processes and determines their recoverability under various disruption scenarios. In addition to maintaining regional backup facilities for all offices, our locations are geographically diverse in order to allow recovery of essential functions at another location in the event of a widespread disruption. In 2004,2006, BCP staff conducted over 100132 different tests to ensure that our technology infrastructure, facilities and staff could respond and recover in a disaster.
Competition
We operate in a highly competitive environment in all areas of our business. Many of our competitors, including State Street Bank and Trust Company,Corporation, JP Morgan Chase, The Bank of New York, Mellon, Citigroup, Mellon,PNC and PNC,Northern Trust, possess substantially greater financial and marketing resources than we do and process a greater amount of financial assets. Other competitive factors include technological advancement and flexibility, breadth of services provided and quality of service. We believe that we compete favorably in these categories.
Competition in the asset servicing industry, especially over the past decade, has impacted both pricing and margins in core services likesuch as global custody services and trustee services.custody. Partially offsetting this more competitive pricing environment is the development of new services that have higher margins. Our continuous investment in technology has permitted us to offer value-added services to clients, such as middle office outsourcing, performance measurement,foreign exchange, securities lending and foreign exchange,performance measurement, on a global basis and at competitive prices. Technological evolution and service innovation have enabled us to generate additional revenue to offset competitive pricing in maturing service lines.
We believe that our size, commitment to technology development and enhancement and responsiveness to client needs provide the asset management industry with a very attractive asset servicing alternative to large money center banks and other asset servicers. As many of our competitors grow larger through acquisition, we believe that our customized and highly responsive service offerings become even more attractive. While consolidation within the investment management and asset servicing industries may adversely affect our ability to retain clients that have been acquired, it also creates opportunity for us as prospective clients review their relationships with existing service providers that are affected by acquisitions. In addition, consolidation among large financial institutions may enable us to acquire, at a reasonable price, asset servicing businesses that do not fit within the core focus of these newnewly consolidated financial institutions.
Intellectual Property
Our success is dependent upon our software development methodology and other intellectual property rights that we have developed and own, including FACTS. We rely on trade secret, copyright and trademark laws, and confidentiality agreements with employees and third parties to protect our proprietary technology, all of which offer only limited protection. There can be no assurance that the steps we take in this regard will be adequate to deter misappropriation of our proprietary information or that we will be able to detect unauthorized use. Furthermore, our intellectual property rights may be invalidated or our competitors may develop similar technology independently. In addition, effective copyright, trademark, trade secret and other protection may not be available in certain international markets that we service.
Employees
Employees
On December 31, 2004,2006, we had 2,7784,265 employees. We maintain a professional development program for entry level staff. Successful completion of the program is required of most newly hired employees. This training program is supplemented by ongoing education on systems and technological developments and innovations, the financial services industry, the regulatory environment and our client base. This program is administered by experienced full-time trainers that continually enhance existing courses and develop new programs to match an evolving business and regulatory environment.
None of our employees are covered by collective bargaining agreements, and we believe our relations with our employees are good.
Regulation and Supervision
Virtually all aspects of our business and operations are regulated under state and federal law. In addition to the laws governing businesses and employers, generally, we are subject to federal and state laws and regulations applicable to financial institutions and their parent companies. The operations of our securities broker affiliate, Investors Securities Services, Inc.,LLC, are also subject to federal and state securities laws, as well as the rules of both the Securities and Exchange Commission (‘SEC’) and the National Association of Securities Dealers, Inc. ("NASD"(‘NASD’). The principal objective of state and federal banking laws is the maintenance of the safety and soundness of financial institutions and the federal deposit insurance system, the protection of consumers or classes of consumers and the furtherance of broad public policy goals, rather than the specific protection of stockholders of a bank or its parent company. Some of the significant statutory and regulatory provisions to which we and our subsidiaries are subject are described below. The description of these statutory and regulatory provisions is not complete and is qualified in its entirety by reference to the particular statutory or regulatory provision. Any change in applicable law or regulation may have a material effect on our business, prospects and operations, as well as those of our subsidiaries.
Investors Financial
General.As a registered BHC,Bank Holding Company (‘BHC’), Investors Financial is subject to regulation under the Bank Holding Company Act of 1956, as amended ("BHCA"(‘BHCA’), and to inspection, examination and supervision by the Board of Governors of the Federal Reserve System ("FRB"(‘FRB’) and by the Massachusetts Commissioner of Banks ("Commissioner"(‘Commissioner’). We are required to file reports of our operations with, and are subject to examination by, the FRB and the Commissioner. The FRB has the authority to issue orders to bank holding companies ("BHCs")BHCs to cease and desist from unsafe or unsound banking practices and violations of conditions imposed by, or violations of agreements with, the FRB. The FRB is also empowered to assess civil money penalties against companies or individuals who violate the BHCA or orders or regulations thereunder, to order termination of nonbanking activities of nonbanking subsidiaries of BHCs and to order termination of ownership and control of a nonbanking subsidiary by a BHC.
BHCA-Activities and Other Limitations.The BHCA prohibits a BHC from acquiring substantially all the assets of a bank or acquiring direct or indirect ownership or control of more than 5% of any class of the voting shares of any bank, BHC or savings association, or increasing such ownership or control of any bank, BHC or savings association, or merging or consolidating with any BHC without prior approval of the FRB. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 ("Riegle-Neal"(‘Riegle-Neal’) permits adequately capitalized and adequately managed BHCs, as determined by the FRB, to acquire banks located in any state, subject to certain concentration limits and other conditions. Subject to certain conditions, Riegle-Neal also generally authorizes the interstate mergers of banks and, to a lesser extent, interstate branching, soas long as the law of the host state specifically authorizes such action. Massachusetts law imposes certain approval requirements with respect to acquisitions by a BHC of certain banking institutions and to mergers of BHCs.
Unless a BHC becomes a financial holding company ("FHC"(‘FHC’) under the Gramm-Leach-Bliley Act of 1999 ("GLBA"(‘GLBA’), the BHCA also prohibits a BHC from acquiring a direct or indirect interest in or control of more than 5% of the voting securities of any company that is not a bank or a BHC and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiary banks, except that it may engage in and may own shares of companies engaged in certain activities the FRB determined to be so closely related to banking or managing and controlling banks as to be a proper incident thereto. Before permitting a BHC to engage in such activities that are closely related to banking or making an investment in a company engaged in such activities, the FRB is required to weigh the expected benefit to the public, such as greater convenience, increased competition or gains in efficiency, against the possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interests or unsound banking practices.
The GLBA permits a BHC that qualifies and elects to be treated as a FHC to engage in a significantly broader range of financial activities than BHCs, such as Investors Financial, that have not elected FHC status. "Financial activities"“Financial activities” is broadly defined to include not only banking, insurance and securities activities, but also merchant banking and additional activities that the FRB, in consultation with the Secretary of the Treasury, determines to be financial in nature or incidental to such financial activities, or that the FRB determines to be complementary activities that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally. To elect to become a FHC, a BHC, such as Investors Financial, must meet certain tests and file an election with the FRB. To qualify, all of a BHC'sBHC’s subsidiary banks must be well-capitalized and well-managed, as measured by regulatory guidelines. In addition, each of the BHC'sBHC’s banks must have been rated "satisfactory"“satisfactory” or better in its most recent federal Community Reinvestment Act ("CRA"(‘CRA’) evaluation. A BHC that elects to be treated as a FHC may face significant consequences if its banks fail to maintain the required capital and management ratings, including entering into an agreement with the FRB which imposes limitations on its operations. Investors Financial has not elected to become a FHC.
Capital Requirements.The FRB has adopted capital adequacy guidelines applicable to United States banking organizations. The FRB'sFRB’s capital adequacy guidelines generally require BHCs to maintain total capital equal to 8% of total risk-adjusted assets and off-balance sheet items (the "Total‘Total Risk-Based Capital Ratio"Ratio’), with at least 50% of that amount consisting of Tier 1, or core capital, and the remaining amount consisting of Tier 2, or supplementary capital. Tier 1 capital for BHCs generally consists of the sum of common stockholders'stockholders’ equity and perpetual preferred stock (subject to certain limitations), less goodwill and other nonqualifying intangible assets. Tier 2 capital generally consists of hybrid capital instruments, perpetual debt and mandatory convertible debt securities; perpetual preferred stock, not included as Tier 1 capital; term subordinated debt and intermediate-term preferred stock; and, subject to limitations, general allowances for loan and lease losses. Assets are adjusted under the risk-based guidelines to take into account different risk characteristics.
In addition to the risk-based capital requirements, the FRB requires BHCs to maintain a minimum leverage capital ratio of Tier 1 capital to its average total consolidated assets (the "Leverage Ratio"‘Leverage Ratio’) of 3.0%3%. Total average consolidated assets for this purpose does not include goodwill and any other intangible assets and investments that the FRB determines should be deducted from Tier 1 capital. The FRB has announced that the 3.0%3% Leverage Ratio requirement is the minimum for the top-rated BHCs. All other BHCs are required to maintain a minimum Leverage Ratio of 4.0%4%. BHCs with supervisory, financial, operational or managerial weaknesses, as well as BHCs that are anticipating or experiencing significant growth, are expected to maintain capital ratios well above the minimum levels. Because we anticipate significant future growth, we will be required to maintain a Leverage Ratio of 4.0%4% or higher.
We are currently in compliance with both the Total Risk-Based Capital Ratio and the Leverage Ratio requirements, and management expects these ratios to remain in compliance with the FRB'sFRB’s capital
capital adequacy guidelines. At December 31, 2004,2006, our Total Risk-Based Capital Ratio and Leverage Ratio were 20.54%19.04% and 5.85%7.63%, respectively.
TheIn June 2004, the Basel Committee on Banking Supervision (‘Basel Committee’) released the document “International Convergence of Capital Measurement and Capital Standards: A Revised Framework”. The Framework, also referred to as Basel II, is designed to secure international convergence on regulations and standards governing the capital adequacy of internationally active banking organizations. In September 2006, the U.S. banking and thrift supervisory agencies issued a Notice of Proposed Rulemaking setting forth a proposed framework for the timing and qualification process for U.S. banks that are either required (‘core banks’) or choose (‘opt-in banks’) to be subject to Basel II. As currently proposed, the new rules as applied in the U.S. are expected to become effective on January 1, 2009, subject to transitional parallel testing beginning on January 1, 2008. Although Investors Bank is not required to be compliant with the new rules, we are in the process of developing and implementing a new proposed capital adequacy framework ("program to achieve Basel II compliance. Ultimately, U.S. implementation of Basel II will depend on, and will be subject to, final regulations and related policies promulgated by the New Accord" or "Basel II"). The New Accord is expected to be implemented on a transitional basis inU.S. supervisory agencies. We cannot predict the United States in 2007 and become fully effective in 2008. We are monitoring the status and progressfinal form of the Basel II and the relatedrules, nor their impact if any, on our operations and are preparing for their implementation.risk-based capital.
Control Acquisitions.The Change in Bank Control Act prohibits a person or group of persons from acquiring "control"“control” of a depository institution or a depository institution holding company unless the FRB has been notified and has not objected to the proposal. Under a rebuttable presumption established by the FRB, the acquisition of 10% or more of a class of voting securities of a depository institution or depository institution holding company with a class of securities registered under Section 12 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"‘Exchange Act’), would, under the circumstances set forth in the presumption, constitute the acquisition of control of the depository institution or a depository institution holding company. In addition, any company, as that term is broadly defined in the statute, would be required to obtain the approval of the FRB under the BHCA before acquiring 25% (5% in the case of an acquirer that is a BHC) or more of any class of voting securities of a bank or BHC or a savings association, or otherwise obtaining control or a controlling influence over such an institution.
Massachusetts Law.Investors Financial is also considered a BHC for purposes of Massachusetts law. Accordingly, we have registered with the Commissioner and are obligated to make reports to the Commissioner. Under Massachusetts law, any person that proposes to acquire, directly or indirectly, 25% or more of any class of voting securities of a company must give prior notice to the Massachusetts Commissioner of Banks, who may disapprove the transaction. Additionally, any company that is a BHC under Massachusetts law must obtain the approval of the Massachusetts Board of Bank Incorporation ("Massachusetts BBI") before acquiring more than 5% of the voting stock of a company. As a general matter, however, the Commissioner does not rule upon or regulate the activities in which a BHC or its nonbank subsidiaries engage.
Cash Dividends. FRB policy provides that a bank or a BHC generally should not maintain its existing rate of cash dividends on common stock unless the organization'sorganization’s net income available to common shareholders over the past year has been sufficient to fully fund the dividends and the prospective rate of earnings retention appears consistent with the organization'sorganization’s capital needs, asset quality and overall financial condition. FRB policy further provides that a BHC should not maintain a level of cash dividends to its shareholders that places undue pressure on the capital of bank subsidiaries, or that can be funded only through additional borrowings or other arrangements that may undermine the BHC'sBHC’s ability to serve as a source of strength.
Source of Strength.FRB policy requires BHCs to serve as sources of financial and managerial strength to their subsidiary banks and, if necessary, to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and to maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks in a
manner consistent with FRB policy. This support may be required at times when the BHC may not have the resources to provide it. Accordingly, Investors Financial is expected to commit resources to the Bank in circumstances where it might not do so absent such policy.
Investors Bank
General.The Bank is subject to extensive regulation and examination by the Commissioner and the FRB, its primary federal banking regulator. The Bank became a member of the Federal Reserve System (‘FRS’) (a ‘state member bank’) in October 2006. Prior to becoming a state member bank, the Bank’s primary federal regulator was the Federal Deposit Insurance Corporation ("FDIC"(‘FDIC’), which insures. Although the Bank's deposits, andFDIC is no longer its primary federal regulator, the Bank, like all insured depository institutions, is nevertheless subject to certain
requirements established by the FRB.FDIC, which insures the Bank’s deposits. The federal and state laws and regulations whichthat are applicable to banks regulate among other things, the scope of their business, their investments, their reserves against deposits, the timing of the availability of certain deposited funds, the amount of loans to individuals and related borrowers, the nature and amount of and collateral for certain loans, and the amount of interest that may be charged on loans. Various state consumer laws and regulations also affect the operations of state banks.
FDIC Insurance Premiums.The Bank currently pays deposit insurance premiums to the FDIC based on an assessment rate established by the FDIC for Bank Insurance Fund-memberFund (‘BIF’)-member institutions. The FDIC has established a risk-based premium system under which the FDIC classifies institutions based on their capital ratios and on other relevant information and generally assesses higher rates on those institutions that tend to pose greater risks to the federal deposit insurance funds. ThePrior to the enactment of the Federal Deposit Insurance Reform Act ("FDIA"of 2005 (the ‘FDIR Act’) does not requireon February 8, 2006, the FDIC was not required to charge all banks deposit insurance premiums when the ratio of deposit insurance reserves to insured deposits iswas maintained above specified levels. However, asUnder new rules issued by the FDIC pursuant to the FDIR Act, however, the FDIC will impose assessments on all banks at a resultrate determined by the institution’s risk classification regardless of general economic conditions, it is possible that the ratio of deposit insurance reserves to insured deposits could fall below the minimum ratio that FDIA requires, which would resultdeposits. The new rules were issued November 2, 2006 and became effective on January 1, 2007. An increase in the FDIC setting deposit insurance assessment rates sufficient to increase deposit insurance reserves to the required ratio. We cannot predict whether the FDIC will be required to increaseBank’s deposit insurance assessments above their current levels.over previous levels as a result of the new rules would have an adverse effect on net earnings.
Additionally, as a result of the passage of the FDIR Act: (i) the BIF will be merged with the FDIC’s Savings Association Insurance Fund creating the Deposit Insurance Fund (the ‘DIF’); (ii) the $100,000 per account insurance level will be indexed to reflect inflation; (iii) deposit insurance coverage for certain retirement accounts will be increased to $250,000; and (iv) a cap will be placed on the level of the DIF and dividends will be paid to banks once the level of the DIF exceeds the specified threshold.
Capital Requirements.The FDICFRB has promulgated regulations and adopted a statement of policy regarding the capital adequacy of state-chartered banks, which, like the Bank, are not members of the Federal Reserve System. These requirements are substantially similar to those adopted by the FRB regarding BHCs.
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"(‘FDICIA’), among other things, identifies five capital categories for insured depository institutions (well capitalized,(well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized) and requires the federal bank regulatory agencies to implement systems for "prompt“prompt corrective action"action” for insured depository institutions that do not meet minimum capital requirements within such categories. FDICIA imposes progressively more restrictive constraints on operations, management and capital distributions, depending on the category in which an institution is classified. Failure to meet the capital guidelines could also subject a banking institution to capital raisingcapital-raising requirements. An "undercapitalized"“undercapitalized” bank must develop a capital restoration plan, and its parent holding company must guarantee that bank'sbank’s compliance with the plan. The liability of thea parent holding company under any such guarantee is limited to the lesser of five percent5% of the bank'sa
bank’s assets at the time it became "undercapitalized"“undercapitalized” or the amount needed to comply with the plan. Furthermore, in the event of the bankruptcy of thea parent holding company, such guarantee would take priority over the parent'sa parent’s general unsecured creditors. In addition, FDICIA requires the various regulatory agencies to prescribe certain non-capital standards for safety and soundness relating generally to operations and management, asset quality and executive compensation, and permits regulatory action against a financial institution that does not meet such standards.
The various regulatory agencies have adopted substantially similar regulations that define the five capital categories identified by FDICIA, using the total risk-based capital, Tier 1 risk-based capital and leverage capital ratios as the relevant capital measures. Such regulations establish various degrees of corrective action to be taken when an institution is considered undercapitalized. Under the regulations, a "well capitalized"“well-capitalized” institution must have a Tier 1 risk-based capital ratio of at least six percent,6%, a total risk-based capital ratio of at least ten percent10% and a leverage ratio of at least five percent5% and not be subject to a capital directive order. Regulators also must take into consideration (a) concentrations of credit risk; (b) interest rate risk (when the interest rate sensitivity of an institution'sinstitution’s assets does not match the sensitivity of its liabilities or its off-balance-sheet position); and (c) risks from non-traditional activities, as well as an institution'sinstitution’s ability to manage those risks, when determining the adequacy of an institution'sinstitution’s capital. This evaluation will be made as a part of the institution'san institution’s regular safety and
soundness examination. At December 31, 2004,2006, the Bank was deemed to be a well-capitalized institution.
The Community Reinvestment Act. The Community Reinvestment Act ("CRA"(‘CRA’) requires lenders to identify the communities served by the institution'sinstitution’s offices and other deposit takingdeposit-taking facilities and to make loans and investments and provide services that meet the credit needs of these communities. Regulatory agencies examine each of the banks and rate such institutions'institutions’ compliance with CRA as "Outstanding"“Outstanding”, "Satisfactory"“Satisfactory”, "Needs“Needs to Improve"Improve” or "Substantial Noncompliance"“Substantial Noncompliance”. Failure of an institution to receive at least a "Satisfactory"“Satisfactory” rating could inhibit such institution or its holding company from undertaking certain activities, including engaging in activities newly permitted as a financial holding company under the GLBA and acquisitions of other financial institutions. The FRB and the FDICother federal banking agencies must take into account the record of performance of banks in meeting the credit needs of the entire community served, including low- and moderate-income neighborhoods, before they approve certain bank acquisitions, mergers, branch establishments and other transactions proposed by banking organizations. Massachusetts has also enacted a similar statute that requires the Commissioner to evaluate the Bank'sBank’s performance in helping to meet the credit needs of its entire community and to take that record into account in considering certain applications. Management believes the Bank is currently in compliance with all CRA requirements.
Customer Information Security.The FDICFRB and other bank regulatory agencies have established standards for safeguarding nonpublic personal information about customers that implement provisions of the GLBA. Specifically, the Information Security Guidelines established by the GLBA require each financial institution, under the supervision and ongoing oversight of its Board of Directors or an appropriate Board committee, to develop, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, to protect against anticipated threats or hazards to the security or integrity of such information;information and to protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer.
Privacy. The GLBA requires financial institutions to implement policies and procedures regarding the disclosure of nonpublic personal information about consumers to nonaffiliated third parties. In general, the statute requires financial institutions to explain to consumers their policies and procedures regarding the disclosure of such nonpublic personal information, and, unless otherwise required or permitted by law, financial institutions are prohibited from disclosing such information except as provided in their policies and procedures.
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USA Patriot Act.The USA Patriot Act of 2001 (the "USA‘USA Patriot Act"Act’), designed to deny terrorists and others the ability to obtain anonymous access to the U.S. financial system, has significant implications for depository institutions, broker-dealers and other businesses involved in the transfer of money. The USA Patriot Act, together with the implementing regulations of various federal regulatory agencies, require financial institutions, including the Bank, to adopt and implement policies and procedures with respect to, among other things, anti-money laundering compliance, suspicious activity and currency transaction reporting, customer identity verification and customer risk analysis. The statute and its underlying regulations also permit information sharing for counter-terrorist purposes between federal law enforcement agencies and financial institutions, as well as among financial institutions, subject to certain conditions, and require federal banking agencies to evaluate the effectiveness of an applicant in combating money laundering activities when considering applications filed under Section 3 of the BHCA or the Bank Merger Act. Management believes that we are currently in compliance with all requirements prescribed by the USA Patriot Act and all applicable regulations.
Dividends.The FDICFRB has the authority to use its enforcement powers to prohibit a bank from paying dividends if, in its opinion, the payment of dividends would constitute an unsafe or unsound
practice. practice, and generally restricts a state member bank’s ability to pay dividends or other capital distributions. For example, a state member bank may not declare or pay a dividend if the total of all dividends declared during the calendar year, including the proposed dividend, exceeds the sum of the bank’s net income during the current calendar year and the retained net income of the prior two calendar years, unless the dividend has been approved by the FRB. Federal law also prohibits the payment of dividends by a bank that will result in the bank failing to meet its applicable capital requirements on a pro forma basis. Under Massachusetts law, the board of directors of a trust company, such as the Bank, may declare from "net profits"“net profits” cash dividends no more often than quarterly, provided that there is no impairment to the trust company'scompany’s capital stock. Moreover, prior Commissioner approval is required if the total of all dividends declared by a trust company in any calendar year would exceed the total of its net profits for that year combined with its retained net profits for the previous two years, less any required transfer to surplus or a fund for the retirement of any preferred stock. These restrictions on the Bank'sBank’s ability to declare and to pay dividends may limit Investors Financial'sFinancial’s ability to pay dividends to its stockholders. We cannot predict future dividend payments of
Investments. The FRB imposes quantitative limitations and other conditions, including notice requirements, on a state member bank’s investments in bank premises, stocks and investment securities. The FRB also imposes conditions on a state member bank’s ability to invest in foreign corporations. These limitations may prevent the Bank at this time.from making investments it would otherwise make.
Other Securities Law Issues.The GLBA requires a bank that acts as investment adviser to a registered investment company to register as an investment adviser or to conduct such advisory activities through a separately identifiable department or division of the bank so registered. Accordingly, the Bank furnishes investment advice to registered investment companies through a separately identifiable department or division of the Bank that is registered with the SEC as an investment adviser. Federal and state laws impose onerous obligations on registered investment advisers, including fiduciary duties, recordkeeping requirements and disclosure obligations. Currently, management believes that we arethe Bank is in compliance with these requirements.
Regulation of Investment Companies.Certain of our mutual fund and unit investment trust clients are regulated as "investment companies"“investment companies” as that term is defined under the Investment Company Act of 1940, as amended (the "ICA"),ICA and are subject to examination and reporting requirements applicable to the services we provide. The provisions of the ICA and the regulations promulgated thereunder prescribe the type of institution which may act as a custodian of investment company assets, as well as the manner in which a custodian administers the assets in its custody. Because we serve as custodian for a number of our investment company clients, these regulations require, among other things, that we maintain certain minimum aggregate capital, surplus, and undivided profits. Additionally, arrangements between us and clearing agencies or other securities depositories must meet
ICA requirements for segregation of assets, identification of assets and client approval. Currently, management believes we are in compliance with all minimum capital and securities depository requirements. Investment companies are also subject to extensive recordkeeping and reporting requirements. These requirements dictate the type, volume and duration of the recordkeeping we undertake, either in our role as custodian for an investment company or as a provider of administrative services to an investment company. Further, we must follow specific ICA guidelines when calculating the net asset value of a client mutual fund. Consequently, changes in the statutes or regulations governing recordkeeping and reporting or valuation calculations will affect the manner in which we conduct our operations.
Availability of Filings
You may access, free of charge, copies of the following documents and related amendments, if any, in the Investor Relations section of our web site at www.ibtco.com:
1)
- Our Annual Reports on Form 10-K;
2)
- Our Quarterly Reports on Form 10-Q;
3)
- Our Current Reports on Form 8-K; and
4)
- Our Proxy Statement.
You may also access, free of charge, copies of the following corporate governance documents in the Investor Relations section of our web sitewebsite at www.ibtco.com:
1)www.ibtco.com:
1)- Our Code of Conduct;
2)
- Our Corporate Governance Guidelines;
3)
- Our Audit Committee Charter;
4)
- Our Nominating and Corporate Governance Committee Charter; and
5)
- Our Compensation Committee Charter.
We post these documents on our web site as soon as reasonably practicable after we file or furnish them electronically with or to the Securities and Exchange Commission or, in the case of the corporate governance documents, as soon as reasonably practicalpracticable after material amendment. The information contained on our web site is not incorporated by reference into this document and should not be considered a part of this Report. Our web site address is included in this document as an inactive textual reference only.
ITEM 1A. RISK FACTORS.
Our operating results are subject to fluctuations in interest rates and the securities markets.
A significant portion of our fees is based on the market value of the assets we process. Accordingly, our operating results are subject to fluctuations in interest rates and securities markets as these fluctuations affect the market value of assets processed. Our net interest income is primarily driven by the spread between earnings on our investments and loan portfolios relative to our cost of funds. The relationship between short-term and long-term interest rates, referred to as the shape of the yield curve, affects the market value of, and the earnings produced by, our investment and loan portfolios, and thus could impact our net interest income. In addition, narrower investment portfolio reinvestment and purchase spreads have impacted, and could potentially continue to impact, our net interest income.
Volatility in the equity markets can have a material effect on our asset-based fees. While reductions in asset servicing fees may be offset by increases in other sources of revenue, a sustained downward movement of the broad equity markets will likely have an adverse impact on our earnings.
Our growth depends in part on the ability of our clients to generate fund flows by selling their investment products to new and existing investors. Fluctuations in interest rates or the securities markets can lead to investors seeking alternatives to the investment offerings of our clients, which could result in a lesser amount of assets processed and correspondingly lower fees. For example, if the value of equity or fixed income assets held by our clients were to increase or decrease by 10% for a sustained period of time, we estimate currently that this market movement, by itself, would cause a corresponding change of less than 5% in our earnings per share.
We may not consummate our merger with State Street Corporation.
Consummation of the transaction contemplated by the Agreement and Plan of Merger is subject to customary closing conditions, including stockholder and regulatory approval. Failure to complete the merger could have a material adverse impact on our ability to sell our services to new clients.
A material portion of our revenue is derived from our relationship with Barclays Global Investors, N.A. (‘BGI’) and related entities.
As a result of our ongoing relationship with BGI’s iShares and Master Investment Portfolios, our assumption of the operations of the U.S. asset administration unit of BGI in 2001 and our servicing assets for Barclays Global Investors Canada, Ltd., BGI accounted for approximately 18%, 18% and 17% of our net operating revenue for the years ended December 31, 2006, 2005 and 2004, respectively. During 2006, we renewed our U.S. asset administration outsourcing agreement and our iShares and Master Investment Portfolio custody and fund accounting agreements with BGI, and we expect that BGI will continue to account for a significant portion of our net operating revenue. We provide services to BGI under long-term contracts that may be terminated before the expiration of the contracts under certain circumstances that we have described in filings with the SEC as described below. While we believe that our relationship with BGI is excellent, the loss of BGI’s business would cause our net operating revenue to decline significantly and would have an adverse effect on our quarterly and annual results.
The outsourcing agreement was renewed pursuant to an amendment (the ‘Amendment’) to the Custodial, Fund Accounting and Services Agreement between the Bank and BGI dated May 1, 2001 (the ‘Custodial Agreement’). Under the terms of the Amendment, the Custodial Agreement is extended through April 30, 2013. As provided in the Amendment, BGI may terminate the Custodial Agreement upon sixty days prior written notice: (i) as to any underlying account if BGI fails to receive any consent required by law for the Bank to act as servicing agent for such account; (ii) as to any underlying account if the continued provision of services by the Bank to such account would be inconsistent with BGI’s fiduciary duties under applicable law; or (iii) as to the entire Custodial Agreement in the event a conservator or receiver is appointed for the Bank under applicable federal law. In addition, BGI may terminate the Custodial Agreement prior to April 30, 2013 if the Bank fails to meet a certain number of service level commitments for four consecutive months in any rolling twelve-month period or if the Bank materially breaches a material provision of the Custodial Agreement, in both cases subject to customary notice and opportunity to cure provisions.
Also, under the terms of the Amendment, the parties have agreed to assess the fee schedule and status of each party and of the industry 90 days prior to November 1, 2009 and to negotiate in good faith any appropriate amendments to the fee schedule arising from that assessment. If the parties are unable to agree on an amended fee schedule by November 1, 2009, BGI may terminate the Custodial Agreement.
The Amendment also provides that the Bank will continue to service BGI for up to two years, or longer under certain circumstances, after expiration or termination by BGI of the Custodial Agreement.
We may incur losses due to operational errors.
The services that we provide require complex processes and interaction with numerous third parties. While we maintain sophisticated computer systems and a comprehensive system of internal controls, and our operational history has been excellent, from time to time we may make operational errors for which we are responsible to our clients. In addition, even though we maintain appropriate errors and omissions and other insurance policies, an operational error could result in a significant liability to us and may have a material adverse effect on our results of operations.
We face significant competition from other financial services companies, which could negatively affect our operating results.
We are part of an extremely competitive asset servicing industry. Many of our current and potential competitors have longer operating histories, greater name recognition and substantially greater financial, marketing and other resources than we do. These greater resources could, for example, allow our competitors to develop technology superior to our own. In addition, we face the risk that large mutual fund complexes may build in-house asset servicing capabilities and no longer outsource these services to us. As a result, we may not be able to compete effectively with current or future competitors, which could result in a loss of existing clients or difficulty in gaining new clients.
We may incur significant costs defending legal claims.
We have been named in lawsuits in U.S. District Court in Massachusetts alleging, among other things, violations of securities laws. While we believe these claims are without merit, we cannot be sure that we will prevail in the defense of these claims. We are also party to other litigation and we may become subject to other legal claims in the future. Litigation is costly and could divert the attention of management. For a more detailed discussion of our ongoing lawsuits, please see Item 3. Legal Proceedings, in Part I of this report.
The failure to properly manage our growth could adversely affect the quality of our services and result in the loss of clients.
We have experienced a period of rapid growth that has required the dedication of significant management and other resources. Continued growth could place a strain on our management and other resources. To manage future growth effectively, we must continue to invest in our operational, financial and other internal systems, and our human resources, which could affect our profitability.
We must hire and retain skilled personnel in order to succeed.
Qualified personnel, in particular managers and other senior personnel, are in great demand throughout the financial services industry. As a result, we could find it increasingly difficult to continue to attract and retain sufficient numbers of these highly skilled employees, which could affect our ability to attract and retain clients. In addition, uncertainty regarding integration in our merger with State Street Corporation could cause key employees to seek employment elsewhere.
We may not reap all or any of the expected benefits of our recent increased spending.
To position us for future growth, we have accelerated some disciplined investments during 2006. We believe our investments in personnel, technology and office space are necessary to support our future growth in areas such as Europe, technology, alternative investments, middle office outsourcing and fund
services. While these investments have and will continue to decrease our short-term operating margins, we believe they are necessary to build the foundation for future growth. However, we may not reap any or all of the expected benefits of our recent investments.
We may not be able to protect our proprietary technology.
Our proprietary technology is important to our business. We rely on trade secret, copyright and trademark laws and confidentiality agreements with employees and third parties to protect our proprietary technology, all of which offer only limited protection. These intellectual property rights may be invalidated or our competitors may develop similar technology independently. Legal proceedings to enforce our intellectual property rights may be unsuccessful and could also be expensive and divert management’s attention.
Our quarterly and annual operating results may fluctuate.
Our quarterly and annual operating results are difficult to predict and may fluctuate from quarter to quarter and annually for several reasons, including:
· The timing of commencement or termination of client engagements;
· Changes in interest rates, the relationship between different interest rates or equity values;
· The rate of net inflows and outflows of investor funds in the investment vehicles offered by our clients; and
· The timing and magnitude of share repurchases under our share repurchase plan.
Most of our expenses, such as employee compensation and rent, are relatively fixed. As a result, any shortfall in revenue relative to our expectations could significantly affect our operating results.
We are subject to extensive federal and state regulations that impose complex restraints on our business.
Federal and state laws and regulations applicable to financial institutions and their parent companies apply to us. Our primary regulators are the Federal Reserve Board of Governors (‘FRB’), the Federal Deposit Insurance Corporation (‘FDIC’), the Office of the Commissioner of Banks of the Commonwealth of Massachusetts, the Securities and Exchange Commission, the National Association of Securities Dealers, Inc. (‘NASD’), the State of Vermont Department of Banking, Insurance, Securities and Health Care Administration (‘BISHCA’), the Office of the Superintendent of Financial Institutions in Canada (‘OSFI’), the Irish Financial Services Regulatory Authority (‘IFSRA’), the Cayman Islands Monetary Authority (‘CIMA’), the Financial Services Authority in the United Kingdom (‘FSA’) and the Commission de Surveillance du Secteur Financier in Luxembourg (‘CSSF’). Virtually all aspects of our operations are subject to specific requirements or restrictions and general regulatory oversight including the following:
· The FRB and the FDIC maintain capital requirements that we must meet. Failure to meet those requirements could lead to severe regulatory action or even receivership. We are currently considered to be “well-capitalized”;
· Under Massachusetts law, the Bank may be restricted in its ability to pay dividends to Investors Financial, which may in turn restrict our ability to pay dividends to our stockholders;
· The FRB and the FDIC are empowered to assess monetary penalties against, and to order termination of activities by, companies or individuals who violate the law;
· The NASD maintains certain regulatory requirements that our securities broker affiliate, Investors Securities Services, LLC, must meet. Failure to meet those requirements could lead to severe regulatory action;
· BISHCA maintains certain regulatory requirements that our insurance captive affiliate, Investors Vermont Insurance Company, must meet. Failure to meet those requirements could lead to regulatory action; and
· Our international operations are subject to regulatory oversight by regulators in the jurisdictions in which we operate, including the OSFI, the IFSRA, the CIMA, the FSA and the CSSF. Failure to comply with applicable international regulatory requirements could result in regulatory action and impact our ability to provide services in those jurisdictions.
Banking law restricts our ability to own the stock of certain companies and also makes it more difficult for us to be acquired. Also, we have not elected financial holding company status under the federal Gramm-Leach-Bliley Act of 1999. This may place us at a competitive disadvantage with respect to other organizations.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES.
The following table provides certain summary information with respect to the principal properties that we leased as of December 31, 2004:2006:
Location
| | Function
| | Sq. Ft.
| | Expiration Date
| | | | | Function | | Sq. Ft. | | Expiration Date | |
|---|
| 200 Clarendon Street, Boston, MA | | Principal Executive Offices and Operations Center | | 334,229 | | 2011 | | 200 Clarendon Street, Boston, MA | | Principal Executive Offices and
Operations Center | | 387,127 | | | 2014 | | |
| 100 Huntington Avenue, Boston, MA | | Operations Center | | 150,269 | | 2007 | | 100 Huntington Avenue, Boston, MA | | Operations Center | | 350,647 | | | 2014 | | |
800 Boylston Street, Boston, MA | | 800 Boylston Street, Boston, MA | | Operations Center | | 49,430 | | | 2014 | | |
| 1 Exeter Plaza, Boston, MA | | Training Center | | 14,870 | | 2007 | | 1 Exeter Plaza, Boston, MA | | Training Center | | 14,870 | | | 2007 | | |
| 33 Maiden Lane, New York, NY | | Operations Center | | 21,994 | | 2011 | | |
| 980 Ninth Street, Sacramento, CA | | Operations Center | | 53,580 | | 2008 | | 980 Ninth Street, Sacramento, CA | | Operations Center | | 79,421 | | | 2015 | | |
| 1277 Treat Boulevard, Walnut Creek, CA | | Operations Center | | 18,921 | | 2008 | | 1277 Treat Boulevard, Walnut Creek, CA | | Operations Center | | 18,921 | | | 2008 | | |
33 Maiden Lane, New York, NY | | 33 Maiden Lane, New York, NY | | Operations Center | | 21,994 | | | 2011 | | |
Iveagh Court, Dublin | | Iveagh Court, Dublin | | Offshore Processing Center | | 67,183 | | | 2028 | * | |
Park Place, Dublin | | Park Place, Dublin | | Offshore Processing Center | | 40,388 | | | 2031 | ** | |
| 1 First Canadian Place, Toronto | | Offshore Processing Center | | 17,790 | | 2006 | | 1 First Canadian Place, Toronto | | Offshore Processing Center | | 17,790 | | | 2011 | | |
| Iveagh Court, Dublin | | Offshore Processing Center | | 49,306 | | 2028 | * | |
17 Dominion Street, London | | 17 Dominion Street, London | | Operations Center | | 4,478 | | | 2010 | | |
26 Boulevard Royal, Luxembourg | | 26 Boulevard Royal, Luxembourg | | Operations Center | | 474 | | | 2007 | | |
*Pursuant to the terms of the contract, this lease can be terminated in 2013 by paying six months rent as compensation.
** Pursuant to the terms of the contract, this lease can be terminated in 2019 by paying twelve months rent as compensation.
For more information, see Note 16 of theour Notes to Consolidated Financial Statements.Statements included in this Report.
ITEM 3. LEGAL PROCEEDINGS.
On January 31, 2003, we were named in a class action lawsuit alleging, among other things, violations of California wage and hour laws at our Sacramento and Walnut Creek facilities. The lawsuit was filed in the Superior Court of California, County of Sacramento. In March 2004, a settlement between the parties was approved by the court and administration and payment of the settlement of the claim was completed in June 2004. The Company's payment under the settlement agreement was approximately $0.9 million.
On June 27, 2003, we and an individual employee of ours were named in a lawsuit alleging, among other things, that we breached an implied covenant of good faith and fair dealing in a subadvisory contract with Opus Investment Management, Inc. ("Opus") and that our individual employee engaged in a breach of fiduciary duties and tortious interference with a contract. Opus had been a subadviser to the Merrimac Funds, for which we act as investment adviser. Upon the expiration of Opus' contract on June 1, 2003, the Merrimac Funds elected not to re-appoint Opus as subadviser. The lawsuit was filed in the Superior Court inof Worcester, Massachusetts and sought unspecified damages. In October 2006, the parties settled the
lawsuit. Included in other operating expenses in our consolidated statement of income for the year ended December 31, 2006 is approximately $1.8 million for settlement costs, legal fees and administrative costs related to the settlement.
We and certain of our officers were named as defendants in three purported class action complaints that were filed on or about August 4, 2005, August 15, 2005, and September 30, 2005 in the United States District Court for the District of Massachusetts, Boston, Massachusetts. The U.S. District Court has consolidated those cases and appointed lead plaintiffs, who filed a consolidated complaint against us and seven of our current and former officers on February 3, 2006. Among other things, the consolidated complaint asserts that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 during the period April 10, 2001 until July 15, 2005. The allegations in the consolidated complaint predominantly relate to: (1) our October 2004 restatement of our financial results, and (2) our July 2005 revision of public guidance regarding our future financial performance. The consolidated complaint seeks unspecified damages. The lawsuitdamages, interest, fees, and costs. On May 14, 2006, we filed a motion to dismiss all claims asserted in the consolidated complaint. That motion is currently inpending before the discovery phase.Court. We strongly believe that the claims are withoutlawsuit lacks merit and we intend to defend against the claims vigorously. However, we cannot predict the outcome of the lawsuit at this time, and we can give no assurance that it will not materially adversely affect our rights vigorously.financial condition or results of operations.
We and nine of our officers and directors are named as defendants in two shareholder derivative complaints that were filed on or about September 22, 2005 and October 17, 2005 in the United States District Court for the District of Massachusetts, Boston, Massachusetts. Among other things, the complaints assert that the defendants are liable for breach of fiduciary duty, unjust enrichment, abuse of control, mismanagement, misappropriation of information, insider trading, and violation of Section 14(a) of the Securities Exchange Act of 1934. The complaint filed on September 22, 2005 also seeks reimbursement under the Sarbanes-Oxley Act of 2002. The allegations in the complaints predominantly relate to: (1) our October 2004 restatement of our financial results, and (2) our July 2005 revision of public guidance regarding our future financial performance. The complaints seek unspecified damages, attorneys’ fees, accountant and expert fees, and costs. We are also named as a nominal defendant in these complaints, although the actions are derivative in nature and purportedly asserted on behalf of us. We are in the process of evaluating these claims. However, we cannot predict the outcome of the lawsuits at this time, and we can give no assurance that they will not materially adversely affect our financial condition or results of operations.
In July 2000, two of our Dublin subsidiaries, Investors Trust & Custodial Services (Ireland) Ltd. ("ITC"(‘ITC’) and Investors Fund Services (Ireland) Ltd. ("IFS"(‘IFS’), received a plenary summons in the High Court, Dublin, Ireland. The summons named ITC and IFS as defendants in an action brought by the FTF Forex ConceptForexConcept Fund Plc (the "Fund"‘Fund’), a former client. The summons also named as defendants FTF Forex Trading and Finance, S.A., the Fund'sFund’s investment manager, Ernst & Young, LLP, the Fund'sFund’s auditors, and Dresdner Bank-Kleinwort Benson (Suisse) S.A., a trading counterparty to the Fund. The Fund is an investment vehicle organized in Dublin to invest in foreign exchange contracts. A total of approximately $4.7 million had been invested in the Fund. Most of that money was lost prior to the Fund'sFund’s closing to subscriptions in June 1999.
In January 2001, ITC, IFS and the other defendants named in the plenary summons received a statement of claim by the Fund seeking unspecified damages allegedly arising from breach of contract, misrepresentation and breach of warranty, negligence and breach of duty of care, and breach of fiduciary duty, among others. We have notified our insurers and intend to defend this claim vigorously. Based on our investigation through December 31, 2004,2006, we do not expect this matter to have a material adverse effect on our business, financial condition or results of operations.
22
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of our security holders during the quarter ended December 31, 2004.
PART II
ITEM 5. MARKET FOR REGISTRANT'SREGISTRANT’S COMMON EQUITY, AND RELATED STOCKHOLDER MATTERS.
MATTERS AND ISSUER PURCHASE OF EQUITY SECURITIES.
PRICE RANGE OF COMMON STOCK AND DIVIDEND HISTORY AND POLICYPrice Range of Common Stock and Dividend History and Policy
Our common stock is quoted on the Nasdaq NationalNASDAQ Global Select Market under the symbol "IFIN"“IFIN”. The following table sets forth, for the calendar periods indicated, the high and low sale prices for the common stock as reported by NasdaqNASDAQ and dividends per share paid on the common stock.
| | High
| | Low
| | Dividend
| | High | | Low | | Dividend | |
|---|
| 2004 | | | | | | | |
2006 | | | | | | | | |
| First quarter | | $ | 46.15 | | $ | 37.87 | | $ | 0.0175 | | $ | 48.11 | | $ | 36.36 | | $ | 0.0225 | |
| Second quarter | | 44.75 | | 34.68 | | 0.0175 | | 50.98 | | 41.40 | | 0.0225 | |
| Third quarter | | 48.90 | | 39.79 | | 0.0175 | | 46.82 | | 41.49 | | 0.0225 | |
| Fourth quarter | | 50.40 | | 35.00 | | 0.0175 | | 44.26 | | 37.00 | | 0.0225 | |
2003 |
|
|
|
|
|
| |
2005 | | | | | | | | |
| First quarter | | $ | 29.50 | | $ | 21.53 | | $ | 0.0150 | | $ | 53.44 | | $ | 45.33 | | $ | 0.0200 | |
| Second quarter | | 29.50 | | 20.18 | | 0.0150 | | 51.05 | | 36.05 | | 0.0200 | |
| Third quarter | | 34.65 | | 27.52 | | 0.0150 | | 42.80 | | 31.67 | | 0.0200 | |
| Fourth quarter | | 39.09 | | 31.40 | | 0.0150 | | 40.98 | | 30.64 | | 0.0200 | |
As of January 31, 2005,2007, there were approximately 864587 stockholders of record.
We currently intend to retain the majority of future earnings to fund the development and growth of our business. Our ability to pay dividends on our common stock may depend on the receipt of dividends from Investors Bank. In addition, we may not pay dividends on our common stock if we are in default under certain agreements that we entered into in connection with the sale of the 9.77% Capital Securities by Investors Capital Trust I. See Note 10 of our Notes to Consolidated Financial Statements included with this Report. Any dividend payments by Investors Bank are subject to certain restrictions imposed by federal law and by the Massachusetts Commissioner of Banks. See "Business—‘Business - Regulation and Supervision"Supervision’ for additional information. Subject to regulatory requirements, we expect to pay an annual dividend to our stockholders, currently estimated to be in an amount equal to $0.08$0.10 per share of outstanding common stock (approximately $5.3$6.6 million based upon 66,595,34965,628,108 shares outstanding as of December 31, 2004)2006). We expect to declare and pay such dividend ratably on a quarterly basis.
The information required under this item regarding securities authorized for issuance under equity compensation plans is incorporated herein by reference to the section entitled "Stock Plans"‘Stock Plans’ contained in our definitive proxy statement pursuant to Regulation 14A, which proxy statement will be filed with the Securities and Exchange Commission not later than 120 days after the close of our fiscal year ended December 31, 2004.2006.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
Period (shares in thousands)
| | Total
Number of
Shares
Purchased(1)
| | Average
Price Paid Per
Share
|
|---|
| October 1 - October 31, 2004 | | 41 | | $ | 42.77 |
| November 1 - November 30, 2004 | | 59 | | | 41.66 |
| December 1 - December 31, 2004 | | 2 | | | 45.55 |
| | |
| | | |
| | | 102 | | $ | 43.36 |
| | |
| | | |
Period | | | | a | | b | | c | | d | |
October 1 - October 31, 2006 | | 113,600 | | $ | 38.40 | | 113,600 | | $ | 145,638,023 | |
November 1 - November 30, 2006 | | 656,434 | | $ | 38.80 | | 641,639 | | $ | 120,735,516 | |
December 1 - December 31, 2006 | | — | | — | | — | | $ | 120,735,516 | |
Total | | 770,034 | | $ | 38.74 | | 755,239 | | $ | 120,735,516 | |
(a) Total number of shares purchased
(b) Average price paid per share
(c) Total number of shares purchased as part of a publicly announced plan
(d) Approximate dollar value that may yet be purchased under the plan
In June 2006, we announced that our Board of Directors had authorized a new repurchase plan of up to $150.0 million of our common stock in the open market over the twelve months following the announcement. We do not expect our stock repurchase program to have a material impact on our capital resources, such as maintaining risk-based capital ratios in excess of capital adequacy guidelines and our ability to pay dividends on our common stock. As of December 31, 2006, we have repurchased 755,239 shares totaling approximately $29.3 million under this plan. The plan expires in June 2007.
Stock Performance
The following graph compares the change in the cumulative total stockholder return on the Company’s common stock for the period from January 1, 2002 through December 31, 2006, with the cumulative total return on the Center for Research in Securities Prices Index for the NASDAQ Stock Market (‘NASDAQ Stock Market Index’) and the Center for Research in Securities Prices Index for NASDAQ financial stocks (‘NASDAQ Financial Stocks Index’). The comparison assumes $100 was invested on December 31, 2001 in the Company’s common stock at the $32.77 closing price on that day and in each of the shares set forthforegoing indices and assumes reinvestment of dividends, if any.
Comparison of Five Year Cumulative Total Return Among
Investors Financial Services Corp., NASDAQ Stock Market Index
and NASDAQ Financial Stocks Index
The following graph compares the change in the above table were purchased bycumulative total stockholder return on the Company in connectionCompany’s common stock for the period from January 1, 1996 through December 31, 2006, with the exercisecumulative total return on the Center for Research in Securities Prices Index for the NASDAQ Stock Market (‘NASDAQ Stock Market Index’) and the Center for Research in Securities Prices Index for NASDAQ financial stocks (‘NASDAQ Financial Stocks Index’). The comparison assumes $100 was invested on December 29, 1995 in the Company’s common stock at the $2.53 closing price on that day and in each of outstanding options issued by the Company.foregoing indices and assumes reinvestment of dividends, if any.
The Company does not currently maintain publicly announced repurchase plans or programs.Comparison of Ten Year Cumulative Total Return Among
Investors Financial Services Corp., NASDAQ Stock Market Index
and NASDAQ Financial Stocks Index
ITEM 6. SELECTED FINANCIAL DATA.
The following table contains certain of our consolidated financial and statistical information and should be read in conjunction with "Management's‘Management’s Discussion and Analysis of Financial Condition and Results of Operations"Operations’, our Consolidated Financial Statements and Notes to Consolidated Financial Statements, and other financial information appearing elsewhere in this Report. (Dollars in thousands, except per share and employee data):
| | For the Year Ended December 31,
| | | For the Year Ended December 31, | |
|---|
| | 2004
| | 2003(1)
| | 2002
| | 2001
| | 2000
| | | 2006 | | 2005 | | 2004 | | 2003(1) | | 2002 | |
|---|
| Statement of Income Data(2): | | | | | | | | | | | | |
Statement of Income Data: | | | | | | | | | | | | |
| Noninterest income | | $ | 425,491 | | $ | 336,193 | | $ | 298,844 | | $ | 254,487 | | $ | 170,876 | | | $ | 639,454 | | $ | 525,537 | | $ | 425,491 | | $ | 336,193 | | $ | 298,844 | |
| Net interest income | | 187,680 | | 153,914 | | 138,725 | | 98,355 | | 56,375 | | | 164,194 | | 170,425 | | 187,680 | | 153,914 | | 138,725 | |
| | |
| |
| |
| |
| |
| | |
| Net operating revenues | | 613,171 | | 490,107 | | 437,569 | | 352,842 | | 227,251 | | | 803,648 | | 695,962 | | 613,171 | | 490,107 | | 437,569 | |
| Operating expenses | | 398,383 | | 344,921 | | 341,395 | | 289,176 | | 177,875 | | | 579,354 | | 460,109 | | 398,383 | | 344,921 | | 341,395 | |
| | |
| |
| |
| |
| |
| | |
| Income before income taxes | | 214,788 | | 145,186 | | 96,174 | | 63,666 | | 49,376 | | | 224,294 | | 235,853 | | 214,788 | | 145,186 | | 96,174 | |
| Income taxes | | 72,826 | | 52,765 | | 28,737 | | 18,980 | | 15,800 | | | 70,491 | | 76,035 | | 72,826 | | 52,765 | | 28,737 | |
| | |
| |
| |
| |
| |
| | |
| Net income | | $ | 141,962 | | $ | 92,421 | | $ | 67,437 | | $ | 44,686 | | $ | 33,576 | | | $ | 153,803 | | $ | 159,818 | | $ | 141,962 | | $ | 92,421 | | $ | 67,437 | |
| | |
| |
| |
| |
| |
| | |
| Per Share Data(3): | | | | | | | | | | | | |
Per Share Data: | | | | | | | | | | | | |
| Basic earnings per share | | $ | 2.15 | | $ | 1.42 | | $ | 1.05 | | $ | 0.71 | | $ | 0.57 | | | $ | 2.34 | | $ | 2.42 | | $ | 2.15 | | $ | 1.42 | | $ | 1.05 | |
| | |
| |
| |
| |
| |
| | |
| Diluted earnings per share | | $ | 2.09 | | $ | 1.39 | | $ | 1.02 | | $ | 0.68 | | $ | 0.54 | | | $ | 2.28 | | $ | 2.37 | | $ | 2.09 | | $ | 1.39 | | $ | 1.02 | |
| | |
| |
| |
| |
| |
| | |
| Dividends per share | | $ | 0.07 | | $ | 0.06 | | $ | 0.05 | | $ | 0.04 | | $ | 0.03 | | | $ | 0.09 | | $ | 0.08 | | $ | 0.07 | | $ | 0.06 | | $ | 0.05 | |
| | |
| |
| |
| |
| |
| | |
| Balance Sheet Data: | | | | | | | | | | | | | | | | | | | | | | |
| Total assets at end of period | | $ | 11,167,825 | | $ | 9,223,178 | | $ | 7,214,740 | | $ | 5,297,913 | | $ | 3,811,869 | | | $ | 11,558,206 | | $ | 12,088,734 | | $ | 11,142,690 | | $ | 9,223,178 | | $ | 7,214,740 | |
| Average Balance Sheet Data: | | | | | | | | | | | | | | | | | | | | | | |
| Interest-earning assets | | $ | 9,770,924 | | $ | 7,556,061 | | $ | 5,769,971 | | $ | 4,376,947 | | $ | 2,753,814 | | | $ | 11,288,335 | | $ | 11,364,656 | | $ | 9,770,924 | | $ | 7,556,061 | | $ | 5,769,971 | |
| Total assets | | 10,306,015 | | 8,139,985 | | 6,173,187 | | 4,648,128 | | 2,900,177 | | | 11,929,813 | | 12,033,698 | | 10,276,479 | | 8,139,985 | | 6,173,187 | |
| Total deposits | | 4,495,858 | | 3,153,306 | | 2,342,247 | | 2,043,124 | | 1,551,880 | | | 5,453,856 | | 4,099,305 | | 4,495,858 | | 3,153,306 | | 2,342,247 | |
| Junior subordinated debentures(4) | | 24,774 | | 24,194 | | — | | — | | — | | |
| Trust preferred securities(4) | | — | | — | | 24,667 | | 25,000 | | 25,000 | | |
| Common stockholders' equity | | 625,964 | | 483,923 | | 395,101 | | 307,565 | | 155,809 | | |
Junior subordinated debentures(2) | | | 24,774 | | 24,774 | | 24,774 | | 24,194 | | — | |
Trust preferred securities(2) | | | — | | — | | — | | — | | 24,667 | |
Common stockholders’ equity | | | 866,514 | | 758,552 | | 625,964 | | 483,923 | | 395,101 | |
| Selected Financial Ratios: | | | | | | | | | | | | | | | | | | | | | | |
| Return on average equity | | 22.7 | % | | 19.1 | % | | 17.1 | % | | 14.5 | % | | 21.5 | % | | 17.7 | % | 21.1 | % | 22.7 | % | 19.1 | % | 17.1 | % |
| Return on average assets | | 1.4 | % | | 1.1 | % | | 1.1 | % | | 1.0 | % | | 1.2 | % | | 1.3 | % | 1.3 | % | 1.4 | % | 1.1 | % | 1.1 | % |
| Average common equity as a % of average assets | | 6.1 | % | | 5.9 | % | | 6.4 | % | | 6.6 | % | | 5.4 | % | |
| Dividend payout ratio(5) | | 3.3 | % | | 4.3 | % | | 4.9 | % | | 5.9 | % | | 5.6 | % | |
| Tier 1 capital ratio(6) | | 20.5 | % | | 17.6 | % | | 15.3 | % | | 16.6 | % | | 13.4 | % | |
| Leverage ratio(6) | | 5.9 | % | | 5.4 | % | | 5.4 | % | | 5.8 | % | | 5.2 | % | |
| Noninterest income as % of net operating income | | 69.4 | % | | 68.6 | % | | 68.3 | % | | 72.1 | % | | 75.2 | % | |
Average common equity as a % of | | | | | | | | | | | | |
average assets | | | 7.3 | % | 6.3 | % | 6.1 | % | 5.9 | % | 6.4 | % |
Dividend payout ratio(3) | | | 3.9 | % | 3.4 | % | 3.3 | % | 4.3 | % | 4.9 | % |
Tier 1 capital ratio(4) | | | 19.0 | % | 18.5 | % | 20.5 | % | 17.6 | % | 15.3 | % |
Leverage ratio(4) | | | 7.6 | % | 6.0 | % | 5.9 | % | 5.4 | % | 5.4 | % |
Noninterest income as % of net | | | | | | | | | | | | |
operating income | | | 79.6 | % | 75.5 | % | 69.4 | % | 68.6 | % | 68.3 | % |
| Other Statistical Data: | | | | | | | | | | | | | | | | | | | | | | |
| Assets processed at end of period(7) | | $ | 1,430,471,217 | | $ | 1,056,871,924 | | $ | 785,418,321 | | $ | 813,605,957 | | $ | 303,236,286 | | |
Assets processed at end of period(5) | | | $ | 2,211,740,622 | | $ | 1,792,571,911 | | $ | 1,430,471,217 | | $ | 1,056,871,924 | | $ | 785,418,321 | |
| Employees at end of period | | 2,778 | | 2,413 | | 2,591 | | 2,618 | | 1,779 | | | 4,265 | | 3,252 | | 2,778 | | 2,413 | | 2,591 | |
(1)Effective July 1, 2003, we adopted the Company adopted provisions of SFASStatement of Financial Accounting Standards No. 150,Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, which resulted in a reclassification of the trust preferred securities from mezzanine financing to liabilities. As such, interest expense associated with the trust preferred securities was reclassified to net interest income.
(2)All numbers shown in this table have been restated to reflect reclassifications related to EITF No. 01-14.
(3)All numbers shown in this table have been restated to reflect the two-for-one stock splits paid March 17, 1999, June 15, 2000 and June 14, 2002, where applicable.
(4)Effective October 1, 2003, the Companywe adopted the provisions of FINFASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities, which resulted in the deconsolidation of Investors Capital Trust I, the trust that holds the trust preferred securities.
(5)
(3)We intend to retain the majority of future earnings to fund development and growth of our business. We currently expect to pay cash dividends at an annualized rate of $0.08$0.10 per share subject to regulatory requirements. Refer to "Market Risk: Liquidity"‘Liquidity’ included in Management'sManagement’s Discussion and Analysis of Financial Condition and Results of Operations for further information.
(6)
(4)Refer to "Capital Resources"‘Capital Resources’ included within Management'sManagement’s Discussion and Analysis of Financial Condition and Results of Operations for further information.
(7)
(5)Assets processed is the total dollar value of financial assets on the reported date for which we provide one or more of the following services: middle office outsourcing, global custody, multicurrency accounting, fund administration, securities lending,middle office outsourcing, foreign exchange, cash management, securities lending, investment advisory, performance measurement, institutional transfer agency, investment advisory services, lines of credit and brokerage and transition management services.
26
ITEM 7. MANAGEMENT'S MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
You should read the following discussion together with our Consolidated Financial Statements and related Notes to Consolidated Financial Statements, which are included elsewhere in this Report. The following discussion contains forward-looking statements that reflect plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. See "Certain“Certain Factors That May Affect Future Results"Results” herein.
Overview
We provide asset administration services for the financial services industry through our wholly-owned subsidiary, Investors Bank & Trust Company. We provide core services and value-added services to a variety of financial asset managers, including mutual fund complexes, investment advisors, hedge funds, family offices, banks and insurance companies. Core services include middle office outsourcing, global custody, multicurrency accounting, fund administration and fund administration.middle office outsourcing. Value-added services include securities lending, foreign exchange, cash management, securities lending, investment advisory, performance measurement, institutional transfer agency, investment advisory services, lines of credit and brokerage and transition management services. We have offices located in the United States, Ireland, Canada, and the Cayman Islands, the United Kingdom and Luxembourg with a vast global subcustodian network established to accommodate the international needs of our clients. At December 31, 2004,2006, we provided services for approximately $1.4$2.2 trillion in net assets, including approximately $236 billion$0.4 trillion in foreign net assets.
We grow our business by selling our services to new clients and by further penetrating our existing clients. We believe that we service less than 10%approximately 12% of the assets managed by our existing clients, and we have traditionally achieved significant success in growing client relationships. Our ability to service new clients and expand our relationships with existing clients depends on our provision of superior client service. Our growth is also affected by overall market conditions in the global securities markets, the interest rate environment, the regulatory environment for us and our clients and the success of our clients in marketing their products.
We derive our asset servicing revenue from providing these core and value-added services. We derive our net interest income by investing the cash balances our clients leave on deposit with us. Since we price our service offerings on a bundled basis, our share of earnings from these investments is viewed as part of the total compensation that our clients pay us for servicing their assets. In establishing a fee structure for a specific client, we analyze all expected revenue and expenses. We believe net operating revenue (net(noninterest income plus net interest income plus noninterest income)) and net income are the most meaningful measures of our financial results.
As an asset administration services company, the amount of net operating revenue that we generate is impacted by overall market conditions, client activity and the prevailing interest rate environment. Over the course of the past two years, we have benefited from the appreciation of the market values of the assets we service for our clients. A significant portion of our core services revenue is based upon the amount of assets under administration.we process. As market values of underlying assets fluctuate, so will our revenue. We have managed this volatility by offering a tiered pricing structure for our asset-based fees. As asset values increase, the basis point fee is reduced for the incremental assets. When asset values decrease, revenue is only impacted at the then marginal rate. Many of our value-added services are transactional based, and we receive a fee for each transaction processed. We have continued to experienceThe lower net interest margin compressionexperienced during 2004 due2006 as compared to lower spreads,2005 is primarily resulting from lower yielding investment securities, as a result of increased purchasesexternal market factors and the repricing characteristics of variable-rate securitiesour balance sheet. The yield curve remained inverted for the majority of 2006, impacting reinvestment and purchase spreads on investments. The majority of our liability base reprices to overnight or short-term rates which, given the increase in short-term rates during 2004. In addition, we experienced prepaymentsthe first half of higher yielding fixed-rate securities during 2004. We primarily reinvested the cash flows from the securities that prepaid in2006, has also contributed to lower yielding variable-rate securities. Our net interest margin compression was also due to prepayment penalties, related to the prepayment of high-rate borrowings, and higher interest ratesresults year-to-date.
To position us for future growth, we accelerated some disciplined investments during the second halfthird and fourth quarters of 2004, which caused an increase2006. We believe our investments in average rates paid on our interest-bearing liabilities in 2004 as compared to 2003.
In 2003, we settled a tax assessment with the Commonwealth of Massachusetts. In March 2003, a retroactive change in the Commonwealth of Massachusetts tax law disallowed a dividends received deduction taken by the Bank on dividends it had received since 1999 from a wholly-owned real estate investment trust. During the second quarter of 2003, we settled this disputed tax assessment with the Massachusetts Department of Revenue, agreeing to pay approximately 50% of the liability. As a result of this change in tax law, we recorded an additional state tax expense of approximately $7.2 million, net of federal income tax benefit, in 2003.
We remain focused on our sales efforts, prudent expense managementpersonnel, technology and increasing our operating efficiency. These goalsoffice space are complicated by the need to build infrastructurenecessary to support our rapidfuture growth by the needin areas such as technology, alternative investments, middle office outsourcing, fund services and our European presence. While these investments have and will continue to maintain state-of-the-art systems and by the need to retain and motivatedecrease our workforce.
In our 2004 and 2003 earnings releases, we reported non-GAAPshort-term operating income and non-GAAP operating earnings per share information that exclude the effect of the state tax assessment settlement discussed above. We believe that non-GAAP operating earnings provide a more meaningful presentation of our 2003 results of operations because they do not include the one-time tax charge which was unrelated to our core operations. The following table presents a reconciliation between net income and earnings per share presented on the face of our Statements of Income and the non-GAAP measure of net operating income referenced in our earnings releases (Dollars in thousands, except per share data):
GAAP Earnings
| | For the Year Ended December 31,
|
|---|
| | 2004
| | 2003
| | 2002
|
|---|
| Income before taxes | | $ | 214,788 | | $ | 145,186 | | $ | 96,174 |
| Provision for income taxes | | | 72,826 | | | 52,765 | | | 28,737 |
| | |
| |
| |
|
| Net Income | | $ | 141,962 | | $ | 92,421 | | $ | 67,437 |
| | |
| |
| |
|
| Earnings per share: | | | | | | | | | |
| | Basic | | $ | 2.15 | | $ | 1.42 | | $ | 1.05 |
| | |
| |
| |
|
| | Diluted | | $ | 2.09 | | $ | 1.39 | | $ | 1.02 |
| | |
| |
| |
|
Non-GAAP Operating Earnings
| | For the Year Ended December 31,
|
|---|
| | 2004
| | 2003
| | 2002
|
|---|
| Income before taxes | | $ | 214,788 | | $ | 145,186 | | $ | 96,174 |
| Provision for income taxes | | | 72,826 | | | 45,565 | (1) | | 28,737 |
| | |
| |
| |
|
| Net Income | | $ | 141,962 | | $ | 99,621 | | $ | 67,437 |
| | |
| |
| |
|
| Earnings per share: | | | | | | | | | |
| | Basic | | $ | 2.15 | | $ | 1.53 | | $ | 1.05 |
| | |
| |
| |
|
| | Diluted | | $ | 2.09 | | $ | 1.50 | | $ | 1.02 |
| | |
| |
| |
|
(1)Provision for income taxes for the year ended December 31, 2003 excludes a $7.2 million charge, net of federal income tax benefit, that resulted from a retroactive change in the Commonwealth of Massachusetts tax law enacted inmargins through the first quarterhalf of 2003 and the Company's subsequent settlement of the resulting tax assessment with the Massachusetts Department of Revenue. The effect of the exclusions is an increase in basic and diluted earnings per share of $0.11.
2007, we believe they are necessary to position us for future growth.Critical Accounting Policies
Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America, which require us to make estimates and assumptions. We have identified the following accounting policies that, as a result of the complexities of the underlying accounting standards and operations involved, could result in significant changes to our consolidated financial condition or consolidated results of operations under different conditions or using different assumptions. Senior management has discussed these critical accounting policies with the Audit Committee.
Derivative Financial InstrumentsInstruments——HedgeCash flow hedge accounting requires that we measure the changes in fair value of derivatives designated as hedges as compared to changes in expected cash flows of the underlying hedged transactions for each reporting period. This process involves the estimation of the expected future cash flows of hedged transactions. Interest rate swaps are valued using a nationally recognized swap valuation model. The LIBOR (London InterBank Offered Rate) curve in this model serves as the basis for computing the market value of the swap portfolio. If short-term interest rates increase, as they did during the first half of 2006, we would expect the swaps wouldto gain in value. Conversely, if short-term interest rates decrease, we would expect there wouldto be a corresponding decline in the market value of the swap portfolio. The measurement of fair value of our derivatives portfolio is based upon market values, however, in the absence of quoted market values, measurement involves the use of valuation models. The use of alternative valuation methodologies could have a significant effect on estimated fair value.interest rate curve and spreads.
Defined Benefit Pension AssumptionsAssumptions——Each fiscal year, we must assess and select the discount rate, compensation increase percentage and average return on plan assets assumptions in order to determine our net periodic pension cost and to project our benefit obligations under our defined benefit plans. The discount rate is based on the weighted-average yield on high-quality fixed-income investments that are expected to match the plan'splan’s projected cash flows. The compensation increase percentage is based upon management'smanagement’s current and expected salary increases. The average return on plan assets is based on the expected return on the plan'splan’s current investment portfolio, which can reflect the historical returns of the various asset classes.
For the fiscal year ended December 31, 2004,2006, the discount rate used to determine the projected benefit obligations for both our qualified defined benefit pension plan (‘pension plan’) and our nonqualified, unfunded, supplemental retirement plan (‘SERP’) was 6.00%. The discount rate was 0.25% higher than the rate at December 31, 2005 primarily due to increased yields in long-term bond indices. The compensation increase percentage assumption for our SERP ranged from 4.00% to 10.00% at December 31, 2006, which was consistent with the prior year.
For the fiscal year ended December 31, 2006, the discount rate used to determine net periodic pension benefit/cost for both our pension plan and our SERP was 5.75%. The rate of compensation increase for both our pension plan and our SERP of 4.00% at December 31, 2006 was consistent with the rate used in the prior year. The average return on plan assets were 5.8%, 4.0% and 8.5%, respectively. The discount rate was lower by 0.45% compared tofor our pension plan of 8.50% for the year ended December 31, 2003 due to a decline in interest rates. The compensation increase assumption at December 31, 2004 was slightly higher by 0.25% than at December 31, 2003 and the rate of return on plan assets of 8.5%2006 has remained consistent with the prior year. Net
Effective December 31, 2005, all pension plan participant’s accounts were frozen, and effective January 1, 2006, no further pension plan benefit will accrue on behalf of any pension plan participant. As a result, we recorded a net periodic pension benefit on our pension plan for 2006 of $0.2 million, as
compared to a $0.8 million net periodic pension expense, excluding the effect of curtailment, for the year ended December 31, 2005. We expect the net periodic pension benefit on our pension plan to be approximately $0.5 million in fiscal year 2007.
The net periodic pension expense for 2004the SERP was $0.8$4.4 million and is expectedfor the year ended December 31, 2006, which was consistent with the prior year. We expect the net periodic pension expense on our SERP to be approximately $0.9$4.2 million in fiscal year 2005.2007.
At December 31, 2004, the discount rate assumption for our nonqualified, unfunded, supplemental retirement plan, which covers certain employees, was 5.8%. The compensation increase percentage assumption ranged from 4.0% to 10.0% at December 31, 2004, compared to 3.75% at December 31, 2003. The net periodic expense for 2004 for the supplemental retirement plan was $2.5 million and is expected to be approximately $3.8 million in fiscal year 2005. The increase in the expected pension cost in 2005 is due to a lower discount rate, combined with changes in the participant mortality rates and an increase in the compensation increase percentage assumption.
New Accounting Pronouncements
In December 2004,June 2006, the Financial Accounting Standards Board ("FASB"(‘FASB’) issued SFASFASB Interpretation No. 123 (revised 2004),48, Share-Based PaymentAccounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 (‘FIN 48’). SFAS 123R requires that compensation cost relatingFIN 48 establishes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to share-based payment transactions be taken in a tax return. Pursuant to FIN 48, the effects of a tax position are recognized in the financial statements with measurementwhen it is more likely than not, based on the technical merits, that the position will be sustained upon examination by the taxing authority. Conversely, previously recognized tax positions are derecognized when it is no longer more likely than not that the tax position would be sustained upon examination. FIN 48 also requires certain disclosures regarding unrecognized tax benefits and the amounts and classification of the related interest and penalties. FIN 48 is effective for fiscal years beginning after December 15, 2006. Accordingly, we adopted FIN 48 on January 1, 2007, and there was no material impact to our financial condition or results of operations.
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (‘SFAS 157’). SFAS 157 defines fair value, ofestablishes a framework for measuring fair value, and expands upon existing disclosures about fair value measurements. SFAS 157 does not require any new fair value measurements. Rather, the guidance contained in SFAS 157 applies to assets, liabilities, and certain equity or liability instruments issued. The Statementthat are already measured at fair value under existing accounting pronouncements. SFAS 157 is effective as of thefor fiscal years beginning of the first interim reporting period that begins after JuneNovember 15, 2005, and replaces SFAS No. 123,Accounting for Stock-Based Compensation, and supercedes APB Opinion No. 25,Accounting for Stock Issued to Employees. We currently use the intrinsic-value method to measure compensation cost related
to our share-based transactions. We will adopt SFAS 123R in the third quarter of 2005 and are in the process of determining the methodology we will use and the impact on our results of operations and financial condition.2007. We do not anticipate any material impact to our financial condition or results of operations as a result of the adoption of SFAS 123R.157.
In March 2004,September 2006, the Emerging Issues Task Force ("EITF"SEC issued Staff Accounting Bulletin 108, Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements (‘SAB 108’). SAB 108 provides interpretive guidance on how the effects of the FASB reachedcarryover or reversal of prior year financial statement misstatements should be considered in quantifying a consensus on EITF Issue No. 03-1,The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. As originally issued, EITF Issue No. 03-1 was to becurrent year misstatement. SAB 108 is effective for all annual or interim financial statements for periods beginningcovering the first fiscal year ending after JuneNovember 15, 2004, however, a partial deferral2006. Accordingly, we adopted SAB 108 on December 31, 2006, and there was issued in September 2004. EITF Issue No. 03-1 addresses the identification of other-than-temporarily impaired investments, and requires that an impairment charge be recognized for other-than-temporarily impaired investments for which there is neither the ability nor intentno material impact to hold either until maturity or until the market value of the investment recovers. We continue to monitor the FASB's discussions regarding EITF Issue No. 03-1, and to assess the impact of its application on our financial condition andor results of operations.
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (‘SFAS 159’). SFAS 159 permits entities to elect to measure certain financial instruments and other items at fair value through earnings. The fair value option may be applied on an instrument by instrument basis, is irrevocable and is applied only to entire instruments. SFAS 159 requires additional financial statement presentation and disclosure requirements for those entities that elect to adopt the standard and is effective for fiscal years beginning after November 15, 2007. We do not anticipate any material impact to our financial condition or results of operations as a result of the adoption of SFAS 159.
Certain Factors That May Affect Future Results
From time to time, information provided by us, statements made by our employees, or information included in our filings with the Securities and Exchange CommissionSEC (including this Form 10-K) may contain statements which are not historical facts, so-called "forward-looking“forward-looking statements,"” which are made under Section 21E of the
Securities Exchange Act of 1934 and which involve risks and uncertainties. These statements relate to future events or our future financial performance and are identified by words such as "may," "will," "could," "should," "expect," "plan," "intend," "seek," "anticipate," "believe," "estimate," "potential,"“may”, “could”, “should”, “expect”, “plan”, “intend”, “seek”, “anticipate”, “believe”, “estimate”, “potential”, or "continue"“continue” or other comparable terms or the negative of those terms. Forward-looking statements in this Form 10-K include certain statements regarding closing of our acquisition by State Street Corporation, liquidity, capital resources, growth rate, annual dividend payments, interest rate conditions, the shape of the yield curve, interest rate sensitivity, compliance with capital adequacy guidelines, loss exposure on lines of credit, the timing and effect on earnings of derivative gains and losses,foreign exchange revenue, cash management revenue, securities lending revenue, net interest income, operating margin, operating expenses, including occupancy expenses and needs, transaction processing services expense, professional fee expense, compensation expense, travel and sales expense, investments in technology, pension plan and supplemental pension expense, depreciation expense, effective tax rate,investments in Federal Home Loan Bank of Boston (‘FHLBB’) capital stock, the effect on earnings of changes in equity values or fixed income values, the effects of increased prepayments and reduced investment opportunities for our net interest income, the effect of any anticipated activity under our stock repurchase plan, contributing to our supplemental retirement plan, the effect of new accounting pronouncements, the effect of amortization, the effect of an opportunity arising from industry consolidation, our expected effective tax rate and the effect of certain legal claims against us. Our actual future results may differ significantly from those stated in any forward-looking statements. Factors that may cause such differences include, but are not limited to, the factors discussed below.in Item 1A of this Form 10-K. Each of these factors, and others, are discussed from time to time in our filings with the SEC.
Our operating results are subject to fluctuations in interest rates and the securities markets.
A significant portion of our fees is based on the market value of the assets we process. Accordingly, our operating results are subject to fluctuations in interest rates and securities markets as these fluctuations affect the market value of assets processed. Current market conditions, including the recent volatility in the equity markets, can have a material effect on our asset-based fees. While reductions in asset servicing fees may be offset by increases in other sources of revenue, a sustained downward movement of the broad equity markets will likely have an adverse impact on our earnings. Fluctuations in interest rates or the securities markets can also lead to investors seeking alternatives to the investment offerings of our clients, which could result in a lesser amount of assets processed and correspondingly lower fees. Also, our net interest income is earned by investing depositors' funds in our investment portfolio and, in small part, by making loans. Changes in interest rates and/or the relationship between short-term and long-term interest rates could adversely affect the market value of, or the earnings produced by, our investment and loan portfolios, and thus could adversely affect our operating results.
A material portion of our revenue is derived from our relationship with Barclays Global Investors, N.A. ("BGI") and related entities.
As a result of our selection to service assets for Barclays Global Investors Canada, Ltd., our assumption of the operations of the U.S. asset administration unit of BGI in 2001 and our ongoing relationship with BGI's iShares and Master Investment Portfolios, BGI accounted for approximately 17% of our net operating revenue during the year ended December 31, 2004. We expect that BGI will continue to account for a significant portion of our net operating revenue. While we provide services to BGI under long-term contracts, those contracts may be terminated for certain regulatory and fiduciary reasons. The loss of BGI's business would cause our net operating revenue to decline significantly and may have an adverse effect on our quarterly and annual results.
We may incur losses due to operational errors.
The services that we provide require complex processes and interaction with numerous third parties. While we maintain sophisticated computer systems and a comprehensive system of internal controls, and our operational history has been excellent, from time to time we may make operational errors for which we are responsible to our clients. In addition, even though we maintain appropriate errors and omissions and other insurance policies, an operational error could result in a significant liability to us and may have a material adverse effect on our results of operations.
We face significant competition from other financial services companies, which could negatively affect our operating results.
We are part of an extremely competitive asset servicing industry. Many of our current and potential competitors have longer operating histories, greater name recognition and substantially greater financial, marketing and other resources than we do. These greater resources could, for example, allow our competitors to develop technology superior to our own. In addition, we face the risk that large mutual fund complexes may build in-house asset servicing capabilities and no longer outsource these services to us. As a result, we may not be able to compete effectively with current or future competitors, which could result in a loss of existing clients or difficulty in gaining new clients.
We may incur significant costs defending legal claims.
We have been named in a lawsuit in Massachusetts state court alleging, among other things, violations of a covenant of good faith and fair dealing in a contract. While we believe this claim is without merit, we cannot be sure that we will prevail in the defense of this claim. We are also party to other litigation and we may become subject to other legal claims in the future. Litigation is costly and could divert the attention of management.
Our future results depend, in part, on successful integration of pending and possible future acquisitions and outsourcing transactions.
Integration of acquisitions and outsourcing transactions is complicated and frequently presents unforeseen difficulties and expenses which can affect whether and when a particular acquisition or outsourcing transaction will be accretive to our earnings per share. Any future acquisitions or outsourcing transactions will present similar challenges. These acquisitions or outsourcing transactions can also consume a significant amount of management's time.
The failure to properly manage our growth could adversely affect the quality of our services and result in the loss of clients.
We have been experiencing a period of rapid growth that has required the dedication of significant management and other resources. Continued rapid growth could place a strain on our management and
other resources. To manage future growth effectively, we must continue to invest in our operational, financial and other internal systems, and our human resources.
We must hire and retain skilled personnel in order to succeed.
Qualified personnel, in particular managers and other senior personnel, are in great demand throughout the financial services industry, especially if the recent economic recovery proves sustainable. We could find it increasingly difficult to continue to attract and retain sufficient numbers of these highly skilled employees, which could affect our ability to attract and retain clients.
We may not be able to protect our proprietary technology.
Our proprietary technology is important to our business. We rely on trade secret, copyright and trademark laws and confidentiality agreements with employees and third parties to protect our proprietary technology, all of which offer only limited protection. These intellectual property rights may be invalidated or our competitors may develop similar technology independently. Legal proceedings to enforce our intellectual property rights may be unsuccessful, and could also be expensive and divert management's attention.
Our quarterly and annual operating results may fluctuate.
Our quarterly and annual operating results are difficult to predict and may fluctuate from quarter to quarter and annually for several reasons, including:
•The timing of commencement or termination of client engagements;
•The rate of net inflows and outflows of investor funds in the investment vehicles offered by our clients; and
•Changes in interest rates and equity values.
Most of our expenses, such as employee compensation and rent, are relatively fixed. As a result, any shortfall in revenue relative to our expectations could significantly affect our operating results.
We are subject to extensive federal and state regulations that impose complex restraints on our business.
Federal and state laws and regulations applicable to financial institutions and their parent companies apply to us. Our primary regulators are the Federal Reserve Board ("FRB"), the Federal Deposit Insurance Corporation ("FDIC"), the Massachusetts Commissioner of Banks and the National Association of Securities Dealers, Inc. ("NASD"). Virtually all aspects of our operations are subject to specific requirements or restrictions and general regulatory oversight including the following:
•The FRB and the FDIC maintain capital requirements that we must meet. Failure to meet those requirements could lead to severe regulatory action or even receivership. We are currently considered to be "well capitalized";
•Under Massachusetts law, the Bank may be restricted in its ability to pay dividends to Investors Financial, which may in turn restrict our ability to pay dividends to our stockholders;
•The FRB and the FDIC are empowered to assess monetary penalties against, and to order termination of activities by, companies or individuals who violate the law; and
•The NASD maintains certain regulatory requirements that our securities broker affiliate, Investors Securities Services, Inc., must meet. Failure to meet those requirements could lead to severe regulatory action.
Banking law restricts our ability to own the stock of certain companies and also makes it more difficult for us to be acquired.
Statements of Income
Comparison of Operating Results for the Years Ended December 31, 20042006 and 2003.2005.
Net income for the year ended December 31, 20042006 was $142.0$153.8 million, up 54%down 4% from $92.4$159.8 million for the same period in 2003.2005. The principal factors contributing todecrease primarily resulted from continued pressure on our net income growth were growth ininterest margin, as well as increased operating expenses. This decrease was offset substantially by increased asset servicing fees, of 27% in additionwhich reflect our ability to a 22% increase in net interest income. Net income growth was partially offset by a 16% increase in operating expenses, largely duesell to new business, additional headcount and technology requirements. Our income statement for the year ended December 31, 2003 reflects the net effect of the first quarter 2003 tax accrualexisting clients combined with market appreciation and its later partial reversal resulting from our settlement with the Massachusetts Department of Revenue. Absent the effects of this tax matter, net income for the year ended December 31, 2004 increased 43% from net operating income for the same period in 2003.strong client fund flows.
Fees and Other Revenue
The components of fees and other revenue are as follows (Dollars in thousands):
| | For the Year Ended December 31,
| | | For the Year Ended
December 31, | |
|---|
| | 2004
| | 2003
| | Change
| | | 2006 | | 2005 | | Change | |
|---|
| Total asset servicing fees | | $ | 423,200 | | $ | 333,586 | | 27 | % | | $ | 631,240 | | $ | 509,059 | | | 24 | % | |
| Other operating income | | 2,057 | | 2,607 | | (21 | )% | | 5,691 | | 4,081 | | | 39 | % | |
| Gain on sale of investment | | 234 | | — | | 100 | % | |
| | |
| |
| | | | |
Gain on sale of investments | | | 2,523 | | 12,397 | | | * | | |
| Total fees and other revenue | | $ | 425,491 | | $ | 336,193 | | 27 | % | | $ | 639,454 | | $ | 525,537 | | | 22 | % | |
| | |
| |
| | | | |
*Percentage is not considered meaningful.
The largest components of asset servicing fees are custody, multicurrency accounting and fund administration, which increased 24%21% to $314.3$453.6 million for the year ended December 31, 20042006 from $254.2$375.6 million for the same period in 2003.2005. Custody, multicurrency accounting and fund administration fees are based in part on the value of assets processed. Assets processed is the total dollar value of financial assets on the reported date for which we provide one or more of the following services: middle office outsourcing, global custody, multicurrency accounting, fund administration, securities lending,middle office outsourcing, foreign exchange, cash management, securities lending, investment advisory, performance measurement, institutional transfer agency, investment advisory services, lines of credit and brokerage and transition management services.
The change in net assets processed includes the following components (Dollars in billions):
|
| | For the Year Ended
December 31, 2004
| | | For the Year Ended
December 31, 2006 | | For the Three Months Ended
December 31, 2006 | |
|---|
| Net assets processed, beginning of period | Net assets processed, beginning of period | | $ | 1,057 | | | | $ | 1,793 | | | | $ | 2,035 | | |
| | |
| | |
| Change in net assets processed: | Change in net assets processed: | | | | | | | | | | | | |
| Sales to new clients | Sales to new clients | | 54 | | | | 8 | | | | 7 | | |
| Further penetration of existing clients | Further penetration of existing clients | | 37 | | | | 29 | | | | 4 | | |
| Lost clients | Lost clients | | (3 | ) | | | (1 | ) | | | — | | |
| Fund flows and market gain | Fund flows and market gain | | 285 | | | | 383 | | | | 166 | | |
| | |
| | |
| | Total change in net assets processed | | 373 | | |
| | |
| | |
Total change in net assets processed | | | | 419 | | | | 177 | | |
| Net assets processed, end of period | Net assets processed, end of period | | $ | 1,430 | | | | $ | 2,212 | | | | $ | 2,212 | | |
| | |
| | |
The majority of the increase in assets processed was due to sales to new and existing clients, the ability of our clients to develop and sell product, which generates fund flows that have a direct, positive impact on our business, and higher asset values compared to a year ago. As indicated in the
"Overview" ‘Overview’ section, our core services fees are generated by charging a fee based upon the value of assets processed. As market values or clients'clients’ asset levels fluctuate, so will our revenue. Our tiered pricing structure, coupled with minimum and flat fees, allow us to manage this volatility to a certain extent. As asset values increase, the basis point fee typically lowers. When asset values decrease, revenue is only impacted by the asset decline at the then marginal rate.
If the value of equity or fixed income assets held by our clients were to increase or decrease by 10%, for a sustained period of time, we estimate currently that this market movement, by itself, would cause a corresponding change of approximately 3%less than 5% in our earnings per share. If the value of fixed-income assets held by our clients were to increase or decrease by 10%, we estimate currently that this, by itself, would cause a corresponding change of approximately 2% in our earnings per share. In practice, earningsEarnings per share do not track precisely to the value of the equity and fixed-income markets because conditions present in a market increase or decrease may generate offsetting increases or decreases in other revenue items.and expense items that are influenced by the value of the assets we administer. For example, increased market volatility often results in increasedhigher transaction fee revenue. Also, market value declines may result in increased interest income and sweep fee income as clients move larger amounts of assets into the cash management vehicles that we offer. In addition, our tiered pricing structure reduces the impact of volatility in asset values to a certain extent. However, there can be no assurance that any of these offsetting revenue increasesand expense movements will occur during any future upturn or downturn in the equity or fixed-income markets.markets, or that our tiered pricing structure will reduce the impact on us of a sustained change in asset values.
Transaction-driven income includes our ancillaryvalue-added services, such as foreign exchange, cash management, securities lending and securities lending.investment advisory services.
· Foreign exchange fees were $54.5$81.0 million for the year ended December 31, 2004,2006, up 49%30% from the same period in 2003.2005. The increase in foreign exchange fees is attributable to new clients,business, increased volume of client activity in international markets and volatility in currency markets. Future foreign exchange income is dependent on the levelvolume of new and existing client activity and the overall volatility in the currencies traded.
· Cash management fees, which consist of sweep fees, were $26.4$58.8 million for the year ended December 31, 2004,2006, up 26%56% from the same period in 2003.2005. The increase is the result ofprimarily due to higher domestic and foreign cash balances heldplaced by our clients.clients in the cash management products we offer. Cash management revenue will continue to depend on the level of client balances maintained in the cash management products we offer. If our clients’ investment products continue to maintain higher cash balances than they did in comparable periods, we expect our cash management products.revenue to be positively impacted.
Investment advisory· Securities lending fees were $15.0$27.4 million for the year ended December 31, 2004,2006, up 28%21% from the same period in 2003. The increase in investment advisory fees is attributable to increased average asset values of the Merrimac Master Portfolio, an investment company for which we act as advisor, and where a portion of excess client cash balances are invested. Future investment advisory fees are dependent upon the asset levels within the Merrimac Master Portfolio, which are driven by overall market conditions, client activity and transaction volumes. Securities lending fees were $10.4 million for the year ended December 31, 2004, up 17% from the same period in 2003,2005, primarily due to new business, higher volumes and improved spreads and volumes.market conditions. Securities lending transaction volume is positively affected by the market value of the securities on loan, merger and acquisition activity, increased IPO activity, the seasonality of international dividend arbitrage and a steeper short-end of the yield curve. If the capital markets continue to experience any of the aforementioned activity, it is likely that our securities lending revenue will continue to be positively impacted. If we experience any of the following: 1) a reduction in our securities lending portfolio, 2) lower market values or 3) compression of the spreads earned on our securities lending activity, our securities lending revenue will likely be negatively impacted.
· Investment advisory fees were $7.5 million for the year ended December 31, 2006, down 12% from the same period in 2005. The decrease in investment advisory fees is attributable to lower asset values in our proprietary Merrimac money market funds. Future investment advisory fee income is dependent upon the asset levels within the Merrimac money market funds, which are driven by overall market conditions, client activity and transaction volumes.
· Other service fees were $3.1 million for the year ended December 31, 2006, up 11% from the same period in 2005. Other service fees include income earned on compliance advisory, brokerage and transition management services. The increase in other service fees was primarily due to an increase in commission fees and compliance service fees.
· Other operating income for the year ended December 31, 2006 was $5.7 million, up 39% from the same period in 2005. The increase is primarily due to an increase in interest earned on clearing agency deposits and an increase in the dividend rate on our FHLBB stock.
During the year ended December 31, 2006, we sold municipal securities held in our available for sale portfolio, resulting in the recognition of $2.5 million in gains. During the year ended December 31, 2005, we sold municipal securities and U.S. Treasury securities held in our available for sale portfolio, resulting in the recognition of $12.4 million in gains. These security sales in 2005 and 2006 were the result of a strategy to improve the after-tax yield of our municipal securities portfolio by replacing the sold municipal securities with those that offer a more attractive after-tax yield, as well as to capitalize on strong market conditions.
Net Interest Income
The following table presents the components of net interest income (Dollars in thousands):
| | For the Year Ended December 31,
| | | For the Year Ended December 31, | |
|---|
| | 2004
| | 2003
| | Change
| | | 2006 | | 2005 | | Change | |
|---|
| Interest income | | $ | 313,149 | | $ | 247,094 | | 27 | % | | $ | 557,749 | | $ | 447,705 | | | 25 | % | |
| Interest expense | | 125,469 | | 93,180 | | 35 | % | | 393,555 | | 277,280 | | | 42 | % | |
| | |
| |
| | | | |
| Total net interest income | | $ | 187,680 | | $ | 153,914 | | 22 | % | | $ | 164,194 | | $ | 170,425 | | | (4 | )% | |
| | |
| |
| | | | |
Net interest income is affected by the volume and mix of assets and liabilities and the movement and level of interest rates. The improvementdecrease in our net interest income from the year ended December 31, 2006 was primarily driven by increasing short-term interest rates without a concurrent increase in longer-term rates, which resulted in an inverted yield curve. Consequently, our interest-bearing liabilities, of which the majority is priced based on overnight and short-term rates, have repriced at higher rates faster than our interest-earning assets have repriced, resulting in a lower net interest margin as compared to the year ended December 31, 2005. In addition, reinvestment and purchase spreads on fixed and floating-rate assets were lower than expected due to balance sheet growth, driven by healthy client funding, partially offset by lowermany factors, including yield curve shape and level of rates. Average investment spreads.
During 2004 we continued to employ a strategy of prepaying high-rate borrowings and replacing them with lower cost term funding in order to maintain our net interest margin. Prepayment feessecurity balances were incurred during the first half of 2004 and were $6.8 million, compared to $3.1 million during 2003. This strategy combined with a rising interest rate environment during the second half of 2004 resulted in a 5 basis point increase in the average rate paid on interest-bearing liabilities to 1.39%down $0.3 billion for the year ended December 31, 2004 from 1.34% for2006, compared to the same period in 2003. The majority of our funding sources are priced based on the Federal Funds rate.year ended December 31, 2005, primarily due to slower reinvestment.
The table below presents the changes in net interest income resulting from changes in the volume of interest-earning assets or interest-bearing liabilities and changes in interest rates for the year ended December 31, 20042006 compared to the year ended December 31, 2003.2005. Changes attributed to both volume and rate have been allocated based on the proportion of change in each category (Dollars in thousands):
| | For the Year Ended
December 31, 2004 vs. December 31, 2003
| | For the Year Ended
December 31, 2006 vs. December 31, 2005 | |
|---|
| | Change Due
To Volume
| | Change Due
To Rate
| | Net
| | Change Due
to Volume | | Change Due
to Rate | | Net | |
|---|
| Interest-earning assets | | | | | | | | | | | | | | | | | |
| Fed funds sold and securities purchased under resale agreements | | $ | 275 | | $ | 66 | | $ | 341 | |
Federal funds sold, interest-bearing deposits with other banks and other short-term investments | | | | $ | 5,331 | | | | $ | 1,560 | | | $ | 6,891 | |
| Investment securities | | 69,525 | | (4,821 | ) | | 64,704 | | | (10,160 | ) | | | 101,543 | | | 91,383 | |
| Loans | | 1,057 | | (47 | ) | | 1,010 | | | 3,374 | | | | 8,396 | | | 11,770 | |
| | |
| |
| |
| |
| Total interest-earning assets | | $ | 70,857 | | $ | (4,802 | ) | $ | 66,055 | | | (1,455 | ) | | | 111,499 | | | 110,044 | |
| | |
| |
| |
| |
| Interest-bearing liabilities | | | | | | | | | | | | | | | | | |
| Deposits | | $ | 17,767 | | $ | (6,865 | ) | $ | 10,902 | | | 36,572 | | | | 66,049 | | | 102,621 | |
| Borrowings | | 5,311 | | 16,076 | | 21,387 | | | (51,892 | ) | | | 65,546 | | | 13,654 | |
| | |
| |
| |
| |
| Total interest-bearing liabilities | | $ | 23,078 | | $ | 9,211 | | $ | 32,289 | | | (15,320 | ) | | | 131,595 | | | 116,275 | |
| | |
| |
| |
| |
| Change in net interest income | | $ | 47,779 | | $ | (14,013 | ) | $ | 33,766 | | | $ | 13,865 | | | | $ | (20,096 | ) | | $ | (6,231 | ) |
| | |
| |
| |
| |
Amortization and accretion of debt securities purchased at a premium or discount are amortized or accreted into income using a method which approximates the constant effective yield method. We apply Statement of Financial Accounting Standards No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases (‘SFAS 91’) for the amortization of premiums and accretion of discounts. In calculating the effective yield for securities that represent holdings of large numbers of similar loans for which prepayments are probable and the timing and amount of prepayments can be reasonably estimated, prepayments are anticipated using our actual three-month prepayment experience.
The amount of amortization or accretion to recognize in income is driven by the calculation of the constant effective yield. When calculating this yield, we assume that prepayments will continue from the analysis date to the date of the security’s expected maturity at our most recent three-month prepayment rate. The prepayment rate is updated monthly based on our previous three-month actual prepayment experience.
We utilize three-month prepayment rates to anticipate prepayments because such rates are based on our own actual prepayment experience and because we believe three-month rates are a better estimate of future experience than either one-month or six-month or longer rates. In the opinion of management, a one-month rate does not capture enough experience to predict future prepayment behavior and may create undue volatility in interest income due to one-time fluctuations in prepayment activity. Conversely, in the opinion of management, a six-month or longer rate would not capture enough volatility to predict future prepayment behavior.
If a difference arises between our estimated prepayments and our actual prepayments received, the constant effective yield is recalculated based on our actual payments to date and anticipated future payments. This monthly recalculation results in the carrying value of the security being adjusted to the amount that would have existed had the new effective yield been applied since the purchase date, and a corresponding charge or credit is recognized to interest income.
For securities that do not represent holdings of large numbers of similar loans for which prepayments are probable and the timing and amount of prepayments can be reasonably estimated, the associated
premiums and discounts are amortized or accreted over their contractual term using the constant effective yield. Actual prepayment experience for such securities is reviewed monthly and a proportionate amount of premium or discount is recognized in income at that time such that the effective yield on the remaining portion of the securities continues unchanged.
As of and for the years ended December 31, 2006, 2005, and 2004, we anticipated prepayments on our residential mortgage-backed securities. All other securities do not meet the SFAS 91 criteria for anticipating prepayments. Accordingly, no prepayments were anticipated for these securities.
In addition to investing in both variable and fixed-rate securities, we use derivative instruments to manage our exposure to interest rate risks. See the "Market Risk"‘Market Risk’ section for more detailed information.
Operating Expenses
Total operating expenses were $398.4$579.4 million in 2004,2006, up 16%26% from 2003.2005. The growthincrease in our cost structuretotal operating expenses was largely driven by the new business that we won during 2004, which required usprimarily due to invest
in headcountincreased compensation and technology. It is expected that only incremental expense associated with new business will be added during 2005.benefits, technology and telecommunications, transaction processing services, occupancy and other operating expenses, as detailed below. The components of operating expenses were as follows (Dollars in thousands):
| | For the Year Ended December 31,
| | | For the Year Ended December 31, | |
|---|
| | 2004
| | 2003
| | Change
| | | 2006 | | 2005 | | Change | |
|---|
| Compensation and benefits | | $ | 205,728 | | $ | 186,932 | | 10 | % | | $ | 327,342 | | $ | 250,459 | | | 31 | % | |
| Technology and telecommunications | | 49,816 | | 38,914 | | 28 | % | | 73,909 | | 54,732 | | | 35 | % | |
| Transaction processing services | | 42,159 | | 33,299 | | 27 | % | | 61,396 | | 49,873 | | | 23 | % | |
Occupancy | | | 33,653 | | 26,490 | | | 27 | % | |
| Depreciation and amortization | | 32,124 | | 27,971 | | 15 | % | | 32,819 | | 31,578 | | | 4 | % | |
| Occupancy | | 29,032 | | 29,218 | | (1 | )% | |
| Professional fees | | 15,346 | | 11,189 | | 37 | % | | 13,845 | | 13,380 | | | 3 | % | |
| Travel and sales promotion | | 5,470 | | 4,822 | | 13 | % | | 8,883 | | 6,825 | | | 30 | % | |
| Insurance | | 4,625 | | 3,203 | | 44 | % | | 3,929 | | 4,219 | | | (7 | )% | |
Loss and loss adjustment expenses | | | 30 | | 5,837 | | | * | | |
| Other operating expenses | | 14,083 | | 9,373 | | 50 | % | | 23,548 | | 16,716 | | | 41 | % | |
| | |
| |
| | | | |
| Total operating expenses | | $ | 398,383 | | $ | 344,921 | | 16 | % | | $ | 579,354 | | $ | 460,109 | | | 26 | % | |
| | |
| |
| | | | |
*Percentage is not considered meaningful.
Compensation and benefits increased $18.8 million, or 10%,31% from 2003. Salaries increased2005 due to higher headcount in our North American and annual merit raises by approximately $4.9 millionEuropean offices. Annual salary increases, bonus accruals and $3.0 million, respectively, from 2003options expense also contributed to 2004. In addition, incentive payments that are directly tied to our earnings per share outperformance increased approximately $8.6 million from 2003 to 2004. These increases were partially offset by employee costs that shifted to technology and telecommunications expense as part of our outsourcing arrangement with IBM that was entered intothe growth in the summer of 2004.compensation and benefits expense. Further increases in compensation expense in 20052007 will be primarily dependant upon hiring needs driven by sales to new business wins,and existing clients, the full year impact of staff additions made in 2006, annual meritsalary increases and stock option expenses.share-based compensation.
Technology and telecommunications expense increased $10.9 million, or 28%,35% from 20032005 as a result of increased infrastructure investments in 2004. As mentioned2006. The increase is primarily due to our investment in theItem I. Business section,enhancing our global integrated technology platform, which we entered into an agreement with IBMview as a significant competitive advantage and growth in the summer of 2004 to outsource certain technical infrastructure services. Service expense under this agreement was $9.5 million during 2004, which included initial start-up costs. The costs of these services are offset by decreases in other technology and telecommunications expenses, as the services were previously performed internally or by other service providers. Future technology and telecommunications expense will be dependent upon the amount of new business we win, client integrations and ongoing improvement to our infrastructure.customer volumes. Generally, we expect technology investmentreinvestment to equal approximately 18-20% of net operating revenue.revenue each year, including related compensation costs.
Transaction processing services expense increased 27%23% from 2003 as a result of2005 due to increases in transaction volumes, higher global assetmarket values and transactions with our subcustodians.new business. Future transaction processing servicing expense will be dependent on asset levels and the volume of client transaction activity.
Depreciation and amortizationOccupancy expense increased 15%27% from 2003. This2005 and is also expected to increase resulted frominto the completionmiddle of capitalized software projects in late 2003 and early 2004 and their placement into service. This increase was partially offset by fully depreciated equipment from our 2001 assumption2007, due to the addition of BGI's North American asset administration unit. We will continuenew office space worldwide needed to invest in, and place into service, technology projects in 2005.accommodate growth.
34
Professional fees expense increased 37%3% from 2003,2005, primarily due to increased fees associated with the Merrimac Master Portfolio. The Merrimac fees are asset based and have grown along with the assets of the portfolios. Also in 2004, we incurred additional technicalhigher consulting fees as we hired external consultants to work on certain technology initiatives.for technology. Future professional fees are dependent upon changes in the value of the Merrimac portfolios and upon other business needs for outside professional services.
Travel and sales promotion expense increased 13%30% from 2003.2005. Travel and sales promotion expense consists of expenses incurred by theour sales force, client management staff and other employees in connection with sales calls withon potential clients, andas well as traveling to:to existing client sites our offices in New York and California and our foreign subsidiaries. Alloffices. The increases resulted from a higher level of these activities may increasesales calls on potential clients, a higher level of travel to client sites and foreign offices and attendance at industry conferences. Travel and sales promotion expense in 2005,2007 will be dependent upon new business leads and other client and business needs.
Insurance expense was up 44%The decrease in loss and loss adjustment expenses from 2003. In May 2003, our five-year fixed-rate insurance policy expired, resulting in increased premiums. Our insurance policies are renewed annually and we expect insurance expense in 2005 to continue at approximately2006 is primarily due to a processing error that occurred during the same level as in 2004.fourth quarter of 2005.
Other operating expense increased 50%41% from 2003. The primary contributors to the increase include higher regulatory assessments2005 primarily due to higher deposit liabilities,recruitment costs, higher recruiting expense due to increasedtemporary staffing needs, increased advertising expenseexpenses and increased miscellaneous office expense due to the overall growthour settlement of our business. We expect other operating expense to increase in 2005 due to new business wins.pending litigation.
Income Taxes
Income Taxes
Income taxes were $72.8$70.5 million for the year ended December 31, 2004, up 38%2006, down 7% from the same period in 2003.2005. This decrease in income taxes is attributableprimarily related to a 48% increasedecrease in pretax earnings, as well as a 1% decrease in the 2006 effective tax rate resulting from a change in the recognition threshold of a tax position. The decrease in income taxes and the effective tax rate was partially offset by the decrease in one-time tax benefits. During the second quarter of 2005, we adopted the indefinite reversal provisions of Accounting Principles Board Opinion No. 23, Accounting for Income Taxes—Special Areas (‘APB 23’), which specifies that U.S. income taxes should not be recorded on the year ended December 31, 2004undistributed earnings of a foreign subsidiary if those undistributed earnings have been or will be invested indefinitely in that subsidiary. We determined that the undistributed earnings of our Irish subsidiaries will be permanently invested in our Irish operations to support continued growth. During the second quarter of 2006, we reversed previously accrued taxes resulting from a tax position that no longer met the same period in 2003.probable recognition threshold under Statement of Financial Accounting Standards No. 5, Accounting for Contingencies (‘SFAS 5’).
In 2005,2007, we expect that our effective tax rate will approximate 34.5% to 35.5%33.5% of pretax income.
Comparison of Operating Results for the Years Ended December 31, 20032005 and 2002.2004.
Net income for the year ended December 31, 20032005 was $92.4$159.8 million, up 37%13% from $67.4$142.0 million for the same period in 2002. This increase was the result of2004. The principal factors contributing to our net income growth were growth in net interest income caused by a decline in our costasset servicing fees of funds due to lower interest rates. The increase was also due to growth in fees and other revenue caused by increased net assets processed related to sales to new and existing clients, fund flows, market appreciation during 2003,20% and increased client transaction activity.gain on sale of investments. Net income growth was partially offset by a 1%15% increase in operating expenses (largely due to new business wins, additional headcount and by the additional tax expense incurred astechnology requirements) and a result of our settlement of a tax assessment by the Commonwealth of Massachusetts.9% decrease in net interest income.
Fees and Other Revenue
The components of fees and other revenue are as follows (Dollars in thousands):
| | | For the Year Ended | |
|
| | For the Year Ended December 31,
| | | December 31, | |
|---|
|
| | 2003
| | 2002
| | Change
| | | 2005 | | 2004 | | Change | |
|---|
| Total asset servicing fees | Total asset servicing fees | | $ | 333,586 | | $ | 296,395 | | 13 | % | | $ | 509,059 | | $ | 423,200 | | | 20 | % | |
Gain on sale of investments | | | 12,397 | | 234 | | | * | | |
| Other operating income | Other operating income | | 2,607 | | 2,449 | | 6 | % | | 4,081 | | 2,057 | | | 98 | % | |
| | |
| |
| | | | |
| | Total fees and other revenue | | $ | 336,193 | | $ | 298,844 | | 12 | % | |
| | |
| |
| | | | |
Total fees and other revenue | | | $ | 525,537 | | $ | 425,491 | | | 24 | % | |
*Percentage is not considered meaningful.
The largest components of asset servicing fees are custody, multicurrency accounting and fund administration, which increased 10%20% to $254.2 million. These fees are based$375.6 million for the year ended December 31, 2005 from $314.3 million for the same period in part on the total dollar value of financial assets on the reported date for which we provide one or more of the following services: middle office outsourcing, global custody, multicurrency accounting, fund administration, securities lending, foreign exchange, cash management, performance measurement, institutional transfer agency, investment2004.
advisory services, lines of credit and brokerage and transition management services. The change in net assets processed includes the following components (Dollars in billions):
| | | For the Year Ended | |
|
| | For the Year Ended
December 31, 2003
| | | December 31, 2005 | |
|---|
| Net assets processed, beginning of period | Net assets processed, beginning of period | | $ | 785 | | | | $ | 1,430 | | |
| | |
| | |
| Change in net assets processed: | Change in net assets processed: | | | | | | | | |
| | Sales to new clients | | 1 | | |
| | Lost clients | | (3 | ) | |
| | Further penetration of existing clients | | 39 | | |
| | Fund flows and market gain | | 235 | | |
| | |
| | |
| | | Total change in net assets processed | | 272 | | |
| | |
| | |
Sales to new clients | | | | 159 | | |
Further penetration of existing clients | | | | 42 | | |
Lost clients | | | | (11 | ) | |
Fund flows and market gain | | | | 173 | | |
Total change in net assets processed | | | | 363 | | |
| Net assets processed, end of period | Net assets processed, end of period | | $ | 1,057 | | | | $ | 1,793 | | |
| | |
| | |
The majority of the increase in assets processed was due to wins fromsales to new and existing clients, the ability of our clients to develop and sell product, which generates fund flows that have a direct, positive impact on our business, and slightly higher asset values compared to 2002. As indicateda year ago.
· Foreign exchange fees were $62.1 million for the year ended December 31, 2005, up 14% from the same period in our overview, our core services fees are generated by charging a fee based upon the value of assets processed. As market values or clients' asset levels fluctuate, so will our revenue. Our tiered pricing structure, coupled with minimum and flat fees, allow us to manage this volatility to a certain extent. As asset values increase, the basis point fee typically lowers. When asset values decrease, revenue is only impacted by the asset decline at the then marginal rate.
Transaction-driven income includes our ancillary services, such as foreign exchange, cash management and securities lending.2004. The 49% increase in foreign exchange fees from 2002 is attributable to further penetrationnew business, increased volume of existing clients, the addition of new clients, higher transaction volumesclient activity and volatility within the currencies traded by our clients. The 23% increase in cashcurrency markets.
· Cash management fees were $37.6 million for the year ended December 31, 2005, up 42% from 2002the same period in 2004. The increase is primarily due to increased client balances.higher balances placed by our clients in the cash management products we offer.
· Securities lending fees were down 21%$22.5 million for the year ended December 31, 2005, up 117% from 2002the same period in 2004, primarily due to narrower spreads.new business, higher volumes and improved market conditions.
· Investment advisory fees were $8.4 million for the year ended December 31, 2005, down 44% from the same period in 2004. The decrease in investment advisory fees is attributable to lower asset values in our proprietary Merrimac money market funds combined with advisory fee waivers on certain of the funds.
· Other service fees for the year ended December 31, 2005 were $2.8 million, up 5% from the same period in 2004. The increase in 2005 was due to an increase in compliance and brokerage services.
· Other operating income for the year ended December 31, 2005 was $4.1 million, up 98% from the same period in 2004. The increase is primarily due to an increase in the dividend rate on our holding of FHLBB stock.
Net Interest Income
The following table presents the components of net interest income (Dollars in thousands):
| | For the Year Ended December 31,
| | | For the Year Ended December 31, | |
|---|
| | 2003
| | 2002
| | Change
| | | 2005 | | 2004 | | Change | |
|---|
| Interest income | | $ | 247,094 | | $ | 245,526 | | 1 | % | | $ | 447,705 | | $ | 313,149 | | | 43 | % | |
| Interest expense | | 93,180 | | 106,801 | | (13 | )% | | 277,280 | | 125,469 | | | 121 | % | |
| | |
| |
| | | | |
| Total net interest income | | $ | 153,914 | | $ | 138,725 | | 11 | % | | $ | 170,425 | | $ | 187,680 | | | (9 | )% | |
| | |
| |
| | | | |
The improvementdecrease in our net interest income was primarily driven by declining rates on our liabilities. Although the average funding balance increased $1.7 billionlower interest rate spreads, which was partially offset by growth in 2003, the average rates paid on interest-bearing liabilities declined more rapidly than the volume increase. Also during 2003, we experienced higher volumes of prepayments from our investment portfolio. The cash flows from these prepaymentsAverage investment security balances were reinvestedup approximately $1.5 billion for the year ended December 31, 2005 compared to the same period in lower yielding interest-earning assets.2004.
The table below presents the changes in net interest income resulting from changes in the volume of interest-earning assets or interest-bearing liabilities and changes in interest rates for the year ended December 31, 20032005 compared to the year ended December 31, 2002.2004. Changes attributed to both
volume and rate have been allocated based on the proportion of change in each category (Dollars in thousands):
| | | For the Year Ended | |
| | | December 31, 2005 vs. December 31, 2004 | |
| | For the Year Ended
December 31, 2003 vs. December 31, 2002
| | | Change Due | | Change Due | | | |
|---|
| | Change Due
to Volume
| | Change Due
to Rate
| | Net
| | | to Volume | | to Rate | | Net | |
|---|
| Interest-earning assets | | | | | | | | | | | | | | | | | | | | |
| Fed funds sold and securities purchased under resale agreements | | $ | (202 | ) | $ | (212 | ) | $ | (414 | ) | |
Federal funds sold and short-term investments | | | | $ | 226 | | | | $ | 1,357 | | | $ | 1,583 | |
| Investment securities | | 66,265 | | | (64,086 | ) | | 2,179 | | | | 53,222 | | | | 75,076 | | | 128,298 | |
| Loans | | 522 | | | (719 | ) | | (197 | ) | | | 2,281 | | | | 2,394 | | | 4,675 | |
| | |
| |
| |
| | |
| Total interest-earning assets | | $ | 66,585 | | $ | (65,017 | ) | $ | 1,568 | | | | 55,729 | | | | 78,827 | | | 134,556 | |
| | |
| |
| |
| | |
Interest-bearing liabilities |
|
|
|
|
|
|
|
|
| | | | | | | | | | | |
| Deposits | | $ | 13,005 | | $ | (15,443 | ) | $ | (2,438 | ) | | | (6,879 | ) | | | 33,864 | | | 26,985 | |
| Borrowings | | 14,075 | | | (25,258 | ) | | (11,183 | ) | | | 38,994 | | | | 85,832 | | | 124,826 | |
| | |
| |
| |
| | |
| Total interest-bearing liabilities | | $ | 27,080 | | $ | (40,701 | ) | $ | (13,621 | ) | | | 32,115 | | | | 119,696 | | | 151,811 | |
| | |
| |
| |
| | |
| Change in net interest income | | $ | 39,505 | | $ | (24,316 | ) | $ | 15,189 | | | | $ | 23,614 | | | | $ | (40,869 | ) | | $ | (17,255 | ) |
| | |
| |
| |
| | |
Operating Expenses
Total operating expenses were $460.1 million in 2005, up 15% from 2004. The components of operating expenses were as follows (Dollars in thousands):
| | For the Year Ended December 31,
| | | For the Year Ended December 31, | |
|---|
| | 2003
| | 2002
| | Change
| | | 2005 | | 2004 | | Change | |
|---|
| Compensation and benefits | | $ | 186,932 | | $ | 192,785 | | (3 | )% | | $ | 250,459 | | $ | 205,728 | | | 22 | % | |
| Technology and telecommunications | | 38,914 | | | 42,190 | | (8 | )% | | 54,732 | | 49,816 | | | 10 | % | |
| Transaction processing services | | 33,299 | | | 33,713 | | (1 | )% | | 49,873 | | 42,159 | | | 18 | % | |
Depreciation and amortization | | | 31,578 | | 32,124 | | | (2 | )% | |
| Occupancy | | 29,218 | | | 25,602 | | 14 | % | | 26,490 | | 29,032 | | | (9 | )% | |
| Depreciation and amortization | | 27,971 | | | 16,357 | | 71 | % | |
| Professional fees | | 11,189 | | | 11,829 | | (5 | )% | | 13,380 | | 15,346 | | | (13 | )% | |
| Travel and sales promotion | | 4,822 | | | 5,819 | | (17 | )% | | 6,825 | | 5,470 | | | 25 | % | |
Loss and loss adjustment expenses | | | 5,837 | | 924 | | | * | | |
Insurance | | | 4,219 | | 4,625 | | | (9 | )% | |
| Other operating expenses | | 12,576 | | | 13,100 | | (4 | )% | | 16,716 | | 13,159 | | | 27 | % | |
| | |
| |
| | | | |
| Total operating expenses | | $ | 344,921 | | $ | 341,395 | | 1 | % | | $ | 460,109 | | $ | 398,383 | | | 15 | % | |
| | |
| |
| | | | |
Total operating expenses were $344.9 million in 2003, up 1% from 2002. The marginal increase in operating expenses, despite strong revenue growth, was due to our prudent expense management and our ability to benefit from technology efficiencies.*Percentage is not considered meaningful.
Compensation and benefits expense decreased 3%increased 22% from 20022004 due to a reduction in our average number of employees during 2003higher headcount and annual salary increases.
Technology and telecommunications expense increased 10% from 2004 as a result of efficiencies gained through technology enhancements.increased infrastructure investments in 2005. The increase is also due to our outsourcing agreement with IBM, which we entered into in July of 2004. A portion of the increase is offset by lower compensation costs due to
Technology and telecommunications expense decreased 8% from 2002. Significantemployees transferring to IBM. Also, increases in our processing volumes drove higher technology and telecommunications expense was incurred in 2002 related to the integration of the BGI U.S. asset administration unit into our technology infrastructure which was completed in January 2003.expense.
Transaction processing services expense decreased 1%increased 18% from 2002. During 2002, we were in the process of converting the assets of the assumed BGI U.S. asset administration unit to our subcustodian network which resulted in significant transaction processing expenses during the conversion period. This conversion was completed during 2002. Absent the expenses associated with the conversion, transaction processing fees increased on an overall basis due to increased volumes of client activity.
Occupancy expense increased 14% from 2002. This increase was primarily due to increased space in our Boston and Dublin offices to accommodate growth resulting from new client business.
Depreciation and amortization expense increased 71% from 20022004 as a result of higher global asset values and transactions with our subcustodians.
Professional fees expense decreased 13% from 2004, primarily due to lower subadvisory expense associated with our Merrimac money market funds, resulting from lower average fund balances.
Travel and sales promotion expense increased 25% from 2004. The increase resulted from a higher level of travel to client sites, a higher level of sales calls to potential clients, attendance at industry conferences, and travel related to the completionestablishment of capitalized software projectsour new European offices.
The increase in late 2002loss and 2003 and their placement into service along with additional leasehold improvementsloss adjustment expenses from 2004 to 2005 is due to a processing error identified during the fourth quarter of 2005.
Other operating expense increased 27% from 2004 primarily as a result of the new space we occupied in Bostonhigher recruiting and Dublin.staffing expense.
Income Taxes
Income taxes were $52.8$76.0 million for the year ended December 31, 2003,2005, up 84%4% from the same period in 2002.2004. The factors that contributedincrease in income taxes and the effective tax rate (excluding the effect of APB 23) is primarily attributable to increased pretax earnings as well as a decrease in the percentage of tax-exempt income to pretax income. The increase in income taxes was partially offset by the reversal of a deferred income tax liability related to the significant increase in 2003 included a settlementundistributed earnings of our tax assessment withIrish subsidiaries. During the Commonwealthsecond quarter of Massachusetts Department2005, we recognized the indefinite reversal provision of Revenue and increased pretax earnings.APB 23, which specifies that U.S. income taxes should not be recorded on the undistributed earnings of a foreign subsidiary if those undistributed earnings have been or will be invested indefinitely in that subsidiary. We have determined that the undistributed earnings of our Irish subsidiaries will be permanently invested in our Irish operations to support continued growth.
38
The following tables present average balances, interest income and expense, and yields earned or paid on the major categories of assets and liabilities for the periods indicated (Dollars in thousands):
| | Year Ended December 31, 2006 | | Year Ended December 31, 2005 | | Year Ended December 31, 2004 | |
| | Average
Balance | | Interest | | Average
Yield/Cost | | Average
Balance | | Interest | | Average
Yield/Cost | | Average
Balance | | Interest | | Average
Yield/Cost | |
Interest-earning assets | | | | | | | | | | | | | | | | | | | | | | | | | |
Federal funds sold, interest- bearing deposits with other banks and other short-term investments | | $ | 181,272 | | $ | 9,141 | | | 5.04 | % | | $ | 66,926 | | $ | 2,250 | | | 3.36 | % | | $ | 52,544 | | $ | 667 | | | 1.27 | % | |
Investment securities:(1) | | | | | | | | | | | | | | | | | | | | | | | | | |
Mortgage-backed securities | | 8,154,233 | | 403,717 | | | 4.95 | | | 8,034,870 | | 315,845 | | | 3.93 | | | 6,677,678 | | 221,248 | | | 3.31 | | |
Federal agency
securities | | 1,976,985 | | 91,861 | | | 4.65 | | | 2,333,005 | | 89,864 | | | 3.85 | | | 2,084,988 | | 53,977 | | | 2.59 | | |
State and political subdivisions | | 467,649 | | 20,071 | | | 4.29 | | | 465,451 | | 21,217 | | | 4.56 | | | 490,621 | | 22,300 | | | 4.55 | | |
Other securities | | 204,551 | | 11,927 | | | 5.83 | | | 230,832 | | 9,267 | | | 4.01 | | | 299,529 | | 10,370 | | | 3.46 | | |
Total investment securities | | 10,803,418 | | 527,576 | | | 4.88 | | | 11,064,158 | | 436,193 | | | 3.94 | | | 9,552,816 | | 307,895 | | | 3.22 | | |
Loans(2) | | 303,645 | | 21,032 | | | 6.93 | | | 233,572 | | 9,262 | | | 3.97 | | | 165,564 | | 4,587 | | | 2.77 | | |
Total interest-earning
assets | | 11,288,335 | | 557,749 | | | 4.94 | | | 11,364,656 | | 447,705 | | | 3.94 | | | 9,770,924 | | 313,149 | | | 3.20 | | |
Allowance for loan losses | | (100 | ) | | | | | | | (100 | ) | | | | | | | (100 | ) | | | | | | |
Noninterest-earning assets | | 641,578 | | | | | | | | 669,142 | | | | | | | | 505,655 | | | | | | | |
Total assets | | $ | 11,929,813 | | | | | | | | $ | 12,033,698 | | | | | | | | $ | 10,276,479 | | | | | | | |
Interest-bearing liabilities | | | | | | | | | | | | | | | | | | | | | | | | | |
Deposits: | | | | | | | | | | | | | | | | | | | | | | | | | |
Demand | | $ | 96,292 | | $ | 4,227 | | | 4.39 | % | | $ | 24,470 | | $ | 866 | | | 3.54 | % | | $ | — | | $ | — | | | 0.00 | % | |
Savings | | 4,576,730 | | 168,247 | | | 3.68 | | | 3,428,223 | | 74,391 | | | 2.17 | | | 3,947,865 | | 49,622 | | | 1.26 | | |
Time | | 152,708 | | 7,853 | | | 5.14 | | | 80,729 | | 2,449 | | | 3.03 | | | 68,594 | | 1,099 | | | 1.60 | | |
Securities sold under repurchase
agreements(3) | | 4,490,240 | | 164,970 | | | 3.67 | | | 5,244,614 | | 142,681 | | | 2.72 | | | 4,162,132 | | 54,376 | | | 1.31 | | |
Junior subordinated debentures | | 24,774 | | 2,420 | | | 9.77 | | | 24,774 | | 2,420 | | | 9.77 | | | 24,774 | | 2,420 | | | 9.77 | | |
Other borrowings(4) | | 913,340 | | 45,838 | | | 5.02 | | | 1,643,948 | | 54,473 | | | 3.31 | | | 841,708 | | 17,952 | | | 2.13 | | |
Total interest-bearing liabilities | | 10,254,084 | | 393,555 | | | 3.84 | | | 10,446,758 | | 277,280 | | | 2.65 | | | 9,045,073 | | 125,469 | | | 1.39 | | |
Noninterest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | |
Demand deposits | | 323,228 | | | | | | | | 305,289 | | | | | | | | 252,246 | | | | | | | |
Savings | | 74,008 | | | | | | | | 61,745 | | | | | | | | 72,536 | | | | | | | |
Time deposits | | 230,890 | | | | | | | | 198,849 | | | | | | | | 154,617 | | | | | | | |
Other liabilities | | 181,089 | | | | | | | | 262,505 | | | | | | | | 126,043 | | | | | | | |
Total liabilities | | 11,063,299 | | | | | | | | 11,275,146 | | | | | | | | 9,650,515 | | | | | | | |
Equity | | 866,514 | | | | | | | | 758,552 | | | | | | | | 625,964 | | | | | | | |
Total liabilities and equity | | $ | 11,929,813 | | | | | | | | $ | 12,033,698 | | | | | | | | $ | 10,276,479 | | | | | | | |
Net interest income | | | | $ | 164,194 | | | | | | | | $ | 170,425 | | | | | | | | $ | 187,680 | | | | | |
Net interest margin(5) | | | | | | | 1.45 | % | | | | | | | 1.50 | % | | | | | | | 1.92 | % | |
Average interest rate spread(6) | | | | | | | 1.10 | % | | | | | | | 1.29 | % | | | | | | | 1.81 | % | |
Ratio of interest-earning assets to interest-bearing liabilities | | | | | | | 110.09 | % | | | | | | | 108.79 | % | | | | | | | 108.02 | % | |
(1)
| | Year Ended December 31, 2004
| | Year Ended December 31, 2003
| | Year Ended December 31, 2002
| |
|---|
| | Average
Balance
| | Interest
| | Average
Yield/Cost
| | Average
Balance
| | Interest
| | Average
Yield/Cost
| | Average
Balance
| | Interest
| | Average
Yield/Cost
| |
|---|
| Interest-earning assets | | | | | | | | | | | | | | | | | | | | | | | | | |
| Fed Funds sold and securities purchased under resale agreements | | $ | 52,544 | | $ | 667 | | 1.27 | % | $ | 30,236 | | $ | 326 | | 1.08 | % | $ | 45,042 | | $ | 740 | | 1.64 | % |
| Investment securities(1) | | | 9,552,816 | | | 307,895 | | 3.22 | | | 7,398,373 | | | 243,191 | | 3.29 | | | 5,614,160 | | | 241,012 | | 4.29 | |
| Loans(2) | | | 165,564 | | | 4,587 | | 2.77 | | | 127,452 | | | 3,577 | | 2.81 | | | 110,769 | | | 3,774 | | 3.41 | |
| | |
| |
| | | |
| |
| | | |
| |
| | | |
| Total interest-earning assets | | | 9,770,924 | | | 313,149 | | 3.20 | | | 7,556,061 | | | 247,094 | | 3.27 | | | 5,769,971 | | | 245,526 | | 4.26 | |
| | | | | |
| | | | | | |
| | | | | | |
| | | |
| Allowance for loan losses | | | (100 | ) | | | | | | | (100 | ) | | | | | | | (100 | ) | | | | | |
| Noninterest-earning assets(4) | | | 535,191 | | | | | | | | 584,024 | | | | | | | | 403,316 | | | | | | |
| | |
| | | | | | |
| | | | | | |
| | | | | | |
| Total assets | | $ | 10,306,015 | | | | | | | $ | 8,139,985 | | | | | | | $ | 6,173,187 | | | | | | |
| | |
| | | | | | |
| | | | | | |
| | | | | | |
| Interest-bearing liabilities | | | | | | | | | | | | | | | | | | | | | | | | | |
| Deposits: | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Demand | | $ | — | | $ | — | | 0.00 | % | $ | — | | $ | — | | 0.00 | % | $ | 823 | | $ | 4 | | 0.49 | % |
| | Savings | | | 3,947,865 | | | 49,622 | | 1.26 | | | 2,667,034 | | | 39,809 | | 1.49 | | | 1,945,550 | | | 42,229 | | 2.17 | |
| | Time | | | 68,594 | | | 1,099 | | 1.60 | | | 1,356 | | | 10 | | 0.74 | | | 1,393 | | | 24 | | 1.72 | |
| Securities sold under repurchase agreements(3) | | | 4,162,132 | | | 54,376 | | 1.31 | | | 3,278,555 | | | 29,371 | | 0.90 | | | 2,449,368 | | | 31,166 | | 1.27 | |
| Junior subordinated debentures(4)/trust preferred securities | | | 24,774 | | | 2,420 | | 9.77 | | | 24,194 | | | 2,364 | | 9.77 | | | 24,667 | | | 2,432 | | 9.86 | |
| Other borrowings(5) | | | 841,708 | | | 17,952 | | 2.13 | | | 1,008,036 | | | 21,626 | | 2.15 | | | 845,246 | | | 30,946 | | 3.66 | |
| | |
| |
| | | |
| |
| | | |
| |
| | | |
| Total interest-bearing liabilities | | | 9,045,073 | | | 125,469 | | 1.39 | | | 6,979,175 | | | 93,180 | | 1.34 | | | 5,267,047 | | | 106,801 | | 2.03 | |
| | |
| |
| | | |
| |
| | | |
| |
| | | |
| Noninterest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Demand deposits | | | 252,246 | | | | | | | | 241,594 | | | | | | | | 180,065 | | | | | | |
| | Savings | | | 72,536 | | | | | | | | 130,747 | | | | | | | | 124,416 | | | | | | |
| | Noninterest-bearing time deposits | | | 154,617 | | | | | | | | 112,575 | | | | | | | | 90,000 | | | | | | |
| | Other liabilities | | | 155,579 | | | | | | | | 191,971 | | | | | | | | 116,558 | | | | | | |
| | |
| | | | | | |
| | | | | | |
| | | | | | |
| Total liabilities | | | 9,680,051 | | | | | | | | 7,656,062 | | | | | | | | 5,778,086 | | | | | | |
| Equity | | | 625,964 | | | | | | | | 483,923 | | | | | | | | 395,101 | | | | | | |
| | |
| | | | | | |
| | | | | | |
| | | | | | |
| Total liabilities and equity | | $ | 10,306,015 | | | | | | | $ | 8,139,985 | | | | | | | $ | 6,173,187 | | | | | | |
| | |
| | | | | | |
| | | | | | |
| | | | | | |
| Net interest income | | | | | $ | 187,680 | | | | | | | $ | 153,914 | | | | | | | $ | 138,725 | | | |
| | | | | |
| | | | | | |
| | | | | | |
| | | |
| Net interest margin(6) | | | | | | | | 1.92 | % | | | | | | | 2.04 | % | | | | | | | 2.40 | % |
| | | | | | | | |
| | | | | | | |
| | | | | | | |
| |
| Average interest rate spread(7) | | | | | | | | 1.81 | % | | | | | | | 1.93 | % | | | | | | | 2.23 | % |
| | | | | | | | |
| | | | | | | |
| | | | | | | |
| |
| Ratio of interest-earning assets to interest-bearing liabilities | | | | | | | | 108.02 | % | | | | | | | 108.27 | % | | | | | | | 109.55 | % |
| | | | | | | | |
| | | | | | | |
| | | | | | | |
| |
(1)- Average yield/cost on available for sale securities is based on amortized cost.
(2)
- Average yield/cost on demand loans includes only performing loan balances. During the years ended December 31,
2004, 20032006, 2005 and 20022004 there were no nonperformingnon-performing loan balances.
(3)
- Interest expense includes penalties of $2.9 million in 2004 for prepayment of two term repurchase agreements.
(4)
Effective October 1, 2003, the Company adopted the provisions of FIN 46 (revised December 2003), which resulted in the deconsolidation of Investors Capital Trust I, the trust that holds the trust preferred securities.
(5)- Interest expense includes contractual prepayment penalties of $3.9 million
$3.1 million and $7.6 million in 2004 2003 and 2002, respectively, for prepayment of certain FHLBB borrowings.
(6)(5)Net interest income divided by total interest-earning assets.
(7)(6)Yield on interest-earning assets less rate paid on interest-bearing liabilities.
39
Financial Condition
At December 31, 2004,2006, our total assets were $11.2$11.6 billion, up 21%down 4% from December 31, 2003.2005, primarily due to a net decrease in our investment portfolio. Average interest-earning assets increased $2.2decreased $0.1 billion, or 29%1%, for the year ended December 31, 20042006 compared to the same period last year. Funding foryear, primarily due to paydowns on our asset growth was provided by an increase in average client balances of approximately $2.1 billion offset by a decrease in average external borrowings of approximately $0.1 billion for the year ended December 31, 2004.Federal agency securities.
Investment Portfolio
OurThe income we derive from our investment portfolio is used to invest depositors' fundsgenerated primarily by investing client cash balances and is a component of our asset processing business. In addition, we use theour investment portfolio to secure open positions at securities clearing institutions in connection with our custody services. The following table summarizes our investment portfolio as of the dates indicated (Dollars in thousands):
| | December 31,
| | December 31, | |
|---|
| | 2004
| | 2003
| | 2002
| | 2006 | | 2005 | | 2004 | |
|---|
| Securities held to maturity: | | | | | | | | | | | | | |
| Mortgage-backed securities | | $ | 3,543,961 | | $ | 2,272,030 | | $ | 2,033,620 | | $ | 3,753,497 | | $ | 4,342,254 | | $ | 3,543,961 | |
| Federal agency securities | | 2,274,665 | | 1,906,554 | | 1,287,314 | | 1,680,458 | | 2,305,331 | | 2,274,665 | |
| State and political subdivisions | | 124,091 | | 127,632 | | 117,021 | | 98,375 | | 114,345 | | 124,091 | |
| | |
| |
| |
| |
| Total securities held to maturity | | $ | 5,942,717 | | $ | 4,306,216 | | $ | 3,437,955 | | $ | 5,532,330 | | $ | 6,761,930 | | $ | 5,942,717 | |
| | |
| |
| |
| |
Securities available for sale: |
|
|
|
|
|
| | | | | | | |
| Mortgage-backed securities | | $ | 3,854,900 | | $ | 3,611,980 | | $ | 2,759,793 | | $ | 4,275,051 | | $ | 3,766,101 | | $ | 3,854,900 | |
| State and political subdivisions | | 404,909 | | 355,828 | | 307,292 | | 344,304 | | 392,391 | | 404,909 | |
| Corporate debt | | 176,546 | | 175,816 | | 174,499 | | 169,850 | | 200,692 | | 176,546 | |
| US Treasury securities | | 118,688 | | 113,701 | | — | | — | | — | | 118,688 | |
| Federal agency securities | | — | | 29,609 | | 30,881 | |
| Foreign government securities | | 10,462 | | 9,703 | | — | | 10,535 | | 10,536 | | 10,462 | |
| | |
| |
| |
| |
| Total securities available for sale | | $ | 4,565,505 | | $ | 4,296,637 | | $ | 3,272,465 | | $ | 4,799,740 | | $ | 4,369,720 | | $ | 4,565,505 | |
| | |
| |
| |
| |
The overall increases$1.2 billion, or 18%, decrease in our held to maturity and available for sale portfolios are attributable to investing client deposits and borrowed funds to effectively utilize the Bank's capital and accommodate client fund flows. The $1.6 billion, or 38%, increase in our held to maturitysecurities portfolio from 2003December 31, 2005 to 2004December 31, 2006 is primarily due to investment security purchases that we expect, as we continue to grow our balance sheet, will protect our net interest margin, while maintaining an acceptable risk profile. Thepaydowns and slower reinvestment. Our investment security purchases primarily included floating-rateconsisted of floating interest rate mortgage-backed and Small Business Administration ("SBA") securities which offer an attractive yield and reprice as interest rates increase. Our held to maturity portfolio securities are purchased with anthe intent and ability to hold to maturity. The held to maturity investment portfolio isand are not viewed as our primary source of funds to satisfy liquidity needs.
The $0.3 billion, or 6%, increase in ourOur available for sale securities portfolio increased $0.4 billion, or 10% from 2003December 31, 2005 to 2004 isDecember 31, 2006. The increase was mainly due to purchases of new investment securities, offset by maturities and prepayments. Our investment security purchases included mortgage-backed securities which allow us to diversify our portfolio with assets that reprice more frequently. In addition, weand municipal securities. We believe that we are ablepurchasing these securities allows us to take advantage of attractive yieldyields and limited extension riskcash flows which aligns with our asset and liability strategy. Refer to the gap analysis under the "Market Risk"‘Market Risk’ section for additional details regarding the matching of our interest-earning assets and interest-bearing liabilities.
The average balance of our combined investment portfoliossecurities for the year ended December 31, 20042006 was $9.6$10.8 billion, with an average yield of 3.22%4.88%, compared to an average balance of $7.4$11.1 billion with an average yield of 3.29%3.94% during 2003.the same period in 2005. The decline inincreased portfolio yield is primarily due to an increasehigher rates on our variable-rate securities. Anticipating prepayments in calculating the levelconstant effective yield for mortgage-backed securities may result in more monthly earnings volatility due to the impact of changing interest rates and the resulting adjustments to the amount of amortization. We do not expect
variable-ratechanges to the amount of amortization resulting from anticipating prepayments to have a material effect on our future reported financial results or financial condition.
Prepayment cash flow levels on our Federal agency securities increased in our investment portfolio during 20042006, which we believe was attributable to the expiration of borrower prepayment penalties, increased refinancing and prepaymentsloan payoff activity. Mortgaged-backed security prepayment cash flow levels decreased for most of higher yielding fixed-rate securities. During the second half of 2004 interest rates began2006, primarily attributable to increase, resulting in lower prepayments. For the years ended December 31, 2004 and 2003, we recognized net amortization of $40.7 million and $39.2 million, respectively. If interest rates rise during 2005, we would expect slower prepayments and our overall yield to increase as our variable-rate securities reprice. Conversely, if interest rates were to decline in 2005, we would expect that prepayments would accelerate, with the cash flows from these prepayments being reinvested in lower-yielding assets of equal quality and risk.decreased refinancing opportunities.
We invest in mortgage-backed securities and Federal agency securities to increase the total because they provide a risk/return of theprofile consistent with our investment portfolio.objectives. Mortgage-backed securities and Federal agency securities generally have a higher yield than U.S. Treasury securities due to credit and prepayment risk. Credit risk results from the possibility that a loss may occur if a counterparty, such as the Federal agency issuing the securities, is unable to meet the terms of the contract. Credit risk related to mortgage-backed securities and Federal agency securities is substantially reduced by payment guarantees and credit enhancements. Prepayment risk results from the possibility that changes in interest rates may cause mortgage-backedand other economic factors will result in investment securities paying off earlier than the scheduled maturity date. Refer to be paid off prior to their maturity dates. Federal agency bonds generally have a higher yield than U.S. Treasury securities due to creditthe ‘Market Risk’ section for additional details regarding our net interest income simulation model, which includes the impact of changes in interest rates, and therefore prepayment risk. Credit risk, results from the possibility that the Federal agency issuing the securities may be unable to meet the terms of the security. Credit risk related to mortgage-backed securities and Federal agency bonds is substantially reduced by payment guarantees and credit enhancements.on our net interest income.
We invest in AAA rated, insured municipal securities to generate stable, tax advantaged income. Municipal securities generally have lower stated yields than Federal agency and U.S. Treasury securities, but their after-tax yields are comparable. Municipal securities are subject to call risk. However, all municipal securities that we invest in are insured and AAA rated. Call risk is similar to prepayment risk and results from the possibility that fluctuating interest rates and other factors may result in the exercise of the call option by the issuing municipality prior to the maturity date of the bond.security.
The carrying value, weighted-average yield, and contractual maturity of our securities held to maturity at December 31, 20042006 are reflected in the following table (Dollars in thousands):
| | Years
| | | Years to maturity | |
|---|
| | Under 1
| | 1 to 5
| | 5 to 10
| | Over 10
| | | Under 1 | | 1 to 5 | | 5 to 10 | | Over 10 | |
|---|
| | Amount
| | Yield
| | Amount
| | Yield
| | Amount
| | Yield
| | Amount
| | Yield
| | | Amount | | Yield | | Amount | | Yield | | Amount | | Yield | | Amount | | Yield | |
|---|
| Mortgage-backed securities | | $ | — | | — | | $ | 27,463 | | 4.49 | % | $ | 12,591 | | 4.78 | % | $ | 3,503,907 | | 3.27 | % | | | $ | 341 | | | | 5.67 | % | | | $ | 2,846 | | | | 5.69 | % | | $ | 5,108 | | | 6.68 | % | | $ | 3,745,202 | | | 5.61 | % | |
| Federal agency securities | | | — | | — | | 2,407 | | 2.32 | | 106,572 | | 3.04 | | 2,165,686 | | 3.17 | | | | — | | | | — | | | | 2,520 | | | | 6.67 | | | 339,928 | | | 5.99 | | | 1,338,010 | | | 4.47 | | |
| State and political subdivisions | | | — | | — | | 5,804 | | 5.90 | | 13,408 | | 4.73 | | 104,879 | | 5.11 | | | | — | | | | — | | | | 8,297 | | | | 4.85 | | | 10,764 | | | 5.19 | | | 79,314 | | | 4.97 | | |
| | |
| |
| |
| |
| |
| |
| |
| |
| | |
| Total securities held to maturity | | $ | — | | — | | $ | 35,674 | | 4.57 | % | $ | 132,571 | | 3.37 | % | $ | 5,774,472 | | 3.26 | % | | | $ | 341 | | | | 5.67 | % | | | $ | 13,663 | | | | 5.36 | % | | $ | 355,800 | | | 5.98 | % | | $ | 5,162,526 | | | 5.31 | % | |
| | |
| |
| |
| |
| |
| |
| |
| |
| | |
The carrying value, weighted-average yield, and contractual maturity of our securities available for sale at December 31, 20042006 are reflected in the following table (Dollars in thousands):
| | Years
| | | Years to maturity | |
|---|
| | Under 1
| | 1 to 5
| | 5 to 10
| | Over 10
| | | Under 1 | | 1 to 5 | | 5 to 10 | | Over 10 | |
|---|
| | Amount
| | Yield
| | Amount
| | Yield
| | Amount
| | Yield
| | Amount
| | Yield
| | | Amount | | Yield | | Amount | | Yield | | Amount | | Yield | | Amount | | Yield | |
|---|
| Mortgage-backed securities | | $ | — | | 0.00 | % | $ | 50,591 | | 3.25 | % | $ | 654 | | 3.88 | % | $ | 3,803,655 | | 3.95 | % | | | $ | — | | | | 0.00 | % | | | $ | 24,676 | | | | 5.60 | % | | $ | 135,013 | | | 5.40 | % | | $ | 4,115,362 | | | 5.01 | % | |
| State and political subdivisions | | | 6,625 | | 4.28 | | 138,631 | | 4.71 | | 237,448 | | 4.32 | | 22,205 | | 5.12 | | | | 968 | | | | 5.00 | | | | 3,358 | | | | 4.78 | | | 96,048 | | | 3.94 | | | 243,930 | | | 4.06 | | |
| Corporate debt | | | — | | — | | — | | — | | — | | — | | 176,546 | | 3.11 | | | | — | | | | — | | | | — | | | | — | | | — | | | — | | | 169,850 | | | 6.08 | | |
| US Treasury securities | | | — | | — | | 65,232 | | 2.57 | | 53,456 | | 2.17 | | — | | — | | |
| Foreign government | | | — | | — | | 10,462 | | 3.82 | | — | | — | | — | | — | | | | 10,535 | | | | 3.82 | | | | — | | | | — | | | — | | | — | | | — | | | — | | |
| | |
| |
| |
| |
| |
| |
| |
| |
| | |
| Total securities available for sale | | $ | 6,625 | | 4.28 | % | $ | 264,916 | | 3.87 | % | $ | 291,558 | | 3.92 | % | $ | 4,002,406 | | 3.92 | % | | | $ | 11,503 | | | | 3.92 | % | | | $ | 28,034 | | | | 5.50 | % | | $ | 231,061 | | | 4.79 | % | | $ | 4,529,142 | | | 5.00 | % | |
| | |
| |
| |
| |
| |
| |
| |
| |
| | |
Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Loan Portfolio
Our loan portfolio decreased $65.0$131.7 million, or 33%, from 20032005 to 20042006 primarily due to a decline in client overdrafts and linerepayments of credit advances.lines of credit.
The following table summarizes our loan portfolio for the dates indicated (Dollars in thousands):
| | December 31,
| | | December 31, | |
|---|
| | 2004
| | 2003
| | 2002
| | 2001
| | 2000
| | | 2006 | | 2005 | | 2004 | | 2003 | | 2002 | |
|---|
| Loans to mutual funds | | $ | 22,520 | | $ | 104,954 | | $ | 49,372 | | $ | 50,359 | | $ | 86,316 | | | $ | 152,491 | | $ | 286,144 | | $ | 22,520 | | $ | 104,954 | | $ | 49,372 | |
| Loans to individuals | | 69,402 | | 67,641 | | 76,263 | | 164,443 | | 40,198 | | | 64,118 | | 81,392 | | 69,402 | | 67,641 | | 70,023 | |
| Loans to others | | 42,708 | | 27,035 | | 18,202 | | 17,411 | | 2,855 | | |
| | |
| |
| |
| |
| |
| | |
Commercial and industrial | | | 6,634 | | 15,697 | | 12,177 | | 7,739 | | 6,240 | |
Other | | | 47,550 | | 19,237 | | 30,531 | | 19,296 | | 18,202 | |
| | | 134,630 | | 199,630 | | 143,837 | | 232,213 | | 129,369 | | | 270,793 | | 402,470 | | 134,630 | | 199,630 | | 143,837 | |
| Less: allowance for loan losses | | (100 | ) | | (100 | ) | | (100 | ) | | (100 | ) | | (100 | ) | | (100 | ) | (100 | ) | (100 | ) | (100 | ) | (100 | ) |
| | |
| |
| |
| |
| |
| | |
| Net loans | | $ | 134,530 | | $ | 199,530 | | $ | 143,737 | | $ | 232,113 | | $ | 129,269 | | | $ | 270,693 | | $ | 402,370 | | $ | 134,530 | | $ | 199,530 | | $ | 143,737 | |
| | |
| |
| |
| |
| |
| | |
| Floating Rate | | $ | 134,618 | | $ | 199,618 | | $ | 143,825 | | $ | 232,189 | | $ | 129,337 | | |
| Fixed Rate | | 12 | | 12 | | 12 | | 24 | | 32 | | |
| | |
| |
| |
| |
| |
| | |
| | | $ | 134,630 | | $ | 199,630 | | $ | 143,837 | | $ | 232,213 | | $ | 129,369 | | |
| | |
| |
| |
| |
| |
| | |
Floating rate | | | $ | 270,781 | | $ | 402,458 | | $ | 134,618 | | $ | 199,618 | | $ | 143,825 | |
Fixed rate | | | 12 | | 12 | | 12 | | 12 | | 12 | |
Gross loans | | | $ | 270,793 | | $ | 402,470 | | $ | 134,630 | | $ | 199,630 | | $ | 143,837 | |
We make loans to individually managed account customers and to mutual funds and other pooled product clients. We offer overdraft protection and lines of credit to our clients for the purpose of funding redemptions, covering overnight cash shortfalls, leveraging portfolios and meeting other client borrowing needs. Virtually allThe majority of loans to individually managed account customers are written on a demand basis, bear variable interest rates tied to the Prime rate or the Federal Funds rate and are fully secured by liquid collateral, primarily freely tradable securities held in custody by us for the borrower. We monitor the value of collateral daily to ensure the amount of collateral held by us exceeds the loan balance by a certain threshold. Loans to mutual funds and other pooled product clients include unsecured lines of credit that may, in the event of default, be collateralized at our option by securities held in custody by us for those clients. Loans to individually managed account customers, mutual funds and other pooled product clients also include advances that we make to certain clients pursuant to the terms of our custody agreements with those clients to facilitate securities transactions and redemptions.
At December 31, 2004,2006, our only lending concentrations that exceeded 10% of total loan balances were the lines of credit to mutual fund clients discussed above. These loans were made in the ordinary course of business on the samesubstantially similar terms and conditions prevailing at the time for comparable transactions.
We periodically issue lines of credit and advances to our mutual fund clients to help those clients with security transactions. The President of one of our clients is a related party to James M. Oates, a member of our Board of Directors. At December 31, 2006, we had total contractual agreements for $150.0 million of committed lines of credit with two mutual funds within the related party complex (the ‘mutual funds’). The primary source of repayment of the loans is the proceeds from the sale of investments in the normal course of the mutual funds’ business. As part of the agreement, the mutual funds are required to segregate and maintain specific collateral for us equal to 200% of the lines of credit. At December 31, 2006, loans due from the mutual funds totaled $63.7 million. At December 31, 2005, loans due from the mutual funds totaled $125.0 million. The terms and conditions of our contractual agreements with the mutual funds, including collateral requirements, lending limits and fees, are consistent with other lending clients that have similar composition, size and overall business relationships with us. Also, Mr. Oates must abstain from voting on any board matter involving any proposed transaction with the mutual funds.
Our loan portfolio credit loss experienceperformance has been excellent. There have been no loan charge-offs in the last five years, or in the history of our Company. It is our policy to place a loan on nonaccrual status when either principal or
interest becomes 6090 days past due and the loan'sloan’s collateral is not sufficient to cover both principal and accrued interest. As of December 31, 2004,2006, there were no loans on nonaccrual status no loans greater than 90 days past due, and no troubled debt restructurings. Although virtually all of our loans are fully collateralized with freely tradable securities, management recognizes some credit risk inherent in the loan portfolio, and hastherefore we have recorded an allowance for loan losses of $0.1 million at December 31, 2004,2006, a level which has remained consistent for the past five years. This amountallowance is not allocated to any particular loan, but is intended to absorb any risk of loss inherent in the loan portfolio.portfolio at the balance sheet date that is not captured in our historical loss rates. Management actively monitors the loan portfolio and the underlying collateral and regularly assesses the adequacy of the allowance for loan losses.
Deposits
Total deposits were $5.4$6.1 billion at December 31, 2004,2006, up 28%23% from December 31, 2003.2005. The increase in our deposit balances is a direct result of the growthnew business and our clients holding larger cash positions in assets processed from our custodytheir portfolios.
business. We effectively utilized these cashTime deposits with balances to fundgreater than $100,000 totaled $524.4 million and $230.1 million at December 31, 2006 and 2005, respectively. All time deposits had a significant portionmaturity of our asset growth. The following table represents the average balanceless than three months at December 31, 2006 and weighted-average yield paid on deposits (Dollars in thousands):2005.
| | December 31, 2004
| | December 31, 2003
| |
|---|
| | Average
Balance
| | Weighted-
Average
Yield
| | Average
Balance
| | Weighted-
Average
Yield
| |
|---|
| Interest-bearing: | | | | | | | | | | | |
| Savings | | $ | 3,947,865 | | 1.26 | % | $ | 2,667,034 | | 1.49 | % |
| Time deposits | | | 68,594 | | 1.60 | | | 1,356 | | 0.74 | |
| | |
| | | |
| | | |
| | | $ | 4,016,459 | | 1.26 | % | $ | 2,668,390 | | 1.49 | % |
| | |
| | | |
| | | |
Noninterest-bearing: |
|
|
|
|
|
|
|
|
|
|
|
| Demand deposits | | $ | 252,246 | | — | | $ | 241,594 | | — | |
| Savings | | | 72,536 | | — | | | 130,747 | | — | |
| Time deposits | | | 154,617 | | — | | | 112,575 | | — | |
| | |
| | | |
| | | |
| | | $ | 479,399 | | | | $ | 484,916 | | | |
| | |
| | | |
| | | |
Repurchase Agreements and Short-Term and Other Borrowings
Asset growth was funded in part by increased securities sold under repurchase agreements. Repurchase agreements increased $1.0decreased $1.1 billion, or 31%22%, from 2003December 31, 2005 to 2004.December 31, 2006. The majority of our repurchase agreements are with clients who prefer a moreseek collateralized form of deposit. Repurchase agreements provide for the sale of securities for cash coupled with the obligation to repurchase those securities on a set date or on demand. We usedeposits. Wholesale repurchase agreements including client repurchase agreements, because they provideare a lower coststable source of funding than other short-term borrowings and allow our clientsare used to offset the extra benefitvariability of collateralization of their deposits.deposit flow. The average balance of securities sold under repurchase agreements for the year ended December 31, 20042006 was $4.2$4.5 billion with an average cost of approximately 1.31%3.67%, compared to an average balance of $3.3$5.2 billion and an average cost of approximately 0.90%2.72% for the same period last year.in 2005. The rate increase isin the average cost of repurchase agreements was due to a higher short-term interest rate environment during the last half of 2004 andrates in 2006 compared to a prepayment fee of $2.9 million incurred2005.
The following table represents information regarding our securities sold under repurchase agreements (Dollars in 2004. There were no prepayment fees for the year ended December 31, 2003.thousands):
| | December 31, | | December 31, | | December 31, | |
| | 2006 | | 2005 | | 2004 | |
Outstanding at end of year | | | $ | 3,727,800 | | | | $ | 4,797,868 | | | | $ | 4,255,497 | | |
Maximum outstanding at any month end | | | 4,977,489 | | | | 5,972,855 | | | | 4,749,456 | | |
Average balance for the year | | | 4,490,240 | | | | 5,244,614 | | | | 4,162,132 | | |
Weighted-average rate at end of year | | | 4.15 | % | | | 3.55 | % | | | 1.98 | % | |
Weighted-average rate for the year | | | 3.67 | % | | | 2.72 | % | | | 1.31 | % | |
Short-term and other borrowings decreased $0.5$0.8 billion, or 46%62%, from 2003December 31, 2005 to 2004. We use short-termDecember 31, 2006. Short-term and other borrowings are sources of funding and are used to offset the variability of deposit flow. The average balance of short-term and other borrowings for the year ended December 31, 20042006 was $0.8$0.9 billion with an average cost of approximately 2.13%5.02%, compared to an average balance of $1.0$1.6 billion and an average cost of approximately 2.15%3.31% for the same period last year.in 2005. The increase in the average cost of borrowing for the years ended December 31, 2004short-term and 2003 included prepayment fees of $3.9 million and $3.1 million, respectively. These fees were incurredother borrowings was due to employ an asset and liability strategyincrease in which we replaced high cost borrowings with new borrowings at lower rates.short-term rates during 2006 compared to 2005.
The following table represents information regarding our Federal Funds purchased (Dollars in thousands):
| | December 31, | | December 31, | | December 31, | |
| | 2006 | | 2005 | | 2004 | |
Outstanding at end of year | | | $ | 391,967 | | | | $ | 810,511 | | | | $ | 344,491 | | |
Maximum outstanding at any month end | | | 1,145,025 | | | | 1,603,757 | | | | 739,038 | | |
Average balance for the year | | | 743,101 | | | | 1,298,684 | | | | 491,170 | | |
Weighted-average rate at end of year | | | 5.20 | % | | | 4.25 | % | | | 1.94 | % | |
Weighted-average rate for the year | | | 4.91 | % | | | 3.33 | % | | | 1.45 | % | |
Market Risk
Our clients, in the course of their financial asset management, maintain cash balances, which they can deposit with us on a short-term basis in interest-bearing accounts or client repurchase agreements. We either directly invest these cash balances to earn interest income, or place these deposits in third-party vehicles and remit a portion of the earnings on these investments to our clients after deducting a fee as our compensation for investing clients'clients’ funds in these investment vehicles. In the conduct of these activities, we are subject to market risk.
Market risk is the risk of an adverse financial impact from changes in market prices and interest rates.prices. The level of risk we assume is a function of our overall strategic objectives and liquidity needs, client requirements and market volatility. The active management of market risk is integral to our operations.
Our balance sheet is primarily subject to interest rate risk, which is the risk of loss due to movements in interest rates. Prepayment risk, which is the risk that changes in interest rates and other economic factors will result in investment securities paying off earlier than the scheduled maturity date, is inherent in our investment securities, mainly our mortgage-backed securities and Federal agency securities. Prepayment levels for mortgage-backed securities are primarily driven by changes in interest rates. Prepayment levels for Federal agency securities are driven by a number of factors, including expiration of prepayment penalty provisions, the economic condition of the borrower, borrower refinancing alternatives, and interest rates. The objective of interest rate sensitivity management is to provide sustainable net interest income under various economic conditions.
Our Board of Directors has set asset and liability management policies that define the overall framework for managing interest rate sensitivity, including accountabilities and controls over investment activities. These policies delineate investment limits and strategies that are appropriate, given our liquidity and regulatory requirements. For example, we have established a policy limit stating that projected net interest income over the next twelve months will not changebe impacted by more than 10% given a change in interest rates of up to 200 basis points (+ or –)-) over twelve months.a twelve-month period. Each quarter, our Board of Directors reviews our asset and liability positions, including simulations of the effect of various interest rate scenarios on our capital.net interest income.
The day-to-day responsibility for oversight of the Asset and Liability Management function has been delegated by our Board of Directors to our Asset and Liability Committee ("ALCO"(‘ALCO’). ALCO is a senior management committee consisting of the Chief Executive Officer, the President, the Chief Financial Officer, the Chief Risk Officer and members of the Treasury function. ALCO meets twice monthly. Our primary tool in managing interest rate sensitivity is an income simulation model. Key assumptions in the simulation model include the timing of cash flows, which include forecasted prepayment speeds that are based on market and industry data, maturities and repricing of financial instruments, changes in market conditions, capital planning and deposit sensitivity. The model assumes that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period will change periodically over the period being measured. The model also assumes that a particularthe change in interest rates is reflected uniformly acrossa parallel shift of the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities.across all maturities. These assumptions are inherently uncertain, and as a result, the model cannot precisely predict the effect of changes in
interest rates on our net interest income. Actual results may differ from simulated results due to the timing, magnitude and frequency of interest rate changes and changes in market conditions and management strategies.
The results of the income simulation model as of December 31, 20042006 and 20032005 indicated that an upward shift of interest rates by 200 basis points over a twelve-month period would result in a reduction in projected net interest income of 7.13%approximately 6.2% and 7.83%7.0%, respectively, which isare both within our 10% policy limit. We also simulate a 200 basis point rate reduction over a twelve-month period, however, in the simulation we do not reduce rates below 0% because of the low likelihood that rates will decrease to below 0%.period. This modified simulation would also result in a reductionan increase in projected net interest income of 0.16%approximately 3.3% and 11.42%1.1% at December 31, 20042006 and 2003, respectively. In 2003, the Company's Board of Directors approved a temporary exception to the2005, respectively, both within our 10% limit for decreases in interest rates, as a 200 basis point reduction would have moved interest rates into a negative position.policy limit.
We also use gap analysis as a secondary tool to manage our interest rate sensitivity. Gap analysis involves measurement of the difference in asset and liability repricing on a cumulative basis within a specified time frame. A positive gap indicates that more interest-earning assets than interest-bearing liabilities reprice/mature in a time frame, and a negative gap indicates the opposite. By seeking to minimize the net amount of assets and liabilities that could reprice in the same time frame, we attempt to reduce the risk of significant adverse effects on net interest income caused by interest rate changes. As shown in the cumulative gap position in the table presented below,on the following page, at December 31, 2004,2006, interest-bearing liabilities repriced faster than interest-earning assets in the short term, as has been typical for us.term. Generally speaking, during a period of falling interest rates, net interest income would be higher than it would have been untilbenefit from lower short-term interest rates stabilize.rates. During a period of rising interest rates, such as the one we experienced during 2005 and the first half of 2006, net interest income would be lower than it would have been until interest rates stabilize. Other important determinants of net interest income are the shape of the yield curve, general rate levels, reinvestment spreads, balance sheet growth and mix, and interest rate spreads. We continue to run a closely matched balance sheet by investing the majority of our
assets in short duration, variable-rate securities and addingexecuting interest rate swaps against client liabilities, including client repurchase agreements.
We manage the structure of interest-earning assets and interest-bearing liabilities by adjusting their mix, yield, maturity and/or repricing characteristics based on market conditions. Client deposits and repurchase agreements, which are predominantly short term, are our primary sources of funds. We also use term borrowings and interest rate swap agreements to augment our management of interest rate exposure. The effect of the swap agreements is to lengthen both a forecasted series of fixed-rate overnight liabilities incurred at different daily fixed rates and short-term variable-rate liabilities into longer-term fixed-rate liabilities. The weighted-average fixed-payment rates on our swap agreements were 3.09%3.82% and 3.92%3.51% at December 31, 20042006 and 2003,2005, respectively. Variable-interest payments received are currently indexed to the overnight Federal Funds rate. At December 31, 20042006 and 2003,2005, the weighted-average raterates of variable market-indexed interest payment obligations to the Companyus were 2.22%5.24% and 1.70%4.00%, respectively. The originalremaining terms of swaps at December 31, 2006 range from 21 to 4022 months. These contracts had net fair values of approximately $1.5$13.8 million and $(14.9)$24.2 million at December 31, 20042006 and 2003,2005, respectively.
The following table presents the repricing schedule for our interest-earning assets and interest-bearing liabilities at December 31, 20042006 (Dollars in thousands):
| | Within | | Three | | Six | | One | | | | | |
| | Three | | To Six | | To Twelve | | Year to | | Over Five | | | |
| | Months | | Months | | Months | | Five Years | | Years | | Total | |
Interest-earning assets(1): | | | | | | | | | | | | | | | | | |
Investment securities(2,3) | | $ | 5,921,097 | | $ | 488,872 | | | $ | 740,712 | | | | $ | 2,412,779 | | | $ | 770,003 | | $ | 10,333,463 | |
Federal funds sold, interest-bearing deposits with other banks and other short-term investments | | 323,189 | | — | | | — | | | | — | | | — | | 323,189 | |
Loans—variable rate | | 269,781 | | 1,000 | | | — | | | | — | | | — | | 270,781 | |
Loans—fixed rate | | — | | — | | | — | | | | 12 | | | — | | 12 | |
Total interest-earning
assets | | 6,514,067 | | 489,872 | | | 740,712 | | | | 2,412,791 | | | 770,003 | | 10,927,445 | |
Interest-bearing liabilities: | | | | | | | | | | | | | | | | | |
Demand deposit accounts | | 110,647 | | — | | | — | | | | — | | | — | | 110,647 | |
Savings accounts | | 4,854,711 | | — | | | — | | | | — | | | — | | 4,854,711 | |
Time deposits | | 224,386 | | — | | | — | | | | — | | | — | | 224,386 | |
Interest rate contracts | | (1,330,000 | ) | 260,000 | | | 400,000 | | | | 670,000 | | | — | | — | |
Securities sold under repurchase agreements | | 3,277,800 | | 150,000 | | | 200,000 | | | | 100,000 | | | — | | 3,727,800 | |
Short-term and other borrowings | | 517,051 | | — | | | — | | | | — | | | — | | 517,051 | |
Junior subordinated
debentures | | 24,774 | | — | | | — | | | | — | | | — | | 24,774 | |
Total interest-bearing liabilities | | 7,679,369 | | 410,000 | | | 600,000 | | | | 770,000 | | | — | | 9,459,369 | |
Net interest-sensitivity gap during the period | | $ | (1,165,302 | ) | $ | 79,872 | | | $ | 140,712 | | | | $ | 1,642,791 | | | $ | 770,003 | | $ | 1,468,076 | |
Cumulative gap | | $ | (1,165,302 | ) | $ | (1,085,430 | ) | | $ | (944,718 | ) | | | $ | 698,073 | | | $ | 1,468,076 | | | |
Interest-sensitive assets as a percent of interest-sensitive liabilities (cumulative) | | 84.83 | % | 86.58 | % | | 89.13 | % | | | 107.38 | % | | 115.52 | % | | |
Interest-sensitive assets as a percent of total assets (cumulative) | | 56.36 | % | 60.60 | % | | 67.01 | % | | | 87.88 | % | | 94.54 | % | | |
Net interest-sensitivity gap as a percent of total assets | | (10.08 | )% | 0.69 | % | | 1.22 | % | | | 14.21 | % | | 6.66 | % | | |
Cumulative gap as a percent of total assets | | (10.08 | )% | (9.39 | )% | | (8.17 | )% | | | 6.04 | % | | 12.70 | % | | |
(1)
| | Within
Three
Months
| �� | Three
To Six
Months
| | Six
To Twelve
Months
| | One
Year to
Five Years
| | Over Five
Years
| | Total
|
|---|
| Interest-earning assets(1): | | | | | | | | | | | | | | | | | | |
| | Investment securities(2,3) | | $ | 5,751,344 | | $ | 695,135 | | $ | 1,163,591 | | $ | 2,440,157 | | $ | 421,475 | | $ | 10,471,702 |
| | Loans—variable- rate | | | 134,618 | | | — | | | — | | | — | | | — | | | 134,618 |
| | Loans—fixed rate | | | — | | | — | | | — | | | 12 | | | — | | | 12 |
| | |
| |
| |
| |
| |
| |
|
| | | Total interest-earning assets | | | 5,885,962 | | | 695,135 | | | 1,163,591 | | | 2,440,169 | | | 421,475 | | | 10,606,332 |
Interest-bearing liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| | Savings accounts | | | 4,324,303 | | | — | | | — | | | 38,592 | | | — | | | 4,362,895 |
| | Time deposits | | | 97,669 | | | — | | | — | | | — | | | — | | | 97,669 |
| | Interest rate contracts | | | (1,560,000 | ) | | 90,000 | | | 240,000 | | | 1,230,000 | | | — | | | — |
| | Securities sold under repurchase agreements | | | 3,505,497 | | | — | | | 100,000 | | | 650,000 | | | — | | | 4,255,497 |
| | Short-term and other borrowings | | | 544,681 | | | — | | | — | | | 50,000 | | | — | | | 594,681 |
| | Junior subordinated debentures | | | — | | | — | | | — | | | 24,774 | | | — | | | 24,774 |
| | |
| |
| |
| |
| |
| |
|
| | | Total interest-bearing liabilities | | | 6,912,150 | | | 90,000 | | | 340,000 | | | 1,993,366 | | | — | | | 9,335,516 |
| | |
| |
| |
| |
| |
| |
|
| | | Net interest sensitivity gap during the period | | $ | (1,026,188 | ) | $ | 605,135 | | $ | 823,591 | | $ | 446,803 | | $ | 421,475 | | $ | 1,270,816 |
| | |
| |
| |
| |
| |
| |
|
| | | Cumulative gap | | $ | (1,026,188 | ) | $ | (421,053 | ) | $ | 402,538 | | $ | 849,341 | | $ | 1,270,816 | | | |
| | |
| |
| |
| |
| |
| | | |
Interest-sensitive assets as a percent of interest-sensitive liabilities (cumulative) |
|
|
85.15 |
% |
|
93.99 |
% |
|
105.48 |
% |
|
109.10 |
% |
|
113.61 |
% |
|
|
| | |
| |
| |
| |
| |
| | | |
| Interest-sensitive assets as a percent of total assets (cumulative) | | | 52.70 | % | | 58.93 | % | | 69.35 | % | | 91.20 | % | | 94.97 | % | | |
| | |
| |
| |
| |
| |
| | | |
| Net interest sensitivity gap as a percent of total assets | | | (9.19 | %) | | 5.42 | % | | 7.37 | % | | 4.00 | % | | 3.77 | % | | |
| | |
| |
| |
| |
| |
| | | |
| Cumulative gap as a percent of total assets | | | (9.19 | %) | | (3.77 | %) | | 3.60 | % | | 7.61 | % | | 11.38 | % | | |
| | |
| |
| |
| |
| |
| | | |
(1)- Adjustable rate assets are included in the period in which interest rates are next scheduled to adjust rather than in the period in which they are due. Fixed-rate loans are included in the period in which they are scheduled to be repaid.
(2)
- Mortgage-backed securities are included in the pricing category that corresponds with the earlier of their first repricing date or principal paydown schedule generated from industry sourced prepayment projections.
(3)
- Excludes
$5.4$26.4 million of unsettled securities purchases and $31.0$27.8 million of net unrealized gainslosses as of December 31, 2004.
2006.46
Liquidity
Liquidity
Liquidity represents the ability of an institution to meet present and future financial obligations through either the sale orrunoff due to prepayments, asset sales, maturity of existing assets or the acquisition of additional funds through liability management. For a financial institution such as ours, theseThese obligations arise from the withdrawals of deposits, and the payment of operating expenses.expenses, and the inclusion of capital expenditures for fixed assets and leasehold improvements.
Our primary sources of liquidity include cash and cash equivalents, Federal Funds sold, Federal Reserve Discount Window, new deposits, short-term borrowings, interest and principal payments on securities held to maturity and available for sale, and fees collected from asset administration clients.clients, FHLBB borrowings and the Federal Reserve Discount Window. As a result of our management of liquid assets and our ability to generate liquidity through liability funds, management believes that we maintain overall liquidity sufficient to meet our depositors'depositors’ needs, to satisfy our operating requirements and to fund the payment of an anticipated annual cash dividend of $0.08$0.10 per share for 20052007 (approximately $5.3$6.6 million based upon 66,595,34965,628,108 shares outstanding as of December 31, 2004)2006).
Our ability to pay dividends on Common Stockcommon stock may depend on the receipt of dividends from the Bank. Any dividend payments by the Bank are subject to certain restrictions imposed by the Massachusetts Commissioner of Banks. During all periods presented in this report, the Company did not require dividends from the Bank in order to fund the Company'sCompany’s own dividends. In addition, we may not pay dividends on our Common Stockcommon stock if we are in default under certain agreements entered into in connection with the sale of our Capital Securities. The Capital Securities were issued in 1997 by Investors Capital Trust I, ("ICTI"), a Delaware statutory business trust sponsored by us, and qualify as Tier 1 capital under the capital guidelines of the Federal Reserve.Reserve Board of Governors (‘FRB’).
In June 2006, we announced that our Board of Directors had authorized a new repurchase plan of up to $150.0 million of our common stock over the twelve months following the announcement. We do not expect the stock repurchase program to have a material impact on our capital resources, such as maintaining risk-based capital ratios in excess of capital adequacy guidelines and our ability to pay dividends on our common stock. As of December 31, 2006, we have repurchased $29.3 million of our common stock under this plan.
We have informal borrowing arrangements with various counterparties. Each counterparty has agreed to make funds available to us at the Federal Funds overnight rate. The aggregate amount of these borrowing arrangements as of December 31, 2004 was $3.2 billion. Each bankcounterparty may terminate its arrangement at any time and is under no contractual obligation to provide us with requested funding. Our borrowings under these arrangements are typically on an overnighta short-term basis. We cannot be certain, however, that such funding will be available. Lack of availability of liquid funds could have a material adverse impact on our operations.
We also have Master Repurchase Agreements in place with various counterparties. Each counterparty has agreed on an uncommitted basis to make funds available to us at various rates in exchange for collateral consisting of marketable securities. The aggregate amount of these borrowing arrangements at December 31, 2004 was $5.6 billion.
On April 19, 2004, the Federal Home Loan Bank of Boston ("FHLBB") implemented a new capital structure mandated for all Federal Home Loan Banks by the Gramm-Leach-Bliley Act of 1999 and regulations that were subsequently promulgated in 2001 by the FHLBB's regulator, the Federal Housing Finance Board. The Bank'sOur capital stock investment in the FHLBB totaled $50$29.4 million as of December 31, 2004.2006. This amount reflects a $20.6 million decrease from December 31, 2005. The $50$29.4 million capital stock investment includes both a $25$25.0 million membership component and a $25$4.4 million activity-based component. The Bank's $50membership component of the FHLBB capital stock investment requires a five-year advance notice of withdrawal. Our $29.4 million capital stock investment in the FHLBB provides aan overnight borrowing capacity of approximately $555up to $146.4 million. Under the new capital plan, FHLBB capital stock investments require a five-year advance notice of withdrawal. The amount outstanding under this arrangement atas of December 31, 20042006 was $250$125.0 million. Additional borrowing is available to the Bankus based on prescribed collateral levels and increased investment in FHLBB capital stock. The BankWe currently has no planshave the ability to increase its investment in FHLBB capital stock.
purchase up to $25.0 million of activity-based capital, which would provide a total overnight borrowing capacity of $833.3 million.
In October 2006, we became a member of the Federal Reserve Bank of Boston (‘FRBB’). In connection with our membership, we were required to subscribe to purchase stock of the FRBB totaling 6% of the Bank’s capital and surplus. We fulfilled our obligation to purchase 50% of the subscribed amount by purchasing $7.4 million of FRBB stock. The remaining subscription amount is subject to purchase upon the request of the FRBB.
The following table details our contractual obligations as of December 31, 20042006 (Dollars in thousands):
| | Payments due by period
|
|---|
| | Total
| | Less than 1
year
| | 1-3
years
| | 4-5
years
| | More than
5 years
|
|---|
| Contractual obligations | | | | | | | | | | | | | | | |
| | Debt obligations(1) | | $ | 594,681 | | $ | 544,681 | | $ | 50,000 | | $ | — | | $ | — |
| | Repurchase agreements | | | 4,255,497 | | | 3,605,497 | | | 600,000 | | | 50,000 | | | — |
| | Junior subordinated debentures(2) | | | 24,000 | | | —- | | | 24,000 | | | — | | | — |
| | Operating lease obligations | | | 122,904 | | | 30,294 | | | 50,834 | | | 19,935 | | | 21,841 |
| | |
| |
| |
| |
| |
|
| | | Total | | $ | 4,997,082 | | $ | 4,180,472 | | $ | 724,834 | | $ | 69,935 | | $ | 21,841 |
| | |
| |
| |
| |
| |
|
| | Payments due by period | |
| | | | Less than 1 | | 1-3 | | 4-5 | | More than | |
| | Total | | year | | years | | years | | 5 years | |
Contractual obligations | | | | | | | | | | | |
Debt obligations(1) | | $ | 517,051 | | $ | 517,051 | | $ | — | | $ | — | | $ | — | |
Repurchase agreements | | 3,727,800 | | 3,627,800 | | 100,000 | | — | | — | |
Junior subordinated debentures(2) | | 24,000 | | 24,000 | | — | | — | | — | |
Operating lease obligations | | 299,416 | | 35,189 | | 70,328 | | 72,020 | | 121,879 | |
Total | | $ | 4,568,267 | | $ | 4,204,040 | | $ | 170,328 | | $ | 72,020 | | $ | 121,879 | |
(1)Debt obligations presented are variable in nature and do not include interest amounts.
(2)
These securities ultimately mature in 2027,2027; however, we have the right to redeem the securities as early as February 2007.
| | Payments due by period
|
|---|
| | Total
| | Less than 1
year
| | 1-3
years
| | 4-5
years
| | More than
5 years
|
|---|
| Other commitments | | | | | | | | | | | | | | | |
| | Unused commitments to lend | | $ | 978,776 | | $ | 804,673 | | $ | 174,103 | | $ | — | | $ | — |
| | Fixed price purchase contracts | | | 672,193 | | | 672,193 | | | — | | | — | | | — |
| | Other | | | 159,620 | | | 25,913 | | | 53,368 | | | 52,038 | | | 28,301 |
| | |
| |
| |
| |
| |
|
| | | Total | | $ | 1,810,589 | | $ | 1,502,779 | | $ | 227,471 | | $ | 52,038 | | $ | 28,301 |
| | |
| |
| |
| |
| |
|
| | Payments due by period | |
| | | | Less than 1 | | 1-3 | | 4-5 | | More than | |
| | Total | | year | | years | | years | | 5 years | |
Other commitments | | | | | | | | | | | | | |
Unused commitments to lend | | $ | 1,053,632 | | $ | 1,044,632 | | $ | — | | $ | 9,000 | | | $ | — | | |
Other | | 148,156 | | 37,777 | | 74,844 | | 35,535 | | | — | | |
Total | | $ | 1,201,788 | | $ | 1,082,409 | | $ | 74,844 | | $ | 44,535 | | | $ | — | | |
Included in the Otherother commitments line presented above are contracts in which we are obligated to utilize the data processing services of Electronic Data Systems ("EDS") through December 31, 2005,2008, SEI Investments Company through December 31, 2009 and International Business Machines Corporation ("IBM") through June 30, 2011. The IBM agreement was signed in the summer of 2004. Under the terms of this new agreement, IBM provides to us help desk, identification administration, network management, deskside services, server monitoring and management, on demand computing services and webhosting. Certain of these services were previously provided by EDS. The commitmentcommitments to pay for these services isare based upon transaction volumes and includesinclude inflationary price clauses.
Capital Resources
Historically, we have financed our operations principally through internally generated cash flows. We incur capital expenditures for furniture, fixtures, capitalized software and miscellaneous equipment needs. We lease office space and computing equipment through operating leases. Capital expenditures have been incurred and leases entered into on an as-required basis, primarily to meet our growing operating needs. As a result, our capital expenditures were $23.6$76.7 million and $29.5$33.1 million for the years ended December 31, 20042006 and 2003,2005, respectively. For the year ended December 31, 2004,2006, capital expenditures were comprised of approximately $15.4$33.2 million in capitalized software and projects in process, $7.9$22.8 million in leasehold improvements and $20.7 million in fixed assets, and $0.3 million in leasehold improvements.assets. For the year ended December 31, 2003,2005, capital expenditures were comprised of approximately $15.7$19.0 million in capitalized software and projects in process, $7.4$13.6 million in fixed assets and $6.4$0.5 million in leasehold improvements. Leasehold improvement expenditures
Stockholders’ equity at December 31, 2006 was $938.7 million, up 21% from 2005, primarily due to net income earned and the exercise of stock options. The ratio of average stockholders’ equity to average assets was approximately 7% for the year ended December 31, 2003 were primarily related2006 compared to increased space in our Dublin office, which was needed to support new business.
Stockholders' equity at6% for the year ended December 31, 2004 was $712.3 million, up 32% from 2003, primarily due to net income growth in 2004 and the issuance of common stock related to option exercises and employee
stock purchase plan purchases. The ratio of average stockholders' equity to average assets remained constant at approximately 6% for December 31, 2004 and 2003.2005.
The FRB has adopted capital adequacy guidelines applicable to United States banking organizations. The FRB'sFRB’s capital adequacy guidelines generally require BHCsbank holding companies (‘BHCs’) to maintain total capital equal to 8% of total risk-adjusted assets and off-balance sheet items (the "Total‘Total Risk-Based Capital Ratio"Ratio’), with at least 50% of that amount consisting of Tier 1, or core capital, and the remaining amount consisting of Tier 2, or supplementary capital. Tier 1 capital for BHCs generally consists of the sum of common stockholders'stockholders’ equity and perpetual preferred stock (subject to certain limitations), less goodwill and other nonqualifying intangible assets. Tier 2 capital generally consists of hybrid capital instruments, perpetual debt and mandatory convertible debt securities; perpetual preferred stock, not included as Tier 1 capital; term subordinated debt and intermediate-term preferred stock; and, subject to limitations, general allowances for loan and lease losses. Assets are adjusted under the risk-based guidelines to take into account different risk characteristics.
In addition to the risk-based capital requirements, the FRB requires BHCs to maintain a minimum leverage capital ratio of Tier 1 capital to its average total consolidated assets (the "Leverage Ratio"‘Leverage Ratio’) of 3.0%3%. Total average consolidated assets for this purpose does not include goodwill and any other intangible assets and investments that the FRB determines should be deducted from Tier 1 capital. The FRB has announced that the 3.0%3% Leverage Ratio requirement is the minimum for the top-rated BHCs. All other BHCs are required to maintain a minimum Leverage Ratio of 4.0%4%. BHCs with supervisory, financial, operational or managerial weaknesses, as well as BHCs that are anticipating or experiencing significant growth, are expected to maintain capital ratios well above the minimum levels. Because we anticipate significant future growth, we will be required to maintain a Leverage Ratio of 4.0%4% or higher.
We are currently in compliance with both the Total Risk-Based Capital Ratio and the Leverage Ratio requirements, and management expects these ratios to remain in compliance with the FRB'sFRB’s capital adequacy guidelines. At December 31, 2004,2006, our Total Risk-Based Capital Ratio and Leverage Ratio were 20.54%19.04% and 5.85%7.63%, respectively.
Off Balance Sheet Arrangements
Lines of Credit—At December 31, 2006, we had commitments to mutual funds, individuals and others under collateralized open lines of credit totaling $1.2 billion, against which $184.6 million in loans were drawn. The credit risk involved in issuing lines of credit is essentially the same as that involved in extending demand loans. We do not anticipate any loss as a result of these lines of credit.
Securities Lending—On behalf of our clients, we lend securities to creditworthy broker-dealers. In certain circumstances, we may indemnify our clients for the fair market value of those securities against a failure of the borrower to return such securities. We require the borrowers to provide collateral in an amount equal to, or in excess of, 102% of the fair market value of U.S. dollar-denominated securities borrowed and 105% of the fair market value of non-U.S. dollar-denominated securities borrowed. The borrowed securities are revalued daily to determine whether additional collateral is necessary. As guarantor, we are required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. We measure the fair value of our indemnification obligation by marking our securities lending portfolio to market on a daily basis and comparing the value of the portfolio to the collateral holdings position. The fair value of the indemnification obligation to be recorded would be the deficiency of collateral as compared to the value of the securities out on loan.
With respect to the indemnified securities lending portfolio, the cash and U.S. government securities held by us as collateral at December 31, 2006 totaled $11.1 billion, while the fair value of the portfolio
totaled approximately $10.7 billion. Given that the value of the collateral held was in excess of the value of the securities that we would be required to replace if the borrower defaulted and failed to return such securities, our indemnification obligation was zero and no liability was recorded.
All securities loans are categorized as overnight loans. The maximum potential amount of future payments that we could be required to make would be equal to the market value of the securities borrowed. Since the securities loans are overcollateralized by 2% (for U.S. dollar-denominated securities) to 5% (for non-U.S. dollar-denominated securities) of the fair market value of the loan made, the collateral held by us would be used to satisfy the obligation. In addition, each borrowing agreement includes “set-off” language that allows us to use any excess collateral on other loans to that borrower to cover any collateral shortfall of that borrower. However, there is a potential risk that the collateral would not be sufficient to cover such an obligation if the security on loan increased in value between the time the borrower defaulted and the time the security is “bought-in”. In those instances, we would “buy-in” the security using all available collateral and a loss would result from the difference between the value of the security “bought-in” and the value of the collateral held. We have never experienced a broker default.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The information required by this item is contained in the "Market Risk"‘Market Risk’ section in the "Management's‘Management’s Discussion and Analysis of Financial Condition and Results of Operations,"’ as part of this Report.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The information required by this item is contained in the financial statements and schedules set forth in Item 15(a) under the captions "Consolidated‘Consolidated Financial Statements"Statements’ and "Financial‘Financial Statement Schedules"Schedules’ as a part of this Report.
ITEM 9A. CONTROLS AND PROCEDURES.
As of December 31, 2004,2006, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures. Our disclosure controls and procedures are the controls and other procedures that we designed to ensure that we record, process, summarize and report in a timely manner the information we must disclose in reports that we file or submit to the Securities and Exchange Commission.Commission and that the information required to be disclosed is accumulated and communicated to our principal executive and principal financial officers as appropriate to allow timely decisions regarding required disclosure. Kevin J. Sheehan, our Chairman and Chief Executive Officer, and John N. Spinney, Jr., our Senior Vice President and Chief Financial Officer, reviewed and participated in this evaluation. Based on this evaluation, Messrs. Sheehan and Spinney concluded that, as of December 31, 2004,2006, our disclosure controls and procedures were effective.
During the year ended December 31, 2006, there were no significant changes in our internal control over financial reporting that materially affected our internal control over financial reporting.
50
REPORT OF MANAGEMENT TO THE BOARD OF DIRECTORS AND STOCKHOLDERS
February 28, 2005
26, 2007
To the Board of Directors and Stockholders:
Financial Statements
The management of Investors Financial Services Corp. and its subsidiaries ("(“the Company"Company”) is responsible for the preparation, integrity, and fair presentation of its published financial statements and all other information presented in the Consolidated Financial Statementsconsolidated financial statements of the Company contained in this Report. The consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America and, as such, include amounts based on informed judgments and estimates made by management.
Internal Control
Management is responsible for establishing and maintaining effective internal control over financial reporting, including safeguarding of assets, for financial presentationsstatements in conformity with accounting principles generally accepted in the United States of America. The internal control contains monitoring mechanisms, and actions are taken to correct deficiencies identified. There are inherent limitations in the effectiveness of any internal control, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even effective internal control can provide only reasonable assurance with respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of internal control may vary over time.
Management has made a comprehensive review, evaluation and assessment of the Company'sCompany’s internal control over financial reporting, including safeguarding of assets, for financial presentations in conformity with accounting principles generally accepted in the United States of America as of December 31, 2004.2006, including controls over the preparation by Investors Bank & Trust Company (a wholly owned banking subsidiary of the Company) of the schedules equivalent to the basic financial statements in accordance with the Federal Financial Institutions Examination Council Instructions for Consolidated Reports of Condition and Income for Schedules RC, RI and RI-A (the “Call Report Instructions”). This assessment was based on criteria for effective internal control over financial reporting, including safeguarding of assets, described in "‘Internal Control—Integrated Framework"Framework’ issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management has concluded that the Company maintained effective internal control over financial reporting, including safeguarding of assets, presented in conformity with accounting principles generally accepted in the United States of America as of December 31, 2004.2006.
The Audit Committee of the Board of Directors is comprised entirely of outside directors who are independent of the Company'sCompany’s management; it includes members with banking or related management experience, has access to its own outside counsel, and does not include representatives of any large customers of the institution. The Audit Committee is responsible for recommending to the Board of Directors the selection of independent auditors. It meets periodically with management, the independent auditors and the internal auditors to ensure that they are carrying out their responsibilities. The Audit Committee is also responsible for performing an oversight role by reviewing and monitoring the financial, accounting and auditing procedures of the Company in addition to reviewing the Company'sCompany’s financial reports. The independent auditors and the internal auditors have full and free access to the Audit Committee, with or without the presence of management, to discuss the adequacy of internal control over financial reporting and any other matters which they believe should be brought to the attention of the Audit Committee.
Deloitte & Touche, LLP, an Independent Registered Public Accounting Firm, which has audited and reported on management's assertionthe consolidated financial statements contained in this Form 10-K, has issued their report dated February 26, 2007 on management’s assessment with respect to the effectiveness of the Company'sCompany’s internal control over financial reporting as of December 31, 2004.2006.
Compliance With Laws and Regulations
Management is also responsible for ensuring compliance with the federal laws and regulations concerning loans to insiders and the federal and state laws and regulations concerning dividend restrictions, both of which are designated by the Federal Deposit Insurance Corporation (‘FDIC’) as safety and soundness laws and regulations.
Management assessed its compliance with the designated safety and soundness laws and regulations and has maintained records of its determinations and assessments as required by the FDIC. Based on this assessment, management believes that the Bank has complied, in all material respects, with the designated safety and soundness laws and regulations for the year ended December 31, 2006.
/s/ KEVIN J. SHEEHAN |
|
|
Kevin J. Sheehan
|
Chairman and Chief Executive Officer | | |
/s/ JOHN N. SPINNEY, JR. |
|
|
John N. Spinney, Jr.
|
Senior Vice President
and Chief Financial Officer | | |
52
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Investors Financial Services Corp.:
We have audited management'smanagement’s assessment, included in the accompanying Report of Management to the Board of Directors and Stockholders, that Investors Financial Services Corp. and subsidiaries (the "Company"“Company”) maintained effective internal control over financial reporting as of December 31, 2004,2006, based on the criteria established inInternal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Because management’s assessment and our audit were conducted to meet the reporting requirements of Section 112 of the Federal Deposit Insurance Corporation Improvement Act (FDICIA), management’s assessment and our audit of the Company’s internal control over financial reporting included controls over the preparation by Investors Bank & Trust Company (a wholly-owned banking subsidiary of the Company) of the schedules equivalent to the basic financial statements in accordance with the Federal Financial Institutions Examination Council Instructions for Consolidated Reports of Condition and Income for Schedules RC, RI and RI-A (the “Call Report Instructions”). The Company'sCompany’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management'smanagement’s assessment and an opinion on the effectiveness of the Company'sCompany’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management'smanagement’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company'scompany’s internal control over financial reporting is a process designed by, or under the supervision of, the company'scompany’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company'scompany’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company'scompany’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company'scompany’s assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management'smanagement’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2004,2006, is fairly stated, in all material respects, based on the criteria established inInternal Control—Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004,2006, based on the criteria established inInternal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have not examined and, accordingly, we do not express an opinion or any other form of assurance on management’s statement referring to compliance with laws and regulations.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31, 20042006 of the Company and our report dated February 28, 2005,26, 2007 expressed an unqualified opinion on those financial statements.
DELOITTE & TOUCHE LLP
Boston, Massachusetts
February 28, 2005
ITEM 9B. OTHER INFORMATION
26, 2007
On November 15, 2004, the Company granted options to purchase shares of the Company's common stock to executive officers in the amounts set forth below. The stock option agreements relating to these grants have been filed as exhibits to this Report.54
Name
| | Number of
Shares Underlying
Option Grant
|
|---|
Kevin J. Sheehan | | 93,514 |
Michael F. Rogers | | 90,697 |
Edmund J. Maroney | | 36,736 |
John N. Spinney, Jr. | | 20,000 |
Robert D. Mancuso | | 111,294 |
PART III
PART III
ITEM 10. DIRECTORS, AND EXECUTIVE OFFICERS OF THE REGISTRANT.
AND CORPORATE GOVERNANCE.
The information required under this item is incorporated herein by reference to the information in the sections entitled "Directors and Executive Officers," "Election of Directors" and "Compensation and Other Information Concerning Directors and Executive Officers" contained in our definitive proxy statement pursuant to Regulation 14A, which proxy statement will be filed with the Securities and Exchange Commission not later than 120 days after the close of our fiscal year ended December 31, 2004.2006.
ITEM 11. EXECUTIVE COMPENSATION.
The information required under this item is incorporated herein by reference to the information in the section entitled "Compensation and Other Information Concerning Directors and Officers" contained in our definitive proxy statement pursuant to Regulation 14A, which proxy statement will be filed with the Securities and Exchange Commission not later than 120 days after the close of our fiscal year ended December 31, 2004.2006.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
The information required under this item is incorporated herein by reference to the information in the section entitled "Management and Principal Holders of Voting Securities" contained in our definitive proxy statement pursuant to Regulation 14A, which proxy statement will be filed with the Securities and Exchange Commission not later than 120 days after the close of our fiscal year ended December 31, 2004.2006.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
The information required under this item is incorporated herein by reference to the information in the section entitled "Certain Relationships and Related Transactions" contained in our definitive proxy statement pursuant to Regulation 14A, which proxy statement will be filed with the Securities and Exchange Commission not later than 120 days after the close of our fiscal year ended December 31, 2004.2006.
ITEM 14. PRINCIPAL ACCOUNTANTACCOUNTING FEES AND SERVICES.
The information required under this item is incorporated herein by reference to the information in the section entitled "Ratification of Selection of Independent Registered Public Accounting Firm" contained in our definitive proxy statement pursuant to Regulation 14A, which proxy statement will be filed with the Securities and Exchange Commission not later than 120 days after the close of our fiscal year ended December 31, 2004.2006.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) 1. Consolidated Financial Statements.
For the following consolidated financial information included herein, see Index to Consolidated Financial Statements on Page F-1:
Report of Independent Registered Public Accounting Firm.
Consolidated Balance Sheets as of December 31, 2006 and December 31, 2005.
Consolidated Statements of Income and Comprehensive Income for the Years Ended December 31, 2006, 2005 and 2004.
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2006, 2005 and 2004.
Consolidated Statements of Cash Flows for the Years Ended December 31, 2006, 2005 and 2004.
Notes to Consolidated Financial Statements.
2. Financial Statement Schedules.
None.
3. List of Exhibits.
(a)
| | 1. Consolidated Financial Statements.
|
|---|
Exhibit No. |
|
|
| Description |
2.1(13) | | ForAgreement and Plan of Merger between the following consolidated financial information included herein, see Index on Page F-1:Company and State Street Corporation, dated February 4, 2007 |
3.1(6) | | ReportCertificate of Independent Registered Public Accounting Firm.Incorporation of the Company |
3.2(3) | | Consolidated Balance Sheets asCertificate of December 31, 2004 and December 31, 2003.Amendment of Certificate of Incorporation of the Company |
3.3(5) | | Consolidated StatementsCertificate of IncomeAmendment of Certificate of Incorporation of the Company |
3.4(8) | | Certificate of Amendment of Certificate of Incorporation of the Company |
3.5(9) | | Certificate of Amendment of Certificate of Incorporation of the Company |
3.6(6) | | Amended and Comprehensive IncomeRestated Bylaws of the Company |
4.1(6) | | Specimen certificate representing the common stock of the Company |
10.1(7)* | | Amended and Restated 1995 Stock Plan |
10.2(7)* | | Amended and Restated 1995 Non-Employee Director Stock Option Plan |
10.3(11)* | | 2005 Equity Compensation Plan |
10.4(6) | | Information Technology Services Contract between the Company and Electronic Data Systems, Inc., dated September 20, 1995 |
10.5(1) | | Lease Agreement between the Company and John Hancock Mutual Life Insurance Company, dated November 13, 1995, for the Years Ended December 31, 2004, 2003 and 2002.premises located at 200 Clarendon Street, Boston, Massachusetts |
10.6(11)** | | Consolidated Statements of Stockholders' Equity forAmendment to Lease between Investors Financial Services Corp. and 100 & 200 Clarendon LLC (successors to the Years Ended December 31, 2004, 2003 and 2002.John Hancock Mutual Life Insurance Company), dated January 1, 2005 |
10.7(9)* | | Consolidated Statements of Cash Flows for the Years Ended December 31, 2004, 2003 and 2002.1997 Employee Stock Purchase Plan, as amended |
10.8(2) | | Notes to Consolidated Financial Statements.Amended and Restated Declaration of Trust among the Company and the Trustees named therein, dated January 31, 1997 |
10.9(2) | | 2. Financial Statement Schedules.Indenture between the Company and The Bank of New York, dated January 31, 1997 |
10.10(2) | | Common Securities Guarantee Agreement by the Company as Guarantor, dated January 31, 1997 |
10.11(2) | | None.Capital Securities Guarantee Agreement between the Company as Guarantor and The Bank of New York as Capital Securities Guarantee Trustee, dated January 31, 1997 |
10.12(4) | | 3. ListFirst Amendment, effective January 1, 2000 to Information Technology Services Contract between the Company and Electronic Data Systems, Inc. dated September 20, 1995 |
10.13(4)* | | Amended and Restated Employment Agreement between the Company and Kevin Sheehan |
10.14(4)* | | Change of Exhibits.Control Employment Agreement between the Company and Kevin Sheehan |
10.15(4)* | | Amended and Restated Employment Agreement between the Company and Michael Rogers |
10.16(4)* | | Change of Control Employment Agreement between the Company and Michael Rogers |
10.17(4)* | | Amended and Restated Employment Agreement between the Company and Edmund Maroney |
10.18(4)* | | Change of Control Employment Agreement between the Company and Edmund Maroney |
10.19(4)* | | Amended and Restated Employment Agreement between the Company and Robert Mancuso |
10.20(4)* | | Change of Control Employment Agreement between the Company and Robert Mancuso |
10.21(4)* | | Amended and Restated Employment Agreement between the Company and John Henry |
10.22(4)* | | Change of Control Employment Agreement between the Company and John Henry |
10.23(6)* | | Change of Control Employment Agreement between the Company and John N. Spinney, Jr. |
10.24(7)* | | Employment Agreement between the Company and John N. Spinney, Jr. |
10.25(9) | | Information Technology Services Agreement dated July 1, 2004 between the Company and International Business Machines Corporation. |
10.26(10) | | Stock Option Agreement dated November 15, 2004 between the Company and Kevin J. Sheehan |
10.27(10)* | | Stock Option Agreement dated November 15, 2004 between the Company and Kevin J. Sheehan |
10.28(10)* | | Stock Option Agreement dated November 15, 2004 between the Company and Michael F. Rogers |
10.29(10)* | | Stock Option Agreement dated November 15, 2004 between the Company and Michael F. Rogers |
10.30(10)* | | Stock Option Agreement dated November 15, 2004 between the Company and Edmund J. Maroney |
10.31(10)* | | Stock Option Agreement dated November 15, 2004 between the Company and Edmund J. Maroney |
10.32(10)* | | Stock Option Agreement dated November 15, 2004 between the Company and John N. Spinney, Jr. |
Exhibit No.
| | Description
|
|---|
| 3.1 | (12) | Certificate of Incorporation of the Company |
| 3.2 | (8) | Certificate of Amendment of Certificate of Incorporation of the Company |
| 3.3 | (11) | Certificate of Amendment of Certificate of Incorporation of the Company |
| 3.4 | (14) | Certificate of Amendment of Certificate of Incorporation of the Company |
| 3.5 | (12) | Amended and Restated Bylaws of the Company |
| 4.1 | (12) | Specimen certificate representing the Common Stock of the Company |
| 4.2 | (12) | Stockholder Rights Plan |
| 4.3 | (6) | Amendment No.1 to Stockholder Rights Plan |
| 4.4 | (9) | Amendment No.2 to Stockholder Rights Plan |
| 10.1 | (13)* | Amended and Restated 1995 Stock Plan |
| 10.2 | (13)* | Amended and Restated 1995 Non-Employee Director Stock Option Plan |
| 10.3 | (12) | Information Technology Services Contract between the Company and Electronic Data Systems, Inc., dated September 20, 1995 |
| 10.4 | (1) | Lease Agreement between the Company and John Hancock Mutual Life Insurance Company, dated November 13, 1995, for the premises located at 200 Clarendon Street, Boston, Massachusetts |
| 10.5 | (16)* | 1997 Employee Stock Purchase Plan, as amended. |
| 10.6 | (2) | Amended and Restated Declaration of Trust among the Company and the Trustees named therein, dated January 31, 1997 |
| 10.7 | (2) | Indenture between the Company and The Bank of New York, dated January 31, 1997 |
| 10.8 | (2) | Common Securities Guarantee Agreement by the Company as Guarantor, dated January 31, 1997 |
| 10.9 | (2) | Capital Securities Guarantee Agreement between the Company as Guarantor and The Bank of New York as Capital Securities Guarantee Trustee, dated January 31, 1997 |
| | | |
| 10.10 | (10) | First Amendment, effective January 1, 2000 to Information Technology Services Contract between the Company and Electronic Data Systems, Inc. dated September 20, 1995 |
| 10.11 | (10)* | Amended and Restated Employment Agreement between the Company and Kevin Sheehan |
| 10.12 | (10)* | Change of Control Employment Agreement between the Company and Kevin Sheehan |
| 10.13 | (10)* | Amended and Restated Employment Agreement between the Company and Michael Rogers |
| 10.14 | (10)* | Change of Control Employment Agreement between the Company and Michael Rogers |
| 10.15 | (10)* | Amended and Restated Employment Agreement between the Company and Edmund Maroney |
| 10.16 | (10)* | Change of Control Employment Agreement between the Company and Edmund Maroney |
| 10.17 | (10)* | Amended and Restated Employment Agreement between the Company and Robert Mancuso |
| 10.18 | (10)* | Change of Control Employment Agreement between the Company and Robert Mancuso |
| 10.19 | (10)* | Amended and Restated Employment Agreement between the Company and John Henry |
| 10.20 | (10)* | Change of Control Employment Agreement between the Company and John Henry |
| 10.21 | (12)* | Change of Control Employment Agreement between the Company and John N. Spinney, Jr. |
| 10.22 | (13)* | Employment Agreement between the Company and John N. Spinney, Jr. |
| 10.23 | (16) | Information Technology Services Agreement dated July 1, 2004 between the Company and International Business Machines Corporation. |
| 10.24 | * | Stock Option Agreement dated November 15, 2004 between the Company and Kevin J. Sheehan |
| 10.25 | * | Stock Option Agreement dated November 15, 2004 between the Company and Kevin J. Sheehan |
| 10.26 | * | Stock Option Agreement dated November 15, 2004 between the Company and Michael F. Rogers |
| 10.27 | * | Stock Option Agreement dated November 15, 2004 between the Company and Michael F. Rogers |
| | | |
10.33(10)* | | Stock Option Agreement dated November 15, 2004 between the Company and Robert D. Mancuso |
10.34(12)** | | Amended and Restated Trust 3000 Service Agreement between the Company and SEI Investments Company dated July 1, 2004. |
10.35(12) | | Lease agreement between the Company and Copley Place Associates, LLC dated August 2, 1999, as amended. |
21.1 | | Subsidiaries of the Company |
23.1 | | Consent of Deloitte & Touche LLP |
24.1 | | Power of Attorney (see Power of Attorney and Signature Page of this Report). |
31.1 | | Certificate of Kevin J. Sheehan, Chief Executive Officer |
31.2 | | Certificate of John N. Spinney, Jr., Chief Financial Officer |
32.1 | | Certification of Kevin J. Sheehan, Chief Executive Officer, and John N. Spinney, Jr., Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| 10.28 | * | Stock Option Agreement dated November 15, 2004 between the Company and Edmund J. Maroney |
| 10.29 | * | Stock Option Agreement dated November 15, 2004 between the Company and Edmund J. Maroney |
| 10.30 | * | Stock Option Agreement dated November 15, 2004 between the Company and John N. Spinney, Jr. |
| 10.31 | * | Stock Option Agreement dated November 15, 2004 between the Company and Robert D. Mancuso |
| 21.1 | (15) | Subsidiaries of the Company |
| 23.1 | | Consent of Deloitte & Touche LLP |
| 24.1 | (15) | Power of Attorney |
| 31.1 | | Certificate of Kevin J. Sheehan, Chief Executive Officer |
| 31.2 | | Certificate of John N. Spinney, Jr., Chief Financial Officer |
| 32.1 | | Certification of Kevin J. Sheehan, Chief Executive Officer, and John N. Spinney, Jr., Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
(1)
- Previously filed as an exhibit to Form 10-K for the fiscal year ended October 31, 1995.
(2)
- Previously filed as an exhibit to Form 10-K for the fiscal year ended December 31, 1996 (File No. 000-26996).
(3)
Previously filed as an exhibit to Form 10-K for the fiscal year ended December 31, 1997.
(4)Previously filed as an exhibit to Form 10-K for the fiscal year ended December 31, 1998.
(5)Previously filed as an exhibit to the Company's Registration Statement on Form S-3 (File No. 333-58031)
(6)Previously filed as an exhibit to Form 10-Q for the fiscal quarter ended June 30, 1998.
(7)Previously filed as an exhibit to the Company's Current Report on Form 8-K filed with the Commission on August 19, 1998.
(8)- Previously filed as an exhibit to Form 10-Q for the fiscal quarter ended March 31, 2000.
(9)Previously filed as an Exhibit to the Company's Current Report on Form 8-K filed with the Commission on September 25, 2000.
(10) (4) Previously filed as an exhibit to Form 10-K for the fiscal year ended December 31, 2000.
(11) (5) Previously filed as an exhibit to the Company'sCompany’s Registration Statement on Form S-8 filed with the Commission on November 5, 2001 (File No. 333-72786).
(12) (6) Previously filed as an exhibit to Form 10-K for the fiscal year ended December 31, 2001.
(13) (7) Previously filed as an exhibit to Form 10-K for the fiscal year ended December 31, 2002.
(14) (8) Previously filed as an exhibit to Form 10-Q for the fiscal quarter ended June 30, 2003.
(15)Previously filed as an exhibit to Form 10-K for the fiscal year ended December 31, 2003 and filed with the Commission on February 20, 2004.
(16) (9) Previously filed as an exhibit to Form 10-Q for the fiscal quarter ended June 30, 2004.
(10) Previously filed as an exhibit to Form 10-K for the fiscal year ended December 31, 2004.
(11) Previously filed as an exhibit to Form 10-Q for the fiscal quarter ended March 31, 2005.
(12) Previously filed as an exhibit to Form 10-K for the fiscal year ended December 31, 2005.
(13) Previously filed as an exhibit to Form 8-K filed on February 6, 2007.
*
- Indicates a management contract or a compensatory plan, contract or arrangement.
** Confidential treatment requested pursuant to rule 24b-2 promulgated under the Securities Exchange Act of 1934.
(b) Exhibits.
The Company hereby files as part of this Form 10-K the exhibits listed in Item 15(a)(3) above. Exhibits which are incorporated herein by reference can be inspected and copied at the public reference facilities maintained by the Securities and Exchange Commission, 450 Fifth Street, N.W., Room 1024, Washington, D.C.
(d)(c)
- Financial Statement Schedules.
None.
59
SIGNATURES
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in Boston, Massachusetts on the 2826th day of February, 2005.2007.
| | INVESTORS FINANCIAL SERVICES CORP. |
|
|
By: |
/s/ KEVIN J. SHEEHAN
|
| | | Kevin J. Sheehan
|
| | | Chief Executive Officer and
Chairman of the Board |
POWER OF ATTORNEY AND SIGNATURES
We, the undersigned officers and directors of Investors Financial Services Corp., hereby severally constitute and appoint Kevin J. Sheehan and Michael F. Rogers, and each of them singly, our true and lawful attorneys, with full power to them and each of them singly, to sign for us in our names in the capacities indicated below, all amendments to this report, and generally to do all things in our names and on our behalf in such capacities to enable Investors Financial Services Corp. to comply with the provisions of the Securities Exchange Act of 1934, as amended, and all requirements of the Securities and Exchange Commission.
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed by the following persons in the capacities indicated on the 2826th day of February, 2005.2007.
| | Signature
| | |
|
|
| Title(s)
|
|---|
|
|
|
/s/ KEVIN J. SHEEHAN
Kevin J. Sheehan | | Chief Executive Officer and Chairman of the Board (Principal |
Kevin J. Sheehan | | (Principal Executive Officer); Director |
/s/ MICHAEL F. ROGERS
| | President |
Michael F. Rogers |
|
President |
/s/ JOHN N. SPINNEY, JR.
John N. Spinney, Jr. |
|
Senior Vice President and Chief Financial Officer (Principal |
John N. Spinney, Jr. | | (Principal Financial Officer and Principal Accounting Officer) |
/s/ ROBERT B. FRASER
Robert B. FraserRICHARD P. BOYATZI |
|
Director |
/s/ DONALD G. FRIEDL
Donald G. FriedlRichard P. Boyatzi |
|
Director |
| | |
/s/ JAMES M. OATES
James M. Oates |
|
Director |
/s/ PHYLLIS S. SWERSKY
Phyllis S. Swersky |
|
Director |
/s/ THOMAS P. MCDERMOTT
Thomas P. McDermott |
|
Director |
/s/ FRANK B. CONDON, JR.
| | Director |
Frank B. Condon, Jr. |
|
Director |
/s/ EDWARD F. HINES
Edward F. Hines |
|
Director |
/s/ THOMAS P. MCDERMOTT | | Director |
Thomas P. McDermott | | |
/s/ JAMES M. OATES | | Director |
James M. Oates | | |
/s/ JOHN I. SNOW III | | Director |
John I. Snow III | | |
/s/ PHYLLIS S. SWERSKY | | Director |
Phyllis S. Swersky | | |
61
INVESTORS FINANCIAL SERVICES CORP.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
| | | |
|
| Page
|
|
|---|
Report of Independent Registered Public Accounting Firm | | F-2 |
Consolidated Balance Sheets as of December 31, 20042006 and December 31, 20032005 |
|
F-3 |
Consolidated Statements of Income and Comprehensive Income for the Years Ended December 31, 2004, 20032006, 2005 and 20022004 |
|
F-4 |
Consolidated Statements of Stockholders'Stockholders’ Equity for the Years Ended December 31, 2004, 20032006, 2005 and 20022004 |
|
F-5 |
Consolidated Statements of Cash Flows for the Years Ended December 31, 2004, 20032006, 2005 and 20022004 |
|
F-6 |
Notes to Consolidated Financial Statements |
|
F-7 |
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
of Investors Financial Services Corp.
We have audited the accompanying consolidated balance sheets of Investors Financial Services Corp. and subsidiaries (collectively the "Company"(the “Company”) as of December 31, 20042006 and 2003,2005, and the related consolidated statements of income and comprehensive income, stockholders'stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2004.2006. These financial statements are the responsibility of the Company'sCompany’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the CompanyInvestors Financial Services Corp. at December 31, 20042006 and 2003,2005, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2004,2006, in conformity with accounting principles generally accepted in the United States of America.
As noteddiscussed in Note 102 to the consolidated financial statements, effective OctoberJanuary 1, 2003,2006, the Company adopted the provisions of FASB InterpretationStatement of Financial Accounting Standards No. 46, "Consolidation123 (revised 2004), Share-Based Payment. Also as discussed in Note 2 to the consolidated financial statements, effective December 31, 2006, the Company adopted the provisions of Variable Interest Entities, an InterpretationStatement of Financial Accounting Research Bulletin ("ARB") 51."Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company'sCompany’s internal control over financial reporting as of December 31, 2004,2006, based on the criteria established inInternal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 28, 200526, 2007 expressed an unqualified opinion on management'smanagement’s assessment of the effectiveness of the Company'sCompany’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Company'sCompany’s internal control over financial reporting.
/s/ DELOITTE & TOUCHE LLP
Boston, Massachusetts
February 28, 2005
26, 2007
F-2
INVESTORS FINANCIAL SERVICES CORP.
CONSOLIDATED BALANCE SHEETS
December 31, 20042006 and 2003
(Dollars2005 (Dollars in thousands, except per share data)
| | December 31,
2004
| | December 31,
2003
| |
|---|
| ASSETS | | | | | | | |
Cash and due from banks |
|
$ |
49,059 |
|
$ |
39,689 |
|
| Securities held to maturity (fair value of $5,937,462 and $4,308,578 at December 31, 2004 and 2003, respectively) (Note 3) | | | 5,942,717 | | | 4,306,216 | |
| Securities available for sale (Note 3) | | | 4,565,505 | | | 4,296,637 | |
| Nonmarketable equity securities (Note 3) | | | 50,000 | | | 50,000 | |
| Loans, less allowance for loan losses of $100 at December 31, 2004 and 2003 (Note 4) | | | 134,530 | | | 199,530 | |
| Accrued interest and fees receivable | | | 89,292 | | | 72,816 | |
| Equipment and leasehold improvements, less accumulated depreciation of $61,017 and $47,683 at December 31, 2004 and 2003, respectively (Note 5) | | | 67,883 | | | 76,420 | |
| Goodwill | | | 79,969 | | | 79,969 | |
| Other assets | | | 188,870 | | | 101,901 | |
| | |
| |
| |
| TOTAL ASSETS | | $ | 11,167,825 | | $ | 9,223,178 | |
| | |
| |
| |
LIABILITIES AND STOCKHOLDERS' EQUITY |
|
|
|
|
|
|
|
LIABILITIES: |
|
|
|
|
|
|
|
| Deposits (Note 6): | | | | | | | |
| | Demand | | $ | 690,308 | | $ | 334,823 | |
| | Savings | | | 4,448,405 | | | 3,682,295 | |
| | Time | | | 257,669 | | | 190,000 | |
| | |
| |
| |
| | | Total deposits | | | 5,396,382 | | | 4,207,118 | |
| Securities sold under repurchase agreements (Note 7) | | | 4,255,497 | | | 3,258,001 | |
| Short-term and other borrowings (Note 8) | | | 594,681 | | | 1,098,087 | |
| Due to brokers for open trades payable | | | 5,475 | | | — | |
| Junior subordinated deferrable interest debentures (Note 10) | | | 24,774 | | | 24,774 | |
| Accrued taxes and other expenses | | | 54,967 | | | 52,222 | |
| Other liabilities | | | 123,787 | | | 42,719 | |
| | |
| |
| |
| | | Total liabilities | | | 10,455,563 | | | 8,682,921 | |
| | |
| |
| |
Commitments and contingencies (Note 16) |
|
|
|
|
|
|
|
STOCKHOLDERS' EQUITY: |
|
|
|
|
|
|
|
| Preferred stock, par value $0.01 (shares authorized: 1,000,000; issued and outstanding: none in 2004 and 2003) | | | — | | | — | |
| Common stock, par value $0.01 (shares authorized: 175,000,000 and 100,000,000 in 2004 and 2003, respectively; issued and outstanding: 66,595,349 and 65,436,788 in 2004 and 2003, respectively) | | | 667 | | | 655 | |
| Surplus | | | 272,536 | | | 242,662 | |
| Deferred compensation | | | (572 | ) | | (1,076 | ) |
| Retained earnings | | | 418,034 | | | 280,701 | |
| Accumulated other comprehensive income, net | | | 23,888 | | | 17,865 | |
| Treasury stock, at cost (73,235 and 26,508 shares in 2004 and 2003, respectively) | | | (2,291 | ) | | (550 | ) |
| | |
| |
| |
| | | Total stockholders' equity | | | 712,262 | | | 540,257 | |
| | |
| |
| |
| TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY | | $ | 11,167,825 | | $ | 9,223,178 | |
| | |
| |
| |
| | December 31, | | December 31, | |
| | 2006 | | 2005 | |
Assets | | | | | | | | | |
Cash and due from banks | | | $ | 92,776 | | | | $ | 60,743 | | |
Interest-bearing deposits with other banks | | | 21,218 | | | | 18,894 | | |
Other short-term investments | | | 1,971 | | | | — | | |
Federal funds sold | | | 300,000 | | | | — | | |
Securities held to maturity (including securities pledged of $4,096,013 and $4,529,421 at December 31, 2006 and 2005, respectively) (approximate fair value of $5,508,788 and $6,725,729 at December 31, 2006 and 2005, respectively) (Note 3) | | | 5,532,330 | | | | 6,761,930 | | |
Securities available for sale (including securities pledged of $3,071,503 and $2,997,958 at December 31, 2006 and 2005, respectively) (Note 3) | | | 4,799,740 | | | | 4,369,720 | | |
Nonmarketable equity securities (Note 3) | | | 40,054 | | | | 51,251 | | |
Loans, less allowance for loan losses of $100 at December 31, 2006 and 2005 (Note 4) | | | 270,693 | | | | 402,370 | | |
Accrued interest and fees receivable | | | 134,748 | | | | 119,583 | | |
Equipment and leasehold improvements, less accumulated depreciation of $64,290 and $59,156 at December 31, 2006 and 2005, respectively (Note 5) | | | 113,287 | | | | 69,401 | | |
Goodwill, net | | | 79,969 | | | | 79,969 | | |
Other assets | | | 171,420 | | | | 154,873 | | |
Total Assets | | | $ | 11,558,206 | | | | $ | 12,088,734 | | |
Liabilities and Stockholders’ Equity | | | | | | | | | |
Liabilities: | | | | | | | | | |
Deposits (Note 6): | | | | | | | | | |
Demand | | | $ | 695,821 | | | | $ | 537,558 | | |
Savings | | | 4,924,735 | | | | 4,224,908 | | |
Time | | | 524,386 | | | | 230,124 | | |
Total deposits | | | 6,144,942 | | | | 4,992,590 | | |
Securities sold under repurchase agreements (Note 7) | | | 3,727,800 | | | | 4,797,868 | | |
Short-term and other borrowings (Note 8) | | | 517,051 | | | | 1,356,649 | | |
Due to brokers for open trades payable | | | 26,359 | | | | 21,293 | | |
Junior subordinated deferrable interest debentures (Note 10) | | | 24,774 | | | | 24,774 | | |
Accrued expenses | | | 77,821 | | | | 37,418 | | |
Other liabilities | | | 100,721 | | | | 85,284 | | |
Total liabilities | | | 10,619,468 | | | | 11,315,876 | | |
Commitments and contingencies (Note 16) | | | — | | | | — | | |
Stockholders’ Equity: | | | | | | | | | |
Preferred stock, par value $0.01 (shares authorized: 1,000,000; issued: none at December 31, 2006 and 2005) | | | — | | | | — | | |
Common stock, par value $0.01 (shares authorized: 175,000,000; issued: 68,523,129 and 67,177,306 at December 31, 2006 and 2005, respectively) | | | 685 | | | | 672 | | |
Surplus | | | 334,929 | | | | 286,265 | | |
Deferred compensation | | | — | | | | (311 | ) | |
Retained earnings | | | 720,433 | | | | 572,549 | | |
Accumulated other comprehensive loss, net | | | (14,514 | ) | | | (13,369 | ) | |
Treasury stock, at cost (2,895,021 and 2,124,669 shares at December 31, 2006 and 2005, respectively) | | | (102,795 | ) | | | (72,948 | ) | |
Total stockholders’ equity | | | 938,738 | | | | 772,858 | | |
Total Liabilities and Stockholders’ Equity | | | $ | 11,558,206 | | | | $ | 12,088,734 | | |
See Notes to Consolidated Financial Statements.
F-3
INVESTORS FINANCIAL SERVICES CORP.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
Years Ended December 31, 2006, 2005 and 2004 2003 and 2002
(Dollars(Dollars in thousands, except per share data)
| | December 31,
2004
| | December 31,
2003
| | December 31,
2002
| | |
|---|
| FEES AND OTHER REVENUE: | | | | | | | | |
| Asset servicing fees: | | | | | | | | |
| | Core service fees | | $ | 314,272 | | $ | 254,225 | | $ | 231,520 | | | December 31, | | December 31, | | December 31, | |
| | Ancillary service fees | | 108,928 | | 79,361 | | 64,875 | | | 2006 | | 2005 | | 2004 | |
| | |
| |
| |
| | |
| | | Total asset servicing fees | | 423,200 | | 333,586 | | 296,395 | | |
| | |
| |
| |
| | |
| | Other operating income | | 2,057 | | 2,607 | | 2,449 | | |
| | Gain on sale of investment | | 234 | | — | | — | | |
| | |
| |
| |
| | |
| | | Total fees and other revenue | | 425,491 | | 336,193 | | 298,844 | | |
| | |
| |
| |
| | |
| | Interest income | | 313,149 | | 247,094 | | 245,526 | | |
| | Interest expense | | 125,469 | | 93,180 | | 106,801 | | |
| | |
| |
| |
| | |
| | | Net interest income | | 187,680 | | 153,914 | | 138,725 | | |
| | |
| |
| |
| | |
| | | Net operating revenue | | 613,171 | | 490,107 | | 437,569 | | |
| | |
| |
| |
| | |
| OPERATING EXPENSES: | | | | | | | | |
Fees and Other Revenue: | | | | | | | | | | | | | | |
Asset servicing fees: | | | | | | | | | | | | | | |
Core service fees | | | | $ | 453,573 | | | | $ | 375,596 | | | | $ | 314,272 | | |
Value-added service fees | | | | 177,667 | | | | 133,463 | | | | 108,928 | | |
Total asset servicing fees | | | | 631,240 | | | | 509,059 | | | | 423,200 | | |
Other operating income | | | | 5,691 | | | | 4,081 | | | | 2,057 | | |
Gain on sale of investments | | | | 2,523 | | | | 12,397 | | | | 234 | | |
Total fees and other revenue | | | | 639,454 | | | | 525,537 | | | | 425,491 | | |
Interest income | | | | 557,749 | | | | 447,705 | | | | 313,149 | | |
Interest expense | | | | 393,555 | | | | 277,280 | | | | 125,469 | | |
Net interest income | | | | 164,194 | | | | 170,425 | | | | 187,680 | | |
Net operating revenue | | | | 803,648 | | | | 695,962 | | | | 613,171 | | |
Operating Expenses: | | | | | | | | | | | | | | |
| Compensation and benefits | Compensation and benefits | | 205,728 | | 186,932 | | 192,785 | | | | 327,342 | | | | 250,459 | | | | 205,728 | | |
| Technology and telecommunications | Technology and telecommunications | | 49,816 | | 38,914 | | 42,190 | | | | 73,909 | | | | 54,732 | | | | 49,816 | | |
| Transaction processing services | Transaction processing services | | 42,159 | | 33,299 | | 33,713 | | | | 61,396 | | | | 49,873 | | | | 42,159 | | |
Occupancy | | | | 33,653 | | | | 26,490 | | | | 29,032 | | |
| Depreciation and amortization | Depreciation and amortization | | 32,124 | | 27,971 | | 16,357 | | | | 32,819 | | | | 31,578 | | | | 32,124 | | |
| Occupancy | | 29,032 | | 29,218 | | 25,602 | | |
| Professional fees | Professional fees | | 15,346 | | 11,189 | | 11,829 | | | | 13,845 | | | | 13,380 | | | | 15,346 | | |
| Travel and sales promotion | Travel and sales promotion | | 5,470 | | 4,822 | | 5,819 | | | | 8,883 | | | | 6,825 | | | | 5,470 | | |
| Insurance | Insurance | | 4,625 | | 3,203 | | 945 | | | | 3,929 | | | | 4,219 | | | | 4,625 | | |
Losses and loss adjustment expenses | | | | 30 | | | | 5,837 | | | | 924 | | |
| Other operating expenses | Other operating expenses | | 14,083 | | 9,373 | | 12,155 | | | | 23,548 | | | | 16,716 | | | | 13,159 | | |
| | |
| |
| |
| | |
| | | Total operating expenses | | 398,383 | | 344,921 | | 341,395 | | |
| | |
| |
| |
| | |
| INCOME BEFORE INCOME TAXES | | 214,788 | | 145,186 | | 96,174 | | |
Total operating expenses | | | | 579,354 | | | | 460,109 | | | | 398,383 | | |
Income Before Income Taxes | | | | 224,294 | | | | 235,853 | | | | 214,788 | | |
| Provision for income taxes (Note 9) | Provision for income taxes (Note 9) | | 72,826 | | 52,765 | | 28,737 | | | | 70,491 | | | | 76,035 | | | | 72,826 | | |
| | |
| |
| |
| | |
| NET INCOME | | $ | 141,962 | | $ | 92,421 | | $ | 67,437 | | |
| | |
| |
| |
| | |
| BASIC EARNINGS PER SHARE | | $ | 2.15 | | $ | 1.42 | | $ | 1.05 | | |
| | |
| |
| |
| | |
| DILUTED EARNINGS PER SHARE | | $ | 2.09 | | $ | 1.39 | | $ | 1.02 | | |
| | |
| |
| |
| | |
| COMPREHENSIVE INCOME: | | | | | | | | |
Net Income | | | | $ | 153,803 | | | | $ | 159,818 | | | | $ | 141,962 | | |
Basic Earnings Per Share | | | | $ | 2.34 | | | | $ | 2.42 | | | | $ | 2.15 | | |
Diluted Earnings Per Share | | | | $ | 2.28 | | | | $ | 2.37 | | | | $ | 2.09 | | |
Weighted-Average Basic Shares | | | | 65,730,456 | | | | 66,139,323 | | | | 66,179,286 | | |
Weighted-Average Diluted Shares | | | | 67,493,081 | | | | 67,473,804 | | | | 67,916,217 | | |
Comprehensive Income: | | | | | | | | | | | | | | |
| Net income | Net income | | $ | 141,962 | | $ | 92,421 | | $ | 67,437 | | | | $ | 153,803 | | | | $ | 159,818 | | | | $ | 141,962 | | |
| Other comprehensive income (Note 12): | | | | | | | | |
| | Net unrealized investment (loss) gain | | (7,854 | ) | | (12,963 | ) | | 31,944 | | |
| | Net unrealized derivative instrument gain (loss) | | 13,031 | | 12,019 | | (9,516 | ) | |
| | Cumulative translation adjustment | | 846 | | 577 | | — | | |
| | |
| |
| |
| | |
| | | Other comprehensive income (loss) | | 6,023 | | (367 | ) | | 22,428 | | |
| | |
| |
| |
| | |
Other comprehensive income (loss) (Note 12): | | | | | | | | | | | | | | |
Net unrealized investment gain (loss) | | | | 10,695 | | | | (46,054 | ) | | | (7,854 | ) | |
Net unrealized derivative instrument (loss) gain | | | | (6,525 | ) | | | 8,745 | | | | 13,031 | | |
Cumulative translation adjustment | | | | 1,444 | | | | 52 | | | | 846 | | |
Other comprehensive income (loss) | | | | 5,614 | | | | (37,257 | ) | | | 6,023 | | |
| Comprehensive income | Comprehensive income | | $ | 147,985 | | $ | 92,054 | | $ | 89,865 | | | | $ | 159,417 | | | | $ | 122,561 | | | | $ | 147,985 | | |
| | |
| |
| |
| | |
See Notes to Consolidated Financial Statements.
F-4
INVESTORS FINANCIAL SERVICES CORP.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS'STOCKHOLDERS’ EQUITY
Years Ended December 31, 2006, 2005, and 2004 2003, and 2002
(Dollars(Dollars in thousands, except per share data)
| | | December 31, | | December 31, | | December 31, | |
| | December 31,
2004
| | December 31,
2003
| | December 31,
2002
| | | 2006 | | 2005 | | 2004 | |
|---|
| Common shares | | | | | | | | | | | | | | | | | | | | |
| Balance, beginning of year | | 65,436,788 | | 64,775,042 | | 31,971,404 | | | | 67,177,306 | | | | 66,668,584 | | | | 65,463,296 | | |
| Exercise of stock options | | 1,114,051 | | 548,069 | | 490,827 | | | | 1,211,518 | | | | 394,018 | | | | 1,114,051 | | |
| Common stock issuance | | 91,237 | | 129,371 | | 143,889 | | | | 134,305 | | | | 114,704 | | | | 91,237 | | |
| Common stock repurchased | | (46,727 | ) | | (15,694 | ) | | — | | |
| Stock dividend, two-for-one split | | — | | — | | 32,168,922 | | |
| | |
| |
| |
| | |
| Balance, end of year | | 66,595,349 | | 65,436,788 | | 64,775,042 | | | | 68,523,129 | | | | 67,177,306 | | | | 66,668,584 | | |
| | |
| |
| |
| | |
| Treasury shares | | | | | | | | | | | | | | | | | | | | |
| Balance, beginning of year | | 26,508 | | 10,814 | | 10,814 | | | | 2,124,669 | | | | 73,235 | | | | 26,508 | | |
| Common stock repurchased | | 46,727 | | 15,694 | | — | | | | 770,352 | | | | 2,051,434 | | | | 46,727 | | |
| | |
| |
| |
| | |
| Balance, end of year | | 73,235 | | 26,508 | | 10,814 | | | | 2,895,021 | | | | 2,124,669 | | | | 73,235 | | |
| | |
| |
| |
| | |
| Common stock | | | | | | | | | | | | | | | | | | | | |
| Balance, beginning of year | | $ | 655 | | $ | 648 | | $ | 320 | | | | $ | 672 | | | | $ | 667 | | | | $ | 655 | | |
| Exercise of stock options | | 12 | | 6 | | 5 | | | | 12 | | | | 4 | | | | 12 | | |
| Common stock issuance | | — | | 1 | | 1 | | | | 1 | | | | 1 | | | | — | | |
| Stock dividend, two-for-one split | | — | | — | | 322 | | |
| | |
| |
| |
| | |
| Balance, end of year | | $ | 667 | | $ | 655 | | $ | 648 | | | | $ | 685 | | | | $ | 672 | | | | $ | 667 | | |
| | |
| |
| |
| | |
| Surplus | | | | | | | | | | | | | | | | | | | | |
| Balance, beginning of year | | $ | 242,662 | | $ | 233,337 | | $ | 222,440 | | | | $ | 286,265 | | | | $ | 272,536 | | | | $ | 242,662 | | |
| Exercise of stock options | | 16,056 | | 2,971 | | 2,864 | | |
| Tax benefit from stock options | | 10,651 | | 3,008 | | 4,152 | | |
Share-based awards and exercise of stock options | | | | 37,407 | | | | 7,775 | | | | 16,056 | | |
Tax benefit from exercise of stock options | | | | 6,431 | | | | 2,087 | | | | 10,651 | | |
| Common stock issuance | | 3,355 | | 3,386 | | 3,881 | | | | 4,826 | | | | 3,867 | | | | 3,355 | | |
Transfer of deferred compensation to surplus | | | | (311 | ) | | | — | | | | — | | |
Amortization of deferred compensation | | | | 311 | | | | — | | | | — | | |
| Stock option forfeiture | | (188 | ) | | (40 | ) | | — | | | | — | | | | — | | | | (188 | ) | |
| | |
| |
| |
| | |
| Balance, end of year | | $ | 272,536 | | $ | 242,662 | | $ | 233,337 | | | | $ | 334,929 | | | | $ | 286,265 | | | | $ | 272,536 | | |
| | |
| |
| |
| | |
| Deferred compensation | | | | | | | | | | | | | | | | | | | | |
| Balance, beginning of year | | $ | (1,076 | ) | $ | (1,599 | ) | $ | (2,563 | ) | | | $ | (311 | ) | | | $ | (572 | ) | | | $ | (1,076 | ) | |
Transfer of deferred compensation to surplus | | | | 311 | | | | — | | | | — | | |
Amortization of deferred compensation | | | | — | | | | 261 | | | | 316 | | |
| Stock option forfeiture | | 188 | | 40 | | — | | | | — | | | | — | | | | 188 | | |
| Amortization of deferred compensation | | 316 | | 483 | | 964 | | |
| | |
| |
| |
| | |
| Balance, end of year | | $ | (572 | ) | $ | (1,076 | ) | $ | (1,599 | ) | | | $ | — | | | | $ | (311 | ) | | | $ | (572 | ) | |
| | |
| |
| |
| | |
| Retained earnings | | | | | | | | | | | | | | | | | | | | |
| Balance, beginning of year | | $ | 280,701 | | $ | 192,184 | | $ | 128,288 | | | | $ | 572,549 | | | | $ | 418,034 | | | | $ | 280,701 | | |
| Net income | | 141,962 | | 92,421 | | 67,437 | | | | 153,803 | | | | 159,818 | | | | 141,962 | | |
| Stock dividend, two-for-one split | | — | | — | | (322 | ) | |
| Cash dividend, $0.07, $0.06 and $0.05 per share in the years ended December 31, 2004, 2003 and 2002, respectively | | (4,629 | ) | | (3,904 | ) | | (3,219 | ) | |
| | |
| |
| |
| | |
Cash dividend, $0.09, $0.08 and $0.07 per share in the years ended December 31, 2006, 2005 and 2004, respectively | | | | (5,919 | ) | | | (5,303 | ) | | | (4,629 | ) | |
| Balance, end of year | | $ | 418,034 | | $ | 280,701 | | $ | 192,184 | | | | $ | 720,433 | | | | $ | 572,549 | | | | $ | 418,034 | | |
| | |
| |
| |
| | |
| Accumulated other comprehensive income (loss), net | | | | | | | | |
Accumulated other comprehensive (loss) income, net | | | | | | | | | | | | | | |
| Balance, beginning of year | | $ | 17,865 | | $ | 18,232 | | $ | (4,196 | ) | | | $ | (13,369 | ) | | | $ | 23,888 | | | | $ | 17,865 | | |
| Net unrealized investment (loss) gain | | (7,854 | ) | | (12,963 | ) | | 31,944 | | |
| Net unrealized derivative instrument gain (loss) | | 12,973 | | 11,785 | | (11,129 | ) | |
| Amortization of transition-related adjustment | | — | | 234 | | 1,613 | | |
Net unrealized investment gain (loss) | | | | 11,773 | | | | (46,054 | ) | | | (7,854 | ) | |
Net unrealized derivative instrument (loss) gain | | | | (5,184 | ) | | | 10,473 | | | | 12,990 | | |
| Amortization of terminated interest rate swap agreements | | 58 | | — | | — | | | | (1,341 | ) | | | (1,728 | ) | | | 41 | | |
| Effect of foreign currency translation | | 846 | | 577 | | — | | |
| | |
| |
| |
| | |
Adjustment to initially apply SFAS 158 | | | | (7,837 | ) | | | — | | | | — | | |
Cumulative translation adjustment | | | | 1,444 | | | | 52 | | | | 846 | | |
| Balance, end of year | | $ | 23,888 | | $ | 17,865 | | $ | 18,232 | | | | $ | (14,514 | ) | | | $ | (13,369 | ) | | | $ | 23,888 | | |
| | |
| |
| |
| | |
| Treasury stock | | | | | | | | | | | | | | | | | | | | |
| Balance, beginning of year | | $ | (550 | ) | $ | — | | $ | — | | | | $ | (72,948 | ) | | | $ | (2,291 | ) | | | $ | (550 | ) | |
| Common stock repurchased (46,727 shares at an average price of $37.24 in 2004 and 15,694 shares at an average price of $35.07 in 2003) | | (1,741 | ) | | (550 | ) | | — | | |
| | |
| |
| |
| | |
Common stock repurchased (770,352 shares at an average price of $38.74, 2,051,434 shares at an average price of $34.44, and 46,727 shares at an average price of $37.24 in the years ended December 31, 2006, 2005, and 2004, respectively) | | | | (29,847 | ) | | | (70,657 | ) | | | (1,741 | ) | |
| Balance, end of year | | $ | (2,291 | ) | $ | (550 | ) | $ | — | | | | $ | (102,795 | ) | | | $ | (72,948 | ) | | | $ | (2,291 | ) | |
| | |
| |
| |
| | |
| Total Stockholders' Equity | | $ | 712,262 | | $ | 540,257 | | $ | 442,802 | | |
| | |
| |
| |
| | |
Total Stockholders’ Equity | | | | $ | 938,738 | | | | $ | 772,858 | | | | $ | 712,262 | | |
See Notes to Consolidated Financial Statements.
F-5
INVESTORS FINANCIAL SERVICES CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2006, 2005 and 2004 2003 and 2002
(Dollars(Dollars in thousands)
| | December 31,
2004
| | December 31,
2003
| | December 31,
2002
| |
|---|
| CASH FLOWS FROM OPERATING ACTIVITIES: | | | | | | | | | | |
| Net income | | $ | 141,962 | | $ | 92,421 | | $ | 67,437 | |
| | |
| |
| |
| |
| Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | | | | |
| Equity in undistributed loss of unconsolidated subsidiary | | | 28 | | | 8 | | | — | |
| Depreciation and amortization | | | 32,124 | | | 27,971 | | | 16,357 | |
| Amortization of deferred compensation | | | 316 | | | 483 | | | 964 | |
| Amortization of premiums on securities, net of accretion of discounts | | | 40,743 | | | 39,200 | | | 12,795 | |
| Gain on sale of investment | | | (234 | ) | | — | | | — | |
| Deferred income taxes | | | 2,997 | | | 5,651 | | | 3,972 | |
| Changes in assets and liabilities: | | | | | | | | | | |
| | Accrued interest and fees receivable | | | (16,476 | ) | | (5,555 | ) | | (7,510 | ) |
| | Other assets | | | (89,667 | ) | | (29,878 | ) | | (25,618 | ) |
| | Accrued taxes and other expenses | | | 2,745 | | | 21,465 | | | 2,841 | |
| | Other liabilities | | | 106,795 | | | 6,221 | | | (10,588 | ) |
| | |
| |
| |
| |
| | Net cash provided by operating activities | | | 221,333 | | | 157,987 | | | 60,650 | |
| | |
| |
| |
| |
| CASH FLOWS FROM INVESTING ACTIVITIES: | | | | | | | | | | |
| Proceeds from paydowns/maturities of securities available for sale | | | 1,392,295 | | | 1,608,656 | | | 699,980 | |
| Proceeds from paydowns/maturities of securities held to maturity | | | 1,410,133 | | | 1,902,187 | | | 2,212,594 | |
| Proceeds from sale of securities available for sale | | | 25,041 | | | — | | | — | |
| Purchases of securities available for sale | | | (1,704,293 | ) | | (2,666,066 | ) | | (2,020,022 | ) |
| Purchases of securities held to maturity | | | (3,078,456 | ) | | (2,794,414 | ) | | (2,520,097 | ) |
| Net increase (decrease) in due to brokers for open trades payable | | | 5,475 | | | (286,843 | ) | | — | |
| Net decrease (increase) in loans | | | 65,000 | | | (55,793 | ) | | 88,376 | |
| Purchases of equipment and leasehold improvements | | | (23,559 | ) | | (29,495 | ) | | (48,579 | ) |
| | |
| |
| |
| |
| | Net cash used in investing activities | | | (1,908,364 | ) | | (2,321,768 | ) | | (1,587,748 | ) |
| | |
| |
| |
| |
| CASH FLOWS FROM FINANCING ACTIVITIES: | | | | | | | | | | |
| Net increase (decrease) in demand deposits | | | 355,485 | | | (49,638 | ) | | (122,606 | ) |
| Net increase in time and savings deposits | | | 833,779 | | | 923,838 | | | 1,176,647 | |
| Net increase in securities sold under repurchase agreements | | | 997,496 | | | 956,027 | | | 638,662 | |
| Net (decrease) increase in short-term and other borrowings | | | (503,406 | ) | | 356,980 | | | (169,174 | ) |
| Proceeds from exercise of stock options | | | 16,068 | | | 2,977 | | | 2,869 | |
| Proceeds from issuance of common stock | | | 3,355 | | | 3,387 | | | 3,882 | |
| Common stock repurchase | | | (1,741 | ) | | (550 | ) | | — | |
| Repurchase of company-obligated, mandatorily redeemable, preferred securities of subsidiary trust | | | — | | | — | | | (1,000 | ) |
| Dividends paid to stockholders | | | (4,629 | ) | | (3,904 | ) | | (3,219 | ) |
| | |
| |
| |
| |
| | Net cash provided by financing activities | | | 1,696,407 | | | 2,189,117 | | | 1,526,061 | |
| | |
| |
| |
| |
| EFFECT OF EXCHANGE RATES ON CHANGES IN CASH | | | (6 | ) | | (215 | ) | | — | |
NET INCREASE (DECREASE) IN CASH AND DUE FROM BANKS |
|
|
9,370 |
|
|
25,121 |
|
|
(1,037 |
) |
CASH AND DUE FROM BANKS, BEGINNING OF YEAR |
|
|
39,689 |
|
|
14,568 |
|
|
15,605 |
|
| | |
| |
| |
| |
| CASH AND DUE FROM BANKS, END OF YEAR | | $ | 49,059 | | $ | 39,689 | | $ | 14,568 | |
| | |
| |
| |
| |
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: | | | | | | | | | | |
| | Cash paid for interest | | $ | 121,542 | | $ | 91,858 | | $ | 105,386 | |
| | |
| |
| |
| |
| | Cash paid for income taxes | | $ | 77,819 | | $ | 39,859 | | $ | 24,989 | |
| | |
| |
| |
| |
| SCHEDULE OF NON-CASH INVESTING ACTIVITIES | | | | | | | | | | |
| Change in due to brokers for open trades payable | | $ | — | | $ | — | | $ | 286,843 | |
| | |
| |
| |
| |
| | December 31, | | December 31, | | December 31, | |
| | 2006 | | 2005 | | 2004 | |
Cash Flows From Operating Activities: | | | | | | | | | | | | | |
Net income | | | $ | 153,803 | | | | $ | 159,818 | | | | $ | 141,962 | | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | | | | | | | |
Equity in undistributed loss of unconsolidated subsidiary | | | 28 | | | | 28 | | | | 28 | | |
Depreciation and amortization | | | 32,819 | | | | 31,578 | | | | 32,124 | | |
Share-based compensation | | | 4,538 | | | | — | | | | — | | |
Amortization of deferred compensation | | | — | | | | 261 | | | | 316 | | |
Amortization of premiums on securities, net of accretion of discounts | | | 55,057 | | | | 49,578 | | | | 40,743 | | |
Gain on sale of investments | | | (2,523 | ) | | | (12,397 | ) | | | (234 | ) | |
Excess tax benefit related to share-based compensation | | | (8,017 | ) | | | — | | | | — | | |
Deferred income taxes | | | (390 | ) | | | (6,944 | ) | | | 2,997 | | |
Changes in assets and liabilities: | | | | | | | | | | | | | |
Accrued interest and fees receivable | | | (15,165 | ) | | | (30,291 | ) | | | (16,476 | ) | |
Other assets | | | (17,182 | ) | | | 51,657 | | | | (66,625 | ) | |
Accrued expenses | | | 33,025 | | | | 7,586 | | | | 5,672 | | |
Other liabilities | | | 15,409 | | | | (38,475 | ) | | | 81,040 | | |
Net cash provided by operating activities | | | 251,402 | | | | 212,399 | | | | 221,547 | | |
Cash Flows From Investing Activities: | | | | | | | | | | | | | |
Proceeds from maturities and paydowns of securities available for sale | | | 1,111,359 | | | | 1,400,359 | | | | 1,392,295 | | |
Proceeds from maturities and paydowns of securities held to maturity | | | 1,245,399 | | | | 1,628,989 | | | | 1,410,133 | | |
Proceeds from sale of securities available for sale | | | 134,131 | | | | 376,143 | | | | 25,041 | | |
Proceeds from the redemption of non-marketable equity securities | | | 41,048 | | | | 700 | | | | 328 | | |
Purchases of securities available for sale | | | (1,662,417 | ) | | | (1,649,167 | ) | | | (1,704,293 | ) | |
Purchases of securities held to maturity | | | (67,274 | ) | | | (2,489,882 | ) | | | (3,078,456 | ) | |
Purchases of non-marketable equity securities | | | (29,851 | ) | | | (116 | ) | | | (542 | ) | |
Net increase in due to brokers for open trades payable | | | 5,066 | | | | 15,818 | | | | 5,475 | | |
Net increase in other short-term investments | | | (1,971 | ) | | | — | | | | — | | |
Net increase in Federal funds sold | | | (300,000 | ) | | | — | | | | — | | |
Net decrease (increase) in loans | | | 131,677 | | | | (267,840 | ) | | | 65,000 | | |
Purchases of equipment, leasehold improvements and software | | | (76,677 | ) | | | (33,068 | ) | | | (23,559 | ) | |
Net cash provided by (used in) investing activities | | | 530,490 | | | | (1,018,064 | ) | | | (1,908,578 | ) | |
Cash Flows From Financing Activities: | | | | | | | | | | | | | |
Net increase (decrease) in demand deposits | | | 158,263 | | | | (152,750 | ) | | | 355,485 | | |
Net increase (decrease) in time and savings deposits | | | 994,089 | | | | (251,042 | ) | | | 833,779 | | |
Net (decrease) increase in securities sold under repurchase agreements | | | (1,070,068 | ) | | | 542,371 | | | | 997,496 | | |
Net (decrease) increase in short-term borrowings | | | (839,598 | ) | | | 761,968 | | | | (503,406 | ) | |
Proceeds from exercise of stock options | | | 33,096 | | | | 7,779 | | | | 16,068 | | |
Proceeds from issuance of common stock | | | 4,827 | | | | 3,868 | | | | 3,355 | | |
Common stock repurchase | | | (29,847 | ) | | | (70,657 | ) | | | (1,741 | ) | |
Excess tax benefit related to share-based compensation | | | 8,017 | | | | — | | | | — | | |
Dividends paid to stockholders | | | (5,919 | ) | | | (5,303 | ) | | | (4,629 | ) | |
Net cash (used in) provided by financing activities | | | (747,140 | ) | | | 836,234 | | | | 1,696,407 | | |
Effect of exchange rates on changes in cash | | | (395 | ) | | | 9 | | | | (6 | ) | |
Net Increase In Cash and Due From Banks | | | 34,357 | | | | 30,578 | | | | 9,370 | | |
Cash and Due From Banks, Beginning of Year | | | 79,637 | | | | 49,059 | | | | 39,689 | | |
Cash and Due From Banks, End of Year | | | $ | 113,994 | | | | $ | 79,637 | | | | $ | 49,059 | | |
Supplemental Disclosure of Cash Flow Information: | | | | | | | | | | | | | |
Cash paid for interest | | | $ | 387,190 | | | | $ | 270,121 | | | | $ | 121,542 | | |
Cash paid for income taxes | | | $ | 75,636 | | | | $ | 68,664 | | | | $ | 77,819 | | |
See Notes to Consolidated Financial Statements.
F-6
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2004, 20032006, 2005 and 2002
2004
1. Description of Business
1. DESCRIPTION OF BUSINESS
Investors Financial Services Corp. ("IFSC"(‘IFSC’) provides asset administration services for the financial services industry through its wholly-owned subsidiary, Investors Bank & Trust Company ("(‘the Bank"Bank’). As used herein, the defined term "the Company"“the Company” shall mean IFSC together with the Bank and its domestic and foreign subsidiaries. The Company provides core services and value-added services to a variety of financial asset managers, including mutual fund complexes, investment advisors, family offices, hedge funds, banks and insurance companies. Core services include middle office outsourcing, global custody, multicurrency accounting, fund administration and fund administration.middle office outsourcing. Value-added services include securities lending, foreign exchange, cash management, securities lending, investment advisory, performance measurement, institutional transfer agency, investment advisory services, lines of credit and brokerage and transition management services. The Company is subject to regulation by the Federal Deposit Insurance Corporation, the Federal Reserve Board of Governors (‘FRB’), the Federal Deposit Insurance Corporation (‘FDIC’), the Office of the Commissioner of Banks of the Commonwealth of Massachusetts (‘Commissioner’), the Securities and Exchange Commission ("SEC"(‘SEC’), the National Association of Securities Dealers, Inc. ("NASD"(‘NASD’), the Office of the Superintendent of Financial Institutions in Canada, the Irish Financial Services Regulatory Authority, and the State of Vermont Department of Banking, Insurance, Securities & Health Care Administration.Administration (‘BISHCA’), the Office of the Superintendent of Financial Institutions in Canada (‘OSFI’), the Irish Financial Services Regulatory Authority (‘IFSRA’), the Cayman Islands Monetary Authority (‘CIMA’), the Financial Services Authority in the United Kingdom (‘FSA’) and the Commission de Surveillance du Secteur Financier in Luxembourg (‘CSSF’).
On April 23, 2002,February 4, 2007, the Company entered into an Agreement and Plan of Merger (the ‘Merger Agreement’) with State Street Corporation (‘State Street’). At the closing of the transaction contemplated by the Merger Agreement, the Company will merge into State Street and the Company’s shareholders will receive 0.906 shares of State Street common stock for each share of the Company’s common stock. Each company’s Board of Directors has approved a two-for-one stock splitthe Merger Agreement. The Company expects to complete the transaction in the formthird quarter of a 100% stock dividend2007, subject to stockholderscustomary closing conditions, including regulatory and shareholder approval.
2. Summary of record as of May 24, 2002. All share numbers have been restated to reflect the two-for-one stock split paid June 14, 2002, where applicable.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIESSignificant Accounting Policies
Basis of Presentation—Theconsolidated financial statements include the accounts of the Company and its domestic and foreign subsidiaries. All significant intercompany accounts and transactions have been eliminated.
The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Certain amounts in the prior years'years’ financial statements have been reclassified to conform to the current year'syear’s presentation.
Revenue Recognition
Asset servicing revenue—revenue—The Company recognizes revenue from asset servicing and investment advisory services based on contractual terms signed by the Company'sCompany’s clients. Generally, revenue is
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INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
2. Summary of Significant Accounting Policies (Continued)
accrued by multiplying average or month-end net assets by contracted rates. Asset servicing revenue is considered earned daily as transactions are processed or services are provided.provided and when collectibility is reasonably assured.
Value-added services— revenue—The Company recognizes revenue from its value-added services, such as foreign exchange, securities lending and cash management services,and securities lending, based on the specific type of transaction processed. Value-added services revenue is considered earned daily as transactions are processed or services are provided.provided and when collectibility is reasonably assured.
Interest income—income—The Company recognizes and accrues income on its interest-earning assets as earned using a method which approximates the constant effective yield.yield method.
Cash and Cash Equivalents—For purposes of reporting cash flows and amounts on the consolidated balance sheets, the Company defines cash and cash equivalents to include cash, due from banks, and interest-bearing deposits.deposits with other banks that have original maturities of 90 days or less.
SecuritiesSecurities——TheCompany classifies all equity securities that have readily determinable fair values and all investments in debt securities into one of three categories. Debt securities that the Company has the positive intent and ability to hold to maturity are classified as held to maturity and carried at amortized cost. Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and carried at fair value, with unrealized gains and losses included in earnings. All other debt and equity securities not classified as either held to maturity or trading are classified as available for sale and carried at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income.
NonmarketableNon-marketable securities primarily consist of stock of the Federal Home Loan Bank of Boston ("FHLBB"(‘FHLBB’) and arestock of the Federal Reserve Bank of Boston (‘FRBB’). The FHLBB stock is carried at cost and redeemable at par value. The Company is required to hold this stock under its borrowing arrangement with the FHLBB. The Company was required to purchase stock of the FRBB in connection with its membership with the FRBB.
An investment is considered impaired if the fair value of the investment is less than its cost. The Company's accounting policy forCompany recognizes an impairment requires recognition ofcharge if, based on the facts and circumstances, management determines the impairment to be other than temporary. For example, the Company will record an other than temporary impairment charge on a debt security if it is determined that it is probable that the Company iswill be unable to recover all amounts due under the contractual obligations of the security.
The specific identification method is used to determine gains and losses on sales of securities. Amortization and accretion of debt securities purchased at a premium or discount are amortized or accreted into income byusing a method which approximates the constant effective yield.yield method. The Company applies Statement of Financial Accounting StandardStandards No. 91,Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases ("FAS 91" (‘SFAS 91’) for the amortization of premiums and accretion of discounts. In calculating the effective yield for securities that represent holdings of large numbers of similar loans for which prepayments are probable and the timing and amount of prepayments can be reasonably estimated, prepayments are anticipated using the Company’s actual three-month prepayment experience.
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INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
2. Summary of Significant Accounting Policies (Continued)
The amount of amortization or accretion to recognize in income is driven by the calculation of the constant effective yield. When calculating this yield, the Company assumes that prepayments will continue from the analysis date to the date of the security’s expected maturity at its most recent three-month prepayment rate. The prepayment rate is updated monthly based on the Company’s previous three-month actual prepayment experience.
The Company utilizes three-month prepayment rates to anticipate prepayments because such rates are based on its own actual prepayment experience and because the Company believes three-month rates are a better estimate of future experience than either one-month or six-month or longer rates. In the opinion of management, a one-month rate does not capture enough experience to predict future prepayment behavior and may create undue volatility in interest income due to one-time fluctuations in prepayment activity. Conversely, in the opinion of management, a six-month or longer rate would not capture enough volatility to predict future prepayment behavior.
If a difference arises between the Company’s estimated prepayments and its actual prepayments received, the constant effective yield is recalculated based on the Company’s actual payments to date and anticipated future payments. This monthly recalculation results in the carrying value of the security being adjusted to the amount that would have existed had the new effective yield been applied since the purchase date, and a corresponding charge or credit is recognized to interest income.
For securities that do not represent holdings of large numbers of similar loans for which prepayments are probable and the timing and amount of prepayments can be reasonably estimated, the associated premiums and discounts are amortized or accreted over their contractual term using the constant effective yield. Actual prepayment experience for such securities is reviewed monthly and a proportionate amount of premium or discount is recognized in income at that time such that the effective yield on the remaining portion of the securities continues unchanged.
As of and for the years ended December 31, 2006, 2005 and 2004, the Company anticipated prepayments on its residential mortgage-backed securities. All other securities do not meet the SFAS 91 criteria for anticipating prepayments. Accordingly, no prepayments were anticipated for these securities.
Loans—Intereston loans is credited to income as earned using a method which approximates the effective yield method, and interest is only accrued only if deemed collectible. Accrual of interest on loans is discontinued when management determines that collection of interest is not probable, or when a loan is over 60both greater than 90 days delinquent or if management believes that collectionand the loan’s collateral is not probable. Interest incomesufficient to cover both principal and accrued interest. Accrual of interest is recognizedrestored after all past due principal and interest has been repaidpaid and the Company expects repayment of the remaining contractual principal and interest, or when an improvement in the condition of the loan has occurred that would warrant resumption of interest accruals. Other loan fees and charges, representingincluding service costs for the prepayment of loans, for the delinquent payments or forcharges and other miscellaneous loan services, are recorded as income when collected.
Equipment, Leasehold Improvements and Capitalized Software Costs—Equipmentand leasehold improvements are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are providedrecognized using the straight-line method over the estimated useful lives of the assets which range from three to seven years, and for leasehold improvements over the lesser of the useful life or the life of the lease. For costs incurred to develop computer software for internal use, the Company
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INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
2. Summary of Significant Accounting Policies (Continued)
capitalizes costs incurred during the application and development stage, which includes costs to design the software configuration and interfaces, coding, installation and testing. Costs incurred during the preliminary project along withand post-implementation stages are expensed as incurred. Capitalized software costs are amortized over the estimated useful life onof the project, which can range from three to five years.
Long-Lived Assets—Long-lived assets to be held and used by the Company are reviewed on a quarterly basis to determine whether any events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. For long-lived assets to be held and used, the Company bases its evaluation on such impairment indicators as the nature of the assets, the furtherfuture economic
benefit of the assets, any historical or future profitability measurements, as well as other external market conditions or factors that may be present. During the years ended December 31, 20042006 and 2003,2005, the Company'sCompany’s analyses indicated there waswere no impairmentmaterial impairments of its long-lived assets.
Income Taxes—Income tax expense is based on estimated taxes payable or refundable on a tax return basis for the current year and the changes in deferred tax assets and liabilities during the year. Deferred tax assets and liabilities are established for temporary differences between the accounting basisbases and the tax basisbases of the Company'sCompany’s assets and liabilities at enacted tax rates expected to be in effect when the amounts related to such temporary differences are realized or settled. If the Company determines that it is “more likely than not” that some portion or all of a deferred tax asset will not be realized, the Company records a valuation allowance in accordance with the provisions of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (‘SFAS 109’).
In accordance with Accounting Principles Board Opinion No. 23, Accounting for Income Taxes—Special Areas (‘APB 23’), the Company presumes the undistributed earnings of its foreign subsidiaries will be distributed to its parent company unless the Company adopts the indefinite reversal provisions of APB 23, which would require the Company to provide sufficient evidence to support that the subsidiary has invested or will invest the undistributed earnings indefinitely. The Company recognizes the indefinite reversal provision of APB 23 for its Irish and Cayman Islands subsidiaries due to the projected capital needs necessary to support the continued growth of these entities. As such, the Company does not record U.S. income taxes on the undistributed earnings of its Irish and Cayman Island subsidiaries.
Translation of Foreign Currencies—TheWhere the functional currency is not the U.S. dollar, the Company translates the financial statements of its foreign operations into U.S. dollars. Where the functional currency is not the U.S. dollar, assetsAssets and liabilities are translated into U.S. dollars at period-end exchange rates, while income and expenses are translated using average rates for the period. The resulting translation adjustments are recorded as a component of accumulated other comprehensive income ("OCI"(‘OCI’) in stockholders'stockholders’ equity.
For foreign operations where the functional currency is the U.S. dollar, the local currency financial statements are translatedremeasured into U.S. dollars using period-end exchange rates for monetary assets and liabilities, exchange rates in effect on the date of acquisition for non-monetary assets and liabilities (such as premises and equipment (andand the related depreciation), and the average exchange rates during the period for income and expenses. The resulting translation adjustmentsexchange gains or losses are recorded in current period income.
Derivative Financial Instruments—Derivative financial instruments are recorded in the Company'sCompany’s consolidated balance sheetsheets at fair value.value as other assets or other liabilities, depending on the rights and obligations under the contracts. The Company utilizes derivative financial instruments primarily for
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INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
2. Summary of Significant Accounting Policies (Continued)
balance sheet asset and liability management purposes. ChangesThe effective portion of a change in the fair value of a derivative that is designated and qualifies as a cash flow hedge is reported in OCI, net of taxes, to the extent the hedge is highly effective.taxes. The ineffective portion, which is the extent to which the changeschange in the fair value of the derivative exceedexceeds the changeschange in the variability of the expected future cash flows of the hedged item (on an absolute basis), is reported in net interest income. ChangesThe changes in the fair value of a derivative that is designated and qualifies as a fair value hedge and that is highly effective, is reported in net interest income, along with the change in the fair value of the hedged item forattributable to the risk being hedged. The changeschange in fair value of a derivative that is not designated or does not qualify as a hedge is recognized in earnings.
Hedge accounting is discontinued prospectively if a) the hedging relationship no longer meets the hedging criterion,criteria, b) the derivative expires, or is sold, or terminated or the hedged item no longer exists,exercised, or c) the Company removes the hedge designation. When hedge accounting is discontinued under cash flow hedge accounting, the component of OCI related to the discontinued hedge is amortized to net interest income over the remaining term of the derivative financial instrument. Under fair value hedge accounting, when a hedge is discontinued, the hedged item is no longer adjusted for changes in fair value and the existing basis adjustment is amortized to net interest income. If cash flow hedge accounting is discontinued due to the probability that the forecasted transaction will not occur within the specified period, gains and losses accumulated in OCI related to that hedge are recognized immediately into net interest income.
The Company enters into interest rate derivative contracts that are designated as cash flow hedges of (a) the variability in interest payments related to the planned rollover of short-term liabilities at different fixed rates (thereby resulting in a variable interest expense pattern) and (b) the variability in interest payments related to variable-rate liabilities. The unrealized gains or losses related to these contracts are reported in other assets and other liabilities on the Company'sCompany’s consolidated balance sheet.sheets.
The Company also enters into fixed price purchase contracts that are designed to hedge the variability of the consideration to be paid for the purchase of investment securities. By entering into these contracts, the Company is fixing the price to be paid at a future date for certain investment
securities. The changes in fair value of these fixed price contracts are included as a component of OCI. The unrealized gains and losses are included in other assets and other liabilities on the Company'sCompany’s consolidated balance sheet.sheets.
The Company enters into foreign exchange contracts with clients and enters into matched or offsetting positions with either another client or a financial institution. These contracts are subject to market value fluctuations in foreign currencies. Gains and losses from such fluctuations are netted and recorded as an adjustment to asset servicing fees.fees in the Company’s consolidated statements of income. Unrealized gains or losses resulting from purchases and sales of foreign exchange contracts are included within the respective other assets and other liabilities categories on the Company'sCompany’s consolidated balance sheet.sheets. Foreign exchange contracts with the same counterparty are netted in the Company'sCompany’s consolidated balance sheetsheets when a master netting agreement exists.
Securities Sold Under Repurchase Agreements—TheCompany enters into sales of securities under agreements to repurchase.repurchase as a low cost source of funding for its operations. These agreements are treated as financings,secured borrowings, and the obligations to repurchase securities sold are reflected as liabilities in the consolidated balance sheets. Securities pledged as collateral under agreements to repurchase are reflected as assets in the accompanying consolidated balance sheets.
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INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
2. Summary of Significant Accounting Policies (Continued)
Share-basedShare-Based Compensation—On January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (‘SFAS 123R’). SFAS 123R requires that compensation cost relating to share-based payment transactions be recognized in the financial statements, with measurement based upon the fair value of the equity or liability instruments issued. The Company measuresadopted SFAS 123R using the modified prospective application method. Under that method, compensation expensecost for equity awards granted after January 1, 2006 is recognized over the service period based on the grant date fair value. In addition, compensation cost for the portion of awards for which the requisite service has not been rendered that are outstanding as of January 1, 2006 is recognized prospectively as the requisite service is rendered. The compensation cost for that portion of awards is based on the grant date fair value of those awards as calculated under the pro forma disclosures of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (‘SFAS 123’). In accordance with the modified prospective application method, the financial statements of periods prior to the adoption of SFAS 123R have not been restated.
The following table sets forth share-based compensation cost and the related tax benefit recognized in the consolidated income statements for all of the Company’s share-based compensation plans (Dollars in thousands):
| | For the Year Ended
December 31, | |
| | 2006 | | 2005 | | 2004 | |
Share-based compensation cost | | $ | 4,538 | | $ | 261 | | $ | 316 | |
Income tax benefit | | $ | 580 | | $ | — | | $ | — | |
Certain of the Company’s share-based awards contain terms that provide for a graded vesting schedule whereby portions of the awards vest in increments over the requisite service period. As provided for under SFAS 123R, the Company has elected to recognize compensation cost for awards granted on or after January 1, 2006 with graded vesting schedules on a straight-line basis over the requisite service period for the entire award.
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INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
2. Summary of Significant Accounting Policies (Continued)
Prior to adopting SFAS 123R, the Company measured compensation cost for share-based compensation plans using the intrinsic value method.method under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (‘APB 25’),and made pro forma disclosures of the fair value method under SFAS 123. The intrinsic value method measures compensation cost as the amount by which the fair market value of the Company’s common stock exceeds the option exercise price on the measurement date, which is typically the date of grant. Generally, options granted havehad an exercise price equivalent to the fair market value at the measurement date. Accordingly, no compensation cost has beenwas recorded. If share-based compensation cost were recognized using the fair value method, stock options would be valued at grant date using the Black-Scholes valuation model and the resulting compensation costscost would have decreased net income as indicated below (Dollars in thousands, except per share data):
| | | For the Year Ended | | For the Year Ended | |
|
| | December 31,
2004
| | December 31,
2003
| | December 31,
2002
| | | December 31,
2005 | | December 31,
2004 | |
|---|
| Net income as reported | Net income as reported | | $ | 141,962 | | $ | 92,421 | | $ | 67,437 | | | | $ | 159,818 | | | | $ | 141,962 | | |
| Deduct: Total share-based employee compensation expense determined under fair-value based method for all awards, net of related tax effects | | (15,146 | ) | | (10,467 | ) | | (14,447 | ) | |
| | |
| |
| |
| | |
Deduct: Total share-based employee compensation cost determined under the fair value method for all awards, net of related tax effects | | | | (19,832 | ) | | | (16,679 | ) | |
| Pro forma net income | Pro forma net income | | $ | 126,816 | | $ | 81,954 | | $ | 52,990 | | | | $ | 139,986 | | | | $ | 125,283 | | |
| | |
| |
| |
| | |
| Earnings per share: | Earnings per share: | | | | | | | | | | | | | | | | |
| | Basic—as reported | | $ | 2.15 | | $ | 1.42 | | $ | 1.05 | | |
| | Basic—pro forma | | 1.92 | | 1.26 | | 0.82 | | |
| | Diluted—as reported | | $ | 2.09 | | $ | 1.39 | | $ | 1.02 | | |
| | Diluted—pro forma | | 1.87 | | 1.23 | | 0.80 | | |
Basic-as reported | | | | $ | 2.42 | | | | $ | 2.15 | | |
Basic-pro forma | | | | $ | 2.12 | | | | $ | 1.89 | | |
Diluted-as reported | | | | $ | 2.37 | | | | $ | 2.09 | | |
Diluted-pro forma | | | | $ | 2.07 | | | | $ | 1.85 | | |
The fair value of each option grant was estimated on the date of grant using the Black-Scholes valuation model with the following weighted-average assumptions for the years ended December 31, 2004, 2003,2005 and 2002,2004, respectively: an average assumed risk-free interest rate of 3.08%, 2.37%,4.55% and 2.40%3.08%, an expected lifeterm of four years, an average expected volatility of 41.04% and 50.49%, 55.86%, and 56.20%, andan average dividend yield of 0.20% and 0.16%.
The amount of share-based compensation cost (net of tax) included in net income as reported was $0.2 million for both the years ended December 31, 2005 and 2004.
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INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
2. Summary of Significant Accounting Policies (Continued)
The following table presents the effect of changing from the intrinsic value method under APB 25 to the fair value method under SFAS 123R for the year ended December 31, 2006 (Dollars in thousands, except per share data):
| | For the Year Ended | |
| | December 31,
2006 | |
Increase/(Decrease) in: | | | | | |
Income from continuing operations | | | $ | (4,325 | ) | |
Income before income taxes | | | (4,325 | ) | |
Net income | | | (2,966 | ) | |
Cash flow from operations | | | (8,017 | ) | |
Cash flow from financing activities | | | 8,017 | | |
Basic EPS | | | $ | (0.05 | ) | |
Diluted EPS | | | $ | (0.05 | ) | |
The fair value of each option grant under the Director Plan, the Stock Plan, and the 2005 Plan (each as described further in Note 11) was estimated on the grant date using the Black-Scholes valuation model with the following weighted-average assumptions for the year ended December 31, 2006: an average assumed risk-free interest rate of 4.76%, 0.20%an average expected term of five years, an average expected volatility of 41.92%, and 0.22%an average dividend yield of 0.20%.
The Company bases its estimate of expected term on the historical exercise and post-vesting employment termination behavior for similar grants. The Company’s volatility assumption is based on the historical volatility of the Company’s stock over a period equating to the expected term of the employee share option, using weekly price observations and looking backward from the date of grant.
The fair value of the option feature of grants under the 1997 Employee Stock Purchase Plan (‘ESPP’) (as described further in Note 11) was estimated on the grant date using the Black-Scholes valuation model with the following weighted-average assumptions for the year ended December 31, 2006: an average assumed risk-free rate of 4.79%, an expected term of 0.5 years, an average volatility of 37.55%, and an average dividend yield of 0.23%.
The expected term for the ESPP is equal to the six-month payment period. The Company estimates expected volatility for the ESPP in the same manner as for employee stock options, except that daily volatility is used instead of weekly volatility. The Company uses daily volatility for the ESPP because weekly volatility over six months does not result in a statistically significant number of data points upon which to base the volatility calculation.
SFAS 123R also requires that any deferred compensation related to share-based awards granted prior to January 1, 2006 must be eliminated against the appropriate equity accounts. In connection with the Company’s adoption of SFAS 123R, the presentation in the consolidated statement of stockholders’ equity for the year ended December 31, 2006 was revised to reflect the transfer of balances previously reported in deferred compensation to surplus.
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INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
2. Summary of Significant Accounting Policies (Continued)
Earnings Per ShareShare——Basicearnings per share ("EPS"(‘EPS’) wereis computed by dividing net income by the weighted-average number of common shares outstanding during the year. Diluted EPS reflects the
potential dilution that could occur if contracts to issue common stock were exercised into common stock that then shared in the earnings of the Company.
Reconciliation The reconciliation from Basic EPS to Diluted EPS is as follows (Dollars in thousands, except per share data):
| | Income
| | Weighted-Average
Shares
| | Per Share
Amount
| | | | | Weighted-Average | | Per Share | |
|---|
| | | Income | | Shares | | Amount | |
December 31, 2006 | | | | | | | | | | | | |
Basic EPS | | | | | | | | | | | | |
Income available to common stockholders | | | $ 153,803 | | | 65,730,456 | | | | $ 2.34 | | |
Dilutive effect of common equivalent shares
of stock options | | | — | | | 1,762,625 | | | | (0.06 | ) | |
Diluted EPS | | | $ 153,803 | | | 67,493,081 | | | | $ 2.28 | | |
December 31, 2005 | | | | | | | | | | | | |
Basic EPS | | | | | | | | | | | | |
Income available to common stockholders | | | $ 159,818 | | | 66,139,323 | | | | $ 2.42 | | |
Dilutive effect of common equivalent shares
of stock options | | | — | | | 1,334,481 | | | | (0.05 | ) | |
Diluted EPS | | | $ 159,818 | | | 67,473,804 | | | | $ 2.37 | | |
| December 31, 2004 | | | | | | | | | | | | | | | | | | |
| Basic EPS | | | | | | | | | | | | | | | | | | |
| Income available to common stockholders | | $ | 141,962 | | 66,179,286 | | $ | 2.15 | | | $ 141,962 | | | 66,179,286 | | | | $ 2.15 | | |
| Dilutive effect of common equivalent shares of stock options | | — | | 1,736,931 | | (0.06 | ) | | — | | | 1,736,931 | | | | (0.06 | ) | |
| | |
| |
| |
| | |
| Diluted EPS | | $ | 141,962 | | 67,916,217 | | $ | 2.09 | | | $ 141,962 | | | 67,916,217 | | | | $ 2.09 | |
| | |
| |
| |
| | |
| December 31, 2003 | | | | | | | | |
| Basic EPS | | | | | | | | |
| Income available to common stockholders | | $ | 92,421 | | 65,098,960 | | $ | 1.42 | | |
| Dilutive effect of common equivalent shares of stock options | | — | | 1,376,502 | | (0.03 | ) | |
| | |
| |
| |
| | |
| Diluted EPS | | $ | 92,421 | | 66,475,462 | | $ | 1.39 | | |
| | |
| |
| |
| | |
| December 31, 2002 | | | | | | | | |
| Basic EPS | | | | | | | | |
| Income available to common stockholders | | $ | 67,437 | | 64,429,592 | | $ | 1.05 | | |
| Dilutive effect of common equivalent shares of stock options | | — | | 1,942,102 | | (0.03 | ) | |
| | |
| |
| |
| | |
| Diluted EPS | | $ | 67,437 | | 66,371,694 | | $ | 1.02 | | |
| | |
| |
| |
| | |
For the yearyears ended December 31, 2006, 2005 and 2004, there were 132,905 options 733,015 options and 29,451 option sharesoptions which were not considered dilutive for earnings per share calculations. For the year ended December 31, 2003, there were 3,517,655 option shares which were not considered dilutive for earnings per share calculations. For the year ended December 31, 2002, there were 1,432,575 option shares which were not considered dilutive for earnings per share calculations.EPS calculations, respectively.
GuaranteesGuarantees——On behalf of its clients, the Company lends securities to creditworthy broker-dealers. In certain circumstances, the Company may indemnify its clients for the fair market value of those securities against a failure of the borrower to return such securities. The Company requires the borrowers to provide collateral in an amount equal to, or in excess of, 102% of the fair market value of U.S. dollar-denominated securities borrowed and 105% of the fair market value of non-U.S. dollar-denominated securities borrowed. The borrowed securities are revalued daily to determine whether additional collateral is necessary. As guarantor, the Company is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The Company measures the fair value of its indemnification obligation by marking its securities lending portfolio to market on a daily basis and comparing the value of the portfolio to the collateral holdings position. The fair value of the indemnification obligation to be recorded would be the deficiency of collateral as compared to the value of the securities out on loan.
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INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
2. Summary of Significant Accounting Policies (Continued)
GoodwillGoodwill——On January 1, 2002,TheCompany reviews goodwill for impairment on an annual basis, or if events or changes in circumstances indicate it would be more likely than not that the Company adopted SFAS No. 142,Goodwill and Other Intangible Assets, which supersedes APB No. 17,Intangible Assets. SFAS No. 142 addresses how intangible assets that are acquired individually or with a groupfair value of other assets (but not those acquired in a business combination) shouldthe goodwill would be accounted for in financial statements upon their acquisition. This statement also addresses how goodwill and other intangible assets should be accounted for after they have been
initially recognized in the financial statements. This statement affects the accounting of goodwill, includes guidelines for the determination, measurement and testing of impairment, and requires disclosure of information about goodwill and other intangible assets in the years subsequent to their acquisition that was not previously required. This statement eliminates the amortization of goodwill, and requires that goodwill be reviewed at least annually for impairment. This statement affects all goodwill recognized on our consolidated balance sheet, regardless of when the assets were initially recorded. Upon adoption of SFAS No. 142, the Company ceased amortization of goodwill.reduced below its carrying value. As of December 31, 2004,2006, there was no impairment of goodwill.
New Accounting Pronouncements
In December 2004,June 2006, the Financial Accounting Standards Board ("FASB"(‘FASB’) issued SFASFASB Interpretation No. 123 (revised 2004),48, Share-Based PaymentAccounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 (‘FIN 48’). SFAS 123R requires that compensation cost relatingFIN 48 establishes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to share-based payment transactions be taken in a tax return. Pursuant to FIN 48, the effects of a tax position are recognized in the financial statements with measurementwhen it is more likely than not, based on the technical merits, that the position will be sustained upon examination. Conversely, previously recognized tax positions are derecognized when it is no longer more likely than not that the fair valuetax position would be sustained upon examination. FIN 48 also requires certain disclosures regarding unrecognized tax benefits and the amounts and classification of the equity or liability instruments issued. The Statementrelated interest and penalties. FIN 48 is effective as offor fiscal years beginning after December 15, 2006. Accordingly, the beginning ofCompany adopted FIN 48 on January 1, 2007, and there was no material impact to the first interim reporting period that begins after June 15, 2005, and replaces SFAS No. 123,Accounting for Stock-Based Compensation, and supercedes APB Opinion No. 25,Accounting for Stock Issued to Employees. The Company currently uses the intrinsic-value method to measure compensation cost related to its share-based transactions. The Company will adopt SFAS 123R in the third quarter of 2005 and is in the process of determining the methodology it will use and the impact on itsfinancial condition or results of operations of the Company.
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (‘SFAS 157’). SFAS 157 defines fair value, establishes a framework for measuring fair value, and financial condition.expands upon existing disclosures about fair value measurements. SFAS 157 does not require any new fair value measurements. Rather, the guidance contained in SFAS 157 applies to assets, liabilities, and certain equity instruments that are already measured at fair value under existing accounting pronouncements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. The Company does not anticipate any material impact to its financial condition or results of operations as a result of the adoption of SFAS 123R.157.
In September 2006, the SEC issued Staff Accounting Bulletin 108, Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements (‘SAB 108’). SAB 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year financial statement misstatements should be considered in quantifying a current year misstatement. SAB 108 is effective for financial statements covering the first fiscal year ending after November 15, 2006. Accordingly, the Company adopted SAB 108 on December 31, 2006, and there was no material impact to the financial condition or results of operations of the Company.
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (‘SFAS 159’). SFAS 159 permits entities to elect to measure certain financial instruments and other items at fair value through earnings. The fair value option may be applied on an instrument by instrument basis, is irrevocable and is applied only to entire instruments. SFAS 159 requires additional financial statement presentation and disclosure requirements for those entities that elect to adopt the standard and is effective for fiscal years beginning after November 15, 2007. The Company does not anticipate any material impact to its financial condition or results of operations as a result of the adoption of SFAS 159.
In MarchF-16
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004 the Emerging Issues Task Force ("EITF") of the FASB reached a consensus on EITF Issue No. 03-1,The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. As originally issued, EITF Issue No. 03-1 was to be effective for all annual or interim financial statements for periods beginning after June 15, 2004, however, a partial deferral was issued in September 2004. EITF Issue No. 03-1 addresses the identification of other-than-temporarily impaired investments, and requires that an impairment charge be recognized for other-than-temporarily impaired investments for which there is neither the ability nor intent to hold either until maturity or until the market value of the investment recovers. The Company continues to monitor the FASB's discussions regarding EITF Issue No. 03-1 and to assess the impact of its application on the Company's financial condition and results of operations.
3. SECURITIESSecurities
Amortized cost amounts and fair values of securities are summarized as follows as of December 31, 20042006 (Dollars in thousands):
Held to Maturity
| | Amortized
Cost
| | Unrealized
Gains
| | Unrealized
(Losses)
| | Fair Value
|
|---|
| Mortgage-backed securities | | $ | 3,543,961 | | $ | 13,269 | | $ | (7,802 | ) | $ | 3,549,428 |
| Federal agency securities | | | 2,274,665 | | | 1,658 | | | (18,443 | ) | | 2,257,880 |
| State and political subdivisions | | | 124,091 | | | 6,090 | | | (27 | ) | | 130,154 |
| | |
| |
| |
| |
|
| Total | | $ | 5,942,717 | | $ | 21,017 | | $ | (26,272 | ) | $ | 5,937,462 |
| | |
| |
| |
| |
|
Available for Sale
| | Amortized
Cost
| | Unrealized
Gains
| | Unrealized
(Losses)
| | Fair Value
|
|---|
| Mortgage-backed securities | | $ | 3,848,255 | | $ | 21,596 | | $ | (14,951 | ) | $ | 3,854,900 |
| State and political subdivisions | | | 384,859 | | | 20,110 | | | (60 | ) | | 404,909 |
| Corporate debt | | | 177,201 | | | 911 | | | (1,566 | ) | | 176,546 |
| US Treasury securities | | | 113,843 | | | 4,845 | | | — | | | 118,688 |
| Foreign government securities | | | 10,302 | | | 160 | | | — | | | 10,462 |
| | |
| |
| |
| |
|
| Total | | $ | 4,534,460 | | $ | 47,622 | | $ | (16,577 | ) | $ | 4,565,505 |
| | |
| |
| |
| |
|
| | Amortized | | Unrealized | | Unrealized | | | |
Held to Maturity | | | | Cost | | Gains | | (Losses) | | Fair Value | |
Mortgage-backed securities | | $ 3,753,497 | | | $ 7,271 | | | | $ (25,584 | ) | | $ 3,735,184 | |
Federal agency securities | | 1,680,458 | | | 2,956 | | | | (12,328 | ) | | 1,671,086 | |
State and political subdivisions | | 98,375 | | | 4,206 | | | | (63 | ) | | 102,518 | |
Total | | $ 5,532,330 | | | $ 14,433 | | | | $ (37,975 | ) | | $ 5,508,788 | |
| | | | | | | | | | | | | | | |
| | Amortized | | Unrealized | | Unrealized | | | |
Available for Sale | | | | Cost | | Gains | | (Losses) | | Fair Value | |
Mortgage-backed securities | | $ 4,302,932 | | | $ 7,400 | | | | $ (35,281 | ) | | $ 4,275,051 | |
State and political subdivisions | | 343,204 | | | 2,090 | | | | (990 | ) | | 344,304 | |
Corporate debt | | 170,797 | | | 226 | | | | (1,173 | ) | | 169,850 | |
Foreign government securities | | 10,559 | | | — | | | | (24 | ) | | 10,535 | |
Total | | $ 4,827,492 | | | $ 9,716 | | | | $ (37,468 | ) | | $ 4,799,740 | |
| | | | | | | | | | | | | | | |
Amortized cost amounts and fair values of securities are summarized as follows as of December 31, 20032005 (Dollars in thousands):
Held to Maturity
| | Amortized
Cost
| | Unrealized
Gains
| | Unrealized
(Losses)
| | Fair Value
|
|---|
| Mortgage-backed securities | | $ | 2,272,030 | | $ | 23,089 | | $ | (16,367 | ) | $ | 2,278,752 |
| Federal agency securities | | | 1,906,554 | | | 1,657 | | | (12,800 | ) | | 1,895,411 |
| State and political subdivisions | | | 127,632 | | | 6,890 | | | (107 | ) | | 134,415 |
| | |
| |
| |
| |
|
| Total | | $ | 4,306,216 | | $ | 31,636 | | $ | (29,274 | ) | $ | 4,308,578 |
| | |
| |
| |
| |
|
Available for Sale
| | Amortized
Cost
| | Unrealized
Gains
| | Unrealized
(Losses)
| | Fair Value
| |
|---|
| | | | Amortized | | Unrealized | | Unrealized | | | |
Held to Maturity | | | | | Cost | | Gains | | (Losses) | | Fair Value | |
| Mortgage-backed securities | | $ | 3,593,470 | | $ | 28,740 | | $ | (10,230 | ) | $ | 3,611,980 | Mortgage-backed securities | | $ 4,342,254 | | | $ 11,420 | | | | $ (29,818 | ) | | $ 4,323,856 | |
Federal agency securities | | Federal agency securities | | 2,305,331 | | | 1,560 | | | | (23,914 | ) | | 2,282,977 | |
| State and political subdivisions | | 333,777 | | 22,119 | | (68 | ) | | 355,828 | State and political subdivisions | | 114,345 | | | 4,646 | | | | (95 | ) | | 118,896 | |
| Corporate debt | | 178,394 | | 314 | | (2,892 | ) | | 175,816 | |
| US Treasury securities | | 111,305 | | 2,396 | | — | | 113,701 | |
| Federal agency securities | | 29,600 | | 9 | | — | | 29,609 | |
| Foreign government securities | | 9,644 | | 59 | | — | | 9,703 | |
| | |
| |
| |
| |
| |
| Total | | $ | 4,256,190 | | $ | 53,637 | | $ | (13,190 | ) | $ | 4,296,637 | Total | | $ 6,761,930 | | | $ 17,626 | | | | $ (53,827 | ) | | $ 6,725,729 | |
| | |
| |
| |
| |
| | | | | | | | | | | | | | | |
Nonmarketable
| | Amortized | | Unrealized | | Unrealized | | | |
Available for Sale | | | | Cost | | Gains | | (Losses) | | Fair Value | |
Mortgage-backed securities | | $ 3,810,797 | | | $ 3,882 | | | | $ (48,578 | ) | | $ 3,766,101 | |
State and political subdivisions | | 388,789 | | | 5,515 | | | | (1,913 | ) | | 392,391 | |
Corporate debt | | 201,499 | | | 736 | | | | (1,543 | ) | | 200,692 | |
Foreign government securities | | 10,539 | | | — | | | | (3 | ) | | 10,536 | |
Total | | $ 4,411,624 | | | $ 10,133 | | | | $ (52,037 | ) | | $ 4,369,720 | |
| | | | | | | | | | | | | | | |
Excluded from the above tables are nonmarketable equity securities, at December 31, 2004 and 2003which consisted primarily of stock of the Federal Home Loan BankFRBB and FHLBB at December 31, 2006 and stock of Boston ("FHLBB"). On April 19, 2004, the FHLBB implemented a new capital structure mandated for all Federal Home Loan Banks by the Gramm-Leach-Bliley Actat December 31, 2005. There was no FRBB stock held as of 1999 and regulations that were subsequently promulgated in 2001 by the FHLBB's regulator, the Federal Housing Finance Board. IBT'sDecember 31, 2005. The Company’s capital stock investment in the FHLBB totaled $50$29.4 million as of December 31, 2004.2006. This amount reflects a $20.6 million decrease from December 31, 2005. The $50$29.4 million capital stock investment includes both a $25$25.0 million membership component and a $25$4.4 million activity-based component. UnderThe membership component of the new capital plan, FHLBB capital stock investments requireinvestment requires a five-year advance notice of withdrawal. The Bank's $50Company’s $29.4 million capital stock investment in the FHLBB provides aan overnight borrowing capacity of approximately $555up to $146.4 million. The amount
F-17
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
3. Securities (Continued)
outstanding under this arrangement atas of December 31, 20042006 was $250$125.0 million. AdditionalThe Company currently has the ability to purchase up to $25.0 million of activity-based capital, which would provide a total overnight borrowing capacity of $833.3 million.
In October 2006, the Company became a member of the FRBB. In connection with its membership, the Company was required to subscribe to purchase stock of the FRBB totaling 6% of the Bank’s capital and surplus. The Company fulfilled its obligation to purchase 50% of the subscribed amount by purchasing $7.4 million of FRBB stock. The remaining subscription amount is availablesubject to IBT based on prescribed collateral levels and increased investment in FHLBB capital stock.purchase upon the request of the FRBB.
The amortized cost amounts and fair values of securities by contractual maturity are as follows (Dollars in thousands):
| | December 31, 2004
|
|---|
Held to Maturity
| | Amortized
Cost
| | Fair Value
|
|---|
| Due within one year | | $ | — | | $ | — |
| Due from one to five years | | | 35,674 | | | 36,152 |
| Due five years up to ten years | | | 132,571 | | | 133,136 |
| Due after ten years | | | 5,774,472 | | | 5,768,174 |
| | |
| |
|
| Total | | $ | 5,942,717 | | $ | 5,937,462 |
| | |
| |
|
| | December 31, 2004
| | | December 31, 2006 | |
|---|
Available for Sale
| | Amortized
Cost
| | Fair Value
| |
|---|
| | | | Amortized | | | |
Held to Maturity | | | | | Cost | | Fair Value | |
| Due within one year | | $ | 6,568 | | $ | 6,625 | Due within one year | | $ 341 | | $ 342 | |
| Due from one to five years | | 254,457 | | 264,916 | Due from one to five years | | 13,663 | | 13,804 | |
| Due five years up to ten years | | 279,149 | | 291,558 | Due five years up to ten years | | 355,800 | | 357,776 | |
| Due after ten years | | 3,994,286 | | 4,002,406 | Due after ten years | | 5,162,526 | | 5,136,866 | |
| | |
| |
| |
| Total | | $ | 4,534,460 | | $ | 4,565,505 | Total | | $ 5,532,330 | | $ 5,508,788 | |
| | |
| |
| | | | | | | |
| | December 31, 2006 | |
| | Amortized | | | |
Available for Sale | | | | Cost | | Fair Value | |
Due within one year | | $ 11,514 | | $ 11,503 | |
Due from one to five years | | 27,591 | | 28,034 | |
Due five years up to ten years | | 228,318 | | 231,061 | |
Due after ten years | | 4,560,069 | | 4,529,142 | |
Total | | $ 4,827,492 | | $ 4,799,740 | |
| | | | | | | |
During the year ended December 31, 2006, the Company sold forty-two securities classified as available for sale totaling $134.1 million using the specific identification method. The book value of the securities was $131.6 million and resulted in a gross realized gain of $2.5 million for the year ended December 31, 2006. During the year ended 2005, the Company sold eighty-five securities classified as available for sale totaling $376.1 million using the specific identification method. The book value of the securities was $363.7 million and resulted in a gross realized gain of $12.4 million for the year ended December 31, 2005. During the year ended December 31, 2004, the Company sold one security classified as available for sale totaling $25.0 million using the specific identification method. The book value of the security was $24.8 million resultingand resulted in a gross realized gain of $0.2 million. There were no sales of securities availablemillion for sale during the yearsyear ended December 31, 20032004.
F-18
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2002.2004
3. Securities (Continued)
The carrying value of securities pledged amounted to approximately $6.3$7.2 billion at December 31, 20042006 and $5.6$7.5 billion at December 31, 2003.2005. Securities are pledged primarily to secure clearings with other depository institutions, secure repurchase agreements and secure outstanding FHLBB borrowings.
On a quarterly basis the Company reviews its investment portfolio on a security by security basis for any investment that may be other than temporarily impaired. In its evaluation, the Company considers the length of time the security has been impaired, the severity of the impairment, the financial condition and future prospects of the issuer, and the Company'sCompany’s ability and intent to hold the security to maturity or until it recovers in value.
The unrealized losses related to the Company'sCompany’s investment in mortgage-backed and federalFederal agency securities are attributable to changes in market interest rates. The contractual cash flows for certain of these securities are guaranteed by agencies of the U.S. government, including government sponsored agencies. As a result, the Company'sCompany’s exposure to the credit risk of these securities is minimal. At December 31, 2004,2006, there were 590 investment876 mortgage-backed and Federal agency securities that were in unrealized loss positions. The market value decline as a percentage of amortized cost for the Company'sCompany’s mortgage-backed and Federal agency investment securities portfolio was less than 1% at December 31, 2004.2006. The Company has the intent and ability to hold these securities until forecasted recovery, which may in some cases be maturity. The Company does not consider these investments to be other than temporarily impaired at December 31, 2004.
2006. Corporate debt securities include trust preferred securities ("trups"(‘trups’) issued by reputable financial institutions. The credit ratings of the underlying issuers range from A1 to Aa3 ratings. The Company holds senior tranches of these issuances and believes that it will recover all contractual payments. The
unrealized losses related to the trups portfolio are due to changes in market interest rates.credit spreads. At December 31, 2004,2006, there were five6 corporate debt securities that were in unrealized loss positions. The Company has the intent and ability to hold these securities until forecasted recovery and does not consider these investments to be other than temporarily impaired at December 31, 2004.2006.
Unrealized losses related to the Company'sCompany’s investments in state and political subdivisions securities were due to changes in market interest rates. The Company reviewed the investment securities credit ratings, which were all Aaa. At December 31, 2004,2006, there were six185 state and political subdivisions investment securities in an unrealized loss position. The credit rating on the securities were all Aaa and scheduled payments continue to be made on a timely basis. Given the minimal amount of unrealized losses and the limited amount of credit exposure, the Company does not consider these investments to be other than temporarily impaired at December 31, 2004.2006.
F-19
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
3. Securities (Continued)
The following table representspresents the information about ourthe Company’s temporarily impaired investments at December 31, 20042006 (Dollars in thousands):
| | Less than 12 months
| | 12 months or longer
| | Total
| | Less than 12 months | | 12 months or longer | | Total | |
|---|
| | Fair Value
| | Unrealized
Losses
| | Fair Value
| | Unrealized
Losses
| | Fair Value
| | Unrealized
Losses
| | Fair Value | | Unrealized
Losses | | Fair Value | | Unrealized
Losses | |
Fair Value
| | Unrealized
Losses | |
|---|
| Mortgage-backed securities | | $ | 2,518,100 | | $ | 15,704 | | $ | 545,709 | | $ | 7,049 | | $ | 3,063,809 | | $ | 22,753 | | $ | 1,816,592 | | | $ | 7,677 | | | $ | 3,572,895 | | | $ | 53,188 | | | $ | 5,389,487 | | | $ | 60,865 | | |
| Federal agency securities | | | 1,446,223 | | | 12,332 | | | 518,045 | | | 6,111 | | | 1,964,268 | | | 18,443 | | 167,095 | | | 409 | | | 1,065,865 | | | 11,919 | | | 1,232,960 | | | 12,328 | | |
| Corporate debt | | | — | | | — | | | 47,894 | | | 1,566 | | | 47,894 | | | 1,566 | | 10,082 | | | 8 | | | 48,317 | | | 1,165 | | | 58,399 | | | 1,173 | | |
| State and political subdivisions | | | 5,565 | | | 15 | | | 6,025 | | | 72 | | | 11,590 | | | 87 | | 127,530 | | | 907 | | | 16,446 | | | 146 | | | 143,976 | | | 1,053 | | |
| | |
| |
| |
| |
| |
| |
| |
| Total temporarily impaired securities: | | $ | 3,969,888 | | $ | 28,051 | | $ | 1,117,673 | | $ | 14,798 | | $ | 5,087,561 | | $ | 42,849 | |
| | |
| |
| |
| |
| |
| |
| |
Foreign | | | — | | | — | | | 10,535 | | | 24 | | | 10,535 | | | 24 | | |
Total temporarily impaired securities | | | $ | 2,121,299 | | | $ | 9,001 | | | $ | 4,714,058 | | | $ | 66,442 | | | $ | 6,835,357 | | | $ | 75,443 | | |
The following table representspresents the information about ourthe Company’s temporarily impaired investments at December 31, 20032005 (Dollars in thousands):
| | Less than 12 months
| | 12 months or longer
| | Total
| | Less than 12 months | | 12 months or longer | | Total | |
|---|
| | Fair Value
| | Unrealized
Losses
| | Fair Value
| | Unrealized
Losses
| | Fair Value
| | Unrealized
Losses
| | Fair Value | | Unrealized
Losses | |
Fair Value
| | Unrealized
Losses | | Fair Value | | Unrealized
Losses | |
|---|
| Mortgage-backed securities | | $ | 2,216,886 | | $ | 26,496 | | $ | 8,543 | | $ | 101 | | $ | 2,225,429 | | $ | 26,597 | | $ | 4,566,743 | | | $ | 43,821 | | | $ | 1,486,521 | | | $ | 34,575 | | | $ | 6,053,264 | | | $ | 78,396 | | |
| Federal agency securities | | | 1,005,518 | | | 8,378 | | | 600,457 | | | 4,422 | | | 1,605,975 | | | 12,800 | | 1,443,951 | | | 10,809 | | | 883,807 | | | 13,105 | | | 2,327,758 | | | 23,914 | | |
| Corporate debt | | | 25,667 | | | 333 | | | 46,876 | | | 2,559 | | | 72,543 | | | 2,892 | | — | | | — | | | 47,911 | | | 1,543 | | | 47,911 | | | 1,543 | | |
| State and political subdivisions | | | 9,591 | | | 154 | | | 154 | | | 21 | | | 9,745 | | | 175 | | 146,147 | | | 1,856 | | | 8,173 | | | 152 | | | 154,320 | | | 2,008 | | |
| | |
| |
| |
| |
| |
| |
| |
| Total temporarily impaired securities: | | $ | 3,257,662 | | $ | 35,361 | | $ | 656,030 | | $ | 7,103 | | $ | 3,913,692 | | $ | 42,464 | |
| | |
| |
| |
| |
| |
| |
| |
Foreign | | | 10,536 | | | 3 | | | — | | | — | | | 10,536 | | | 3 | | |
Total temporarily impaired securities | | | $ | 6,167,377 | | | $ | 56,489 | | | $ | 2,426,412 | | | $ | 49,375 | | | $ | 8,593,789 | | | $ | 105,864 | | |
F-20
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
4. Loans4. LOANS
Loans consist of demand loans to custody clients of the Company, including individuals, and not-for-profit institutions and loans to mutual fund clients. The loans to mutual funds and other pooled product clients include lines of credit and advances pursuant to the terms of the custody agreements between the Company and those mutual fund clients to facilitate securities transactions and redemptions. Generally,Almost all of the Company’s commitments to fund loans are at variable rates. The credit risk associated with these loans is considered low since the loans are, or may be, in the event of default, collateralized with marketable securities held by the Company as custodian. However, management recognizes some credit risk inherent in the portfolio, and therefore the Company has recorded an allowance for loan losses of $0.1 million at December 31, 2006, a level which has remained consistent for the past five years. This allowance is not allocated to any particular loan, but is intended to absorb any risk of loss inherent in the loan portfolio at the balance sheet date that is not captured in the Company’s historical loss rates. Management actively monitors the loan portfolio and the underlying collateral and regularly assesses the adequacy of the allowance for loan losses. There were no impaired orloans, non-performing loans, or loans on nonaccrual status at December 31, 20042006 and 2003.2005. In addition, there have beenwere no loan charge-offs or recoveries during the years ended December 31, 2004, 20032006, 2005 and 2002.2004. Loans consisted of the followingare summarized as follows (Dollars in thousands):
| | | December 31, | | December 31, | |
| | December 31,
2004
| | December 31,
2003
| | | 2006 | | 2005 | |
|---|
| Loans to mutual funds | | $ | 22,520 | | $ | 104,954 | | | | $ | 152,491 | | | | $ | 286,144 | | |
| Loans to individuals | | 69,402 | | 67,641 | | | | 64,118 | | | | 81,392 | |
| Loans to others | | 42,708 | | 27,035 | | |
| | |
| |
| | |
Commercial and industrial | | | | 6,634 | | | | 15,697 | |
Other | | | | 47,550 | | | | 19,237 | |
| | | 134,630 | | 199,630 | | | | 270,793 | | | | 402,470 | |
| Less allowance for loan losses | | (100 | ) | | (100 | ) | | | (100 | ) | | | (100 | ) | |
| | |
| |
| | |
| Total | | $ | 134,530 | | $ | 199,530 | | | | $ | 270,693 | | | | $ | 402,370 | | |
| | |
| |
| | |
The Company had unused commitments to lend of approximately $978.8 million$1.1 billion and $759.5 million$0.9 billion at December 31, 20042006 and 2003,2005, respectively. The terms of these commitments are similar to the terms of outstanding loans.
The Company periodically issues lines of credit and advances to its mutual fund clients to help those clients with security transactions. The President of one of those clients is a related party to James M. Oates, a member of the Company’s Board of Directors. As of December 31, 2006, the Company had total contractual agreements for $150.0 million of committed lines of credit with two mutual funds within the related party complex (the ‘mutual funds’). The primary source of repayment of the loans is the proceeds from the sale of investments in the normal course of the mutual funds’ business. As part of the agreement, the mutual funds are required to segregate and maintain specific collateral for the Company equal to 200% of the lines of credit. At December 31, 2006, loans due from the mutual funds totaled $63.7 million. At December 31, 2005, loans due from the mutual funds totaled $125.0 million. Total interest and commitment fee revenue from the mutual funds for the years ended December 31, 2006, 2005 and 2004 was $5.7 million, $2.7 million and $0.4 million, respectively. The terms and conditions of the Company’s contractual agreements with the mutual funds, including collateral requirements, lending limits and fees, are consistent with other lending clients that have similar composition, size and overall business
F-21
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
4. Loans (Continued)
relationships with the Company. Also, Mr. Oates abstains from voting on any board matter involving any proposed transaction with the mutual funds.
5. EQUIPMENT AND LEASEHOLD IMPROVEMENTSEquipment and Leasehold Improvements
The major components of equipment and leasehold improvements are as follows (Dollars in thousands):
| | | December 31, | | December 31, | |
| | December 31,
2004
| | December 31,
2003
| | | 2006 | | 2005 | |
|---|
| Furniture, fixtures and equipment | | $ | 113,204 | | $ | 108,278 | | | | $ | 138,459 | | | | $ | 112,310 | | |
| Leasehold improvements | | 15,696 | | 15,825 | | | | 39,118 | | | | 16,247 | | |
| | |
| |
| | |
| Total | | 128,900 | | 124,103 | | | | 177,577 | | | | 128,557 | | |
| Less accumulated depreciation and amortization | | (61,017 | ) | | (47,683 | ) | | | (64,290 | ) | | | (59,156 | ) | |
| | |
| |
| | |
| Equipment and leasehold improvements, net | | $ | 67,883 | | $ | 76,420 | | | | $ | 113,287 | | | | $ | 69,401 | | |
| | |
| |
| | |
Included in furniture, fixtures and equipment were capitalized internal software costs of $75.3$87.6 million and $61.5$73.3 million as ofat December 31, 20042006 and 2003,2005, respectively. Depreciation expense was $30.1$29.0 million, $26.1$29.4 million and $14.8$30.1 million for the years ended December 31, 2004, 20032006, 2005 and 2002,2004, respectively. Amortization expense was $2.0$3.8 million, $1.9$2.2 million and $1.6$2.0 million for the years ended December 31, 2006, 2005 and 2004, 2003 and 2002, respectively.
6. DEPOSITSDeposits
The following is a summary of deposit balances by type (Dollars in thousands):
| | | December 31, | | December 31, | |
|
| | December 31,
2004
| | December 31,
2003
| | 2006 | | 2005 | |
|---|
| Interest-bearing deposits: | Interest-bearing deposits: | | | | | | | | | | | | | |
| | Savings | | $ | 4,362,895 | | $ | 3,632,913 | |
| | Time | | 97,669 | | — | |
| | |
| |
| |
Demand | | | | $ | 110,647 | | | | $ | 85,157 | | |
Savings | | | | 4,854,711 | | | | 4,195,486 | | |
Time | | | | 224,386 | | | | 55,124 | | |
| Total interest-bearing deposits | Total interest-bearing deposits | | 4,460,564 | | 3,632,913 | | | 5,189,744 | | | | 4,335,767 | | |
| | |
| |
| |
| Noninterest-bearing deposits: | Noninterest-bearing deposits: | | | | | | | | | | | | | |
| | Demand | | 690,308 | | 334,823 | |
| | Savings | | 85,510 | | 49,382 | |
| | Time | | 160,000 | | 190,000 | |
| | |
| |
| |
Demand | | | | 585,174 | | | | 452,401 | | |
Savings | | | | 70,024 | | | | 29,422 | | |
Time | | | | 300,000 | | | | 175,000 | | |
| Total noninterest-bearing deposits | Total noninterest-bearing deposits | | 935,818 | | 574,205 | | | 955,198 | | | | 656,823 | | |
| | |
| |
| |
| Total | Total | | $ | 5,396,382 | | $ | 4,207,118 | | | $ | 6,144,942 | | | | $ | 4,992,590 | | |
| | |
| |
| |
Time deposits with balances greater than $100,000 totaled $257.6$524.4 million and $190.0$230.1 million at December 31, 20042006 and 2003,2005, respectively. All time deposits had a maturity of less than three months at December 31, 20042006 and 2003.2005. The aggregate amounts of overdraft deposits that have been reclassified as loan balances were $86.2 million and $162.2 million at December 31, 2006 and 2005, respectively.
F-22
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
7. SECURITIES SOLD UNDER REPURCHASE AGREEMENTSSecurities Sold Under Repurchase Agreements
The following table represents information regardingInformation on the Company's securities sold underCompany’s repurchase agreements and the corresponding securities pledged as collateral at December 31, 2006 is as follows (Dollars in thousands):
| | December 31,
2004
| | December 31,
2003
| | December 31,
2002
| |
|---|
| Outstanding at end of period | | $ | 4,255,497 | | $ | 3,258,001 | | $ | 2,301,974 | |
| Maximum outstanding at any month end | | | 4,749,456 | | | 3,546,131 | | | 2,931,041 | |
| Average balance for the year | | | 4,162,132 | | | 3,278,555 | | | 2,449,368 | |
| Weighted-average rate at end of period | | | 1.98 | % | | 1.09 | % | | 1.20 | % |
| Weighted-average rate for the period | | | 1.31 | % | | 0.90 | % | | 1.27 | % |
| | Securities Pledged as Collateral | | | | | |
| | Mortgage-backed | | Federal Agency | | Repurchase Agreements | |
| | Amortized Cost | | Fair Value | | Amortized Cost | | Fair Value | | Carrying Value | | Rate | |
Maturity of Repurchase Agreements: | | | | | | | | | | | | | | | | | | | |
Overnight | | | $ | 2,427,665 | | | $ | 2,417,385 | | | $ | 915,827 | | | $ | 907,608 | | | $ | 3,177,800 | | | 4.26 | % |
2 to 30 days | | | — | | | — | | | — | | | — | | | — | | | — | |
30 to 90 days | | | 77,939 | | | 77,360 | | | — | | | — | | | 100,000 | | | 3.40 | % |
Over 90 days | | | 498,404 | | | 492,436 | | | — | | | — | | | 450,000 | | | 3.52 | % |
Total | | | $ | 3,004,008 | | | $ | 2,987,181 | | | $ | 915,827 | | | $ | 907,608 | | | $ | 3,727,800 | | | | |
Approximately $4.3 billion and $3.4 billion of securities were pledged to collateralize
The weighted-average interest rate paid on repurchase agreements as ofwas 3.67% and 2.72% for the years ended December 31, 20042006 and 2003,2005, respectively. The Company has Master Repurchase Agreements in place with various counterparties to make funds available to us at various rates in exchange for collateral consisting of marketable securities. The aggregate amounts of these borrowing arrangements as of December 31, 2004 and 2003 were $5.6 billion and $3.9 billion, respectively, of which $1.3 billion and $0.6 billion, respectively, were available at December 31, 2004 and 2003.
8. SHORT-TERM AND OTHER BORROWINGSShort-Term and Other Borrowings
The components of short-term and other borrowings are as follows (Dollars in thousands):
| | December 31,
2004
| | December 31,
2003
|
|---|
| Federal funds purchased | | $ | 344,491 | | $ | 697,855 |
| Federal Home Loan Bank of Boston short-term advances | | | 200,000 | | | — |
| Federal Home Loan Bank of Boston overnight advances | | | — | | | 250,000 |
| Federal Home Loan Bank of Boston long-term advances | | | 50,000 | | | 150,000 |
| Treasury, Tax and Loan account | | | 190 | | | 232 |
| | |
| |
|
| Total | | $ | 594,681 | | $ | 1,098,087 |
| | |
| |
|
| | December 31,
2006 | | December 31,
2005 | |
Federal Funds purchased | | | $ | 391,967 | | | | $ | 810,511 | | |
FHLBB overnight advances | | | 125,000 | | | | 400,000 | | |
FHLBB short-term advances | | | — | | | | 146,000 | | |
Treasury, Tax and Loan account | | | 84 | | | | 138 | | |
Total | | | $ | 517,051 | | | | $ | 1,356,649 | | |
For the years ended December 31, 2004 and 2003, maturities on FHLBB advances ranged from overnight to September 2006.
The Company has borrowing arrangements with the FHLBB and the Federal Reserve Discount Window and the FHLBB, which have been utilized on an overnight and long-termshort-term basis to satisfy funding requirements. Approximately $1.6 billion and $1.9 billion of securities were pledged to collateralize these advances as of
F-23
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 20042006, 2005 and 2003,2004
8. Short-Term and Other Borrowings (Continued)
A summary of the borrowing arrangements are as follows (Dollars in thousands):
| | December 31, | |
| | 2006 | | 2005 | |
Federal Reserve Discount Window: | | | | | |
Borrowing capacity | | $ | 1,984,499 | | $ | 1,372,312 | |
Borrowing utilized | | — | | — | |
Maturity range | | — | | — | |
Securities pledged | | 2,077,291 | | 1,447,941 | |
Federal Home Loan Bank of Boston: | | | | | |
Borrowing capacity | | $ | 146,430 | | $ | 833,333 | |
Borrowing utilized | | 125,000 | | 546,000 | |
Maturity range | | Overnight | | Overnight to
September 2006 | |
Securities pledged | | 925,286 | | 955,743 | |
For the years ended December 31, 2006 and 2005, the weighted-average interest rate paid on short-term and other borrowings was 5.02% and 3.31%, respectively. The Company currently has informalthe ability to purchase up to $25.0 million of activity-based capital of the FHLBB, which would provide a total overnight borrowing arrangements with various counterparties to make funds available to the Company at the Federal Funds overnight rate. The aggregate amountscapacity of these borrowing arrangements at December 31, 2004 and 2003 were $3.2 billion and $2.4 billion, respectively, of which $2.9 billion and $1.7 billion, respectively, were available at December 31, 2004 and 2003.$833.3 million.
The following table represents information regarding the Company's Federal Funds purchased (Dollars in thousands):
| | December 31,
2004
| | December 31,
2003
| | December 31,
2002
| |
|---|
| Outstanding at end of period | | $ | 344,491 | | $ | 697,855 | | $ | 130,648 | |
| Maximum outstanding at any month end | | | 739,038 | | | 697,855 | | | 375,000 | |
| Average balance for the year | | | 491,170 | | | 432,490 | | | 254,093 | |
| Weighted-average rate at end of period | | | 1.94 | % | | 0.99 | % | | 1.20 | % |
| Weighted-average rate for the period | | | 1.45 | % | | 1.14 | % | | 1.71 | % |
9. INCOME TAXESIncome Taxes
The components of income tax expense are as follows (Dollars in thousands):
| | | December 31, | | December 31, | | December 31, | |
|
| | December 31,
2004
| | December 31,
2003
| | December 31,
2002
| | 2006 | | 2005 | | 2004 | |
|---|
| Current: | Current: | | | | | | | | | | | | | | | | | | | |
| | Federal | | $ | 62,690 | | $ | 32,752 | | $ | 24,172 | |
| | State | | 5,892 | | 14,310 | | 532 | |
| | Foreign | | 1,247 | | 52 | | 61 | |
| | |
| |
| |
| |
| | | 69,829 | | 47,114 | | 24,765 | |
| | |
| |
| |
| |
Federal | | | | $ | 64,665 | | | | $ | 76,533 | | | | $ | 62,690 | | |
State | | | | 5,168 | | | | 5,420 | | | | 5,892 | | |
Foreign | | | | 1,048 | | | | 1,026 | | | | 1,247 | | |
Total current | | | | 70,881 | | | | 82,979 | | | | 69,829 | | |
Deferred: |
Deferred: |
|
|
|
|
|
| | | | | | | | | | | | | |
| | Federal | | 3,413 | | 5,989 | | 3,972 | |
| | State | | 94 | | (338 | ) | | — | |
| | Foreign | | (510 | ) | | — | | — | |
| | |
| |
| |
| |
| | | 2,997 | | 5,651 | | 3,972 | |
| | |
| |
| |
| |
Federal | | | | (687 | ) | | | (9,543 | ) | | | 3,413 | | |
State | | | | 318 | | | | 1,788 | | | | 94 | | |
Foreign | | | | (21 | ) | | | 811 | | | | (510 | ) | |
Total deferred | | | | (390 | ) | | | (6,944 | ) | | | 2,997 | | |
| Total income taxes | Total income taxes | | $ | 72,826 | | $ | 52,765 | | $ | 28,737 | | | $ | 70,491 | | | | $ | 76,035 | | | | $ | 72,826 | | |
| | |
| |
| |
| |
F-24
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
9. Income Taxes (Continued)
Differences between the effective income tax rate and the federal statutory rates are as follows:
| | | December 31, | | December 31, | | December 31, | |
| | December 31,
2004
| | December 31,
2003
| | December 31,
2002
| | | 2006 | | 2005 | | 2004 | |
|---|
| Federal statutory rate | | 35.00 | % | 35.00 | % | 35.00 | % | | | 35.00 | % | | | 35.00 | % | | | 35.00 | % | |
| State income tax rate, net of federal benefit | | 1.81 | | 6.25 | | 0.35 | | | | 1.59 | | | | 2.00 | | | | 1.81 | | |
| Tax-exempt income, net of disallowance | | (3.61 | ) | (4.89 | ) | (6.12 | ) | | | (3.04 | ) | | | (2.89 | ) | | | (3.61 | ) | |
Foreign taxes | | | | 0.53 | | | | 0.83 | | | | — | | |
Undistributed foreign earnings | | | | (1.09 | ) | | | (4.12 | ) | | | — | | |
| Other | | 0.71 | | (0.01 | ) | 0.66 | | | | (1.56 | ) | | | 1.41 | | | | 0.71 | | |
| | |
| |
| |
| | |
| Effective tax rate | | 33.91 | % | 36.35 | % | 29.89 | % | | | 31.43 | % | | | 32.23 | % | | | 33.91 | % | |
| | |
| |
| |
| | |
In March 2003, a retroactive change
The Company reversed previously accrued taxes of approximately $5.3 million in the Commonwealth of Massachusetts tax law disallowed a dividends received deduction taken by the Bank on dividends it had received since 1999 from a wholly-owned real estate investment trust. During the second quarter of 2003, we settled this disputed2006, resulting from a tax assessmentposition that no longer met the probable recognition threshold under Statement of Financial Accounting Standards No. 5, Accounting for Contingencies (‘SFAS 5’).
At December 31, 2006, the Company had a foreign non-capital loss carryforward of approximately $6.8 million, which begins to expire in 2009. In accordance with the Massachusetts Departmentprovisions of Revenue, agreeing to pay approximately 50%SFAS 109, the Company believes that it is more likely than not that the related deferred tax asset of the liability.$2.2 million will not be realized. As a result, a valuation allowance for the entire deferred tax asset amount has been recorded.
The Company provides U.S. federal income taxes on the unremitted earnings of this retroactive change in tax law,foreign subsidiaries, except to the extent that such earnings are permanently reinvested outside the United States. At December 31, 2006, there were accumulated unremitted earnings of certain foreign subsidiaries of $36.5 million. Pursuant to the provisions of APB 23, the Company recorded an additional state tax expense of approximately $7.2 million, net ofhas not provided for U.S. federal income taxes or foreign withholding taxes on these earnings since it is the Company’s current intention to permanently reinvest those earnings outside of the U.S. If the capital in these subsidiaries had been temporarily invested, a U.S. deferred tax benefit, in 2003.liability of $9.0 million would have been recorded.
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
9. Income Taxes (Continued)
The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities consist of the following (Dollars in thousands):
| | | December 31, | | December 31, | |
|
| | December 31,
2004
| | December 31,
2003
| | | 2006 | | 2005 | |
|---|
| Deferred tax assets: | Deferred tax assets: | | | | | | | | | | | | | | |
| | Employee benefit plans | | $ | 3,883 | | $ | 3,190 | | |
| | Other | | 1,350 | | 441 | | |
| | |
| |
| | |
| | | 5,233 | | 3,631 | | |
| | |
| |
| | |
Securities available for sale | | | | $ | 13,017 | | | | $ | 16,622 | | |
Employee benefit plans | | | | 14,470 | | | | 7,094 | | |
Other | | | | 3,481 | | | | 3,691 | | |
Deferred tax assets | | | | 30,968 | | | | 27,407 | | |
Valuation allowance | | | | (2,239 | ) | | | (565 | ) | |
Total deferred tax assets | | | | 28,729 | | | | 26,842 | | |
Deferred tax liabilities: |
Deferred tax liabilities: |
|
|
|
|
| | | | | | | | | |
| | Unrealized hedging (gain) loss | | (2,306 | ) | | 4,723 | | |
| | Depreciation and amortization | | (9,882 | ) | | (8,266 | ) | |
| | Undistributed income of foreign subsidiaries | | (6,160 | ) | | (2,887 | ) | |
| | Pension plan | | (1,172 | ) | | (1,462 | ) | |
| | Securities available for sale | | (10,162 | ) | | (14,469 | ) | |
| | |
| |
| | |
| | | (29,682 | ) | | (22,361 | ) | |
| | |
| |
| | |
| Net deferred tax liability | | $ | (24,449 | ) | $ | (18,730 | ) | |
| | |
| |
| | |
Unrealized hedging gain | | | | (7,998 | ) | | | (13,224 | ) | |
Depreciation and amortization | | | | (11,364 | ) | | | (10,698 | ) | |
Undistributed income of foreign subsidiaries | | | | — | | | | (69 | ) | |
Pension plan | | | | (1,312 | ) | | | (1,196 | ) | |
Total deferred tax liabilities | | | | (20,674 | ) | | | (25,187 | ) | |
Net deferred tax asset | | | | $ | 8,055 | | | | $ | 1,655 | | |
10. COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUST HOLDING JUNIOR SUBORDINATED DEFERRABLE INTEREST DEBENTURES OF THE COMPANYSubsidiary Trust Holding Junior Subordinated Deferrable Interest Debentures of the Company
On January 31, 1997, Investors Capital Trust I ("ICTI"(‘ICTI’), a trust sponsored and wholly-owned by the Company, issued $25 million in 9.77% Trust Preferred Securities (the "Capital Securities"‘Capital Securities’), the proceeds of which were invested by the trustICT1 in the same aggregate principal amount of the Company'sCompany’s newly issued 9.77% Junior Subordinated Deferrable Interest Debentures due February 1, 2027 (the "Junior‘Junior Subordinated Debentures"Debentures’). The Capital Securities have a call date ofwere callable on February 1, 2007.2007; however, the Company did not redeem the Capital Securities at that time. The $25 million aggregate principal amount of the Junior Subordinated Debentures represents the sole asset of ICTI. The Company has guaranteed, on a subordinated basis, distributions and other payments due on the Capital Securities (the "Guarantee"‘Guarantee’). The Guarantee, when taken together with the Company'sCompany’s obligations under (i) the Junior Subordinated Debentures; (ii) the indenture pursuant to which the Junior Subordinated Debentures were issued; and (iii) the Amended and Restated Declaration of Trust governing ICTI, constitutes a full and unconditional guarantee of ICTI'sICTI’s obligations under the Capital Securities. No other subsidiary of the Company guarantees these Capital Securities. Certain of the Company'sCompany’s subsidiaries may require prior approval of the Commissioner of Banks of the Commonwealth of Massachusetts if the total dividends for a calendar year would exceed net profits for the year combined with retained net profits for the previous two years. These restrictions on the ability to pay dividends to the Company may restrict the Company'sCompany’s ability to pay dividends to its shareholders. In 2002, the Company repurchased $1.0 million of the Capital Securities.
Effective October 1, 2003, the Company adopted provisions of FIN 46. As a result of the adoption of this Interpretation, the Company was required to deconsolidate ICTI theis an unconsolidated wholly-owned trust that issued the Capital Securities. Therefore,and therefore, the Company presents in its consolidated financial statementsthe junior subordinated debentures as a liability and its investment in ICTI as a component of other assets. The income for the three months during 2003 that ICTI was notassets in its consolidated is considered immaterial.financial statements.
F-26
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
11. STOCKHOLDERS' EQUITYStockholders’ Equity
As of December 31, 2004,2006, the Company hasCompany’s capital stock consisted of 1,000,000 authorized 1,000,000 shares of Preferred Stockpreferred stock, of which no shares were issued, and 175,000,000 authorized shares of Common Stock, all with acommon stock, of which 68,523,129 shares were issued. All shares have par value of $0.01 per share.
On April 23, 2002, the Board of Directors approved a two-for-one stock split in the form of a 100% stock dividend to stockholders of record on May 24, 2002. The dividend was paid on June 14, 2002. A total of 32,168,922 shares of common stock were issued in connection with the stock split. The stock split did not result in a change in the $0.01 par value per share of the common stock or in total stockholders' equity.
At the Annual Meeting of Stockholders of the Company held on April 13, 2004, stockholders approved an increase in the number of authorized shares of Common Stock from 100,000,000 to 175,000,000. On May 5, 2004, the Company amended its Certificate of Incorporation to increase the number of authorized shares of Common Stock to 175,000,000. These shares are available for issuance for general corporate purposes as determined by the Company's Board of Directors.
The Company has three stock optionfour equity incentive plans: the Amended and Restated 1995 Stock Plan ("(‘Stock Plan"Plan’), the Amended and Restated 1995 Non-Employee Director Stock Option Plan ("(‘Director Plan"Plan’), and the 1997 Employee Stock Purchase Plan ("ESPP"(‘ESPP’) and the 2005 Equity Incentive Plan (the ‘2005 Plan’).
At The 2005 Plan supersedes both the Annual MeetingStock Plan and the Director Plan, both of Stockholderswhich continue in effect only with regard to options outstanding under those plans. Options awarded under the Stock Plan, the Director Plan and the 2005 Plan generally vest over zero to four years of continuous service and generally have ten-year contractual terms. The exercise prices of these awards are generally equal to the fair market value of the Company’s common stock on the date the awards are granted. There were no amendments to any plans during the year ended December 31, 2006.
Cash received from options exercised under all share-based payment arrangements for the year ended December 31, 2006 was $33.1 million. The actual tax benefit realized for the tax deductions related to these exercises amounted to $7.0 million for the year ended December 31, 2006.
In June 2006, the Company held on April 23, 2002, stockholders approved the amendment and restatementannounced that its Board of Directors authorized a repurchase of up to $150.0 million of the Company'sCompany’s common stock over the next twelve months following the announcement. As of December 31, 2006, the Company has repurchased $29.3 million of its common stock. The plan expires in June 2007.
The Stock Plan, to increase the number of shares available for grant pursuant toDirector Plan, and the plan from 6,140,000 to 7,640,000. 2005 Plan
Effective with the June 2002start of the 2005 Plan, 45,703 shares of the Director Plan and 3,439,197 shares of the Stock Plan were transferred to the 2005 Plan. On April 14, 2005, the shareholders authorized an additional 2,000,000 shares of common stock split,for issuance under the number of shares available to grant increased to 15,280,000. 2005 Plan.
Of the 15,280,000 shares of Common Stock authorized for issuance under the Stock2005 Plan at December 31, 2004, 3,431,7502006, 4,107,719 were available for grant as of that date. Under the Stock Plan, the Company may grant options to purchase shares of Common Stock to certain employees, consultants, directors and officers. The options may be awarded as incentive stock options (employees only), nonqualified stock options, stock awards or opportunities to make direct purchases of stock. No options were granted to consultants during the yearyears ended December 31, 2006, 2005 and 2004.
The terms of the Director Plan provide for the grant of options to non-employee directors to purchase up to a maximum of 800,000 shares of Common Stock. Of the 800,000 shares of Common Stock authorized for issuance under the plan, 64,995 were available for grant at December 31, 2004.
Pursuant to the terms of the Director Plan, each non-employee director receives an automatic annual grant of options to purchase the number of shares then specified by the Director Plan, as described below. Additionally, any non-employee director may elect to receive options to acquire shares of the Company's Common Stock in lieu of such director's cash retainer. Any such election is subject to certain restrictions under the Director Plan. The number of shares of stock underlying the option granted in lieu of cash is equal to the quotient obtained by dividing the cash retainer by the fair market value of an option on the date of grant, which is based on the Black-Scholes valuation model.
The Director Plan provides that, on the date of each Annual Meeting, each person who is a member of the Board immediately after the Annual Meeting of the Company and who is not an employee of the Company shall be automatically granted an option to purchase 5,000 shares of the Company's Common Stock. Options granted under the Director Plan will vest in 36 equal monthly installments beginning on the date of grant, subject to certain restrictions.
The exercise price of options under the Director Plan and the incentive options under the Stock Plan may not be less than the fair market value at the date of the grant. The exercise price of nonqualified options under the Stock Plan is determined by the compensation committee of the Board of Directors. All options become exercisable as specified by the compensation committee at the date of the grant.
At the Annual Meeting of Stockholders of the Company held on April 13, 2004, stockholders approved an amendment to the Company's ESPP to increase the number of shares of Common Stock that may be issued thereunder from 1,120,000 to 1,620,000.
On February 13, 2001, the Company granted 8,000 shares of Common Stock under the Stock Plan to former employees of the Chase advisor custody unit. This grant is subject to the Company's right to repurchase the shares if the employees' employment with the Company terminates. The Company's right to repurchase the shares lapses in five equal annual installments beginning one year from the date of grant. During 2002, the Company chose not to exercise its right to repurchase 3,200 shares issued in connection with this grant when an employee's employment with the Company terminated.
On May 1, 2001, the Company granted 58,000 nonqualified stock options under the Stock Plan to former employees of the U.S. asset administration unit of BGI in connection with the assumption of the operations of the unit. The exercise price of the options is 10% of the fair market value of the Common Stock at the close of market on the date of grant. The grants are exercisable immediately, but any shares acquired on exercise are subject to the Company's right to repurchase the shares at the exercise price if the employees' employment with the Company terminates. The Company's right to repurchase the shares lapses in five equal annual installments beginning one year from the date of grant. During 2004 and 2003, the Company cancelled 5,600 and 1,200 options, respectively, relating to the unvested portion for employees whose employment terminated during the year.
On October 16, 2001, the Company granted 10,000 nonqualified stock options to an officer of the Company under the Stock Plan. The exercise price of the options is 10% of the fair market value of the Common Stock at the close of market on the date of grant. The grants are exercisable immediately, but any shares acquired on exercise are subject to the Company's right to repurchase the shares at the exercise price if the officer's employment with the Company terminates. The Company's right to repurchase the shares lapses in five equal annual installments beginning one year from the date of grant.
The Company has recorded deferred compensation of $0.6 million$0 and $1.1$0.3 million at December 31, 20042006 and 2003, respectively, related to the grants described in the above three paragraphs.2005, respectively. Amortization of deferred compensation was $316,000, $483,000,$0, $0.3 million and $964,000$0.3 million for the years ended December 31, 2006, 2005 and 2004, 2003,respectively.
F-27
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2002, respectively.2004
11. Stockholders’ Equity (Continued)
A summary of option activity under boththe Director Plan, Stock Plan and 2005 Plan for the year ended December 31, 2006 are as follows:
| | Number of
Options | | Weighted-
Average
Exercise
Price | | Weighted-
Average
Remaining
Contractual
Term | | Aggregate
Intrinsic
Value
($000) | |
Outstanding at January 1, 2006 | | 6,919,316 | | | $ | 31 | | | | | | | | | | |
Granted | | 81,557 | | | 46 | | | | | | | | | | |
Exercised | | (1,257,593 | ) | | 28 | | | | | | | | | | |
Forfeited or expired | | (36,007 | ) | | 39 | | | | | | | | | | |
Outstanding at December 31, 2006 | | 5,707,273 | | | 31 | | | | 5.6 years | | | | $ | 65,115 | | |
Exercisable at December 31, 2006 | | 5,524,039 | | | $ | 31 | | | | 5.5 years | | | | $ | 64,217 | | |
The weighted-average grant-date fair values per option of options granted during the years ended December 31, 2006, 2005 and 2004 were $19.68, $14.81, and $16.78, respectively. The total intrinsic value of options exercised during the years ended December 31, 2006, 2005 and 2004 were $21.8 million, $8.0 million, and $27.3 million, respectively.
As of December 31, 2006, there was $1.4 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Stock Plan, the Director Plan and the Stock Plan2005 Plan. That cost is as follows:expected to be recognized over a weighted-average period of approximately 1 year.
| | December 31, 2004
| | December 31, 2003
| | December 31, 2002
|
|---|
| | Shares
| | Weighted-
Average
Exercise
Price
| | Shares
| | Weighted-
Average
Exercise
Price
| | Shares
| | Weighted-
Average
Exercise
Price
|
|---|
| Outstanding at beginning of year | | 6,547,086 | | $ | 24 | | 6,621,157 | | $ | 22 | | 6,921,610 | | $ | 20 |
| Granted | | 902,558 | | | 41 | | 737,399 | | | 34 | | 674,414 | | | 32 |
| Exercised | | (1,396,211 | ) | | 20 | | (654,230 | ) | | 9 | | (761,893 | ) | | 7 |
| Canceled | | (124,081 | ) | | 32 | | (157,240 | ) | | 32 | | (212,974 | ) | | 29 |
| | |
| | | | |
| | | | |
| | | |
| Outstanding at end of year | | 5,929,352 | | | 28 | | 6,547,086 | | | 24 | | 6,621,157 | | | 22 |
| | |
| | | | |
| | | | |
| | | |
| Outstanding and exercisable at year end | | 4,949,879 | | | | | 4,712,586 | | | | | 4,202,545 | | | |
| | |
| | | | |
| | | | |
| | | |
The following table summarizes information about stock options outstanding atA summary of the status of the Company’s nonvested shares for the year ended December 31, 2004:2006 is presented below:
| | Options Outstanding
| |
| |
|
|---|
| | Options Exercisable
|
|---|
| |
| | Weighted-
Average
Remaining
Contractual
Life
| |
|
|---|
Range of Exercise Prices
| | Number
Outstanding at
December 31,
2004
| | Weighted-
Average
Exercise
Price
| | Number
Exercisable at
December 31,
2004
| | Weighted-
Average
Exercise
Price
|
|---|
| $0–10 | | 771,898 | | 3.3 years | | $ | 6 | | 771,898 | | $ | 6 |
| 10–20 | | 790,749 | | 4.2 | | | 11 | | 790,749 | | | 11 |
| 20–30 | | 82,072 | | 6.1 | | | 25 | | 60,936 | | | 26 |
| 30–40 | | 3,407,757 | | 6.9 | | | 33 | | 2,531,349 | | | 33 |
| 40–50 | | 876,876 | | 9.3 | | | 41 | | 794,947 | | | 41 |
| | |
| | | | | | |
| | | |
| | | 5,929,352 | | 6.4 | | | 28 | | 4,949,879 | | | 27 |
| | |
| | | | | | |
| | | |
Nonvested Shares | | | | Number of
Shares | | Weighted-Average
Grant-Date
Fair Value | |
Nonvested at January 1, 2006 | | | 5,000 | | | | $ | 34 | | |
Granted | | | — | | | | — | | |
Vested | | | (1,000 | ) | | | 34 | | |
Forfeited | | | — | | | | — | | |
Nonvested at December 31, 2006 | | | 4,000 | | | | $ | 34 | | |
The total fair values of shares vested during the year ended December 31, 2006, 2005 and 2004 were $0.03 million, $0 and $0, respectively.
ESPP
Under the terms of the 1997 Employee Stock Purchase Plan,ESPP, the Company may issue up to 1,620,000 shares of Common Stockcommon stock pursuant to the exercise of nontransferable options granted to participating employees. The 1997 Employee Stock Purchase PlanESPP permits eligible employees to purchase up to 8,000 shares of Common Stockcommon stock per payment period, subject to limitations provided by Section 423(b) of the Internal Revenue Code, through accumulated payroll
F-28
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
11. Stockholders’ Equity (Continued)
deductions. The purchases are made twice a year at a price equal to the lesser of (i) 90% of the market value of the Common StockCompany’s common stock on the first business day of the payment period or (ii) 90% of the market value of the Common StockCompany’s common stock on the last business day of the payment period. The payment periods consist of two six-month periods, January 1 through June 30 and July 1 through December 31. The NASDAQ Stock Market became a registered national securities exchange with the SEC in August 2006. In accordance with the terms of the plan, because the Company is now traded on a national securities exchange, the Company will calculate the market value on a measurement day to be the average of the high and low prices of the Company’s common stock on that day. This calculation method applies to all purchases made during and after the six-month period ended December 31, 2006.
A summary of the 1997 Employee Stock Purchase PlanESPP shares is as follows:
| | December 31,
| | | December 31, | |
|---|
| | 2004
| | 2003
| | 2002
| | | 2006 | | 2005 | | 2004 | |
|---|
| Total shares available under the plan beginning of year | | 227,504 | | 356,875 | | 500,764 | | |
Total shares available under the plan, beginning of year | | | 521,563 | | 636,267 | | 227,504 | |
| Approved increase in shares available | | 500,000 | | — | | — | | | — | | — | | 500,000 | |
| Issued at June 30 | | (47,681 | ) | (70,606 | ) | (61,193 | ) | | (68,506 | ) | (54,862 | ) | (47,681 | ) |
| Issued at December 31 | | (43,556 | ) | (58,765 | ) | (82,696 | ) | | (65,802 | ) | (59,842 | ) | (43,556 | ) |
| | |
| |
| |
| | |
| Total shares available under the plan end of year | | 636,267 | | 227,504 | | 356,875 | | |
| | |
| |
| |
| | |
Total shares available under the plan, end of year | | | 387,255 | | 521,563 | | 636,267 | |
At the Annual Meeting of Stockholders of the Company held on April 13, 2004, stockholders approved an amendment to the Company’s ESPP to increase the number of shares of common stock that may be issued thereunder from 1,120,000 to 1,620,000.
For the first payment period in the year ended December 31, 2006, the purchase price of the stock was $33.52, or 90% of the market value of the Company’s common stock on the first business day of the payment period ending June 30, 2006. For the second payment period in the year ended December 31, 2006, the purchase price of the stock was $38.45, or 90% of the market value of the average of the high and low price of the Company’s common stock on the last business day of the payment period ending December 31, 2006.
During the year ended December 31, 2005, the purchase prices of the stock were $34.25 and $33.25, or 90% of the market value of the common stock on the last business day of the payment periods ending June 30, 2005 and December 31, 2005, respectively.
During the year ended December 31, 2004, the purchase prices of the stock were $35.00 and $38.75, or 90% of the market value of the Common Stockcommon stock on the first business day of the payment periods ending June 30, 2004 and December 31, 2004, respectively.
DuringPrior to the adoption of SFAS 123R, the ESPP was considered a non-compensatory plan and, therefore, no compensation cost was recognized. However, pursuant to SFAS 123R, the ESPP is considered a compensatory plan, effective January 1, 2006. Accordingly, compensation cost is computed as the sum of: (a) 10% of the fair market value of the Company’s common stock on the first day of the purchase period and (b) the fair value of the option features, calculated using the Black-Scholes valuation model. Compensation cost is recognized ratably over the payment period based on the components of fair
F-29
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
11. Stockholders’ Equity (Continued)
value in the preceding sentence and the number of shares that could be purchased at grant date based on the estimated total withholdings and the discounted market price of the stock on grant date. The weighted-average grant-date fair value of awards granted under the ESPP was $7.86 per share for the payment period from January 1, 2006 through June 30, 2006 and $9.86 per share for the payment period from July 1, 2006 through December 31, 2006. Compensation cost related to the ESPP was $1.2 million for the year ended December 31, 2003, the purchase prices of the stock were $25.50 and $27.00, or 90% of the market value of the Common Stock on the first business day of the payment periods ending June 2006.
F-30 2003 and
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2003, respectively.2006, 2005 and 2004
During the year ended December 31, 2002, the purchase prices of the stock were $30.00 and $24.75, or 90% of the market value of the Common Stock on the first business day of the payment period ending June 30, 2002 and the last business day of the payment period ending December 31, 2002, respectively.
12. COMPREHENSIVE INCOMEComprehensive Income
Comprehensive income represents the change in equity of the Company during a period from transactions and other events and circumstances from non-shareholder sources. It includes all changes in equity during a period except those resulting from investments by shareholders and distributions to shareholders. The Company'sCompany’s other comprehensive income and related tax effects for the years ended December 31, 2004, 20032006, 2005 and 20022004 are as follows (Dollars in thousands):
|
| | Pre-tax
Amount
| | Tax (Expense)
Benefit
| | After-tax
Amount
| | | Pre-tax
Amount | | Tax (Expense)
Benefit | | After-tax
Amount | |
|---|
2006 | | | | | | | | | | |
Unrealized gains on securities: | | | | | | | | | | |
Unrealized holding gains arising during the period | | | $ | 16,675 | | | $ | (4,629 | ) | | $ | 12,046 | |
Less: reclassification adjustment for gains included in net income | | | 2,523 | | | (1,073 | ) | | 1,450 | |
Net unrealized holding gains arising during the period | | | 14,152 | | | (3,556 | ) | | 10,596 | |
Other | | | 156 | | | (57 | ) | | 99 | |
Net unrealized gains | | | 14,308 | | | (3,613 | ) | | 10,695 | |
Net unrealized derivative instrument loss | | | (9,020 | ) | | 3,836 | | | (5,184 | ) |
Amortization of terminated interest rate swap agreements | | | (2,360 | ) | | 1,019 | | | (1,341 | ) |
Currency translation adjustment | | | 1,444 | | | — | | | 1,444 | |
Other comprehensive income | | | $ | 4,372 | | | $ | 1,242 | | | $ | 5,614 | |
2005 | | | | | | | | | | |
Unrealized losses on securities: | | | | | | | | | | |
Unrealized holding losses arising during the period | | | $ | (60,552 | ) | | $ | 21,481 | | | $ | (39,071 | ) |
Less: reclassification adjustment for gains included in net income | | | 12,397 | | | (5,185 | ) | | 7,212 | |
Net unrealized holding losses arising during the period | | | (72,949 | ) | | 26,666 | | | (46,283 | ) |
Other | | | 394 | | | (165 | ) | | 229 | |
Net unrealized losses | | | (72,555 | ) | | 26,501 | | | (46,054 | ) |
Net unrealized derivative instrument gain | | | 18,002 | | | (7,529 | ) | | 10,473 | |
Amortization of terminated interest rate swap agreements | | | (2,970 | ) | | 1,242 | | | (1,728 | ) |
Currency translation adjustment | | | 52 | | | — | | | 52 | |
Other comprehensive income | | | $ | (57,471 | ) | | $ | 20,214 | | | $ | (37,257 | ) |
| 2004 | 2004 | | | | | | | | | | | | | | | | |
| Unrealized losses on securities: | Unrealized losses on securities: | | | | | | | | | | | | | | | | |
| Unrealized holding losses arising during the period | Unrealized holding losses arising during the period | | $ | (9,402 | ) | $ | 3,284 | | $ | (6,118 | ) | | $ | (9,168 | ) | | $ | 3,202 | | | $ | (5,966 | ) |
Less: reclassification adjustment for gains included in net income | | | 234 | | | (82 | ) | | 152 | |
Net unrealized holding losses arising during the period | | | (9,402 | ) | | 3,284 | | | (6,118 | ) |
| Other | Other | | (2,671 | ) | | 935 | | (1,736 | ) | | (2,671 | ) | | 935 | | | (1,736 | ) |
| | |
| |
| |
| | |
| | Net unrealized losses | | (12,073 | ) | | 4,219 | | (7,854 | ) | |
Net unrealized losses | | | (12,073 | ) | | 4,219 | | | (7,854 | ) |
| Net unrealized derivative instrument gain | Net unrealized derivative instrument gain | | 19,958 | | (6,985 | ) | | 12,973 | | | 19,984 | | | (6,994 | ) | | 12,990 | |
| Amortization of terminated interest rate swap agreements | Amortization of terminated interest rate swap agreements | | 89 | | (31 | ) | | 58 | | | 63 | | | (22 | ) | | 41 | |
| Currency translation adjustment | Currency translation adjustment | | 846 | | — | | 846 | | | 846 | | | — | | | 846 | |
| | |
| |
| |
| | |
| | Other comprehensive income | | $ | 8,820 | | $ | (2,797 | ) | $ | 6,023 | | |
| | |
| |
| |
| | |
2003 |
|
|
|
|
|
|
| |
| Unrealized losses on securities: | | | | | | | | |
| Unrealized holding losses arising during the period | | $ | (18,006 | ) | $ | 6,046 | | $ | (11,960 | ) | |
| Other | | (1,542 | ) | | 539 | | (1,003 | ) | |
| | |
| |
| |
| | |
| | Net unrealized losses | | (19,548 | ) | | 6,585 | | (12,963 | ) | |
| Net unrealized derivative instrument gain | | 17,663 | | (5,878 | ) | | 11,785 | | |
| Amortization of transition related adjustment | | 361 | | (127 | ) | | 234 | | |
| Currency translation adjustment | | 577 | | — | | 577 | | |
| | |
| |
| |
| | |
| | Other comprehensive income | | $ | (947 | ) | $ | 580 | | $ | (367 | ) | |
| | |
| |
| |
| | |
| | | | | | | | | |
Other comprehensive income | | | $ | 8,820 | | | $ | (2,797 | ) | | $ | 6,023 | |
F-31
2002 |
|
|
|
|
|
|
|
|
|
|
| Unrealized gains on securities: | | | | | | | | | | |
| Unrealized holding gains arising during the period | | $ | 49,556 | | $ | (17,612 | ) | $ | 31,944 | |
| | |
| |
| |
| |
| | Net unrealized gains | | | 49,556 | | | (17,612 | ) | | 31,944 | |
| Net unrealized derivative instrument loss | | | (17,122 | ) | | 5,993 | | | (11,129 | ) |
| Amortization of transition related adjustment | | | 2,482 | | | (869 | ) | | 1,613 | |
| | |
| |
| |
| |
| | Other comprehensive income | | $ | 34,916 | | $ | (12,488 | ) | $ | 22,428 | |
| | |
| |
| |
| |
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
13. EMPLOYEE BENEFIT PLANSEmployee Benefit Plans
Pension Plan—The Company has a trusteed, noncontributory, qualified defined benefit pension plan (‘Pension Plan’) covering substantially all of its employees who were hired before January 1, 1997. The benefits are based on years of service and the employee'semployee’s compensation during employment. Generally, the Company'sCompany’s funding policy is to contribute annually the maximum amount that can be deducted for federal income tax purposes. Contributions are intended to provide not only for benefits attributed to service to date but also for benefits expected to be earned in the future. The plan document was amended in December 2001 to freeze benefit accruals for certain highly compensated participants as of December 31, 2002, as well as to change the maximum allowable compensation projected for future years. Such highly compensated participants will receive their future full benefit accrual under the Company's nonqualified supplemental retirement plan, as described below. The plan document was also amended inand December 2004 to freeze benefit accruals for certain highly compensated participants as ofparticipants. Effective December 31, 2004. The Company uses a December 31 measurement date for this plan.2005, all Pension Plan participants’ accounts were frozen and effective January 1, 2006, no further Pension Plan benefit will accrue on behalf of any Pension Plan participant.
Supplemental Retirement Plan—The Company also has a nonqualified, unfunded, supplemental retirement plan ("SERP"(‘SERP’) which was established in 1994 and covers certain employees and pays benefits that supplement any benefits paid under the qualified plan.Pension Plan. Benefits under the supplemental planSERP are generally based on compensation not includable in the calculation of benefits to be paid under the qualified plan.Pension Plan. The plan document was amended in April 2000 to eliminate the compensation cap and include bonuses and commissions of certain employees. The Company uses a
Effective December 31, measurement date2006, the Company adopted the provisions of FASB Statement No. 158, Employers’ Accounting for this plan.Defined Benefit Pension and Other Postretirement Plans (‘SFAS 158’). SFAS 158 changes current practice by requiring employers to recognize the overfunded or underfunded positions of defined benefit postretirement plans, including pension plans, on the balance sheet. The funded status is defined as the difference between the projected benefit obligation and the fair value of plan assets. SFAS 158 also requires employers to recognize the change in funded status in other comprehensive income (a component of shareholders’ equity). Upon adopting SFAS 158, the Company recognized the funded status of its SERP and pension plans on its consolidated balance sheet. As a result, the Company recognized an adjustment of $6.8 million to the ending balance of accumulated other comprehensive income, net of tax, which represented the net losses, transition (assets) obligations, and prior service costs that had not been included in net periodic benefit cost as of December 31, 2006.
F-32
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
13. Employee Benefit Plans (Continued)
The incremental effect of applying SFAS 158 on individual line items of the Company’s consolidated balance sheet consisted of the following:
| | Before
Application
of SFAS 158 | | Adjustments | | After
Application
of SFAS 158 | |
Pension Plan | | | | | | | | | |
Asset for pension benefits | | $ | 3,095 | | | $ | (2,079 | ) | | $ | 1,016 | |
Deferred income tax asset | | — | | | 884 | | | 884 | |
Accumulated other comprehensive income | | — | | | 1,195 | | | 1,195 | |
SERP | | | | | | | | | |
SERP liability | | $ | (19,908 | ) | | $ | (9,408 | ) | | $ | (29,316 | ) |
Deferred income tax asset | | 648 | | | 4,916 | | | 5,564 | |
Intangible assets | | 2,150 | | | (2,150 | ) | | — | |
Accumulated other comprehensive income | | 876 | | | 6,642 | | | 7,518 | |
Pension Plan & SERP | | | | | | | | | |
Total assets | | $ | 11,556,635 | | | $ | 1,571 | | | $ | 11,558,206 | |
Total liabilities | | 10,610,060 | | | 9,408 | | | 10,619,468 | |
Total stockholders’ equity | | 946,575 | | | (7,837 | ) | | 938,738 | |
F-33
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
13. Employee Benefit Plans (Continued)
The following table sets forth the status of the Company's qualified defined benefit pension planCompany’s Pension Plan and supplemental retirement planSERP (Dollars in thousands):
|
| | December 31, 2004
| | December 31, 2003
| | | December 31, 2006 | | December 31, 2005 | |
|---|
|
| | Pension Plan
| | SERP
| | Pension Plan
| | SERP
| | | Pension Plan | | SERP | | Pension Plan | | SERP | |
|---|
| Change in benefit obligation: | Change in benefit obligation: | | | | | | | | | | | | | | | | | | | | | | |
| | Benefit obligation at beginning of year | | $ | 18,050 | | $ | 15,500 | | $ | 14,511 | | $ | 13,309 | | |
| | Service cost | | 927 | | 953 | | 834 | | 878 | | |
| | Interest cost | | 1,110 | | 969 | | 1,025 | | 898 | | |
| | Actuarial loss | | 3,282 | | 6,121 | | 2,728 | | 415 | | |
| | Benefits paid | | (1,228 | ) | | — | | (1,048 | ) | | — | | |
| | |
| |
| |
| |
| | |
| | Projected benefit obligation at the end of the year | | 22,141 | | 23,543 | | 18,050 | | 15,500 | | |
| | |
| |
| |
| |
| | |
Benefit obligation at beginning of year | | | | $ | 16,817 | | | $ | 27,576 | | | $ | 22,141 | | | $ | 23,543 | |
Service cost | | | | — | | | 1,846 | | | 744 | | | 1,788 | |
Interest cost | | | | 1,015 | | | 1,571 | | | 1,143 | | | 1,475 | |
Actuarial loss | | | | 146 | | | (1,170 | ) | | 249 | | | 1,057 | |
Benefits paid | | | | (1,052 | ) | | (507 | ) | | (1,100 | ) | | (287 | ) |
Curtailments | | | | — | | | — | | | (6,360 | ) | | — | |
Projected benefit obligation at the end of the year | | | | 16,926 | | | 29,316 | | | 16,817 | | | 27,576 | |
| Change in plan assets: | Change in plan assets: | | | | | | | | | | | | | | | | | | | | | | |
| | Assets at the beginning of the year | | 17,246 | | — | | 12,916 | | — | | |
| | | Employer contributions | | — | | — | | 3,000 | | — | | |
| | | Actual return | | 1,167 | | — | | 2,378 | | — | | |
| | | Benefits paid | | (1,228 | ) | | — | | (1,048 | ) | | — | | |
| | |
| |
| |
| |
| | |
| | Assets at the end of the year | | 17,185 | | — | | 17,246 | | — | | |
| | |
| |
| |
| |
| | |
| Funded status | | (4,956 | ) | | (23,543 | ) | | (804 | ) | | (15,500 | ) | |
| | |
| |
| |
| |
| | |
| | Unrecognized net transition asset | | (67 | ) | | 15 | | (106 | ) | | 20 | | |
| | Unrecognized prior service cost | | (296 | ) | | 2,439 | | (306 | ) | | 2,585 | | |
| | Unrecognized net loss | | 8,668 | | 12,787 | | 5,392 | | 7,106 | | |
| | |
| |
| |
| |
| | |
Assets at the beginning of the year | | | | 16,888 | | | — | | | 17,185 | | | — | |
Employer contributions | | | | — | | | 507 | | | — | | | 287 | |
Actual return | | | | 2,106 | | | — | | | 803 | | | — | |
Benefits paid | | | | (1,052 | ) | | (507 | ) | | (1,100 | ) | | (287 | ) |
Assets at the end of the year | | | | 17,942 | | | — | | | 16,888 | | | — | |
Funded status at the end of year | | | | $ | 1,016 | | | $ | (29,316 | ) | | 71 | | | (27,576 | ) |
Unrecognized net transition (asset) obligation | | | | NM | | | NM | | | (28 | ) | | 10 | |
Unrecognized prior service cost | | | | NM | | | NM | | | — | | | 2,294 | |
Unrecognized net loss | | | | NM | | | NM | | | 2,817 | | | 12,902 | |
| Net amount recognized | Net amount recognized | | $ | 3,349 | | $ | (8,302 | ) | $ | 4,176 | | $ | (5,789 | ) | | | NM | | | NM | | | $ | 2,860 | | | $ | (12,370 | ) |
| | |
| |
| |
| |
| | |
NM—information is not meaningful. Due to the adoption of SFAS 158, these amounts are now recorded as a component of accumulated other comprehensive income.
Amounts recognized in the consolidated balance sheet consistprior to the adoption of SFAS 158 consisted of the following (Dollars in thousands):
| | December 31, 2004
| | December 31, 2003
| | | December 31, 2005 | |
|---|
| | Pension Plan
| | SERP
| | Pension Plan
| | SERP
| | | Pension Plan | | SERP | |
|---|
| Prepaid benefit cost | | $ | 3,349 | | $ | — | | $ | 4,176 | | $ | — | | | | $ | 2,860 | | | $ | — | |
| Accrued benefit cost | | — | | (14,019 | ) | | — | | (8,285 | ) | | | — | | | (18,074 | ) |
| Intangible assets | | — | | 2,454 | | — | | 2,496 | | | | — | | | 2,304 | |
| Accumulated other comprehensive income | | — | | 3,263 | | — | | — | | | | — | | | 3,400 | |
| | |
| |
| |
| |
| | |
| Net amount recognized | | $ | 3,349 | | $ | (8,302 | ) | $ | 4,176 | | $ | (5,789 | ) | | | $ | 2,860 | | | $ | (12,370 | ) |
| | |
| |
| |
| |
| | |
F-34
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
13. Employee Benefit Plans (Continued)
Amounts recognized in the consolidated balance sheet upon adoption of SFAS 158 on December 31, 2006 consisted of the following (Dollars in thousands):
| | December 31, 2006 | |
| | Pension Plan | | SERP | |
Pension assets | | | $ | 1,016 | | | $ | — | |
Pension liabilities | | | — | | | 29,316 | |
| | | $ | 1,016 | | | $ | 29,316 | |
Amounts recognized in accumulated other comprehensive income upon adoption of SFAS 158 consist of (Dollars in thousands):
| | December 31, 2006 | |
| | Pension Plan | | SERP | |
Net loss | | | $ | 1,195 | | | $ | 6,280 | |
Prior service cost | | | — | | | 1,235 | |
Net transition obligation | | | — | | | 3 | |
| | | $ | 1,195 | | | $ | 7,518 | |
The accumulated benefit obligation for the qualified defined benefit pension planPension Plan was $16.0$16.9 million and $13.0$16.8 million at December 31, 20042006 and 2003,2005, respectively. The accumulated benefit obligation for the supplemental retirement planSERP was $14.0$19.9 million and $8.3$18.1 million at December 31, 20042006 and 2003,2005, respectively.
Net periodic pension cost for the Company's qualified defined benefit pension planCompany’s Pension Plan and supplemental retirement planSERP included the following components (Dollars in thousands):
| | December 31, 2004
| | December 31, 2003
|
|---|
| | Pension Plan
| | SERP
| | Pension Plan
| | SERP
|
|---|
| Service cost—benefits earned/benefit obligations | | $ | 927 | | $ | 953 | | $ | 834 | | $ | 878 |
| Interest cost on projected benefit obligations | | | 1,110 | | | 969 | | | 1,025 | | | 898 |
| Expected return on plan assets | | | (1,450 | ) | | — | | | (1,085 | ) | | — |
| Net amortization and deferral | | | 240 | | | 591 | | | 248 | | | 649 |
| | |
| |
| |
| |
|
| Net periodic pension cost | | $ | 827 | | $ | 2,513 | | $ | 1,022 | | $ | 2,425 |
| | |
| |
| |
| |
|
| | December 31, 2006 | | December 31, 2005 | |
| | Pension Plan | | SERP | | Pension Plan | | SERP | |
Net Periodic Benefit Cost | | | | | | | | | | | | | |
Service cost—benefits earned / benefit obligations | | | $ | — | | | $ | 1,846 | | | $ | 744 | | | $ | 1,788 | |
Interest cost on projected benefit obligations | | | 1,015 | | | 1,571 | | | 1,143 | | | 1,475 | |
Expected return on plan assets | | | (1,413 | ) | | — | | | (1,435 | ) | | — | |
Curtailment gain | | | — | | | — | | | (275 | ) | | — | |
Amortization of net transition (asset) obligation | | | (28 | ) | | 5 | | | (38 | ) | | 5 | |
Amortization of prior service cost | | | — | | | 145 | | | (22 | ) | | 145 | |
Amortization of net loss | | | 191 | | | 805 | | | 373 | | | 942 | |
Net periodic pension (benefit) cost | | | $ | (235 | ) | | $ | 4,372 | | | $ | 490 | | | $ | 4,355 | |
The estimated net loss, prior service cost, and transition obligation for the defined benefit pension plans that will be amortized from accumulated other comprehensive income into net periodic benefit cost over the next fiscal year are $665, $145 and $5, respectively.
F-35
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
13. Employee Benefit Plans (Continued)
The weighted-average discount rate and the rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligations were as follows:
| | December 31, 2004
| | December 31, 2003
| | | December 31, 2006 | | December 31, 2005 | |
|---|
| | Pension Plan
| | SERP
| | Pension Plan
| | SERP
| | | Pension Plan | | SERP | | Pension Plan | | SERP | |
|---|
| Discount rate | | 5.80 | % | 5.80 | % | 6.25 | % | 6.25 | % | | | 6.00 | % | | 6.00 | % | | 5.75 | % | | 5.75 | % |
| Rate of compensation increases | | 4.00 | | 4.00-10.00 | | 3.75 | | 3.75 | | | | N/A | | | 4.00-10.00 | | | 4.00 | | | 4.00-10.00 | |
The weighted-average discount rate, rate of increase in future compensation levels, and expected rate of return on plan assets used in determining the net periodic pension cost were as follows:
| | December 31, 2004
| | December 31, 2003
| | | December 31, 2006 | | December 31, 2005 | |
|---|
| | Pension Plan
| | SERP
| | Pension Plan
| | SERP
| | | Pension Plan | | SERP | | Pension Plan | | SERP | |
|---|
| Discount rate | | 6.25 | % | 6.25 | % | 6.75 | % | 6.75 | % | | | 5.75 | % | | | 5.75 | % | | | 5.80 | % | | | 5.80 | % | |
| Rate of compensation increases | | 3.75 | | 3.75 | | 3.75 | | 3.75 | | | | 4.00 | | | | 4.00 | | | | 4.00 | | | | 4.00 | | |
| Expected rate of return on plan assets | | 8.50 | | — | | 8.50 | | — | | | | 8.50 | | | | — | | | | 8.50 | | | | — | |
The Company has utilized an expected rate of return on plan assets of 8.5%8.50%, which is consistent with the weighted-average of the historical return indices for specific portfolio assets.
The Company's pension planCompany’s Pension Plan allocation by asset category is as follows:
Asset Category
| | December 31,
2004
| | December 31,
2003
| | | | | December 31, 2006 | | December 31, 2005 | |
|---|
| Cash and short-term investments | | 0.5 | % | 23.3 | % | Cash and short-term investments | | | 1.4 | % | | | 1.3 | % | |
| Equity securities | | 69.2 | | 60.0 | | Equity securities | | | 70.5 | | | | 68.4 | | |
| Debt securities | | 30.3 | | 16.7 | | Debt securities | | | 28.1 | | | | 30.3 | | |
| | |
| |
| | |
| Total | | 100.0 | % | 100.0 | % | Total | | | 100.0 | % | | | 100.0 | % | |
| | |
| |
| | |
The Company'sCompany’s core investment objectives for the pension trustPension Plan are long-term capital appreciation and growth of income, while protecting the principal value of trust assets from long-term permanent loss and, within reason, from large short-term fluctuations. The approved investment policies of the trust anticipate fixed income investments to compose 25-55% and equity securities to compose 45-75% of the total portfolio. Cash equivalents may be used to provide liquidity, income and stability to the portfolio.
Cash and short-term investments represent money market funds at December 31, 20042006 and 2003.2005. Equity securities supply current income and growth through market appreciation. The Company invests in quality companies with securities that are readily marketable. The equity securities portfolio is diversified with no more than 10% of the portfolio invested in any one particular industry at December 31, 2004 and 2003. Debt securities offer a source of current income and reduce the variability of the portfolio'sportfolio’s total market value. Fixed income investments were limited to issues by the United States GovernmentU.S. government and its agencies, and investment grade corporate bonds at December 31, 20042006 and 2003.2005. The pension trustPension Plan was in full compliance with the approved pension objectives and policies for the years ended December 31, 20042006 and 2003.2005. At December 31, 20042006 and 2003,2005, the pension did not hold any securities of the Company.
The Company expectsdoes not expect to contribute up to $4 million to its pension planPension Plan during 2005.2007, and no contributions were made during 2006.
F-36
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
13. Employee Benefit Plans (Continued)
At December 31, 20042006 and 2003,2005, the SERP plan remained an unfunded plan. The Company does not expect to contributeanticipate making any contributions to the planSERP during 2005.2007.
The following table shows the expected future benefit payments for the next ten years (Dollars in thousands):
| | Pension Plan | | SERP | |
2007 | | | $ | 270 | | | $ | 177 | |
2008 | | | 292 | | | 180 | |
2009 | | | 339 | | | 185 | |
2010 | | | 363 | | | 191 | |
2011 | | | 384 | | | 199 | |
2012 - 2016 | | | 2,748 | | | 3,214 | |
| | | | | | | | | |
Employee Savings Plan—The Company sponsors a qualified defined contribution employee savings plan covering substantially all employees. The Company matches employee contributions to the plan up to specified amounts. The total cost of this plan to the Company was $4.5 million, $3.7 million and $3.2 million for the years ended December 31, 2006, 2005 and 2004, 2003 and 2002.respectively.
14. OFF BALANCE SHEET FINANCIAL INSTRUMENTSOff Balance Sheet Financial Instruments
Lines of Credit—At December 31, 2004,2006, the Company had commitments to mutual funds, individuals and mutual fundsothers under collateralized open lines of credit totaling $1.1$1.2 billion, against which $89.9$184.6 million in loans were drawn. The credit risk involved in issuing lines of credit is essentially the same as that involved in extending demand loans. The Company does not anticipate any loss as a result of these lines of credit.
Securities Lending—On behalf of its clients, the Company lends securities to creditworthy broker-dealers. In certain circumstances, the Company may indemnify its clients for the fair market value of those securities against a failure of the borrower to return such securities. The Company requires the borrowers to provide collateral in an amount equal to, or in excess of, 102% of the fair market value of U.S. dollar-denominated securities borrowed and 105% of the fair market value of non-U.S. dollar-denominated securities borrowed. The borrowed securities are revalued daily to determine whether additional collateral is necessary. As guarantor, the Company is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The Company measures the fair value of its indemnification obligation by marking its securities lending portfolio to market on a daily basis and comparing the value of the portfolio to the collateral holdings position. The fair value of the indemnification obligation to be recorded would be the deficiency of collateral as compared to the value of the securities out on loan.
With respect to the indemnified securities lending portfolio, the cash and U.S. government securities held by the Company as collateral at December 31, 20042006 totaled $4.9$11.1 billion, while the fair value of the securities lending portfolio totaled approximately $4.7$10.7 billion. Given that the collateral held was in excess of the value of the securities that the Company would be required to replace if the borrower defaulted and failed to return such securities, the Company'sCompany’s indemnification obligation was zero and no liability was recorded.
F-37
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
14. Off Balance Sheet Financial Instruments (Continued)
All securities loans are categorized as overnight loans. The maximum potential amount of future payments that the Company could be required to make would be equal to the market value of the securities borrowed. Since the securities loans are overcollateralized by 2% (for U.S. dollar-denominated securities) to 5% (for non-U.S. dollar-denominated securities) of the fair market value of
the loan made, the collateral held by the Company would be used to satisfy the obligation. In addition, each borrowing agreement includes "set-off"“set-off” language that allows the Company to use any excess collateral on other loans to that borrower to cover any collateral shortfall of that borrower. However, there is a potential risk that the collateral would not be sufficient to cover such an obligation if the security on loan increased in value between the time the borrower defaulted and the time the security is "bought-in."“bought-in”. In those instances, the Company would "buy-in"“buy-in” the security using all available collateral and a loss would result from the difference between the value of the security "bought-in"“bought-in” and the value of the collateral held. The Company has never experienced a broker default.
15. DERIVATIVE FINANCIAL INSTRUMENTSDerivative Financial Instruments
Interest Rate Contracts—Interest rate contracts involve an agreement with a counterparty to exchange cash flows based on an underlying interest rate index. A swap agreement involves the exchange of a series of interest payments, either at a fixed or variable-rate, based upon the notional amount without the exchange of the underlying principal amount. The Company'sCompany’s exposure from these interest rate contracts results from the possibility that one party may default on its contractual obligation when the contracts are in a gain position. The Company has experienced no terminations by counterparties of interest rate swaps. Credit risk is limited to the positive fair value of the derivative financial instrument, which is significantly less than the notional value. As of December 31, 2004, the credit riskThe positive fair values related to the Company'sCompany’s interest rate contracts waswere approximately $1.8 million.$13.8 million and $24.3 million at December 31, 2006 and 2005, respectively, which are included in other assets on the Company’s consolidated balance sheets.
The Company enters into pay-fixed/receive-floating interest rate swap agreements. These instruments have been designated as cash flow hedges of variable-rate liabilities.liabilities and a forecasted series of fixed-rate overnight liabilities incurred at different daily fixed rates (thereby resulting in a variable interest expense pattern). The contractual or notional amounts of the interest rate swap agreements held by the Company were approximately $1.6 billion and $1.2$1.9 billion at December 31, 20042006 and 2003,2005, respectively. These contracts had net fair values of approximately $1.5$13.8 million and $(14.9)$24.2 million at December 31, 20042006 and 2003,2005, respectively. These fair values are included in the respective other assets and other liabilities categories on the Company'sCompany’s consolidated balance sheet.sheets. See also Note 17 for additional information on the fair value of the interest rate contracts.
For the year ended December 31, 2004,2006, the Company recognized a net pre-tax gainsloss of $4.1$1.5 million, which represented the total ineffectiveness for all cash flow hedges. For the years ended December 31, 20032005 and 2002,2004, the Company recognized net pre-tax gains of $3.5 million and $4.1 million, respectively, which represented the total ineffectiveness related tofor all cash flow hedges had an insignificant impact on earnings.hedges.
F-38
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
15. Derivative Financial Instruments (Continued)
As of December 31, 2004,2006, the Company expects that approximately $3.3$5.9 million of deferred net after-tax gains on derivative contracts included in other comprehensive income will be reclassified to net interest income within the next twelve months. This expectation is based on the net discounted cash flows from derivative instrumentsexisting cash flow hedging short-term variable-rate liabilities,derivatives, as well as the amortization of gains from the termination ofterminated cash flow hedging derivatives.
Foreign Exchange Contracts—Foreign exchange contracts involve an agreement to exchange the currency of one country for the currency of another country at an agreed-upon rate and settlement date. Foreign exchange contracts consist of spot, forward and swap contracts. Spot contracts call for the exchange of one currency for another and usually settle in two business days. Forward contracts call for the exchange of one currency for another at a date beyond spot. In a currency swap, the holder of a currency transacts simultaneously both a spot and a forward transaction in that currency for an equivalent amount of another currency to get temporary liquidity in the currency owned. The Company'sCompany’s risk from foreign exchange contracts results from the possibility that one party may default on its contractual obligation or from movements in exchange rates. Credit risk is limited to the positive market value of the derivative financial instrument, which is significantly less than the notional value. The notional value of the Company'sCompany’s foreign exchange contracts as ofat December 31, 20042006 and 20032005 was
$6.9 $13.5 billion and $1.6$6.3 billion, respectively. As of December 31, 2004, the British Pound foreign exchange contracts represented approximately 43% of the notional value outstanding. As of December 31, 2003, theThe Euro foreign exchange contracts represented approximately 31%71% and 57% of the notional value outstanding.outstanding as of December 31, 2006 and 2005, respectively. Unrealized gains or losses resulting from purchases and sales of foreign exchange contracts are included within the respective other assets and other liabilities categories on the Company'sCompany’s consolidated balance sheet.sheets. Unrealized gains in other assets were $99.6$27.5 million and $16.1$20.8 million as ofat December 31, 20042006 and 2003,2005, respectively. Unrealized losses in other liabilities were $98.5$27.0 million and $15.9$19.7 million as ofat December 31, 20042006 and 2003,2005, respectively. See also Note 17 for additional information on the fair value of ourthe Company’s foreign exchange contracts. Foreign exchange contracts with the same counterparty are netted in the Company'sCompany’s consolidated balance sheetsheets when a master netting agreement exists. These contracts have not been designated as hedging instruments; therefore, all changes in fair value are included in asset servicing fees.
Other—The Company also enters into fixed price purchase contracts that are designed to hedge the variability of the consideration to be paid for the purchase of investment securities. By entering into these contracts, the Company is fixing the price to be paid at a future date for certain investment securities. At December 31, 2004 and 2003,2006 the Company had $672.2no fixed price purchase contracts outstanding to purchase investment securities. At December 31, 2005, the Company had $97.5 million and $792.1 million, respectively, of fixed price purchase contracts outstanding to purchase investment securities. Changes in fair value of these cash flow hedges are included as a component of other comprehensive income.
16. COMMITMENTS AND CONTINGENCIESCommitments and Contingencies
Restrictions on Cash Balances—The Company is required to maintain certain average cash reserve balances. The average required reserve balance with the Federal Reserve Bank ("FRB")FRB for the two-week period including December 31, 20042006 was approximately $30.6$35.8 million. In addition, the Company's other assets categoryCompany’s consolidated balance sheet includes deposits totaling $27.1$44.4 million, which were pledged to secure clearings with depository institutions.institutions as of December 31, 2006.
F-39
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
16. Commitments and Contingencies (Continued)
Lease Commitments—Minimum future commitments on noncancelable operating leases at December 31, 20042006 were as follows (Dollars in thousands):
Fiscal Year Ending
| | Bank Premises
| | Equipment
| | Total
| | | | Bank Premises | | Equipment | | Total | |
|---|
| 2005 | | $ | 25,561 | | $ | 4,733 | | $ | 30,294 | |
| 2006 | | 25,722 | | 2,116 | | 27,838 | |
| 2007 | | 22,485 | | 511 | | 22,996 | 2007 | | | $ | 32,722 | | | | $ | 2,467 | | | $ | 35,189 | |
| 2008 | | 10,491 | | 19 | | 10,510 | 2008 | | | 32,813 | | | | 1,351 | | | 34,164 | |
| 2009 and beyond | | 31,265 | | 1 | | 31,266 | |
| | |
| |
| |
| |
2009 | | 2009 | | | 35,793 | | | | 371 | | | 36,164 | |
2010 | | 2010 | | | 35,581 | | | | 49 | | | 35,630 | |
2011 | | 2011 | | | 36,366 | | | | 24 | | | 36,390 | |
2012 and beyond | | 2012 and beyond | | | 121,879 | | | | — | | | 121,879 | |
| Total | | $ | 115,524 | | $ | 7,380 | | $ | 122,904 | Total | | | $ | 295,154 | | | | $ | 4,262 | | | $ | 299,416 | |
| | |
| |
| |
| |
Total rent expense was approximately $33.4$36.8 million, $36.1$29.2 million and $34.5$33.4 million for the years ended December 31, 2004, 20032006, 2005 and 2002,2004, respectively.
Effective January 1, 2001,In 2005, the Company renewed its five-year service agreement with Electronic Data Systems ("EDS"(‘EDS’), which now expires December 31, 2005.2008. Under the terms of the agreement, EDS provides data processing services to the Company, which has agreed to pay certain monthly service fees based on usage. Service expense under this contract was $8.3$4.7 million, $7.7$7.3 million and $7.4$8.3 million for the years ended December 31, 2004, 20032006, 2005 and 2002,2004, respectively.
In 2004, the Company renewed its agreement with SEI Investments Company ("SEI"(‘SEI’), which now expires on December 31, 2009. Under the terms of this agreement, SEI provides data processing
services to the Company, which has agreed to pay certain monthly service fees based upon usage. Service expense under this contract was $5.0$6.4 million, $4.9$5.3 million and $5.2$5.0 million for the years ended December 31, 2004, 20032006, 2005 and 2002,2004, respectively.
In 2004, the Company signed a service agreement with International Business Machines Corporation ("IBM"(‘IBM’). Under the terms of this agreement, IBM provides support for our network and hardware environments and the Company’s help desk identification administration, network management, deskside services, server monitoring and management, on demand computing services and webhosting to theservices. The Company which has agreed to pay certain monthly services fees based upon usage. This agreement expires June 30, 2011. Service expense under this contract which commenced in the summer of 2004, was $26.4 million, $13.7 million and $9.5 million for the yearyears ended December 31, 2004.2006, 2005 and 2004, respectively.
Contingencies—The Company provides a broad range of services to financial asset managers, such as mutual fund complexes, family offices, investment advisors, banks and insurance companies. Core services include middle office outsourcing, global custody, multicurrency accounting and fund administration. Value-added services include securities lending, foreign exchange, cash management, performance measurement, institutional transfer agency, investment advisory services, lines of credit and brokerage and transition management services. Assets processed, held by the Company in a fiduciary capacity are not included in the consolidated balance sheets since suchthese items are not assets of the Company. Management conducts regular reviews of its fiduciary responsibilities and considers the results in preparing its consolidated financial statements. In the opinion of management, there arewere no contingent liabilities related to its fiduciary capacity at December 31, 20042006 that arewere material to the consolidated financial position or consolidated results of operations of the Company.
The Company and certain of its officers were named as defendants in three purported class action complaints that were filed on or about August 4, 2005, August 15, 2005, and September 30, 2005 in the United States District Court for the District of Massachusetts, Boston, Massachusetts. The U.S. District
F-40
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
16. Commitments and Contingencies (Continued)
Court has consolidated those cases and appointed lead plaintiffs, who filed a consolidated complaint against the Company and seven of its current and former officers on February 3, 2006. Among other things, the consolidated complaint asserts that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 during the period April 10, 2001 until July 15, 2005. The allegations in the consolidated complaint predominantly relate to: (1) the Company’s October 2004 restatement of its financial results, and (2) the Company’s July 2005 revision of public guidance regarding its future financial performance. The consolidated complaint seeks unspecified damages, interest, fees, and costs. On May 14, 2006, the Company filed a motion to dismiss all claims asserted in the consolidated complaint. That motion is currently pending before the Court. The Company strongly believes that the lawsuit lacks merit and the Company intends to defend against the claims vigorously. However, the Company cannot predict the outcome of the lawsuit at this time, and the Company can give no assurance that it will not materially adversely affect the Company’s financial condition or results of operations.
The Company and nine of its officers and directors are named as defendants in two shareholder derivative complaints that were filed on or about September 22, 2005 and October 17, 2005 in the United States District Court for the District of Massachusetts, Boston, Massachusetts. Among other things, the complaints assert that the defendants are liable for breach of fiduciary duty, unjust enrichment, abuse of control, mismanagement, misappropriation of information, insider trading, and violation of Section 14(a) of the Securities Exchange Act of 1934. The complaint filed on September 22, 2005 also seeks reimbursement under the Sarbanes-Oxley Act of 2002. The allegations in the complaints predominantly relate to: (1) The Company’s October 2004 restatement of its financial results, and (2) the Company’s July 2005 revision of public guidance regarding its future financial performance. The complaints seek unspecified damages, attorneys’ fees, accountant and expert fees, and costs. The Company is also named as a nominal defendant in these complaints, although the actions are derivative in nature and purportedly asserted on behalf of the Company. The Company is in the process of evaluating these claims. However, the Company cannot predict the outcome of the lawsuits at this time, and the Company can give no assurance that they will not materially adversely affect our financial condition or results of operations.
In July 2000, two of the Company'sCompany’s Dublin subsidiaries, Investors Trust & Custodial Services (Ireland) Ltd. ("ITC"(‘ITC’) and Investors Fund Services (Ireland) Ltd. ("IFS"(‘IFS’), received a plenary summons in the High Court, Dublin, Ireland. The summons named ITC and IFS as defendants in an action brought by the FTF ForexConcept Fund Plc (the "Fund"‘Fund’), a former client. The summons also named as defendants FTF Forex Trading and Finance, S.A., the Fund'sFund’s investment manager, Ernst & Young, LLP, the Fund'sFund’s auditors, and Dresdner Bank-Kleinwort Benson (Suisse) S.A., a trading counterparty to the Fund. The Fund is an investment vehicle organized in Dublin to invest in foreign exchange contracts. A total of approximately $4.7 million had been invested in the Fund. Most of that money was lost prior to the Fund'sFund’s closing to subscriptions in June 1999.
In January 2001, ITC, IFS and the other defendants named in the plenary summons received a statement of claim by the Fund seeking unspecified damages allegedly arising from breach of contract, misrepresentation and breach of warranty, negligence and breach of duty of care, and breach of fiduciary duty, among others. The Company has notified its insurers and intends to defend this claim vigorously. Based on its investigation through December 31, 2004,2006, the Company does not expect this matter to have a material adverse effect on its business, financial condition or results of operations.
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
17. FAIR VALUE OF FINANCIAL INSTRUMENTSFair Value of Financial Instruments
The carrying valueamount and estimated fair value of financial instruments are as follows (Dollars in thousands):
| | | December 31, 2006 | | December 31, 2005 | |
|
| | December 31, 2004
| | December 31, 2003
| | Carrying | | Fair | | Carrying | | Fair | |
|---|
|
| | Carrying
Amount
| | Fair
Value
| | Carrying
Amount
| | Fair
Value
| | Amount | | Value | | Amount | | Value | |
|---|
| Financial Assets: | Financial Assets: | | | | | | | | | | | | | | | | | |
| | Cash and due from banks | | $ | 49,059 | | $ | 49,059 | | $ | 39,689 | | $ | 39,689 | |
| | Securities held to maturity | | 5,942,717 | | 5,937,462 | | 4,306,216 | | 4,308,578 | |
| | Securities available for sale | | 4,565,505 | | 4,565,505 | | 4,296,637 | | 4,296,637 | |
| | Loans, net of allowance | | 134,530 | | 134,530 | | 199,530 | | 199,530 | |
| | Interest rate contracts | | 1,849 | | 1,849 | | 158 | | 158 | |
| | Foreign exchange contracts | | 99,576 | | 99,576 | | 16,114 | | 16,114 | |
Cash and due from banks | | | $ | 92,766 | | $ | 92,766 | | $ | 60,743 | | $ | 60,743 | |
Interest-bearing deposits with other banks | | | 21,218 | | 21,218 | | 18,894 | | 18,894 | |
Other short-term investments | | | 1,971 | | 1,971 | | — | | — | |
Securities held to maturity | | | 5,532,330 | | 5,508,788 | | 6,761,930 | | 6,725,729 | |
Securities available for sale | | | 4,799,740 | | 4,799,740 | | 4,369,720 | | 4,369,720 | |
Loans, net of allowance | | | 270,693 | | 270,693 | | 402,370 | | 402,370 | |
Interest rate contracts | | | 13,845 | | 13,845 | | 24,251 | | 24,251 | |
Foreign exchange contracts | | | 27,459 | | 27,459 | | 20,805 | | 20,805 | |
Financial Liabilities: |
Financial Liabilities: |
|
|
|
|
|
|
|
| | | | | | | | | |
| | Deposits | | $ | 5,396,382 | | $ | 5,396,382 | | $ | 4,207,118 | | $ | 4,207,118 | |
| | Securities sold under repurchase agreements | | 4,255,497 | | 4,197,590 | | 3,258,001 | | 3,261,227 | |
| | Short-term & other borrowings | | 594,681 | | 594,411 | | 1,098,087 | | 1,102,449 | |
| | Interest rate contracts | | 310 | | 310 | | 15,103 | | 15,103 | |
| | Foreign exchange contracts | | 98,531 | | 98,531 | | 15,901 | | 15,901 | |
Deposits | | | $ | 6,144,942 | | $ | 6,144,942 | | $ | 4,992,590 | | $ | 4,992,590 | |
Securities sold under repurchase agreements | | | 3,727,800 | | 3,726,154 | | 4,797,868 | | 4,736,958 | |
Short-term and other borrowings | | | 517,051 | | 517,051 | | 1,356,649 | | 1,356,649 | |
Interest rate contracts | | | 86 | | 86 | | 101 | | 101 | |
Foreign exchange contracts | | | 26,975 | | 26,975 | | 19,665 | | 19,665 | |
The fair value estimates presented herein are based on pertinent information available to management as ofat December 31, 20042006 and 2003.2005. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been significantly revalued for the purposes of these consolidated financial statements since those dates and, therefore, current estimates of fair value may differ significantly from the amounts presented herein.
The Company uses the following methods and assumptions to determine the fair value of selected financial instruments:
Short-term financial assets and liabilities—For financial instruments with a short or no stated maturity, prevailing market rates and limited credit risk, carrying amounts approximate fair value. Those financial instruments include cash and due from banks, interest bearing deposits with other banks, other short-term investments, loans and deposits.
Securities, available for sale and held to maturity—Fair values were based on prices obtained from an independent nationally recognized pricing service, or in the absence of such, prices were obtained directly from selected broker-dealers.
Securities sold under repurchase agreements and short-term and other borrowings—Fair values of the Company'sCompany’s long-term borrowings and long-term repurchase agreements were based on quoted market prices, when available, and prevailing market rates for borrowings of similar terms. Carrying amounts for
F-42
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
17. Fair Value of Financial Instruments (Continued)
short-term borrowings and short-term repurchase agreements approximate fair value due to the short-term nature of these instruments.
Interest rate swap agreementscontracts—Fair values were based on the estimated amount that the Company would receive or pay to terminate the swap agreements, taking into account the current interest rates and the creditworthiness of the swap counterparties.
Foreign exchange contracts—Fair values were based on quoted market prices of comparable instruments. Foreign exchange contracts have been reduced by offsetting balances with the same counterparty where a master netting agreement exists.
18. Regulatory Matters18. REGULATORY MATTERS
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company'sCompany’s and the Bank'sBank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank'sBank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company'sCompany’s and the Bank'sBank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of Total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2004,2006, that the Company and the Bank meet all capital adequacy requirements to which they are subject.
As of December 31, 2004,2006, the most recent notification from the Federal Deposit Insurance Corporation categorized the Company and the Bank as well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, the Company and the Bank must maintain minimum Total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Company'sCompany’s or the Bank'sBank’s category.
F-43
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
18. Regulatory Matters (Continued)
The following table presents the capital ratios for the Company and the Bank (Dollars in thousands):
|
| | Actual
| | For Capital
Adequacy Purposes:
| | To Be Well
Capitalized Under
Prompt Corrective
Action Provisions:
| | | | | | | | | | | To Be Well- | |
|---|
|
| | Amount
| | Ratio
| | Amount
| | Ratio
| | Amount
| | Ratio
| | | | | | | | | | | Capitalized Under | |
|---|
| As of December 31, 2004: | | | | | | | | | | | | | | | | | |
| Total Capital | | | | | | | | | | | | | | | | | |
| | (to Risk-Weighted Assets—the Company) | | $ | 636,219 | | 20.54 | % | $ | 247,782 | | 8.00 | % | | N/A | | N/A | | | | | | | For Capital | | Prompt Corrective | |
| | (to Risk-Weighted Assets—the Bank) | | $ | 618,166 | | 19.98 | % | $ | 247,572 | | 8.00 | % | $ | 309,465 | | 10.00 | % | | Actual | | Adequacy Purposes | | Action Provisions | |
| | | Amount | | Ratio | | Amount | | Ratio | | Amount | | Ratio | |
As of December 31, 2006: | | | | | | | | | | | | | | | | |
Total Capital | | | | | | | | | | | | | | | | |
(to Risk-Weighted Assets-the Company) | | | $ | 900,299 | | 19.04 | % | $ | 378,305 | | | 8.00 | % | | N/A | | N/A | |
Total Capital | | | | | | | | | | | | | | | | |
(to Risk-Weighted Assets-the Bank) | | | $ | 863,841 | | 18.28 | % | $ | 378,048 | | | 8.00 | % | | $ | 472,560 | | 10.00 | % |
| Tier 1 Capital | Tier 1 Capital | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | (to Risk-Weighted Assets—the Company) | | $ | 636,119 | | 20.54 | % | $ | 123,891 | | 4.00 | % | | N/A | | N/A | | |
| | (to Risk-Weighted Assets—the Bank) | | $ | 618,066 | | 19.97 | % | $ | 123,786 | | 4.00 | % | $ | 185,679 | | 6.00 | % | |
(to Risk-Weighted Assets-the Company) | | | $ | 900,199 | | 19.04 | % | $ | 189,152 | | | 4.00 | % | | N/A | | N/A | |
| Tier 1 Capital | Tier 1 Capital | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | (to Average Assets—the Company) | | $ | 636,119 | | 5.85 | % | $ | 435,080 | | 4.00 | % | | N/A | | N/A | | |
| | (to Average Assets—the Bank) | | $ | 618,066 | | 5.68 | % | $ | 435,017 | | 4.00 | % | $ | 543,772 | | 5.00 | % | |
As of December 31, 2003: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
(to Risk-Weighted Assets-the Bank) | | | $ | 863,741 | | 18.28 | % | $ | 189,024 | | | 4.00 | % | | $ | 283,536 | | 6.00 | % |
Tier 1 Capital | | | | | | | | | | | | | | | | |
(to Average Assets-the Company) | | | $ | 900,199 | | 7.63 | % | $ | 472,082 | | | 4.00 | % | | N/A | | N/A | |
Tier 1 Capital | | | | | | | | | | | | | | | | |
(to Average Assets-the Bank) | | | $ | 863,741 | | 7.32 | % | $ | 471,715 | | | 4.00 | % | | $ | 589,643 | | 5.00 | % |
As of December 31, 2005: | | | | | | | | | | | | | | | | |
| Total Capital | Total Capital | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | (to Risk-Weighted Assets—the Company) | | $ | 467,651 | | 17.62 | % | $ | 212,382 | | 8.00 | % | | N/A | | N/A | | |
| | (to Risk-Weighted Assets—the Bank) | | $ | 462,073 | | 17.42 | % | $ | 212,200 | | 8.00 | % | $ | 265,250 | | 10.00 | % | |
(to Risk-Weighted Assets-the Company) | | | $ | 731,833 | | 18.50 | % | $ | 316,553 | | | 8.00 | % | | N/A | | N/A | |
Total Capital | | | | | | | | | | | | | | | | |
(to Risk-Weighted Assets-the Bank) | | | $ | 720,113 | | 18.21 | % | $ | 316,349 | | | 8.00 | % | | $ | 395,436 | | 10.00 | % |
| Tier 1 Capital | Tier 1 Capital | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | (to Risk-Weighted Assets—the Company) | | $ | 467,551 | | 17.61 | % | $ | 106,191 | | 4.00 | % | | N/A | | N/A | | |
| | (to Risk-Weighted Assets—the Bank) | | $ | 461,973 | | 17.42 | % | $ | 106,100 | | 4.00 | % | $ | 159,150 | | 6.00 | % | |
(to Risk-Weighted Assets-the Company) | | | $ | 731,733 | | 18.49 | % | $ | 158,276 | | | 4.00 | % | | N/A | | N/A | |
| Tier 1 Capital | Tier 1 Capital | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | (to Average Assets—the Company) | | $ | 467,551 | | 5.36 | % | $ | 349,185 | | 4.00 | % | | N/A | | N/A | | |
| | (to Average Assets—the Bank) | | $ | 461,973 | | 5.29 | % | $ | 349,000 | | 4.00 | % | $ | 436,250 | | 5.00 | % | |
(to Risk-Weighted Assets-the Bank) | | | $ | 720,013 | | 18.21 | % | $ | 158,174 | | | 4.00 | % | | $ | 237,262 | | 6.00 | % |
Tier 1 Capital | | | | | | | | | | | | | | | | |
(to Average Assets-the Company) | | | $ | 731,733 | | 5.95 | % | $ | 491,685 | | | 4.00 | % | | N/A | | N/A | |
Tier 1 Capital | | | | | | | | | | | | | | | | |
(to Average Assets-the Bank) | | | $ | 720,013 | | 5.86 | % | $ | 491,549 | | | 4.00 | % | | $ | 614,437 | | 5.00 | % |
Under Massachusetts law, trust companies such as the Bank, like national banks, may pay dividends no more often than quarterly, and only out of net profits and to the extent that such payments will not impair the Bank'sBank’s capital stock and surplus account. Moreover, prior Commissioner approval is required if the total dividends for a calendar year would exceed net profits for that year combined with retained net profits for the previous two years. These restrictions on the ability of the Bank to pay dividends to the Company may restrict the ability of the Company to pay dividends to its stockholders.
F-44
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
18. Regulatory Matters (Continued) (Continued)
The operations of the Company'sCompany’s securities broker affiliate, Investors Securities Services, Inc.LLC (‘ISS’), are subject to federal and state securities laws, as well as the rules of both the SEC and the NASD. Management believes, as of December 31, 2004,2006, that Investors Securities Services, Inc. metISS is in material compliance with all of the foregoing requirements to which it is subject.
The operations of the Company’s captive insurance affiliate, Investors Vermont Insurance Company (‘IVIC’), are subject to the laws and regulations of the BISHCA. Management believes, as of December 31, 2006, that IVIC is in material compliance with all of the foregoing requirements to which it is subject.
The operations of the Company’s affiliated international subsidiaries are subject to laws and regulations of various regulators, including the OSFI, the IFSRA, the CIMA, the FSA and the CSSF. Management believes, as of December 31, 2006, that its affiliated international subsidiaries are all in compliance with all of the foregoing requirements to which each is subject.
In June 2004, the Basel Committee on Banking Supervision (‘Basel Committee’) released the document “International Convergence of Capital Measurement and Capital Standards: A Revised Framework.” The Framework, also referred to as Basel II, is designed to secure international convergence on regulations and standards governing the capital adequacy of internationally active banking organizations. In September 2006, the U.S. banking and thrift supervisory agencies issued a notice of Proposed Rulemaking setting forth a proposed framework for the timing and qualification process for U.S. banks that are either required (“core banks”) or choose (“opt-in banks”) to be subject to Basel II. As currently proposed, the new rules as applied in the U.S. are expected to become effective on January 1, 2009, subject to transitional parallel testing beginning on January 1, 2008. Although the Bank is not required to be compliant with the new rules, the Bank is in the process of developing and implementing a program to achieve Basel II compliance. Ultimately, U.S. implementation of Basel II will depend on, and will be subject to, final regulations and related policies promulgated by the U.S. supervisory agencies. The Bank cannot predict the final form of the rules, nor their impact on its risk-based capital.
F-45
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
19. NET INTEREST INCOMENet Interest Income
The components of interest income and interest expense are as follows (Dollars in thousands):
|
| | December 31,
| | December 31, | |
|---|
|
| | 2004
| | 2003
| | 2002
| | 2006 | | 2005 | | 2004 | |
|---|
| Interest income: | Interest income: | | | | | | | | | | | | | |
| | Federal funds sold and securities sold under repurchase agreements | | $ | 667 | | $ | 326 | | $ | 740 | |
| | Investment securities held to maturity and available for sale | | 307,895 | | 243,191 | | 241,012 | |
| | Loans | | 4,587 | | 3,577 | | 3,774 | |
| | |
| |
| |
| |
| | | Total interest income | | $ | 313,149 | | $ | 247,094 | | $ | 245,526 | |
| | |
| |
| |
| |
Federal funds sold, interest-bearing deposits with other banks and other short-term investments | | | $ | 9,141 | | $ | 2,250 | | $ | 667 | |
Investment securities: | | | | | | | | |
Mortgage-backed securities | | | 403,717 | | 315,845 | | 221,248 | |
Federal agency securities | | | 91,861 | | 89,864 | | 53,977 | |
State and political subdivisions (exempt from federal tax) | | | 20,071 | | 21,217 | | 22,300 | |
Other securities | | | 11,927 | | 9,267 | | 10,370 | |
Loans | | | 21,032 | | 9,262 | | 4,587 | |
Total interest income | | | $ | 557,749 | | $ | 447,705 | | $ | 313,149 | |
| Interest expense: | Interest expense: | | | | | | | | | | | | | |
| | Deposits | | $ | 50,721 | | $ | 39,819 | | $ | 42,257 | |
| | Short-term and other borrowings | | 74,748 | | 53,361 | | 64,544 | |
| | |
| |
| |
| |
| | | Total interest expense | | $ | 125,469 | | $ | 93,180 | | $ | 106,801 | |
| | |
| |
| |
| |
| | | Net interest income | | $ | 187,680 | | $ | 153,914 | | $ | 138,725 | |
| | |
| |
| |
| |
Deposits | | | $ | 180,327 | | $ | 77,706 | | $ | 50,721 | |
Securities sold under repurchase agreements | | | 164,970 | | 142,681 | | 54,376 | |
Short-term and other borrowings | | | 45,838 | | 54,473 | | 17,952 | |
Junior subordinated debentures | | | 2,420 | | 2,420 | | 2,420 | |
Total interest expense | | | $ | 393,555 | | $ | 277,280 | | $ | 125,469 | |
Net interest income | | | $ | 164,194 | | $ | 170,425 | | $ | 187,680 | |
20. SELECTED QUARTERLY FINANCIAL DATASelected Quarterly Financial Data (unaudited)
(Dollars (Dollars in thousands, except per share data, as restated)data):
Year Ended December 31, 2004
| | First
Quarter
| | Second
Quarter
| | Third
Quarter
| | Fourth
Quarter
|
|---|
| Noninterest income | | $ | 106,770 | | $ | 109,741 | | $ | 100,572 | | $ | 108,408 |
| Interest income | | | 73,636 | | | 69,140 | | | 80,474 | | | 89,899 |
| Interest expense | | | 25,215 | | | 27,065 | | | 32,207 | | | 40,982 |
| Operating expenses | | | 100,134 | | | 100,700 | | | 94,491 | | | 103,058 |
| Income before income taxes | | | 55,057 | | | 51,116 | | | 54,348 | | | 54,267 |
| Income taxes | | | 18,504 | | | 17,120 | | | 18,214 | | | 18,988 |
| Net income | | | 36,553 | | | 33,996 | | | 36,134 | | | 35,279 |
| Basic earnings per share | | | 0.56 | | | 0.51 | | | 0.54 | | | 0.54 |
| Diluted earnings per share | | | 0.54 | | | 0.50 | | | 0.53 | | | 0.52 |
Year Ended December 31, 2003
| | First
Quarter
| | Second
Quarter
| | Third
Quarter
| | Fourth
Quarter
|
|---|
| Noninterest income | | $ | 74,916 | | $ | 84,393 | | $ | 85,223 | | $ | 91,661 |
| Interest income | | | 61,058 | | | 61,054 | | | 59,995 | | | 64,987 |
| Interest expense | | | 21,566 | | | 23,623 | | | 23,088 | | | 24,903 |
| Operating expenses | | | 85,719 | | | 90,953 | | | 81,940 | | | 86,309 |
| Income before income taxes | | | 28,689 | | | 30,871 | | | 40,190 | | | 45,436 |
| Income taxes | | | 22,822 | | | 2,947 | | | 12,732 | | | 14,264 |
| Net income | | | 5,867 | | | 27,924 | | | 27,458 | | | 31,172 |
| Basic earnings per share | | | 0.09 | | | 0.43 | | | 0.42 | | | 0.48 |
| Diluted earnings per share | | | 0.09 | | | 0.42 | | | 0.41 | | | 0.47 |
| | First | | Second | | Third | | Fourth | |
Year Ended December 31, 2006 | | | | Quarter | | Quarter | | Quarter | | Quarter | |
Noninterest income | | $ | 149,467 | | $ | 169,128 | | $ | 154,874 | | $ | 165,985 | |
Interest income | | 134,437 | | 137,921 | | 140,338 | | 145,053 | |
Interest expense | | 91,116 | | 99,356 | | 101,348 | | 101,735 | |
Operating expenses | | 135,684 | | 148,925 | | 139,154 | | 155,591 | |
Income before income taxes | | 57,104 | | 58,768 | | 54,710 | | 53,712 | |
Income taxes | | 19,701 | | 14,469 | | 18,327 | | 17,994 | |
Net income | | 37,403 | | 44,299 | | 36,383 | | 35,718 | |
Basic earnings per share | | 0.57 | | 0.68 | | 0.55 | | 0.54 | |
Diluted earnings per share | | 0.56 | | 0.65 | | 0.54 | | 0.53 | |
| | | | | | | | | | | | | | | |
F-46
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
20. Selected Quarterly Financial Data (unaudited) (Dollars in thousands, except per share data): (Continued)
| | First | | Second | | Third | | Fourth | |
Year Ended December 31, 2005 | | | | Quarter | | Quarter | | Quarter | | Quarter | |
Noninterest income | | $ | 120,176 | | $ | 128,676 | | $ | 131,215 | | $ | 145,470 | |
Interest income | | 98,055 | | 108,103 | | 114,512 | | 127,035 | |
Interest expense | | 50,442 | | 66,057 | | 76,471 | | 84,310 | |
Operating expenses | | 104,792 | | 113,237 | | 116,130 | | 125,950 | |
Income before income taxes | | 62,997 | | 57,485 | | 53,126 | | 62,245 | |
Income taxes | | 22,049 | | 13,358 | | 17,894 | | 22,734 | |
Net income | | 40,948 | | 44,127 | | 35,232 | | 39,511 | |
Basic earnings per share | | 0.61 | | 0.66 | | 0.54 | | 0.61 | |
Diluted earnings per share | | 0.60 | | 0.64 | | 0.53 | | 0.60 | |
| | | | | | | | | | | | | | | |
21. GEOGRAPHIC REPORTING AND SERVICE LINESGeographic Reporting and Service Lines
The Company does not utilize segment information for internal reporting as management views the Company as one segment. The following represents net operating revenue by geographic area and long-lived assets (including goodwill) by geographic area (Dollars in thousands):
| | Net Operating Revenue
For the Years Ended December 31,
| |
| |
| | | Net Operating Revenue | | Long-Lived Assets | |
|---|
| | Long-Lived Assets
| | | For the Years Ended December 31, | | December 31 | | December 31 | |
|---|
Geographic Information:
| |
|---|
| | 2004
| | 2003
| | 2002
| | 2004
| | 2003
| |
|---|
Geographic Information | | | | | 2006 | | 2005 | | 2004 | | 2006 | | 2005 | |
| United States | | $ | 579,168 | | $ | 468,724 | | $ | 423,615 | | $ | 141,801 | | $ | 149,631 | United States | | $ | 748,133 | | $ | 653,305 | | $ | 579,168 | | | $ | 182,276 | | | | $ | 141,810 | | |
| Ireland | | 28,835 | | 18,601 | | 11,960 | | 5,930 | | 6,698 | Ireland | | 48,567 | | 37,061 | | 28,835 | | | 9,269 | | | | 6,325 | | |
| Canada | | 4,989 | | 2,579 | | 1,915 | | 121 | | 60 | Canada | | 6,233 | | 5,427 | | 4,989 | | | 116 | | | | 385 | | |
United Kingdom | | United Kingdom | | 364 | | 3 | | — | | | 1,520 | | | | 850 | | |
Luxembourg | | Luxembourg | | 196 | | — | | — | | | 75 | | | | — | | |
| Cayman Islands | | 179 | | 203 | | 79 | | — | | — | Cayman Islands | | 155 | | 166 | | 179 | | | — | | | | — | | |
| | |
| |
| |
| |
| |
| |
| Total | | $ | 613,171 | | $ | 490,107 | | $ | 437,569 | | $ | 147,852 | | $ | 156,389 | Total | | $ | 803,648 | | $ | 695,962 | | $ | 613,171 | | | $ | 193,256 | | | | $ | 149,370 | | |
| | |
| |
| |
| |
| |
| | | | | | | | | | | | | | | | | | | | | | |
BGI
Barclays Global Investors, N.A. (‘BGI’) accounted for 17%18%, 16%18% and 16%17% of the Company'sCompany’s consolidated net operating revenues for the years ended December 31, 2004, 20032006, 2005 and 2002,2004, respectively. No client other than BGI accounted for more than 10% of the Company'sCompany’s consolidated net operating revenues in the years ended December 31, 2004, 20032006, 2005 and 2002.2004.
F-47
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
21. Geographic Reporting and Service Lines (Continued)
The following represents the Company'sCompany’s asset servicing fees by service line (Dollars in thousands):
|
| | For the Years Ended December 31,
| | | For the Years Ended
December 31, | |
|---|
Asset servicing fees by service lines:
| Asset servicing fees by service lines:
| | | | 2006 | | 2005 | | 2004 | |
|---|
| | 2004
| | 2003
| | 2002
| |
|---|
| Core service fees: | Core service fees: | | | | | | | Core service fees: | | | | | | | |
| | Custody, accounting and administration | | $ | 314,272 | | $ | 254,225 | | $ | 231,520 | |
| | |
| |
| |
| |
| Ancillary service fees: | | | | | | | |
| | Foreign exchange | | 54,466 | | 36,501 | | 24,469 | |
| | Cash management | | 26,396 | | 20,884 | | 16,974 | |
| | Investment advisory | | 15,020 | | 11,777 | | 11,909 | |
| | Securities lending | | 10,385 | | 8,903 | | 11,328 | |
| | Other service fees | | 2,661 | | 1,296 | | 195 | |
| | |
| |
| |
| |
| | | Total ancillary service fees | | 108,928 | | 79,361 | | 64,875 | |
| | |
| |
| |
| |
Custody, multicurrency accounting and fund administration | | Custody, multicurrency accounting and fund administration | | $ | 453,573 | | $ | 375,596 | | $ | 314,272 | |
Value-added service fees: | | Value-added service fees: | | | | | | | |
Foreign exchange | | Foreign exchange | | 80,957 | | 62,107 | | 54,466 | |
Cash management | | Cash management | | 58,777 | | 37,592 | | 26,396 | |
Securities lending | | Securities lending | | 27,381 | | 22,536 | | 10,385 | |
Investment advisory | | Investment advisory | | 7,464 | | 8,442 | | 15,020 | |
Other service fees | | Other service fees | | 3,088 | | 2,786 | | 2,661 | |
Total value-added service fees | | Total value-added service fees | | 177,667 | | 133,463 | | 108,928 | |
| Total | Total | | $ | 423,200 | | $ | 333,586 | | $ | 296,395 | Total | | $ | 631,240 | | $ | 509,059 | | $ | 423,200 | |
| | | |
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| |
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22. FINANCIAL STATEMENTS OF INVESTORS FINANCIAL SERVICES CORP. (PARENT ONLY):Financial Statements of Investors Financial Services Corp. (Parent Only)
The following represents the separate condensed financial statements of IFSC (Dollars in thousands):
Statements of Income
| | December 31, 2004
| | December 31, 2003
| | December 31, 2002
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| Equity in undistributed income of bank subsidiary | | $ | 144,595 | | $ | 95,088 | | $ | 69,299 | |
| Equity in undistributed income (loss) of nonbank subsidiary | | | — | | | 278 | | | (58 | ) |
| Equity in undistributed loss of unconsolidated nonbank subsidiary | | | (28 | ) | | (8 | ) | | — | |
| Dividend income from nonbank subsidiaries | | | — | | | 57 | | | 96 | |
| Dividend income from unconsolidated nonbank subsidiary | | | 76 | | | 19 | | | — | |
| Management fee paid by nonbank subsidiaries | | | — | | | — | | | 55 | |
| Interest expense on junior subordinated deferrable interest debentures | | | (2,420 | ) | | (2,420 | ) | | (2,488 | ) |
| Operating expenses | | | (1,703 | ) | | (2,214 | ) | | (467 | ) |
| Income tax benefit | | | 1,442 | | | 1,621 | | | 1,000 | |
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| Net Income | | $ | 141,962 | | $ | 92,421 | | $ | 67,437 | |
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Balance Sheets
| | December 31, 2004
| | December 31, 2003
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| Assets: | | | | | | | |
| | Cash | | $ | 14,312 | | $ | 3,433 | |
| | Investments in bank subsidiary | | | 720,501 | | | 559,231 | |
| | Investments in nonbank subsidiaries | | | 738 | | | 766 | |
| | Receivable due from bank subsidiary | | | 2,035 | | | 1,659 | |
| | Other assets | | | 650 | | | 1,155 | |
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| Total Assets | | $ | 738,236 | | $ | 566,244 | |
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| Liabilities and Stockholders' Equity | | | | | | | |
| Liabilities: | | | | | | | |
| | Accrued expenses | | $ | 43 | | $ | 56 | |
| | Payable due to nonbank subsidiary | | | 1,157 | | | 1,157 | |
| | Subordinated debt | | | 24,774 | | | 24,774 | |
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| | | Total liabilities | | | 25,974 | | | 25,987 | |
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| Stockholders' Equity: | | | | | | | |
| | Common stock | | | 667 | | | 655 | |
| | Surplus | | | 272,536 | | | 242,662 | |
| | Deferred compensation | | | (572 | ) | | (1,076 | ) |
| | Retained earnings | | | 418,034 | | | 280,701 | |
| | Accumulated other comprehensive income, net | | | 23,888 | | | 17,865 | |
| | Treasury stock | | | (2,291 | ) | | (550 | ) |
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| | | Total stockholders' equity | | | 712,262 | | | 540,257 | |
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| Total Liabilities and Stockholders' Equity | | $ | 738,236 | | $ | 566,244 | |
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| | Year ended | | Year ended | | Year ended | |
Statements of Income | | | | December 31, 2006 | | December 31, 2005 | | December 31, 2004 | |
Equity in undistributed income of bank subsidiary | | | $ | 156,798 | | | | $ | 99,809 | | | | $ | 144,595 | | |
Equity in undistributed loss of unconsolidated nonbank subsidiary | | | (29 | ) | | | (28 | ) | | | (28 | ) | |
Dividend income from bank subsidiary | | | — | | | | 63,000 | | | | — | | |
Dividend income from unconsolidated nonbank subsidiary | | | 76 | | | | 76 | | | | 76 | | |
Interest expense on junior subordinated deferrable interest debentures | | | (2,420 | ) | | | (2,420 | ) | | | (2,420 | ) | |
Operating expenses | | | (2,260 | ) | | | (2,254 | ) | | | (1,703 | ) | |
Income tax benefit | | | 1,638 | | | | 1,635 | | | | 1,442 | | |
Net Income | | | $ | 153,803 | | | | $ | 159,818 | | | | $ | 141,962 | | |
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F-48
Statements of Cash Flows
| | December 31,
2004
| | December 31,
2003
| | December 31,
2002
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| Cash flows from operating activities: | | | | | | | | | | |
| | Net income | | $ | 141,962 | | $ | 92,421 | | $ | 67,437 | |
| Adjustments to reconcile net income to net cash used by operating activities: | | | | | | | | | | |
| | Amortization of deferred compensation | | | 316 | | | 483 | | | 964 | |
| | Amortization of premium expense | | | 28 | | | 195 | | | — | |
| | Change in assets and liabilities: | | | | | | | | | | |
| | | Receivable due from bank subsidiary | | | (376 | ) | | 942 | | | (583 | ) |
| | | Receivable due from nonbank subsidiary | | | — | | | — | | | — | |
| | | Income tax receivable | | | 484 | | | (484 | ) | | — | |
| | | Other assets | | | (8 | ) | | (861 | ) | | 1 | |
| | | Payable due to nonbank subsidiary | | | — | | | 1,155 | | | (207 | ) |
| | | Accrued expenses | | | (13 | ) | | 14 | | | (12 | ) |
| | Equity in undistributed income of bank subsidiary | | | (144,595 | ) | | (95,088 | ) | | (69,299 | ) |
| | Equity in undistributed (income) loss of nonbank subsidiary | | | — | | | (278 | ) | | 58 | |
| | Equity in undistributed loss of unconsolidated nonbank subsidiary | | | 28 | | | 8 | | | — | |
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| Net cash used in operating activities | | | (2,174 | ) | | (1,493 | ) | | (1,641 | ) |
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| Cash flows from investing activities: | | | | | | | | | | |
| | Payments for investments in and advances to subsidiary | | | — | | | — | | | — | |
| Net cash used in investing activities | | | — | | | — | | | — | |
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| Cash flows from financing activities: | | | | | | | | | | |
| | Proceeds from exercise of stock options | | | 16,068 | | | 2,977 | | | 2,869 | |
| | Proceeds from issuance of common stock | | | 3,355 | | | 3,387 | | | 3,882 | |
| | Common stock repurchased | | | (1,741 | ) | | (550 | ) | | — | |
| | Cost of issuance of restricted stock | | | — | | | — | | | — | |
| | Repurchase of company-obligated, mandatorily redeemable, preferred securities of subsidiary trust | | | — | | | — | | | (1,000 | ) |
| | Dividends paid | | | (4,629 | ) | | (3,904 | ) | | (3,219 | ) |
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| Net cash provided by financing activities | | | 13,053 | | | 1,910 | | | 2,532 | |
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| Net increase (decrease) in cash and due from banks | | | 10,879 | | | 417 | | | 891 | |
| Cash and due from banks, beginning of year | | | 3,433 | | | 3,016 | | | 2,125 | |
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| Cash and due from banks, end of year | | $ | 14,312 | | $ | 3,433 | | $ | 3,016 | |
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QuickLinks
DOCUMENTS INCORPORATED BY REFERENCE
SIGNATURES
POWER OF ATTORNEY AND SIGNATURES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
INVESTORS FINANCIAL SERVICES CORP. CONSOLIDATED BALANCE SHEETS December 31, 2004 and 2003 (Dollars in thousands, except per share data)
INVESTORS FINANCIAL SERVICES CORP. CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME Years Ended December 31, 2004, 2003 and 2002 (Dollars in thousands, except per share data)
INVESTORS FINANCIAL SERVICES CORP. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Years Ended December 31, 2004, 2003, and 2002 (Dollars in thousands, except per share data)
INVESTORS FINANCIAL SERVICES CORP. CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 2004, 2003 and 2002 (Dollars in thousands)
INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2004, 20032006, 2005 and 2002200422. Financial Statements of Investors Financial Services Corp. (Parent Only) (Continued)
Balance Sheets | | December 31,
2006 | | December 31,
2005 | |
Assets: | | | | | | | | | |
Cash | | | $ | 34,554 | | | | $ | 10,303 | | |
Investments in bank subsidiary | | | 926,279 | | | | 785,138 | | |
Investments in nonbank subsidiaries | | | 681 | | | | 710 | | |
Receivable due from bank subsidiary | | | 2,600 | | | | 1,991 | | |
Other assets | | | 666 | | | | 709 | | |
Total Assets | | | $ | 964,780 | | | | $ | 798,851 | | |
Liabilities and Stockholders’ Equity: | | | | | | | | | |
Liabilities: | | | | | | | | | |
Accrued expenses | | | $ | 98 | | | | $ | 62 | | |
Payable due to nonbank subsidiary | | | 1,157 | | | | 1,157 | | |
Junior subordinated deferrable interest debentures | | | 24,774 | | | | 24,774 | | |
Income tax payable | | | 13 | | | | — | | |
Total liabilities | | | 26,042 | | | | 25,993 | | |
Stockholders’ Equity: | | | | | | | | | |
Common stock | | | 685 | | | | 672 | | |
Surplus | | | 334,929 | | | | 286,265 | | |
Deferred compensation | | | — | | | | (311 | ) | |
Retained earnings | | | 720,433 | | | | 572,549 | | |
Accumulated other comprehensive loss, net | | | (14,514 | ) | | | (13,369 | ) | |
Treasury stock | | | (102,795 | ) | | | (72,948 | ) | |
Total stockholders’ equity | | | 938,738 | | | | 772,858 | | |
Total Liabilities and Stockholders’ Equity | | | $ | 964,780 | | | | $ | 798,851 | | |
F-49
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004
22. Financial Statements of Investors Financial Services Corp. (Parent Only) (Continued)
| | Year ended | | Year ended | | Year ended | |
Statements of Cash Flows | | December 31,
2006 | | December 31,
2005 | | December 31,
2004 | |
Cash flows from operating activities: | | | | | | | | | | | | | |
Net income | | | $ | 153,803 | | | | $ | 159,818 | | | | $ | 141,962 | | |
Adjustments to reconcile net income to net cash (used in) provided by operating activities: | | | | | | | | | | | | | |
Equity in undistributed income of bank subsidiary | | | (156,798 | ) | | | (99,809 | ) | | | (144,595 | ) | |
Equity in undistributed loss of unconsolidated | | | | | | | | | | | | | |
nonbank subsidiary | | | 29 | | | | 28 | | | | 28 | | |
Share-based awards | | | 4,538 | | | | — | | | | — | | |
Amortization of deferred compensation | | | — | | | | 261 | | | | 316 | | |
Amortization of premium expense | | | 28 | | | | 28 | | | | 28 | | |
Excess tax benefit related to share-based awards | | | (8,017 | ) | | | — | | | | — | | |
Change in assets and liabilities: | | | | | | | | | | | | | |
Receivable due from bank subsidiary | | | (609 | ) | | | 44 | | | | (376 | ) | |
Income tax receivable/payable | | | 111 | | | | (98 | ) | | | 484 | | |
Other assets | | | 9 | | | | 13 | | | | (8 | ) | |
Accrued expenses | | | 36 | | | | 19 | | | | (13 | ) | |
Net cash (used in) provided by operating activities | | | (6,870 | ) | | | 60,304 | | | | (2,174 | ) | |
Cash flows from financing activities: | | | | | | | | | | | | | |
Proceeds from exercise of stock options | | | 33,096 | | | | 7,779 | | | | 16,068 | | |
Proceeds from issuance of common stock | | | 4,827 | | | | 3,868 | | | | 3,355 | | |
Common stock repurchase | | | (29,847 | ) | | | (70,657 | ) | | | (1,741 | ) | |
Excess tax benefit related to share-based awards | | | 8,017 | | | | — | | | | — | | |
Dividends paid to stockholders | | | (5,919 | ) | | | (5,303 | ) | | | (4,629 | ) | |
Tax benefit related to the issuance of share-based awards | | | 20,947 | | | | — | | | | — | | |
Net cash provided by (used in) financing activities | | | 31,121 | | | | (64,313 | ) | | | 13,053 | | |
Net increase (decrease) in cash and due from banks | | | 24,251 | | | | (4,009 | ) | | | 10,879 | | |
Cash and due from banks, beginning of year | | | 10,303 | | | | 14,312 | | | | 3,433 | | |
Cash and due from banks, end of year | | | $ | 34,554 | | | | $ | 10,303 | | | | $ | 14,312 | | |
F-50