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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-K/A
10-KAmendment No. 1

(Mark One)


ýx


ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


For the fiscal year ended December 31, 20032005

OR


OR


o


TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


For the transition period from            to            

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

(IRS Employer

incorporation or organization)

04-3279817
(IRS Employer

Identification No.)


200 Clarendon Street

P.O. Box 9130

Boston, Massachusetts

02116

(Address of principal executive offices)



02116

(Zip Code)

Registrant'sRegistrant’s telephone number, including area code:  (617) 937-6700

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $.01 Par Value
Series A Junior Preferred Stock Purchase Rights

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x  Noo

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yeso  No x

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. Yes ýx  Noo

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K 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.

Large accelerated filer   xAccelerated filero      Non-accelerated filero

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yesý No o  No x

The aggregate market value of Common Stockcommon stock held by non-affiliates of the registrant was $1,807,090,067$2,431,820,932 based on the last reported sale price of $29.03$37.82 on The Nasdaq National Market on June 30, 20032005 as reported by Nasdaq.

As of November 11, 2004,January 31, 2006, there were 66,462,87165,332,641 shares of Common Stockcommon stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

The registrant filedwill file a definitive Proxy Statement pursuant to Regulation 14A within 120 days of the end of the fiscal year ended December 31, 2003.2005. Portions of such Proxy Statement are incorporated by reference in Part III.



INVESTORS FINANCIAL SERVICES CORP.
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003


EXPLANATORY NOTE

        This Amendment to Investors Financial Services Corp.'s Annual Report on Form 10-K for the year ended December 31, 2003 includes restated financial statements as of December 31, 2003 and 2002, and for the years ended December 31, 2003, 2002 and 2001. This restatement relates to our application of Statement of Financial Accounting Standard No. 91,Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases ("FAS 91").

        The principal application of FAS 91 to our financial statements is in determining the accounting treatment of premiums paid and discounts realized on our purchase of securities backed by mortgages and other loans. Historically, we had applied the prospective method to determine the amortization of premiums and the accretion of discounts for the securities in our investment portfolio. Our management and Audit Committee have determined that the retrospective method is the appropriate method under FAS 91 to determine the amortization of premiums and the accretion of discounts for certain of our securities.

        This application of FAS 91 results in the following changes in reported income before income taxes for the periods presented in this report:

    •
    an increase in income before income taxes of approximately $1.0 million for the year ended December 31, 2003;

    •
    a decrease in income before income taxes of approximately $2.3 million for the year ended December 31, 2002; and

    •
    a decrease in income before income taxes of approximately $8.5 million for the year ended December 31, 2001.

        This application of FAS 91 also results in changes to other comprehensive income, net of tax, as well as other changes in our disclosures regarding our portfolio. Other comprehensive income, net of tax, increased on a cumulative basis by $4.9 million, $5.9 million and $6.1 million as of December 31, 2003, 2002 and 2001, respectively.



        The following tables summarize the effect of the restatement on our consolidated financial statements for the years ended December 31, 2003, 2002 and 2001 (Dollars in thousands, except per share data):

 
 For the year ended December 31, 2003
 
 
 As
Previously
Reported
 As
Restated
 
Statement of Income       
Interest income $246,063 $247,094 
Net interest income  152,883  153,914 
Net operating revenue  489,076  490,107 
Income before income taxes  144,155  145,186 
Provision for income taxes  52,395  52,765 
Net income  91,760  92,421 
Basic earnings per share $1.41 $1.42 
Diluted earnings per share $1.38 $1.39 

Comprehensive Income
 
 
 
 
 
 
 
Net income $91,760 $92,421 
Other comprehensive income:       
 Net unrealized investment loss  (11,878) (12,963)
  Other comprehensive income (loss)  718  (367)
Comprehensive income  92,478  92,054 

Statement of Cash Flows
 
 
 
 
 
 
 
Net income $91,760 $92,421 
Adjustments to reconcile net income to net cash provided by operating activities:       
 Amortization of premiums on securities, net of accretions of discounts  40,231  39,200 
 Other liabilities  27,316  27,686 
  Net cash provided by operating activities  157,987  157,987 

 
 For the year ended December 31, 2002
 
 
 As
Previously
Reported
 As
Restated
 
Statement of Income       
Interest income $247,847 $245,526 
Net interest income  141,046  138,725 
Net operating revenue  439,890  437,569 
Income before income taxes  98,495  96,174 
Provision for income taxes  29,549  28,737 
Net income  68,946  67,437 
Basic earnings per share $1.07 $1.05 
Diluted earnings per share $1.04 $1.02 

Comprehensive Income
 
 
 
 
 
 
 
Net income $68,946 $67,437 
Other comprehensive income:       
 Net unrealized investment gain  32,100  31,944 
  Other comprehensive income  22,584  22,428 
Comprehensive income  91,530  89,865 

Statement of Cash Flows
 
 
 
 
 
 
 
Net income $68,946 $67,437 
Adjustments to reconcile net income to net cash provided by operating activities:       
 Amortization of premiums on securities, net of accretions of discounts  10,474  12,795 
 Other liabilities  (6,935) (7,747)
  Net cash provided by operating activities  60,650  60,650 

 
 For the year ended December 31, 2001
 
 
 As
Previously
Reported
 As
Restated
 
Statement of Income       
Interest income $252,054 $243,571 
Net interest income  106,838  98,355 
Net operating revenue  361,325  352,842 
Income before income taxes  72,149  63,666 
Provision for income taxes  21,949  18,980 
Net income  50,200  44,686 
Basic earnings per share $0.79 $0.71 
Diluted earnings per share $0.76 $0.68 

Comprehensive Income
 
 
 
 
 
 
 
Net income $50,200 $44,686 
Other comprehensive income:       
 Net unrealized investment gain  1,120  7,211 
  Other comprehensive loss  (8,857) (2,766)
Comprehensive income  41,343  41,920 

Statement of Cash Flows
 
 
 
 
 
 
 
Net income $50,200 $44,686 
Adjustments to reconcile net income to net cash provided by operating activities:       
 Amortization of premiums on securities, net of accretions of discounts  255  8,738 
 Other assets  (25,329) (28,298)
  Net cash provided by operating activities  55,506  55,506 

 
 
 
 
 
 
 
 
 
 As of December 31, 2003
 As of December 31, 2002
 
 As
Previously
Reported
 As
Restated
 As
Previously
Reported
 As
Restated
Balance Sheet            
Securities held to maturity $4,307,610 $4,306,216 $3,438,689 $3,437,955
Total assets  9,224,572  9,223,178  7,215,474  7,214,740
Other liabilities  95,757  94,941  85,676  85,096
Total liabilities  8,683,737  8,682,921  6,748,518  6,747,938
Retained earnings  286,138  280,701  198,282  192,184
Accumulated other comprehensive income, net  13,006  17,865  12,288  18,232
Total stockholders' equity  540,835  540,257  442,956  442,802
Total liabilities and stockholders' equity  9,224,572  9,223,178  7,215,474  7,214,740

        In addition, the weighted-average yield on federal agency securities held to maturity in the maturity table in the "Management's Discussion and Analysis of Financial Condition and Results of Operations" in this Report has been restated to correct clerical errors as follows:

 
 5-10 years
 Over 10 years
 
 
 As
Previously
Reported
 As
Restated
 As
Previously
Reported
 As
Restated
 
Federal agency securities 2.76%2.28%3.16%2.71%
Total securities held to maturity 3.05%2.77%2.99%2.79%

        This Report, as amended, covers the year ended December 31, 2003 and was originally filed on February 20, 2004. This Report has been amended to restate certain financial statements and related financial results only and does not reflect events after the filing of the original report and does not modify or update disclosures as originally filed, except as required to reflect the effect of the restatement. Contemporaneously with the filing of this Report, we have also filed:

    •
    an amended Quarterly Report on Form 10-Q/A for the quarter ended March 31, 2004; and

    •
    an amended Quarterly Report on Form 10-Q/A for the quarter ended June 30, 2004.

        Our Quarterly Report on Form 10-Q for the quarter ended September 30, 2004 should be referenced for our current disclosures.



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, 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 and mutual fund administration. Our value-added services include securities lending, foreign exchange, cash management, performance measurement, institutional transfer agency, investment advisory services, lines of credit middle office outsourcing, and brokerage and transition management services. At December 31, 2003,2005, we provided services for approximately $1.1$1.8 trillion in net assets, including approximately $177 billion$0.3 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 and the Cayman Islands.

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 manymultiple 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 turn,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.    WhileDespite the ratestock market declines of financial asset value growth decreased slightly in recent years,2000 through 2002, over the past ten years growth in financial assets under management has beenremained 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 $13.9$17.3 trillion at December 31, 2002,2004, up from $5.9$7.1 trillion in 1992,1994, 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. Despite recent declines, theThe U.S. mutual fund market has grown at a compounded annual growth rate of approximately 14%13% since



1992, 1994, and held over $6approximately $7.8 trillion in assets at December 31, 2002. 2004.


The following table presents U.S. financial assets, including mutual funds (Dollars in billions):
 December 31,
2002
 December 31,
1992
 Compounded
Annual
Growth
Rate
 

 

December 31, 2004

 

December 31, 1994

 

Compounded
Annual
Growth Rate

 

U.S. Financial AssetsU.S. Financial Assets       

 

 

 

 

 

 

 

 

 

 

 

 

 

Mutual FundsMutual Funds $6,007.00 $1,625.50 13.96%

 

 

$

7,787

 

 

 

$

2,198

 

 

 

13

%

 

Life Insurance CompaniesLife Insurance Companies 3,366.00 1,587.00 7.81 

 

 

4,160

 

 

 

1,863

 

 

 

8

 

 

Private Pension FundsPrivate Pension Funds 3,686.00 2,051.40 6.04 

 

 

4,444

 

 

 

2,352

 

 

 

7

 

 

Bank Personal Trusts and EstatesBank Personal Trusts and Estates 807.90 629.60 2.53 

 

 

925

 

 

 

670

 

 

 

3

 

 

 
 
   
Total $13,866.90 $5,893.50 8.93%
 
 
   

Total

 

 

$

17,316

 

 

 

$

7,083

 

 

 

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 service 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. SmallerOther 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, Internet data delivery, regulatory changes, decimalization of stock prices 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 middle and back 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:

·

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 of larger pools of assets.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, such 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, domestic ETF assets increased 31% to approximately $296 billion as of December 31, 2005 from approximately $226 billion as of December 31, 2004.

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 source, hedge fund assets in particular have grown at an impressive rate for several years and total approximately $1.3 trillion at the end of 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 offer 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.

        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. In this environment, investors have the option of purchasing multi-class fund shares with the commission structure that best meets their short-term and long-term investment strategy. 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 lines with a single investment.

        Another innovation in the mutual fund industry is the advent of exchange traded funds, or ETFs. ETFs are securities that replicate an index and are traded on a national securities exchange, usually 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, globally, ETF assets grew 39% from approximately $142 billion at year end in 2002 to $198 billion at year-end 2003.

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 particular demandparticularly for value-added services like foreign exchange. At December 31, 2005, we provided services for approximately $1.8 trillion in net assets, including approximately $0.3 trillion of foreign net assets.

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 securities lending and foreign exchange. We also believe that efficient integration of these services is critical to both service quality and profitability. In order to continue to growThe following discussion outlines the key components of our business, we pursue our core strategies.growth 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

      •

      ·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 result in increasedallow us to constantly improve processing quality and efficiency and an increased ability to implement service innovations for our clients.clients quickly. 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. TheWe 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, limited partnerships and ETFs. We also have expertise in servicing the more complicated fund of funds and offshore fund structures.funds. Because 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.

    Deliver Superior Service.We strive to deliver superior and innovative client service. We believe service quality in client relationships is the key to maintaining and expanding existing business as well asclient 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 worktasks 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 havemanage multiple pools of assets that they manage.assets. Once a mutual fund complexan investment manager becomes a client, we believe that complexthis client is more likely to select us to service more funds,products, provide additional services, or both. For example, a mutual fund company may manage two or more families of mutual funds or an insurance company may manage a family of retail mutual funds and a series of mutual funds to offer variable annuity products. If we are engaged to provide services for only some of thecertain 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 bythrough 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, family offices, banks and insurance companies. We think of these services in two groupings: core services and value-added services.

    Core Services

    Value-Added Services


    •

    Global Custody

    •

    Securities Lending


    •

    ·  Middle Office Outsourcing



    Multicurrency Accounting

    •

    Foreign Exchange

    ·  Securities Lending


    •

    ·  Global Custody



    Mutual

    ·  Foreign Exchange

    ·  Multicurrency Accounting

    ·  Cash Management

    ·  Fund Administration



    •

    Cash Management





    •

    ·Investment Advisory Services






    •

    Middle Office Outsourcing

    ·  Performance Measurement






    •

    Performance Measurement





    •

    ·Institutional Transfer Agency






    •

    ·Lines of Credit






    •

    ·Brokerage and Transition Management Services

     

    Our value-added services help clients develop and execute their strategies, enhancingand evaluate and manage their returns, and evaluating and managing risk.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 middle office 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 $1.1$1.8 trillion at December 31, 2003.2005. At December 31, 2003,2005, our foreign net assets processed totaled approximately $177 billion.$0.3 trillion.

    In order to service our clients worldwide, we have established a network of global subcustodians in 99almost 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 offshore



    fund accounting. Weaccounting services to clients in Europe and Canada, which we continue to view the offshore market as aareas of significant business opportunity and will continue to invest in expansion to support client demand.opportunity.

            Mutual Fund Administration.    Mutual fundFund administration services include management reporting, regulatory reporting, compliance monitoring, tax accounting and return preparation, partnership administration and partnership administration.chief compliance officer services and support. In addition to these ongoing services, we also provide mutual 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 mutual funds and other pooled investment vehicles.

    Value-Added Services

    Securities Lending.Securities lending involves the lending of clients'clients’ securities to brokers and other institutions for a fee. Receipt of securities lending fees improves a client'sclient’s return on the underlying securities. We act as agent for our clients for both international and domestic securities lending 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.

    Investment Advisory Services.The Bank acts as investment advisor to the Merrimac Master Portfolio, an open-end investment management company registered under the Investment Company Act of 1940. 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 Income 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. At December 31, 2003,2005, the total net assets of the portfolio approximated $7.0$5.2 billion. The portfolio'sportfolio’s master funds serve as investment vehicles for seven domestic feeder funds and two offshore feeder funds whose shares are sold to institutional investors.

            Middle Office Outsourcing.    We also provide middle office outsourcing services to clients. 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 who needs to receive 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.

    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, 2003,2005, we had gross loans outstanding to clients of approximately $200$402 million, which represented approximately 2%3% 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 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, New York, Toronto, Dublin and DublinLondon offices provide 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 andwho works with the client on designing new products and specific systems requirements, providingprovides consulting support, anticipatinganticipates the client'sclient’s needs and coordinatingcoordinates 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 16.4%18% of our consolidated net operating revenues for each of the yearsyear ended December 31, 20032005, approximately 17% for the year ended December 31, 2004 and 2002.approximately 16% for the year ended December 31, 2003. No client other than BGI accounted for more than 5%10% of our net operating revenues for the years ended December 31, 20032005, 2004 and 2002.2003. See “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



    computer 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. The informationcurrencies and must be processed and then used forbefore system-wide updating and reporting.

    8



    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. We have met and continue to meet these needs through standardized data extracts and automated interfaces developed over the past several years.

            These abilities helpTechnology 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 Internet as a means to communicate with clients and external parties. Through the implementation of our strategic Internet plan, our goal is to position ourselves to take advantage of Internet technologies while providingWe also provide secure value-added services to our clients.clients over the Internet. We utilize a secure extranet environment that provides the authentication, access controls, intrusion detection, encryption and firewalls needed to assureensure the protection of client information and assets. Internet-based applications provide our clients with secure electronic access to their data over the Internet 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 or EDS,(“EDS”), located in Plano, Texas. In addition, International Business Machines (“IBM”), located in Armonk, New York, provides support for our network and hardware environments and our help desk services. By outsourcing mainframe processing,these infrastructure support functions, we can focus our resources on systems development and minimize our capital investment in large-scale computer equipment. EDS offersand 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 itstheir large and diverse customer base,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 itstheir computer hardware.

            Our current agreement with EDS obligates EDS to provide us with comprehensive data processing services and obligates us to utilize EDS' services for a significant amount of our data processing requirements. We Under both contracts we are billed monthly for these services provided by EDS or IBM on an as-used basis in accordance with a predetermined pricing schedule for specific products and services. EDS began providing services for us



    in December 1990. Our current agreement with EDS is scheduled to expire on December 31, 2005. EDS also provides us2008. Our current agreement with mainframe disaster recovery services.IBM is scheduled to expire on June 30, 2011.

    Each year we spendtarget spending approximately 18-20% of our consolidated net operating revenue on technology. Because of our relationshiprelationships with EDS and IBM and our system architecture, we are able to focusdevote the majority of our technology spend oninvestments to development, rather than support or infrastructure.

    Our trust processing services are provided by SEI Investments Company (“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, 2005.2009.

    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, Bankour locations are geographically diverse in order to allow recovery of essential functions toat another location in the event of a wide spreadwidespread disruption. In 2003,2005, BCP staff conducted over 80100 different tests to ensure that our technology infrastructure, facilities and staff could respond and recover in a disaster.

            The securities industry is moving to a straight-through-processing environment where all trades will flow directly from a client's trading platform to our own system to produce a net asset value calculation. We have made substantial progress in completing the systems infrastructure and functional modifications required to provide straight-through-processing capabilities. We believe that we can accomplish the transition to a full straight-through-processing environment without adversely affecting our financial results, operations or the services we provide to our clients.

    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, JP Morgan Chase, The Bank of New York, Citigroup, Mellon and PNC, 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, securities lending and foreign exchange, all 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 even larger through acquisition, we believe that our customized and highly responsive service offerings become even more attractive. While consolidation within the industryinvestment 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.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 new,newly 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 trade protection may not be available in certain international markets that we service.


    Employees

    On December 31, 2003,2005, we had 2,4133,252 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 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 generally applicable state and federal laws governing businesses and employers, we are further regulated bysubject to federal and state laws and regulations applicable to financial institutions and their parent companies. Furthermore, theThe 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”). Virtually all aspectsThe principal objective of our operations are subject to specific requirements or restrictions and general regulatory oversight. Statestate and federal banking laws have as their principal objectiveis the maintenance of the safety and soundness of financial institutions and the federal deposit insurance system, the protection of consumers or classes of consumers orand the furtherance of broad public policy goals, rather than the specific protection of stockholders of a bank or its parent company.

            Several Some of the more significant statutory and regulatory provisions applicable to banks and bank holding companies ("BHC") to which Investors Financialwe and itsour subsidiaries are subject are described more fully below, together with certain statutory and regulatory matters concerning Investors Financial and its subsidiaries.below. The description of these statutory and regulatory provisions doesis not purport to be 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 Investors Financial'sour business, prospects and operations, as well as those of itsour 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 a reportreports of our operations with, and are subject to examination by, the FRB and the Commissioner. The FRB has the authority to issue orders to 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 generally authorizes(“Riegle-Neal”) permits adequately capitalized and adequately managed BHCs, as determined by the FRB, to acquire banks located in any state, possibly subject to certain state-imposed age and deposit 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. In addition,branching, so long as discussed more fully below,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”) (as discussed below), 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 makeengage 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 establishedpermits a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms,BHC that qualifies and other financial service providers by revising and expanding the BHCA framework to permit BHCs that qualify and electelects to be treated as FHCsa FHC to engage in a significantly broader range of financial activities broader than would be permissible for traditional BHCs, such as Investors Financial, that have not elected to be treated as FHCs. "Financial activities"FHC status. “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. In sum, 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.

            In order toTo elect to become a FHC, and thus engage in a broader range of financial activities, a BHC, such as Investors Financial, must meet certain tests and file an election form with the FRB. To qualify, all of a BHC'sBHC’s subsidiary banks must be well-capitalized (as discussed below under "Investors Bank") and well-managed, as measured by regulatory guidelines. In addition, to engage in the new activities, 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 and may even require divestitures. Such possible ramifications may limit the ability of a bank subsidiary to significantly expand or acquire less than well-capitalized and well-managed institutions. At this time,operations. Investors Financial has not elected and has not otherwise determined whether it will elect, to become a FHC.

    Capital Requirements.The FRB has adopted capital adequacy guidelines which it uses in assessing the adequacy of capital in examining and supervising a BHC and in analyzing applications upon which it acts.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 in the case of the latter to limitations on the kind and amount of such stocks which may be included as Tier 1 capital)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, which is not eligible to be 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 (defined by reference to the risk-based capital guidelines) to its average total consolidated assets (the "Leverage Ratio"“Leverage Ratio”) of 3.0%. Total average consolidated assets for this purpose does not include for example, 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% Leverage Ratio requirement is the minimum for the top-rated BHCs without any supervisory, financial or operational weaknesses or deficiencies or those, which are not experiencing or anticipating



    significant growth.BHCs. All other BHCs are required to maintain a minimum Leverage Ratio of 4.0%. 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% or higher.

    We are currently are in compliance with both the Total Risk-Based Capital Ratio and the Leverage Ratio requirements, and our management expects these ratios to remain in compliance with the FRB'sFRB’s capital


    adequacy guidelines. (Separate, but substantially similar, capital adequacy guidelines under Federal Deposit Insurance Corporation ("FDIC") regulations apply to the Bank, as discussed more fully below.) At December 31, 2003,2005, our Total Risk-Based Capital Ratio and Leverage Ratio were 17.62%18.50% and 5.36%5.95%, respectively.

            U.S. bank regulatory authorities and international bank supervisory organizations, principallyIn June 2004, the Basel Committee on Banking Supervision ("(“Basel Committee"Committee”), currently are considering changes 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 risk-based capital adequacy framework, which ultimately could affectof internationally active banking organizations. In September 2005, the appropriate capital guidelines, including changes (suchFFIEC (U.S. banking and thrift supervisory agencies) revised guidance on the timing and qualification process for U.S. banks that will become subject to Basel II. The new rules as those relating to lending to registered broker-dealers) that are of particular relevance to banks, such asapplied in the Bank, that engage in significant securities activities. Among other things, the Basel Committee rules, whichU.S. are expected to become effective around 2006, would add operational risk as a third componenton January 1, 2009, subject to transitional parallel testing beginning on January 1, 2008. Although we are not required to be compliant with the denominatornew rules, we are in the process of developing an implementation 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 FFIEC supervisory agencies. We cannot predict the final form of the risk-capital calculation, in addition to credit and market risks. We are monitoring the status and progress of the Basel Committee rules, and the relatednor their impact if any, on our operations and are preparing for their implementation.risk-based capital.

            Limitations on Acquisitions of Common Stock.Control Acquisitions.The federal 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 given at least 60 days to review, public noticenotified and has been provided, and the FRB does not objectobjected 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 such as us, 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 due to the manner in which it acquired the Bank.law. Accordingly, we have registered with the Commissioner and are obligated to make reports to the Commissioner. Further, as aUnder Massachusetts BHC, Investors Financial may notlaw, any person that proposes to acquire, alldirectly or substantially allindirectly, 25% or more of the assetsany class of voting securities of a banking institution, merge or consolidate withcompany must give prior notice to the Massachusetts Commissioner of Banks, who may disapprove the transaction. Additionally, any othercompany that is a BHC or acquire direct or indirect ownership or control of any voting stock in any other banking institution if it will own or control more than 5% thereof withoutunder Massachusetts law must obtain the prior consentapproval of the Massachusetts Board of Bank Incorporation.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, in connection therewith, to stand readyif 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 bank holding companyBHC may not have the resources to provide it. Similarly, under the cross-guarantee provisions of the Federal Deposit Insurance Act ("FDIA"), the FDIC can hold any FDIC- insured depository institution liable for any loss suffered or anticipated by the FDIC in connection with (1) the "default" of a commonly controlled FDIC-insured depository institution; or (2) any assistance provided by the FDIC to a commonly controlled FDIC-insured depository institution "in danger of default." Accordingly, Investors Financial is expected to commit resources to the Bank in circumstances where it might not do so absent such policy.

    13



    Investors Bank

            Disclosure Controls and Procedures.General.    The Sarbanes-Oxley Act of 2002, ("Sarbanes-Oxley") implements a broad range of corporate governance and accounting measures for public companies (including publicly-held bank holding companies such as the Company) designed to promote honesty and transparency in corporate America. Sarbanes-Oxley's principal provisions, many of which have been interpreted through regulations released in 2003, provide for and include, among other things:

      •
      The creation of an independent accounting oversight board;

      •
      Auditor independence provisions which restrict nonaudit services that accountants may provide to their audit clients;

      •
      Additional corporate governance and responsibility measures, including the requirement that the chief executive officer and chief financial officer of a public company certify financial statements;

      •
      The forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer's securities by directors and senior officers in the twelve-month period following initial publication of any financial statements that later require restatement;

      •
      An increase in the oversight of, and enhancement of certain requirements relating to, audit committees of public companies and how they interact with the Company's independent auditors;

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      Requirements that audit committee members must be independent and are barred from accepting consulting, advisory or other compensatory fees from the issuer;

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      Requirements that companies disclose whether at least one member of the audit committee is a "financial expert" (as such term is defined by the SEC) and if not, why not;

      •
      Expanded disclosure requirements for corporate insiders, including accelerated reporting of stock transactions by insiders and a prohibition on insider trading during pension blackout periods;

      •
      A prohibition on personal loans to directors and officers, except certain loans made by insured financial institutions, such as the Bank, on nonpreferential terms and in compliance with other bank regulatory requirements;

      •
      Disclosure of a code of ethics and filing a Form 8-K for a change or waiver of such code; and

      •
      A range of enhanced penalties for fraud and other violations.

              We are monitoring the status of other related ongoing rulemaking by the SEC and other regulatory entities. Currently, management believes that we are in compliance with the rulemaking promulgated to date.

      Investors Bank

         General.The Bank is subject to extensive regulation and examination by the Commissioner and the FDIC,Federal Deposit Insurance Corporation (“FDIC”), which insures the Bank'sBank’s deposits, to the maximum extent permitted by law, and to certain requirements established by the FRB. The federal and state laws and regulations which 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 and the nature and amount of and collateral for certain loans.

      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. FDIAThe Federal Deposit Insurance Act (“FDIA”) does not require the FDIC to charge all banks deposit insurance premiums when the ratio of deposit insurance reserves to insured deposits is maintained above specified levels. However, as a result of general economic conditions, and recent bank failures, it is possible that the ratio of deposit insurance reserves to insured deposits could fall below the minimum ratio that FDIA requires, which would result 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 increase deposit insurance assessments above their current levels.

      In February 2006, Congress enacted the Federal Deposit Insurance Reform Act of 2005 (the “FDIR Act”). As a result of the passage of the FDIR Act, over the course of the next year, among other things: (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 FDIC 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, as described above.BHCs.

              Moreover,The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), identifies five capital categories for insured depository institutions (well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized) and requires the federal bank regulatory agencies to implement systems for “prompt corrective 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-raising requirements. An “undercapitalized” bank must develop a capital restoration plan, and its parent holding company must guarantee that bank’s compliance with the plan. The liability of the parent holding company under any such guarantee is limited to the lesser of 5% of the bank’s assets at the time it became “undercapitalized” or the amount needed to comply with the plan. Furthermore, in the event of the bankruptcy of the parent holding company, such guarantee would take priority over the 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 promulgatedadopted substantially similar regulations to implementthat define the systemfive 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 prompt corrective action established by Section 38 of the FDIA.to be taken when an institution is considered undercapitalized. Under the regulations, a bank generally shall be deemed to be:

        *
        "well capitalized" if it has a total risk-based capital ratio of 10.0% or greater, has“well-capitalized” institution must have a Tier 1 risk-based capital ratio of 6.0% or greater, has a leverage ratio of 5.0% or greater and is not subject to any written agreement, order, capital directive or prompt corrective action directive;

        *
        "adequately capitalized" if it hasat least 6%, a total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital ratio of 4.0% or greater,at least 10% and a leverage ratio of 4.0% or greater (3.0% under certain circumstances)at least 5% 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’s assets does not meetmatch the definitionsensitivity of a "well capitalized" bank;

        *
        "undercapitalized" if it has a total risk-based capital ratio that is less than 8.0%, a Tier 1 risk-based capital ratio that is less than 4.0%its liabilities or a leverage ratio that is less than 4.0% (3.0% under certain circumstances);

        *
        "significantly undercapitalized" if it has a total risk-based capital ratio that is less than 6.0%, a Tier 1 risk-based capital ratio that is less than 3.0% or a leverage ratio that is less than 3.0%its off-balance-sheet position); and

        *
        "critically undercapitalized" if it has (c) risks from non-traditional activities, as well as an institution’s ability to manage those risks, when determining the adequacy of an institution’s capital. This evaluation will be made as a ratio of tangible equity to total assets that is equal to or less than 2.0%.

              An institution generally must file a written capital restoration plan which meets specified requirements with an appropriate FDIC regional director within 45 dayspart of the date that the institution



      receives notice or is deemed to have notice that it is undercapitalized, significantly undercapitalized or critically undercapitalized. An institution, which is required to submit a capital restoration plan, must concurrently submit a performance guaranty by each company that controls the institution. A critically undercapitalized institution generally is to be placed in conservatorship or receivership within 90 days unless the FDIC formally determines that forbearance from such action would better protect the deposit insurance fund.

              Immediately upon becoming undercapitalized, an institution becomes subject to the provisions of Section 38 of the FDIA, including for example, (i) restricting payment of capital distributionsinstitution’s regular safety and management fees, (ii) requiring that the FDIC monitor the condition of the institution and its efforts to restore its capital, (iii) requiring submission of a capital restoration plan, (iv) restricting the growth of the institution's assets and (v) requiring prior approval of certain expansion proposals.

      soundness examination. At December 31, 2003,2005, the Bank was deemed to be a well-capitalized institution for the above purposes. Bank regulators may raise capital requirements applicable to banking organizations beyond current levels. We are unable to predict whether higher capital requirements will be imposed and, if so, at what levels and on what schedules. Therefore, we cannot predict what effect such higher requirements may have on us. As is discussed above, the Bank would be required to remain a well-capitalized institution at all times if we elected to be treated as a FHC.institution.

              Brokered Deposits.The Community Reinvestment Act.    Section 29 of   The Community Reinvestment Act (“CRA”) requires lenders to identify the FDIA and FDIC regulations generally limitcommunities served by the ability of an insured depository institution to accept, renew or roll over any brokered deposit depending on the institution's capital category. These restrictions have not had a material impact on the Bank's operations because the Bank historically has not relied upon brokered deposits as a source of funding. At December 31, 2003, the Bank did not have any brokered deposits.

              Transactions with Affiliates.    Sections 23A and 23B of the Federal Reserve Act, which apply to the Bank, are designed primarily to protect against a depository institution suffering losses in certain transactions with affiliates, which includes Investors Financialinstitution’s offices and other subsidiaries of Investors Financial. For example, the Bank is subject to certain restrictions on loans to us, on investment in the stock or securities thereof, on the taking of such stock or securities as collateral for loans to any borrower and on the issuance of a guarantee or letter of credit on our behalf. The Bank also is subject to certain restrictions on most types of transactions with us, requiring that the terms of such transactions be substantially equivalent to terms to similar transactions with nonaffiliates. The FRB recently adopted a final rule, which became effective April 1, 2003, to implement comprehensively Sections 23A and 23B of the Federal Reserve Act. This new rule, among other things, specifies that derivative transactions are subject to Section 23B (including use of daily marks and two way collateralization) but generally not to Section 23A, except derivatives in which the bank provides credit protection to a nonbank affiliate on behalf of an affiliate will be treated as a guarantee for purposes of Section 23A, and requires banks to establish policies and procedures (which the Bank has established) to monitor credit exposure to affiliates. The rule treats derivatives in which a bank provides credit protection to a nonaffiliate with respect to an obligation of an affiliate as a guarantee of an obligation of an affiliate subject to regulation under the rule.

              Activities and Investments of Insured State-Chartered Banks.    Section 24 of the FDIA generally limits the activities as principal and equity investments of FDIC-insured, state-chartered banks, such as the Bank, to those that are permissible for national banks. In 1999, the FDIC substantially revised its regulations implementing Section 24 of the FDIA to ease the ability of FDIC-insured, state-chartered banks to engage in certain activities not permissible for national banks,deposit-taking facilities and to expedite FDIC review of bank applicationsmake loans and notice to engage in such activities.

              Further, the GLBA permits national banksinvestments and state banks, to the extent permitted under state law, to establish a financial subsidiary to engage in certain new activities which are permissible for



      subsidiaries of an FHC. In order to form a financial subsidiary, a national bank or state bank and each of its depository institution affiliates must be well-capitalized and well-managed. Such banksprovide services that establish a financial subsidiary will become subject to certain capital deduction, risk management and affiliate transaction rules, among other requirements. Also, the FDIC's final rules governing the establishment of financial subsidiaries adopt the position that activities that a national bank could only engage in through a financial subsidiary, such as securities underwriting, only may be conducted in a financial subsidiary by a state nonmember bank. However, activities that a national bank could not engage in through a financial subsidiary, such as real estate development or investment, continue to be governed by the FDIC's standard activities rules. Moreover, to mirror the FRB's actions with respect to state member banks, the final rules provide that a state bank subsidiary that engages only in activities that the bank could engage in directly (regardless of the nature of the activities) will not be deemed to be a financial subsidiary.

              CRA.    The CRA requires the FDIC to assess an institution's record of helping to meet the credit needs of these communities. Regulatory agencies examine each of the local communitiesbanks and rate such institutions’ compliance with CRA as “Outstanding”, “Satisfactory”, “Needs to Improve” or “Substantial Noncompliance”. Failure of an institution to receive at least a “Satisfactory” rating could inhibit such institution or its holding company from undertaking certain activities, including engaging in whichactivities newly permitted as a financial holding company under the institution is chartered, consistent withGLBA and acquisitions of other financial institutions. The FRB and the institution's safe and sound operation, and toFDIC must take this record into account when evaluatingthe 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 applications.

      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. For purposes of the CRA, the Bank has been designated as a "wholesale institution" by the Commissioner and as a "special purpose" institution by the FDIC. The wholesale institution designation reflects the nature of our business as other than a retail financial institution and prescribes CRA review criteria applicable to the Bank's particular type of business. As a part of the CRA program, the Bank is subject to periodic CRA examinations by the Commissioner (but not the FDIC because special purpose institutions are exempt from such FDIC review) and maintains comprehensive records of its CRA activities for this purpose. Management believes the Bank is currently in compliance with all CRA requirements.

      Customer Information Security.The FDIC and other bank regulatory agencies have adopted final guidelines for establishingestablished standards for safeguarding nonpublic personal information about customers that implement provisions of the GLBA (the "Guidelines"). Among other things,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, thereof, to develop, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, to protect against any 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 FDICGLBA requires financial institutions to implement policies and other regulatory agencies have published final privacy rules pursuant to provisions ofprocedures regarding the GLBA ("Privacy Rules"). The Privacy Rules, which govern the treatmentdisclosure of nonpublic personal information about consumers byto nonaffiliated third parties. In general, the statute requires financial institutions require a financial institution to provide noticeexplain to customers (and other consumers in some circumstances) about its privacytheir policies and practices, describeprocedures regarding the conditions under which a financial institution may disclosedisclosure of such nonpublic personal information, to nonaffiliated third parties and, provide a method for consumers to prevent aunless otherwise required or permitted by law, financial institutioninstitutions are prohibited from disclosing thatsuch information to most nonaffiliated third parties by "opting-out" of that disclosure, subject to certain exceptions.except as provided in their policies and procedures.

      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 additional or amend existing policies and procedures with respect to, among other things, anti-money laundering compliance,



      suspicious activity and currency transaction reporting, customer identity verification and due diligence on customers. Theycustomer 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 the FRB (and other federal banking agencies)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 currently effective requirements prescribed by the USA Patriot Act and all applicable final implementing regulations.

              Massachusetts Law-Dividends.Dividends.The FDIC 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. 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 the Bank at this time.

              Regulatory Enforcement Authority.    The enforcement powers available to federal and state banking regulators include, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders and to initiate injunctive actions against banking organizations and institution-affiliated parties, as defined. In general, these enforcement actions may be initiated for violations of law and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with regulatory authorities. Under certain circumstances federal and state law require disclosure and reports of certain criminal offenses and also final enforcement actions by the federal banking agencies.

              Transfer Agency.    In order to serve as transfer agent to our clients that execute transactions in publicly-traded securities, we must register with the SEC as a transfer agent under the Exchange Act. As a registered transfer agent, we are subject to certain reporting and recordkeeping requirements. Currently, management believes that we are in compliance with these registration, reporting and recordkeeping requirements.

              Regulation of Investment Companies.    Certain of our mutual fund and unit investment trust clients are regulated as "investment companies" as that term is defined under the Investment Company Act of 1940, as amended (the "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. Future legislative and regulatory changes in the existing laws and regulations governing custody of investment company assets, particularly with respect to custodian qualifications, may have a material and adverse impact on us. Currently, management believes we are in compliance with all minimum capital and securities depository requirements. Further, we are not aware of any proposed or pending regulatory developments, which, if approved, would adversely affect the ability of us to act as custodian to an investment company.



              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.

              New legislation or regulatory requirements could have a significant impact on the information reporting requirements applicable to our clients and may in the short term adversely affect our ability to service those clients at a reasonable cost. Any failure by us to provide such support could cause the loss of customers and have a material adverse effect on our financial results. Additionally, legislation or regulations may be proposed or enacted to regulate us in a manner which may adversely affect our financial results.

      Other Securities LawsLaw Issues.The GLBA amended the federal securities laws to eliminate the blanket exceptions that banks traditionally have had from the definition of "broker" and "dealer" for a "bank." In February 2003, the SEC extended the temporary exemption from the definition of "dealer" for banks until September 30, 2003 and, in April 2003, it extended the temporary exemption from the definition of "broker" until November 12, 2004. In February 2003, the SEC also issued final rules that, among other things, adopt amendments to its rule granting an exemption to banks from dealer registration forde minimis riskless principal transactions, and to its rule that defines terms used in the bank exception to dealer registration for asset-backed transactions and it adopted a new exemption for banks from the definition of broker and dealer under the Exchange Act for certain securities lending transactions. Banks not falling within the specific exemptions provided by the new law may have to register with the SEC as a broker or a dealer or both and become subject to SEC jurisdiction. We do not expect these new rules to have a material effect on us, as we recently formed a registered broker-dealer subsidiary.

              The GLBA also amended the federal securities laws to eliminate the blanket exceptions that banks traditionally have had from the definition of "investment adviser." With respect to investment adviser registration, 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 are in compliance with these requirements.

              Future Legislation.Regulation of Investment Companies.    ChangesCertain of our mutual fund and unit investment trust clients are regulated as “investment companies” as that term is defined under the Investment Company Act of 1940, as amended (the “ICA”), and are subject to examination and reporting requirements applicable to the lawsservices 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 statesstatutes or regulations governing recordkeeping and countries where Investors Financial and its subsidiaries transact business canreporting or valuation calculations will affect the operating environment of BHCs and their subsidiariesmanner in substantial and unpredictable ways. We cannot accurately predict whether those changes in laws and regulations will occur, and, if they do occur, the ultimate effect they would have uponwhich we conduct our financial condition or results of operation.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 site at www.ibtco.com.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 practical 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.


        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 Discussion and Analysis of Financial Condition and Results of 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,
        		 
         
        		 2003
        (As Restated)(1)
        		 2002
        (As Restated)
        		 2001
        (As Restated)
        		 2000
        		 1999
        		 
        Statement of Income Data(2):                
        Net interest income $153,914 $138,725 $98,355 $56,375 $33,330 
        Noninterest income  336,193  298,844  254,487  170,876  141,414 
          
        		 
        		 
        		 
        		 
        		 
        Net operating revenues  490,107  437,569  352,842  227,251  174,744 
        Operating expenses  344,921  341,395  289,176  177,875  143,468 
          
        		 
        		 
        		 
        		 
        		 
        Income before income taxes  145,186  96,174  63,666  49,376  31,276 
        Income taxes  52,765  28,737  18,980  15,800  10,008 
          
        		 
        		 
        		 
        		 
        		 
        Net income $92,421 $67,437 $44,686 $33,576 $21,268 
          
        		 
        		 
        		 
        		 
        		 
        Per Share Data(3):                
        Basic earnings per share $1.42 $1.05 $0.71 $0.57 $0.37 
          
        		 
        		 
        		 
        		 
        		 
        Diluted earnings per share $1.39 $1.02 $0.68 $0.54 $0.36 
          
        		 
        		 
        		 
        		 
        		 
        Dividends per share $0.06 $0.05 $0.04 $0.03 $0.02 
          
        		 
        		 
        		 
        		 
        		 
        Balance Sheet Data:                
        Total assets at end of period $9,223,178 $7,214,740 $5,297,913 $3,811,869 $2,553,862 
        Average Balance Sheet Data:                
        Interest-earning assets $7,556,061 $5,769,971 $4,376,947 $2,753,814 $1,837,963 
        Total assets  8,139,985  6,173,187  4,648,128  2,900,177  1,971,499 
        Total deposits  3,153,306  2,342,247  2,043,124  1,551,880  1,150,814 
        Junior subordinated debentures(4)  24,194  —  —  —  — 
        Trust preferred securities(4)  —  24,667  25,000  25,000  25,000 
        Common stockholders' equity  483,923  395,101  307,565  155,809  118,622 
        Selected Financial Ratios:                
        Return on average equity  19.1% 17.1% 14.5% 21.5% 17.9%
        Return on average assets  1.1% 1.1% 1.0% 1.2% 1.1%
        Average common equity as a % of average assets  5.9% 6.4% 6.6% 5.4% 6.0%
        Dividend payout ratio(5)  4.3% 4.9% 5.9% 5.6% 5.6%
        Tier 1 capital ratio(6)  17.6% 15.3% 16.6% 13.4% 15.0%
        Leverage ratio(6)  5.4% 5.4% 5.8% 5.2% 5.5%
        Noninterest income as % of net operating income  68.6% 68.3% 72.1% 75.2% 80.9%
        Other Statistical Data:                
        Assets processed at end of period(7) $1,056,871,924 $785,418,321 $813,605,957 $303,236,286 $290,162,547 
        Employees at end of period  2,413  2,591  2,618  1,779  1,507 
        (1)
        Effective July 1, 2003, the Company adopted provisions of SFAS 150, 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 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)
        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 $0.07 per share subject to regulatory requirements. Refer to "Market Risk: Liquidity" included in Management's Discussion and Analysis of Financial Condition and Results of Operations for further information.

        (6)
        Refer to "Capital Resources" included within Management's Discussion and Analysis of Financial Condition and Results of Operations for further information.

        (7)
        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: global custody, multicurrency accounting, mutual fund administration, securities lending, foreign exchange, cash management, performance measurement, institutional transfer agency, investment advisory services, lines of credit, middle office outsourcing and brokerage and transition management services.


        ITEM 7. 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.

        Recent Developments

                On October 21, 2004, our Audit Committee, in consultation with management, determined to amend its Annual Report on Form 10-K for the fiscal year ended December 31, 2003 and the subsequent Quarterly Reports on Form 10-Q for the quarters ended March 31, 2004 and June 30, 2004 to restate the financial statements (the "relevant financial statements") and related information contained therein. Our restatement arises from the application of 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 ("FAS 91").

                The principal application of FAS 91 to our financial statements is in determining the accounting treatment of premiums paid and discounts realized on our purchase of securities backed by mortgages and other loans. Historically, we had applied the prospective method to determine the amortization of premiums and the accretion of discounts for the securities in our investment portfolio. Our management and Audit Committee have determined that the retrospective method is the appropriate method under FAS 91 to determine the amortization of premiums and the accretion of discounts for certain of our securities.

                This application of FAS 91 results in the following changes in reported income before income taxes for the periods presented in this Report:

          •
          an increase in income before income taxes of approximately $1.0 million for the year ended December 31, 2003;

          •
          a decrease in income before income taxes of approximately $2.3 million for the year ended December 31, 2002; and

          •
          a decrease in income before income taxes of approximately $8.5 million for the year ended December 31, 2001.

                This application of FAS 91 also results in changes to other comprehensive income, net of tax, as well as other changes in our disclosures regarding our portfolio, including net interest margin during the periods listed above.

        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, family offices, banks and insurance companies. Core services include global custody, multicurrency accounting and mutual fund administration. Value-added services include securities lending, foreign exchange, cash management, performance measurement, institutional transfer agency, investment advisory services, lines of credit, middle office outsourcing and brokerage and transition management services. We have offices located in the United States, Ireland, Canada, and the Cayman Islands with a vast subcustodian global network established to accommodate the international needs of our clients. At December 31, 2003, we provided services for approximately $1.1 trillion in net assets, including approximately $177 billion 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% 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, the regulatory environment for us and our clients and the success of our clients 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. Our share of earnings from these investments is viewed as part of the total compensation that our clients pay us for servicing their assets. Our service offerings are priced on a bundled basis. In establishing a fee structure for a specific client, we analyze all expected revenue and expenses. We believe net operating revenue (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 year, we have benefited from the appreciation of the market values of assets we service for our clients. A significant portion of our core services revenue is based upon the amount of assets under administration. 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. Many of our value-added services are transactional based, and we receive a fee for each transaction processed. We have also continued to experience net interest margin compression in this low interest rate environment because we have little room to reduce further the rates we pay on our interest-bearing liabilities, yet high volumes of prepayments in our investment portfolio have caused us to reinvest these cash flows in lower-yielding assets.

                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. Despite the additional tax expense, we were still able to generate a 37% growth in net income for the year ended December 31, 2003 when compared to the same period in the prior year.

                We continue to remain focused on our sales efforts, prudent expense management and increasing efficiency. These goals are complicated by the need to build infrastructure to support our rapid growth, by the need to maintain state-of-the-art systems and by the need to retain and motivate our high caliber workforce.

                In our 2003 earnings releases, we reported operating income and per share information that exclude the effect of the state tax assessment settlement previously discussed above. We believe that operating earnings provide a more meaningful presentation of the results of operations because they do not include the one-time tax charge which was unrelated to our operations. The following table presents a reconciliation between earnings presented on the face of our Statement 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,
         
        		 2003
        		 2002
        		 2001
        Income before taxes $145,186 $96,174 $63,666
        Provision for income taxes  52,765  28,737  18,980
          
        		 
        		 
        Net Income $92,421 $67,437 $44,686
          
        		 
        		 
        Earnings per share:         
         Basic $1.42 $1.05 $0.71
          
        		 
        		 
         Diluted $1.39 $1.02 $0.68
          
        		 
        		 

        Pro Forma Operating Earnings

         
        		 For the Year Ended
        December 31,
         
        		 2003
        		 2002
        		 2001
        Income before taxes $145,186 $96,174 $63,666
        Provision for income taxes  45,565(1) 28,737  18,980
          
        		 
        		 
        Net Income $99,621 $67,437 $44,686
          
        		 
        		 
        Earnings per share:         
         Basic $1.53 $1.05 $0.71
          
        		 
        		 
         Diluted $1.50 $1.02 $0.68
          
        		 
        		 
        (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 in the first quarter 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.

        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 results of operations under different conditions or using different assumptions. Senior management has discussed these critical accounting policies with the audit committee.

        Derivative Financial Instruments—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 interest rates increase, the swaps would gain in value. Conversely, if interest rates decrease, there would be a corresponding decline in the market value of the swaps portfolio. Changes in conditions or the occurrence of unforeseen events could affect the timing of the recognition of changes in fair value of certain hedging derivatives. The measurement of fair value is based upon market values, however, in the absence of quoted market values, measurement involves valuation estimates. These estimates are based on methodologies deemed appropriate under existing circumstances. However, the use of alternative assumptions could have a significant effect on estimated fair value.

        Defined Benefit Pension Assumptions—Each fiscal year, we must assess and select the discount rate, compensation increase percentage and average return on plan assets assumptions in order 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's projected cash flows. The compensation increase percentage is based upon management's current and expected salary increases. The average return on plan assets is based on the expected return on the plan's current investment portfolio, which can reflect the historical returns of the various asset classes. For the fiscal year ended December 31, 2003, the discount rate, compensation increase and average return on plan assets were 6.25%, 3.75% and 8.50%, respectively. The discount rate at December 31, 2003 was lower than that at December 31, 2002 by 0.50% due to a decline in interest rates, and the compensation increase percentage was equal to the prior year as assumptions on compensation increases remain consistent. The rate of return on plan assets of 8.50% has remained consistent with the prior year as the historical long-term return on plan assets has been consistent with the estimated rate. In addition, this increase in expense is expected to be partially offset by the incremental return on our additional $3.0 million contribution made in 2003. Net periodic pension expense for 2003 was $1.0 million and is expected to be approximately $1.4 million in fiscal year 2004.

                The discount rate and compensation increase percentage assumptions for our nonqualified, unfunded, supplemental retirement plan, which covers certain employees, are the same as those of our defined benefit pension plan. The net periodic expense for 2003 for the supplemental retirement plan was $2.4 million and is expected to be approximately $2.5 million in fiscal year 2004.

        New Accounting Principles

                In April 2003, the Financial Accounting Standards Board ("FASB") issued SFAS No. 149,Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities, resulting in more consistent reporting of contracts as either derivatives or hybrid instruments. SFAS No. 149 was effective for contracts entered into or modified after June 30, 2003, and is applied on a prospective basis. We have evaluated our financial accounting and reporting for all derivative instruments and found them to be consistent with SFAS No. 149.

                In May 2003, the FASB issued SFAS No. 150,Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. SFAS No. 150 requires an issuer to classify financial instruments within its scope as a liability (or an asset in some circumstances). This Statement provides that these instruments must be classified as liabilities in the consolidated balance sheet and recorded at fair value. We adopted the provisions of this Statement effective July 1, 2003. The adoption of this Statement did not have a material impact on our financial position.

                In January 2003, the FASB issued Interpretation No. 46 (revised December 2003),Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin ("ARB") 51. This interpretation addresses consolidation by business enterprises of variable interest entities ("VIE"). This



        interpretation requires a VIE to be consolidated by a company if that company is subject to a majority of the risk of loss from the VIE's activities or entitled to receive a majority of the entity's residual returns, or both. The provisions are effective for any new entities that are originated subsequent to January 31, 2003. For entities that were originated prior to February 1, 2003, the provisions of this interpretation were to be effective October 1, 2003. We have adopted the provisions of this interpretation. In 1997, Investors Capital Trust I ("ICTI"), a wholly-owned subsidiary of the Company, issued mandatorily redeemable preferred securities, or Capital Securities. At the same time, in order to support payments under the Capital Securities, the Company issued junior subordinated debentures to ICTI. As a result of the adoption of this interpretation, we were required to deconsolidate ICTI. Therefore, in its consolidated financial statements, the Company presents the junior subordinated debentures underlying the Capital Securities as a liability and its investment in ICTI as a component of other assets. The income of ICTI for the three months that ICTI was not consolidated is considered immaterial.

        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 Commission (including this Form 10-K/A) may contain statements which are not historical facts, so-called "forward-looking statements," 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," or "continue" or other comparable terms or the negative of those terms. Forward-looking statements in this Form 10-K/A include certain statements regarding liquidity, annual dividend payments, interest rate conditions, interest rate sensitivity, loss exposure on lines of credit, the timing and effect on earnings of derivative gains and losses, securities lending revenue, compensation expense, depreciation expense, effective tax rate, the effect on earnings of changes in equity values 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. 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. CurrentOur net interest income is earned by investing depositors’ funds in our investment portfolio and, in small part, by making loans. A rising short-term interest rate environment, such as we are now experiencing, generally causes downward pressure on net interest income. Changes in the relationship between short-term and long-term interest rates, referred to as the yield curve, could also adversely affect the market conditions, includingvalue of, or the recent volatilityearnings produced by, our investment and loan portfolios, and thus could adversely affect our operating results. The current flat yield curve, where short-term rates have increased while long-term rates have failed to increase, has resulted in a decrease in our net interest margin that will continue to have a material impact on 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 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,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.

        In addition, we are experiencing narrower investment portfolio reinvestment spreads, which reduces our net interest income. If reinvestments spreads on the security types we purchase remain narrow, or become narrower, our net interest income is earned by investing depositors' funds in our investment portfolio and secondarily making loans. Rapid 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.will continue to be impacted negatively.

        A material portion of our revenue is derived from our relationship with Barclays Global Investors, N.A. ("BGI"(“BGI”) and related entities.

        As a result of our selection to service assets for Barclays Global Investors Canada, Ltd.,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 ongoing



        relationship with BGI's iShares and Master Investment Portfolios,servicing assets for Barclays Global Investors Canada, Ltd., BGI accounted for approximately 18%, 17% and 16% of our net operating revenue duringfor the yearyears ended December 31, 2003.2005, 2004 and 2003, respectively. We recently renewed our U.S. asset administration outsourcing agreement with BGI and we expect that BGI will continue to account for a significant portion of our net operating revenue. While weWe provide services to BGI under long-term contracts those contractsthat may be terminated forbefore the expiration of the contracts under certain regulatorycircumstances that we have described in filings with the Securities and fiduciary reasons. TheExchange Commission (“SEC”), as described below. While we believe that our relationship with BGI is excellent, the loss of BGI'sBGI’s business would cause our net operating revenue to decline significantly and maywould likely 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. In addition, 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 isthese claims are without merit, we cannot be sure that we will prevail in the defense of this claim.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.

        Our future results depend, in part, on successful integration of pendingprior 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'smanagement’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 experiencingexperienced 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.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, especially if the recent economic recovery proves sustainable. Weindustry. 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.

        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'smanagement’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

          •
          Rapid changes in interest rates

          ·       The timing and equity values.

        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 ("FRB"(“FRB”), the Federal Deposit Insurance Corporation ("FDIC"(“FDIC”), the Massachusetts Commissioner of Banks, and the National Association of Securities Dealers, Inc. ("NASD"(“NASD”), and the State of Vermont Department of Banking, Insurance, Securities and Health Care Administration (“BISHCA”). 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"“well-capitalized”;

          •

          ·Under Massachusetts law, the Bank may be restricted in its ability to pay dividends to Investors Financial Services Corp., 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.LLC, must meet. Failure to meet those requirements could lead to severe regulatory action.

        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 Office of the Superintendent of Financial Institutions in Canada, the Irish Financial Services Regulatory Authority, the Cayman Islands Monetary Authority and the Financial Services Authority (“FSA”) in the United Kingdom. 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.

        20



        ITEM 2.                PROPERTIES.

        The following table provides certain summary information with respect to the principal properties that we leased as of December 31, 2005:

        Location

         

         

         

        Function

         

        Sq. Ft.

         

        Expiration Date

        200 Clarendon Street, Boston, MA

         

        Principal Executive Offices and Operations Center

         

        387,127

         

        2014

        100 Huntington Avenue, Boston, MA

         

        Operations Center

         

        150,269

         

        2014

        1 Exeter Plaza, Boston, MA

         

        Training Center

         

        14,870

         

        2007

        800 Boylston Street, Boston, MA

         

        Operations Center

         

        24,715

         

        2014

        33 Maiden Lane, New York, NY

         

        Operations Center

         

        21,994

         

        2011

        980 Ninth Street, Sacramento, CA

         

        Operations Center

         

        53,580

         

        2008

        1277 Treat Boulevard, Walnut Creek, CA

         

        Operations Center

         

        18,921

         

        2008

        1 First Canadian Place, Toronto

         

        Offshore Processing Center

         

        17,790

         

        2006

        Iveagh Court, Dublin

         

        Offshore Processing Center

         

        67,183

         

        2028*

        17 Dominion Street, London

         

        Offshore Processing Center

         

        4,478

         

        2010

        *Pursuant to the terms of the contract, this lease can be terminated in 2013 by paying six months rent as compensation.

        For more information, see Note 16 of the Notes to Consolidated Financial Statements.

        ITEM 3.                LEGAL PROCEEDINGS.

        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’s contract on June 1, 2003, the Merrimac Funds elected not to re-appoint Opus as subadviser. The lawsuit was filed in Superior Court in Worcester, Massachusetts and seeks unspecified damages. The lawsuit is currently in the discovery phase. We believe that the claims are without merit and intend to defend our rights vigorously. However, we cannot predict the outcome of this lawsuit at this time, and we can give no assurance that it will not affect our financial condition or results of operations in a materially adverse way.

        In July 2000, two of our Dublin subsidiaries, Investors Trust & Custodial Services (Ireland) Ltd. (“ITC”) and Investors Fund Services (Ireland) Ltd. (“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”), a former client. The summons also named as defendants FTF Forex Trading and Finance, S.A., the Fund’s investment manager, Ernst & Young, LLP, the Fund’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’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, 2005, we do not expect this matter to have a material adverse effect on our business, financial condition or results of operations.



        StatementsInvestors Financial Services Corp. and five of Operations

        Comparison of Operating Resultsits officers are 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 Years EndedDistrict of Massachusetts, Boston, Massachusetts. Among other things, the complaints filed on August 4, 2005 and August 15, 2005 assert that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 during the period October 15, 2003 until July 15, 2005. Among other things, the complaint filed on September 30, 2005 asserts that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 during the period July 16, 2003 until July 15, 2005. 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, interest, fees, and costs. We strongly believe that the lawsuits lack merit and we intend to defend against the claims vigorously. 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.

        Investors Financial Services Corp. 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. We strongly believe that the lawsuits lack merit and we intend to defend against the claims vigorously. 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.

        22



        PART II

        ITEM 5.           ��    MARKET FOR REGISTRANT’S COMMON EQUITY, AND ISSUER PURCHASE OF EQUITY SECURITIES AND RELATED STOCKHOLDER MATTERS.

        PRICE RANGE OF COMMON STOCK AND DIVIDEND HISTORY AND POLICY

        Our common stock is quoted on the Nasdaq National Market under the symbol “IFIN”. The following table sets forth, for the calendar periods indicated, the high and low sale prices for the common stock as reported by Nasdaq and dividends per share paid on the common stock.

         

         

        High

         

        Low

         

        Dividend

         

        2005

         

         

         

         

         

         

         

        First quarter

         

        $

        53.44

         

        $

        45.33

         

        $

        0.0200

         

        Second quarter

         

        51.05

         

        36.05

         

        0.0200

         

        Third quarter

         

        42.80

         

        31.67

         

        0.0200

         

        Fourth quarter

         

        40.98

         

        30.64

         

        0.0200

         

        2004

         

         

         

         

         

         

         

        First quarter

         

        $

        46.15

         

        $

        37.87

         

        $

        0.0175

         

        Second quarter

         

        44.75

         

        34.68

         

        0.0175

         

        Third quarter

         

        48.90

         

        39.79

         

        0.0175

         

        Fourth quarter

         

        50.40

         

        35.00

         

        0.0175

         

        As of January 31, 2006, there were approximately 837 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—Regulation and 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 $0.09 per share of outstanding common stock (approximately $5.9 million based upon 65,052,637 shares outstanding as of December 31, 20032005). We expect to declare and 2002.pay such dividend ratably on a quarterly basis.

                Net incomeThe 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” 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, 2005.

        Purchases of Equity Securities by the Issuer and Affiliated Purchasers

        In July 2005, we announced that our Board of Directors authorized a repurchase plan of up to $150.0 million of our common stock in the open market during the twelve months following the announcement. The repurchase plan expires in June 2006. For the three months ended December 31, 2005, there was no activity under this plan.


        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 Discussion and Analysis of Financial Condition and Results of 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,

         

         

         

        2005

         

        2004

         

        2003(1)

         

        2002

         

        2001

         

        Statement of Income Data(2):

         

         

         

         

         

         

         

         

         

         

         

        Noninterest income

         

        $

        525,537

         

        $

        425,491

         

        $

        336,193

         

        $

        298,844

         

        $

        254,487

         

        Net interest income

         

        170,425

         

        187,680

         

        153,914

         

        138,725

         

        98,355

         

        Net operating revenues

         

        695,962

         

        613,171

         

        490,107

         

        437,569

         

        352,842

         

        Operating expenses

         

        460,109

         

        398,383

         

        344,921

         

        341,395

         

        289,176

         

        Income before income taxes

         

        235,853

         

        214,788

         

        145,186

         

        96,174

         

        63,666

         

        Income taxes

         

        76,035

         

        72,826

         

        52,765

         

        28,737

         

        18,980

         

        Net income

         

        $

        159,818

         

        $

        141,962

         

        $

        92,421

         

        $

        67,437

         

        $

        44,686

         

        Per Share Data(3):

         

         

         

         

         

         

         

         

         

         

         

        Basic earnings per share

         

        $

        2.42

         

        $

        2.15

         

        $

        1.42

         

        $

        1.05

         

        $

        0.71

         

        Diluted earnings per share

         

        $

        2.37

         

        $

        2.09

         

        $

        1.39

         

        $

        1.02

         

        $

        0.68

         

        Dividends per share

         

        $

        0.08

         

        $

        0.07

         

        $

        0.06

         

        $

        0.05

         

        $

        0.04

         

        Balance Sheet Data:

         

         

         

         

         

         

         

         

         

         

         

        Total assets at end of period

         

        $

        12,096,393

         

        $

        11,167,825

         

        $

        9,223,178

         

        $

        7,214,740

         

        $

        5,297,913

         

        Average Balance Sheet Data:

         

         

         

         

         

         

         

         

         

         

         

        Interest-earning assets

         

        $

        11,364,656

         

        $

        9,770,924

         

        $

        7,556,061

         

        $

        5,769,971

         

        $

        4,376,947

         

        Total assets

         

        12,066,523

         

        10,306,015

         

        8,139,985

         

        6,173,187

         

        4,648,128

         

        Total deposits

         

        4,099,305

         

        4,495,858

         

        3,153,306

         

        2,342,247

         

        2,043,124

         

        Junior subordinated debentures(4)

         

        24,774

         

        24,774

         

        24,194

         

        —

         

        —

         

        Trust preferred securities(4)

         

        —

         

        —

         

        —

         

        24,667

         

        25,000

         

        Common stockholders’ equity

         

        758,552

         

        625,964

         

        483,923

         

        395,101

         

        307,565

         

        Selected Financial Ratios:

         

         

         

         

         

         

         

         

         

         

         

        Return on average equity

         

        21.1

        %

        22.7

        %

        19.1

        %

        17.1

        %

        14.5

        %

        Return on average assets

         

        1.3

        %

        1.4

        %

        1.1

        %

        1.1

        %

        1.0

        %

        Average common equity as a % of average assets

         

        6.3

        %

        6.1

        %

        5.9

        %

        6.4

        %

        6.6

        %

        Dividend payout ratio(5)

         

        3.4

        %

        3.3

        %

        4.3

        %

        4.9

        %

        5.9

        %

        Tier 1 capital ratio(6)

         

        18.5

        %

        20.5

        %

        17.6

        %

        15.3

        %

        16.6

        %

        Leverage ratio(6)

         

        6.0

        %

        5.9

        %

        5.4

        %

        5.4

        %

        5.8

        %

        Noninterest income as % of net operating income

         

        75.5

        %

        69.4

        %

        68.6

        %

        68.3

        %

        72.1

        %

        Other Statistical Data:

         

         

         

         

         

         

         

         

         

         

         

        Assets processed at end of period(7)

         

        $

        1,792,571,911

         

        $

        1,430,471,217

         

        $

        1,056,871,924

         

        $

        785,418,321

         

        $

        813,605,957

         

        Employees at end of period

         

        3,252

         

        2,778

         

        2,413

         

        2,591

         

        2,618

         

        (1)    Effective July 1, 2003, the Company adopted provisions of SFAS 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 $92.4 million, up 37% from $67.4 million for the same period in 2002. The principal factors contributingreclassified to the net income growth included 11% growth in net interest income caused by a declineincome.

        (2)    All numbers shown in our cost of funds duethis table have been restated to lower interest rates, and a 12% growth in noninterest income caused by increased net assets processedreflect reclassifications related to sales to new and existing clients, fund flows, market appreciation, and increased client transaction activity. Net income growth was partially offset by a 1% increase in operating expenses due to prudent expense management and capitalizing on technology improvements to create efficiencies and by the additional tax expense incurred as a resultEmerging Issues Task Force Issue No. 01-14, Income Statement Characterization of a settlement of a tax assessment by the Commonwealth of Massachusetts. Refer toIncome Taxes within this sectionReimbursements Received for further discussion regarding our settlement of this tax assessment.“Out-of-pocket” Expenses Incurred.

        Net Operating Revenue(3)    All numbers shown in this table have been restated to reflect the two-for-one stock split paid June 14, 2002, where applicable.

                The components(4)    Effective October 1, 2003, the Company adopted the provisions of net operating revenue are as follows (DollarsFASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities, which resulted in thousands):

         
        		 For the Year Ended December 31,
        		 
         
        		 2003
        		 2002
        		 Change
        		 
        Net interest income $153,914 $138,725 11%
        Noninterest income  336,193  298,844 12%
          
        		 
        		   
        Total net operating revenue $490,107 $437,569 12%
          
        		 
        		   

        Net Interest Incomethe deconsolidation of Investors Capital Trust I, the trust that holds the trust preferred securities.

                Net interest income was $153.9 million in 2003, up 11% from 2002. Net interest income is affected by the volume and mix of assets and liabilities, and the movement and level of interest rates. For(5)    We intend to retain the majority of 2003, interest rates continuedfuture earnings to decline in general with signs of stabilization beginning in the third quarter of 2003. The improvement in our net interest income was primarily driven by declining rates on our liabilities. Our average rate paid on interest-bearing liabilities was 1.34% for the year ended December 31, 2003, a 69 basis point decline from 2.03% for the same period in 2002. During 2003fund development and 2002, the Company repaid long-term Federal Home Loan Bank of Boston ("FHLBB") borrowings and replaced these sources of funds with lower cost funding as a strategy to help maintain and preserve net interest margin. Although the average funding balance increased $1.7 billion from $5.3 billion in 2002 to $7.0 billion 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 prepayments were reinvested in lower yielding interest-earning assets. Through increased lower cost client funding, we were able to maintain our interest income at a pace relatively equivalent to the decline in average interest rates earned.

                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, 2003 compared to the year ended December 31, 2002. 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, 2003 vs. December 31, 2002
        		 
         
        		 Change Due
        to Volume
        		 Change Due
        To Rate
        		 Net
        		 
        Interest-earning assets          
        Fed funds sold and securities purchased under resale agreements $(202)$(212)$(414)
        Investment securities  66,265  (64,086) 2,179 
        Loans  522  (719) (197)
          
        		 
        		 
        		 
        Total interest-earning assets $66,585 $(65,017)$1,568 
          
        		 
        		 
        		 
        Interest-bearing liabilities          
        Deposits $13,005 $(15,443)$(2,438)
        Borrowings  14,075  (25,258) (11,183)
          
        		 
        		 
        		 
        Total interest-bearing liabilities $27,080 $(40,701)$(13,621)
          
        		 
        		 
        		 
        Change in net interest income $39,505 $(24,316)$15,189 
          
        		 
        		 
        		 

                We use derivative instruments to manage exposures to interest rate risks. We routinely enter into interest rate swap agreements in which we pay a fixed interest rate and receive a floating interest rate. These transactions are designed to hedge a portiongrowth of our liabilities. By entering into abusiness. We currently expect to pay fixed/receive floating interestcash dividends at an annualized rate swap, a portion of our liabilities is effectively converted$0.09 per share subject to a fixed-rate liability for the term of the interest rate swap agreement. Our derivatives are designated as highly effective cash flow hedges. To the extent there is hedge ineffectiveness it is included as a component of the net interest margin. Hedge ineffectiveness had an insignificant impact on earnings for the years ended December 31, 2003 and 2002. We expect that hedge ineffectiveness will continue to have an insignificant effect on net interest margin in 2004.

                We periodically run interest rate simulation models to understand the effect of various interest rate scenarios on our capital and net income. The results of the income simulation model as of December 31, 2003 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 7.83%. 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%. This modified simulation results in a decrease in projected net interest income of 11.42%.regulatory requirements. Refer to the "Market Risk" section“Liquidity” included in Management’s Discussion and Analysis of this documentFinancial Condition and Results of Operations for more detailed information regarding our income simulation methodologyfurther information.

        (6)    Refer to “Capital Resources” included within Management’s Discussion and policies.Analysis of Financial Condition and Results of Operations for further information.

        Noninterest Income(7)   

                Noninterest income was $336.2 million in 2003, up 12% from 2002. The principal factors driving noninterest income are market trends and the level of client activity. The S&P 500, Dow Jones Industrial Average, and Europe, Australia, Far East indices increased approximately 29%, 17% and



        35%, respectively, in 2003 resulting in higher assets processed values from which we generate our core service revenue. Noninterest income consists of the following items (Dollars in thousands):

         
        		 For the Years Ended
        December 31,
        		 
         
        		 2003
        		 2002
        		 Change
        		 
        Core service fees:         
         Custody, accounting and administration $254,225 $231,520 10%
          
        		 
        		   
        Ancillary service fees:         
         Foreign exchange  36,501  24,469 49%
         Cash management  20,884  16,974 23%
         Investment advisory  11,777  11,909 (1%)
         Securities lending  8,903  11,328 (21%)
         Other service fees  1,296  195 565%
          
        		 
        		   
          Total ancillary service fees  79,361  64,875 22%
          
        		 
        		   
        Total asset servicing fees  333,586  296,395 13%
        Other operating income  2,607  2,449 6%
          
        		 
        		   
        Total noninterest income $336,193 $298,844 12%
          
        		 
        		   

                Asset servicing fees for the year ended December 31, 2003 increased 13% to $333.6 million from 2002. The largest components of asset servicing fees are custody, accounting and administration, which increased 10% to $254.2 million for the year ended December 31, 2003 from $231.5 million in the same period of 2002. Custody, accounting and 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, or multicurrency accounting.accounting, fund administration, securities lending, foreign exchange, cash management, performance measurement, institutional transfer agency, investment advisory services, lines of credit and brokerage and transition management services.

        24



        ITEM 7.                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 changefollowing 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 Factors That May Affect Future 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, family offices, 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. We have offices located in the United States, Ireland, Canada, the Cayman Islands and the United Kingdom with a vast global subcustodian network established to accommodate the international needs of our clients. At December 31, 2005, we provided services for approximately $1.8 trillion in net assets, processed includes the following components (Dollarsincluding approximately $0.3 trillion in billions):foreign net assets.

         
        		 For the Year Ended
        December 31, 2003
        		 
        Net assets processed, beginning of period $785 
        Sales to new clients  1 
        Lost clients  (3)
        Further penetration of existing clients  39 
        Fund flows and market gain  235 
          
        		 
        Net assets processed, end of period $1,057 
          
        		 

                The majorityWe grow our business by selling our services to new clients and by further penetrating our existing clients. We believe that we service approximately 10% of the increaseassets managed by our existing clients, and we have traditionally achieved significant success in assets processed resulted from improved marketgrowing 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 conditions overin the course ofglobal securities markets, the past year,interest rate environment, the regulatory environment for us and our clients and the abilitysuccess of our clients to continue toin marketing their products.

        We derive our asset servicing revenue from providing 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 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 new products or additional fund flows, which are additional investments in their existing products. As indicated in our overview,is impacted by overall market conditions, client activity and the prevailing interest rate environment. A significant portion of our core services fees are generated by charging a feerevenue is based upon the valueamount of assets processed.we process. As market values or clients' asset levelsof underlying assets fluctuate, so will our revenue. OurWe have managed this volatility by offering a tiered pricing structure coupled with minimum and flat fees, allow us to manage this volatility.for our asset-based fees. As asset values increase, the basis point fee typically lowers, while whenis reduced for the incremental assets. When asset values decrease, revenue is only impacted by the asset decline at the then marginal rate.

                If Many of our value-added services are transactional based, and we receive a fee for each transaction processed. We have continued to experience net interest margin compression during 2005 due to a relatively flat yield curve, lower reinvestment spreads and the valueliability sensitive nature of equityour balance sheet. Because we are a liability sensitive institution, as overnight interest rates rise, most of our liabilities reprice but our assets held by our clients weretake longer to increase or decrease by 10%, we estimate that this, by itself, would currently cause a corresponding change of approximately 3% 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 that this, by itself, would currently cause a corresponding change of approximately 2% in our earnings per share. In practice, earnings per share do not track preciselyreprice due to the valuenature of their reset provisions (i.e., monthly, quarterly and annually). The lower interest rate spreads we experienced in 2005 were also due to the equitynarrowing of market spreads on reinvestment and purchase opportunities for fixed and floating-rate investment assets. In 2006, we expect to see short-term rates continue to rise and a continued very flat yield curve.



        markets because conditions present in a market increase or decrease may generate offsetting increases or decreases in other revenue items. For example, market volatility often results in increased transaction fee revenue. Also, market 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. However, there can be no assurance that these offsetting revenue increases will occur during any future downturn in the equity markets.

                Transaction-driven income includesWe remain focused on our ancillary services, such as foreign exchange, cash management and securities lending. Foreign exchange fees were $36.5 million for the year ended December 31, 2003, up 49% from the same period in 2002. The increase in foreign exchange fees is attributable to further penetration of existing clients, the addition of new clients, higher transaction volumes and increased volatility within the currencies traded by our clients. Future foreign exchange income is dependent on the level of client activity and the overall volatility in the currencies traded. Cash management fees, which consist of sweep fees, were $20.9 million for the year ended December 31, 2003, up 23% from the same period in 2002. The increase is primarily due to increased client balances. Cash management revenue will continue to depend on the level of client balances maintained in the cash management products. If our clients' funds continue to attract high volumes of cash flows, our cash management revenue will be positively impacted. Securities lending fees were $8.9 million for the year ended December 31, 2003, down 21% from the same period in 2002, primarily due to narrower spreads. Securities lending transaction volume is positively affected by the market value of the securities on loan, merger and acquisition activity, increased IPO activity and a steeper short-end of the yield curve. If the capital markets experience any of the aforementioned activity, it is likely that our securities lending revenue will be positively impacted. If we experience a reduction in our securities lending portfolio, lower market values and continued compression of the spreads earned on securities lending activity, our securities lending revenue will likely be negatively impacted.

        Operating Expenses

                Total operating expenses were $344.9 million in 2003, up 1% from 2002. The marginal increase in operating expenses, despite strong revenue growth, is due to oursales efforts, prudent expense management and increasing our abilityoperating efficiency. These goals are complicated by the need to benefit from technology efficiencies. It is expected that only incremental expense associated with new business will be added during 2004. The components of operating expenses were as follows (Dollars in thousands):

         
        		 For the Year Ended December 31,
        		 
         
        		 2003
        		 2002
        		 Change
        		 
        Compensation and benefits $186,932 $192,785 (3)%
        Technology and telecommunications  38,914  42,190 (8)%
        Transaction processing services  33,299  33,713 (1)%
        Occupancy  29,218  25,602 14%
        Depreciation and amortization  27,971  16,357 71%
        Professional fees  11,189  11,829 (5)%
        Travel and sales promotion  4,822  5,819 (17)%
        Other operating expenses  12,576  13,100 (4)%
          
        		 
        		   
        Total operating expenses $344,921 $341,395 1%
          
        		 
        		   

                Compensation and benefits expense was $186.9 million in 2003, down 3% from 2002. The average number of employees decreased 7% to 2,459 during the year ended December 31, 2003 from 2,648 for the year ended December 31, 2002. We experienced a reduction in compensation costs as a result of efficiencies gained through technology enhancements made during 2002 and 2003. It is expected that



        compensation expense will increase in 2004 due to employee merit raises and additional compensation arising from new hires neededbuild infrastructure to support new business wins.our growth, the need to maintain state-of-the-art systems and the need to retain and motivate our workforce.

                Technology and telecommunications expense was $38.9 million inIn 2003, down 8% from 2002. Technology and telecommunications expense consists primarily of contract programming, outsourced services, telecommunications and costs related to hardware and software licenses. In 2002, the Company incurred significant technology and telecommunications expense on the integration of the BGI U.S. asset administration unit into our technology infrastructure, which was completed in January 2003. After the significant integration of 2002, we lowered our technology reinvestment (reflected in both technology and compensation expenses) to our target of approximately 20% of revenue.

                Transaction processing services expense was $33.3 million in 2003, down 1% from 2002. Overall transaction volumes increased during 2003, generating larger subcustodian expense and pricing fees. However, 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. Future transaction processing servicing expense will be dependent on the volume of client activity.

                Occupancy expense was $29.2 million in 2003, up 14% from 2002. This increase was primarily due to increased space in our Dublin office to accommodate the significant growth experienced by that office resulting from new client business. At the end of 2002, we signed a new lease agreement and increased our Dublin office from approximately 16 thousand square feet to approximately 50 thousand square feet. Also, 2003 includes the full twelve-month impact of additional space in our Boston offices that we occupied in July 2002. Occupancy expense should remain relatively consistent for 2004.

                Depreciation and amortization expense was $28.0 million in 2003, up 71% from 2002. This increase resulted from completion of capitalized software projects in late 2002 and 2003 and their placement into service along with the addition of leasehold improvements as a result of the new space we occupied in Boston and Dublin. The capitalized projects placed in service also provided efficiencies that allowed us to reduce our compensation and benefits and technology and telecommunications expenses. Enhancements to our straight-through-processing platform resulted in a significant amount of efficiency gain in 2003. Depreciation expense is expected to increase in 2004 as a result of additional capitalized software costs being placed into service in 2003 and 2004.

        Income Taxes

                Income taxes were $52.8 million for the year ended December 31, 2003, up 84% from the same period in 2002. Two factors contributed to the significant increase in 2003, including a settlement ofsettled a tax assessment with the Commonwealth of Massachusetts Department of Revenue and increased pretax earnings.

        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 retroactive change in tax law, we recorded an additional state tax expense of approximately $7.2 million, net of federal income tax benefit, in 2003.

        In our 2003 and 2004 earnings releases, we expectreported non-GAAP 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 effective rate will approximate 32.5%2003 results of operations because they do not include the one-time tax charge which was unrelated to 33.5%our core operations. The following table presents a reconciliation between net income and earnings per share presented on the face of pretax income.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,

         

         

         

        2005

         

        2004

         

        2003

         

        Income before taxes

         

        $

        235,853

         

        $

        214,788

         

        $

        145,186

         

        Provision for income taxes

         

        76,035

         

        72,826

         

        52,765

         

        Net Income

         

        $

        159,818

         

        $

        141,962

         

        $

        92,421

         

        Earnings per share:

         

         

         

         

         

         

         

        Basic

         

        $

        2.42

         

        $

        2.15

         

        $

        1.42

         

        Diluted

         

        $

        2.37

         

        $

        2.09

         

        $

        1.39

         

        Non-GAAP Operating Earnings

         

         

        For the Year Ended

         

         

         

        December 31,

         

         

         

        2005

         

        2004

         

        2003

         

        Income before taxes

         

        $

        235,853

         

        $

        214,788

         

        $

        145,186

         

        Provision for income taxes

         

        76,035

         

        72,826

         

        45,565 

        (1)

        Net Income

         

        $

        159,818

         

        $

        141,962

         

        $

        99,621

         

        Earnings per share:

         

         

         

         

         

         

         

        Basic

         

        $

        2.42

         

        $

        2.15

         

        $

        1.53

         

        Diluted

         

        $

        2.37

         

        $

        2.09

         

        $

        1.50

         

        (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 in the first quarter 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.

        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 results of operations under different conditions or using different assumptions. Senior management has discussed these critical accounting policies with the Audit Committee.

        Derivative Financial Instruments—Cash 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 2005, we would expect the swaps to gain in value. Conversely, if short-term interest rates decrease, we would expect there to 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 interest rate curve and spreads.

        Defined Benefit Pension Assumptions—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’s projected cash flows. The compensation increase percentage is based upon management’s current and expected salary increases. The average return on plan assets is based on the expected return on the plan’s current investment portfolio, which can reflect the historical returns of the various asset classes.

        For the fiscal year ended December 31, 2005, the discount rate, compensation increase percentage and average return on plan assets used to determine net periodic pension cost for our qualified defined benefit pension plan were 5.80%, 4.00% and 8.50%, respectively. The discount rate was 0.45% lower than the rate at December 31, 2004 due to a retraction of the projected yield curve during the year. The compensation increase assumption at December 31, 2005 was slightly higher by 0.25% than at December 31, 2004 and the rate of return on plan assets of 8.50% has remained consistent with the prior year. Net periodic pension expense for the pension plan for 2005, excluding the effect of curtailment, was $0.8 million, as compared to $0.8 million for the year ended December 31, 2004. We expect the net periodic pension expense to be approximately $0.2 million in fiscal year 2006.

        At December 31, 2005, the discount rate assumption used to project the benefit obligation for our nonqualified, unfunded, supplemental retirement plan, which covers certain employees, was 5.75%. The compensation increase percentage assumption ranged from 4.0% to 10.0% at December 31, 2005, which was consistent with the prior year. The net periodic pension expense for 2005 for the supplemental retirement plan, using a 5.80% discount rate and 4.00% compensation increase, was $4.3 million, as compared to $2.5 million for the year ended December 31, 2004. The net periodic pension expense is expected to be approximately $5.3 million in fiscal year 2006.

        New Accounting Pronouncements

        In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards 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. We currently use the intrinsic-value method to measure compensation cost related to our share-based transactions. SFAS 123R replaces SFAS 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees.


        In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB 107”), which expresses the views of the SEC regarding the interaction of SFAS 123R and certain SEC regulations and provides the SEC’s views regarding the valuation of share-based payment arrangements for public companies.

        In April 2005, the SEC issued Release 2005-57, which delayed the effective date for SFAS 123R to reporting periods in the first fiscal year beginning after June 15, 2005. Accordingly, we adopted SFAS 123R on January 1, 2006, effective for financial periods in 2006. There was no impact to our financial condition or results of operations upon adoption.

        In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, Accounting Changes and Error Corrections—a replacement of APB Opinion No. 20 and FASB Statement No. 3 (“SFAS 154”). SFAS 154 replaces APB Opinion No. 20, Accounting Changes, and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements, and changes the accounting and reporting requirements for a change in accounting principle. SFAS 154 applies to all voluntary changes in an accounting principle, as well as to changes required by a new accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. SFAS 154 is effective for accounting changes and error corrections made in fiscal years beginning after December 15, 2005 and requires retrospective application to prior periods’ financial statements for most voluntary changes in an accounting principle, unless it is impracticable to do so.  We do not anticipate any material impact to our financial condition or results of operations as a result of the adoption of SFAS 154.

        In February 2006, the FASB issued Statement of Financial Accounting Standards No. 155, Accounting for Certain Hybrid Instruments—an amendment of FASB Statements No. 133 and 140 (“SFAS 155”). SFAS 155 allows financial instruments that have embedded derivatives to be accounted for as a whole if the holder elects to account for the whole instrument on a fair value basis. SFAS 155 eliminates the need to bifurcate the derivative from its host, as previously required under Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedge Accounting (“SFAS 133”). SFAS 155 also amends SFAS 133 by establishing a requirement to evaluate interests in securitized financial assets to determine whether they are free standing derivatives or whether they contain embedded derivatives that require bifurcation. SFAS 155 is effective for all hybrid financial instruments acquired or issued by the Company on or after January 1, 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 155.

        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 SEC (including this Form 10-K) may contain statements which are not historical facts, so-called “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,” “could,” “should,” “expect,” “plan,” “intend,” “seek,” “anticipate,” “believe,” “estimate,” “potential,” or “continue” or other comparable terms or the negative of those terms. Forward-looking statements in this Form 10-K include certain statements regarding liquidity, 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 and the reclassification of net after-tax gains on derivative contracts, securities lending revenue, net interest income, operating expenses, including occupancy expenses and needs, transaction processing services expense, professional fee expense, compensation expense, travel and sales expense, investments in technology and compensation expense, pension plan and supplemental pension expense, depreciation expense, effective tax rate, investments in FHLBB capital stock, the effect on earnings of changes in equity values or fixed income, the effects of increased prepayments and reduced investment opportunities for our net interest income, our ability to execute our stock repurchase plan 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 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.

        Statements of Income

        Comparison of Operating Results for the Years Ended December 31, 20022005 and 2001.2004.

        Net Operatingincome for the year ended December 31, 2005 was $159.8 million, up 13% from $142.0 million for the same period in 2004. The principal factors contributing to our net income growth were growth in asset servicing fees of 20% and increased gain on sale of investments. Net income growth was partially offset by a 15% increase in operating expenses (largely due to new business wins, additional headcount and technology requirements) and a 9% decrease in net interest income.

        Fees and Other Revenue

        The components of net operatingfees and other revenue are as follows (Dollars in thousands):

         
        		 For the Year Ended December 31,
        		 
         
        		 2002
        		 2001
        		 Change
        		 
        Net interest income $138,725 $98,355 41%
        Noninterest income  298,844  254,487 17%
          
        		 
        		   
        Total net operating revenue $437,569 $352,842 24%
          
        		 
        		   

         

         

        For the Year Ended

         

         

         

        December 31,

         

         

         

        2005

         

        2004

         

        Change

         

        Total asset servicing fees

         

        $

        509,059

         

        $

        423,200

         

         

        20

        %

         

        Gain on sale of investments

         

        12,397

         

        234

         

         

        *

         

         

        Other operating income

         

        4,081

         

        2,057

         

         

        98

        %

         

        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 20% to $375.6 million for the year ended December 31, 2005 from $314.3 million for the same period in 2004. 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, foreign exchange, cash management, 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

         

        For the Three Months Ended

         

         

         

        December 31, 2005

         

        December 31, 2005

         

        Net assets processed, beginning of period

         

         

        $

        1,430

         

         

         

        $

        1,734

         

         

        Change in net assets processed:

         

         

         

         

         

         

         

         

         

        Sales to new clients

         

         

        159

         

         

         

        —

         

         

        Further penetration of existing clients

         

         

        42

         

         

         

        4

         

         

        Lost clients

         

         

        (11

        )

         

         

        —

         

         

        Fund flows and market gain

         

         

        173

         

         

         

        55

         

         

        Total change in net assets processed

         

         

        363

         

         

         

        59

         

         

        Net assets processed, end of period

         

         

        $

        1,793

         

         

         

        $

        1,793

         

         

        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 slightly higher asset values compared to a year ago. As indicated in the “Overview” section, 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.

        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. Earnings 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 and expense items that are influenced by the value of the assets we administer. For example, increased market volatility often results in higher 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 and expense movements will occur during any future upturn or downturn in the equity or fixed-income 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 value-added services, such as foreign exchange, cash management, securities lending and investment advisory services.

        ·       Foreign exchange fees were $62.1 million for the year ended December 31, 2005, up 14% from the same period in 2004. The increase in foreign exchange fees is attributable to new business, increased volume of client activity and volatility in currency markets. Future foreign exchange income is dependent on the volume of new and existing client activity and overall volatility in the currencies traded.

        ·       Cash management fees, which consist of sweep fees, were $37.6 million for the year ended December 31, 2005, up 42% from the same period in 2004. The increase is primarily due to higher balances placed by our 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 revenue to be positively impacted.

        ·       Securities lending fees were $22.5 million for the year ended December 31, 2005, up 117% from the same period in 2004, primarily due to new business, higher volumes and improved 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 and a steeper short-end of the yield curve. If the capital markets continue to experience the aforementioned characteristics, it is likely that our securities lending revenue will continue to be positively impacted. If we experience a reduction in our securities lending portfolio, lower market values or compression of the spreads earned on our securities lending activity, our securities lending revenue will likely be negatively impacted.

        ·       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. 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. We discontinued advisory fee waivers in the second quarter of 2005.

        ·       Other service fees for the year ended December 31, 2005 were $2.8 million, up 5% from the same period in 2004. Other service fees include income earned on compliance advisory, brokerage and transition management services. 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.

        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. We sold these securities as part 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,

         

         

         

        2005

         

        2004

         

        Change

         

        Interest income

         

        $

        447,705

         

        $

        313,149

         

         

        43

        %

         

        Interest expense

         

        277,280

         

        125,469

         

         

        121

        %

         

        Total net interest income

         

        $

        170,425

         

        $

        187,680

         

         

        (9

        )%

         

        Net interest income is affected by the volume and mix of assets and liabilities and the movement and level of interest rates. The decrease in our net interest income was primarily driven by lower interest rate spreads, which was partially offset by growth in our investment portfolio. Lower interest rate spreads were due to increasing short-term interest rates without a concurrent increase in longer-term rates, which resulted in a relatively flat yield curve. Consequently, our interest-bearing liabilities, of which the majority is priced based on overnight floating rates, have repriced at higher rates faster than our interest-earning assets have repriced, resulting in a lower net interest margin. In addition, reinvestment and purchase spreads on fixed and floating-rate assets were lower than expected due to higher market demand, especially for shorter-term and floating-rate fixed income investments. Average investment security balances were up approximately $1.5 billion for the year ended December 31, 2005 compared to the same period in 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, 20022005 compared to the year ended December 31, 2001.2004. 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, 2002 vs. December 31, 2001
        		 

         

        For the Year Ended
        December 31, 2005 vs. December 31, 2004

         


        		 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 $329 $(1,191)$(862)

        Federal Funds sold and securities purchased under resale agreements

         

         

        $

        226

         

         

         

        $

        1,357

         

         

        $

        1,583

         

        Investment securities 67,021 (62,406) 4,615 

         

         

        53,222

         

         

         

        75,076

         

         

        128,298

         

        Loans (148) (1,650) (1,798)

         

         

        2,281

         

         

         

        2,394

         

         

        4,675

         

         
        		 
        		 
        		 
        Total interest-earning assets $67,202 $(65,247)$1,955 

         

         

        $

        55,729

         

         

         

        $

        78,827

         

         

        $

        134,556

         

         
        		 
        		 
        		 

        Interest-bearing liabilities
         
         
         
         
         
         
         

         

         

         

         

         

         

         

         

         

         

         

        Deposits $8,128 $(31,209)$(23,081)

         

         

        $

        (6,879

        )

         

         

        $

        33,864

         

         

        $

        26,985

         

        Borrowings 26,295 (41,629) (15,334)

         

         

        38,994

         

         

         

        85,832

         

         

        124,826

         

         
        		 
        		 
        		 
        Total interest-bearing liabilities $34,423 $(72,838)$(38,415)

         

         

        $

        32,115

         

         

         

        $

        119,696

         

         

        $

        151,811

         

         
        		 
        		 
        		 
        Change in net interest income $32,779 $7,591 $40,370 

         

         

        $

        23,614

         

         

         

        $

        (40,869

        )

         

        $

        (17,255

        )

         
        		 
        		 
        		 

         Net interest

        31



        Amortization and accretion of debt securities purchased at a premium or discount are amortized or accreted into income was $138.7 millionusing a method which approximates the constant effective yield method. We apply Statement of Financial Accounting Standard 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 2002, up 41% from 2001. The improvement in net interest income primarily reflected the positive effect of balance sheet growthis driven by increased client deposits and a steepthe calculation of the constant effective yield. When calculating this yield, curve. The net interest margin increased to 2.40% in 2002we assume that prepayments will continue from 2.25% in 2001 duethe analysis date to the costdate of interest-earning liabilities decreasing fasterthe 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 priceopinion of interest-earning assets, offsetmanagement, a one-month rate does not capture enough experience to predict future prepayment behavior and may create undue volatility in part by prepayment costs incurred during the year as a result of an asset liability strategy to prepay higher rate FHLBB advances with borrowed funds at a more favorable rate.

                Average interest-earning assets, primarily investment securities, were $5.8 billion in 2002, up 32% from 2001. Funding for the asset growth was provided by a combination of client deposits of $0.8 billion and external borrowings of $0.6 billion. The effect of changes in volume of interest-earning assets and interest-bearing liabilities was an increase in net interest income of approximately $32.8 million in 2002.



                Average yield on interest-earning assets was 4.26% in 2002, down 130 basis points from 2001. The average rate that we paid on interest-bearing liabilities was 2.03% in 2002, down 164 basis points from 2001. The decrease in rates reflected the lower interest rate environment in 2002 compared with 2001. The effect on net interest income due to changesone-time fluctuations in rates was an increaseprepayment activity. Conversely, in the opinion of approximately $7.6 million duringmanagement, 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 fiscal yearconstant 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, 2002. Net interest income includes prepayment costs of $7.6 million in 20022005, 2004, and $2.4 million in 2001.

                On January 1, 2001,2003, we adopted SFAS No. 133, as amendedanticipated prepayments on our mortgage-backed securities. All other securities, including Federal agency securities, state and interpreted, which established accountingpolitical subdivisions, corporate debt, U.S. Treasury securities, and reporting standards for derivative instruments. All derivatives, whether designated in hedging relationships or not, are required to be recorded on the balance sheet at fair value. If the derivative is designated as a fair value hedge, the change in the fair value of the derivative and the item being hedged will be recognized in earnings. If the derivative is designated as a cash flow hedge, the effective portions of changes in the fair value of the derivative are recorded in Other Comprehensive Income ("OCI"). Ineffective portions of changes, as determined in accordance with SFAS No. 133, in the fair value of the cash flow hedges are recognized in earnings. For derivatives thatforeign government securities do not qualify as hedges, changesmeet the SFAS 91 criteria for anticipating prepayments. Accordingly, no prepayments were anticipated for these securities.

        In addition to investing in their fair value are recognized in earnings. The adoption of SFAS No. 133 on January 1, 2001, resulted in no cumulative effect-type adjustmentboth variable and fixed-rate securities, we use derivative instruments to manage our net income. However, we recorded a reductionexposure to OCI of $3.9 million, net of tax, and a corresponding liability for the fair value of the interest rate swaps. The reduction to OCI andrisks. See the recognition of the liability were primarily attributable to net unrealized losses on cash flow hedges as of initial adoption. In conjunction with the adoption, we elected to reclassify approximately $402 million of securities from held to maturity to available“Market Risk” section for sale, which further reduced OCI by approximately $1.4 million, net of tax.

                Hedge ineffectiveness, determined in accordance with SFAS No. 133, had an insignificant impact on earnings for the year ended December 31, 2002 and 2001. No cash flow hedges were dedesignated or discontinued for the year ended December 31, 2002 and 2001.

                Net interest income included net gains of $1.6 million, net of tax, for the twelve months ended December 31, 2002 derived from interest rate swaps relating to SFAS No. 133. The net gain consisted of a $3.3 million gain, net of tax, for the twelve-month period on changes in the fair value of derivative instruments not designated as hedging instruments. There were also $1.7 million of derivative losses, net of tax, for the twelve-month period that resulted primarily from the reclassification of transition adjustment-related derivative losses from OCI to net interest income in accordance with SFAS No. 133. Approximately $0.2 million, net of tax, of the remaining transition adjustment of net derivative losses included in OCI will be reclassified into earnings. The recognition in net interest income of the transition adjustment derivative losses from OCI was offset by derivative gains from changes in the fair value liability of the interest rate swaps as they reach maturity.more detailed information.



        Noninterest Income

                Noninterest income was $298.8 million in 2002, up 17% from 2001. Noninterest income consists of the following items (Dollars in thousands):

         
        		 For the Years Ended
        December 31,
        		 
         
        		 2002
        		 2001
        		 Change
        		 
        Core service fees:         
         Custody, accounting and administration $231,520 $200,205 16%
          
        		 
        		   
        Ancillary service fees:         
         Foreign exchange  24,469  19,269 27%
         Cash management  16,974  15,046 13%
         Securities lending  11,328  9,371 21%
         Investment advisory  11,909  7,320 63%
         Other service fees  195  148 32%
          
        		 
        		   
          Total ancillary service fees  64,875  51,154 27%
          
        		 
        		   
        Total asset servicing fees  296,395  251,359 18%

        Other operating income
         
         
        2,449
         
         
        3,128
         
        (22
        %)
          
        		 
        		   
        Total noninterest income $298,844 $254,487 17%
          
        		 
        		   

                Asset servicing fees for the year ended December 31, 2002 increased 18% to $296.4 million from 2001. The largest component of asset servicing fees are custody, accounting, transfer agency and administration, which are based in part on assets processed. Net assets processed decreased $29 billion to $785 billion at December 31, 2002 from 2001. The change in net assets processed includes the following components (Dollars in billions):

         
        		 For the Year Ended
        December 31, 2002
        		 
        Sales to new clients $24 
        Further penetration of existing clients  26 
        Fund flows and market loss  (79)
          
        		 
         Net change in assets processed $(29)
          
        		 

                Our ability to win business and the ability of our clients to sell additional product, thus generating fund flows, allowed us to minimize the impact of the equity market downturn in 2002. Our tiered pricing structure for asset-based fees also contributed to this inverse correlation. Because our asset-based fees for most clients decrease as assets increase, as asset values deteriorate, revenue is only impacted by the asset decline at the then marginal rate. Despite the decrease in assets processed, transaction volume increased, which positively impacted fee income.

                Foreign exchange fees increased due to higher transaction volumes and volatility in the currencies traded by our clients. Cash management and securities lending fees increased with the addition of new clients and increased excess client cash balances. Increased investment advisory service fees were the result of growth in asset size 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.

                Other operating income consists of dividends received relating to FHLBB stock investment. The decrease in 2002 other operating income compared to 2001 resulted primarily from a decrease in the dividend rate paid on the FHLBB stock.



        Operating Expenses

        Total operating expenses were $341.4$460.1 million in 2002,2005, up 18%15% from 2001.2004. The increase in total operating expenses was primarily due to increased compensation and benefits, technology and telecommunications, transaction processing services, travel and sales promotion, loss and loss adjustment expenses 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,

         


        		 2002
        		 2001
        		 Change
        		 

         

        2005

         

        2004

         

        Change

         

        Compensation and benefits $192,785 $164,186 17%

         

        $

        250,459

         

        $

        205,728

         

         

        22

        %

         

        Technology and telecommunications 42,190 39,194 8%

         

        54,732

         

        49,816

         

         

        10

        %

         

        Transaction processing services 33,713 28,710 17%

         

        49,873

         

        42,159

         

         

        18

        %

         

        Depreciation and amortization

         

        31,578

         

        32,124

         

         

        (2

        )%

         

        Occupancy 25,602 17,965 43%

         

        26,490

         

        29,032

         

         

        (9

        )%

         

        Depreciation and amortization 16,357 8,404 95%
        Professional fees 11,829 7,933 49%

         

        13,380

         

        15,346

         

         

        (13

        )%

         

        Travel and sales promotion 5,819 5,349 9%

         

        6,825

         

        5,470

         

         

        25

        %

         

        Amortization of goodwill — 3,559 (100)%

        Loss and loss adjustment expenses

         

        5,837

         

        924

         

         

        *

         

         

        Insurance

         

        4,219

         

        4,625

         

         

        (9

        )%

         

        Other operating expenses 13,100 13,876 (6)%

         

        16,716

         

        13,159

         

         

        27

        %

         

         
        		 
        		   
        Total operating expenses $341,395 $289,176 18%

         

        $

        460,109

         

        $

        398,383

         

         

        15

        %

         

         
        		 
        		   

        *                    Percentage is not considered meaningful

        Compensation and benefits expense was $192.8 million in 2002, up 17%increased 22% from 2001. The average number of employees increased 15%2004 due to 2,648 during the year ended December 31, 2002 from 2,299 for the year ended December 31, 2001. In 2002, we increased the number of employees to support new businesshigher headcount and the expansion of existing client relationships. Benefits, including payroll taxes, group insurance plans, retirement plan contributions and tuition reimbursement, increased $6.6 million for the year ended December 31, 2002, consistent with the increase in headcount. Theannual salary increases. Further increases in compensation expense in 2006 will be primarily dependant upon sales to new and benefits expense were offset by $8.4 million, which was accounted for as capitalized software development costsexisting clients, the full year impact of staff additions made in 2002.2005 related to the overall growth of our business, annual salary increases and the full year effect of the adoption of SFAS 123R.

        Technology and telecommunications expense was $42.2 millionincreased 10% from 2004 as a result of increased infrastructure investments in 2002, up 8% from 2001. Increased hardware, software, mainframe and trust2005. 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 employees transferring to IBM. Also, increases in our processing volumes drove higher technology and telecommunications expenditures neededexpense. Generally, we expect technology reinvestment to support new business and increased transaction volumes accounted for $7.8 millionequal approximately 18-20% of the year-to-year change. Offsetting these increases was $4.8 millionnet operating revenue each year, including related to outsourced network monitoring, help desk and other outsourced services required in 2001, and not in 2002, primarily due to the acquisition of certain institutional custody business lines from Chase Manhattan Bank, N.A. in 2001.compensation costs.

        Transaction processing services expense was $33.7 million in 2002, up 17%increased 18% from 2001. The increase related primarily to increased subcustodian and pricing fees, driven by increased volumes of transactions and changes in assets processed for clients, largely a result of the BGI U.S. asset administration unit assumption in May 2001 and the addition of new business in 2002.

                Occupancy expense was $25.6 million in 2002, up 43% from 2001. This increase was due primarily to increased space in our Boston, New York and Dublin offices and the California offices assumed from BGI.

                Depreciation and amortization expense was $16.4 million in 2002, up 95% from 2001. This increase resulted from completion of capitalized software projects in 2002 and their placement into service and the addition of leasehold improvements2004 as a result of higher global asset values and transactions with our subcustodians. Future transaction processing servicing expense will be dependent on asset levels and the new space we occupied in Boston, New York, Dublin and California.volume of client transaction activity.

        Professional fees were $11.8 million in 2002, up 49%expense decreased 13% from 20012004, primarily due to increased accounting, legal and consulting services provided during the periods, as well as increased feeslower subadvisory expense associated with theour Merrimac Master Portfolio. The Merrimacmoney market funds, resulting from lower average fund balances. Future professional fees are asset based and the increase results from growthdependent upon changes in the sizevalue of the Merrimac Master Portfolio.portfolios and upon other business needs for outside professional services.



        Travel and sales promotion expense was $5.8 million in 2002, up 9%increased 25% from 2001.2004. Travel and sales promotion expense consists of expenses incurred by the sales force, client management staff and other employees in connection with sales calls toon potential clients, as well as traveling to existing client sites and to our New York and California offices and our foreign subsidiaries.offices. The increases 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 establishment of our new European offices. Travel and sales expense may increase in 2006, dependent upon new business leads and other client and business needs.


        The increase in loss and loss adjustment expenses from 2004 to 2005 is due to a processing error identified during the fourth quarter of 2005.

                AmortizationOther operating expense increased 27% from 2004 primarily as a result of goodwillhigher recruiting and staffing expense. We expect other operating expense ceased as of January 1, 2002,to increase in 2006 due to staffing and recruiting costs as a result of the adoptiongrowth of SFASour business.

        Income Taxes

        Income taxes were $76.0 million for the year ended December 31, 2005, up 4% from the same period in 2004. The increase in income taxes and the effective tax rate (excluding the effect of Accounting Principles Board Opinion No. 142. Please refer23, Accounting for Income Taxes—Special Areas (“APB 23”)) is primarily attributable to Note 2increased 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 undistributed earnings of our Irish subsidiaries. During the second quarter of 2005, we recognized the indefinite reversal provision of 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.

        In 2006, we expect that our effective tax rate will approximate 34.5% of pretax income.

        Comparison of Operating Results for the Years Ended December 31, 2004 and 2003.

        Net income for the year ended December 31, 2004 was $142.0 million, up 54% from $92.4 million for the same period in 2003. The principal factors contributing to our notesnet income growth were growth in asset servicing fees of 27% in addition to consolidated financial statements.a 22% increase in net interest income. Net income growth was partially offset by a 16% increase in operating expenses, largely due 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 accrual 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. We provide a full reconciliation of this non-GAAP measure in the Overview of this Management’s Discussion and Analysis of Financial Condition and Results of Operations.

        Fees and Other Revenue

        The components of fees and other revenue are as follows (Dollars in thousands):

         

         

        For the Year Ended
        December 31,

         

         

         

        2004

         

        2003

         

        Change

         

        Total asset servicing fees

         

        $

        423,200

         

        $

        333,586

         

         

        27

        %

         

        Other operating income

         

        2,057

         

        2,607

         

         

        (21

        )%

         

        Gain on sale of investment

         

        234

         

        —

         

         

        *

         

         

        Total fees and other revenue

         

        $

        425,491

         

        $

        336,193

         

         

        27

        %

         

        *                    Percentage is not considered meaningful

        The largest components of asset servicing fees are custody, multicurrency accounting and fund administration, which increased 24% to $314.3 million for the year ended December 31, 2004 from $254.2 million for the same period in 2003.


        The change in net assets processed includes the following components (Dollars in billions):

         

         

        For the Year Ended
        December 31, 2004

         

        Net assets processed, beginning of period

         

         

        $

        1,057

         

         

        Change in net assets processed:

         

         

         

         

         

        Sales to new clients

         

         

        54

         

         

        Further penetration of existing clients

         

         

        37

         

         

        Lost clients

         

         

        (3

        )

         

        Fund flows and market gain

         

         

        285

         

         

        Total change in net assets processed

         

         

        373

         

         

        Net assets processed, end of period

         

         

        $

        1,430

         

         

        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.

        ·       Foreign exchange fees were $54.5 million for the year ended December 31, 2004, up 49% from the same period in 2003. The increase in foreign exchange fees is attributable to new business, increased volume of client activity and volatility in currency markets.

        ·       Cash management fees were $26.4 million for the year ended December 31, 2004, up 26% from the same period in 2003. The increase is primarily due to higher balances placed by our clients in the cash management products we offer.

        ·       Investment advisory fees were $15.0 million for the year ended December 31, 2004, up 28% from the same period in 2003. The increase in investment advisory fees is attributable to increased average asset values of the Merrimac money market funds, an investment company for which we act as advisor, and where a portion of excess client cash balances are invested.

        ·       Securities lending fees were $10.4 million for the year ended December 31, 2004, up 17% from the same period in 2003, primarily due to improved spreads and volumes.

        Net Interest Income

        The following table presents the components of net interest income (Dollars in thousands):

         

         

        For the Year Ended December 31,

         

         

         

        2004

         

        2003

         

        Change

         

        Interest income

         

        $

        313,149

         

        $

        247,094

         

         

        27

        %

         

        Interest expense

         

        125,469

         

        93,180

         

         

        35

        %

         

        Total net interest income

         

        $

        187,680

         

        $

        153,914

         

         

        22

        %

         

        The improvement in our net interest income was primarily due to balance sheet growth, driven by healthy client funding, partially offset by lower investment spreads.

        During 2004 we employed a strategy of prepaying high-rate borrowings and replacing them with lower cost term funding in order to maintain our net interest margin. Prepayment fees incurred during 2004 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% for the year ended December 31, 2004 from 1.34% for the same period in 2003.

        35



        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, 2004 compared to the year ended December 31, 2003. 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 

         

         

         

        Change Due
        to Volume 

         

        Change Due
        To Rate 

         

        Net 

         

        Interest-earning assets

         

         

         

         

         

         

         

         

         

         

         

        Fed funds sold and securities purchased under resale agreements

         

         

        $

        275

         

         

         

        $

        66

         

         

        $

        341

         

        Investment securities

         

         

        69,525

         

         

         

        (4,821

        )

         

        64,704

         

        Loans

         

         

        1,057

         

         

         

        (47

        )

         

        1,010

         

        Total interest-earning assets

         

         

        $

        70,857

         

         

         

        $

        (4,802

        )

         

        $

        66,055

         

        Interest-bearing liabilities

         

         

         

         

         

         

         

         

         

         

         

        Deposits

         

         

        $

        17,767

         

         

         

        $

        (6,865

        )

         

        $

        10,902

         

        Borrowings

         

         

        5,311

         

         

         

        16,076

         

         

        21,387

         

        Total interest-bearing liabilities

         

         

        $

        23,078

         

         

         

        $

        9,211

         

         

        $

        32,289

         

        Change in net interest income

         

         

        $

        47,779

         

         

         

        $

        (14,013

        )

         

        $

        33,766

         

        Operating Expenses

        Total operating expenses were $13.1$398.4 million in 2002, down 6%2004, up 16% from 2003. The growth in our cost structure was largely driven by the new business that we won during 2004, which required us to invest in headcount and technology. The components of operating expenses were as follows (Dollars in thousands):

         

         

        For the Year Ended December 31,

         

         

         

        2004

         

        2003

         

        Change

         

        Compensation and benefits

         

        $

        205,728

         

        $

        186,932

         

         

        10

        %

         

        Technology and telecommunications

         

        49,816

         

        38,914

         

         

        28

        %

         

        Transaction processing services

         

        42,159

         

        33,299

         

         

        27

        %

         

        Depreciation and amortization

         

        32,124

         

        27,971

         

         

        15

        %

         

        Occupancy

         

        29,032

         

        29,218

         

         

        (1

        )%

         

        Professional fees

         

        15,346

         

        11,189

         

         

        37

        %

         

        Travel and sales promotion

         

        5,470

         

        4,822

         

         

        13

        %

         

        Loss and loss adjustment expenses

         

        924

         

        799

         

         

        16

        %

         

        Insurance

         

        4,625

         

        3,203

         

         

        44

        %

         

        Other operating expenses

         

        13,159

         

        8,574

         

         

        53

        %

         

        Total operating expenses

         

        $

        398,383

         

        $

        344,921

         

         

        16

        %

         

        Compensation and benefits increased $18.8 million, or 10%, from 2003. Salaries increased due to higher headcount and annual merit raises. These increases were partially offset by employee costs that shifted to technology and telecommunications expense as part of our outsourcing arrangement with IBM that we initiated in the summer of 2004.

        Technology and telecommunications expense increased $10.9 million, or 28%, from 2003 as a result of increased infrastructure investments in 2004. As mentioned previously, we entered into an agreement with IBM 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 were partially offset by decreases in other technology and telecommunications expenses, as the services were previously performed internally or by other service providers.

        Transaction processing services expense increased 27% from 2003 as a result of higher global asset values and transactions with our subcustodians.

        Depreciation and amortization expense increased 15% from 2003. This increase resulted from the completion 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 assumption of BGI’s North American asset administration unit.

        Professional fees expense increased 37% from 2003, primarily due to increased fees associated with the Merrimac money market funds. The Merrimac fees are asset based and grew along with the assets of the portfolios during 2004. Also in 2004, we incurred additional technical consulting fees as strict cost controls continued across the organization. we hired external consultants to assist with technology initiatives.

        Travel and sales promotion expense increased 13% from 2003.

        Insurance expense was up 44% from 2003. In May 2003, our five-year fixed-rate insurance policy expired, resulting in increased premiums.

        Other operating expenses include fees forexpense increased 53% from 2003. The primary contributors to the increase included higher regulatory assessments due to higher deposit liabilities, higher recruiting expense due to increased staffing needs, increased advertising expense and increased miscellaneous office supplies and postage, storage, temporary help, client accommodations and various regulatory fee assessments.expense due to the overall growth of our business.

        Income Taxes

        Income taxes were $28.7$72.8 million for the year ended December 31, 2004, up 38% from the same period in 2002, up 51%2003. This increase is attributable to a 48% increase in pretax earnings for the year ended December 31, 2004 from 2001, consistent with the increased level of pre-tax income. The overall effective tax rate was relatively flat at 29.9% for 2002 and 29.8% for 2001.same period in 2003.



        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, 2003
        		 Year Ended December 31, 2002
        		 Year Ended December 31, 2001
        		 

         

        Year Ended December 31, 2005

         

        Year Ended December 31, 2004

         

        Year Ended December 31, 2003

         
        		 Average
        Balance
        		 Interest
        		 Average
        Yield/Cost
        		 Average
        Balance
        		 Interest
        		 Average
        Yield/Cost
        		 Average
        Balance
        		 Interest
        		 Average
        Yield/Cost
        		 

         

        Average
        Balance

         

        Interest

         

        Average
        Yield/Cost

         

        Average
        Balance

         

        Interest

         

        Average
        Yield/Cost

         

        Average
        Balance

         

        Interest

         

        Average
        Yield/Cost

         

        Interest-earning assetsInterest-earning assets                         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

        Fed Funds sold and securities purchased under resale agreements $30,236 $326 1.08%$45,042 $740 1.64%$36,038 $1,602 4.45%
        Investment securities(1)  7,398,373  243,191 3.29  5,614,160  241,012 4.29  4,227,035  236,397 5.59 

        Federal Funds sold and securities purchased under resale agreements

         

        $

        66,926

         

        $

        2,250

         

         

        3.36

        %

         

        $

        52,544

         

        $

        667

         

         

        1.27

        %

         

        $

        30,236

         

        $

        326

         

         

        1.08

        %

         

        Investment securities:(1)

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

        Mortgage-backed securities

         

        8,034,870

         

        315,845

         

         

        3.93

         

         

        6,677,678

         

        221,248

         

         

        3.31

         

         

        5,065,472

         

        170,700

         

         

        3.37

         

         

        Federal agency securities

         

        2,333,005

         

        89,864

         

         

        3.85

         

         

        2,084,988

         

        53,977

         

         

        2.59

         

         

        1,675,520

         

        46,455

         

         

        2.77

         

         

        State and political
        securities

         

        465,451

         

        21,217

         

         

        4.56

         

         

        490,621

         

        22,300

         

         

        4.55

         

         

        437,182

         

        20,477

         

         

        4.68

         

         

        Other securities

         

        230,832

         

        9,267

         

         

        4.01

         

         

        299,529

         

        10,370

         

         

        3.46

         

         

        220,199

         

        5,559

         

         

        2.52

         

         

        Total investment securities

         

        11,064,158

         

        436,193

         

         

        3.94

         

         

        9,552,816

         

        307,895

         

         

        3.22

         

         

        7,398,373

         

        243,191

         

         

        3.29

         

         

        Loans(2)Loans(2)  127,452  3,577 2.81  110,769  3,774 3.41  113,874  5,572 4.89 

         

        233,572

         

        9,262

         

         

        3.97

         

         

        165,564

         

        4,587

         

         

        2.77

         

         

        127,452

         

        3,577

         

         

        2.81

         

         

         
        		 
        		   
        		 
        		   
        		 
        		   
        Total interest-earning assetsTotal interest-earning assets  7,556,061  247,094 3.27  5,769,971  245,526 4.26  4,376,947  243,571 5.56 

         

        11,364,656

         

        447,705

         

         

        3.94

         

         

        9,770,924

         

        313,149

         

         

        3.20

         

         

        7,556,061

         

        247,094

         

         

        3.27

         

         

         
        		 
        		   
        		 
        		   
        		 
        		   
        Allowance for loan lossesAllowance for loan losses  (100)      (100)      (100)     

         

        (100

        )

         

         

         

         

         

         

        (100

        )

         

         

         

         

         

         

        (100

        )

         

         

         

         

         

         

        Noninterest-earning assets(3)  584,024       403,316       271,281      
         
        		      
        		      
        		      

        Noninterest-earning assets(4)

         

        701,967

         

         

         

         

         

         

         

        535,191

         

         

         

         

         

         

         

        584,024

         

         

         

         

         

         

         

        Total assetsTotal assets $8,139,985      $6,173,187      $4,648,128      

         

        $

        12,066,523

         

         

         

         

         

         

         

        $

        10,306,015

         

         

         

         

         

         

         

        $

        8,139,985

         

         

         

         

         

         

         

         
        		      
        		      
        		      
        Interest-bearing liabilitiesInterest-bearing liabilities                         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

        Deposits:Deposits:                         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

        Demand $— $— 0.00%$823 $4 0.49%$3,456 $60 1.74%
        Savings  2,667,034  39,809 1.49  1,945,550  42,229 2.17  1,708,220  65,265 3.82 
        Time  1,356  10 0.74  1,393  24 1.72  239  13 5.44 
        Securities sold under repurchase agreements  3,278,555  29,371 0.90  2,449,368  31,166 1.27  1,546,271  47,338 3.06 
        Junior subordinated debentures(3)/trust preferred securities  24,194  2,364 9.77  24,667  2,432 9.86  25,000  2,443 9.77 
        Other borrowings(4)  1,008,036  21,626 2.15  845,246  30,946 3.66  672,127  30,097 4.48 
         
        		 
        		   
        		 
        		   
        		 
        		   

        Demand

         

        $

        24,470

         

        $

        866

         

         

        3.54

        %

         

        $

        —

         

        $

        —

         

         

        0.00

        %

         

        $

        —

         

        $

        —

         

         

        0.00

        %

         

        Savings

         

        3,428,223

         

        74,391

         

         

        2.17

         

         

        3,947,865

         

        49,622

         

         

        1.26

         

         

        2,667,034

         

        39,809

         

         

        1.49

         

         

        Time

         

        80,729

         

        2,449

         

         

        3.03

         

         

        68,594

         

        1,099

         

         

        1.60

         

         

        1,356

         

        10

         

         

        0.74

         

         

        Securities sold under repurchase agreements(3)

         

        5,244,614

         

        142,681

         

         

        2.72

         

         

        4,162,132

         

        54,376

         

         

        1.31

         

         

        3,278,555

         

        29,371

         

         

        0.90

         

         

        Junior subordinated debentures(4)/ trust preferred securities

         

        24,774

         

        2,420

         

         

        9.77

         

         

        24,774

         

        2,420

         

         

        9.77

         

         

        24,194

         

        2,364

         

         

        9.77

         

         

        Other borrowings(5)

         

        1,643,948

         

        54,473

         

         

        3.31

         

         

        841,708

         

        17,952

         

         

        2.13

         

         

        1,008,036

         

        21,626

         

         

        2.15

         

         

        Total interest-bearing liabilitiesTotal interest-bearing liabilities  6,979,175  93,180 1.34  5,267,047  106,801 2.03  3,955,313  145,216 3.67 

         

        10,446,758

         

        277,280

         

         

        2.65

         

         

        9,045,073

         

        125,469

         

         

        1.39

         

         

        6,979,175

         

        93,180

         

         

        1.34

         

         

         
        		 
        		   
        		 
        		   
        		 
        		   
        Noninterest-bearing liabilities:Noninterest-bearing liabilities:                         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

        Demand deposits  241,594       180,065       180,260      
        Savings  130,747       124,416       73,415      
        Noninterest-bearing time deposits  112,575       90,000       77,534      
        Other liabilities  191,971       116,558       54,041      
         
        		      
        		      
        		      

        Demand deposits

         

        305,289

         

         

         

         

         

         

         

        252,246

         

         

         

         

         

         

         

        241,594

         

         

         

         

         

         

         

        Savings

         

        61,745

         

         

         

         

         

         

         

        72,536

         

         

         

         

         

         

         

        130,747

         

         

         

         

         

         

         

        Noninterest-bearing time deposits

         

        198,849

         

         

         

         

         

         

         

        154,617

         

         

         

         

         

         

         

        112,575

         

         

         

         

         

         

         

        Other liabilities

         

        295,330

         

         

         

         

         

         

         

        155,579

         

         

         

         

         

         

         

        191,971

         

         

         

         

         

         

         

        Total liabilitiesTotal liabilities  7,656,062       5,778,086       4,340,563      

         

        11,307,971

         

         

         

         

         

         

         

        9,680,051

         

         

         

         

         

         

         

        7,656,062

         

         

         

         

         

         

         

        EquityEquity  483,923       395,101       307,565      

         

        758,552

         

         

         

         

         

         

         

        625,964

         

         

         

         

         

         

         

        483,923

         

         

         

         

         

         

         

         
        		      
        		      
        		      
        Total liabilities and equityTotal liabilities and equity $8,139,985      $6,173,187      $4,648,128      

         

        $

        12,066,523

         

         

         

         

         

         

         

        $

        10,306,015

         

         

         

         

         

         

         

        $

        8,139,985

         

         

         

         

         

         

         

         
        		      
        		      
        		      

        Net interest income
        Net interest income
         
         
         
         
        $
        153,914
         
         
         
         
         
         
        $
        138,725
         
         
         
         
         
         
        $
        98,355
         
         
         

         

         

         

        $

        170,425

         

         

         

         

         

         

         

        $

        187,680

         

         

         

         

         

         

         

        $

        153,914

         

         

         

         

         

            
        		      
        		      
        		   
        Net interest margin(5)       2.04%      2.40%      2.25%
               
        		       
        		       
        		 
        Average interest rate spread(6)       1.93%      2.23%      1.89%
               
        		       
        		       
        		 

        Net interest margin(6)

         

         

         

         

         

         

        1.50

        %

         

         

         

         

         

         

        1.92

        %

         

         

         

         

         

         

        2.04

        %

         

        Average interest rate spread(7)

         

         

         

         

         

         

        1.29

        %

         

         

         

         

         

         

        1.81

        %

         

         

         

         

         

         

        1.93

        %

         

        Ratio of interest-earning assets to interest-bearing liabilitiesRatio of interest-earning assets to interest-bearing liabilities       108.27%      109.55%      110.66%

         

         

         

         

         

         

        108.79

        %

         

         

         

         

         

         

        108.02

        %

         

         

         

         

         

         

        108.27

        %

         

               
        		       
        		       
        		 

        (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, 2005, 2004 and 2003 there were no non-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.

        (4)

        (5)Interest expense includes contractual prepayment penalties of $3.9 million and $3.1 million $7.6 millionin 2004 and $2.4 million in 2003, 2002 and 2001, respectively, for prepayment of certain FHLBB borrowings.

        (5)

        (6)Net interest income divided by total interest-earning assets.

        (6)

        (7)Yield on interest-earning assets less rate paid on interest-bearing liabilities.

        38




        Financial Condition

        At December 31, 2003,2005, our total assets were $9.2$12.1 billion, up 28%8% from December 31, 2002. We manage our balance sheet growth to accomplish several goals, which include maintaining a leverage ratio of approximately 5.5%, utilizing our capital to provide maximum shareholder value, and accommodating the fund flows of our clients.2004. Average interest-earning assets increased $1.8$1.6 billion, or 31%16%, for the year ended December 31, 20032005 compared to the same period last year. Funding for ourOur asset growth was providedprimarily funded by a combination of an increase in average client balances of approximately $1.2 billion and an increaseincreases in average external borrowings, including repurchase agreements, of approximately $0.6$1.6 billion for the year ended December 31, 2003.2005.

        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 the 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,

         


        		 2003
        		 2002
        		 2001

         

        2005

         

        2004

         

        2003

         

        Securities held to maturity:      

         

         

         

         

         

         

         

        Mortgage-backed securities $2,272,030 $2,033,620 $2,587,105

         

        $

        4,342,254

         

        $

        3,543,961

         

        $

        2,272,030

         

        Federal agency securities 1,906,554 1,287,314 456,117

         

        2,305,331

         

        2,274,665

         

        1,906,554

         

        State and political subdivisions 127,632 117,021 91,888

         

        114,345

         

        124,091

         

        127,632

         

        Foreign government securities — — 2,501
         
        		 
        		 
        Total securities held to maturity $4,306,216 $3,437,955 $3,137,611

         

        $

        6,761,930

         

        $

        5,942,717

         

        $

        4,306,216

         

         
        		 
        		 

        Securities available for sale:
         
         
         
         
         
         

         

         

         

         

         

         

         

        Mortgage-backed securities $3,611,980 $2,759,793 $1,228,841

         

        $

        3,766,101

         

        $

        3,854,900

         

        $

        3,611,980

         

        State and political subdivisions 355,828 307,292 241,467

         

        392,391

         

        404,909

         

        355,828

         

        Corporate debt 175,816 174,499 120,505

         

        200,692

         

        176,546

         

        175,816

         

        US Treasury securities 113,701 — —

         

        —

         

        118,688

         

        113,701

         

        Federal agency securities 29,609 30,881 30,848

         

        —

         

        —

         

        29,609

         

        Foreign government securities 9,703 — —

         

        10,536

         

        10,462

         

        9,703

         

         
        		 
        		 
        Total securities available for sale $4,296,637 $3,272,465 $1,621,661

         

        $

        4,369,720

         

        $

        4,565,505

         

        $

        4,296,637

         

         
        		 
        		 

         

        The overall increases$0.8 billion, or 14%, increase in our held to maturity and available for sale portfolios are attributable to investing excess cash and borrowed funds to effectively utilize the Bank's capital and accommodate client fund flows. Our held to maturitysecurities portfolio increased $868.3 million, or 25%, to $4.3 billion atfrom December 31, 2003 from $3.4 billion at2004 to December 31, 2002. As we continue2005 is primarily due to growinvestment security purchases allowing us to utilize our balance sheet, we purchase investment securities that will protect our net interest margin,capital, while maintaining an acceptable risk profile. The increase in theOur investment security purchases primarily consisted of floating interest rate mortgage-backed securities which offer an attractive yield and reprice as interest rates increase. Our held to maturity portfolio stems primarily from purchases of federal agency securities particularly those issued by the Small Business Administration ("SBA"). SBA securities provide an attractive yield with limited credit risk and prepayment risk in a rapidly changing interest rate environment. The weighted-average life of the SBA securities correspond with our overall asset liability strategy. SBA securities that we hold are variable rate securities indexed to the Prime rate and 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.

        Our available for sale securities portfolio increased $1.0decreased $0.2 billion, or 31%, to $4.3 billion at4% from December 31, 2003 from $3.3 billion at2004 to December 31, 2002.2005. The increase in the available for sale portfolio is primarilydecrease was mainly due to an increase in oursales of U.S. Treasuries and municipal securities during 2005 and investment security maturities and prepayments, partially offset by purchases of investment securities. Our investment security purchases primarily included mortgage-backed securities portfolioand municipal securities. We believe that purchasing these securities allows us to take advantage of $852.2 million, or 31%,attractive yields and the addition



        of $113.7 million of U.S. Treasury securities. In an effort to maintain our net interest margin, we have increased our position in mortgage-backed securities. As interest rates stop declining and are likely to increase, floating rate and hybrid mortgage-backed securities should offer a healthy effective yield and limited extension risk,cash 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, 20032005 was $7.4$11.1 billion, with an average yield of 3.29%3.94%, compared to an average balance of $5.6$9.6 billion with an average yield of 4.29%3.22% during 2002.the same period in 2004. The declineincrease in the yield is primarily due to our variable-rate securities repricing at higher interest rates. Anticipating prepayments in calculating the constant 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. A rising rate environment will generally decrease the rate of prepayments, which may have the effect of lengthening the expected maturity of mortgage-backed securities. Accordingly, the amount of amortization recognized each period will decline, but the same total net premium will be spread over a longer time horizon, thereby increasing net income in the overall interestthen current period. In a decreasing rate environment. As interest rates declined throughoutenvironment, the year, we experienced a higher levelrate of prepayments resulting in increased principal cash payments that were reinvested in lower-yielding securities. In addition,generally increases, which may have the accelerated prepayments caused us to recognize at a faster rateeffect of shortening the premiumexpected maturity of the mortgage-backed securities and therefore increasing the amount of amortization, associated with the affected securities. During 2003, we recognizedthereby decreasing net amortization of $39.2 million for the year ended December 31, 2003 compared to $12.8 million of net amortizationincome in the same periodthen current period. We do not expect changes to our amount of 2002. Theamortization resulting from anticipating prepayments to have a material effect of this accelerated amortization loweredon our effective yieldfuture reported financial results or financial condition.

        Prepayment cash flow levels on the investment portfolio. During the second half of 2003, interest rates began to stabilize, resultingour Federal agency securities increased in lower prepayments. A significant portion of our investment portfolio is variable rate in nature. If interest rates2005, which we believe were to rise during 2004, 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 2004, we would expect that prepayments would accelerate and be comparativeattributable to the activity in 2003, with theexpiration of borrower prepayment penalties, increased refinancing and loan payoff activity. Mortgaged-backed security prepayment cash flows from these prepayments being reinvested in lower-yielding assetsflow levels also increased for most of equal quality and risk.2005, primarily attributable to increased refinancing opportunities.

        We invest in mortgage-backed securities and Federal agency bonds and corporate debtsecurities to increase the total return of the investment portfolio. Mortgage-backed securities and Federal agency bonds 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. Prepayment risk results from the possibility that changes in interest rates may cause mortgage-backed securities to be paid off prior to their maturity dates. Federal agency bonds generally have a higher yield than U.S. Treasury securities due to credit and call risk. Credit risk results from the possibility that the Federal agency issuing the bonds may be unable to meet the terms of the bond. 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 Federal agency prior to the maturity date of the bond. Credit risk related to mortgage-backed securities and Federal agency bonds is substantially reduced by payment guarantees and credit enhancements. Prepayment risk results from the possibility that changes in interest rates and other economic factors will result in investment securities being paid off earlier than the scheduled maturity date. Refer to the “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, 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 creditcall risk. However, all municipal securitiesCall risk is similar to prepayment risk and results from the possibility that we investfluctuating interest rates and other factors may result in are insured and AAA rated.the exercise of the call option by the issuing municipality prior to the maturity date of the bond.

        The carrying value, weighted-average yield, and contractual maturity of our securities held to maturity at December 31, 20032005 are reflected in the following table (Dollars in thousands):


        		 Years
        		 

         

        Years

         


        		 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 $5 5.71%$31,732 3.89%$68,668 2.91%$2,171,625 2.73%

         

         

        $

        118

         

         

         

        6.31

        %

         

         

        $

        21,127

         

         

         

        4.90

        %

         

        $

        3,993

         

         

        6.23

        %

         

        $

        4,317,016

         

         

        4.80

        %

         

        Federal agency securities  — —  — —  41,705 2.28  1,864,849 2.71 

         

         

        —

         

         

         

        —

         

         

         

        3,814

         

         

         

        4.90

         

         

        237,101

         

         

        4.78

         

         

        2,064,416

         

         

        4.48

         

         

        State and political subdivisions  — —  5,626 5.19  9,069 4.71  112,937 5.08 

         

         

        3,754

         

         

         

        6.33

         

         

         

        3,844

         

         

         

        5.33

         

         

        13,286

         

         

        4.82

         

         

        93,461

         

         

        4.97

         

         

         
        		   
        		   
        		   
        		   
        Total securities held to maturity $5 5.71%$37,358 4.05%$119,442 2.77%$4,149,411 2.79%

         

         

        $

        3,872

         

         

         

        6.33

        %

         

         

        $

        28,785

         

         

         

        4.96

        %

         

        $

        254,380

         

         

        4.81

        %

         

        $

        6,474,893

         

         

        4.70

        %

         

         
        		   
        		   
        		   
        		   

         

        The carrying value, weighted-average yield, and contractual maturity of our securities available for sale at December 31, 20032005 are reflected in the following table (Dollars in thousands):


        		 Years
        		 

         

        Years

         

         


        		 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 $—   $—   $—   $3,611,980 3.73%

         

         

        $

        —

         

         

         

        0.00

        %

         

        $

        56,861

         

         

        4.90

        %

         

        $

        486

         

         

        6.23

        %

         

        $

        3,708,754

         

         

        4.34

        %

         

         

        State and political subdivisions  5,394 4.45% 90,290 4.81% 216,060 4.47% 44,084 4.89 

         

         

        498

         

         

         

        4.45

         

         

        66,697

         

         

        4.71

         

         

        102,365

         

         

        4.05

         

         

        222,831

         

         

        3.78

         

         

         

        Corporate debt  — —  — —  — —  175,816 2.05 

         

         

        —

         

         

         

        —

         

         

        —

         

         

        —

         

         

        —

         

         

        —

         

         

        200,692

         

         

        5.10

         

         

         

        US Treasury securities  — —  — —  113,701 1.95  — — 
        Federal agency securities  29,609 5.49  — —  — —  — — 
        Foreign government  — —  9,703 3.82  — —  — — 

         

         

        —

         

         

         

        —

         

         

        10,536

         

         

        3.82

         

         

        —

         

         

        —

         

         

        —

         

         

        —

         

         

         

         
        		   
        		   
        		   
        		   
        Total securities available for sale $35,003 5.33%$99,993 4.71%$329,761 3.60%$3,831,880 3.67%

         

         

        $

        498

         

         

         

        4.45

        %

         

        $

        134,094

         

         

        4.72

        %

         

        $

        102,851

         

         

        4.06

        %

         

        $

        4,132,277

         

         

        4.35

        %

         

         

         
        		   
        		   
        		   
        		   

         


        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 increased $55.8$267.8 million, or 39%199%, from 2004 to $199.5 million at December 31, 2003 from $143.7 million at December 31, 2002. The majority of the2005 primarily due to an increase relatesin loans to additional advances on clients' lines of credit, partially offset by a decline in client overdrafts. At December 31, 2003, client overdrafts were $54.3 million compared to $73.0 million at December 31, 2002.mutual funds.

        The following table summarizes our loan portfolio for the dates indicated (Dollars in thousands):


        		 December 31,
        		 

         

        December 31,

         


        		 2003
        		 2002
        		 2001
        		 2000
        		 1999
        		 

         

        2005

         

        2004

         

        2003

         

        2002

         

        2001

         

        Loans to mutual funds $104,954 $49,372 $50,359 $86,316 $44,369 

         

        $

        286,144

         

        $

        22,520

         

        $

        104,954

         

        $

        49,372

         

        $

        50,359

         

        Loans to individuals 67,641 76,263 164,443 40,198 62,335 

         

        81,392

         

        69,402

         

        67,641

         

        76,263

         

        164,443

         

        Loans to others 27,035 18,202 17,411 2,855 2,688 

         

        34,934

         

        42,708

         

        27,035

         

        18,202

         

        17,411

         

         
        		 
        		 
        		 
        		 
        		 

         

        402,470

         

        134,630

         

        199,630

         

        143,837

         

        232,213

         

         199,630 143,837 232,213 129,369 109,392 
        Less: allowance for loan losses (100) (100) (100) (100) (100)

         

        (100

        )

        (100

        )

        (100

        )

        (100

        )

        (100

        )

         
        		 
        		 
        		 
        		 
        		 
        Net loans $199,530 $143,737 $232,113 $129,269 $109,292 

         

        $

        402,370

         

        $

        134,530

         

        $

        199,530

         

        $

        143,737

         

        $

        232,113

         

         
        		 
        		 
        		 
        		 
        		 
        Floating Rate $199,618 $143,825 $232,189 $129,337 $109,379 
        Fixed Rate 12 12 24 32 13 
         
        		 
        		 
        		 
        		 
        		 
         $199,630 $143,837 $232,213 $129,369 $109,392 
         
        		 
        		 
        		 
        		 
        		 

        Floating rate

         

        $

        402,458

         

        $

        134,618

         

        $

        199,618

         

        $

        143,825

         

        $

        232,189

         

        Fixed rate

         

        12

         

        12

         

        12

         

        12

         

        24

         

        Gross loans

         

        $

        402,470

         

        $

        134,630

         

        $

        199,630

         

        $

        143,837

         

        $

        232,213

         

         

        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, 2003,2005, 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 same 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, 2005, 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, 2005, loans due from the mutual funds totaled $125.0 million. There were no loans outstanding from any related party mutual fund complex at December 31, 2004.

        In January 2006, we entered into a $30.0 million committed line of credit agreement with a series of trusts (“the trusts”). Edward F. Hines, a member of our Board of Directors, is a trustee of the trusts and is a partner in the firm that manages the assets held in the trusts. The line of credit is secured by assets of the


        trusts, which assets are held by Investors Bank as custodian. The primary source of repayment of the loans is the proceeds from the sale of investments in the normal course of the trusts’ business.

        The terms and conditions of our contractual agreements with the mutual funds and trusts discussed above, 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 and Mr. Hines abstain from voting on any board matter involving the proposed transactions with the mutual funds and trusts, respectively, discussed above.

        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 60 days past due and the loan'sloan’s collateral is not sufficient to cover both principal and accrued interest. As of December 31, 2003,2005, 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 has an allowance for loan losses of $0.1 million at December 31, 2003,2005, a level of which has remained consistent for the past five years. This amount is not allocated to any particular loan, but is intended to absorb any risk of loss inherent in the loan portfolio. 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 $4.2$5.0 billion at December 31, 2003, up 26%2005, down 7% from December 31, 2002.2004. The increasedecrease in our deposit balances is a direct result of our clients leavingbeing more cash on depositfully invested in the equity and fixed income markets.

        Time deposits with us. We effectively utilized these cash balances to fundgreater than $100,000 totaled $230.1 million and $257.6 million at December 31, 2005 and 2004, respectively. All time deposits had a portionmaturity of our asset growth. The following table represents the average balanceless than three months at December 31, 2005 and weighted-average yield paid on deposits (Dollars in thousands):2004.

         
        		 December 31, 2003
        		 December 31, 2002
        		 
         
        		 Average
        Balance
        		 Weighted-
        Average
        Yield
        		 Average
        Balance
        		 Weighted-
        Average
        Yield
        		 
        Interest-bearing:           
        Demand deposits $— 0.00%$823 0.49%
        Savings  2,667,034 1.49  1,945,550 2.17 
        Time deposits  1,356 0.74  1,393 1.72 
          
        		   
        		   
          $2,668,390 1.49%$1,947,766 2.17%
          
        		   
        		   

        Noninterest-bearing:
         
         
         
         
         
         
         
         
         
         
         
        Demand deposits $241,594 — $180,065 — 
        Savings  130,747 —  124,416 — 
        Time deposits  112,575 —  90,000 — 
          
        		   
        		   
          $484,916   $394,481   
          
        		   
        		   

        Repurchase Agreements and Short-Term and Other Borrowings

        Asset growth was funded in part by increased securities sold under repurchase agreements. Repurchase agreements increased $1.0$0.5 billion, or 42%13%, to $3.3 billion atfrom December 31, 2003 from $2.3 billion at2004 to December 31, 2002.2005. The majority of our repurchase agreements are with clients who prefer a more 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 use repurchase agreements, including client repurchase agreements, because they provide a lower cost source of funding than other short-term borrowings.borrowings and allow our clients the extra benefit of collateralization of their deposits. The average balance of securities sold under repurchase agreements for the year ended December 31, 20032005 was $3.3$5.2 billion with an average cost of approximately 0.90%2.72%, compared to an average balance of $2.4$4.2 billion and an average cost of approximately 1.27%1.31% for the same period last year.in 2004. The declineincrease in the average rate paid oncost of repurchase agreements relateswas due to the overall declinehigher short-term interest rates in the indices2005 compared to which the2004. The average cost of securities sold under repurchase agreements are linked.for the year ended December 31, 2004 included penalties of $2.9 million for the prepayment of two term repurchase agreements. These penalties were incurred to employ an asset and liability strategy in which we replaced high rate borrowings with lower cost term funding. There were no prepayment penalties for the year ended December 31, 2005.

        42



        The following table represents information regarding our securities sold under repurchase agreements (Dollars in thousands):

         

         

        December 31,

         

        December 31,

         

        December 31,

         

         

         

        2005

         

        2004

         

        2003

         

        Outstanding at end of period

         

         

        $

        4,797,868

         

         

         

        $

        4,255,497

         

         

         

        $

        3,258,001

         

         

        Maximum outstanding at any month end

         

         

        5,972,855

         

         

         

        4,749,456

         

         

         

        3,546,131

         

         

        Average balance for the year

         

         

        5,244,614

         

         

         

        4,162,132

         

         

         

        3,278,555

         

         

        Weighted-average rate at end of period

         

         

        3.55

        %

         

         

        1.98

        %

         

         

        1.09

        %

         

        Weighted-average rate for the period

         

         

        2.72

        %

         

         

        1.31

        %

         

         

        0.90

        %

         

        Short-term and other borrowings increased $357.0 million,$0.8 billion, or 48%128%, to $1.1 billion atfrom December 31, 2003 from $741.1 million at2004 to December 31, 2002.2005. We use short-term and other borrowings to offset the variability of deposit flow. The average balance of short-term and other borrowings for the year ended December 31, 20032005 was $1.0$1.6 billion with an average cost of approximately 2.15%3.31%, compared to an average balance of $845.2 million$0.8 billion and an average cost of approximately 3.66%2.13% for the same period last year.in 2004.  The increase in the average cost of short-term and other borrowings was due to an increase in short-term rates during 2005 compared to 2004. The average cost of borrowingborrowings for the year ended December 31, 2003,2004 included penalties of $3.9 million for the prepayment fees of $3.1 million. These feescertain FHLBB borrowings. As discussed above, these penalties were incurred to employ an asset-liabilityasset and liability strategy in which we replaced a high rate borrowings with lower cost borrowing with a new borrowing at a lower rate and purchased assets with a similar maturity to lock in spread. We employed the same strategy in 2002. As a result, the average costterm funding. There were no prepayment penalties for the year ended December 31, 2002 included $7.6 million of prepayment fees.2005.

        The following table represents information regarding our Federal Funds purchased (Dollars in thousands):

         

         

        December 31,

         

        December 31,

         

        December 31,

         

         

         

        2005

         

        2004

         

        2003

         

        Outstanding at end of period

         

         

        $

        810,511

         

         

         

        $

        344,491

         

         

         

        $

        697,855

         

         

        Maximum outstanding at any month end

         

         

        1,603,757

         

         

         

        739,038

         

         

         

        697,855

         

         

        Average balance for the year

         

         

        1,298,684

         

         

         

        491,170

         

         

         

        432,490

         

         

        Weighted-average rate at end of period

         

         

        4.25

        %

         

         

        1.94

        %

         

         

        0.99

        %

         

        Weighted-average rate for the period

         

         

        3.33

        %

         

         

        1.45

        %

         

         

        1.14

        %

         

        Market Risk

                We engage in investment activities to accommodate clients' cash management needs and to contribute to overall corporate earnings. 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.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 the investment.investing 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. 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. The objective of interest rate sensitivity management is to provide sustainable net interest revenueincome under various economic conditions. 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. Since client deposits and repurchase agreements, our primary sources of funds, are predominantly short term, we maintain a generally short-term

        Our balance sheet is primarily subject to interest rate repricing structurerisk, 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 being paid off earlier than the scheduled maturity date, is inherent in our investment securities, mainly our mortgage-backed securities and Federal agency bond portfolios. Prepayment levels for our interest-earning assets. We also use term borrowingsmortgage-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 rate swap agreements to augment our management of interest rate exposure. The effect of the swap agreements is to lengthen short-term variable-rate liabilities into longer-term, fixed-rate liabilities.rates.

        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 be reducedimpacted by more than 10% given a change in interest rates of up to 200 basis points (+ or -) over twelve months. 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. Due to current interest rate levels, the Company's Board of Directors has approved a temporary exception to the 10% limit for decreases in interest rates. The Board of Directors approved the policy exception because, with the Federal Funds target rate currently at 1.00%, a 200 basis point further reduction would move rates into a negative position and is therefore not likely to occur.

                Our Board of Directors has delegatedThe 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 both December 31, 20032005 and 20022004 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  7.83% and 6.56%approximately 7%, respectively.which is 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%.period. This modified simulation resultswould result in a decreasean increase in projected net interest income of 11.42% and 14.20%approximately 1% at December 31, 20032005 and 2002, respectively.would have approximately 0% impact at December 31, 2004, both within our 10% 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 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, at December 31, 2003,2005, 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 until interest rates stabilize. During a period of rising interest rates, net interest income would be lower than it would have been until interest rates stabilize. However, at the current absolute level of interest rates, lower interest rates may also lead to lower net interest income due to a diminished ability to lower the rates paid on interest-bearing liabilities, including certain client funds, as rates approach zero. 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 adding 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. Short-term wholesale funding is used to replace temporary deposit outflows and support balance sheet growth. We also use term borrowings and interest rate swap agreements to augment our management of interest rate risk. 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 were 3.51% and 3.09% at December 31, 2005 and 2004, respectively. Variable-interest payments received are currently indexed to the overnight Federal Funds rate. At December 31, 2005 and 2004, the weighted-average rate of variable market-indexed interest payment obligations to the Company were 4.00% and 2.22%, respectively. The remaining terms of swaps range from 0 to 30 months. These contracts had net fair values of approximately $24.2 million and $1.5 million at December 31, 2005 and 2004, respectively.

        The following table presents the repricing schedule for our interest-earning assets and interest-bearing liabilities at December 31, 20032005 (Dollars in thousands):


        		 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) $4,351,570 $449,771 $732,682 $2,670,705  398,125 $8,602,853

         

        Within

         

        Three

         

        Six

         

        One

         

         

         

         

         

        Loans—variable rate  199,618 — — —  —  199,618

         

        Three

         

        To Six

         

        To Twelve

         

        Year to

         

        Over Five

         

         

         

        Loans—fixed rate  — — — 12  —  12

         

        Months

         

        Months

         

        Months

         

        Five Years

         

        Years

         

        Total

         

         
        		 
        		 
        		 
        		 
        		 
         Total interest-earning assets  4,551,188 449,771 732,682 2,670,717  398,125  8,802,483

        Interest-earning assets(1):

         

         

         

         

         

         

         

         

         

         

         

         

         

        Investment securities(2,3)

         

        $

        6,422,257

         

        $

        605,630

         

        $

        948,944

         

        $

        2,706,315

         

        $

        469,115

         

        $

        11,152,261

         

        Loans—variable-rate

         

        394,158

         

        8,300

         

        —

         

        —

         

        —

         

        402,458

         

        Loans—fixed rate

         

        —

         

        12

         

        —

         

        —

         

        —

         

        12

         

        Total interest-earning assets

         

        6,816,415

         

        613,942

         

        948,944

         

        2,706,315

         

        469,115

         

        11,554,731

         


        Interest-bearing liabilities:
        Interest-bearing liabilities:
         
         
         
         
         
         
         
         
         
         
         
         
         
         
         

         

         

         

         

         

         

         

         

         

         

         

         

         

        Savings accounts  3,582,146 — — 50,768  —  3,632,914
        Interest rate contracts  (1,090,000) 90,000 180,000 820,000  —  —
        Securities sold under repurchase agreements  2,858,001 — — 400,000  —  3,258,001
        Short-term and other borrowings  948,087 — — 150,000  —  1,098,087
        Junior subordinated debentures  — — — 24,774  —  24,774
         
        		 
        		 
        		 
        		 
        		 
         Total interest-bearing liabilities  6,298,234 90,000 180,000 1,445,542  —  8,013,776
         
        		 
        		 
        		 
        		 
        		 
         Net interest sensitivity gap during the period $(1,747,046)$359,771 $552,682 $1,225,175 $398,125 $788,707
         
        		 
        		 
        		 
        		 
        		 
         Cumulative gap $(1,747,046)$(1,387,275)$(834,593)$390,582 $788,707   
         
        		 
        		 
        		 
        		 
        		   

        Demand deposit accounts

         

        85,157

         

        —

         

        —

         

        —

         

        —

         

        85,157

         

        Savings accounts

         

        4,137,272

         

        —

         

        —

         

        58,214

         

        —

         

        4,195,486

         

        Time deposits

         

        55,124

         

        —

         

        —

         

        —

         

        —

         

        55,124

         

        Interest rate contracts

         

        (1,735,000

        )

        120,000

         

        265,000

         

        1,350,000

         

        —

         

        —

         

        Securities sold under repurchase agreements

         

        4,047,868

         

        100,000

         

        150,000

         

        500,000

         

        —

         

        4,797,868

         

        Short-term and other borrowings

         

        1,306,649

         

        —

         

        50,000

         

        —

         

        —

         

        1,356,649

         

        Junior subordinated
        debentures

         

        —

         

        —

         

        —

         

        24,774

         

        —

         

        24,774

         

        Total interest-bearing liabilities

         

        7,897,070

         

        220,000

         

        465,000

         

        1,932,988

         

        —

         

        10,515,058

         

        Net interest-sensitivity gap during the period

         

        $

        (1,080,655

        )

        $

        393,942

         

         

        $ 483,944

         

        $

        773,327

         

        $

        469,115

         

        $

        1,039,673

         

        Cumulative gap

         

        $

        (1,080,655

        )

        $

        (686,713

        )

        $

        (202,769

        )

        $

        570,558

         

        $

        1,039,673

         

         

         

        Interest-sensitive assets as a percent of interest-sensitive liabilities (cumulative)Interest-sensitive assets as a percent of interest-sensitive liabilities (cumulative)  72.26% 78.28% 87.29% 104.87% 109.84%  

         

        86.32

        %

        91.54

        %

        97.64

        %

        105.43

        %

        109.89

        %

         

         

         
        		 
        		 
        		 
        		 
        		   
        Interest-sensitive assets as a percent of total assets (cumulative)Interest-sensitive assets as a percent of total assets (cumulative)  49.35% 54.22% 62.17% 91.12% 95.44%  

         

        56.35

        %

        61.43

        %

        69.27

        %

        91.64

        %

        95.52

        %

         

         

         
        		 
        		 
        		 
        		 
        		   
        Net interest sensitivity gap as a percent of total assets  (18.94%) 3.90% 5.99% 13.28% 4.32%  
         
        		 
        		 
        		 
        		 
        		   

        Net interest-sensitivity gap as a percent of total assets

         

        (8.93

        )%

        3.26

        %

        4.00

        %

        6.39

        %

        3.88

        %

         

         

        Cumulative gap as a percent of total assetsCumulative gap as a percent of total assets  (18.94%) (15.04%) (9.05%) 4.23% 8.55%  

         

        (8.93

        )%

        (5.68

        )%

        (1.68

        )%

        4.72

        %

        8.59

        %

         

         

         
        		 
        		 
        		 
        		 
        		   

        (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 $21.3 million of unsettled securities purchases and $41.9 million of net unrealized losses as of December 31, 2005.

        45



        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, these 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 Federal Reserve Discount Window borrowings. As a result of our management of liquid assets and theour 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 $0.07$0.09 per share of outstanding common stock for 20042006 (approximately $4.6$5.9 million based upon 65,436,78865,052,637 shares outstanding as of December 31, 2003)2005).

        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 ICTI,Investors Capital Trust I, a Delaware statutory business trust sponsored by us, and qualify as Tier 1 capital under the capital guidelines of the Federal Reserve.

        In July 2005, we announced that our Board of Directors authorized us to repurchase up to $150.0 million of our common stock in the open market over the next twelve months. The purchase of our common stock has been funded primarily by a dividend from the Bank to the Company. We do not expect the stock purchase program to have a material impact on our liquidity position, our risk-based capital ratios, including our leverage capital ratio, or our ability to pay dividends on our common stock. As of December 31, 2005, we have repurchased $70.7 million of our common stock.

        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, 2003 was $2.4 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 brokercounterparty 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, 2003 was $3.9 billion.

                We also have a borrowing arrangement with the FHLBB. We may borrow amounts determined by prescribed collateral levels and the amount of FHLBB stock we hold. We are required to hold FHLBB stock equal to no less than (i) 1% of our outstanding residential mortgage loan principal (including mortgage pool securities), (ii) 0.3% of total assets, or (iii) total advances fromOn April 19, 2004, the FHLBB divided by a leverage factor of 20. The aggregate amount of borrowing available to us under this arrangement at December 31, 2003 was approximately $1.3 billion. The amount outstanding under this arrangement at December 31, 2003 was $0.4 billion.

                The FHLBB is implementingimplemented a new capital structure and stock-investment rulesmandated for all Federal Home Loan Banks subject to comply with the Gramm-Leach-Bliley Act of 1999 and regulations that were subsequently promulgated in 2001 by the FHLBB'sFHLBB’s regulator, the Federal Housing Finance Board. The Bank'sBank’s capital stock investment in the FHLBB will remain at its current leveltotaled $50.0 million as of $50December 31, 2005. The $50.0 million undercapital stock investment includes both a $25.0 million membership component and a $25.0 million activity-based component. Under the new capital plan, which takes effect on April 19, 2004. FHLBB capital stock investments require a five-year advance notice of withdrawal underwithdrawal. Recent changes to the new capital plan. Under the newFHLBB capital plan our $50have resulted in an increased borrowing capacity. The Bank’s $50.0 million capital stock investment in the FHLBB will provide aprovides an overnight borrowing capacity of approximately $555up to $833.0 million. The amount outstanding under this arrangement at December 31, 2005



        was $546.0 million. Additional borrowing is available to the Bank based on prescribed collateral levels and increased investment in FHLBB capital stock. The Bank currently has no plans to increase its investment in FHLBB capital stock.

        The following table details our contractual obligations as of December 31, 20032005 (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 $1,098,087 $948,087 $150,000 $— $—
         Repurchase agreements  3,258,001  2,858,001  250,000  150,000  —
         Mandatorily redeemable, preferred securities of subsidiary trust(1)  24,000  —  —  24,000  —
         Operating lease obligations  157,544  36,069  58,823  32,573  30,079
          
        		 
        		 
        		 
        		 
          Total $4,537,632 $3,842,157 $458,823 $206,573 $30,079
          
        		 
        		 
        		 
        		 

         

         

        Payments due by period

         

         

         

         

         

        Less than 1

         

        1-3

         

        4-5

         

        More than

         

         

         

        Total

         

        year

         

        years

         

        years

         

        5 years

         

        Contractual obligations

         

         

         

         

         

         

         

         

         

         

         

         

         

        Debt obligations(1)

         

        $

        1,356,649

         

        $

        1,356,649

         

        $

        —

         

        $

        —

         

         

        $

        —

         

         

        Repurchase agreements

         

        4,797,868

         

        4,297,868

         

        500,000

         

        —

         

         

        —

         

         

        Junior subordinated debentures(2)

         

        24,000

         

        —

         

        24,000

         

        —

         

         

        —

         

         

        Operating lease obligations

         

        218,542

         

        32,186

         

        54,048

         

        45,876

         

         

        86,432

         

         

        Total

         

        $

        6,397,059

         

        $

        5,686,703

         

        $

        578,048

         

        $

        45,876

         

         

        $

        86,432

         

         

        (1)

                  Debt obligations presented are variable in nature and do not include interest amounts.

        (2)These securities ultimately mature in 2027, however,however; we have the right to redeem the securities as early as 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 $759,483 $623,966 $135,517 $— $—
         Interest rate swaps (notional amount)  1,180,000  360,000  820,000  —  —
         Fixed price purchase contracts  792,072  792,072  —  —  —
         Other  26,465  13,037  13,428  —  —
          
        		 
        		 
        		 
        		 
          Total $2,758,020 $1,789,075 $968,945 $— $—
          
        		 
        		 
        		 
        		 

         

         

        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

         

        $

        898,879

         

        $

        892,179

         

        $

        —

         

        $

        6,700

         

         

        $

        —

         

         

        Fixed price purchase contracts

         

        97,539

         

        97,539

         

        —

         

        —

         

         

        —

         

         

        Other

         

        147,994

         

        30,800

         

        61,288

         

        47,016

         

         

        8,890

         

         

        Total

         

        $

        1,144,412

         

        $

        1,020,518

         

        $

        61,288

         

        $

        53,716

         

         

        $

        8,890

         

         

         

        Included in the Other commitments line describedpresented above are contracts in which we are obligated to utilize the data processing services of Electronic Data Systems ("EDS") andthrough December 31, 2008, SEI Investments Company ("SEI") through December 31, 2005.2009 and International Business Machines Corporation through June 30, 2011. The commitment to pay for services provided is volume driven. The commitmentcommitments to pay for these services isare based upon transaction volumes and includesinclude inflationary price clauses. To estimate our future contractual obligations for these commitments, we assumed transaction volumes would remain consistent with 2003 volumes and increased the amount by 3% each year.

        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 microcomputersoffice 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 $29.5$33.1 million and $48.6$23.6 million for the yearsyear ended December 31, 20032005 and 2002,2004, respectively. 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. For the year ended December 31, 2002,2004, capital expenditures were comprised of approximately $31.6$15.4 million in capitalized software and projects in process, $14.0$7.9 million in fixed assets and $3.0$0.3 million in leasehold improvements.

                Stockholders'Stockholders’ equity at December 31, 20032005 was $540.3$772.9 million, up 22%,9% from 2002,2004, primarily due to net income growth in 2003.earned, net of our stock repurchase program. The ratio of average stockholders'stockholders’ equity to average assets decreased to 5.9%remained constant at approximately 6% for December 31, 2003 from 6.4% at2005 and 2004.


        In July 2005, we announced that our Board of Directors has authorized us to repurchase up to $150.0 million of our common stock in the open market over the next twelve months. We do not expect our stock purchase 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, 2002, primarily due to asset growth in



        investment securities funded by increases in securities purchased under resale agreements and customer deposits.2005, we have repurchased $70.7 million of our common stock.

        The FRB has adopted a system using internationally consistent risk-based capital adequacy guidelines applicable to evaluate theUnited States banking organizations. The FRB’s capital adequacy of banks andguidelines generally require bank holding companies. Under the risk-based capital guidelines, different categories of assets are assigned different risk weights, based generally upon the perceived credit risk of the asset. These risk weights are multiplied by corresponding asset balancescompanies (“BHCs”) to determine a "risk-weighted" asset base. Certain off-balance sheet items are added to the risk-weighted asset base by converting them to a balance sheet equivalent and assigning them the appropriate risk weight.

                FRB and FDIC guidelines require that banking organizations have a minimum ratio ofmaintain total capital equal to 8% of total risk-adjusted assets and off-balance sheet items of 8.0%. Total capital is defined as the sum of "Tier 1" and "Tier 2" capital elements,(the “Total Risk-Based Capital Ratio”), with at least half50% of that amount consisting of Tier 1, or core capital, and the total capital required to beremaining amount consisting of Tier 1.2, or supplementary capital. Tier 1 capital includes, with certain restrictions,for BHCs generally consists of the sum of common stockholders'stockholders’ equity noncumulativeand perpetual preferred stock a limited amount of cumulative perpetual preferred stock,(subject to certain limitations), less goodwill and minority interests in consolidated subsidiaries, less certainother nonqualifying intangible assets. Tier 2 capital includes, with certain limitations, subordinated debt meeting certain requirements, intermediate-term preferred stock, certaingenerally consists of hybrid capital instruments, certain forms ofperpetual debt and mandatory convertible debt securities; perpetual preferred stock, not included as well as maturing capital instrumentsTier 1 capital; term subordinated debt and intermediate-term preferred stock; and, subject to limitations, general allowances for loan and lease losses. Our Total and Tier 1 capital ratios at December 31, 2003 were 17.62% and 17.61%, respectively, whichAssets are in excess of minimum requirements. The Bank's Total and Tier 1 capital ratios at December 31, 2003 were each 17.42%, which are in excess of minimum requirements.adjusted under the risk-based guidelines to take into account different risk characteristics.

        In addition to the risk-based capital guidelines,requirements, the FRB and the FDIC userequires BHCs to maintain a "Leverage Ratio" as an additional tool to evaluateminimum leverage capital adequacy. The Leverage Ratio is defined to be a company's Tier 1 capital divided by its adjusted average total assets. The Leverage Ratio adopted by the federal banking agencies requires a ratio of 3.0% Tier 1 capital to adjustedits average total consolidated assets (the “Leverage Ratio”) of 3.0%. 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% Leverage Ratio requirement is the minimum for the top-rated banking institutions.BHCs. All other banking institutionsBHCs are required to maintain a minimum Leverage Ratio of 4.0%. 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% to 5.0%. The computation ofor higher.

        We are currently in compliance with both the risk-based capital ratiosTotal Risk-Based Capital Ratio and the Leverage Ratio requiresrequirements, and management expects these ratios to remain in compliance with the FRB’s capital adequacy guidelines. At December 31, 2005, our Total Risk-Based Capital Ratio and Leverage Ratio were 18.50% and 5.95%, respectively.

        Off Balance Sheet Arrangements

        Lines of Credit—At December 31, 2005, we had commitments to mutual funds and individuals under collateralized open lines of credit totaling $1.1 billion, against which $240.3 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 capitalfair market value of Investors Financialthose 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 that105% of Investors Bankthe 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 reducedrecorded 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 most intangible assets. Our Leverage Ratious as collateral at December 31, 20032005 totaled $7.7 billion while the fair value of the portfolio totaled approximately $7.4 billion. Given that the value of the collateral held was 5.36%, which is in excess of regulatory minimums. Investors Bank's Leverage Ratio at December 31, 2003the 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 5.29%, whichzero 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 alsoa potential risk that the collateral would not be sufficient to cover such an obligation if the security on loan increased in excessvalue 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 regulatory minimums. See "Business—Regulationthe security “bought-in” and Supervision"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” section for additional information.in the “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 Financial Statements” and “Financial Statement Schedules” as a part of this Report.


        ITEM 9a.9A.        CONTROLS AND PROCEDURES
        PROCEDURES.

          Evaluation of Disclosure Controls and Procedures

        As of December 31, 2003,2005, 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, 2003,2005, our disclosure controls and procedures were effective.

        Changes in Internal Controls over Financial Reporting49



                Subsequent to the issuance of our consolidated financial statements for the year ended December 31, 2003, the Company's management determined that they should have applied the retrospective method of accounting for premiums and discounts on certain investment securities under Statement of Financial Accounting Standard No. 91,Accounting for Non-Refundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases. As a result, the accompanying Consolidated Balance Sheets as of December 31, 2003 and 2002 and the related Consolidated Statements of Income and Cash Flows for each of the years in the three-year period ended December 31, 2003 have been restated.

                The evaluation referred to above did not identify any change in our internal control over financial reporting that occurred during the period covered by this annual report on Form 10-K that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.


        ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.

          (a) 1. Consolidated Financial Statements.

                For the following consolidated financial information included herein, see Index on Page F-1:

            Report of Management to Stockholders.
            Independent Accountants' Report.
            Report of Independent Registered Public Accounting Firm.
            Consolidated Balance Sheets as of December 31, 2003 and December 31, 2002.
            Consolidated Statements of Income and Comprehensive Income for the Years Ended December 31, 2003, 2002 and 2001.
            Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 2003, 2002 and 2001.
            Consolidated Statements of Cash Flows for the Years Ended December 31, 2003, 2002 and 2001.
            Notes to Consolidated Financial Statements.

            2. Financial Statement Schedules.

            None.


            3. List of Exhibits.

        Exhibit No.
        		Description

        3.1(14
        )
        Certificate of Incorporation of the Company

        3.2(9
        )
        Certificate of Amendment of Certificate of Incorporation of the Company

        3.3(13
        )
        Certificate of Amendment of Certificate of Incorporation of the Company

        3.4(16
        )
        Certificate of Amendment of Certificate of Incorporation of the Company

        3.5(14
        )
        Amended and Restated Bylaws of the Company

        4.1(14
        )
        Specimen certificate representing the Common Stock of the Company

        4.2(14
        )
        Stockholder Rights Plan

        4.3(6
        )
        Amendment No.1 to Stockholder Rights Plan

        4.4(10
        )
        Amendment No.2 to Stockholder Rights Plan

        10.1(15
        )*
        Amended and Restated 1995 Stock Plan

        10.2(15
        )
        Amended and Restated 1995 Non-Employee Director Stock Option Plan

        10.3(14
        )
        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(2
        )*
        1997 Employee Stock Purchase Plan

        10.6(2
        )
        Amended and Restated Declaration of Trust among the Company and the Trustees named therein, dated January 31, 1997

        10.7(2
        )
        Purchase Agreement among the Company, Investors Capital Trust I and Keefe, Bruyette & Woods, Inc., dated January 30, 1997 (Included in Exhibit 10.6)

        10.8(2
        )
        Indenture between the Company and The Bank of New York, dated January 31, 1997

        10.9(2
        )
        Registration Rights Agreement, among the Company, Investors Capital Trust I and Keefe, Bruyette & Woods, Inc., dated January 31, 1997

        10.10(2
        )
        Common Securities Guarantee Agreement by the Company as Guarantor, dated January 31, 1997

        10.11(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

        10.14(8
        )
        Stock Purchase Agreement, dated as of March 19, 1999, by and between the Company and Oakmont Corporation

        10.15(11
        )
        Asset Purchase Agreement between the Company and The Chase Manhattan Bank dated as of November 28, 2000

        10.16(12
        )
        First Amendment, effective January 1, 2000 to Information Technology Services Contract between the Company and Electronic Data Systems, Inc. dated September 20, 1995

        10.17(12
        )*
        Amended and Restated Employment Agreement between the Company and Kevin Sheehan



        10.18(12
        )*
        Change of Control Employment Agreement between the Company and Kevin Sheehan

        10.19(12
        )*
        Amended and Restated Employment Agreement between the Company and Michael Rogers

        10.20(12
        )*
        Change of Control Employment Agreement between the Company and Michael Rogers

        10.21(12
        )*
        Amended and Restated Employment Agreement between the Company and Edmund Maroney

        10.22(12
        )*
        Change of Control Employment Agreement between the Company and Edmund Maroney

        10.23(12
        )*
        Amended and Restated Employment Agreement between the Company and Robert Mancuso

        10.24(12
        )*
        Change of Control Employment Agreement between the Company and Robert Mancuso

        10.25(12
        )*
        Amended and Restated Employment Agreement between the Company and John Henry

        10.26(12
        )*
        Change of Control Employment Agreement between the Company and John Henry

        10.27(14
        )*
        Change of Control Employment Agreement between the Company and John N. Spinney, Jr.

        10.28(15
        )*
        Employment Agreement between the Company and John N. Spinney, Jr.

        21.1 (17
        )
        Subsidiaries of the Company

        23.1

        Consent of Deloitte & Touche LLP

        24.1 (17
        )
        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 the Company's Current Report on Form 8-K filed with the Commission on March 31, 1999.

        (9)
        Previously filed as an exhibit to Form 10-Q for the fiscal quarter ended March 31, 2000.

        (10)
        Previously filed as an Exhibit to the Company's Current Report on Form 8-K filed with the Commission on September 25, 2000.

        (11)
        Previously filed as an exhibit to the Company's Current Report on Form 8-K filed with the Commission on December 6, 2000.

        (12)
        Previously filed as an exhibit to Form 10-K for the fiscal year ended December 31, 2000.

        (13)
        Previously filed as an exhibit to the Company's Registration Statement on Form S-8 filed with the Commission on November 5, 2001 (File No. 333-72786).

        (14)
        Previously filed as an exhibit to Form 10-K for the fiscal year ended December 31, 2001.

        (15)
        Previously filed as an exhibit to Form 10-K for the fiscal year ended December 31, 2002.

        (16)
        Previously filed as an exhibit to Form 10-Q for the fiscal quarter ended June 30, 2003.

        (17)
        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.

        *
        Indicates a management contract or a compensatory plan, contract or arrangement.

          (b) Reports on Form 8-K.

                A Form 8-K was furnished to the Securities and Exchange Commission on October 20, 2003 furnishing information pursuant to Item 9 (Regulation FD) relating to a press release issued by Investors Financial Services Corp. on the same date.

                A Form 8-K was furnished to the Securities and Exchange Commission on October 15, 2003 furnishing information pursuant to Item 12 (Results of Operation and Financial Condition) relating to the press release of Investors Financial Services Corp.'s financial results for the fiscal quarter ended September 30, 2003.

          (c) Exhibits.

                The Company hereby files as part of this Form 10-K/A 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) Financial Statement Schedules.

                None.



        SIGNATURES

                Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this amended report to be signed on its behalf by the undersigned, thereunto duly authorized, in Boston, Massachusetts on the 15th day of November, 2004.

        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

                Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this amended report has been signed by the following persons in the capacities indicated on the 15th day of November, 2004.

        Signature
        		Title(s)



        /s/  KEVIN J. SHEEHAN      
        Kevin J. Sheehan        		Chief Executive Officer and Chairman of the Board (Principal Executive Officer); Director

        /s/          MICHAEL F. ROGERS      
        Michael F. Rogers

        President

        /s/          JOHN N. SPINNEY, JR.      
        John N. Spinney, Jr.

        Senior Vice President and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)

        /s/          ROBERT B. FRASER      
        Robert B. Fraser

        Director

        /s/          DONALD G. FRIEDL      
        Donald G. Friedl

        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.      
        Frank B. Condon, Jr.

        Director

        /s/          EDWARD F. HINES, JR.      
        Edward F. Hines, Jr.

        Director

        INVESTORS FINANCIAL SERVICES CORP.

        INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


        		Page
        Report of Management to StockholdersF-2

        Independent Accountants' Report

        F-4

        Report of Independent Registered Public Accounting Firm

        F-5

        Consolidated Balance Sheets as of December 31, 2003 and December 31, 2002

        F-6

        Consolidated Statements of Income and Comprehensive Income for the Years Ended December 31, 2003, 2002 and 2001

        F-7

        Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 2003, 2002 and 2001

        F-8

        Consolidated Statements of Cash Flows for the Years Ended December 31, 2003, 2002 and 2001

        F-9

        Notes to Consolidated Financial Statements

        F-10


        REPORT OF MANAGEMENT TO THE BOARD OF DIRECTORS AND STOCKHOLDERS

        February 20, 2004March 2, 2006

        To the Board of Directors and Stockholders:

        Financial Statements

                The management of Investors Bank & Trust Company ("the Bank") is responsible for the preparation, integrity, and fair presentation of its published financial statements and all other information presented in the Consolidated Financial Statements of Investors Financial Services Corp. (the "Company") contained in this Report. The financial statements of the Bank 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 both accounting principles generally accepted in the United States of America and the Federal Financial Institutions Examination Council Instructions for Consolidated Reports of Condition and Income for Schedules RC, RI, and RI-A ("Call Report Instructions").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 assessedhas made a comprehensive review, evaluation and assessment of the institution'sCompany’s internal control over financial reporting, including safeguarding of assets, for financial presentations in conformity with both accounting principles generally accepted in the United States of America and Call Report Instructions as of December 31, 2003.2005, 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 believeshas concluded that the BankCompany maintained effective internal control over financial reporting, including safeguarding of assets, presented in conformity with both accounting principles generally accepted in the United States of America and Call Report Instructions as of December 31, 2003.2005.

        The Audit Committee of the Board of Directors is comprised entirely of outside directors who are independent of the Bank'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 BankCompany in addition to reviewing the Bank'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 the consolidated financial statements contained in this Form 10-K, has issued their report dated March 2, 2006 on management’s assessment with respect to the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005.



        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"(“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, 2003.2005.

        /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


        51




        REPORT OF INDEPENDENT ACCOUNTANTS' REPORTREGISTERED PUBLIC ACCOUNTING FIRM

        To the Audit CommitteeBoard of Directors and Stockholders of
        Investors Bank & Trust Company
        200 Clarendon Street
        Boston, Massachusetts 02116Financial Services Corp.

        We have examinedaudited management's assertion,assessment, included in the accompanying Report of Management, to Stockholders, that Investors Bank & Trust CompanyFinancial Services Corp. and subsidiaries (the "Bank"“Company”) maintained effective internal control over financial reporting including safeguardingas of assets, presentedDecember 31, 2005, based on criteria established in conformityInternal 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 both accounting principles generally accepted in the United States of America and the Federal Financial Institutions Examination Council Instructions for Consolidated Reports of Condition and Income for Schedules RC, RI and RI-A (the "Call“Call Report Instructions"Instructions”) as of December 31, 2003 based on the criteria established in"Internal Control—Integrated Framework" issued by the Committee of Sponsoring Organizations of the Treadway Commission (the "COSO" report).  ManagementThe Company'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's assertionassessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our examination.audit.

                Our examination wasWe conducted our audit in accordance with attestationthe standards established byof the American Institute of Certified Public AccountantsCompany Accounting Oversight Board (United States).  Those standards require that we plan and accordingly,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's assessment, testing, and evaluating the design and operating effectiveness of the internal control, and performing such other procedures as we considered necessary in the circumstances.  We believe that our examinationaudit provides a reasonable basis for our opinion.opinions.

        A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company'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'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's assets that could have a material effect on the financial statements.

        Because of the inherent limitations in anyof internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may occur and not be detected.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 internal controlcontrols 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's assertionassessment that the BankCompany maintained effective internal control over financial reporting including safeguarding of assets, presented in conformity with both accounting principles generally accepted in the United States of America and the Call Report Instructions as of December 31, 2003,2005, is fairly stated, in all material respects, based on the criteria established in Internal Control—Integrated Framework issued by the COSO report.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, 2005, based on the criteria established in Internal 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, 2005 of the Company and our report dated March 2, 2006 expressed an unqualified opinion on those financial statements.

        DELOITTE & TOUCHE LLP

        Boston, Massachusetts
        March 2, 2006

        February 20, 2004

        53



        PART III

        ITEM 10.         DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

        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, 2005.

        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, 2005.

        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, 2005.

        ITEM 13.         CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

        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, 2005.

        ITEM 14.         PRINCIPAL ACCOUNTANT 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, 2005.


        PART IV

        ITEM 15.         EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.

        (a)         1.      Consolidated Financial Statements.

        For the following consolidated financial information included herein, see Index on Page F-1:

        Report of Independent Registered Public Accounting Firm.

        Consolidated Balance Sheets as of December 31, 2005 and December 31, 2004.

        Consolidated Statements of Income and Comprehensive Income for the Years Ended December 31, 2005, 2004 and 2003.

        Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2005, 2004 and 2003.

        Consolidated Statements of Cash Flows for the Years Ended December 31, 2005, 2004 and 2003.

        Notes to Consolidated Financial Statements.

        2.                 Financial Statement Schedules.

        None.

        3.                 List of Exhibits.

        Exhibit No.

        Description

          3.1(6)

        Certificate of Incorporation of the Company

          3.2(3)

        Certificate of Amendment of Certificate of Incorporation of the Company

          3.3(5)

        Certificate of Amendment 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 Restated 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 premises located at 200 Clarendon Street, Boston, Massachusetts

        10.6(11)

        Amendment to Lease between Investors Financial Services Corp. and 100 & 200 Clarendon LLC (successors to the John Hancock Mutual Life Insurance Company), dated January 1, 2005

        10.7(9)*

        1997 Employee Stock Purchase Plan, as amended

        10.8(2)

        Amended and Restated Declaration of Trust among the Company and the Trustees named therein, dated January 31, 1997

        10.9(2)

        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)

        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)

        First 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 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.

        10.33(10)*

        Stock Option Agreement dated November 15, 2004 between the Company and Robert D. Mancuso

        10.34**

        Amended and Restated Trust 3000 Service Agreement between the Company and SEI Investments Company dated July 1, 2004.


        10.35

        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.

        (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-Q for the fiscal quarter ended March 31, 2000.

        (4)          Previously filed as an exhibit to Form 10-K for the fiscal year ended December 31, 2000.

        (5)          Previously filed as an exhibit to the Company’s Registration Statement on Form S-8 filed with the Commission on November 5, 2001 (File No. 333-72786).

        (6)          Previously filed as an exhibit to Form 10-K for the fiscal year ended December 31, 2001.

        (7)          Previously filed as an exhibit to Form 10-K for the fiscal year ended December 31, 2002.

        (8)          Previously filed as an exhibit to Form 10-Q for the fiscal quarter ended June 30, 2003.

        (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.

        *                    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.

        (c)          Financial Statement Schedules.

        None.

        57



        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 2nd day of March, 2006.

        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 2nd day of March, 2006.

        Signature

        Title(s)

        /s/ KEVIN J. SHEEHAN

        Chief Executive Officer and Chairman of the Board

        Kevin J. Sheehan

        (Principal Executive Officer); Director

        /s/ MICHAEL F. ROGERS

        President

        Michael F. Rogers

        /s/ JOHN N. SPINNEY, JR.

        Senior Vice President and Chief Financial Officer

        John N. Spinney, Jr

        (Principal Financial Officer and Principal Accounting Officer)

        /s/ RICHARD P. BOYATZI

        Director

        Richard P. Boyatzi

        /s/ FRANK B. CONDON, JR.

        Director

        Frank B. Condon, Jr.

        /s/ ROBERT B. FRASER

        Director

        Robert B. Fraser


        /s/ EDWARD F. HINES

        Director

        Edward F. Hines

        /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

        59



        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, 2005 and December 31, 2004

        F-3

        Consolidated Statements of Income and Comprehensive Income for the Years Ended December 31, 2005, 2004 and 2003

        F-4

        Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2005, 2004 and 2003

        F-5

        Consolidated Statements of Cash Flows for the Years Ended December 31, 2005, 2004 and 2003

        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"“Company”) as of December 31, 20032005 and 2002,2004, 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, 2003.2005. 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 Company at December 31, 20032005 and 2002,2004, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 20032005, in conformity with accounting principles generally accepted in the United States of America.

                As discussedWe have also audited, in Noteaccordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 2, to2006 expressed an unqualified opinion on management’s assessment of the consolidatedeffectiveness of the Company’s internal control over financial statements, effective January 1, 2001,reporting and an unqualified opinion on the Company adoptedeffectiveness of the provisions of Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities," effective January 1, 2002, the Company adopted the provisions of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" and effective October 1, 2003, the Company adopted the provisions of FASB Interpretation No. 46, "Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51".

                As discussed in Note 23, the 2003, 2002 and 2001 consolidatedCompany’s internal control over financial statements have been restated.reporting.

        DELOITTE & TOUCHE LLP

        Boston, Massachusetts
        February 20, 2004 (November 12, 2004,
        as to the effects of the restatement
        discussed in Note 23)March 2, 2006


        F-2




        INVESTORS FINANCIAL SERVICES CORP.
        CONSOLIDATED BALANCE SHEETS
        December 31, 20032005 and 20022004 (Dollars in thousands, except per share data)

         
        		 December 31,
        2003
        (As Restated)
        		 December 31,
        2002
        (As Restated)
        		 
        Assets       
        Cash and due from banks $39,689 $14,568 
        Securities held to maturity (fair value of $4,308,578 and $3,460,754 at December 31, 2003 and 2002, respectively) (Note 4)  4,306,216  3,437,955 
        Securities available for sale (Note 4)  4,296,637  3,272,465 
        Nonmarketable equity securities (Note 4)  50,000  50,000 
        Loans, less allowance for loan losses of $100 at December 31, 2003 and 2002 (Note 5)  199,530  143,737 
        Accrued interest and fees receivable  72,816  67,261 
        Equipment and leasehold improvements, less accumulated depreciation of $47,683 and $25,402 at December 31, 2003 and 2002, respectively (Note 6)  76,420  74,869 
        Goodwill (Note 3)  79,969  79,969 
        Other assets  101,901  73,916 
          
        		 
        		 
        Total Assets $9,223,178 $7,214,740 
          
        		 
        		 

        Liabilities and Stockholders' Equity
         
         
         
         
         
         
         

        Liabilities:
         
         
         
         
         
         
         
        Deposits:       
         Demand $334,823 $384,461 
         Savings  3,682,295  2,858,457 
         Time (Note 7)  190,000  90,000 
          
        		 
        		 
          Total deposits  4,207,118  3,332,918 
        Securities sold under repurchase agreements (Note 8)  3,258,001  2,301,974 
        Short-term and other borrowings (Note 9)  1,098,087  741,107 
        Due to brokers for open trades payable  —  286,843 
        Junior subordinated deferrable interest debentures (Note 11)  24,774  — 
        Other liabilities  94,941  85,096 
          
        		 
        		 
          Total liabilities  8,682,921  6,747,938 
          
        		 
        		 
        Commitments and contingencies (Note 17)       
        Company-obligated, mandatorily redeemable, preferred securities of subsidiary trust holding solely junior subordinated deferrable interest debentures of the Company (Note 11)  —  24,000 
          
        		 
        		 

        Stockholders' Equity:
         
         
         
         
         
         
         
        Preferred stock, par value $0.01 (shares authorized: 1,000,000; issued and outstanding: none in 2003 and in 2002)  —  — 
        Common stock, par value $0.01 (shares authorized: 100,000,000 in 2003 and in 2002; issued and outstanding: 65,436,788 and 64,775,042 in 2003 and 2002, respectively)  655  648 
        Surplus  242,662  233,337 
        Deferred compensation  (1,076) (1,599)
        Retained earnings  280,701  192,184 
        Accumulated other comprehensive income, net  17,865  18,232 
        Treasury stock, at cost (26,508 and 10,814 shares in 2003 and 2002, respectively)  (550) — 
          
        		 
        		 
          Total stockholders' equity  540,257  442,802 
          
        		 
        		 

        Total Liabilities and Stockholders' Equity
         
        $
        9,223,178
         
        $
        7,214,740
         
          
        		 
        		 

         

         

        December 31,

         

        December 31,

         

         

         

        2005

         

        2004

         

        Assets

         

         

         

         

         

         

         

         

         

        Cash and due from banks

         

         

        $

        79,637

         

         

         

        $

        49,059

         

         

        Securities held to maturity (including securities pledged of $4,529,421 and $4,021,625 at December 31, 2005 and 2004, respectively) (approximate fair value of $6,725,729 and $5,937,462 at December 31, 2005 and 2004, respectively) (Note 3)

         

         

        6,761,930

         

         

         

        5,942,717

         

         

        Securities available for sale (including securities pledged of $2,997,958 and $2,312,410 at December 31, 2005 and 2004, respectively) (Note 3)

         

         

        4,369,720

         

         

         

        4,565,505

         

         

        Nonmarketable equity securities (Note 3)

         

         

        50,000

         

         

         

        50,000

         

         

        Loans, less allowance for loan losses of $100 at December 31, 2005 and 2004
        (Note 4)

         

         

        402,370

         

         

         

        134,530

         

         

        Accrued interest and fees receivable

         

         

        119,583

         

         

         

        89,292

         

         

        Equipment and leasehold improvements, less accumulated depreciation of $59,156 and $61,017 at December 31, 2005 and 2004, respectively (Note 5)

         

         

        69,401

         

         

         

        67,883

         

         

        Goodwill

         

         

        79,969

         

         

         

        79,969

         

         

        Other assets

         

         

        163,783

         

         

         

        188,870

         

         

        Total Assets

         

         

        $

        12,096,393

         

         

         

        $

        11,167,825

         

         

        Liabilities and Stockholders’ Equity

         

         

         

         

         

         

         

         

         

        Liabilities:

         

         

         

         

         

         

         

         

         

        Deposits (Note 6):

         

         

         

         

         

         

         

         

         

        Demand

         

         

        $

        537,558

         

         

         

        $

        690,308

         

         

        Savings

         

         

        4,224,908

         

         

         

        4,448,405

         

         

        Time

         

         

        230,124

         

         

         

        257,669

         

         

        Total deposits

         

         

        4,992,590

         

         

         

        5,396,382

         

         

        Securities sold under repurchase agreements (Note 7)

         

         

        4,797,868

         

         

         

        4,255,497

         

         

        Short-term and other borrowings (Note 8)

         

         

        1,356,649

         

         

         

        594,681

         

         

        Due to brokers for open trades payable

         

         

        21,293

         

         

         

        5,475

         

         

        Junior subordinated deferrable interest debentures (Note 10)

         

         

        24,774

         

         

         

        24,774

         

         

        Accrued taxes and other expenses

         

         

        45,077

         

         

         

        54,967

         

         

        Other liabilities

         

         

        85,284

         

         

         

        123,787

         

         

        Total liabilities

         

         

        11,323,535

         

         

         

        10,455,563

         

         

        Commitments and contingencies (Note 16)

         

         

        —

         

         

         

        —

         

         

        Stockholders’ Equity:

         

         

         

         

         

         

         

         

         

        Preferred stock, par value $0.01 (shares authorized: 1,000,000; issued: none in 2005 and 2004)

         

         

        —

         

         

         

        —

         

         

        Common stock, par value $0.01 (shares authorized: 175,000,000; issued: 65,052,637 and 66,595,349 in 2005 and 2004, respectively)

         

         

        672

         

         

         

        667

         

         

        Surplus

         

         

        286,265

         

         

         

        272,536

         

         

        Deferred compensation

         

         

        (311

        )

         

         

        (572

        )

         

        Retained earnings

         

         

        572,549

         

         

         

        418,034

         

         

        Accumulated other comprehensive (loss) income, net

         

         

        (13,369

        )

         

         

        23,888

         

         

        Treasury stock, at cost (2,124,669 and 73,235 shares in 2005 and 2004, respectively)

         

         

        (72,948

        )

         

         

        (2,291

        )

         

        Total stockholders’ equity

         

         

        772,858

         

         

         

        712,262

         

         

        Total Liabilities and Stockholders’ Equity

         

         

        $

        12,096,393

         

         

         

        $

        11,167,825

         

         

        See Notes to Consolidated Financial Statements.


        F-3




        INVESTORS FINANCIAL SERVICES CORP.
        CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
        Years Ended December 31, 2003, 20022005, 2004 and 20012003 (Dollars in thousands, except per share data)


        		 December 31,
        2003
        (As Restated)
        		 December 31,
        2002
        (As Restated)
        		 December 31,
        2001
        (As Restated)
        		 
        Operating Revenue:       
        Interest income:       
        Federal Funds sold and securities purchased under resale agreements $326 $740 $1,602 

         

        December 31,

         

        December 31,

         

        December 31,

         

        Investment securities held to maturity and available for sale (including non-taxable income of $20,477, $17,556 and $14,266, respectively) 243,191 241,012 236,397 

         

        2005

         

        2004

         

        2003

         

        Loans 3,577 3,774 5,572 
         
        		 
        		 
        		 
         Total interest income 247,094 245,526 243,571 
         
        		 
        		 
        		 
        Interest expense:       
        Deposits 39,819 42,257 65,338 
        Short-term and other borrowings 53,361 64,544 79,878 
         
        		 
        		 
        		 
         Total interest expense 93,180 106,801 145,216 
         
        		 
        		 
        		 
         Net interest income 153,914 138,725 98,355 
         
        		 
        		 
        		 
        Noninterest income:       
        Asset servicing fees (Note 21) 333,586 296,395 251,359 
        Other operating income 2,607 2,449 3,128 
         
        		 
        		 
        		 
         Net operating revenue 490,107 437,569 352,842 
         
        		 
        		 
        		 

        Fees and Other Revenue:

         

         

         

         

         

         

         

         

         

         

         

         

         

        Asset servicing fees:

         

         

         

         

         

         

         

         

         

         

         

         

         

        Core service fees

         

         

        $

        375,596

         

         

         

        $

        314,272

         

         

         

        $

        254,225

         

         

        Value-added service fees

         

         

        133,463

         

         

         

        108,928

         

         

         

        79,361

         

         

        Total asset servicing fees

         

         

        509,059

         

         

         

        423,200

         

         

         

        333,586

         

         

        Gain on sale of investments

         

         

        12,397

         

         

         

        234

         

         

         

        —

         

         

        Other operating income

         

         

        4,081

         

         

         

        2,057

         

         

         

        2,607

         

         

        Total fees and other revenue

         

         

        525,537

         

         

         

        425,491

         

         

         

        336,193

         

         

        Interest income

         

         

        447,705

         

         

         

        313,149

         

         

         

        247,094

         

         

        Interest expense

         

         

        277,280

         

         

         

        125,469

         

         

         

        93,180

         

         

        Net interest income

         

         

        170,425

         

         

         

        187,680

         

         

         

        153,914

         

         

        Net operating revenue

         

         

        695,962

         

         

         

        613,171

         

         

         

        490,107

         

         


        Operating Expenses:
        Operating Expenses:
         
         
         
         
         
         
         

         

         

         

         

         

         

         

         

         

         

         

         

         

        Compensation and benefitsCompensation and benefits 186,932 192,785 164,186 

         

         

        250,459

         

         

         

        205,728

         

         

         

        186,932

         

         

        Technology and telecommunicationsTechnology and telecommunications 38,914 42,190 39,194 

         

         

        54,732

         

         

         

        49,816

         

         

         

        38,914

         

         

        Transaction processing servicesTransaction processing services 33,299 33,713 28,710 

         

         

        49,873

         

         

         

        42,159

         

         

         

        33,299

         

         

        Depreciation and amortization

         

         

        31,578

         

         

         

        32,124

         

         

         

        27,971

         

         

        OccupancyOccupancy 29,218 25,602 17,965 

         

         

        26,490

         

         

         

        29,032

         

         

         

        29,218

         

         

        Depreciation and amortization 27,971 16,357 8,404 
        Professional feesProfessional fees 11,189 11,829 7,933 

         

         

        13,380

         

         

         

        15,346

         

         

         

        11,189

         

         

        Travel and sales promotionTravel and sales promotion 4,822 5,819 5,349 

         

         

        6,825

         

         

         

        5,470

         

         

         

        4,822

         

         

        Amortization of goodwill (Note 3) — — 3,559 

        Losses and loss adjustment expenses

         

         

        5,837

         

         

         

        924

         

         

         

        799

         

         

        Insurance

         

         

        4,219

         

         

         

        4,625

         

         

         

        3,203

         

         

        Other operating expensesOther operating expenses 12,576 13,100 13,876 

         

         

        16,716

         

         

         

        13,159

         

         

         

        8,574

         

         

         
        		 
        		 
        		 
         Total operating expenses 344,921 341,395 289,176 
         
        		 
        		 
        		 

        Total operating expenses

         

         

        460,109

         

         

         

        398,383

         

         

         

        344,921

         

         

        Income Before Income TaxesIncome Before Income Taxes 145,186 96,174 63,666 

         

         

        235,853

         

         

         

        214,788

         

         

         

        145,186

         

         

        Provision for income taxes (Note 10) 52,765 28,737 18,980 
         
        		 
        		 
        		 

        Provision for income taxes (Note 9)

         

         

        76,035

         

         

         

        72,826

         

         

         

        52,765

         

         

        Net IncomeNet Income $92,421 $67,437 $44,686 

         

         

        $

        159,818

         

         

         

        $

        141,962

         

         

         

        $

        92,421

         

         

         
        		 
        		 
        		 
        Basic Earnings Per ShareBasic Earnings Per Share $1.42 $1.05 $0.71 

         

         

        $

        2.42

         

         

         

        $

        2.15

         

         

         

        $

        1.42

         

         

         
        		 
        		 
        		 
        Diluted Earnings Per ShareDiluted Earnings Per Share $1.39 $1.02 $0.68 

         

         

        $

        2.37

         

         

         

        $

        2.09

         

         

         

        $

        1.39

         

         

         
        		 
        		 
        		 

        Weighted-Average Basic Shares

         

         

        66,139,323

         

         

         

        66,179,286

         

         

         

        65,098,960

         

         

        Weighted-Average Diluted Shares

         

         

        67,473,804

         

         

         

        67,916,217

         

         

         

        66,475,462

         

         

        Comprehensive Income:Comprehensive Income:       

         

         

         

         

         

         

         

         

         

         

         

         

         

        Net incomeNet income $92,421 $67,437 $44,686 

         

         

        $

        159,818

         

         

         

        $

        141,962

         

         

         

        $

        92,421

         

         

        Other comprehensive income (loss) (Note 13):       
        Cumulative effect of a change in accounting principle — — (3,934)
        Net unrealized investment (loss) gain (12,963) 31,944 7,211 
        Net unrealized derivative instrument gain (loss) 12,019 (9,516) (6,043)
        Cumulative translation adjustment 577 — — 
         
        		 
        		 
        		 
         Other comprehensive income (loss) (367) 22,428 (2,766)
         
        		 
        		 
        		 

        Other comprehensive (loss) income (Note 12):

         

         

         

         

         

         

         

         

         

         

         

         

         

        Net unrealized investment loss

         

         

        (46,054

        )

         

         

        (7,854

        )

         

         

        (12,963

        )

         

        Net unrealized derivative instrument gain

         

         

        8,745

         

         

         

        13,031

         

         

         

        12,019

         

         

        Cumulative translation adjustment

         

         

        52

         

         

         

        846

         

         

         

        577

         

         

        Other comprehensive (loss) income

         

         

        (37,257

        )

         

         

        6,023

         

         

         

        (367

        )

         

        Comprehensive incomeComprehensive income $92,054 $89,865 $41,920 

         

         

        $

        122,561

         

         

         

        $

        147,985

         

         

         

        $

        92,054

         

         

         
        		 
        		 
        		 

        See Notes to Consolidated Financial Statements.


        F-4




        INVESTORS FINANCIAL SERVICES CORP.
        CONSOLIDATED STATEMENTS OF STOCKHOLDERS'STOCKHOLDERS’ EQUITY
        Years Ended December 31, 2003, 2002,2005, 2004, and 20012003 (Dollars in thousands, except per share data)

         

        December 31,

         

        December 31,

         

        December 31,

         


        		 December 31,
        2003
        (As Restated)
        		 December 31,
        2002
        (As Restated)
        		 December 31,
        2001
        (As Restated)
        		 

         

        2005

         

        2004

         

        2003

         

        Common shares       

         

         

         

         

         

         

         

         

         

         

         

         

         

        Balance, beginning of year 64,775,042 31,971,404 29,912,711 

         

         

        66,595,349

         

         

         

        65,436,788

         

         

         

        64,775,042

         

         

        Exercise of stock options 548,069 490,827 381,896 

         

         

        394,018

         

         

         

        1,114,051

         

         

         

        548,069

         

         

        Common stock issuance 129,371 143,889 1,672,797 

         

         

        114,704

         

         

         

        91,237

         

         

         

        129,371

         

         

        Restricted stock issuance — — 4,000 
        Common stock repurchased (15,694) — — 

         

         

        (2,051,434

        )

         

         

        (46,727

        )

         

         

        (15,694

        )

         

        Stock dividend, two-for-one split — 32,168,922 — 
         
        		 
        		 
        		 
        Balance, end of year 65,436,788 64,775,042 31,971,404 

         

         

        65,052,637

         

         

         

        66,595,349

         

         

         

        65,436,788

         

         

         
        		 
        		 
        		 
        Treasury shares       

         

         

         

         

         

         

         

         

         

         

         

         

         

        Balance, beginning of year 10,814 10,814 10,814 

         

         

        73,235

         

         

         

        26,508

         

         

         

        10,814

         

         

        Common stock repurchased 15,694 — — 

         

         

        2,051,434

         

         

         

        46,727

         

         

         

        15,694

         

         

         
        		 
        		 
        		 
        Balance, end of year 26,508 10,814 10,814 

         

         

        2,124,669

         

         

         

        73,235

         

         

         

        26,508

         

         

         
        		 
        		 
        		 
        Common stock       

         

         

         

         

         

         

         

         

         

         

         

         

         

        Balance, beginning of year $648 $320 $299 

         

         

        $

        667

         

         

         

        $

        655

         

         

         

        $

        648

         

         

        Exercise of stock options 6 5 5 

         

         

        4

         

         

         

        12

         

         

         

        6

         

         

        Common stock issuance 1 1 16 

         

         

        1

         

         

         

        —

         

         

         

        1

         

         

        Stock dividend, two-for-one split — 322 — 
         
        		 
        		 
        		 
        Balance, end of year $655 $648 $320 

         

         

        $

        672

         

         

         

        $

        667

         

         

         

        $

        655

         

         

         
        		 
        		 
        		 
        Surplus       

         

         

         

         

         

         

         

         

         

         

         

         

         

        Balance, beginning of year $233,337 $222,440 $95,007 

         

         

        $

        272,536

         

         

         

        $

        242,662

         

         

         

        $

        233,337

         

         

        Exercise of stock options 2,971 2,864 2,131 

         

         

        7,775

         

         

         

        16,056

         

         

         

        2,971

         

         

        Tax benefit from stock options 3,008 4,152 4,158 

         

         

        2,087

         

         

         

        10,651

         

         

         

        3,008

         

         

        Common stock issuance 3,386 3,881 119,014 

         

         

        3,867

         

         

         

        3,355

         

         

         

        3,386

         

         

        Stock option issuance — — 2,130 
        Stock option forfeiture (40) — — 

         

         

        —

         

         

         

        (188

        )

         

         

        (40

        )

         

         
        		 
        		 
        		 
        Balance, end of year $242,662 $233,337 $222,440 

         

         

        $

        286,265

         

         

         

        $

        272,536

         

         

         

        $

        242,662

         

         

         
        		 
        		 
        		 
        Deferred compensation       

         

         

         

         

         

         

         

         

         

         

         

         

         

        Balance, beginning of year $(1,599)$(2,563)$(247)

         

         

        $

        (572

        )

         

         

        $

        (1,076

        )

         

         

        $

        (1,599

        )

         

        Restricted stock issuance — — (335)
        Exercise of stock options — — (13)
        Stock option issuance — — (2,130)
        Stock option forfeiture 40 — — 

         

         

        —

         

         

         

        188

         

         

         

        40

         

         

        Amortization of deferred compensation 483 964 162 

         

         

        261

         

         

         

        316

         

         

         

        483

         

         

         
        		 
        		 
        		 
        Balance, end of year $(1,076)$(1,599)$(2,563)

         

         

        $

        (311

        )

         

         

        $

        (572

        )

         

         

        $

        (1,076

        )

         

         
        		 
        		 
        		 
        Retained earnings       

         

         

         

         

         

         

         

         

         

         

         

         

         

        Balance, beginning of year $192,184 $128,288 $86,113 

         

         

        $

        418,034

         

         

         

        $

        280,701

         

         

         

        $

        192,184

         

         

        Net income 92,421 67,437 44,686 

         

         

        159,818

         

         

         

        141,962

         

         

         

        92,421

         

         

        Stock dividend, two-for-one split — (322) — 
        Cash dividend, $0.06, $0.05 and $0.04 per share in the years ended December 31, 2003, 2002 and 2001, respectively (3,904) (3,219) (2,511)
         
        		 
        		 
        		 

        Cash dividend, $0.08, $0.07 and $0.06 per share in the years ended December 31, 2005, 2004 and 2003, respectively

         

         

        (5,303

        )

         

         

        (4,629

        )

         

         

        (3,904

        )

         

        Balance, end of year $280,701 $192,184 $128,288 

         

         

        $

        572,549

         

         

         

        $

        418,034

         

         

         

        $

        280,701

         

         

         
        		 
        		 
        		 
        Accumulated other comprehensive income (loss), net       

        Accumulated other comprehensive (loss) income, net

         

         

         

         

         

         

         

         

         

         

         

         

         

        Balance, beginning of year $18,232 $(4,196)$(1,430)

         

         

        $

        23,888

         

         

         

        $

        17,865

         

         

         

        $

        18,232

         

         

        Cumulative effect of change in accounting principle — — (3,934)
        Net unrealized investment (loss) gain (12,963) 31,944 7,211 
        Net unrealized derivative instrument gain (loss) 11,785 (11,129) (8,149)

        Net unrealized investment loss

         

         

        (46,054

        )

         

         

        (7,854

        )

         

         

        (12,963

        )

         

        Net unrealized derivative instrument gain

         

         

        10,473

         

         

         

        12,990

         

         

         

        11,785

         

         

        Amortization of transition-related adjustment 234 1,613 2,106 

         

         

        —

         

         

         

        —

         

         

         

        234

         

         

        Effect of foreign currency translation 577 — — 
         
        		 
        		 
        		 

        Amortization of terminated interest rate swap agreements

         

         

        (1,728

        )

         

         

        41

         

         

         

        —

         

         

        Cumulative translation adjustment

         

         

        52

         

         

         

        846

         

         

         

        577

         

         

        Balance, end of year $17,865 $18,232 $(4,196)

         

         

        $

        (13,369

        )

         

         

        $

        23,888

         

         

         

        $

        17,865

         

         

         
        		 
        		 
        		 
        Treasury stock       

         

         

         

         

         

         

         

         

         

         

         

         

         

        Balance, beginning of year $— $— $— 

         

         

        $

        (2,291

        )

         

         

        $

        (550

        )

         

         

        $

        —

         

         

        Common stock repurchased (15,694 shares at an average price of $35.07) (550) — — 
         
        		 
        		 
        		 

        Common stock repurchased (2,051,434 shares at an average price of $34.44 in 2005 and 46,727 shares at an average price of $37.24 in 2004)

         

         

        (70,657

        )

         

         

        (1,741

        )

         

         

        (550

        )

         

        Balance, end of year $(550)$— $— 

         

         

        $

        (72,948

        )

         

         

        $

        (2,291

        )

         

         

        $

        (550

        )

         

         
        		 
        		 
        		 
        Total Stockholders' Equity $540,257 $442,802 $344,289 
         
        		 
        		 
        		 

        Total Stockholders’ Equity

         

         

        $

        772,858

         

         

         

        $

        712,262

         

         

         

        $

        540,257

         

         

        See Notes to Consolidated Financial Statements.


        F-5




        INVESTORS FINANCIAL SERVICES CORP.
        CONSOLIDATED STATEMENTS OF CASH FLOWS
        Years Ended December 31, 2003, 20022005, 2004 and 20012003 (Dollars in thousands)

         

        December 31,

         

        December 31,

         

        December 31,

         
        		 December 31,
        2003
        (As Restated)
        		 December 31,
        2002
        (As Restated)
        		 December 31,
        2001
        (As Restated)
        		 

         

        2005

         

        2004

         

        2003

         

        Cash Flows From Operating Activities:Cash Flows From Operating Activities:       

         

         

         

         

         

         

         

        Net incomeNet income $92,421 $67,437 $44,686 

         

         

        $

        159,818

         

         

         

        $

        141,962

         

         

         

        $

        92,421

         

         

         
        		 
        		 
        		 
        Adjustments to reconcile net income to net cash provided by operating activities:Adjustments to reconcile net income to net cash provided by operating activities:       

         

         

         

         

         

         

         

         

         

         

         

         

         

        Equity in undistributed loss of unconsolidated subsidiaryEquity in undistributed loss of unconsolidated subsidiary 8 — — 

         

         

        28

         

         

         

        28

         

         

         

        8

         

         

        Depreciation and amortizationDepreciation and amortization 27,971 16,357 11,963 

         

         

        31,578

         

         

         

        32,124

         

         

         

        27,971

         

         

        Amortization of deferred compensationAmortization of deferred compensation 483 964 162 

         

         

        261

         

         

         

        316

         

         

         

        483

         

         

        Amortization of premiums on securities, net of accretion of discountsAmortization of premiums on securities, net of accretion of discounts 39,200 12,795 8,738 

         

         

        49,578

         

         

         

        40,743

         

         

         

        39,200

         

         

        Gain on sale of investments

         

         

        (12,397

        )

         

         

        (234

        )

         

         

        —

         

         

        Deferred income taxesDeferred income taxes 5,651 3,972 (245)

         

         

        (6,944

        )

         

         

        2,997

         

         

         

        5,651

         

         

        Changes in assets and liabilities:Changes in assets and liabilities:       

         

         

         

         

         

         

         

         

         

         

         

         

         

        Accrued interest and fees receivable (5,555) (7,510) (11,748)
        Other assets (29,878) (25,618) (28,298)
        Other liabilities 27,686 (7,747) 30,248 
         
        		 
        		 
        		 
        Net cash provided by operating activities 157,987 60,650 55,506 
         
        		 
        		 
        		 

        Accrued interest and fees receivable

         

         

        (30,291

        )

         

         

        (16,476

        )

         

         

        (5,555

        )

         

        Other assets

         

         

        25,409

         

         

         

        (89,667

        )

         

         

        (29,878

        )

         

        Accrued taxes and other expenses

         

         

        (9,890

        )

         

         

        2,745

         

         

         

        21,465

         

         

        Other liabilities

         

         

        5,833

         

         

         

        106,795

         

         

         

        6,221

         

         

        Net cash provided by operating activities

         

         

        212,983

         

         

         

        221,333

         

         

         

        157,987

         

         


        Cash Flows From Investing Activities:
        Cash Flows From Investing Activities:
         
         
         
         
         
         
         

         

         

         

         

         

         

         

         

         

         

         

         

         

        Proceeds from paydowns/maturities of securities available for saleProceeds from paydowns/maturities of securities available for sale 1,608,656 699,980 420,138 

         

         

        1,400,359

         

         

         

        1,392,295

         

         

         

        1,608,656

         

         

        Proceeds from paydowns/maturities of securities held to maturityProceeds from paydowns/maturities of securities held to maturity 1,902,187 2,212,594 1,193,524 

         

         

        1,628,989

         

         

         

        1,410,133

         

         

         

        1,902,187

         

         

        Proceeds from sale of securities available for sale

         

         

        376,143

         

         

         

        25,041

         

         

         

        —

         

         

        Purchases of securities available for salePurchases of securities available for sale (2,666,066) (2,020,022) (865,218)

         

         

        (1,649,167

        )

         

         

        (1,704,293

        )

         

         

        (2,666,066

        )

         

        Purchases of securities held to maturityPurchases of securities held to maturity (2,794,414) (2,520,097) (2,432,570)

         

         

        (2,489,882

        )

         

         

        (3,078,456

        )

         

         

        (2,794,414

        )

         

        Purchase of nonmarketable equity securities — — (35,000)
        Net decrease in due to brokers for open trades payable (286,843) — — 
        Net decrease in Federal Funds sold and repurchase agreements — — 450,000 

        Net increase (decrease) in due to brokers for open trades payable

         

         

        15,818

         

         

         

        5,475

         

         

         

        (286,843

        )

         

        Net (increase) decrease in loansNet (increase) decrease in loans (55,793) 88,376 (102,844)

         

         

        (267,840

        )

         

         

        65,000

         

         

         

        (55,793

        )

         

        Purchase of business — — (49,434)
        Purchases of equipment and leasehold improvements (29,495) (48,579) (35,908)
         
        		 
        		 
        		 
        Net cash used in investing activities (2,321,768) (1,587,748) (1,457,312)
         
        		 
        		 
        		 

        Purchases of equipment, leasehold improvements and software

         

         

        (33,068

        )

         

         

        (23,559

        )

         

         

        (29,495

        )

         

        Net cash used in investing activities

         

         

        (1,018,648

        )

         

         

        (1,908,364

        )

         

         

        (2,321,768

        )

         


        Cash Flows From Financing Activities:
        Cash Flows From Financing Activities:
         
         
         
         
         
         
         

         

         

         

         

         

         

         

         

         

         

         

         

         

        Net (decrease) increase in demand depositsNet (decrease) increase in demand deposits (49,638) (122,606) 144,121 

         

         

        (152,750

        )

         

         

        355,485

         

         

         

        (49,638

        )

         

        Net increase (decrease) in time and savings deposits 923,838 1,176,647 (197,128)

        Net (decrease) increase in time and savings deposits

         

         

        (251,042

        )

         

         

        833,779

         

         

         

        923,838

         

         

        Net increase in securities sold under repurchase agreementsNet increase in securities sold under repurchase agreements 956,027 638,662 411,587 

         

         

        542,371

         

         

         

        997,496

         

         

         

        956,027

         

         

        Net increase (decrease) in short-term and other borrowingsNet increase (decrease) in short-term and other borrowings 356,980 (169,174) 910,035 

         

         

        761,968

         

         

         

        (503,406

        )

         

         

        356,980

         

         

        Proceeds from exercise of stock optionsProceeds from exercise of stock options 2,977 2,869 2,123 

         

         

        7,779

         

         

         

        16,068

         

         

         

        2,977

         

         

        Proceeds from issuance of common stockProceeds from issuance of common stock 3,387 3,882 119,030 

         

         

        3,868

         

         

         

        3,355

         

         

         

        3,387

         

         

        Common stock repurchaseCommon stock repurchase (550) — — 

         

         

        (70,657

        )

         

         

        (1,741

        )

         

         

        (550

        )

         

        Cost of issuance of restricted stock — — (335)
        Repurchase of company-obligated, mandatorily redeemable, preferred securities of subsidiary trust — (1,000) — 
        Dividends paid to stockholdersDividends paid to stockholders (3,904) (3,219) (2,511)

         

         

        (5,303

        )

         

         

        (4,629

        )

         

         

        (3,904

        )

         

         
        		 
        		 
        		 
        Net cash provided by financing activities 2,189,117 1,526,061 1,386,922 
         
        		 
        		 
        		 

        Net cash provided by financing activities

         

         

        836,234

         

         

         

        1,696,407

         

         

         

        2,189,117

         

         


        Effect of exchange rates on changes in cash
        Effect of exchange rates on changes in cash
         
        (215
        )
         
        —
         
        —
         

         

         

        9

         

         

         

        (6

        )

         

         

        (215

        )

         


        Net Increase (Decrease) In Cash and Due From Banks
         
        25,121
         
        (1,037
        )
         
        (14,884
        )
         
        		 
        		 
        		 

        Net Increase In Cash and Due From Banks

         

         

        30,578

         

         

         

        9,370

         

         

         

        25,121

         

         


        Cash and Due From Banks, Beginning of Year
        Cash and Due From Banks, Beginning of Year
         
        14,568
         
        15,605
         
        30,489
         

         

         

        49,059

         

         

         

        39,689

         

         

         

        14,568

         

         

         
        		 
        		 
        		 

        Cash and Due From Banks, End of Year
        Cash and Due From Banks, End of Year
         
        $
        39,689
         
        $
        14,568
         
        $
        15,605
         

         

         

        $

        79,637

         

         

         

        $

        49,059

         

         

         

        $

        39,689

         

         

         
        		 
        		 
        		 

        Supplemental Disclosure of Cash Flow Information:
        Supplemental Disclosure of Cash Flow Information:
         
         
         
         
         
         
         

         

         

         

         

         

         

         

         

         

         

         

         

         

        Cash paid for interest $91,858 $105,386 $146,320 
         
        		 
        		 
        		 
        Cash paid for income taxes $39,859 $24,989 $17,829 
         
        		 
        		 
        		 

        Schedule of Non-cash Investing Activities
         
         
         
         
         
         
         
        Change in due to brokers for open trades payable $— $286,843 $— 
         
        		 
        		 
        		 

        Cash paid for interest

         

         

        $

        270,121

         

         

         

        $

        121,542

         

         

         

        $

        91,858

         

         

        Cash paid for income taxes

         

         

        $

        68,664

         

         

         

        $

        77,819

         

         

         

        $

        39,859

         

         

        See Notes to Consolidated Financial Statements.


        F-6




        INVESTORS FINANCIAL SERVICES CORP.

        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

        Years Ended December 31, 2003, 20022005, 2004 and 20012003

        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"(‘the 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, banks and insurance companies. Core services include middle office outsourcing, global custody, multicurrency accounting and mutual fund administration. Value-added services include securities lending, foreign exchange, cash management, performance measurement, institutional transfer agency, investment advisory services, lines of credit middle office outsourcing and brokerage and transition management services. The Company is subject to regulation by the Federal Deposit Insurance Corporation (‘FDIC’), the Federal Reserve Board of Governors (‘FRB’), the Office of the Commissioner of Banks of the Commonwealth of Massachusetts (‘Commissioner’), the Federal Deposit Insurance CorporationSecurities and Exchange Commission (‘SEC’), the National Association of Securities Dealers, Inc.

                On February 1, 2001, (‘NASD’), the Company completed the issuance and sale of 1,624,145 shares of Common Stock at $71.62 per share in a public offering. A portionOffice of the proceeds was used to fundSuperintendent of Financial Institutions in Canada, the acquisitionIrish Financial Services Regulatory Authority, the State of Vermont Department of Banking, Insurance, Securities & Health Care Administration and the operations of the advisor custody unit of The Chase Manhattan Bank N.A. ("Chase"Financial Services Authority (‘FSA’). The remaining proceeds were used for the assumption of the U.S. asset administration unit of Barclays Global Investors, N.A. and for working capital. These share numbers have not been restated to reflect the two-for-one stock split discussed below.

                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 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.United Kingdom.

        2. Summary of Significant Accounting Policies

        Basis of Presentation—The consolidated 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——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 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.



        Value-added services        Value-added services——The Company recognizes revenue from its value-added services, such as foreign exchange, securities lending and cash management services, based on the specific type of transaction processed. Value-added serviceservices revenue is considered earned daily as transactions are processed or services are provided.

        Interest 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.

        F-7



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003

        2. Summary of Significant Accounting Policies (Continued)

        Cash and Cash Equivalents—For purposes of reporting cash flows, the Company defines cash and cash equivalents to include cash, due from banks, and interest-bearing deposits.

        Securities—The Company 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.

        Nonmarketable securities consist of stock of the Federal Home Loan Bank of Boston ("FHLBB"(‘FHLBB’) and are carried at cost and redeemable at par value. The Company is required to hold this stock under its borrowing arrangement with the FHLBB.

        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 method. The Company applies Statement of Financial Accounting Standard 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 the Company’s 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, 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

        F-8



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003

        2. Summary of Significant Accounting Policies (Continued)

        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 periodicallymonthly and a proportionate amount of premium or discount is recognized in income at that time such that the timingeffective yield on the remaining portion of the accretionsecurities continues unchanged.

        As of and amortization is adjusted accordingly.for the years ended December 31, 2005, 2004, and 2003, the Company anticipated prepayments on its mortgage-backed securities. All other securities, including Federal agency securities, state and political subdivisions, corporate debt, U.S. Treasury securities and foreign government securities, do not meet the SFAS 91 criteria for anticipating prepayments. Accordingly, no prepayments were anticipated for these securities.

        Loans—Interest on 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 overboth greater than 60 days delinquent or if management believes that collectionand the loan’s collateral is not probable.sufficient to cover both principal and accrued interest. Interest income on impaired loans is recognized after all past due principal and interest has been repaid 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—Equipment and leasehold improvements are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are provided 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 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 further 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, 20032005 and 2002,2004, the Company's analysesCompany’s analysis indicated there waswere no impairmentmaterial impairments of its long-lived assets.

        F-9



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003

        2. Summary of Significant Accounting Policies (Continued)

        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 Standard No. 109, Accounting for Income Taxes (‘SFAS 109’).

        The Company recorded a one-time benefit of approximately $7 million in the second quarter of 2005 related to the recognition of the indefinite reversal provision of Accounting Principles Board Opinion No. 23, Accounting for Income Taxes—Special Areas (‘APB 23’). The indefinite reversal provision of APB 23 specifies that U.S. income taxes should not be accrued on the undistributed earnings of a foreign subsidiary if those earnings have been or will be invested indefinitely in that subsidiary’s operations. The Company had previously accrued U.S. income taxes on the undistributed earnings of its Irish subsidiaries. In the second quarter of 2005, the Company recognized the indefinite reversal provision of APB 23 due to the projected capital needs of its Irish subsidiaries necessary to support continued growth. As such, the Company will no longer record U.S. income taxes on the undistributed earnings of its Irish subsidiaries.

        Translation of Foreign Currencies—The Company translates the financial statements of its foreign operations into U.S. dollars. Where the functional currency is not in the U.S. dollar, assets 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’) 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’s balance sheets at fair value as other assets or other liabilities, depending on the rights and obligations under the contracts. The Company does not purchaseutilizes derivative financial instruments primarily for trading purposes. Interest rate swap agreements are matched with specific financial instruments reported on the consolidated balance sheet. All derivatives, whether designated in hedging relationships or not, are required to be recorded on the balance sheet atasset and liability management purposes. Changes in the fair value. Ifvalue of a derivative that is designated and qualifies as a cash flow hedge are reported in OCI, net of taxes, to the extent the hedge is highly effective. The ineffective portion, which is the extent to which the changes in the fair value of the derivative exceed the changes in the variability of the expected future cash flows of the hedged item (on an absolute basis), is reported in net interest income. Changes in the fair value of a derivative that is designated and qualifies as a fair value hedge are reported in net interest income, along with the change in the fair value of the derivative andhedged item attributable to the item being hedged are recognized in earnings. If the derivative is designated as a cash flow hedge, the effective portions ofrisk hedged. The changes in the fair value of thea derivative are recorded in other comprehensive income ("OCI"). Ineffective portions of changes in the fair value of the cash flow hedges are recognized in earnings. For derivatives that do not qualify as hedges, changes in their fair valuea hedge are recognized in earnings.

        F-10



                The adoptionINVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003

        2. Summary of SFAS No. 133 on January 1, 2001, resulted inSignificant Accounting Policies (Continued)

        Hedge accounting is discontinued prospectively if a) the hedging relationship no cumulative effect-type adjustmentlonger meets the hedging criteria, b) the derivative expires, is sold or terminated, or the hedged item no longer exists, 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 income. However,interest income over the Company recorded a reduction to OCIremaining term of $3.9 million, net of tax, and a corresponding liability for the derivative financial instrument. Under fair value ofhedge 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 in net interest income.

        The Company enters into interest rate swaps. The reduction to OCI and the recognition of the liabilityderivative contracts that are primarily attributable to net unrealized losses on previously designated as cash flow hedges. In conjunction withhedges of variable-rate liabilities. The unrealized gains or losses related to these contracts are reported in other assets and other liabilities on the adoption, the Company elected to reclassify



        approximately $402 million of securities from held to maturity to available for sale, which further reduced OCI, net of tax, by approximately $1.4 million.Company’s consolidated balance 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. At December 31, 2003 and 2002, the Company had $792.1 million and $432.6 millionThe changes in fair value of these fixed price purchase contracts outstanding to purchase investment securities.are included as a component of OCI. The unrealized gain isgains and losses are included within thein other assets categoryand other liabilities on the Company'sCompany’s consolidated balance sheet.sheets.

        The Company enters into foreign exchange contracts with clients and strives to enterenters into a matched positionor 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. The foreignsheets. Foreign exchange contracts have been reduced by balances with the same counterparty whereare netted in the Company’s consolidated balance sheets when a master netting agreement exists.

        Securities Sold Under Repurchase Agreements—The Company 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 a liabilityliabilities in the consolidated balance sheets. Securities pledged as collateral under agreements to repurchase are reflected as assets in the accompanying consolidated balance sheets.

        F-11



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003

        2. Summary of Significant Accounting Policies (Continued)

                Stock-BasedShare-based Compensation—The Company measures compensation expense for stock-basedshare-based compensation plans using the intrinsic value method. The intrinsic value method measures compensation cost as the difference of the option exercise price andamount 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 have an exercise price equivalent to the fair market value of the common stock at the measurement date. Accordingly, no compensation cost has been recorded. If stock-basedshare-based compensation 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 costs would have decreased net income as indicated below (Dollars in thousands, except per share data):
        		 December 31,
        2003
        		 December 31,
        2002
        		 December 31,
        2001
        		 

         

        December 31,
        2005

         

        December 31,
        2004

         

        December 31,
        2003

         

        Net income as reportedNet income as reported $92,421 $67,437 $44,686 

         

         

        $

        159,818

         

         

         

        $

        141,962

         

         

         

        $

        92,421

         

         

        Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (10,467) (14,447) (13,615)
         
        		 
        		 
        		 

        Deduct: Total share-based employee compensation expense determined under fair value method for all awards, net of related tax effects

         

         

        (19,832

        )

         

         

        (15,146

        )

         

         

        (10,467

        )

         

        Pro forma net incomePro forma net income $81,954 $52,990 $31,071 

         

         

        $

        139,986

         

         

         

        $

        126,816

         

         

         

        $

        81,954

         

         

         
        		 
        		 
        		 
        Earnings per share:Earnings per share:       

         

         

         

         

         

         

         

         

         

         

         

         

         

        Basic—as reported $1.42 $1.05 $0.71 
        Basic—pro forma 1.26 0.82 0.49 
        Diluted—as reported $1.39 $1.02 $0.68 
        Diluted—pro forma 1.23 0.80 0.47 

        Basic-as reported

         

         

        $

        2.42

         

         

         

        $

        2.15

         

         

         

        $

        1.42

         

         

        Basic-pro forma

         

         

        2.12

         

         

         

        1.92

         

         

         

        1.26

         

         

        Diluted-as reported

         

         

        $

        2.37

         

         

         

        $

        2.09

         

         

         

        $

        1.39

         

         

        Diluted-pro forma

         

         

        2.07

         

         

         

        1.87

         

         

         

        1.23

         

         

         

        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 options granted in the years ended December 31, 2003, 2002,2005, 2004 and 2001,2003, respectively: an average assumed risk-free interest rate based on the five-year Treasury rate, of 2.37%4.55%, 2.40%,3.08% and 4.05%2.37%, an expected life of four years, an average expected volatility of 55.86%41.04%, 56.20%,50.49% and 55.76%55.86%, and average dividend yield of 0.20%, 0.22%,0.16% and 0.15%0.20%.

        Earnings Per Share—Basic earnings per share ("EPS"(“EPS”) wereis computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding during the year. Diluted EPS reflectsadjusts Basic EPS to reflect the potential dilution that could occur if contracts to issue common stock (such as employee stock options) were exercised into common stock that then shared in the earnings of the Company.

        F-12



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003

        2. Summary of Significant Accounting Policies (Continued)

        Reconciliation from Basic EPS to Diluted EPS is as follows (Dollars in thousands, except per share data):


        		 Income
        		 Shares
        		 Per Share
        Amount
        		 

         

         

         

        Weighted-Average

         

        Per Share

         

         

        Income

         

        Shares

         

        Amount

         

        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

         

         

        Dilutive effect of common equivalent shares of stock options

         

        —

         

         

        1,736,931

         

         

         

        (0.06

        )

         

        Diluted EPS

         

        $

        141,962

         

         

        67,916,217

         

         

         

        $

        2.09

         

         

        December 31, 2003       

         

         

         

         

         

         

         

         

         

         

         

        Basic EPS       

         

         

         

         

         

         

         

         

         

         

         

        Income available to common stockholders $92,421 65,098,960 $1.42 

         

        $

        92,421

         

         

        65,098,960

         

         

         

        $

        1.42

         

         

        Dilutive effect of common equivalent shares of stock options — 1,376,502 (0.03)

         

        —

         

         

        1,376,502

         

         

         

        (0.03

        )

         

         
        		 
        		 
        		 
        Diluted EPS $92,421 66,475,462 $1.39 

         

        $

        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 
         
        		 
        		 
        		 
        December 31, 2001       
        Basic EPS       
        Income available to common stockholders $44,686 63,303,594 $0.71 
        Dilutive effect of common equivalent shares of stock options — 2,433,124 (0.03)
         
        		 
        		 
        		 
        Diluted EPS $44,686 65,736,718 $0.68 
         
        		 
        		 
        		 

         There

        For the years ended December 31, 2005, 2004 and 2003, there were 733,015 options, 29,451 options, and 3,517,655 option sharesoptions which were not considered dilutive for earnings per shareEPS calculations, for the year endedrespectively.

        F-13



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003.

        2. Summary of Significant Accounting Policies (Continued)

        Guarantees—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.

                Goodwill—On January 1, 2002, 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 group of other assets (but not those acquired in a business combination) should 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 premiums, 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. As of December 31, 2003, there was no impairment of goodwill. The disclosure requirements of SFAS No. 142 are detailed in Note 3.

                New Accounting Principles—The Company has adopted SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. Among its provisions, this Statement rescinds Statement No. 4,Reporting Gains and Losses from Extinguishment of Debt, and an amendment of that Statement, Statement No. 64,Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements, and eliminates the extraordinary item treatment of reporting gains and losses from extinguishments of debt. During the year ended December 31, 2003, the Company recorded an early extinguishment of $100 million of its FHLBB debt by replacing it with new debt. The Company recognized a $3.1 million early termination fee which has been classified in interest expense. The adoption of this Statement did not have a material impact on the Company's financial position or results of operations.

                The Company has adopted SFAS No. 146,Accounting for Costs Associated with Exit or Disposal Activities. This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities by requiring that a liability for a cost associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. The adoption of this Statement did not have a material impact on the Company's financial position or results of operations.

                In April 2003, the FASB issued SFAS No. 149,Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities, resulting in more consistent reporting of contracts as either derivatives or hybrid instruments. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, and should be applied prospectively. The Company has evaluated its financial accounting and reporting methods for all derivative instruments and has found them to be consistent with SFAS No. 149.

                In May 2003, the FASB issued SFAS No. 150,Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. SFAS No. 150 requires an issuer to classify financial instruments within its scope as a liability (or an asset in some circumstances). The Statement provides that these instruments must be classified as liabilities in the consolidated balance sheet and recorded at fair value. On November 7, 2003, the measurement provisions relating to non-controlling mandatorily redeemable instruments were deferred. The classification provisions of this Statement remain in effect. The Company adopted the provisions of this Statement effective July 1, 2003. The adoption of this Statement did not have a material impact on the Company's financial position.

                In January 2003, the FASB issued Interpretation No. 46 (revised December 2003),Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin ("ARB") 51 ("FIN 46"). This interpretation addresses consolidation by business enterprises of variable interest entities ("VIE"). This interpretation requires a VIE to be consolidated by a company if that company is subject to a majority of the risk of loss from the VIE's activities or entitled to receive a majority of the entity's residual returns, or both. The provisions are effective for any new entities that are originated subsequent to



        January 31, 2003. For entities that were originated prior to February 1, 2003, the provisions of this interpretation were to be effective October 1, 2003.

                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 Investors Capital Trust I ("ICTI"), the wholly-owned trust that issued trust preferred securities. Therefore, the Company presents in its consolidated financial statements junior subordinated debentures as a liability and its investment in ICTI as a component of other assets. The income for the three months that ICTI was not consolidated is considered immaterial. Refer to Note 11 for additional information.

        3. Acquisitions

                On February 1, 2001, the Company purchased the operations of the advisor custody unit of Chase. This unit provided institutional custody services to individual accounts holding approximately $27 billion in assets as of February 1, 2001. These accounts consist of individual accounts, trusts, endowments and corporate accounts whose assets are managed by third-party investment advisors. Pursuant to the terms of the asset purchase agreement, the Company paid to Chase as of closing approximately $31.5 million of the total purchase price, plus another $39.8 million in exchange for the book value of loans to clients. The contingency payment clause expired in 2002, therefore, the Company is not obligated to make any further purchase price payments to Chase. The transaction was accounted for as a purchase.

                On May 1, 2001, the Company assumed the operations of the U.S. asset administration unit of Barclays Global Investors, N.A. ("BGI"), a large international institutional investment manager. The unit, located in Sacramento, California, provides custody, accounting, administration and other operations functions for BGI's North American assets. The transaction was accounted for as a purchase.

                No pro forma results of Chase or BGI are presented as they were not material to the Company's financial condition and operating results for the periods presented.

                Goodwill related to the acquisitions is summarized as follows (Dollars in thousands):

         
        		 December 31,
        2003
        		 December 31,
        2002
        		 December 31,
        2001
        		 
        Goodwill, beginning of year $79,969 $79,969 $34,094 
        Plus purchase of businesses  —  —  49,434 
        Less amortization expense  —  —  (3,559)
          
        		 
        		 
        		 
        Goodwill, end of year $79,969 $79,969 $79,969 
          
        		 
        		 
        		 

                On January 1, 2002, the Company ceased amortization of goodwill. The following table represents the transitional disclosure related to the adoption of SFAS No. 142 (Dollars in thousands, except per share data):

         
        		 December 31,
        2003
        		 December 31,
        2002
        		 December 31,
        2001
        Net income as reported $92,421 $67,437 $44,686
        Add back: Goodwill amortization, net of tax  —  —  2,471
          
        		 
        		 
        Adjusted net income $92,421 $67,437 $47,157
          
        		 
        		 
        Earnings per share:         
         Basic—as reported $1.42 $1.05 $0.71
         Basic—adjusted  1.42  1.05  0.74
         Diluted—as reported $1.39 $1.02 $0.68
         Diluted—adjusted  1.39  1.02  0.72

        4. Securities

                Amortized cost amounts and fair values of securities are summarized as follows as of December 31, 2003 (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
        Mortgage-backed securities $3,593,470 $28,740 $(10,230)$3,611,980
        State and political subdivisions  333,777  22,119  (68) 355,828
        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
          
        		 
        		 
        		 

                Amortized cost amounts and fair values of securities are summarized as follows as of December 31, 2002 (Dollars in thousands):

        Held to Maturity
        		 Amortized
        Cost
        		 Unrealized
        Gains
        		 Unrealized
        (Losses)
        		 Fair Value
        Mortgage-backed securities $2,033,620 $20,716 $(868)$2,053,468
        Federal agency securities  1,287,314  2,433  (4,988) 1,284,759
        State and political subdivisions  117,021  5,566  (60) 122,527
          
        		 
        		 
        		 
        Total $3,437,955 $28,715 $(5,916)$3,460,754
          
        		 
        		 
        		 
        Available for Sale
        		 Amortized
        Cost
        		 Unrealized
        Gains
        		 Unrealized
        (Losses)
        		 Fair Value
        Mortgage-backed securities $2,714,557 $45,384 $(148)$2,759,793
        State and political subdivisions  290,241  17,090  (39) 307,292
        Federal agency securities  29,602  1,279  —  30,881
        Corporate debt  179,612  21  (5,134) 174,499
          
        		 
        		 
        		 
        Total $3,214,012 $63,774 $(5,321)$3,272,465
          
        		 
        		 
        		 

                Nonmarketable equity securities at December 31, 2003 and 2002 consisted of stock of the FHLBB. The Company is required to hold FHLBB stock equal to no less than (i) 1% of our outstanding residential mortgage loan principal (including mortgage pool securities), (ii) 0.3% of total assets, or (iii) total advances from the FHLBB, divided by a leverage factor of 20.



                The amortized cost amounts and fair values of securities by contractual maturity are as follows (Dollars in thousands):

         
        		 December 31, 2003
        Held to Maturity
        		 Amortized
        Cost
        		 Fair Value
        Due within one year $5 $5
        Due from one to five years  37,358  38,819
        Due five years up to ten years  119,442  119,270
        Due after ten years  4,149,411  4,150,484
          
        		 
        Total $4,306,216 $4,308,578
          
        		 
         
        		 December 31, 2003
        Available for Sale
        		 Amortized
        Cost
        		 Fair Value
        Due within one year $34,931 $35,003
        Due from one to five years  95,170  99,993
        Due five years up to ten years  312,225  329,761
        Due after ten years  3,813,864  3,831,880
          
        		 
        Total $4,256,190 $4,296,637
          
        		 

                There were no sales of securities available for sale during the years ended December 31, 2003, 2002 and 2001.

                The carrying value of securities pledged amounted to approximately $5.6 billion at December 31, 2003. Securities are pledged primarily to secure clearings with other depository institutions, secure repurchase agreements and secure outstanding FHLBB borrowings.

                The following table represents the information about our temporarily impaired investments at December 31, 2003 (Dollars in thousands):

         
        		 Less than 12 months
        		 12 months or longer
        		 Total
         
        		 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
        Federal agency securities  1,005,518  8,378  600,457  4,422  1,605,975  12,800
        Corporate debt  25,667  333  46,876  2,559  72,543  2,892
        State and political subdivisions  9,591  154  154  21  9,745  175
          
        		 
        		 
        		 
        		 
        		 
         Total temporarily impaired securities: $3,257,662 $35,361 $656,030 $7,103 $3,913,692 $42,464
          
        		 
        		 
        		 
        		 
        		 

                Federal agency securities in a loss position greater than 12 months are represented by securities issued by the Small Business Association and are guaranteed to recover the contractual principal of these investments. These securities are classified as held to maturity and management believes that the Company will recover all principal; therefore, no impairment losses have been recognized. Corporate



        debt securities in a loss position are represented by Trust Preferred securities ("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; therefore, no impairment losses have been recognized.

                The Company holds Trups issued by other financial institutions. The Company has evaluated its ownership interests of each security and has concluded that the Company is not the primary beneficiary and as such does not need to consolidate the Trup's holdings under the guidance of FIN 46.

        5. 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, the loans are, or may be, in the event of default, collateralized with marketable securities held by the Company as custodian. There were no impaired or non-performing loans at December 31, 2003 and 2002. In addition, there have been no loan charge-offs or recoveries during the years ended December 31, 2003, 2002 and 2001. Loans consisted of the following (Dollars in thousands):

         
        		 December 31,
        2003
        		 December 31,
        2002
        		 
        Loans to mutual funds $104,954 $49,372 
        Loans to individuals  67,641  76,263 
        Loans to others  27,035  18,202 
          
        		 
        		 
           199,630  143,837 
        Less allowance for loan losses  (100) (100)
          
        		 
        		 
        Total $199,530 $143,737 
          
        		 
        		 

                The Company had unused commitments to lend of approximately $759.5 million and $682.4 million at December 31, 2003 and 2002, respectively. The terms of these commitments are similar to the terms of outstanding loans.



        6. Equipment and Leasehold Improvements

                The major components of equipment and leasehold improvements are as follows (Dollars in thousands):

         
        		 December 31,
        2003
        		 December 31,
        2002
        		 
        Furniture, fixtures and equipment $108,278 $90,434 
        Leasehold improvements  15,825  9,837 
          
        		 
        		 
        Total  124,103  100,271 
        Less accumulated depreciation and amortization  (47,683) (25,402)
          
        		 
        		 
        Equipment and leasehold improvements, net $76,420 $74,869 
          
        		 
        		 

                Included in furniture, fixtures and equipment were internal software costs, capitalized in accordance with SOP 98-1, of $61.5 million and $47.5 million as of December 31, 2003 and 2002, respectively. Depreciation expense was $26.1 million, $14.8 million and $7.6 million for the years ended December 31, 2003, 2002 and 2001, respectively. Amortization expense was $1.9 million, $1.6 million and $0.8 million for the years ended December 31, 2003, 2002 and 2001, respectively.


        7. Deposits

                Time deposits at December 31, 2003 and 2002 included non-interest bearing amounts of $190 million and $90 million, respectively. All time deposits had a minimum balance of $100,000 and a maturity of less than three months at December 31, 2003 and 2002. At December 31, 2003 and 2002, $54.3 million and $73.0 million of overdrafts were reclassified to loans.

        8. Securities Sold Under Repurchase Agreements

                The following table represents information regarding the Company's securities sold under repurchase agreements (Dollars in thousands):

         
        		 December 31,
        2003
        		 December 31,
        2002
        		 December 31,
        2001
        		 
        Outstanding at end of period $3,258,001 $2,301,974 $1,663,312 
        Maximum outstanding at any month end  3,546,131  2,931,041  1,884,975 
        Average balance for the year  3,278,555  2,449,368  1,546,271 
        Weighted average rate at end of period  1.09% 1.20% 1.64%
        Weighted average rate for the period  0.90% 1.27% 3.06%

                As of December 31, 2003, $3.4 billion of securities were pledged to collateralize repurchase agreements.

        9. Short-term and Other Borrowings

                The components of short-term and other borrowings are as follows (Dollars in thousands):

         
        		 December 31,
        2003
        		 December 31,
        2002
        Federal funds purchased $697,855 $130,648
        Federal Home Loan Bank of Boston overnight advances  250,000  360,000
        Federal Home Loan Bank of Boston long-term advances  150,000  250,000
        Treasury, Tax and Loan account  232  459
          
        		 
        Total $1,098,087 $741,107
          
        		 

                For the years ended December 31, 2003 and 2002, maturities on FHLBB advances ranged from overnight to September 2006. As of December 31, 2003, $1.9 billion of securities were pledged to collateralize FHLBB overnight and long-term advances.



                The following table represents information regarding the Company's Federal Funds purchased (Dollars in thousands):

         
        		 December 31,
        2003
        		 December 31,
        2002
        		 December 31,
        2001
        		 
        Outstanding at end of period $697,855 $130,648 $130,000 
        Maximum outstanding at any month end  697,855  375,000  394,000 
        Average balance for the year  432,490  254,093  139,243 
        Weighted-average rate at end of period  0.99% 1.20% 1.61%
        Weighted-average rate for the period  1.14% 1.71% 3.62%

        10. Income Taxes

                The components of income tax expense are as follows (Dollars in thousands):

         
        		 December 31,
        2003
        		 December 31,
        2002
        		 December 31,
        2001
        		 
        Current:          
         Federal $32,752 $24,172 $18,822 
         State  14,310  532  285 
         Foreign  52  61  118 
          
        		 
        		 
        		 
           47,114  24,765  19,225 
          
        		 
        		 
        		 
        Deferred:          
         Federal  5,989  3,972  (245)
         State  (338) —  — 
          
        		 
        		 
        		 
           5,651  3,972  (245)
        Total income taxes $52,765 $28,737 $18,980 
          
        		 
        		 
        		 

                Differences between the effective income tax rate and the federal statutory rates are as follows:

         
        		 December 31,
        2003
        		 December 31,
        2002
        		 December 31,
        2001
        		 
        Federal statutory rate 35.00%35.00%35.00%
        State income tax rate, net of federal benefit 6.25 0.35 0.28 
        Tax-exempt income, net of disallowance (4.89)(6.12)(5.36)
        Other (0.01)0.66 (0.11)
          
        		 
        		 
        		 
        Effective tax rate 36.35%29.89%29.81%
          
        		 
        		 
        		 

                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 retroactive change in tax law, we recorded an additional state tax expense of approximately $7.2 million, net of federal income tax benefit, in 2003.


                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,
        2003
        		 December 31,
        2002
        		 
        Deferred tax assets:       
         Employee benefit plans $3,190 $2,264 
         Unrealized hedging loss  5,231  10,497 
         Other  441  210 
          
        		 
        		 
           8,862  12,971 
          
        		 
        		 
        Deferred tax liabilities:       
         Depreciation and amortization  (8,266) (3,204)
         Undistributed income of foreign subsidiaries  (2,887) (1,735)
         Pension plan  (1,462) (766)
         Securities available for sale  (14,469) (20,314)
        Other  (508) (610)
          
        		 
        		 
           (27,592) (26,629)
        Net deferred tax liability $(18,730)$(13,658)
          
        		 
        		 

        11. Company Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust Holding Junior Subordinated Deferrable Interest Debentures of the Company

                On January 31, 1997, ICTI, a trust sponsored and wholly-owned by the Company issued $25 million in 9.77% Trust Preferred Securities (the "Capital Securities"), the proceeds of which were invested by the trust in the same aggregate principal amount of the Company's newly issued 9.77% Junior Subordinated Deferrable Interest Debentures due February 1, 2027 (the "Junior Subordinated Debentures"). The Capital Securities have a call date of February 1, 2007. 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"). The Guarantee, when taken together with the Company'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's obligations under the Capital Securities. No other subsidiary of the Company guarantees these Capital Securities. Certain of the Company'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's ability to pay dividends to the 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, the wholly-owned trust that issued the Capital Securities. Therefore, the Company presents in its consolidated financial statements junior subordinated debentures as a liability and its investment in ICTI as a component of other assets. The income for the three months that ICTI was not consolidated is considered immaterial.

        12. Stockholders' Equity

                As of December 31, 2003, the Company has authorized 1,000,000 shares of Preferred Stock and 100,000,000 shares of Common Stock, all with a 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.

                The Company has three stock option plans: the Amended and Restated 1995 Stock Plan ("Stock Plan"), the Amended and Restated 1995 Non-Employee Director Stock Option Plan ("Director Plan"), and the 1997 Employee Stock Purchase Plan.

                At the Annual Meeting of Stockholders of the Company held on April 17, 2001, stockholders approved the amendment and restatement of the Company's Stock Plan to increase the number of shares available for grant pursuant to the plan from 4,640,000 to 6,140,000. At the Annual Meeting of Stockholders of the Company held on April 23, 2002, stockholders approved the amendment and restatement of the Company's Stock Plan to increase the number of shares available for grant pursuant to the plan from 6,140,000 to 7,640,000. Effective with the June 2002 stock split, the number of shares



        available to grant increased to 15,280,000. Of the 15,280,000 shares of Common Stock authorized for issuance under the Stock Plan at December 31, 2003, 3,877,277 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 year ended December 31, 2003.

                The terms of the Director Plan provide for the grant of options to non-employee directors to purchase up to a maximum of 400,000 shares of Common Stock. Effective with the June 2002 stock split, the number of shares available to grant increased to 800,000. Of the 800,000 shares of Common Stock authorized for issuance under the plan, 103,035 were available for grant at December 31, 2003.

                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.

                At the Annual Meeting of Stockholders of the Company held on April 23, 2002, stockholders approved amendments to the Director Plan providing 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 the number of shares called for by the Director Plan as of that date.

                Formerly, each non-employee director received a grant of options upon their election or appointment and annually thereafter on their anniversary date. The amendments also provide that the number of shares granted to each non-employee director annually be adjusted for stock splits and other capital changes. After giving effect to the stock split paid on June 14, 2002, non-employee directors shall receive an annual grant of options to purchase 5,000 shares. In addition, the amendments provide that options granted under the Director Plan will vest in 36 equal monthly installments beginning on the date of grant, rather than 48 equal monthly installments, subject to certain restrictions. Finally, the amendments to the Director Plan provide that in the event a non-employee director ceases to be a member of the Board by reason of his or her retirement, the Board may vote to accelerate and fully vest all unvested options held by the retiring non-employee director.

                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.

                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 2003, the Company canceled 1,200 options relating to the unvested portion for an employee 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 $1.1 million and $1.6 million at December 31, 2003 and 2002, respectively, related to the grants described in the above three paragraphs. Amortization of deferred compensation was $483,000, $964,000, and $162,000 for the years ended December 31, 2003, 2002 and 2001, respectively.

                A summary of option activity under both the Director Plan and the Stock Plan is as follows:

         
        		 December 31, 2003
        		 December 31, 2002
        		 December 31, 2001
         
        		 Shares
        		 Weighted-
        Average
        Exercise
        Price
        		 Shares
        		 Weighted-
        Average
        Exercise
        Price
        		 Shares
        		 Weighted-
        Average
        Exercise
        Price
        Outstanding at beginning of year 6,621,157 $22 6,921,610 $20 5,793,324 $14
        Granted 737,399  34 674,414  32 2,048,660  32
        Exercised (654,230) 9 (761,893) 7 (831,224) 6
        Canceled (157,240) 32 (212,974) 29 (89,150) 22
          
        		    
        		    
        		   
        Outstanding at end of year 6,547,086  24 6,621,157  22 6,921,610  20
          
        		    
        		    
        		   
        Outstanding and exercisable at year end 4,712,586    4,202,545    3,514,094   
          
        		    
        		    
        		   

                The following table summarizes information about stock options outstanding at December 31, 2003:

         
        		 Options Outstanding
        		 Options Exercisable
        Range of
        Exercise
        Prices
        		 Number
        Outstanding at
        December 31,
        2003
        		 Weighted-
        Average
        Remaining
        Contractual
        Life
        		 Weighted-
        Average
        Exercise
        Price
        		 Number
        Exercisable at
        December 31,
        2003
        		 Weighted-
        Average
        Exercise
        Price
        $  0-10 1,150,458 4.3 years $6 1,150,040 $6
          10-20 1,188,384 5.1            11 1,187,758  11
          20-30 128,923 6.6            26 89,541  26
          30-40 4,057,301 7.9            33 2,271,887  33
          40-50 22,020 7.1            42 13,360  42
          
        		      
        		   
          6,547,086 6.7           $24 4,712,586 $21
          
        		      
        		   

                Under the terms of the 1997 Employee Stock Purchase Plan, the Company may issue up to 1,120,000 shares of Common Stock pursuant to the exercise of nontransferable options granted to participating employees. The 1997 Employee Stock Purchase Plan permits eligible employees to purchase up to 8,000 shares of Common Stock per payment period, subject to limitations provided by Section 423(b) of the Internal Revenue Code, through accumulated payroll 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 Stock on the first business day of the payment period, or (ii) 90% of the market value of the 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.

                A summary of the 1997 Employee Stock Purchase Plan is as follows:

         
        		 December 31,
        		 
         
        		 2003
        		 2002
        		 2001
        		 
         
        		 Shares
        		 Shares
        		 Shares
        		 
        Total shares available under the plan beginning of year 356,875 500,764 598,068 
        Issued at June 30 (70,606)(61,193)(41,976)
        Issued at December 31 (58,765)(82,696)(55,328)
          
        		 
        		 
        		 
        Total shares available under the plan end of year 227,504 356,875 500,764 
          
        		 
        		 
        		 

                During 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 30, 2003 and December 31, 2003, respectively.

                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.



                During the year ended December 31, 2001, the purchase prices of the stock were $30.25 and $29.88, or 90% of the market value of the Common Stock on the first business day of the payment periods ending June 30, 2001 and December 31, 2001, respectively.

        13. Comprehensive 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's other comprehensive income and related tax effects for the years ended December 31, 2003, 2002 and 2001 is as follows (Dollars in thousands):

         
        		 Pre-tax
        Amount
        		 Tax (Expense)
        Benefit
        		 After-tax
        Amount
        		 
        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)
          
        		 
        		 
        		 

        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 
        Currency translation adjustment  —  —  — 
          
        		 
        		 
        		 
         Other comprehensive income $34,916 $(12,488)$22,428 
          
        		 
        		 
        		 
        2001          
        Unrealized gains on securities:          
        Unrealized holding gains arising during the period $11,318 $(4,107)$7,211 
          
        		 
        		 
        		 
         Net unrealized gains  11,318  (4,107) 7,211 
        Net unrealized derivative instrument loss  (12,537) 4,388  (8,149)
        Amortization of transition related adjustment  3,240  (1,134) 2,106 
        Cumulative effect of change in accounting principle  (6,052) 2,118  (3,934)
        Currency translation adjustment  —  —  — 
          
        		 
        		 
        		 
        Other comprehensive income $(4,031)$1,265 $(2,766)
          
        		 
        		 
        		 

        14. Employee Benefit Plans

                Pension Plan—The Company has a trusteed, noncontributory, qualified defined benefit 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's compensation during employment. Generally, the Company'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, 2001, 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 Company uses a December 31 measurement date for this plan.

                Supplemental Retirement Plan—The Company also has a nonqualified, unfunded, supplemental retirement plan ("SERP") which was established in 1994 and covers certain employees and pays benefits that supplement any benefits paid under the qualified plan. Benefits under the supplemental plan are generally based on compensation not includable in the calculation of benefits to be paid under the qualified 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 December 31 measurement date for this plan.



                The following table sets forth the status of the Company's qualified defined benefit pension plan and supplemental retirement plan (Dollars in thousands):

         
        		 December 31, 2003
        		 December 31, 2002
        		 
         
        		 Pension Plan
        		 SERP Plan
        		 Pension Plan
        		 SERP Plan
        		 
        Change in benefit obligation:             
         Benefit obligation at beginning of year $14,511 $13,309 $10,761 $5,604 
          Service cost  834  878  702  601 
          Interest cost  1,025  898  902  650 
          Actuarial loss  2,728  415  2,406  6,454 
          Benefits paid  (1,048) —  (260) — 
          
        		 
        		 
        		 
        		 
         Projected benefit obligation at the end of the year  18,050  15,500  14,511  13,309 
          
        		 
        		 
        		 
        		 

        Change in plan assets:
         
         
         
         
         
         
         
         
         
         
         
         
         
         Assets at the beginning of the year  12,916  —  11,161  — 
          Employer contributions  3,000  —  3,400  — 
          Actual return  2,378  —  (1,385) — 
          Benefits paid  (1,048) —  (260) — 
          
        		 
        		 
        		 
        		 
         Assets at the end of the year  17,246  —  12,916  — 
          
        		 
        		 
        		 
        		 
         Funded status  (804) (15,500) (1,595) (13,309)
          
        		 
        		 
        		 
        		 
          Unrecognized net transition asset  (106) 20  (145) 25 
          Unrecognized prior service cost  (306) 2,585  (315) 2,729 
          Unrecognized net loss  5,392  7,106  4,245  7,191 
          
        		 
        		 
        		 
        		 
         Net amount recognized $4,176 $(5,789)$2,190 $(3,364)
          
        		 
        		 
        		 
        		 

                Amounts recognized in the consolidated balance sheet consist of the following (Dollars in thousands):

         
        		 December 31, 2003
        		 December 31, 2002
        		 
         
        		 Pension Plan
        		 SERP Plan
        		 Pension Plan
        		 SERP Plan
        		 
        Prepaid benefit cost $4,176 $— $2,190 $  
        Accrued benefit cost  —  (8,285) —  (5,208)
        Intangible assets  —  2,496  —  1,844 
        Accumulated other comprehensive income  —  —  —    
          
        		 
        		 
        		 
        		 
        Net amount recognized $4,176 $(5,789)$2,190 $(3,364)
          
        		 
        		 
        		 
        		 

                The accumulated benefit obligation for the qualified defined benefit pension plan was $13.0 million and $10.7 million at December 31, 2003 and 2002, respectively. The accumulated benefit obligation for the supplemental retirement plan was $8.3 million and $5.2 million at December 31, 2003 and 2002, respectively.



                Net periodic pension cost for the Company's qualified defined benefit pension plan and supplemental retirement plan included the following components (Dollars in thousands):

         
        		 December 31, 2003
        		 December 31, 2002
         
        		 Pension
        Plan
        		 SERP
        Plan
        		 Pension
        Plan
        		 SERP
        Plan
        Service cost—benefits earned/benefit obligations $834 $878 $702 $601
        Interest cost on projected benefit obligations  1,025  898  902  650
        Expected return on plan assets  (1,085) —  1,385  —
        Net amortization and deferral  248  649  (2,368) 414
          
        		 
        		 
        		 
        Net periodic pension cost $1,022 $2,425 $621 $1,665
          
        		 
        		 
        		 

                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, 2003
        		 December 31, 2002
        		 
         
        		 Pension Plan
        		 SERP Plan
        		 Pension Plan
        		 SERP Plan
        		 
        Discount rate 6.25%6.25%6.75%6.75%
        Rate of compensation increases 3.75 3.75 3.75 3.75 

                The weighted-average discount rate, rate of increase in future compensation levels and expected return on plan assets used in determining the net periodic pension cost were as follows:

         
        		 December 31, 2003
        		 December 31, 2002
        		 
         
        		 Pension Plan
        		 SERP Plan
        		 Pension Plan
        		 SERP Plan
        		 
        Discount rate 6.75%6.75%7.50%7.50%
        Rate of compensation increases 3.75 3.75 5.00 5.00 
        Expected rate of return on plan assets 8.50 — 8.50 — 

                The Company has utilized an expected rate of return on plan assets of 8.5% as the historical actual long-term return on plan assets accords with this assumption.

                The Company's pension plan allocation by asset category are as follows:

        Asset Category
        		 December 31,
        2003
        		 December 31,
        2002
        		  
        		  
        Cash and short-term investments 23.3%31.8%   
        Equity securities 60.0 46.3    
        Debt securities 16.7 21.9    
          
        		 
        		    
        Total 100.0%100.0%   
          
        		 
        		    

                The Company's core investment objectives for the pension trust 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, 2003 and 2002. 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, 2003 and 2002. Debt securities offer a source of current income, reduce the variability of the portfolio's total market value and hedge against inflation. Fixed income investments were limited to issues by the United States Government and its agencies, and corporate bonds with top four quality ratings of recognized credit services at December 31, 2003 and 2002. The pension trust was in full compliance with the approved pension objectives and policies for the years ended December 31, 2003 and 2002. At December 31, 2003 and 2002, the pension did not hold any securities of the Company.

                The Company expects to contribute approximately $2 to $4 million to its pension plan during 2004.

                At December 31, 2003 and 2002, the SERP plan remained an unfunded plan. The Company does not expect contributing to the plan during 2004.

                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 $3.2 million, $3.2 million and $2.1 million for the years ended December 31, 2003, 2002 and 2001, respectively.

        15. Off Balance Sheet Financial Instruments

                Lines of Credit—At December 31, 2003, the Company had commitments to individuals and mutual funds under collateralized open lines of credit totaling $901.5 million, against which $142.0 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.

        Goodwill—Inaccordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (‘SFAS 142’), the Company ceased amortization of goodwill effective January 1, 2002. The Company 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 fair value of the goodwill would be reduced below its carrying value. As of December 31, 2005, there was no impairment of goodwill.

        New Accounting Pronouncements

        In December 2004, the Financial Accounting Standards Board (‘FASB’) issued 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 currently uses the intrinsic-value method to measure compensation cost related to its share-based transactions. SFAS 123R replaces SFAS 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees.

        In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (‘SAB 107’), which expresses the views of the SEC regarding the interaction of SFAS 123R and certain SEC regulations and provides the SEC’s views regarding the valuation of share-based payment arrangements for public companies.

        In April 2005, the SEC issued Release 2005-57, which delayed the effective date for SFAS 123R to reporting periods in the first fiscal year beginning after June 15, 2005. Accordingly, the Company adopted SFAS 123R on January 1, 2006, effective for financial periods in 2006. There was no impact to the financial condition or results of operations of the Company upon adoption.

        In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, Accounting Changes and Error Corrections-a replacement of APB Opinion No. 20 and FASB Statement No. 3 (‘SFAS 154’). SFAS 154 replaces APB Opinion No. 20, Accounting Changes, and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements, and changes the accounting and reporting requirements for a change in accounting principle. SFAS 154 applies to all voluntary changes in an accounting principle, as well as to changes required by a new accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. SFAS 154 is effective for

        F-14



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003.

        2. Summary of Significant Accounting Policies (Continued)

        accounting changes and error corrections made in fiscal years beginning after December 15, 2005 and requires retrospective application to prior periods’ financial statements for most voluntary changes in an accounting principle, unless it is impracticable to do so. The Company does not anticipate any material impact to its financial condition or results of operations as a result of the adoption of SFAS 154.

        In February 2006, the FASB issued Statement of Financial Accounting Standards No. 155, Accounting for Certain Hybrid Instruments-an amendment of FASB Statements No. 133 and 140 (‘SFAS 155’). SFAS 155 allows financial instruments that have embedded derivatives to be accounted for as a whole if the holder elects to account for the whole instrument on a fair value basis. SFAS 155 eliminates the need to bifurcate the derivative from its host, as previously required under Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedge Accounting (‘SFAS 133’). SFAS 155 also amends SFAS 133 by establishing a requirement to evaluate interests in securitized financial assets to determine whether they are free standing derivatives or whether they contain embedded derivatives that require bifurcation. SFAS 155 is effective for all hybrid financial instruments acquired or issued by the Company on or after January 1, 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 155.

        3. Securities

        Amortized cost amounts and fair values of securities are summarized as follows as of December 31, 2005 (Dollars in thousands):

        Held to Maturity

         

        Amortized
        Cost

         

        Unrealized
        Gains

         

        Unrealized
        (Losses)

         

        Fair Value

         

        Mortgage-backed securities

         

        $

        4,342,254

         

         

        $

        11,420

         

         

         

        $

        (29,818

        )

         

        $

        4,323,856

         

        Federal agency securities

         

        2,305,331

         

         

        1,560

         

         

         

        (23,914

        )

         

        2,282,977

         

        State and political subdivisions

         

        114,345

         

         

        4,646

         

         

         

        (95

        )

         

        118,896

         

        Total

         

        $

        6,761,930

         

         

        $

        17,626

         

         

         

        $

        (53,827

        )

         

        $

        6,725,729

         

        Available for Sale

         

        Amortized
        Cost

         

        Unrealized 
        Gains

         

        Unrealized
        (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

         

        F-15



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003.

        3. Securities (Continued)

        Amortized cost amounts and fair values of securities are summarized as follows as of December 31, 2004 (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

         

        Excluded from the above tables are nonmarketable equity securities, which consisted of stock of the FHLBB at December 31, 2005 and 2004. On April 19, 2004, the FHLBB implemented a new capital structure mandated for all Federal Home Loan Banks subject to 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’s capital stock investment in the FHLBB totaled $50.0 million as of December 31, 2005. The $50.0 million capital stock investment includes both a $25.0 million membership component and a $25.0 million activity-based component. Under the new capital plan, FHLBB capital stock investments require a five-year advance notice of withdrawal. Recent changes to the FHLBB capital plan have resulted in an increased borrowing capacity. The Bank’s $50.0 million capital stock investment in the FHLBB provides an overnight borrowing capacity of up to $833.0 million. The amount outstanding under this arrangement at December 31, 2005 was $546.0 million. Additional borrowing is available to the Bank based on prescribed collateral levels and increased investment in FHLBB capital stock. The Bank currently has no plans to increase its investment in FHLBB capital stock.

        The amortized cost amounts and fair values of securities by contractual maturity are as follows (Dollars in thousands):

         

         

        December 31, 2005

         

        Held to Maturity

         

        Amortized
        Cost

         

        Fair Value

         

        Due within one year

         

         

        $

        3,872

         

         

        $

        3,938

         

        Due from one to five years

         

         

        28,785

         

         

        28,806

         

        Due five years up to ten years

         

         

        254,380

         

         

        254,656

         

        Due after ten years

         

         

        6,474,893

         

         

        6,438,329

         

        Total

         

         

        $

        6,761,930

         

         

        $

        6,725,729

         

        F-16



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003.

        3. Securities (Continued)

         

         

        December 31, 2005

         

        Available for Sale

         

        Amortized
        Cost

         

        Fair Value

         

        Due within one year

         

         

        $

        492

         

         

        $

        498

         

        Due from one to five years

         

         

        132,358

         

         

        134,094

         

        Due five years up to ten years

         

         

        101,183

         

         

        102,851

         

        Due after ten years

         

         

        4,177,591

         

         

        4,132,277

         

        Total

         

         

        $

        4,411,624

         

         

        $

        4,369,720

         

        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 total book value of the securities sold were $363.7 million, resulting in gross realized gains of $12.4 million. 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 resulting in a gross realized gain of $0.2 million. There were no sales of securities during the year ended December 31, 2003.

        The carrying value of securities pledged amounted to approximately $7.5 billion at December 31, 2005 and $6.3 billion at December 31, 2004. 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’s ability and intent to hold the security to maturity or until it recovers in value.

        The unrealized losses related to the Company’s investment in mortgage-backed and Federal agency securities are attributable to changes in market interest rates. The contractual cash flows of these securities are guaranteed by agencies of the U.S. government, including government sponsored agencies. As a result, the Company’s exposure to the credit risk of these securities is minimal. At December 31, 2005, there were 320 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’s mortgage-backed and Federal agency securities portfolio was less than 2% at December 31, 2005. 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, 2005.

        Corporate debt securities include trust preferred securities (‘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 credit spreads. At December 31, 2005, there were five 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, 2005.

        F-17



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003.

        3. Securities (Continued)

        Unrealized losses related to the Company’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, 2005, there were five state and political subdivisions investment securities in an unrealized loss position. 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, 2005.

        The following table represents the information about the Company’s temporarily impaired investments at December 31, 2005 (Dollars in thousands):

         

         

        Less than 12 months

         

        12 months or longer

         

        Total

         

         

         


        Fair Value

         

        Unrealized
        Losses

         


        Fair Value

         

        Unrealized
        Losses

         


        Fair Value

         

        Unrealized
        Losses

         

        Mortgage-backed securities

         

        $

        4,566,743

         

         

        $

        43,821

         

         

        $

        1,486,521

         

         

        $

        34,575

         

         

        $

        6,053,264

         

         

        $

        78,396

         

         

        Federal agency securities

         

        1,443,951

         

         

        10,809

         

         

        883,807

         

         

        13,105

         

         

        2,327,758

         

         

        23,914

         

         

        Corporate debt

         

        —

         

         

        —

         

         

        47,911

         

         

        1,543

         

         

        47,911

         

         

        1,543

         

         

        State and political subdivisions

         

        146,147

         

         

        1,856

         

         

        8,173

         

         

        152

         

         

        154,320

         

         

        2,008

         

         

        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

         

         

        The following table represents the information about the Company’s temporarily impaired investments at December 31, 2004 (Dollars in thousands):

         

         

        Less than 12 months

         

        12 months or longer

         

        Total

         

         

         


        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

         

         

        Federal agency securities

         

        1,446,223

         

         

        12,332

         

         

        518,045

         

         

        6,111

         

         

        1,964,268

         

         

        18,443

         

         

        Corporate debt

         

        —

         

         

        —

         

         

        47,894

         

         

        1,566

         

         

        47,894

         

         

        1,566

         

         

        State and political subdivisions

         

        5,565

         

         

        15

         

         

        6,025

         

         

        72

         

         

        11,590

         

         

        87

         

         

        Total temporarily impaired securities

         

        $

        3,969,888

         

         

        $

        28,051

         

         

        $

        1,117,673

         

         

        $

        14,798

         

         

        $

        5,087,561

         

         

        $

        42,849

         

         

        F-18



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003.

        4. Loans

        Loans consist of demand loans to custody clients of the Company, including individuals, not-for-profit institutions and 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 clients to facilitate securities transactions and redemptions. Almost all of the Company’s commitments to fund loans are at variable rates. Generally, the loans are, or may be, in the event of default, collateralized with marketable securities held by the Company as custodian. Although virtually all of our loans are fully collateralized with freely tradable securities, management recognizes some credit risk inherent in the loan portfolio, and has an allowance for loan losses of $0.1 million at December 31, 2005, a level which has remained consistent for the past five years. This amount is not allocated to any particular loan, but is intended to absorb any risk of loss inherent in the loan portfolio. 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 loans, non-performing loans, or loans on nonaccrual status at December 31, 2005 and 2004. In addition, there were no loan charge-offs or recoveries during the years ended December 31, 2005, 2004 and 2003. Loans are summarized as follows (Dollars in thousands):

         

         

        December 31,

         

        December 31,

         

         

         

        2005

         

        2004

         

        Loans to mutual funds

         

         

        $

        286,144

         

         

         

        $

        22,520

         

         

        Loans to individuals

         

         

        81,392

         

         

         

        69,402

         

         

        Loans to others

         

         

        34,934

         

         

         

        42,708

         

         

         

         

         

        402,470

         

         

         

        134,630

         

         

        Less allowance for loan losses

         

         

        (100

        )

         

         

        (100

        )

         

        Total

         

         

        $

        402,370

         

         

         

        $

        134,530

         

         

        The Company had unused commitments to lend of approximately $898.9 million and $978.8 million at December 31, 2005 and 2004, 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, 2005, 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, 2005, loans due from the mutual funds totaled $125.0 million. There were no loans outstanding from any related party mutual fund complex at December 31, 2004. Total interest and commitment fee revenue from the mutual funds for the years ended December 31, 2005 and 2004 was $2.7 million and $0.4 million, respectively. There was no interest or commitment fee revenue on any related party loans for the year ended December 31, 2003.

        In January 2006, the Company entered into a $30.0 million committed line of credit agreement with a series of trusts (“the trusts”). Edward F. Hines, a member of the Company’s Board of Directors, is a trustee of the trusts and is a partner in the firm that manages the assets held in the trusts. The line of credit

        F-19



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003.

        4. Loans (Continued)

        is secured by assets of the trusts, which assets are held by Investors Bank as custodian. The primary source of repayment of the loans is the proceeds from the sale of investments in the normal course of the trusts’ business.

        The terms and conditions of the Company’s contractual agreements with the mutual funds and trusts discussed above, including collateral requirements, lending limits and fees, are consistent with other lending clients that have similar composition, size and overall business relationships with the Company. Also, Mr. Oates and Mr. Hines abstain from voting on any board matter involving the proposed transactions with the mutual funds and trusts, respectively, discussed above.

        5. Equipment and Leasehold Improvements

        The major components of equipment and leasehold improvements are as follows (Dollars in thousands):

         

         

        December 31,
        2005

         

        December 31,
        2004

         

        Furniture, fixtures and equipment

         

         

        $

        112,310

         

         

         

        $

        113,204

         

         

        Leasehold improvements

         

         

        16,247

         

         

         

        15,696

         

         

        Total

         

         

        128,557

         

         

         

        128,900

         

         

        Less accumulated depreciation and amortization

         

         

        (59,156

        )

         

         

        (61,017

        )

         

        Equipment and leasehold improvements, net

         

         

        $

        69,401

         

         

         

        $

        67,883

         

         

        Included in furniture, fixtures and equipment were capitalized internal software costs of $73.3 million and $75.3 million at December 31, 2005 and 2004, respectively. Depreciation expense was $29.4 million, $30.1 million and $26.1 million for the years ended December 31, 2005, 2004 and 2003, respectively. Amortization expense was $2.2 million, $2.0 million and $1.9 million for the years ended December 31, 2005, 2004 and 2003, respectively.

        F-20



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003

        6. Deposits

        The following is a summary of deposit balances by type (Dollars in thousands):

         

         

        December 31,
        2005

         

        December 31, 
        2004

         

        Interest-bearing deposits:

         

         

         

         

         

         

         

         

         

        Demand

         

         

        $

        85,157

         

         

         

        $

        —

         

         

        Savings

         

         

        4,195,486

         

         

         

        4,362,895

         

         

        Time

         

         

        55,124

         

         

         

        97,669

         

         

        Total interest-bearing deposits

         

         

        4,335,767

         

         

         

        4,460,564

         

         

        Noninterest-bearing deposits:

         

         

         

         

         

         

         

         

         

        Demand

         

         

        452,401

         

         

         

        690,308

         

         

        Savings

         

         

        29,422

         

         

         

        85,510

         

         

        Time

         

         

        175,000

         

         

         

        160,000

         

         

        Total noninterest-bearing deposits

         

         

        656,823

         

         

         

        935,818

         

         

        Total

         

         

        $

        4,992,590

         

         

         

        $

        5,396,382

         

         

        Time deposits with balances greater than $100,000 totaled $230.1 million and $257.6 million at December 31, 2005 and 2004, respectively. All time deposits had a maturity of less than three months at December 31, 2005 and 2004. The aggregate amounts of overdraft deposits that have been reclassified as loan balances were $162.2 million and $41.6 million at December 31, 2005 and 2004, respectively.

        7. Securities Sold Under Repurchase Agreements

        Information on the Company’s repurchase agreements and the corresponding securities pledged as collateral is as follows (Dollars in thousands):

         

         

        Mortgage-backed securities

         

        Federal agency securities

         

        Repurchase Agreements

         

         

         

        Amortized Cost

         

        Fair Value

         

        Amortized Cost

         

        Fair Value

         

        Amortized Cost

         

        Rate

         

        Maturity of Repurchase Agreements:

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

        Overnight

         

         

        $

        1,739,883

         

         

        $

        1,733,766

         

         

        $

        1,456,234

         

         

        $

        1,440,022

         

         

        $

        3,024,835

         

         

        3.40

        %

        2 to 30 days

         

         

        754,483

         

         

        741,199

         

         

        —

         

         

        —

         

         

        734,967

         

         

        4.21

        %

        30 to 90 days

         

         

        262,471

         

         

        260,189

         

         

        —

         

         

        —

         

         

        195,530

         

         

        4.40

        %

        Over 90 days

         

         

        769,395

         

         

        761,467

         

         

        —

         

         

        —

         

         

        842,536

         

         

        3.34

        %

        Total

         

         

        $

        3,526,232

         

         

        $

        3,496,621

         

         

        $

        1,456,234

         

         

        $

        1,440,022

         

         

        $

        4,797,868

         

         

         

         

        Approximately $4.9 billion and $4.3 billion of securities were pledged to collateralize repurchase agreements as of December 31, 2005 and 2004, respectively. The weighted-average interest rate paid on repurchase agreements was 2.72% and 1.31% for the years ended December 31, 2005 and 2004, respectively.

        F-21



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003

        8. Short-term and Other Borrowings

           The components of short-term and other borrowings are as follows (Dollars in thousands):

         

         

        December 31,
        2005

         

        December 31,
        2004

         

        Federal Funds purchased

         

         

        $

        810,511

         

         

         

        $

        344,491

         

         

        Federal Home Loan Bank of Boston overnight advances

         

         

        400,000

         

         

         

        —

         

         

        Federal Home Loan Bank of Boston short-term advances

         

         

        146,000

         

         

         

        200,000

         

         

        Federal Home Loan Bank of Boston long-term advances

         

         

        —

         

         

         

        50,000

         

         

        Treasury, Tax and Loan account

         

         

        138

         

         

         

        190

         

         

        Total

         

         

        $

        1,356,649

         

         

         

        $

        594,681

         

         

        For the years ended December 31, 2005 and 2004, maturities on FHLBB advances ranged from overnight to September 2006. The Company has borrowing arrangements with the FHLBB, which have been utilized on an overnight, short-term and long-term basis to satisfy funding requirements. The aggregate amounts of these borrowing arrangements at December 31, 2005 and 2004 were $0.8 billion and $0.6 billion, respectively, of which $0.5 billion and $0.3 billion, respectively, were utilized at December 31, 2005 and 2004. Approximately $2.4 billion and $1.6 billion of securities were pledged to collateralize these advances as of December 31, 2005 and 2004, respectively. The weighted-average interest rate paid on short-term and other borrowings was 3.31% and 2.13% for the years ended December 31, 2005 and 2004, respectively.

        9. Income Taxes

        The components of income tax expense are as follows (Dollars in thousands):

         

         

        December 31,
        2005

         

        December 31,
        2004

         

        December 31,
        2003

         

        Current:

         

         

         

         

         

         

         

         

         

         

         

         

         

        Federal

         

         

        $

        76,533

         

         

         

        $

        62,690

         

         

         

        $

        32,752

         

         

        State

         

         

        5,420

         

         

         

        5,892

         

         

         

        14,310

         

         

        Foreign

         

         

        1,026

         

         

         

        1,247

         

         

         

        52

         

         

        Total current

         

         

        82,979

         

         

         

        69,829

         

         

         

        47,114

         

         

        Deferred:

         

         

         

         

         

         

         

         

         

         

         

         

         

        Federal

         

         

        (9,543

        )

         

         

        3,413

         

         

         

        5,989

         

         

        State

         

         

        1,788

         

         

         

        94

         

         

         

        (338

        )

         

        Foreign

         

         

        811

         

         

         

        (510

        )

         

         

        —

         

         

        Total deferred

         

         

        (6,944

        )

         

         

        2,997

         

         

         

        5,651

         

         

        Total income taxes

         

         

        $

        76,035

         

         

         

        $

        72,826

         

         

         

        $

        52,765

         

         

        F-22



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003

        9. Income Taxes (Continued)

        Differences between the effective income tax rate and the federal statutory rates are as follows:

         

         

        December 31,
        2005

         

        December 31,
        2004

         

        December 31,
        2003

         

        Federal statutory rate

         

         

        35.00

        %

         

         

        35.00

        %

         

         

        35.00

        %

         

        State income tax rate, net of federal benefit

         

         

        2.00

         

         

         

        1.81

         

         

         

        6.25

         

         

        Tax-exempt income, net of disallowance

         

         

        (2.89

        )

         

         

        (3.61

        )

         

         

        (4.89

        )

         

        Foreign taxes

         

         

        0.83

         

         

         

        —

         

         

         

        —

         

         

        Undistributed foreign earnings

         

         

        (4.12

        )

         

         

        —

         

         

         

        —

         

         

        Other

         

         

        1.41

         

         

         

        0.71

         

         

         

        (0.01

        )

         

        Effective tax rate

         

         

        32.23

        %

         

         

        33.91

        %

         

         

        36.35

        %

         

        At December 31, 2005, the Company had a foreign non-capital loss carryforward of approximately $1.6 million, which begins to expire in 2009. In accordance with the provisions of SFAS 109, the Company believes that it is more likely than not that the deferred tax asset of $0.6 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 foreign subsidiaries, except to the extent that such earnings are permanently reinvested outside the United States. At December 31, 2005, there were accumulated unremitted earnings of certain foreign subsidiaries of $27.7 million. Pursuant to the provisions of APB 23, the Company has 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 liability of $6.9 million would have been recorded.

        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, the Company settled this disputed tax assessment with the Massachusetts Department of Revenue, agreeing to pay approximately 50% of the liability. As a result of this retroactive change in tax law, the Company recorded an additional state tax expense of approximately $7.2 million, net of federal income tax benefit, in 2003.

        F-23



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003

        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,
        2005

         

        December 31,
        2004

         

        Deferred tax assets:

         

         

         

         

         

         

         

         

         

        Securities available for sale

         

         

        $

        16,622

         

         

         

        $

        —

         

         

        Employee benefit plans

         

         

        7,094

         

         

         

        3,883

         

         

        Other

         

         

        3,691

         

         

         

        1,350

         

         

        Deferred tax assets

         

         

        27,407

         

         

         

        5,233

         

         

        Valuation allowance

         

         

        (565

        )

         

         

        —

         

         

        Total deferred tax assets

         

         

        26,842

         

         

         

        5,233

         

         

        Deferred tax liabilities:

         

         

         

         

         

         

         

         

         

        Unrealized hedging gain

         

         

        (13,224

        )

         

         

        (2,306

        )

         

        Depreciation and amortization

         

         

        (10,698

        )

         

         

        (9,882

        )

         

        Undistributed income of foreign subsidiaries

         

         

        (69

        )

         

         

        (6,160

        )

         

        Pension plan

         

         

        (1,196

        )

         

         

        (1,172

        )

         

        Securities available for sale

         

         

        —

         

         

         

        (10,162

        )

         

        Total deferred tax liabilities

         

         

        (25,187

        )

         

         

        (29,682

        )

         

        Net deferred tax asset (liability)

         

         

        $

        1,655

         

         

         

        $

        (24,449

        )

         

        10. Company Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust Holding Junior  Subordinated Deferrable Interest Debentures of the Company

        On January 31, 1997, Investors Capital Trust I (“ICTI”), a trust sponsored and wholly-owned by the Company, issued $25 million in 9.77% Trust Preferred Securities (the “Capital Securities”), the proceeds of which were invested by the trust in the same aggregate principal amount of the Company’s newly issued 9.77% Junior Subordinated Deferrable Interest Debentures due February 1, 2027 (the “Junior Subordinated Debentures”). The Capital Securities have a call date of February 1, 2007. 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”). The Guarantee, when taken together with the Company’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’s obligations under the Capital Securities. No other subsidiary of the Company guarantees these Capital Securities. Certain of the Company’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’s ability to pay dividends to its shareholders.

        Effective October 1, 2003, the Company adopted provisions of FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities (“FIN 46”). As a result of the adoption of FIN 46, the Company was required to deconsolidate ICTI, the wholly-owned trust that issued the Capital

        F-24



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003

        10. Company Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust Holding Junior  Subordinated Deferrable Interest Debentures of the Company (Continued)

        Securities. Therefore, the Company presents in its consolidated financial statements 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 not consolidated is considered immaterial.

        11. Stockholders’ Equity

        As of December 31, 2005, the Company’s capital stock consisted of authorized 1,000,000 shares of preferred stock and 175,000,000 shares of common stock, all with a par value of $0.01 per share.

        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 four equity incentive plans: the Amended and Restated 1995 Stock Plan (“Stock Plan”), the Amended and Restated 1995 Non-Employee Director Stock Option Plan (“Director Plan”), the 1997 Employee Stock Purchase Plan (“ESPP”) and the 2005 Equity Incentive Plan, which was approved by the stockholders on April 14, 2005 (the “2005 Plan”). The 2005 Plan supersedes both the Stock Plan and the Director Plan, both of which continue in effect only with regard to options outstanding under those plans. Pursuant to the terms of the 2005 Plan, awards under the 2005 Plan may include incentive stock options, nonstatutory stock options, stock appreciation rights, restricted stock, restricted stock units and performance units, qualified performance-based awards, and stock grants. There were no amendments to any plans during the year ended December 31, 2005.

        Effective with the start 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 for issuance under the 2005 Plan.

        Of the shares authorized for issuance under the 2005 Plan at December 31, 2005, 4,104,013 were available for grant as of that date. No options were granted to consultants during the years ended December 31, 2005, 2004 and 2003.

        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.

        The Company has recorded deferred compensation of $0.3 million and $0.6 million at December 31, 2005 and 2004, respectively. Amortization of deferred compensation was $0.3 million, $0.3 million and $0.5 million for the years ended December 31, 2005, 2004 and 2003, respectively.

        F-25



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003

        11. Stockholders’ Equity (Continued)

        A summary of option activity under the Director Plan, Stock Plan and 2005 Plan are as follows:

         

         

        December 31, 2005

         

        December 31, 2004

         

        December 31, 2003

         

         

         

        Shares

         

        Weighted-
        Average
        Exercise
        Price

         

        Shares

         

        Weighted-
        Average
        Exercise
        Price

         

        Shares

         

        Weighted-
        Average
        Exercise
        Price

         

        Outstanding at beginning of year

         

         

        5,929,352

         

         

         

        $

        28

         

         

         

        6,547,086

         

         

         

        $

        24

         

         

         

        6,621,157

         

         

         

        $

        22

         

         

        Granted

         

         

        1,518,580

         

         

         

        39

         

         

         

        902,558

         

         

         

        41

         

         

         

        737,399

         

         

         

        34

         

         

        Exercised

         

         

        (454,146

        )

         

         

        22

         

         

         

        (1,396,211

        )

         

         

        20

         

         

         

        (654,230

        )

         

         

        9

         

         

        Canceled

         

         

        (74,470

        )

         

         

        35

         

         

         

        (124,081

        )

         

         

        32

         

         

         

        (157,240

        )

         

         

        32

         

         

        Outstanding at end of year

         

         

        6,919,316

         

         

         

        31

         

         

         

        5,929,352

         

         

         

        28

         

         

         

        6,547,086

         

         

         

        24

         

         

        Outstanding and exercisable at year end

         

         

        6,510,182

         

         

         

         

         

         

         

        4,949,879

         

         

         

         

         

         

         

        4,712,586

         

         

         

         

         

         

        The following table summarizes information about stock options outstanding at December 31, 2005:

         

         

        Options Outstanding

         

        Options
        Exercisable

         

        Range of
        Exercise
        Prices

         

        Number
        Outstanding at
        December 31,
        2005

         

        Weighted-
        Average
        Remaining
        Contractual
        Life

         

        Weighted-
        Average
        Exercise
        Price

         

        Number
        Exercisable at
        December 31,
        2005

         

        Weighted-
        Average
        Exercise
        Price

         

         

        $

        0-10

         

         

         

        669,684

         

         

         

        2.4 years

         

         

         

        $

        6

         

         

         

        669,684

         

         

         

        $

        6

         

         

         

        10-20

         

         

         

        692,239

         

         

         

        3.2

         

         

         

        11

         

         

         

        692,239

         

         

         

        11

         

         

         

        20-30

         

         

         

        68,620

         

         

         

        4.9

         

         

         

        25

         

         

         

        65,530

         

         

         

        25

         

         

         

        30-40

         

         

         

        4,588,428

         

         

         

        7.2

         

         

         

        35

         

         

         

        4,259,461

         

         

         

        35

         

         

         

        40-50

         

         

         

        893,932

         

         

         

        8.3

         

         

         

        41

         

         

         

        816,855

         

         

         

        41

         

         

         

        50-60

         

         

         

        6,413

         

         

         

        5.2

         

         

         

        51

         

         

         

        6,413

         

         

         

        51

         

         

         

         

         

         

         

        6,919,316

         

         

         

        6.5

         

         

         

        31

         

         

         

        6,510,182

         

         

         

        30

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

        Under the terms of the ESPP, the Company may issue up to 1,620,000 shares of common stock pursuant to the exercise of nontransferable options granted to participating employees. The ESPP permits eligible employees to purchase up to 8,000 shares of common stock per payment period, subject to limitations provided by Section 423(b) of the Internal Revenue Code, through accumulated payroll 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 stock on the first business day of the payment period (rounded to the next quarter-dollar), or (ii) 90% of the market value of the common stock on the last business day of the payment

        F-26



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003

        11. Stockholders’ Equity (Continued)

        period (rounded to the next quarter-dollar). The payment periods consist of two six-month periods, January 1 through June 30 and July 1 through December 31.

        A summary of the ESPP shares is as follows:

         

         

        December 31,

         

         

         

        2005

         

        2004

         

        2003

         

        Total shares available under the Plan, beginning of year 

         

        636,267

         

        227,504

         

        356,875

         

        Approved increase in shares available

         

        —

         

        500,000

         

        —

         

        Issued at June 30

         

        (54,862

        )

        (47,681

        )

        (70,606

        )

        Issued at December 31

         

        (59,842

        )

        (43,556

        )

        (58,765

        )

        Total shares available under the plan, end of year

         

        521,563

         

        636,267

         

        227,504

         

        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 period 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 stock on the first business day of the payment periods ending June 30, 2004 and December 31, 2004, respectively.

        During 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 30, 2003 and December 31, 2003, respectively.

        In July 2005, the Company announced that its Board of Directors authorized a repurchase plan of up to $150.0 million of the Company’s common stock in the open market over the twelve months following the announcement. The plan expires in June 2006. During the year ended December 31, 2005, the Company repurchased $70.7 million of its common stock.

        F-27



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003

        12. Comprehensive 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’s other comprehensive income and related tax effects for the years ended December 31, 2005, 2004 and 2003 are as follows (Dollars in thousands):

         

         

        Pre-tax

         

        Tax (Expense)

         

        After-tax

         

         

         

        Amount

         

        Benefit

         

        Amount

         

        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

         

         

         

         

         

         

         

         

         

        Unrealized losses on securities:

         

         

         

         

         

         

         

         

         

        Unrealized holding losses arising during the period

         

        $

        (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

         

        (2,671

        )

         

        935

         

         

        (1,736

        )

        Net unrealized losses

         

        (12,073

        )

         

        4,219

         

         

        (7,854

        )

        Net unrealized derivative instrument gain

         

        19,984

         

         

        (6,994

        )

         

        12,990

         

        Amortization of terminated interest rate swap agreements

         

        63

         

         

        (22

        )

         

        41

         

        Currency translation adjustment

         

        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

        )

        F-28



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003

        13. Employee 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’s compensation during employment. Generally, the Company’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 and December 2004 to freeze benefit accruals for certain highly compensated participants. Effective January 1, 2006, no further Pension Plan benefit will accrue on behalf of any Pension Plan participant, and effective December 31, 2005, all Pension Plan participant’s accounts were frozen. The Company uses a December 31 measurement date for this plan.

        Supplemental Retirement Plan—The Company also has a nonqualified, unfunded, supplemental retirement plan (‘SERP’) which was established in 1994 and covers certain employees and pays benefits that supplement any benefits paid under the Pension Plan. Benefits under the SERP are generally based on compensation not includable in the calculation of benefits to be paid under the 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 December 31 measurement date for this plan.

        The following table sets forth the status of the Company’s Pension Plan and SERP (Dollars in thousands):

         

         

        December 31, 2005

         

        December 31, 2004

         

         

         

        Pension Plan

         

        SERP

         

        Pension Plan

         

        SERP

         

        Change in benefit obligation:

         

         

         

         

         

         

         

         

         

         

         

         

         

        Benefit obligation at beginning of year

         

         

        $

        22,141

         

         

        $

        23,543

         

         

        $

        18,050

         

         

        $

        15,500

         

        Service cost

         

         

        744

         

         

        1,788

         

         

        927

         

         

        953

         

        Interest cost

         

         

        1,143

         

         

        1,475

         

         

        1,110

         

         

        969

         

        Actuarial loss

         

         

        249

         

         

        1,057

         

         

        3,282

         

         

        6,121

         

        Benefits paid

         

         

        (1,100

        )

         

        (287

        )

         

        (1,228

        )

         

        —

         

        Curtailments

         

         

        (6,360

        )

         

        —

         

         

        —

         

         

        —

         

        Projected benefit obligation at the end of the year

         

         

        16,817

         

         

        27,576

         

         

        22,141

         

         

        23,543

         

        Change in plan assets:

         

         

         

         

         

         

         

         

         

         

         

         

         

        Assets at the beginning of the year

         

         

        17,185

         

         

        —

         

         

        17,246

         

         

        —

         

        Employer contributions

         

         

        —

         

         

        287

         

         

        —

         

         

        —

         

        Actual return

         

         

        803

         

         

        —

         

         

        1,167

         

         

        —

         

        Benefits paid

         

         

        (1,100

        )

         

        (287

        )

         

        (1,228

        )

         

        —

         

        Assets at the end of the year

         

         

        16,888

         

         

        —

         

         

        17,185

         

         

        —

         

        Funded status

         

         

        71

         

         

        (27,576

        )

         

        (4,956

        )

         

        (23,543

        )

        Unrecognized net transition (asset) obligation

         

         

        (28

        )

         

        10

         

         

        (67

        )

         

        15

         

        Unrecognized prior service cost

         

         

        —

         

         

        2,294

         

         

        (296

        )

         

        2,439

         

        Unrecognized net loss

         

         

        2,817

         

         

        12,902

         

         

        8,668

         

         

        12,787

         

        Net amount recognized

         

         

        $

        2,860

         

         

        $

        (12,370

        )

         

        $

        3,349

         

         

        $

        (8,302

        )

        F-29



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003

        13. Employee Benefit Plans (Continued)

        Amounts recognized in the consolidated balance sheet consist of the following (Dollars in thousands):

         

         

        December 31, 2005

         

        December 31, 2004

         

         

         

        Pension Plan

         

        SERP

         

        Pension Plan

         

        SERP

         

        Prepaid benefit cost

         

         

        $

        2,860

         

         

        $

        —

         

         

        $

        3,349

         

         

        $

        —

         

        Accrued benefit cost

         

         

        —

         

         

        (18,074

        )

         

        —

         

         

        (14,019

        )

        Intangible assets

         

         

        —

         

         

        2,304

         

         

        —

         

         

        2,454

         

        Accumulated other comprehensive income

         

         

        —

         

         

        3,400

         

         

        —

         

         

        3,263

         

        Net amount recognized

         

         

        $

        2,860

         

         

        $

        (12,370

        )

         

        $

        3,349

         

         

        $

        (8,302

        )

        The accumulated benefit obligation for the Pension Plan was $16.8 million and $16.0 million at December 31, 2005 and 2004, respectively. The accumulated benefit obligation for the SERP was $18.1 million and $14.0 million at December 31, 2005 and 2004, respectively.

        Net periodic pension cost for the Company’s Pension Plan and SERP included the following components (Dollars in thousands):

         

         

        December 31, 2005

         

        December 31, 2004

         

         

         

        Pension Plan

         

        SERP

         

        Pension Plan

         

        SERP

         

        Service cost—benefits earned / benefit obligations

         

         

        $

        744

         

         

        $

        1,788

         

         

        $

        927

         

         

        $

        953

         

        Interest cost on projected benefit obligations

         

         

        1,143

         

         

        1,475

         

         

        1,110

         

         

        969

         

        Expected return on plan assets

         

         

        (1,435

        )

         

        —

         

         

        (1,450

        )

         

        —

         

        Curtailment gain

         

         

        (275

        )

         

        —

         

         

        —

         

         

        —

         

        Net amortization and deferral

         

         

        313

         

         

        1,092

         

         

        240

         

         

        591

         

        Net periodic pension cost

         

         

        $

        490

         

         

        $

        4,355

         

         

        $

        827

         

         

        $

        2,513

         

        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, 2005

         

        December 31, 2004

         

         

         

        Pension Plan

         

        SERP

         

        Pension Plan

         

        SERP

         

        Discount rate

         

         

        5.75

        %

         

        5.75

        %

         

        5.80

        %

         

        5.80

        %

        Rate of compensation increases

         

         

        4.00

         

         

        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, 2005

         

        December 31, 2004

         

         

         

        Pension Plan

         

        SERP

         

        Pension Plan

         

        SERP

         

        Discount rate

         

         

        5.80

        %

         

         

        5.80

        %

         

         

        6.25

        %

         

         

        6.25

        %

         

        Rate of compensation increases

         

         

        4.00

         

         

         

        4.00

         

         

         

        3.75

         

         

         

        3.75

         

         

        Expected rate of return on plan assets

         

         

        8.50

         

         

         

        —

         

         

         

        8.50

         

         

         

        —

         

         

        The Company has utilized an expected rate of return on plan assets of 8.50%, which is consistent with the weighted-average of the historical return indices for specific portfolio assets.

        F-30



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003

        13. Employee Benefit Plans (Continued)

        The Company’s Pension Plan allocation by asset category is as follows:

        Asset Category

         

         

         

        December 31, 2005

         

        December 31, 2004

         

        Cash and short-term investments

         

         

        1.3

        %

         

         

        0.5

        %

         

        Equity securities

         

         

        68.4

         

         

         

        69.2

         

         

        Debt securities

         

         

        30.3

         

         

         

        30.3

         

         

        Total

         

         

        100.0

        %

         

         

        100.0

        %

         

        The Company’s core investment objectives for the Pension 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, 2005 and 2004. 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, 2005 and 2004. Debt securities offer a source of current income and reduce the variability of the portfolio’s total market value. Fixed income investments were limited to issues by the United States Government and its agencies, and investment grade corporate bonds at December 31, 2005 and 2004. The Pension Plan was in full compliance with the approved pension objectives and policies for the years ended December 31, 2005 and 2004. At December 31, 2005 and 2004, the pension did not hold any securities of the Company.

        The Company does not expect to contribute to its Pension Plan during 2006.

        At December 31, 2005 and 2004, the SERP remained an unfunded plan. The Company does not expect to contribute to the SERP during 2006.

        The following table shows the expected future benefit payments for the next ten years (Dollars in thousands):

         

         

        Pension Plan

         

        SERP

         

        2006

         

         

        $

        244

         

         

        $

        167

         

        2007

         

         

        290

         

         

        171

         

        2008

         

         

        315

         

         

        175

         

        2009

         

         

        376

         

         

        180

         

        2010

         

         

        407

         

         

        188

         

        2011 - 2015

         

         

        3,003

         

         

        1,410

         

        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 $3.7 million for the year ended December 31, 2005 and $3.2 million for the years ended December 31, 2004 and 2003.

        F-31



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003

        14. Off Balance Sheet Financial Instruments

        Lines of Credit—At December 31, 2005, the Company had commitments to mutual funds and individuals under collateralized open lines of credit totaling $1.1 billion, against which $240.3 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, 20032005 totaled $4.5$7.7 billion, while the fair value of the portfolio totaled approximately $4.3$7.4 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.

        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-denominateddollar- 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 suchthose 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.

        16.15. Derivative 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,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

        F-32



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003

        15. Derivative Financial Instruments (Continued)

        less than the notional value. During 2003,As of December 31, 2005, the positive fair value related to the Company’s interest rate contracts was approximately $24.3 million.

        The Company had agreements to assumeenters into pay-fixed/receive-floating interest rate swap agreements. These instruments have been designated as cash flow hedges of variable-rate liabilities and a forecasted series of fixed-rate overnight liabilities incurred at different daily fixed rates (thereby resulting in a variable interest payments in exchange for receiving variable market-indexed interest payments. The original terms range from 24 to 36 months.expense pattern). The contractual or notional amounts of the interest rate swap agreements held by the Company were approximately $1.2$1.9 billion and $1.0$1.6 billion at December 31, 20032005 and 2002,2004, respectively. The weighted-average fixed-payment rates were 3.92% and 4.63% at December 31, 2003 and 2002, respectively. Variable-interest payments received are indexed to the Prime and the overnight Federal Funds rate for 2003. At December 31, 2003 and 2002, the weighted-average rate of variable market-indexed interest payment obligations to the Company were 1.70% and 1.55%, respectively. The effect of these agreements was to lengthen short-term variable-rate liabilities into longer-term fixed-rate liabilities. These contracts had net fair values of approximately $(14.9)$24.2 million and $(33.1)$1.5 million at December 31, 20032005 and 2002,2004, 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 1817 for additional information on the fair value of the interest rate contracts. These instruments have been designated as

        For the years ended December 31, 2005 and 2004, the Company recognized net pre-tax gains of $3.5 million and $4.1 million, respectively, which represented the total ineffectiveness for all cash flow hedges.



        Changes in fair value of effective portions are included as a component of other comprehensive income. Changes in fair value of ineffective portions are included in net interest income.

                Hedge For the year ended December 31, 2003, total ineffectiveness determined in accordance with SFAS No. 133,related to cash flow hedges had an insignificant impact on earnings for the years endedearnings.

        As of December 31, 2003, 2002 and 2001. Net interest income also included $0.42005, the Company expects that approximately $9.3 million of deferred net after-tax gains on derivative losses for the twelve-month period that resulted from the reclassification of transition adjustment-related derivative losses from OCIcontracts included in other comprehensive income will be reclassified to net interest income in accordance with SFAS No. 133. The recognition inwithin the next twelve months. This expectation is based on the net interest incomediscounted cash flows from existing cash flow hedging derivatives, as well as the amortization of the transition adjustment derivative losses from OCI will be offset by derivative gains from changes in the fair value liability of the interest rate swaps as they reach maturity. As of December 31, 2003, the Company had reclassified into earnings all of the remaining transition adjustment of net derivative losses included in OCI.terminated cash flow hedging derivatives.

        Foreign Exchange ContractsContracts——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, 20032005 and 20022004 was $1.6$6.3 billion and $0.7$6.9 billion, respectively. As of December 31, 2003 and 2002,2005, the European UnitEuro foreign exchange contracts represented approximately 31% and 38%57% of the of the notional value outstanding asoutstanding. As of December 31, 2003 and 2002, respectively.2004, the British Pound foreign exchange contracts represented approximately 43% of the notional value outstanding. 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 $16.1$20.8 million and $4.4$99.6 million as ofat December 31, 20032005 and 2002,2004, respectively. Unrealized losses in other liabilities were $15.9$19.7 million and $4.5$98.5 million as ofat December 31, 20032005 and 2002,2004, respectively. See also Note 1817 for additional information on the fair value of ourthe Company’s foreign exchange contracts. Foreign exchange contracts have been reduced by offsetting balances with the same counterparty whereare netted in the Company’s consolidated balance sheets 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.

        F-33



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003

        15. Derivative Financial Instruments (Continued)

        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, 20032005 and 2002,2004, the Company had $792.1$97.5 million and $432.6$672.2 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.



        17.16. Commitments 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, 20032005 was approximately $22.3$51.9 million. In addition, the Company's other assets categoryCompany’s balance sheet includes deposits totaling $29.5$43.9 million, which were pledged to secure clearings with depository institutions.institutions at December 31, 2005.

        Lease Commitments—Minimum future commitments on noncancelable operating leases at December 31, 20032005 were as follows (Dollars in thousands):

        Fiscal Year Ending
        		 Bank Premises
        		 Equipment
        		 Total

         

         

         

        Bank Premises

         

        Equipment

         

        Total

         

        2004 $25,128 $10,941 $36,069
        2005  25,361  6,212  31,573
        2006  25,461  1,789  27,250

        2006

         

         

        $

        28,502

         

         

         

        $

        3,684

         

         

        $

        32,186

         

        2007  22,259  33  22,292

        2007

         

         

        27,734

         

         

         

        1,847

         

         

        29,581

         

        2008 and beyond  40,344  16  40,360
         
        		 
        		 

        2008

        2008

         

         

        23,959

         

         

         

        508

         

         

        24,467

         

        2009

        2009

         

         

        22,935

         

         

         

        5

         

         

        22,940

         

        2010

        2010

         

         

        22,935

         

         

         

        1

         

         

        22,936

         

        2011 and beyond

        2011 and beyond

         

         

        86,432

         

         

         

        —

         

         

        86,432

         

        Total $138,553 $18,991 $157,544

        Total

         

         

        $

        212,497

         

         

         

        $

        6,045

         

         

        $

        218,542

         

         
        		 
        		 

         

        Total rent expense was approximately $36.1$29.2 million, $34.5$33.4 million and $24.5$36.1 million for the years ended December 31, 2003, 20022005, 2004 and 2001,2003, respectively.

                Effective January 1, 2001,In December 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 $7.7$7.3 million, $7.4$8.3 million and $5.0$7.7 million for the years ended December 31, 2003, 20022005, 2004 and 2001,2003, respectively.

        In 2001,2004, the Company renewed its agreement with SEI Investments Company (‘SEI’), which now expires on December 31, 2005.2009. 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 $4.9$5.3 million, $5.2$5.0 million and $4.2$4.9 million for the years ended December 31, 2005, 2004 and 2003, 2002respectively.

        In 2004, the Company signed a service agreement with International Business Machines Corporation (‘IBM’). Under the terms of this agreement, IBM provides support for our network and 2001,hardware environments and our help desk services. We have agreed to pay certain monthly services fees based upon

        F-34



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003

        16. Commitments and Contingencies (Continued)

        usage. This agreement expires June 30, 2011. Service expense under this contract was $13.7 million and $9.5 million for the years ended December 31, 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 global custody, multicurrency accounting and mutual fund administration. Value-added services include securities lending, foreign exchange, cash management, performance measurement, institutional transfer agency, investment advisory services, lines of credit, middle office outsourcing 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 at December 31, 20032005 that arewere material to the consolidated financial position or results of operations of the Company.



        On June 27, 2003, the Company and an individual employee of the Company were named in a lawsuit alleging, among other things, that the Company breached an implied covenant of good faith and fair dealing in a subadvisory contract with Opus Investment Management, Inc. (‘Opus’), and that the individual employee of the Company engaged in a breach of fiduciary duties and tortious interference with a contract. Opus had been a subadviser to the Merrimac Funds, for which the Company acts as investment adviser. Upon the expiration of Opus’s contract on June 1, 2003, the Merrimac Funds elected not to re-appoint Opus as subadviser. The lawsuit was filed in Superior Court in Worcester, Massachusetts and seeks unspecified damages. The lawsuit is currently in the discovery phase. The Company believes that the claims are without merit and intends to vigorously defend the rights of the Company. However, the Company cannot predict the outcome of this lawsuit at this time, and the Company can give no assurance that it will not affect the Company’s financial condition or results of operations in a materially adverse way.

        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, 2003,2005, the Company does not expect this matter to have a material adverse effect on its business, financial condition or results of operations.

                In January 2001, Mopex, Inc.Investors Financial Services Corp. and five of its officers are named as defendants in three purported class action complaints that were filed an action entitledMopex, Inc. v. Chicago Stock Exchange, Inc., et al., Civil Action No. 01 C 0302 (the "Complaint"),on or about August 4, 2005, August 15, 2005, and September 30, 2005 in the United States District Court for the Northern District of Illinois. InMassachusetts, Boston, Massachusetts. Among other things, the Complaint, Mopex allegescomplaints filed on August 4, 2005 and August 15, 2005 assert that the Bankdefendants violated Sections 10(b) and numerous20(a) of the Securities Exchange Act of 1934 during the period October 15, 2003 until July 15, 2005. Among other entities, including Barclays Global Investors, State Street Bankthings, the complaint filed on September 30, 2005 asserts that the defendants violated Sections 10(b) and Trust Company,20(a) of the Securities Exchange Act of 1934 during the period

        F-35



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and Merrill Lynch, Pierce, Fenner & Smith, Inc., infringed U.S. Patent No. 6,088,685, entitled, "Open End Mutual Fund Securitization Process," assigned to Mopex. On or about May 9,2003

        16. Commitments and Contingencies (Continued)

        July 16, 2003 the parties to the action executed a settlement agreement and filed a joint stipulated order of dismissal. On May 13, 2003, the court entered the order of dismissal, terminating the case.until July 15, 2005. The order of dismissal entered by the court provided for the dismissal of Mopex's claims without prejudice. We did not pay or promise to pay any money to Mopex to obtain the dismissal. Moreover, our counterclaims against Mopex were dismissed without prejudice, keeping alive our defensesallegations in the eventcomplaints predominantly relate to: (1) the Company’s October 2004 restatement of any further litigation involving this patent.

                On January 31, 2003,its financial results, and (2) the Company was named in a class action lawsuit alleging, among other things, violationsCompany’s July 2005 revision of California wagepublic guidance regarding its future financial performance. The complaints seek unspecified damages, interest, fees, and hour laws atcosts. We strongly believe that the Company's Sacramentolawsuits lack merit and Walnut Creek facilities. The lawsuit was filed inwe intend to defend against the Superior Court of California, County of Sacramento. On July 23, 2003,claims vigorously. However, we cannot predict the Company reached an agreement in principle with representativesoutcome of the plaintiffs to settle the case. As currently agreed, the settlementlawsuits at this time, and we can give no assurance that they will not have a material impact on the Company's business,materially adversely affect our financial condition or results of operations. The settlement is subject to proper administration

        Investors Financial Services Corp. and nine of payments to the class membersits officers and final approval by the court. In anticipation of this settlementdirectors are named as defendants in two shareholder derivative complaints that were filed on or about September 22, 2005 and related costs, the Company accrued a liability of approximately $1.0 millionOctober 17, 2005 in the second quarterUnited States District Court for the District of 2003.

                In March 2003, a retroactive changeMassachusetts, 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 Commonwealthcomplaints predominantly relate to: (1) the Company’s October 2004 restatement of Massachusetts tax law disallowed a dividends received deduction taken byits financial results, and (2) the Bank on dividends it had received since 1999 from a wholly-owned real estate investment trust. DuringCompany’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. We strongly believe that the second quarter of 2003,lawsuits lack merit and we settled this disputed tax assessment withintend to defend against the Massachusetts Department of Revenue, agreeing to pay approximately 50%claims vigorously. However, we cannot predict the outcome of the liability. As a resultlawsuits at this time, and we can give no assurance that they will not materially adversely affect our financial condition or results of this retroactive change in tax law, we recorded an additional state tax expense of approximately $7.2 million, net of federal income tax benefit, in 2003.operations.


        18.17. Fair Value of Financial Instruments

        The carrying valueamount and estimated fair value of financial instruments are as follows (Dollars in thousands):
        		 December 31, 2003
        		 December 31, 2002

         

        December 31, 2005

         

        December 31, 2004

         
        		 Carrying
        Amount
        		 Fair
        Value
        		 Carrying
        Amount
        		 Fair
        Value

         

        Carrying
        Amount

         

        Fair
        Value

         

        Carrying
        Amount

         

        Fair
        Value

         

        Financial Assets:Financial Assets:        

         

         

         

         

         

         

         

         

         

        Cash and due from banks $39,689 $39,689 $14,568 $14,568
        Securities held to maturity 4,306,216 4,308,578 3,437,955 3,460,754
        Securities available for sale 4,296,637 4,296,637 3,272,465 3,272,465
        Loans, net allowance 199,530 199,530 143,737 143,737
        Interest rate contracts 158 158 — —
        Foreign exchange contracts 16,114 16,114 4,394 4,394

        Cash and due from banks

         

        $

        79,637

         

        $

        79,637

         

        $

        49,059

         

        $

        49,059

         

        Securities held to maturity

         

        6,761,930

         

        6,725,729

         

        5,942,717

         

        5,937,462

         

        Securities available for sale

         

        4,369,720

         

        4,369,720

         

        4,565,505

         

        4,565,505

         

        Loans, net of allowance

         

        402,370

         

        402,370

         

        134,530

         

        134,530

         

        Interest rate contracts

         

        24,251

         

        24,251

         

        1,849

         

        1,849

         

        Foreign exchange contracts

         

        20,805

         

        20,805

         

        99,576

         

        99,576

         


        Financial Liabilities:
        Financial Liabilities:
         
         
         
         
         
         
         
         

         

         

         

         

         

         

         

         

         

        Deposits 4,207,118 4,207,118 3,332,918 3,332,918
        Securities sold under repurchase agreements 3,258,001 3,261,227 2,301,974 2,301,974
        Short-term & other borrowings 1,098,087 1,102,449 741,107 741,107
        Interest rate contracts 15,103 15,103 33,145 33,145
        Foreign exchange contracts 15,901 15,901 4,504 4,504

        Deposits

         

        $

        4,992,590

         

        $

        4,992,590

         

        $

        5,396,382

         

        $

        5,396,382

         

        Securities sold under repurchase agreements

         

        4,797,868

         

        4,736,958

         

        4,255,497

         

        4,197,590

         

        Short-term and other borrowings

         

        1,356,649

         

        1,356,649

         

        594,681

         

        594,411

         

        Interest rate contracts

         

        101

         

        101

         

        310

         

        310

         

        Foreign exchange contracts

         

        19,665

         

        19,665

         

        98,531

         

        98,531

         

         

        F-36



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003

        17. Fair Value of Financial Instruments (Continued)

        The fair value estimates presented herein are based on pertinent information available to management as ofat December 31, 20032005 and 2002.2004. 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, 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 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.

        19.18. 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- balanceoff-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)

        F-37



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003

        18. Regulatory Matters (Continued)

        to average assets (as defined). Management believes, as of December 31, 2003,2005, that the Company and the Bank meet all capital adequacy requirements to which they are subject.

        As of December 31, 2003,2005, 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.

        The following table presents the capital ratios for the BankCompany and the CompanyBank (Dollars in thousands):

         
        		 Actual
        		 For Capital
        Adequacy Purposes:
        		 To Be Well
        Capitalized Under
        Prompt Corrective
        Action Provisions:
        		 
         
        		 Amount
        		 Ratio
        		 Amount
        		 Ratio
        		 Amount
        		 Ratio
        		 
        As of December 31, 2003:                
         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%
         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%
         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%
        As of December 31, 2002:                
         Total Capital                
          (to Risk-Weighted Assets—the Company) $368,701 15.30%$192,796 8.00% N/A N/A 
          (to Risk-Weighted Assets—the Bank) $363,400 15.08%$192,796 8.00%$240,995 10.00%
         Tier 1 Capital                
          (to Risk-Weighted Assets—the Company) $368,601 15.29%$96,398 4.00% N/A N/A 
          (to Risk-Weighted Assets—the Bank) $363,300 15.08%$96,398 4.00%$144,597 6.00%
         Tier 1 Capital                
          (to Average Assets—the Company) $368,601 5.43%$271,769 4.00% N/A N/A 
          (to Average Assets—the Bank) $363,300 5.35%$271,741 4.00%$339,676 5.00%

         

         

         

         

         

         

         

         

         

         

        To Be Well-

         

         

         

         

         

         

         

         

         

         

         

        Capitalized Under

         

         

         

         

         

         

         

        For Capital

         

        Prompt Corrective

         

         

         

        Actual

         

        Adequacy Purposes

         

        Action Provisions

         

         

         

        Amount

         

        Ratio

         

        Amount

         

        Ratio

         

        Amount

         

        Ratio

         

        As of December 31, 2005:

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

        Total Capital

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

        (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

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

        (to Risk-Weighted Assets-the Company)

         

        $

        731,733

         

        18.49

        %

        $

        158,276

         

         

        4.00

        %

         

        N/A

         

        N/A

         

        Tier 1 Capital

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

        (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

        %

        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

         

        Total Capital

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

        (to Risk-Weighted Assets-the Bank)

         

        $

        618,166

         

        19.98

        %

        $

        247,572

         

         

        8.00

        %

         

        $

        309,465

         

        10.00

        %

        Tier 1 Capital

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

        (to Risk-Weighted Assets-the Company)

         

        $

        636,119

         

        20.54

        %

        $

        123,891

         

         

        4.00

        %

         

        N/A

         

        N/A

         

        Tier 1 Capital

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

        (to Risk-Weighted Assets-the Bank)

         

        $

        618,066

         

        19.97

        %

        $

        123,786

         

         

        4.00

        %

         

        $

        185,679

         

        6.00

        %

        Tier 1 Capital

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

        (to Average Assets-the Company)

         

        $

        636,119

         

        5.85

        %

        $

        435,080

         

         

        4.00

        %

         

        N/A

         

        N/A

         

        Tier 1 Capital

         

         

         

         

         

         

         

         

         

         

         

         

         

         

         

        (to Average Assets-the Bank)

         

        $

        618,066

         

        5.68

        %

        $

        435,017

         

         

        4.00

        %

         

        $

        543,772

         

        5.00

        %

         

        F-38



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003.

        18. Regulatory Matters (Continued)

        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.

        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 Securities and Exchange CommissionSEC and the National Association of Securities Dealers, Inc.NASD. Management believes, as of December 31, 2003,2005, 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 State of Vermont Department of Banking, Insurance, Securities and Health Care Administration. Management believes, as of December 31, 2005, that IVIC is in material compliance with all of the foregoing requirements to which it 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 2005, the FFIEC (U.S. banking and thrift supervisory agencies) revised guidance on the timing and qualification process for U.S. banks that will become subject to Basel II. 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 Company is not required to be compliant with the new rules, the Company is in the process of developing an implementation 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 FFIEC supervisory agencies. The Company cannot predict the final form of the rules, nor their impact on the Company’s risk-based capital.

        F-39



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003.


        19. Net Interest Income

        The components of interest income and interest expense are as follows (Dollars in thousands):

         

         

        December 31,

         

         

         

        2005

         

        2004

         

        2003

         

        Interest income:

         

         

         

         

         

         

         

        Federal Funds sold and securities sold under repurchase agreements

         

        $

        2,250

         

        $

        667

         

        $

        326

         

        Investment securities held to maturity and available for sale

         

        436,193

         

        307,895

         

        243,191

         

        Loans

         

        9,262

         

        4,587

         

        3,577

         

        Total interest income

         

        $

        447,705

         

        $

        313,149

         

        $

        247,094

         

        Interest expense:

         

         

         

         

         

         

         

        Deposits

         

        $

        77,706

         

        $

        50,721

         

        $

        39,819

         

        Securities sold under repurchase agreements

         

        142,681

         

        54,376

         

        29,371

         

        Short-term and other borrowings

         

        54,473

         

        17,952

         

        21,626

         

        Junior subordinated debentures

         

        2,420

         

        2,420

         

        2,364

         

        Total interest expense

         

        $

        277,280

         

        $

        125,469

         

        $

        93,180

         

        Net interest income

         

        $

        170,425

         

        $

        187,680

         

        $

        153,914

         

        20. Selected Quarterly Financial Data (unaudited) (Dollars in thousands, except per share data, as restated)data):

        Year Ended December 31, 2003
        		 First
        Quarter
        		 Second
        Quarter
        		 Third
        Quarter
        		 Fourth
        Quarter
        Interest income $61,058 $61,054 $59,995 $64,987
        Interest expense  21,566  23,623  23,088  24,903
        Noninterest income  74,916  84,393  85,223  91,661
        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
        Year Ended December 31, 2002
        		 First
        Quarter
        		 Second
        Quarter
        		 Third
        Quarter
        		 Fourth
        Quarter
        Interest income $57,968 $61,115 $65,144 $61,299
        Interest expense  23,505  28,783  28,546  25,967
        Noninterest income  71,042  76,565  75,751  75,486
        Operating expenses  83,233  85,595  86,316  86,251
        Income before income taxes  22,272  23,302  26,033  24,567
        Income taxes  6,648  6,919  7,878  7,292
        Net income  15,624  16,383  18,155  17,275
        Basic earnings per share  0.24  0.26  0.28  0.27
        Diluted earnings per share  0.24  0.25  0.27  0.26

         

         

        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

         

         

         

         

         

        First

         

        Second

         

        Third

         

        Fourth

         

        Year Ended December 31, 2004

         

         

         

        Quarter

         

        Quarter

         

        Quarter

         

        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

         

        F-40



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003.

        21. Geographic 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:
        2003
        		 2002
        		 2001
        		 2003
        		 2002

        Geographic Information

         

         

         

        2005

         

        2004

         

        2003

         

        2005

         

        2004

         

        United States $468,724 $423,615 $342,228 $149,631 $154,060

        United States

         

        $

        653,305

         

        $

        579,168

         

        $

        468,724

         

         

        $

        141,810

         

         

         

        $

        141,801

         

         

        Ireland 18,601 11,960 8,282 6,698 773

        Ireland

         

        37,061

         

        28,835

         

        18,601

         

         

        6,325

         

         

         

        5,930

         

         

        Canada 2,579 1,915 2,246 60 5

        Canada

         

        5,427

         

        4,989

         

        2,579

         

         

        385

         

         

         

        121

         

         

        Cayman Islands 203 79 86 — —

        Cayman Islands

         

        166

         

        179

         

        203

         

         

        —

         

         

         

        —

         

         

         
        		 
        		 
        		 
        		 

        United Kingdom

        United Kingdom

         

        3

         

        —

         

        —

         

         

        850

         

         

         

        —

         

         

        Total $490,107 $437,569 $352,842 $156,389 $154,838

        Total

         

        $

        695,962

         

        $

        613,171

         

        $

        490,107

         

         

        $

        149,370

         

         

         

        $

        147,852

         

         

         
        		 
        		 
        		 
        		 

         BGI

        Barclays Global Investors, N.A. (‘BGI’) accounted for 16%18%, 16%17% and 14%16% of the Company'sCompany’s consolidated net operating revenues for the years ended December 31, 2003, 20022005, 2004 and 2001,2003, respectively. No client other than BGI accounted for more than 5%10% of the Company'sCompany’s consolidated net operating revenues in the years ended December 31, 20032005, 2004 and 2002. For the year ended December 31, 2001, the Commonfund represented 5.43% of total revenue.2003.

        The following represents the Company'sCompany’s asset servicing fees by service line (Dollars in thousands):

         

        For the Years Ended

         
        		 For the Years Ended
        December 31,

         

        December 31,

         

        Asset servicing fees by service lines:
        		Asset servicing fees by service lines:

         

         

         

        2005

         

        2004

         

        2003

         

        2003
        		 2002
        		 2001
        Core service fees:Core service fees:      

        Core service fees:

         

         

         

         

         

         

         

        Custody, accounting and administration $254,225 $231,520 $200,205
         
        		 
        		 

        Ancillary service fees:
         
         
         
         
         
         
        Foreign exchange 36,501 24,469 19,269
        Cash management 20,884 16,974 15,046
        Investment advisory 11,777 11,909 7,320
        Securities lending 8,903 11,328 9,371
        Other service fees 1,296 195 148
         
        		 
        		 
         Total ancillary service fees 79,361 64,875 51,154
         
        		 
        		 

        Custody, multicurrency accounting and fund administration

        Custody, multicurrency accounting and fund administration

         

        $

        375,596

         

        $

        314,272

         

        $

        254,225

         

        Value-added service fees:

        Value-added service fees:

         

         

         

         

         

         

         

        Foreign exchange

        Foreign exchange

         

        62,107

         

        54,466

         

        36,501

         

        Cash management

        Cash management

         

        37,592

         

        26,396

         

        20,884

         

        Securities lending

        Securities lending

         

        22,536

         

        10,385

         

        8,903

         

        Investment advisory

        Investment advisory

         

        8,442

         

        15,020

         

        11,777

         

        Other service fees

        Other service fees

         

        2,786

         

        2,661

         

        1,296

         

        Total value-added service fees

        Total value-added service fees

         

        133,463

         

        108,928

         

        79,361

         

        TotalTotal $333,586 $296,395 $251,359

        Total

         

        $

        509,059

         

        $

        423,200

         

        $

        333,586

         

         
        		 
        		 

        F-41



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003

        22. Financial Statements of Investors Financial Services Corp. (Parent Only):

        The following represents the separate condensed financial statements of IFSC (Dollars in thousands):

         
        		 December 31, 2003
        		 December 31, 2002
        		 December 31, 2001
        		 
        Statements of Income          
        Equity in undistributed income of bank subsidiary $95,088 $69,299 $46,756 
        Equity in undistributed income (loss) of nonbank subsidiary  278  (58) (196)
        Equity in undistributed loss of unconsolidated nonbank subsidiary  (8) —  — 
        Dividend income from nonbank subsidiaries  57  96  75 
        Dividend income from unconsolidated nonbank subsidiary  19  —  — 
        Management fee paid by nonbank subsidiaries  —  55  60 
        Interest expense on junior subordinated deferrable interest debentures  (2,420) (2,488) (2,518)
        Operating expenses  (2,214) (467) (540)
        Income tax benefit  1,621  1,000  1,049 
          
        		 
        		 
        		 
        Net Income $92,421 $67,437 $44,686 
          
        		 
        		 
        		 

         
        		 December 31, 2003
        		 December 31, 2002
        		 
        Balance Sheets       
        Assets:       
         Cash $3,433 $3,016 
         Investments in bank subsidiary  559,231  461,501 
         Investments in nonbank subsidiaries  766  497 
         Receivable due from bank subsidiary  1,659  2,601 
         Other assets  1,155  5 
          
        		 
        		 
        Total Assets $566,244 $467,620 
          
        		 
        		 

        Liabilities and Stockholders' Equity
         
         
         
         
         
         
         

        Liabilities:
         
         
         
         
         
         
         
         Accrued expenses $56 $42 
         Payable due to nonbank subsidiary  1,157  2 
         Subordinated debt  24,774  24,774 
          
        		 
        		 
          Total liabilities  25,987  24,818 
          
        		 
        		 
         
        Stockholders' Equity:
         
         
         
         
         
         
         
         Common stock  655  648 
         Surplus  242,662  233,337 
         Deferred compensation  (1,076) (1,599)
         Retained earnings  280,701  192,184 
         Accumulated other comprehensive income, net  17,865  18,232 
         Treasury stock  (550) — 
          
        		 
        		 
          Total stockholders' equity  540,257  442,802 
          
        		 
        		 
        Total Liabilities and Stockholders' Equity $566,244 $467,620 
          
        		 
        		 

        Statements of Income

         

        December 31,
         2005

         

        December 31,
        2004

         

        December 31,
        2003

         

        Equity in undistributed income of bank subsidiary

         

         

        $

        99,809

         

         

         

        $

        144,595

         

         

         

        $

        95,088

         

         

        Equity in undistributed income of nonbank subsidiary

         

         

        —

         

         

         

        —

         

         

         

        278

         

         

        Equity in undistributed loss of unconsolidated nonbank subsidiary

         

         

        (28

        )

         

         

        (28

        )

         

         

        (8

        )

         

        Dividend income from bank subsidiary

         

         

        63,000

         

         

         

        —

         

         

         

        —

         

         

        Dividend income from nonbank subsidiaries

         

         

        —

         

         

         

        —

         

         

         

        57

         

         

        Dividend income from unconsolidated nonbank subsidiary

         

         

        76

         

         

         

        76

         

         

         

        19

         

         

        Interest expense on junior subordinated deferrable interest debentures

         

         

        (2,420

        )

         

         

        (2,420

        )

         

         

        (2,420

        )

         

        Operating expenses

         

         

        (2,254

        )

         

         

        (1,703

        )

         

         

        (2,214

        )

         

        Income tax benefit

         

         

        1,635

         

         

         

        1,442

         

         

         

        1,621

         

         

        Net Income

         

         

        $

        159,818

         

         

         

        $

        141,962

         

         

         

        $

        92,421

         

         

         
        		 December 31,
        2003
        		 December 31,
        2002
        		 December 31,
        2001
        		 
        Statements of Cash Flows          
        Cash flows from operating activities:          
         Net income $92,421 $67,437 $44,686 
          
        		 
        		 
        		 
        Adjustments to reconcile net income to net cash used by operating activities:          
         Amortization of deferred compensation  483  964  162 
         Amortization of premium expense  195  —  — 
         Change in assets and liabilities:          
          Receivable due from bank subsidiary  942  (583) (1,482)
          Receivable due from nonbank subsidiary  —  —  516 
          Income tax receivable  (484) —  — 
          Payable due to nonbank subsidiary  1,155  (207) 120 
          Accrued expenses  14  (12) 5 
          Other assets  (861) 1  (3)
         Equity in undistributed income of bank subsidiary  (95,088) (69,299) (46,756)
         Equity in undistributed (income) loss of nonbank subsidiary  (278) 58  196 
         Equity in undistributed loss of unconsolidated nonbank subsidiary  8  —  — 
          
        		 
        		 
        		 
        Net cash used in operating activities  (1,493) (1,641) (2,556)
          
        		 
        		 
        		 

        Cash flows from investing activities:
         
         
         
         
         
         
         
         
         
         
         Payments for investments in and advances to subsidiary  —  —  (116,338)
          
        		 
        		 
        		 
        Net cash used in investing activities  —  —  (116,338)
          
        		 
        		 
        		 

        Cash flows from financing activities:
         
         
         
         
         
         
         
         
         
         
         Proceeds from exercise of stock options  2,977  2,869  2,123 
         Proceeds from issuance of common stock  3,387  3,882  119,030 
         Common stock repurchased  (550) —  — 
         Cost of issuance of restricted stock  —  —  (335)
         Repurchase of company-obligated, mandatorily redeemable, preferred securities of subsidiary trust  —  (1,000) — 
         Dividends paid  (3,904) (3,219) (2,511)
          
        		 
        		 
        		 
        Net cash provided by financing activities  1,910  2,532  118,307 
          
        		 
        		 
        		 
        Net increase (decrease) in cash and due from banks  417  891  (587)
        Cash and due from banks, beginning of year  3,016  2,125  2,712 
          
        		 
        		 
        		 
        Cash and due from banks, end of year $3,433 $3,016 $2,125 
          
        		 
        		 
        		 

        23. RestatementF-42

                The Company has approximately $8.6 billion of investment securities on its balance sheet as of December 31, 2003. Certain types of investments held by the Company were purchased with discounts or premiums to par value.

                The principal application of 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 ("FAS 91") to the Company's financial statements is in determining the accounting treatment of premiums paid and discounts realized on its purchase of securities backed by mortgages and other loans. Historically, the Company had applied the prospective method to determine the amortization of premiums and the accretion of discounts for the securities in its investment portfolio. The Company's management and Audit Committee have determined that the retrospective method is the appropriate method under FAS 91 to determine the amortization of premiums and the accretion of discounts for certain of the Company's securities.

                This application of FAS 91 results in the following changes in reported income before income taxes for the periods presented in this Report:

          •
          an increase in income before income taxes of approximately $1.0 million for the year ended December 31, 2003;

          •
          a decrease in income before income taxes of approximately $2.3 million for the year ended December 31, 2002; and

          •
          a decrease in income before income taxes of approximately $8.5 million for the year ended December 31, 2001.

                This application of FAS 91 also results in changes to other comprehensive income, net of tax, as well as other changes in the Company's disclosures regarding its portfolio. Other comprehensive income, net of tax, increased on a cumulative basis by $4.9 million, $5.9 million and $6.1 million as of December 31, 2003, 2002 and 2001, respectively.



                The following tables summarize the effect of the restatement on the Company's consolidated financial statements for the years ended December 31, 2003, 2002 and 2001 (Dollars in thousands, except per share data):

         
        		 For the year ended
        December 31, 2003
        		 
         
        		 As
        Previously
        Reported
        		 As
        Restated
        		 
        Statement of Income       
        Interest income $246,063 $247,094 
        Net interest income  152,883  153,914 
        Net operating revenue  489,076  490,107 
        Income before income taxes  144,155  145,186 
        Provision for income taxes  52,395  52,765 
        Net income  91,760  92,421 
        Basic earnings per share $1.41 $1.42 
        Diluted earnings per share $1.38 $1.39 

        Comprehensive Income
         
         
         
         
         
         
         
        Net income $91,760 $92,421 
        Other comprehensive income:       
        Net unrealized investment loss  (11,878) (12,963)
        Other comprehensive income (loss)  718  (367)
        Comprehensive income  92,478  92,054 

        Statement of Cash Flows
         
         
         
         
         
         
         
        Net income $91,760 $92,421 
        Adjustments to reconcile net income to net cash provided by operating activities:       
        Amortization of premiums on securities, net of accretions of discounts  40,231  39,200 
        Other liabilities  27,316  27,686 
        Net cash provided by operating activities  157,987  157,987 

         
        		 For the year ended
        December 31, 2002
        		 
         
        		 As
        Previously
        Reported
        		 As
        Restated
        		 
        Statement of Income       
        Interest income $247,847 $245,526 
        Net interest income  141,046  138,725 
        Net operating revenue  439,890  437,569 
        Income before income taxes  98,495  96,174 
        Provision for income taxes  29,549  28,737 
        Net income  68,946  67,437 
        Basic earnings per share $1.07 $1.05 
        Diluted earnings per share $1.04 $1.02 

        Comprehensive Income
         
         
         
         
         
         
         
        Net income $68,946 $67,437 
        Other comprehensive income:       
         Net unrealized investment gain  32,100  31,944 
          Other comprehensive income  22,584  22,428 
        Comprehensive income  91,530  89,865 

        Statement of Cash Flows
         
         
         
         
         
         
         
        Net income $68,946 $67,437 
        Adjustments to reconcile net income to net cash provided by operating activities:       
         Amortization of premiums on securities, net of accretions of discounts  10,474  12,795 
         Other liabilities  (6,935) (7,747)
          Net cash provided by operating activities  60,650  60,650 

         
        		 For the year ended
        December 31, 2001
        		 
         
        		 As
        Previously
        Reported
        		 As
        Restated
        		 
        Statement of Income       
        Interest income $252,054 $243,571 
        Net interest income  106,838  98,355 
        Net operating revenue  361,325  352,842 
        Income before income taxes  72,149  63,666 
        Provision for income taxes  21,949  18,980 
        Net income  50,200  44,686 
        Basic earnings per share $0.79 $0.71 
        Diluted earnings per share $0.76 $0.68 

        Comprehensive Income
         
         
         
         
         
         
         
        Net income $50,200 $44,686 
        Other comprehensive income:       
         Net unrealized investment gain  1,120  7,211 
          Other comprehensive loss  (8,857) (2,766)
        Comprehensive income  41,343  41,920 

        Statement of Cash Flows
         
         
         
         
         
         
         
        Net income $50,200 $44,686 
        Adjustments to reconcile net income to net cash provided by operating activities:       
         Amortization of premiums on securities, net of accretions of discounts  255  8,738 
         Other assets  (25,329) (28,298)
          Net cash provided by operating activities  55,506  55,506 

         
         
         
         
         
         
         
         
         
        		 As of December 31, 2003
        		 As of December 31, 2002
         
        		 As
        Previously
        Reported
        		 As
        Restated
        		 As
        Previously
        Reported
        		 As
        Restated
        Balance Sheet            
        Securities held to maturity $4,307,610 $4,306,216 $3,438,689 $3,437,955
        Total assets  9,224,572  9,223,178  7,215,474  7,214,740
        Other liabilities  95,757  94,941  85,676  85,096
        Total liabilities  8,683,737  8,682,921  6,748,518  6,747,938
        Retained earnings  286,138  280,701  198,282  192,184
        Accumulated other comprehensive income, net  13,006  17,865  12,288  18,232
        Total stockholders' equity  540,835  540,257  442,956  442,802
        Total liabilities and stockholders' equity  9,224,572  9,223,178  7,215,474  7,214,740

                In addition, the weighted-average yield on federal agency securities held to maturity in the maturity table in the "Management's Discussion and Analysis of Financial Condition and Results of Operations" in this Report has been restated to correct clerical errors as follows:

         
        		 5-10 years
        		 Over 10 years
        		 
         
        		 As
        Previously
        Reported
        		 As
        Restated
        		 As
        Previously
        Reported
        		 As
        Restated
        		 
        Federal agency securities 2.76%2.28%3.16%2.71%
        Total securities held to maturity 3.05%2.77%2.99%2.79%



        QuickLinks

        SIGNATURES
        CONSOLIDATED BALANCE SHEETS
        CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
        CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
        INVESTORS FINANCIAL SERVICES CORP. CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 2003, 2002 and 2001 (Dollars in thousands)
        INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2003, 20022005, 2004 and 2001        2003

        22. Financial Statements of Investors Financial Services Corp. (Parent Only) (Continued)

        Balance Sheets

         

        December 31,
        2005

         

        December 31,
        2004

         

        Assets:

         

         

         

         

         

         

         

         

         

        Cash

         

         

        $

        10,303

         

         

         

        $

        14,312

         

         

        Investments in bank subsidiary

         

         

        785,138

         

         

         

        720,501

         

         

        Investments in nonbank subsidiaries

         

         

        710

         

         

         

        738

         

         

        Receivable due from bank subsidiary

         

         

        1,991

         

         

         

        2,035

         

         

        Other assets

         

         

        709

         

         

         

        650

         

         

        Total Assets

         

         

        $

        798,851

         

         

         

        $

        738,236

         

         

        Liabilities and Stockholders’ Equity:

         

         

         

         

         

         

         

         

         

        Liabilities:

         

         

         

         

         

         

         

         

         

        Accrued expenses

         

         

        $

        62

         

         

         

        $

        43

         

         

        Payable due to nonbank subsidiary

         

         

        1,157

         

         

         

        1,157

         

         

        Subordinated debt

         

         

        24,774

         

         

         

        24,774

         

         

        Total liabilities

         

         

        25,993

         

         

         

        25,974

         

         

        Stockholders’ Equity:

         

         

         

         

         

         

         

         

         

        Common stock

         

         

        672

         

         

         

        667

         

         

        Surplus

         

         

        286,265

         

         

         

        272,536

         

         

        Deferred compensation

         

         

        (311

        )

         

         

        (572

        )

         

        Retained earnings

         

         

        572,549

         

         

         

        418,034

         

         

        Accumulated other comprehensive (loss) income, net

         

         

        (13,369

        )

         

         

        23,888

         

         

        Treasury stock

         

         

        (72,948

        )

         

         

        (2,291

        )

         

        Total stockholders’ equity

         

         

        772,858

         

         

         

        712,262

         

         

        Total Liabilities and Stockholders’ Equity

         

         

        $

        798,851

         

         

         

        $

        738,236

         

         

        F-43



        INVESTORS FINANCIAL SERVICES CORP.
        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
        Years Ended December 31, 2005, 2004 and 2003

        22. Financial Statements of Investors Financial Services Corp. (Parent Only) (Continued)

        Statements of Cash Flows

         

        December 31,
        2005

         

        December 31,
        2004

         

        December 31,
        2003

         

        Cash flows from operating activities:

         

         

         

         

         

         

         

         

         

         

         

         

         

        Net income

         

         

        $

        159,818

         

         

         

        $

        141,962

         

         

         

        $

        92,421

         

         

        Adjustments to reconcile net income to net cash used by operating activities:

         

         

         

         

         

         

         

         

         

         

         

         

         

        Amortization of deferred compensation

         

         

        261

         

         

         

        316

         

         

         

        483

         

         

        Amortization of premium expense

         

         

        28

         

         

         

        28

         

         

         

        195

         

         

        Change in assets and liabilities:

         

         

         

         

         

         

         

         

         

         

         

         

         

        Receivable due from bank subsidiary

         

         

        44

         

         

         

        (376

        )

         

         

        942

         

         

        Income tax receivable

         

         

        (98

        )

         

         

        484

         

         

         

        (484

        )

         

        Other assets

         

         

        13

         

         

         

        (8

        )

         

         

        (861

        )

         

        Payable due to nonbank subsidiary

         

         

        —

         

         

         

        —

         

         

         

        1,155

         

         

        Accrued expenses

         

         

        19

         

         

         

        (13

        )

         

         

        14

         

         

        Equity in undistributed income of bank subsidiary

         

         

        (99,809

        )

         

         

        (144,595

        )

         

         

        (95,088

        )

         

        Equity in undistributed income of nonbank subsidiary

         

         

        —

         

         

         

        —

         

         

         

        (278

        )

         

        Equity in undistributed loss of unconsolidated nonbank subsidiary

         

         

        28

         

         

         

        28

         

         

         

        8

         

         

        Net cash provided by operating activities

         

         

        60,304

         

         

         

        (2,174

        )

         

         

        (1,493

        )

         

        Cash flows from financing activities:

         

         

         

         

         

         

         

         

         

         

         

         

         

        Proceeds from exercise of stock options

         

         

        7,779

         

         

         

        16,068

         

         

         

        2,977

         

         

        Proceeds from issuance of common stock

         

         

        3,868

         

         

         

        3,355

         

         

         

        3,387

         

         

        Common stock repurchased

         

         

        (70,657

        )

         

         

        (1,741

        )

         

         

        (550

        )

         

        Dividends paid

         

         

        (5,303

        )

         

         

        (4,629

        )

         

         

        (3,904

        )

         

        Net cash used in financing activities

         

         

        (64,313

        )

         

         

        13,053

         

         

         

        1,910

         

         

        Net (decrease) increase in cash and due from banks

         

         

        (4,009

        )

         

         

        10,879

         

         

         

        417

         

         

        Cash and due from banks, beginning of year

         

         

        14,312

         

         

         

        3,433

         

         

         

        3,016

         

         

        Cash and due from banks, end of year

         

         

        $

        10,303

         

         

         

        $

        14,312

         

         

         

        $

        3,433

         

         

        F-44