** **

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

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** **

**FORM 10-Q**

** **

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** **

**(MarkOne)**

 
| **ý** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|---------------------------------------------------------------------------------------------------|

** **

**Forthe Quarterly period ended June 30, 2004**

** **

**or**

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

** **

**Forthe Transition period from         to       **

** **

**0-26996**(Commission File Number) 

 

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** **

**INVESTORSFINANCIAL SERVICES CORP.**

(Exactname of registrant as specified in its charter)

** **

| **Delaware**                                                     | ** ** | **04-3279817**                     |
|------------------------------------------------------------------|------------|------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |       | (IRS Employer  Identification No.) |
|                                                             |       |                               |
| **200  Clarendon Street,  P.O. Box 9130, Boston, MA**            | ** ** | **02117-9130**                     |
| (Address of principal  executive offices)                        |       | (Zip Code)                         |
|                                                             |       |                               |
| **(617) 937-6700**                                               |
| (Registrant’s telephone number, including area code)        |

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes ýNo o

 

Indicate by check mark whether the registrantis an accelerated filer (as defined in Exchange Act Rule 12b-2).  Yes ý No o

 

As of July 31, 2004 there were66,279,901 shares of Common Stock outstanding.

 

 

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**INVESTORS FINANCIAL SERVICES CORP.**

** **

**INDEX**

** **
| **PART I.**    | **FINANCIAL INFORMATION**                                                                                                       |   |
|----------------|---------------------------------------------------------------------------------------------------------------------------------|--------|
| ** **     | ** **                                                                                                                      |   |
| Item  1.       | Unaudited  Condensed Consolidated Financial Statements                                                                          |   |
|           |                                                                                                                            |   |
|           | Unaudited  Condensed Consolidated Balance Sheets  June 30, 2004 and December 31, 2003                                 |   |
|           |                                                                                                                            |   |
|           | Unaudited  Condensed Consolidated Statements of Income and Comprehensive Income  Six months ended June 30, 2004 and 2003   |   |
|           |                                                                                                                            |   |
|           | Unaudited  Condensed Consolidated Statements of Income and Comprehensive Income  Three months ended June 30, 2004 and 2003 |   |
|           |                                                                                                                            |   |
|           | Unaudited  Condensed Consolidated Statements of Stockholders’ Equity  Six months ended June 30, 2004 and 2003         |   |
|           |                                                                                                                            |   |
|           | Unaudited Condensed  Consolidated Statements of Cash Flows  Six months ended June 30, 2004 and 2003                        |   |
|           |                                                                                                                            |   |
|           | Notes to Unaudited Condensed  Consolidated Financial Statements                                                                 |   |
|           |                                                                                                                            |   |
|           | Report  of Independent Registered Public Accounting Firm                                                                        |   |
|           |                                                                                                                            |   |
| Item  2.       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                     |   |
|           |                                                                                                                            |   |
| Item  3.       | Quantitative  and Qualitative Disclosures about Market Risk                                                                     |   |
|           |                                                                                                                            |   |
| Item  4.       | Controls  and Procedures                                                                                                        |   |
|           |                                                                                                                            |   |
| **PART II.**   | **OTHER INFORMATION**                                                                                                           |   |
| ** **     | ** **                                                                                                                      |   |
| Item 1.        | Legal Proceedings                                                                                                               |   |
|           |                                                                                                                            |   |
| Item 2.        | Changes in Securities, Use of  Proceeds and Issuer Purchases of Equity Securities                                               |   |
|           |                                                                                                                            |   |
| Item 4.        | Submission of Matters to a Vote of  Security Holders                                                                            |   |
|           |                                                                                                                            |   |
| Item 6.        | Exhibits and Reports on Form 8-K                                                                                                |   |
|           |                                                                                                                            |   |
| **SIGNATURES** |                                                                                                                            |

 

2

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**PART I. FINANCIAL INFORMATION**

**Item 1**.           Unaudited CondensedConsolidated Financial Statements

 

**INVESTORS FINANCIAL SERVICES CORP.**

**UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS**

**June 30, 2004 and December 31, 2003(Dollars in thousands, except share data)**

 
| ** **                                                                                                                                                                                                                                                | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
|                                                                                                                                                                                                                                                      | ** ** | ** **              | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                                                                                                                                                                |       |                    |       |                        |       |
| Cash and due  from banks                                                                                                                                                                                                                                  |       | $                       | 42,779     |                        | $          | 39,689 |   |
| Federal  Funds sold                                                                                                                                                                                                                                       |       | 425,000                 |       | —                      |       |
| Securities  held to maturity (approximate fair value of $5,095,999 and $4,308,578 at  June 30, 2004 and December 31, 2003, respectively)                                                                                                        |       | 5,096,930               |       | 4,307,610                   |       |
| Securities  available for sale                                                                                                                                                                                                                            |       | 4,605,279               |       | 4,296,637                   |       |
| Nonmarketable  equity securities                                                                                                                                                                                                                          |       | 50,000                  |       | 50,000                      |       |
| Loans, less  allowance for loan losses of $100 at June 30, 2004 and December 31,  2003                                                                                                                                                          |       | 192,183                 |       | 199,530                     |       |
| Accrued  interest and fees receivable                                                                                                                                                                                                                     |       | 83,704                  |       | 72,816                      |       |
| Equipment  and leasehold improvements, less accumulated depreciation of $52,289 and  $47,683 at June 30, 2004 and December 31, 2003, respectively                                                                                               |       | 71,493                  |       | 76,420                      |       |
| Goodwill,  net                                                                                                                                                                                                                                            |       | 79,969                  |       | 79,969                      |       |
| Deposits  pledged to secure clearings                                                                                                                                                                                                                     |       | 188,226                 |       | 29,646                      |       |
| Other assets                                                                                                                                                                                                                                              |       | 85,860                  |       | 72,255                      |       |
|                                                                                                                                                                                                                                                      |       |                    |       |                        |       |
| **Total  Assets**                                                                                                                                                                                                                                         |       | $                       | 10,921,423 |                        | $          | 9,224,572 |   |
|                                                                                                                                                                                                                                                      |       |                    |       |                        |       |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                                                                                            |       |                    |       |                        |       |
| **Liabilities:**                                                                                                                                                                                                                                          |       |                    |       |                        |       |
| Deposits:                                                                                                                                                                                                                                                 |       |                    |       |                        |       |
| Demand                                                                                                                                                                                                                                                    |       | $                       | 1,052,848  |                        | $          | 334,823 |   |
| Savings                                                                                                                                                                                                                                                   |       | 3,585,156               |       | 3,682,295                   |       |
| Time                                                                                                                                                                                                                                                      |       | 365,169                 |       | 190,000                     |       |
| Total  deposits                                                                                                                                                                                                                                           |       | 5,003,173               |       | 4,207,118                   |       |
|                                                                                                                                                                                                                                                      |       |                    |       |                        |       |
| Securities  sold under repurchase agreements                                                                                                                                                                                                              |       | 4,287,675               |       | 3,258,001                   |       |
| Short-term  and other borrowings                                                                                                                                                                                                                          |       | 789,119                 |       | 1,098,087                   |       |
| Due to  brokers for open trades payable                                                                                                                                                                                                                   |       | 135,866                 |       | —                      |       |
| Junior  subordinated deferrable interest debentures                                                                                                                                                                                                       |       | 24,774                  |       | 24,774                      |       |
| Other  liabilities                                                                                                                                                                                                                                        |       | 79,273                  |       | 95,757                      |       |
| Total liabilities                                                                                                                                                                                                                                         |       | 10,319,880              |       | 8,683,737                   |       |
|                                                                                                                                                                                                                                                      |       |                    |       |                        |       |
| Commitments  and contingencies                                                                                                                                                                                                                            |       | —                  |       | —                      |       |
|                                                                                                                                                                                                                                                      |       |                    |       |                        |       |
| **Stockholders’  Equity:**                                                                                                                                                                                                                           |       |                    |       |                        |       |
| Preferred  stock, par value $0.01 (shares authorized: 1,000,000; issued and outstanding:  none at June 30, 2004 and December 31, 2003)                                                                                                          |       | —                  |       | —                      |       |
| Common  stock, par value $0.01 (shares authorized: 175,000,000 at June 30, 2004  and 100,000,000 at December 31, 2003; issued and outstanding:  66,224,998 and 65,436,788 at June 30,  2004 and December 31, 2003, respectively) |       | 662                     |       | 655                         |       |
| Surplus                                                                                                                                                                                                                                                   |       | 260,686                 |       | 242,662                     |       |
| Deferred  compensation                                                                                                                                                                                                                                    |       | (780                    | )          | (1,076                      | )          |
| Retained  earnings                                                                                                                                                                                                                                        |       | 354,222                 |       | 286,138                     |       |
| Accumulated  other comprehensive income, net                                                                                                                                                                                                              |       | (12,697                 | )          | 13,006                      |       |
| Treasury  stock, at cost (26,508 shares at June 30, 2004 and December 31,  2003)                                                                                                                                                                |       | (550                    | )          | (550                        | )          |
| Total  stockholders’ equity                                                                                                                                                                                                                          |       | 601,543                 |       | 540,835                     |       |
|                                                                                                                                                                                                                                                      |       |                    |       |                        |       |
| **Total  Liabilities and Stockholders’ Equity**                                                                                                                                                                                                      |       | $                       | 10,921,423 |                        | $          | 9,224,572 |   |

 

*See Notes to Unaudited Condensed ConsolidatedFinancial Statements.*

 

3

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**INVESTORS FINANCIAL SERVICES CORP.**

**UNAUDITEDCONDENSED****CONSOLIDATED STATEMENTSOF INCOME AND COMPREHENSIVE INCOME**

**Six Months Ended June 30, 2004 and 2003(Dollars in thousands, except per share data)**

 
| ** **                                 | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** |
|--------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| **Fees and  Other Revenue:**               | ** ** | ** **              | ** ** | ** **              | ** ** |
| Asset  servicing fees:                     |       |                    |       |                    |       |
| Core service  fees                         |       | $                       | 154,849    |                    | $          | 118,838 |   |
| Ancillary  service fees                    |       | 60,331                  |       | 39,043                  |       |
| Total asset  servicing fees                |       | 215,180                 |       | 157,881                 |       |
| Other  operating income                    |       | 1,097                   |       | 1,428                   |       |
| Gain on sale  of investment                |       | 234                     |       | —                  |       |
| Total fees  and other revenue              |       | 216,511                 |       | 159,309                 |       |
|                                       |       |                    |       |                    |       |
| Interest  income                           |       | 142,533                 |       | 121,554                 |       |
| Interest  expense                          |       | 52,280                  |       | 45,189                  |       |
| Net interest  income                       |       | 90,253                  |       | 76,365                  |       |
| Net  operating revenue                     |       | 306,764                 |       | 235,674                 |       |
|                                       |       |                    |       |                    |       |
| **Operating  Expenses:**                   |       |                    |       |                    |       |
| Compensation  and benefits                 |       | 109,094                 |       | 100,735                 |       |
| Transaction  processing services           |       | 21,138                  |       | 16,339                  |       |
| Technology  and telecommunications         |       | 20,722                  |       | 18,850                  |       |
| Depreciation  and amortization             |       | 16,721                  |       | 12,685                  |       |
| Occupancy                                  |       | 14,260                  |       | 14,530                  |       |
| Professional  fees                         |       | 7,256                   |       | 6,255                   |       |
| Travel and  sales promotion                |       | 2,579                   |       | 2,068                   |       |
| Insurance                                  |       | 2,360                   |       | 796                     |       |
| Other  operating expenses                  |       | 6,704                   |       | 4,414                   |       |
| Total  operating expenses                  |       | 200,834                 |       | 176,672                 |       |
|                                       |       |                    |       |                    |       |
| **Income  Before Income Taxes**            |       | 105,930                 |       | 59,002                  |       |
|                                       |       |                    |       |                    |       |
| Provision  for income taxes                |       | 35,537                  |       | 25,570                  |       |
|                                       |       |                    |       |                    |       |
| **Net  Income**                            |       | $                       | 70,393     |                    | $          | 33,432 |   |
| ** **                                 |       |                    |       |                    |       |
| **Basic  Earnings Per Share**              |       | $                       | 1.07       |                    | $          | 0.51 |   |
| ** **                                 |       |                    |       |                    |       |
| **Diluted  Earnings Per Share**            |       | $                       | 1.04       |                    | $          | 0.50 |   |
|                                       |       |                    |       |                    |       |
| **Comprehensive  Income:**                 |       |                    |       |                    |       |
| Net income                                 |       | $                       | 70,393     |                    | $          | 33,432 |   |
| Other  comprehensive income:               |       |                    |       |                    |       |
| Net  unrealized investment (loss) gain     |       | (37,157                 | )          | 8,538                   |       |
| Net  unrealized derivative instrument gain |       | 11,854                  |       | 2,416                   |       |
| Cumulative  translation adjustment         |       | (400                    | )          | 245                     |       |
| Other  comprehensive (loss) income         |       | (25,703                 | )          | 11,199                  |       |
| Comprehensive  income                      |       | $                       | 44,690     |                    | $          | 44,631 |   |

 

*See Notes to Unaudited Condensed Consolidated Financial Statements.*

 

4

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**INVESTORS FINANCIAL SERVICES CORP.**

**UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME****AND COMPREHENSIVE INCOME**

**Three Months Ended June 30, 2004 and2003 (Dollars in thousands, except per share data)**

 
| ** **                                 | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** |
|--------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| **Fees and  Other Revenue:**               | ** ** | ** **              | ** ** | ** **              | ** ** |
| Asset  servicing fees:                     |       |                    |       |                    |       |
| Core service  fees                         |       | $                       | 78,755     |                    | $          | 62,078 |   |
| Ancillary  service fees                    |       | 30,238                  |       | 21,657                  |       |
| Total asset  servicing fees                |       | 108,993                 |       | 83,735                  |       |
| Other  operating income                    |       | 748                     |       | 658                     |       |
| Total fees  and other revenue              |       | 109,741                 |       | 84,393                  |       |
|                                       |       |                    |       |                    |       |
| Interest  income                           |       | 71,357                  |       | 61,205                  |       |
| Interest  expense                          |       | 27,065                  |       | 23,623                  |       |
| Net interest  income                       |       | 44,292                  |       | 37,582                  |       |
| Net  operating revenue                     |       | 154,033                 |       | 121,975                 |       |
|                                       |       |                    |       |                    |       |
| **Operating  Expenses:**                   |       |                    |       |                    |       |
| Compensation  and benefits                 |       | 53,771                  |       | 50,964                  |       |
| Technology  and telecommunications         |       | 10,456                  |       | 9,559                   |       |
| Transaction  processing services           |       | 10,198                  |       | 9,531                   |       |
| Depreciation  and amortization             |       | 8,767                   |       | 6,606                   |       |
| Occupancy                                  |       | 6,869                   |       | 7,205                   |       |
| Professional  fees                         |       | 4,018                   |       | 3,304                   |       |
| Travel and  sales promotion                |       | 1,497                   |       | 1,083                   |       |
| Insurance                                  |       | 1,164                   |       | 572                     |       |
| Other  operating expenses                  |       | 3,960                   |       | 2,129                   |       |
| Total  operating expenses                  |       | 100,700                 |       | 90,953                  |       |
|                                       |       |                    |       |                    |       |
| **Income  Before Income Taxes**            |       | 53,333                  |       | 31,022                  |       |
|                                       |       |                    |       |                    |       |
| Provision  for income taxes                |       | 17,915                  |       | 3,002                   |       |
|                                       |       |                    |       |                    |       |
| **Net  Income**                            |       | $                       | 35,418     |                    | $          | 28,020 |   |
| ** **                                 |       |                    |       |                    |       |
| **Basic  Earnings Per Share**              |       | $                       | 0.54       |                    | $          | 0.43 |   |
| ** **                                 |       |                    |       |                    |       |
| **Diluted  Earnings Per Share**            |       | $                       | 0.52       |                    | $          | 0.42 |   |
|                                       |       |                    |       |                    |       |
| **Comprehensive  Income:**                 |       |                    |       |                    |       |
| Net income                                 |       | $                       | 35,418     |                    | $          | 28,020 |   |
| Other  comprehensive income:               |       |                    |       |                    |       |
| Net  unrealized investment (loss) gain     |       | (60,513                 | )          | 1,817                   |       |
| Net  unrealized derivative instrument gain |       | 13,016                  |       | 873                     |       |
| Cumulative  translation adjustment         |       | (317                    | )          | 254                     |       |
| Other  comprehensive (loss) income         |       | (47,814                 | )          | 2,944                   |       |
| Comprehensive  (loss) income               |       | $                       | (12,396    | )                       | $          | 30,964 |   |

 

*See Notes to Unaudited Condensed Consolidated Financial Statements.*

 

5

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**INVESTORS FINANCIAL SERVICES CORP.**

**UNAUDITED****CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**

**Six Months Ended June 30, 2004 and 2003(Dollars in thousands, except share data)**

 
| ** **                                                                                                  | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| **Common shares**                                                                                           | ** ** | ** **              | ** ** | ** **              | ** ** |
| Balance, beginning of period                                                                                |       | 65,436,788              |       | 64,775,042              | ** ** |
| Exercise of stock options                                                                                   |       | 740,529                 |       | 292,951                 | ** ** |
| Common stock issuance                                                                                       |       | 47,681                  |       | 70,606                  | ** ** |
| Balance, end of period                                                                                      |       | 66,224,998              |       | 65,138,599              | ** ** |
| ** **                                                                                                  | ** ** | ** **              | ** ** | ** **              | ** ** |
| **Treasury shares**                                                                                         | ** ** | ** **              | ** ** | ** **              | ** ** |
| Balance, beginning of period                                                                                |       | 26,508                  |       | 10,814                  | ** ** |
| Balance, end of period                                                                                      |       | 26,508                  |       | 10,814                  | ** ** |
| ** **                                                                                                  | ** ** | ** **              | ** ** | ** **              | ** ** |
| **Common stock**                                                                                            | ** ** | ** **              | ** ** | ** **              | ** ** |
| Balance, beginning of period                                                                                |       | $                       | 655        |                    | $          | 648 | ** ** |
| Exercise of stock options                                                                                   |       | 7                       |       | 3                       | ** ** |
| Balance, end of period                                                                                      |       | 662                     |       | 651                     | ** ** |
| ** **                                                                                                  | ** ** | ** **              | ** ** | ** **              | ** ** |
| **Surplus**                                                                                                 | ** ** | ** **              | ** ** | ** **              | ** ** |
| Balance, beginning of period                                                                                |       | 242,662                 |       | 233,337                 | ** ** |
| Exercise of stock options                                                                                   |       | 10,005                  |       | 1,046                   | ** ** |
| Tax benefit from exercise of stock options                                                                  |       | 6,539                   |       | 1,221                   | ** ** |
| Common stock issuance                                                                                       |       | 1,668                   |       | 1,800                   | ** ** |
| Stock option forfeiture                                                                                     |       | (188                    | )          | —                  | ** ** |
| Balance, end of period                                                                                      |       | 260,686                 |       | 237,404                 | ** ** |
| ** **                                                                                                  | ** ** | ** **              | ** ** | ** **              | ** ** |
| **Deferred compensation**                                                                                   | ** ** | ** **              | ** ** | ** **              | ** ** |
| Balance, beginning of period                                                                                |       | (1,076                  | )          | (1,599                  | )          |
| Stock option forfeiture                                                                                     |       | 188                     |       | —                  |       |
| Amortization of deferred compensation                                                                       |       | 108                     |       | 273                     |       |
| Balance, end of period                                                                                      |       | (780                    | )          | (1,326                  | )          |
| ** **                                                                                                  | ** ** | ** **              | ** ** | ** **              | ** ** |
| **Retained earnings**                                                                                       | ** ** | ** **              | ** ** | ** **              | ** ** |
| Balance, beginning of period                                                                                |       | 286,138                 |       | 198,282                 |       |
| Net income                                                                                                  |       | 70,393                  |       | 33,432                  |       |
| Cash dividend, $0.035 and $0.030 per share in the periods ending  June 30, 2004 and 2003, respectively |       | (2,309                  | )          | (1,947                  | )          |
| Balance, end of period                                                                                      |       | 354,222                 |       | 229,767                 |       |
| ** **                                                                                                  | ** ** | ** **              | ** ** | ** **              | ** ** |
| **Accumulated other comprehensive income, net**                                                             | ** ** | ** **              | ** ** | ** **              | ** ** |
| Balance, beginning of period                                                                                |       | 13,006                  |       | 12,288                  | ** ** |
| Net unrealized investment (loss) gain                                                                       |       | (37,157                 | )          | 8,538                   | ** ** |
| Net unrealized derivative instrument gain                                                                   |       | 11,844                  |       | 2,225                   | ** ** |
| Amortization of transition-related adjustment                                                               |       | —                  |       | 191                     | ** ** |
| Amortization of terminated interest rate swap agreements                                                    |       | 10                      |       | —                  | ** ** |
| Effect of foreign currency translation                                                                      |       | (400                    | )          | 245                     | ** ** |
| Balance, end of period                                                                                      |       | (12,697                 | )          | 23,487                  | ** ** |
| ** **                                                                                                  | ** ** | ** **              | ** ** | ** **              | ** ** |
| **Treasury stock**                                                                                          | ** ** | ** **              | ** ** | ** **              | ** ** |
| Balance, beginning of period                                                                                |       | (550                    | )          | —                  | ** ** |
| Balance, end of period                                                                                      |       | (550                    | )          | —                  | ** ** |
| ** **                                                                                                  | ** ** | ** **              | ** ** | ** **              | ** ** |
| **Total Stockholders’ Equity**                                                                         | ** ** | $                       | 601,543    |                    | $          | 489,983 | ** ** |

 

*See Notes to Unaudited Condensed Consolidated Financial Statements.*

 

6

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**INVESTORS FINANCIAL SERVICES CORP.**

**UNAUDITE**DCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS 

**Six Months Ended June 30, 2004 and 2003(Dollars in thousands)**

 
| ** **                                                                           | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** |
|--------------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
|                                                                                 | ** ** | ** **              | ** ** | ** **              | ** ** |
| **Cash  Flows From Operating Activities:**                                           |       |                    |       |                    |       |
| Net income                                                                           |       | $                       | 70,393     |                    | $          | 33,432 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities:   |       |                    |       |                    |       |
| Equity in  undistributed loss of unconsolidated subsidiary                           |       | 14                      |       | —                  |       |
| Depreciation  and amortization                                                       |       | 16,721                  |       | 12,685                  |       |
| Amortization  of deferred compensation                                               |       | 108                     |       | 273                     |       |
| Amortization  of premiums on securities, net of accretion of discounts               |       | 22,166                  |       | 17,217                  |       |
| Gain on sale  of investment                                                          |       | (234                    | )          | —                  |       |
| Changes in  assets and liabilities:                                                  |       |                    |       |                    |       |
| Accrued  interest and fees receivable                                                |       | (10,888                 | )          | (630                    | )          |
| Other assets                                                                         |       | (13,552                 | )          | (25,967                 | )          |
| Other  liabilities                                                                   |       | 22,150                  |       | 15,378                  |       |
| Net cash  provided by operating activities                                           |       | 106,878                 |       | 52,388                  |       |
|                                                                                 |       |                    |       |                    |       |
| **Cash  Flows From Investing Activities:**                                           |       |                    |       |                    |       |
| Proceeds  from maturities and paydowns of securities available for sale              |       | 717,922                 |       | 731,064                 |       |
| Proceeds  from maturities and paydowns of securities held to maturity                |       | 758,965                 |       | 1,008,261               |       |
| Proceeds  from sale of securities available for sale                                 |       | 25,041                  |       | —                  |       |
| Purchases of  securities available for sale                                          |       | (1,115,949              | )          | (1,145,407              | )          |
| Purchases of  securities held to maturity                                            |       | (1,563,748              | )          | (1,600,492              | )          |
| Net increase  in deposits pledged to secure clearings                                |       | (158,580                | )          | (15,050                 | )          |
| Net increase  (decrease) in due to brokers for open trades payable                   |       | 135,866                 |       | (96,538                 | )          |
| Net increase  in Federal Funds sold and securities purchased under resale agreements |       | (425,000                | )          | (110,000                | )          |
| Net decrease  in loans                                                               |       | 7,347                   |       | 17,034                  |       |
| Purchases of  fixed assets, capitalized software and leasehold improvements          |       | (11,779                 | )          | (17,023                 | )          |
| Net cash  used for investing activities                                              |       | (1,629,915              | )          | (1,228,151              | )          |
|                                                                                 |       |                    |       |                    |       |
| **Cash  Flows From Financing Activities:**                                           |       |                    |       |                    |       |
| Net increase  in demand deposits                                                     |       | 718,025                 |       | 150,005                 |       |
| Net increase  in time and savings deposits                                           |       | 78,030                  |       | 89,533                  |       |
| Net increase  in securities sold under repurchase agreements                         |       | 1,029,674               |       | 784,938                 |       |
| Net  (decrease) increase in short-term and other borrowings                          |       | (308,968                | )          | 146,817                 |       |
| Proceeds  from exercise of stock options                                             |       | 10,012                  |       | 1,049                   |       |
| Proceeds  from issuance of common stock                                              |       | 1,668                   |       | 1,800                   |       |
| Cash  dividends to shareholders                                                      |       | (2,309                  | )          | (1,947                  | )          |
| Net cash  provided by financing activities                                           |       | 1,526,132               |       | 1,172,195               |       |
|                                                                                 |       |                    |       |                    |       |
| **Effect  of exchange rates on cash**                                                |       | (5                      | )          | 245                     |       |
|                                                                                 |       |                    |       |                    |       |
| **Net  Increase (Decrease) in Cash and Due From Banks**                              |       | 3,090                   |       | (3,323                  | )          |
| ** **                                                                           |       |                    |       |                    |       |
| **Cash and  Due From Banks, Beginning of Period**                                    |       | 39,689                  |       | 14,568                  |       |
| ** **                                                                           |       |                    |       |                    |       |
| **Cash and  Due From Banks, End of Period**                                          |       | $                       | 42,779     |                    | $          | 11,245 |   |

 

*See Notes to Unaudited Condensed Consolidated Financial Statements.*

 

7

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**INVESTORS FINANCIAL SERVICES CORP.**

**NOTES TOUNAUDITED****CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**(Information is as of and for the six monthsand the three months ended June 30, 2004 and 2003)**

 

**1.****                    Description ofBusiness**

 

Investors Financial Services Corp. (‘IFSC’) provides asset administrationservices for the financial services industry through its wholly-ownedsubsidiary, Investors Bank & Trust Company (‘the Bank’).  As used herein, the defined term “theCompany” shall mean IFSC together with the Bank and its domestic and foreign subsidiaries.  The Company provides core services andvalue-added services to a variety of financial asset managers, including mutualfund complexes, investment advisors, family offices, banks and insurancecompanies.  Core services include globalcustody, multicurrency accounting and mutual fund administration.  Value-added services include securitieslending, foreign exchange, cash management, performance measurement,institutional transfer agency, investment advisory services, lines of credit,middle office outsourcing and brokerage and transition managementservices.  The Company is subject toregulation by the Federal Deposit Insurance Corporation, the Federal ReserveBoard of Governors, the Office of the Commissioner of Banks of the Commonwealthof Massachusetts, the Securities and Exchange Commission (‘SEC’), the NationalAssociation of Securities Dealers, Inc., the Office of the Superintendent ofFinancial Institutions in Canada, the Irish Financial Services RegulatoryAuthority, and the State of Vermont Department of Banking, Insurance,Securities & Health Care Administration.

 

**2.****                    InterimFinancial Statements**

 

The unaudited condensed consolidated interim financial statements ofthe Company and subsidiaries as of June 30, 2004 and December 31,2003, and for the six-month and the three-month periods ended June 30,2004 and 2003 have been prepared by the Company pursuant to the rules andregulations of the SEC.  Certaininformation and footnote disclosures normally included in annual financialstatements prepared in accordance with accounting principles generally acceptedin the United States of America (‘GAAP’) have been condensed or omitted aspermitted by such rules and regulations. All adjustments, consisting of normal recurring adjustments, necessary fortheir fair presentation in conformity with GAAP are included.  Management believes that the disclosures areadequate to present fairly the financial position, results of operations andcash flows at the dates and for the periods presented. It is suggested thatthese interim financial statements be read in conjunction with the financialstatements and the notes thereto included in the Company’s latest annual reporton Form 10-K. Results for interim periods are not necessarily indicative ofthose to be expected for the full fiscal year. Certain amounts in priorfinancial statements have been reclassified to conform to the currentpresentation.

 

***Employee Stock-Based Compensation –***The Company measures compensation cost for stock-based compensation plans usingthe intrinsic value method. The intrinsic value method measures compensationcost as the difference of the option exercise price and the fair market valueof the common stock on the measurement date, which is typically the date ofgrant.  Generally, options granted havean exercise price equivalent to the fair market value at the measurementdate.  Accordingly, no compensation costhas been recorded.  If stock-basedcompensation were recognized using the fair value method, stock options wouldbe valued at grant date using the Black-Scholes valuation model andcompensation costs would have decreased net income as indicated below (Dollarsin thousands, except per share data):

 
| ** **                                                                                                                                          | ** ** | **For the Six Months  Ended June 30,** | ** ** | **For the Three Months  Ended June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                                                                          | ** ** | **2004**                                    | ** ** | **2003**                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                                                                                |       |                                        |       |                                          |       |   |   |   |   |
| Net income  as reported                                                                                                                             |       | $                                           | 70,393     |                                          | $          | 33,432 |   | $ | 35,418 |   | $ | 28,020 |   |
| Deduct:  Total stock-based employee compensation  expense determined under fair value based method for all awards, net of  related tax effects |       | (5,177                                      | )          | (3,504                                        | )          | (3,691 | ) | (1,820 | ) |
| Pro forma  net income                                                                                                                               |       | $                                           | 65,216     |                                          | $          | 29,928 |   | $ | 31,727 |   | $ | 26,200 |   |
|                                                                                                                                                |       |                                        |       |                                          |       |   |   |   |   |
| Earnings per  share:                                                                                                                                |       |                                        |       |                                          |       |   |   |   |   |
| Basic-as  reported                                                                                                                                  |       | $                                           | 1.07       |                                          | $          | 0.51 |   | $ | 0.54 |   | $ | 0.43 |   |
| Basic-pro  forma                                                                                                                                    |       | $                                           | 0.99       |                                          | $          | 0.46 |   | $ | 0.48 |   | $ | 0.40 |   |
|                                                                                                                                                |       |                                        |       |                                          |       |   |   |   |   |
| Diluted-as  reported                                                                                                                                |       | $                                           | 1.04       |                                          | $          | 0.50 |   | $ | 0.52 |   | $ | 0.42 |   |
| Diluted-pro  forma                                                                                                                                  |       | $                                           | 0.96       |                                          | $          | 0.45 |   | $ | 0.47 |   | $ | 0.40 |   |

 

8

----

 

The fair value of each option grant was estimated on the date of grantusing the Black-Scholes valuation model with the following assumptions for thesix months ended June 30, 2004 and 2003, respectively: an average assumedrisk-free interest rate of 2.89% and 2.17%, an expected life of four years, anaverage expected volatility of 52.84% and 56.26%, and an average dividend yieldof 0.17% and 0.23%.

 

For the three months ended June 30, 2004 and 2003, respectively,the following assumptions were used in the Black-Scholes valuation model: anassumed risk-free interest rate of 3.40% and 2.04%, an expected life of fouryears, an expected volatility of 51.73% and 56.34%, and a dividend yield of0.16% and 0.21%.

 

***Earnings Per Share –***Basicearnings per share (‘EPS’) were computed by dividing net income by theweighted-average number of common shares outstanding during the year. DilutedEPS reflects the potential dilution that could occur if contracts to issueCommon Stock were exercised into Common Stock that then shared in the earningsof the Company.  The reconciliation fromBasic to Diluted EPS is as follows (Dollars in thousands, except share data):

 
| ** **                                   | ** ** | **For the Six Months Ended  June 30,** | ** ** | **For the Three Months Ended  June 30,** | ** ** |
|----------------------------------------------|------------|---------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                   | ** ** | **2004**                                    | ** ** | **2003**                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                         |       |                                        |       |                                          |       |   |   |   |   |
| Income  available to common stockholders     |       | $                                           | 70,393     |                                          | $          | 33,432 |   | $ | 35,418 |   | $ | 28,020 |   |
|                                         |       |                                        |       |                                          |       |   |   |   |   |
| Basic  weighted-average shares outstanding   |       | 65,976,331                                  |       | 64,958,192                                    |       | 66,115,552 |   | 65,029,738 |   |
| Dilutive  effect of stock options            |       | 1,731,942                                   |       | 1,353,435                                     |       | 1,583,639 |   | 1,271,681 |   |
| Diluted  weighted-average shares outstanding |       | 67,708,273                                  |       | 66,311,627                                    |       | 67,699,191 |   | 66,301,419 |   |
|                                         |       |                                        |       |                                          |       |   |   |   |   |
| Earnings per  share:                         |       |                                        |       |                                          |       |   |   |   |   |
| Basic                                        |       | $                                           | 1.07       |                                          | $          | 0.51 |   | $ | 0.54 |   | $ | 0.43 |   |
|                                         |       |                                        |       |                                          |       |   |   |   |   |
| Diluted                                      |       | $                                           | 1.04       |                                          | $          | 0.50 |   | $ | 0.52 |   | $ | 0.42 |   |

 

There were 42,109 and 3,587,429 option shares which were not considereddilutive for purposes of EPS calculations for the six-month periods endedJune 30, 2004 and 2003, respectively. For the three-month periods ended June 30, 2004 and 2003 there were193,514 and 3,591,643 option shares, respectively, which were not considereddilutive for purposes EPS calculations.

 

***New Accounting Principles*-**In March 2004, the Emerging Issues Task Force (‘EITF’) of theFinancial Accounting Standards Board reached a consensus on EITF Issue No.03-1, *The Meaning of Other-Than-Temporary Impairment andIts Application to Certain Investments.*EITF Issue 03-1 is effectivefor all annual or interim financial statements for periods beginning afterJune 15, 2004. EITF Issue 03-1 addresses the identification ofother-than-temporarily impaired investments, and requires that an impairmentcharge be recognized for other-than-temporarily impaired investments for whichthere is neither the ability nor intent to hold either until maturity or untilthe market value of the investment recovers. The Company does not anticipate any material impact to its financialcondition or results of operations.

 

9

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**3.****                    Securities**

 

Amortized cost amounts and fair values of securities are summarized asfollows as of June 30, 2004 (Dollars in thousands):

 
| **Held to Maturity**              | ** ** | **Amortized  Cost** | ** ** | **Unrealized  Gains** | ** ** | **Unrealized  (Losses)** | ** ** | **Fair  Value** | ** ** |
|-----------------------------------|------------|---------------------|------------|-----------------------|------------|--------------------------|------------|-----------------|------------|
|                              |       |                |       |                  |       |                     |       |            |       |
| Mortgage-backed  securities       |       | $                   | 2,875,683  |                  | $          | 14,079                   |       | $               | (12,960    | ) | $ | 2,876,802 |   |
| Federal  agency securities        |       | 2,091,904           |       | 3,656                 |       | (9,077                   | )          | 2,086,483       |       |
| State and  political subdivisions |       | 129,343             |       | 3,823                 |       | (452                     | )          | 132,714         |       |
|                              |       |                |       |                  |       |                     |       |            |       |
| Total                             |       | $                   | 5,096,930  |                  | $          | 21,558                   |       | $               | (22,489    | ) | $ | 5,095,999 |   |

 
| **Available for Sale**            | ** ** | **Amortized  Cost** | ** ** | **Unrealized  Gains** | ** ** | **Unrealized  (Losses)** | ** ** | **Fair  Value** | ** ** |
|-----------------------------------|------------|---------------------|------------|-----------------------|------------|--------------------------|------------|-----------------|------------|
|                              |       |                |       |                  |       |                     |       |            |       |
| Mortgage-backed  securities       |       | $                   | 3,947,970  |                  | $          | 6,815                    |       | $               | (44,186    | ) | $ | 3,910,599 |   |
| State and  political subdivisions |       | 382,550             |       | 12,007                |       | (790                     | )          | 393,767         |       |
| Corporate  debt                   |       | 177,767             |       | 842                   |       | (1,435                   | )          | 177,174         |       |
| U.S.  Treasury securities         |       | 112,614             |       | 1,851                 |       | —                   |       | 114,465         |       |
| Foreign  government securities    |       | 9,259               |       | 15                    |       | —                   |       | 9,274           |       |
|                              |       |                |       |                  |       |                     |       |            |       |
| Total                             |       | $                   | 4,630,160  |                  | $          | 21,530                   |       | $               | (46,411    | ) | $ | 4,605,279 |   |

 

Amortized cost amounts and fair values of securities are summarized asfollows as of December 31, 2003 (Dollars in thousands):

 
| **Held to Maturity**              | ** ** | **Amortized  Cost** | ** ** | **Unrealized  Gains** | ** ** | **Unrealized  (Losses)** | ** ** | **Fair  Value** | ** ** |
|-----------------------------------|------------|---------------------|------------|-----------------------|------------|--------------------------|------------|-----------------|------------|
|                              |       |                |       |                  |       |                     |       |            |       |
| Mortgage-backed  securities       |       | $                   | 2,273,466  |                  | $          | 11,596                   |       | $               | (6,310     | ) | $ | 2,278,752 |   |
| Federal  agency securities        |       | 1,906,512           |       | 1,699                 |       | (12,800                  | )          | 1,895,411       |       |
| State and  political subdivisions |       | 127,632             |       | 6,890                 |       | (107                     | )          | 134,415         |       |
|                              |       |                |       |                  |       |                     |       |            |       |
| Total                             |       | $                   | 4,307,610  |                  | $          | 20,185                   |       | $               | (19,217    | ) | $ | 4,308,578 |   |

 
| **Available for Sale**            | ** ** | **Amortized  Cost** | ** ** | **Unrealized  Gains** | ** ** | **Unrealized  (Losses)** | ** ** | **Fair  Value** | ** ** |
|-----------------------------------|------------|---------------------|------------|-----------------------|------------|--------------------------|------------|-----------------|------------|
|                              |       |                |       |                  |       |                     |       |            |       |
| Mortgage-backed  securities       |       | $                   | 3,600,924  |                  | $          | 22,658                   |       | $               | (11,602    | ) | $ | 3,611,980 |   |
| State and  political subdivisions |       | 333,777             |       | 22,119                |       | (68                      | )          | 355,828         |       |
| Corporate  debt                   |       | 178,394             |       | 314                   |       | (2,892                   | )          | 175,816         |       |
| U.S.  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                             |       | $                   | 4,263,644  |                  | $          | 47,555                   |       | $               | (14,562    | ) | $ | 4,296,637 |   |

 

The carrying value of securities pledged amounted to approximately $5.9and $5.6 billion at June 30, 2004 and December 31, 2003.  Securities are pledged primarily to secureclearings with other depository institutions, to secure repurchase agreementsand to secure outstanding Federal Home Loan Bank of Boston (‘FHLBB’)borrowings.

 

The Company regularly reviews its held tomaturity and available for sale securities portfolios for possibleimpairment.  At June 30, 2004, nosecurities were other-than-temporarily impaired.

 

10

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**4.****                    Loans**

 

Loans consist of demand loans to custody clients of the Company,including individuals, not-for-profit institutions and mutual fund clients. Theloans to mutual funds and other pooled product clients include lines of creditand advances pursuant to the terms of the custody agreements between theCompany and those clients to facilitate securities transactions andredemptions. 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 nonperforming loans at June 30, 2004 andDecember 31, 2003.  In addition,there were no loan charge-offs or recoveries during the six months endedJune 30, 2004 and the year ended December 31, 2003. Loans aresummarized as follows (Dollars in thousands):

 

| ** **                      | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|---------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Loans to  individuals           |       | $                       | 91,292     |                        | $          | 67,641 |   |
| Loans to  mutual funds          |       | 66,437                  |       | 104,954                     |       |
| Loans to  others                |       | 34,554                  |       | 27,035                      |       |
| Gross loans                     |       | 192,283                 |       | 199,630                     |       |
| Less  allowance for loan losses |       | (100                    | )          | (100                        | )          |
|                            |       |                    |       |                        |       |
| Total                           |       | $                       | 192,183    |                        | $          | 199,530 |   |

 

**5.****                    Deposits**

 

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

 

| ** **                          | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Interest-bearing  deposits:         |       |                    |       |                        |       |
| Savings                             |       | $                       | 3,575,512  |                        | $          | 3,632,913 |   |
| Time                                |       | 130,169                 |       | —                      |       |
| Total  interest-bearing deposits    |       | 3,705,681               |       | 3,632,913                   |       |
|                                |       |                    |       |                        |       |
| Noninterest-bearing  deposits:      |       |                    |       |                        |       |
| Demand                              |       | 1,052,848               |       | 334,823                     |       |
| Savings                             |       | 9,644                   |       | 49,382                      |       |
| Time                                |       | 235,000                 |       | 190,000                     |       |
| Total  noninterest-bearing deposits |       | 1,297,492               |       | 574,205                     |       |
|                                |       |                    |       |                        |       |
| Total                               |       | $                       | 5,003,173  |                        | $          | 4,207,118 |   |

 

**6.****                    SecuritiesSold Under Repurchase Agreements**

 

The components of securities sold under repurchase agreements are asfollows (Dollars in thousands):

 

| ** **                          | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
|                                |       |                    |       |                        |       |
| Repurchase  agreements - short term |       | $                       | 3,587,675  |                        | $          | 2,858,001 |   |
| Repurchase  agreements - long term  |       | 700,000                 |       | 400,000                     |       |
| Total                               |       | $                       | 4,287,675  |                        | $          | 3,258,001 |   |

 

Approximately $4.3 billion and $3.4 billion of securities were pledgedto collateralize repurchase agreements as of June 30, 2004 andDecember 31, 2003, respectively.

 

11

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**7.****                    Short-term andOther Borrowings**

 

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

 

| ** **                                           | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
|                                                 |       |                    |       |                        |       |
| Federal  Funds purchased                             |       | $                       | 739,038    |                        | $          | 697,855 |   |
| Federal Home  Loan Bank of Boston long-term advances |       | 50,000                  |       | 150,000                     |       |
| Federal Home  Loan Bank of Boston overnight advances |       | —                  |       | 250,000                     |       |
| Treasury,  Tax and Loan account                      |       | 81                      |       | 232                         |       |
|                                                 |       |                    |       |                        |       |
| Total                                                |       | $                       | 789,119    |                        | $          | 1,098,087 |   |

 

The Company has borrowing arrangements with the FHLBB and the FederalReserve Discount Window, which have been utilized on an overnight and long-termbasis to satisfy funding requirements. Approximately $1.4 billion and $1.9 billion of securities were pledgedto collateralize these advances as of June 30, 2004 and December 31,2003, respectively.

 

**8.****                    Stockholders’Equity**

 

As of June 30, 2004, the Company’s authorized capital stockconsisted of 1,000,000 shares of Preferred Stock and 175,000,000 shares ofCommon Stock, all with a par value of $0.01 per share.

 

At the Annual Meeting of Stockholders of the Company held onApril 13, 2004, stockholders approved an increase in the number ofauthorized shares of Common Stock from 100,000,000 to 175,000,000.  On May 5, 2004, the Company amended itsCertificate of Incorporation to increase the number of authorized shares ofCommon Stock to 175,000,000.  Theseshares are available for issuance for general corporate purposes as determinedby the Company’s Board of Directors.

 

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

 

At the Annual Meeting of Stockholders of the Company held onApril 13, 2004, stockholders approved an amendment to the Company’s ESPPto increase the number of shares of Common Stock that may be issued thereunderfrom 1,120,000 to 1,620,000.

 

During the six months ended June 30, 2004, the following activityoccurred under the Director Plan and the Stock Plan:

 

| ** **                                         | ** ** | **June 30, 2004** | ** ** |
|----------------------------------------------------|------------|------------------------|------------|
| ** **                                         | ** ** | **Shares**             | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
|                                               |       |                   |       |   |   |
| Outstanding  at December 31, 2003             |       | 6,547,086              |       | $ | 24 |   |
| Granted                                            |       | 261,274                |       | 41 |   |
| Exercised                                          |       | (963,175               | )          | 20 |   |
| Canceled                                           |       | (78,306                | )          | 31 |   |
| Outstanding  at June 30, 2004                 |       | 5,766,879              |       | $ | 26 |   |
|                                               |       |                   |       |   |   |
| Outstanding  and Exercisable at June 30, 2004 |       | 4,141,844              |       |   |   |

 

12

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A summary of activity under the ESPP is as follows:

 

| ** **                                                  | ** ** | **For the Six  Months Ended  June 30,  2004** | ** ** | **For the  Year Ended  December 31,  2003** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------------------|------------|--------------------------------------------------|------------|
| Total shares  available under the ESPP, beginning of period |       | 227,504                                            |       | 356,875                                          |       |
| Approved  increase in shares available                      |       | 500,000                                            |       | —                                           |       |
| Issued at  June 30                                     |       | (47,681                                            | )          | (70,606                                          | )          |
| Issued at  December 31                                 |       | —                                             |       | (58,765                                          | )          |
|                                                        |       |                                               |       |                                             |       |
| Total shares  available under the ESPP, end of period       |       | 679,823                                            |       | 227,504                                          |       |

 

For the six-month period ended June 30, 2004, the purchase priceof the stock was $35.00, or 90% of the market value of the Common Stock on thefirst business day of the payment period ending June 30, 2004.

 

During the year ended December 31, 2003, the purchase prices ofthe stock were $25.50 and $27.00, or 90% of the market value of the CommonStock on the first business day of the payment periods ending June 30,2003 and December 31, 2003, respectively.

 

**9.****              Employee BenefitPlans**

 

***Pension Plan -***The Company has a trusteed, noncontributory, qualified defined benefit pensionplan covering substantially all of its employees who were hired beforeJanuary 1, 1997.  The benefits arebased on years of service and the employee’s compensation duringemployment.  Generally, the Company’sfunding policy is to contribute annually the maximum amount that can bededucted for federal income tax purposes. Contributions are intended to provide not only for benefits attributedto 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 accrualsfor certain highly compensated participants as of December 31, 2001, aswell as to change the maximum allowable compensation projected for future years.  Such highly compensated participants willreceive their future full benefit accrual under the Company’s nonqualifiedsupplemental retirement plan, as described below.  The Company uses a December 31measurement 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 paysbenefits that supplement any benefits paid under the qualified plan.  Benefits under the supplemental plan aregenerally based on compensation not includable in the calculation of benefitsto be paid under the qualified plan. The Company uses a December 31measurement date for this plan.

 

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

 

| ** **                                      | ** ** | **June 30, 2004** | ** ** | **June 30, 2003** | ** ** |
|-------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                      | ** ** | **Pension Plan**       | ** ** | **SERP**               | ** ** | **Pension Plan** | ** ** | **SERP** | ** ** |
|                                            |       |                   |       |                   |       |   |   |   |   |
| Service cost                                    |       | $                      | 463        |                   | $          | 476 |   | $ | 417 |   | $ | 439 |   |
| Interest  cost on projected benefit obligations |       | 555                    |       | 484                    |       | 513 |   | 449 |   |
| Expected  return on plan assets                 |       | (725                   | )          | —                 |       | (543 | ) | — |   |
| Net  amortization and deferral                  |       | 120                    |       | 296                    |       | 124 |   | 325 |   |
| Net periodic  pension cost                      |       | $                      | 413        |                   | $          | 1,256 |   | $ | 511 |   | $ | 1,213 |   |

 

The Company expects to contribute approximately $2 to $4 million to itspension plan during 2004.  During theperiod ended June 30, 2004, the Company did not make any contributions tothe plan.

 

At June 30, 2004, the SERP remained an unfunded plan.  Consistent with the Company’s expectations atDecember 31, 2003, no contributions to the SERP are anticipated during2004.

 

13

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**10.****             Off-Balance SheetFinancial Instruments**

 

***Lines of Credit****-* At June 30, 2004, the Company had commitments toindividuals and mutual funds under collateralized open lines of credit totaling$1.0 billion, against which $88.0 million in loans were drawn. The credit riskinvolved in issuing lines of credit is essentially the same as that involved inextending demand loans. The Company does not anticipate any loss as a result ofthese lines of credit.

 

***Securities Lending****-* On behalf of its clients, the Company lends securities tocreditworthy broker-dealers.  In certaincircumstances, the Company may indemnify its clients for the fair market valueof those securities against a failure of the borrower to return suchsecurities.  The Company requires theborrowers to provide collateral in an amount equal to, or in excess of, 102% ofthe fair market value of U.S. dollar-denominated securities borrowed and 105%of the fair market value of non-U.S. dollar-denominated securitiesborrowed.  The borrowed securities arerevalued daily to determine whether additional collateral is necessary.  As guarantor, the Company is required torecognize, at the inception of a guarantee, a liability for the fair value ofthe obligation undertaken in issuing the guarantee.  The Company measures the fair value of itsindemnification obligation by marking its securities lending portfolio tomarket on a daily basis and comparing the value of the portfolio to thecollateral holdings position.  The fairvalue of the indemnification obligation to be recorded would be the deficiencyof collateral as compared to the value of the securities out on loan.

 

With respect to the indemnified securities lending portfolio, the cashand U.S. government securities held by the Company as collateral atJune 30, 2004 totaled $4.8 billion while the fair value of the portfoliototaled approximately $4.6 billion.  Giventhat the collateral held was in excess of the value of the securities that theCompany would be required to replace if the borrower defaulted and failed toreturn such securities, the Company’s indemnification obligation was zero andno liability was recorded.

 

All securities loans are categorized as overnight loans. The maximumpotential amount of future payments that the Company could be required to makewould be equal to the market value of the securities borrowed.  Since the securities loans are overcollateralizedby 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, thecollateral held by the Company would be used to satisfy the obligation.  In addition, each borrowing agreementincludes “set-off” language that allows the Company to use any excesscollateral on other loans to that borrower to cover any collateral shortfall ofthat borrower.  However, there is apotential risk that the collateral would not be sufficient to cover such anobligation if the security on loan increased in value between the time theborrower defaulted and the time the security is “bought-in.”  In those instances, the Company would“buy-in” the security using all available collateral and a loss would resultfrom the difference between the value of the security “bought-in” and the valueof the collateral held.  The Company hasnever experienced a broker default.

 

**11.**             Derivative FinancialInstruments

 

***Interest Rate Contracts***- Interest rate contracts involve an agreement with a counterparty to exchangecash flows based on an underlying interest rate index.  A swap agreement involves the exchange of aseries of interest payments, either at a fixed or variable rate, based upon thenotional amount without the exchange of the underlying principal amount. TheCompany’s exposure from these interest rate contracts results from thepossibility that one party may default on its contractual obligation when thecontracts are in a gain position.  TheCompany has experienced no terminations by counterparties of interest rateswaps.  Credit risk is limited to thepositive fair value of the derivative financial instrument, which issignificantly less than the notional value. During the periods presented, the Company had agreements to assumefixed-rate interest payments in exchange for receiving variable market-indexedinterest payments.  The contractual ornotional amounts of the interest rate swap agreements held by the Company wereapproximately $1.3 billion and $1.2 billion at June 30, 2004 andDecember 31, 2003. The effect of these agreements was to lengthenshort-term variable-rate liabilities into longer-term fixed-rateliabilities.  These contracts had netfair values of approximately $3.6 million and $(14.9) million at June 30,2004 and December 31, 2003, respectively. These fair values are includedin the respective other assets and other liabilities categories on theCompany’s consolidated balance sheet. These instruments have been designated as cash flow hedges.  Changes in fair value of effective portionsare included as a component of other comprehensive income.  Changes in fair value of ineffective portionsare included in net interest income and were $0.9 million for both the sixmonths and three months ended June 30, 2004.

 

In May 2004, the Company terminated $280.0 million of its interest rateswap agreements discussed above.  As aresult, an after-tax net loss of $0.4 million was included in othercomprehensive income and will be amortized over the life of the underlyingcontracts through 2006.  The Companyestimates that net derivative gains and losses reclassified into earningswithin the next twelve months will be immaterial. These terminated interest rateswap agreements were replaced with new interest rate swap agreements and termborrowings in order to more favorably manage exposure to changes in interestrates.

 

14

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***Foreign Exchange Contracts***- Foreign exchange contracts involve an agreement to exchange the currency ofone country for the currency of another country at an agreed-upon rate andsettlement date.  Foreign exchangecontracts consist of spot, forward and swap contracts.  Spot contracts call for the exchange of onecurrency for another and usually settle in two business days.  Forward contracts call for the exchange ofone currency for another at a date beyond spot. In a currency swap, the holder of a currency transacts simultaneouslyboth a spot and a forward transaction in that currency for an equivalent amountof another currency to get temporary liquidity in the currency owned.  The Company’s risk from foreign exchangecontracts results from the possibility that one party may default on itscontractual obligation and from movements in exchange rates.  Credit risk is limited to the positive marketvalue of the derivative financial instrument, which is significantly less thanthe notional value. The notional values of the Company’s foreign exchangecontracts as of June 30, 2004 and December 31, 2003 were $2.1 billionand $1.6 billion, respectively. Unrealized gains or losses resulting from purchases and sales of foreignexchange contracts are included within the respective other assets and otherliabilities categories on the Company’s consolidated balance sheet.  Unrealized gains in other assets were $4.7million and $16.1 million as of June 30, 2004 and December 31, 2003,respectively.  Unrealized losses in otherliabilities were $4.5 million and $15.9 million as of June 30, 2004 andDecember 31, 2003, respectively. Foreign exchange contracts have been reduced by offsetting balances withthe same counterparty where a master netting agreement exists.  These contracts have not been designated ashedging instruments, therefore, all changes in fair value are included in assetservicing fees.

 

***Other*** - TheCompany also enters into fixed price purchase contracts that are designed tohedge the variability of the consideration to be paid for the purchase ofinvestment securities.  By entering intothese contracts, the Company is fixing the price to be paid at a future datefor certain investment securities. At June 30, 2004 and December 31,2003, the Company had $639.4 million and $792.1 million, respectively, of fixedprice purchase contracts outstanding to purchase investment securities. Changesin fair value of these cash flow hedges are included as a component of othercomprehensive income.

 

**12.****             Commitments andContingencies**

 

***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’) forthe two-week period including June 30, 2004 was approximately $33.0million.  In addition, the Company’sbalance sheet includes deposits totaling approximately $188.2 million, whichwere pledged to secure clearings with depository institutions.

 

***Contingencies*** -Assets processed held by the Company in a fiduciary capacity are not includedin the consolidated balance sheets since these items are not assets of theCompany.  Management conducts regularreviews of its fiduciary responsibilities and considers the results inpreparing its consolidated financial statements.  In the opinion of management, there were nocontingent liabilities at June 30, 2004 that were material to theconsolidated financial position or results of operations of the Company.

 

**13.****             Regulatory Matters**

 

The Company and the Bank are subject to various regulatory capitalrequirements administered by the federal banking agencies.  Failure to meet minimum capital requirementscan initiate certain mandatory and possibly additional discretionary actions byregulators that, if undertaken, could have a direct material adverse effect onthe Company’s and the Bank’s consolidated financial position and results ofoperations.  Under capital adequacyguidelines and the regulatory framework for prompt corrective action, the Bankmust meet specific capital guidelines that involve quantitative measures of theBank’s assets, liabilities, and certain off-balance sheet items as calculatedunder regulatory accounting practices. The Company’s and the Bank’s capital amounts and classification are alsosubject to qualitative judgments by the regulators about components, riskweightings, and other factors.

 

Quantitative measures established by regulation to ensure capitaladequacy require the Company and the Bank to maintain minimum amounts andratios (set forth in the following table) of Total and Tier 1 capital (asdefined in the regulations) to risk-weighted assets (as defined), and of Tier 1capital (as defined) to average assets (as defined).  Management believes, as of June 30,2004, that the Company and the Bank meet all capital adequacy requirements towhich they are subject.

 

The most recent notification from the Federal Deposit InsuranceCorporation categorized the Company and the Bank as well-capitalized under theregulatory framework for prompt corrective action.  To be categorized as well-capitalized, theCompany and the Bank must maintain minimum Total risk-based, Tier 1 risk-based,and Tier 1 leverage ratios as set forth in the following table.  There are no conditions or events since thatnotification that management believes have changed the Company’s or the Bank’scategory.

 

15

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The following table presents the capital ratios for the Bank and theCompany (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 June 30, 2004:**                          | ** ** | ** ** | ** ** | ** **                         | ** ** | ** **                                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total  Capital  (to Risk-Weighted Assets-the Company)  |       | $          | 559,099    |                               | 18.04      | %                                                                       | $          | 247,983 |   | 8.00 | % | N/A |   | N/A |   |
| Total  Capital  (to Risk-Weighted Assets-the Bank)     |       | $          | 545,415    |                               | 17.61      | %                                                                       | $          | 247,774 |   | 8.00 | % | $ | 309,717 |   | 10.00 | % |
| Tier 1  Capital  (to Risk-Weighted Assets-the Company) |       | $          | 558,999    |                               | 18.03      | %                                                                       | $          | 123,991 |   | 4.00 | % | N/A |   | N/A |   |
| Tier 1  Capital  (to Risk-Weighted Assets-the Bank)    |       | $          | 545,315    |                               | 17.61      | %                                                                       | $          | 123,887 |   | 4.00 | % | $ | 185,830 |   | 6.00 | % |
| Tier 1  Capital  (to Average Assets-the Company)       |       | $          | 558,999    |                               | 5.58       | %                                                                       | $          | 400,397 |   | 4.00 | % | N/A |   | N/A |   |
| Tier 1  Capital  (to Average Assets-the Bank)          |       | $          | 545,315    |                               | 5.45       | %                                                                       | $          | 400,340 |   | 4.00 | % | $ | 500,425 |   | 5.00 | % |
|                                                   |       |       |       |                               |       |                                                                    |       |   |   |   |   |   |   |
| **As of December 31, 2003:**                      | ** ** | ** ** | ** ** | ** **                         | ** ** | ** **                                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total  Capital  (to Risk-Weighted Assets-the Company)  |       | $          | 472,511    |                               | 17.79      | %                                                                       | $          | 212,479 |   | 8.00 | % | N/A |   | N/A |   |
| Total  Capital  (to Risk-Weighted Assets-the Bank)     |       | $          | 466,933    |                               | 17.60      | %                                                                       | $          | 212,297 |   | 8.00 | % | $ | 265,371 |   | 10.00 | % |
| Tier 1  Capital  (to Risk-Weighted Assets-the Company) |       | $          | 472,411    |                               | 17.79      | %                                                                       | $          | 106,240 |   | 4.00 | % | N/A |   | N/A |   |
| Tier 1  Capital  (to Risk-Weighted Assets-the Bank)    |       | $          | 466,833    |                               | 17.59      | %                                                                       | $          | 106,148 |   | 4.00 | % | $ | 159,223 |   | 6.00 | % |
| Tier 1  Capital  (to Average Assets-the Company)       |       | $          | 472,411    |                               | 5.41       | %                                                                       | $          | 349,516 |   | 4.00 | % | N/A |   | N/A |   |
| Tier 1  Capital  (to Average Assets-the Bank)          |       | $          | 466,833    |                               | 5.35       | %                                                                       | $          | 349,331 |   | 4.00 | % | $ | 436,663 |   | 5.00 | % |

 

Under Massachusetts law, trust companies such as the Bank, likenational banks, may pay dividends no more often than quarterly, and only out ofnet profits and to the extent that such payments will not impair the Bank’scapital stock and surplus account. Moreover, prior Commissioner approval is required if the total dividendsfor a calendar year would exceed net profits for that year combined withretained net profits for the previous two years.  These restrictions on the ability of the Bankto pay dividends to the Company may restrict the ability of the Company to paydividends to its stockholders.

 

The operations of the Company’s securities broker affiliate, InvestorsSecurities Services, Inc., are subject to federal and state securities laws, aswell as the rules of both the Securities and Exchange Commission and theNational Association of Securities Dealers, Inc.  Management believes, as of June 30,2004, that Investors Securities Services, Inc. is in material compliance withall of the foregoing requirements to which it is subject.

 

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**14.****             Geographic Reportingand Service Lines**

 

The Company does not utilize segment information for internal reportingas management views the Company as one segment. The following represents netoperating revenue and long-lived assets (including goodwill) by geographic area(Dollars in thousands):

 
| ** **                  | ** ** | **Net Operating Revenue**                   | ** ** | ** **                                    | ** ** |
|-----------------------------|------------|---------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                  | ** ** | **For the Six Months Ended  June 30,** | ** ** | **For the Three Months Ended  June 30,** | ** ** | **Long-Lived Assets** | ** ** |
| **June 30,**           | ** ** | **December 31,**                       | ** ** |
| **Geographic Information:** | ** ** | **2004**                                    | ** ** | **2003**                                      | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
|                        |       |                                        |       |                                          |       |   |   |   |   |   |   |   |   |
| United  States              |       | $                                           | 290,997    |                                          | $          | 226,438 |   | $ | 145,414 |   | $ | 116,942 |   | $ | 145,071 |   | $ | 149,631 |   |
| Ireland                     |       | 13,440                                      |       | 8,391                                         |       | 7,343 |   | 4,633 |   | 6,304 |   | 6,698 |   |
| Canada                      |       | 2,237                                       |       | 807                                           |       | 1,231 |   | 379 |   | 87 |   | 60 |   |
| Cayman  Islands             |       | 90                                          |       | 38                                            |       | 45 |   | 21 |   | — |   | — |   |
|                        |       |                                        |       |                                          |       |   |   |   |   |   |   |   |   |
| Total                       |       | $                                           | 306,764    |                                          | $          | 235,674 |   | $ | 154,033 |   | $ | 121,975 |   | $ | 151,462 |   | $ | 156,389 |   |

 

Barclays Global Investors, N.A. (‘BGI’) accounted for approximately 17%of the Company’s consolidated net operating revenues for the six- andthree-month periods ended June 30, 2004, and 16% of the Company’sconsolidated net operating revenues for the six- and three-month periods endedJune 30, 2003.  No client other thanBGI accounted for more than 10% of the Company’s consolidated net operatingrevenues for the six- and three-month periods ended June 30, 2004 and2003.

 

The following represents the Company’s asset servicing fees by servicelines (Dollars in thousands):

 

| ** **                              | ** ** | **For the Six Months Ended  June 30,** | ** ** | **For the Three Months Ended  June 30,** | ** ** |
|-----------------------------------------|------------|---------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                              | ** ** | **2004**                                    | ** ** | **2003**                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                    |       |                                        |       |                                          |       |   |   |   |   |
| Core service  fees:                     |       |                                        |       |                                          |       |   |   |   |   |
| Custody,  accounting and administration |       | $                                           | 154,849    |                                          | $          | 118,838 |   | $ | 78,755 |   | $ | 62,078 |   |
|                                    |       |                                        |       |                                          |       |   |   |   |   |
| Ancillary  service fees:                |       |                                        |       |                                          |       |   |   |   |   |
| Foreign  exchange                       |       | 33,008                                      |       | 16,823                                        |       | 14,513 |   | 10,090 |   |
| Cash  management                        |       | 12,338                                      |       | 10,667                                        |       | 6,738 |   | 5,632 |   |
| Investment  advisory                    |       | 8,033                                       |       | 6,092                                         |       | 4,563 |   | 2,877 |   |
| Securities  lending                     |       | 5,724                                       |       | 4,842                                         |       | 3,581 |   | 2,654 |   |
| Other  service fees                     |       | 1,228                                       |       | 619                                           |       | 843 |   | 404 |   |
| Total  ancillary service fees           |       | 60,331                                      |       | 39,043                                        |       | 30,238 |   | 21,657 |   |
|                                    |       |                                        |       |                                          |       |   |   |   |   |
| Total asset  servicing fees             |       | $                                           | 215,180    |                                          | $          | 157,881 |   | $ | 108,993 |   | $ | 83,735 |   |

 

**15.****             Net Interest Income**

 

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

 

| ** **                                                          | ** ** | **For the Six Months Ended  June 30,** | ** ** | **For the Three Months Ended  June 30,** | ** ** |
|---------------------------------------------------------------------|------------|---------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                          | ** ** | **2004**                                    | ** ** | **2003**                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| Interest  income:                                                   |       |                                        |       |                                          |       |   |   |   |   |
| Federal  Funds sold and securities sold under repurchase agreements |       | $                                           | 314        |                                          | $          | 182 |   | $ | 152 |   | $ | 166 |   |
| Investment  securities held to maturity and available for sale      |       | 140,067                                     |       | 119,594                                       |       | 70,178 |   | 60,109 |   |
| Loans                                                               |       | 2,152                                       |       | 1,778                                         |       | 1,027 |   | 930 |   |
| Total  interest income                                              |       | 142,533                                     |       | 121,554                                       |       | 71,357 |   | 61,205 |   |
| Interest  expense:                                                  |       |                                        |       |                                          |       |   |   |   |   |
| Deposits                                                            |       | 22,274                                      |       | 18,231                                        |       | 10,904 |   | 9,114 |   |
| Short-term  and other borrowings                                    |       | 30,006                                      |       | 26,958                                        |       | 16,161 |   | 14,509 |   |
| Total  interest expense                                             |       | 52,280                                      |       | 45,189                                        |       | 27,065 |   | 23,623 |   |
|                                                                |       |                                        |       |                                          |       |   |   |   |   |
| Net interest  income                                                |       | $                                           | 90,253     |                                          | $          | 76,365 |   | $ | 44,292 |   | $ | 37,582 |   |

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Stockholders ofInvestors Financial Services Corp.Boston, Massachusetts

 

We have reviewed the accompanying condensedconsolidated balance sheet of Investors Financial Services Corp. andsubsidiaries (the “Company”) as of June 30, 2004, and the relatedcondensed consolidated statements of income and comprehensive income for thethree-month and six-month periods ended June 30, 2004 and 2003, and theconsolidated statements of stockholders’ equity and cash flows for the six-monthperiods ended June 30, 2004 and 2003.  These interim financialstatements are the responsibility of the Company’s management.

 

We conducted our reviews in accordance withstandards of the Public Company Accounting Oversight Board (UnitedStates).  A review of interim financial information consists principallyof applying analytical procedures and making inquiries of persons responsiblefor financial and accounting matters.  It is substantially less in scopethan an audit conducted in accordance with standards of the Public CompanyAccounting Oversight Board (United States), the objective of which is theexpression of an opinion regarding the financial statements taken as awhole.  Accordingly, we do not express such an opinion.

 

Based on our reviews, we are not aware of anymaterial modifications that should be made to such condensed consolidatedinterim financial statements for them to be in conformity with accountingprinciples generally accepted in the United States of America.

 

We have previously audited, in accordancewith standards of the Public Company Accounting Oversight Board (UnitedStates), the consolidated balance sheet of Investors Financial Services Corp.and subsidiaries as of December 31, 2003, and the related consolidatedstatements of income and comprehensive income, stockholders’ equity, and cashflows for the year then ended (not presented herein); and in our report datedFebruary 20, 2004, we expressed an unqualified opinion on thoseconsolidated financial statements.  In our opinion, the information setforth in the accompanying condensed consolidated balance sheet as ofDecember 31, 2003 is fairly stated, in all material respects, in relationto the consolidated balance sheet from which it has been derived.

 

DELOITTE & TOUCHE LLP

 

Boston,MassachusettsAugust 6, 2004

 

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**Item2****.****           Management’s Discussionand Analysis of Financial Condition and Results of Operations**

 

**Overview**

 

*You should read the following discussiontogether with our Unaudited Consolidated Financial Statements and related Notesto Unaudited Consolidated Financial Statements, which are included elsewhere inthis Report.  The following discussioncontains forward-looking statements that reflect plans, estimates and beliefs.  Our actual results could differ materiallyfrom those discussed in the forward-looking statements.*

 

We provideasset administration services for the financial services industry through ourwholly-owned subsidiary, Investors Bank & Trust Company (‘IBT’).  We provide core services and value-addedservices to a variety of financial asset managers, including mutual fundcomplexes, investment advisors, family offices, banks and insurance companies.  Core services include global custody,multicurrency accounting and mutual fund administration.  Value-added services include securitieslending, foreign exchange, cash management, performance measurement,institutional transfer agency, investment advisory services, lines of credit,middle office outsourcing and brokerage and transition managementservices.  We have offices located in theUnited States, Ireland, Canada and the Cayman Islands, as well as a network ofglobal subcustodians in more than 90 countries. At June 30, 2004, we provided services for approximately $1.2trillion in net assets, including approximately $222 billion in foreign netassets.

 

We grow ourbusiness by selling our services to new clients and by further penetrating ourexisting clients.  We believe that wecurrently service less than 10% of the assets managed by our existing clients,and we have traditionally achieved significant success in growing clientrelationships.  Our ability to servicenew clients and expand our relationships with existing clients depends on ourprovision of superior client service. Our growth is also affected by overall market conditions, the regulatoryenvironment for us and our clients and the success of our clients at marketingtheir products.

 

We derive ourasset servicing revenue from providing these core and value-addedservices.  We derive our net interestincome by investing the cash balances our clients leave on deposit withus.  Our share of earnings from theseinvestments is viewed as part of the total compensation that our clients pay usfor servicing their assets.  Our serviceofferings are priced on a bundled basis. In establishing a fee structure for a specific client, we analyze allexpected revenue and expenses.  Webelieve net operating revenue (net interest income plus noninterest income) andnet income are the most meaningful measures of our financial results.

 

As a providerof asset administration services, the amount of net operating revenue that wegenerate is impacted by overall market conditions, client activity, and theprevailing interest rate environment. Over the course of the past year, we have benefited from theappreciation of the market values of the assets we service for our clients. Asignificant portion of our core services revenue is based upon the amount ofassets under administration.  As marketvalues of underlying assets fluctuate, so will our revenue.  We have managed this volatility by offering atiered pricing structure for our asset-based fees.  As asset values increase, the basis point feeis reduced for the incremental assets. Many of our value-added services are transactional based, and we receivea fee for each transaction processed.  Wehave also continued to experience net interest margin compression in this lowinterest rate environment because we have little room to reduce further therates we pay on our interest-bearing liabilities.  We have structured our balance sheet toaccommodate an expected****increase inrates by the Federal Open Market Committee (‘FOMC’) over the next eighteenmonths.  We expect to experience some netinterest margin pressure, however, we believe net interest income will continueto grow during this period.

 

We continue toremain focused on our sales efforts, prudent expense management and increasingoperational efficiency.  These goals arecomplicated by our need to build infrastructure to support our rapid growth,maintain and enhance our technology and retain and motivate our workforce.

 

EffectiveJuly 1, 2004, we entered into a seven-year contract with InternationalBusiness Machines Corporation (‘IBM’), to outsource certain technicalinfrastructure services.  As theseservices are currently performed by IBT or other service providers, thiscontract is not expected to have a material impact on our financial conditionor results of operations.  Alldevelopment and maintenance of proprietary software and systems will continueto be performed by IBT.

 

In our 2003earnings releases, in addition to reporting GAAP results, we also reportedoperating income and operating earnings per share information that excluded theeffect of the previously disclosed $13.9 million, or $0.21 per diluted share,one-time tax accrual that we recorded in the first quarter of 2003 and itslater partial reversal of approximately $6.7 million, or $0.10 per share, net offederal income taxes, in the second quarter of 2003.  The accrual resulted from a retroactive taxlaw change by the Commonwealth of Massachusetts disallowing a dividendsreceived deduction taken by IBT on dividends received since 1999 from awholly-owned real estate investment trust. In the second quarter of 2003, we settled this tax matter pursuant to anagreement to pay 50% of the liability. We believe that non-GAAP operating income and operating earnings pershare provide a more meaningful presentation of our results of operationsbecause they do not include the one-time tax charge which was unrelated to ourongoing operations.

 

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The following table presents a reconciliationbetween net income and earnings per share presented on the face of ourUnaudited Condensed Consolidated Statements of Income and the non-GAAP measureof net operating income and operating earnings per share referenced in ourearnings releases (Dollars in thousands, except per share data):

 

**GAAP Earnings (unaudited)**

 
| ** **                  | ** ** | **For the Six Months Ended  June 30,** | ** ** | **For the Three Months Ended  June 30,** | ** ** |
|-----------------------------|------------|---------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                  | ** ** | **2004**                                    | ** ** | **2003**                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
|                        |       |                                        |       |                                          |       |   |   |   |   |
| Income  before taxes        |       | $                                           | 105,930    |                                          | $          | 59,002 |   | $ | 53,333 |   | $ | 31,022 |   |
| Provision  for income taxes |       | 35,537                                      |       | 25,570                                        |       | 17,915 |   | 3,002 |   |
| Net income                  |       | $                                           | 70,393     |                                          | $          | 33,432 |   | $ | 35,418 |   | $ | 28,020 |   |
| Earnings per  share:        |       |                                        |       |                                          |       |   |   |   |   |
| Basic                       |       | $                                           | 1.07       |                                          | $          | 0.51 |   | $ | 0.54 |   | $ | 0.43 |   |
|                        |       |                                        |       |                                          |       |   |   |   |   |
| Diluted                     |       | $                                           | 1.04       |                                          | $          | 0.50 |   | $ | 0.52 |   | $ | 0.42 |   |

 

**Non-GAAP Operating Earnings (unaudited)**

 
| ** **                     | ** ** | **For the Six Months Ended  June 30,** | ** ** | **For the Three Months Ended  June 30,** | ** ** |
|--------------------------------|------------|---------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                     | ** ** | **2004**                                    | ** ** | **2003**                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
|                           |       |                                        |       |                                          |       |   |   |   |   |
| Income  before taxes           |       | $                                           | 105,930    |                                          | $          | 59,002 |   | $ | 53,333 |   | $ | 31,022 |   |
| Provision  for income taxes    |       | 35,537                                      |       | 18,370                                        | (1)        | 17,915 |   | 9,702 | (2) |
| Net  operating income          |       | $                                           | 70,393     |                                          | $          | 40,632 |   | $ | 35,418 |   | $ | 21,320 |   |
| Operating  earnings per share: |       |                                        |       |                                          |       |   |   |   |   |
| Basic                          |       | $                                           | 1.07       |                                          | $          | 0.63 |   | $ | 0.54 |   | $ | 0.33 |   |
|                           |       |                                        |       |                                          |       |   |   |   |   |
| Diluted                        |       | $                                           | 1.04       |                                          | $          | 0.61 |   | $ | 0.52 |   | $ | 0.32 |   |

 

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(1) Provision for income taxes for the six months ended June 30, 2003excludes a $13.9 million charge, net of federal income tax benefit, related toa retroactive change in Massachusetts tax law enacted in the first quarter of2003 and excludes the subsequent reversal of $6.7 million of the provision, netof federal income taxes, due to the settlement of this matter.  The effect of the exclusions is an increaseof $0.12 per basic share and  $0.11 perdiluted share.

 

(2)  Provision for income taxesfor the three months ended June 30, 2003 excludes the reversal of $6.7million of federal income tax benefit, net of federal taxes, due to thesettlement of a matter with the Massachusetts Department of Revenue relating toa retroactive change in Massachusetts tax law enacted in the first quarter of2003. The effect of the exclusion is a decrease of $0.10 per basic and dilutedshare.

 

20

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**CertainFactors That May Affect Future Results**

 

From time to time, information provided byus, statements made by our employees, or information included in our filingswith the Securities and Exchange Commission (‘SEC’) (including this Form 10-Q)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 orour 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 thenegative of those terms.  Forward-lookingstatements in this Form 10-Q include certain statements regarding futurechanges in operating expenses (including compensation and benefits, transactionprocessing services, technology and telecommunications, depreciation andamortization, insurance expense, and other operating expenses), net interestincome, client funding, the effective tax rate for 2004, hedge ineffectiveness,liquidity, annual dividend payments, interest rate conditions, interest ratesensitivity, loss exposure on lines of credit, future pension costs and fundinglevels, the timing and effect on earnings of derivative gains and losses, theeffect on earnings of changes in equity values and the effect of certain legalclaims against us.  Our actual futureresults may differ significantly from those stated in any forward-lookingstatements.  Factors that may cause suchdifferences include, but are not limited to, the factors discussed below.  Each of these factors, and others, arediscussed from time to time in our filings with the SEC.

 

*Our operating results are subject tofluctuations in interest rates and the securities markets.*

 

A significantportion of our fees are based on the market value of the assets weprocess.  Accordingly, our operatingresults are subject to fluctuations in interest rates and securities markets asthese fluctuations affect the market value of assets processed.  While reductions in asset servicing fees maybe offset by increases in other sources of revenue, a sustained downwardmovement of the broad equity markets will likely have an adverse impact on ourearnings.  Fluctuations in interest ratesor the securities markets can also lead to investors seeking alternatives tothe investment offerings of our clients, which could result in a lesser amountof assets processed and correspondingly lower fees.  Also, our net interest income is earned byinvesting depositors’ funds and making loans. While we expect interest rates to continue to rise over the nexteighteen months, rapid, sustained changes in interest rates and/or therelationship between short-term and long-term interest rates could adverselyaffect the market value of, or the earnings produced by, our investment andloan portfolios, and thus could adversely affect our operating results.

 

*A material portion of our revenues is derivedfrom our relationship with Barclays Global Investors, N.A. (‘BGI’) and relatedentities.*

 

As a result ofour selection in 2003 to service assets for Barclays Global Investors Canada,Ltd., our assumption of the operations of the U.S. asset administration unit ofBGI in 2001 and our ongoing relationship with BGI’s iShares and MasterInvestment Portfolios, BGI accounted for approximately 17% of our net operatingrevenue during the six months and three months ended June 30, 2004.  We expect that BGI will continue to accountfor a significant portion of our net operating revenue.  While we provide services to BGI underlong-term contracts, those contracts may be terminated for certain regulatoryand fiduciary reasons.  The loss of BGI’sbusiness would cause our net operating revenue to decline and would likely havean adverse effect on our quarterly and annual results.

 

*We may incur losses due to operationalerrors.*

 

The servicesthat we provide require complex processes and interaction with numerous thirdparties.  While we maintain sophisticatedcomputer systems and a comprehensive system of controls, and our operationalhistory has been excellent, from time to time we may make operational errorsfor which we are responsible to our clients. In addition, even though we maintain appropriate errors and omissionsand other insurance policies, an operational error could result in significantliability to us and may have a material adverse effect on our financialcondition and results of operations.

 

*We face significant competition from otherfinancial services companies, which could negatively affect our operatingresults.*

 

We are part ofan extremely competitive asset servicing industry.  Many of our current and potential competitorshave longer operating histories, greater name recognition and substantiallygreater 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 assetservicing capabilities and no longer outsource these services to us.  As a result, we may not be able to competeeffectively with current or future competitors, which could result in a loss ofexisting clients or difficulty in gaining new clients.

 

21

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*We may incur significant costs defendinglegal claims.*

 

We have beennamed 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 webelieve this claim is without merit, we cannot be sure that we will prevail inthe defense of this claim.  Litigation iscostly and could divert the attention of management.  We may become subject to other legal claimsin the future.

 

*Our future results depend, in part, onsuccessful integration of possible future acquisitions and outsourcingtransactions.*

 

Integration ofacquisitions and outsourcing transactions is complicated and frequentlypresents unforeseen difficulties and expenses which can affect whether and whena particular acquisition or outsourcing transaction will be accretive to ourearnings per share.  Any futureacquisitions or outsourcing transactions will present these or similarchallenges. These acquisitions and outsourcing transactions can also consume asignificant amount of management’s time.

 

*The failure to properly manage our growthcould adversely affect the quality of our services and result in the loss ofclients.*

 

We have beenexperiencing a period of rapid growth that has required the dedication ofsignificant management and other resources. Continued rapid growth could placea strain on our management and other resources. To manage future growth effectively, we must continue to invest in ouroperational, financial and other internal systems, and in our human resources.

 

*We must hire and retain skilled personnel inorder to succeed.*

 

Qualifiedpersonnel, in particular managers and other senior personnel, are in greatdemand throughout the financial services industry, especially as the economybegins to recover.  We could find itincreasingly difficult to continue to attract and retain sufficient numbers ofthese highly skilled employees, which could affect our ability to attract andretain clients.

 

*We may not be able to protect our proprietarytechnology.*

 

Our proprietary technology is important toour business.  We rely on trade secret,copyright and trademark laws and confidentiality agreements with employees andthird parties to protect our proprietary technology, all of which offer onlylimited protection.  These intellectualproperty rights may be invalidated or our competitors may develop similartechnology independently.  Legalproceedings to enforce our intellectual property rights may be unsuccessful,and could also be expensive and divert management’s attention.

 

*Our quarterly and annual operating resultsmay fluctuate.*

 

Our quarterlyand annual operating results are difficult to predict and may fluctuate fromquarter to quarter and annually for several reasons, including:

 

•                                          Thetiming of commencement or termination of client engagements;

 

•                                          Therate of net inflows and outflows of investor funds in the investment vehiclesoffered by our clients; and

 

•                                          Rapid,sustained changes in interest rates and equity values.

 

Most of ourexpenses, like employee compensation and rent, are relatively fixed.  As a result, any shortfall in revenuerelative to our expectations could significantly affect our operating results.

 

*We are subject to extensive federal and stateregulations that impose complex restraints on our business.*

 

Federal andstate laws and regulations applicable to financial institutions and theirparent companies apply to us.  Ourprimary regulators are the Federal Reserve Board (‘FRB’), the Federal DepositInsurance Corporation  (‘FDIC’), theMassachusetts Commissioner of Banks and the National Association of SecuritiesDealers, Inc. (‘NASD’).  Virtually allaspects of our operations are subject to specific requirements or restrictionsand general regulatory oversight including the following:

 

•                                          TheFRB and the FDIC maintain capital requirements that we must meet. Failure tomeet those requirements could lead to severe regulatory action or evenreceivership. We are currently considered to be “well capitalized”;

 

•                                          UnderMassachusetts law, IBT may be restricted in its ability to pay dividends toInvestors Financial, which may in turn restrict our ability to pay dividends toour stockholders;

 

22

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•                                          TheFRB and the FDIC are empowered to assess monetary penalties against, and toorder termination of activities by, companies or individuals who violate thelaw; and

 

•                                          TheNASD maintains certain regulatory requirements that our securities brokeraffiliate, Investors Securities Services, Inc. must meet.  Failure to meet those requirements could leadto severe regulatory action.

 

Banking lawrestricts our ability to own the stock of certain companies and also makes itmore difficult for us to be acquired. Also, we have not elected financial holding company status under thefederal Gramm-Leach-Bliley Act of 1999. This may place us at a competitive disadvantage with respect to otherorganizations.

 

23

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**Statementsof Operations**

 

***Comparison ofOperating Results for the Six and Three Months Ended June 30, 2004 and2003***

 

Net income for the six months endedJune 30, 2004 was $70.4 million, up 111% from $33.4 million for the sameperiod in 2003.  Net income for the threemonths ended June 30, 2004 was $35.4 million, up 26% from $28.0 for thesame period in 2003. Our income statements for the six- and three-month periodsended June 30, 2003 each reflect the net effect of the first quarter 2003tax accrual and its later partial reversal resulting from our settlement withthe Massachusetts Department of Revenue. Refer to *Income Taxes*within this section for further discussion regarding our settlement ofthis tax assessment. Absent the effects of this tax matter, net income for thesix months and three months ended June 30, 2004 increased 73% and 66%,respectively, from net operating income for the same periods in 2003.  Overall the increases in net income can beattributed to our ability to sell to new and existing clients, strong clientfund flows and a favorable interest rate environment. Net operating revenue forthe six months and three months ended June 30, 2004 grew 30% and 26%,respectively, with only a 14% and 11% increase, respectively, in operatingexpenses.

 

*Fees and Other Revenue*

 

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

 
| ** **                    | ** ** | **For the Six Months Ended  June 30,** | ** ** | **For the Three Months Ended  June 30,** | ** ** |
|-------------------------------|------------|---------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                    | ** ** | **2004**                                    | ** ** | **2003**                                      | ** ** | **Change** | ** ** | **2004** | ** ** | **2003** | ** ** | **Change** | ** ** |
|                          |       |                                        |       |                                          |       |   |   |   |   |   |   |   |   |
| Total asset  servicing fees   |       | $                                           | 215,180    |                                          | $          | 157,881 |   | 36 | % | $ | 108,993 |   | $ | 83,735 |   | 30 | % |
| Other  operating income       |       | 1,097                                       |       | 1,428                                         |       | (23 | )% | 748 |   | 658 |   | 14 | % |
| Gain on sale  of investment   |       | 234                                         |       | —                                        |       | 100 | % | — |   | — |   | — |   |
|                          |       |                                        |       |                                          |       |   |   |   |   |   |   |   |   |
| Total fees  and other revenue |       | $                                           | 216,511    |                                          | $          | 159,309 |   | 36 | % | $ | 109,741 |   | $ | 84,393 |   | 30 | % |

 

Asset servicing fees for the six months andthree months ended June 30, 2004 increased 36% and 30%, respectively, fromthe same periods in 2003.  The largestcomponents of asset servicing fees are custody, accounting and administration,which increased 30% to $154.8 million for the six months ended June 30,2004 and increased 27% to $78.8 million for the three months endedJune 30, 2004 from the same periods in 2003.  Custody, accounting and administration feesare based in part on the value of assets processed.  Assets processed is the total dollar value offinancial assets on the reported date for which we provide global custody ormulticurrency accounting.  The change innet assets processed includes the following components (Dollars in billions):

 

| ** **                                 | ** ** | **For the Six Months Ended  June 30, 2004** | ** ** | **For the Three Months Ended  June 30, 2004** | ** ** |
|--------------------------------------------|------------|--------------------------------------------------|------------|----------------------------------------------------|------------|
|                                       |       |                                             |       |                                               |       |
| Net assets  processed, beginning of period |       | $                                                | 1,057      |                                               | $          | 1,131 |   |
| Change in  net assets processed:           |       |                                             |       |                                               |       |
| Sales to new  clients                      |       | 3                                                |       | 2                                                  |       |
| Further  penetration of existing clients   |       | 16                                               |       | 9                                                  |       |
| Lost clients                               |       | (1                                               | )          | —                                             |       |
| Fund flows  and market gain                |       | 128                                              |       | 61                                                 |       |
| Total change  in net assets processed      |       | 146                                              |       | 72                                                 |       |
| Net assets  processed, end of period       |       | $                                                | 1,203      |                                               | $          | 1,203 |   |

 

The majority of the increase in assetsprocessed resulted from client fund flows, and to a lesser extent marketappreciation.  In addition, we signedseveral new advisory clients and family offices and won business from numerousexisting clients.  Our core services feesare 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 pricingstructure, coupled with minimum and flat fees, allows us to manage thisvolatility.  As asset values increase,the basis point fee typically declines, while when asset values decrease,revenue is only impacted by the asset decline at the then marginal rate.

 

If the valueof equity assets held by our clients was to increase or decrease by 10%, weestimate that this, by itself, would currently cause a corresponding change ofapproximately 3% in our earnings per share. If the value of fixed-income assets held by our clients was to increaseor decrease by 10%, we estimate that this, by itself, would currently cause acorresponding change of approximately 2% in our earnings per share.  In practice, earnings per share do not trackprecisely to the value of the equity markets because conditions present in amarket increase or decrease may generate offsetting increases or decreases inother revenue items.  For example, marketvolatility often results in increased transaction fee revenue.  Also, market declines may result in increasednet

 

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interest income and sweep fee income asclients move larger amounts of assets into the cash management vehicles that weoffer. However, there can be no assurance that these offsetting revenueincreases will occur during any future downturn in the equity markets.

 

Transaction-driven income includes ourancillary services, such as foreign exchange, cash management, securitieslending and investment advisory services. Foreign exchange fees were $33.0 million for the six months endedJune 30, 2004, up 96% from the same period in 2003, and were $14.5 millionfor the three months ended June 30, 2004, up 44% from the same period in2003.  The increase in foreign exchangefees for both periods is attributable to new clients, higher transactionvolumes and increased volatility in currency markets.  Future foreign exchange income is dependenton the volume of client activity and the overall volatility in the currenciestraded.  Cash management fees, whichconsist of sweep fees, were $12.3 million for the six months endedJune 30, 2004, up 16% from the same period in 2003, and were $6.7 millionfor the three months ended June 30, 2004, up 20% from the same period in2003. The increases for both periods are primarily due to higher domestic andforeign balances held by our clients. Cash management revenue will continue to depend on the level of clientbalances maintained in the cash management products we offer.  If our clients’ investment products continueto maintain increasing cash balances, our cash management revenue will bepositively impacted.

 

Investment advisory fees were $8.0 millionfor the six months ended June 30, 2004, up 32% from the same period in2003, and were $4.6 million for the three months ended June 30, 2004, up59% from the same period in 2003.  Theincreases in investment advisory fees are attributable to higher balances inour proprietary Merrimac money market funds. Future investment advisory fee income is dependent upon asset levelswithin the Merrimac money market funds which are driven by overall marketconditions, client activity and transaction volumes.  Securities lending fees were $5.7 million forthe six months ended June 30, 2004, up 18% from the same period in 2003,and were $3.6 million for the three months ended June 30, 2004, up 35%from the same period in 2003, due to higher volumes in both periods.  Securities lending transaction volume ispositively affected by the market value of the securities on loan, merger andacquisition activity, increased IPO activity and a steeper short-end of theyield curve.  If the capital marketsexperience any of the aforementioned activity, it is likely that our securitieslending revenue will be positively impacted. If we experience a reduction in our securities lending portfolio, lowermarket values and continued compression of the spreads earned on securitieslending activity, our securities lending revenue will likely be negativelyimpacted.  Other service fees for the sixmonths ended June 30, 2004 were $1.2 million, up 98% from the same periodlast year, and were $0.8 million for the three months ended June 30, 2004,up 109% from the same period last year. Other service fees are earned on brokerage and transition managementservices, which were provided in greater volume for both periods in 2004compared to 2003.

 

Other operating income consists of dividendsreceived relating to the Federal Home Loan Bank of Boston (‘FHLBB’) stockinvestment and miscellaneous fees for systems consulting services.  For the six months ended June 30, 2004,other operating income decreased 23% compared to the same period last year, dueto a lower yield paid on our FHLBB stock investment and to the high volume ofclient systems development projects performed in 2003.  Other operating income increased 14% for thethree months ended June 30, 2004 compared to the same period last year.  Although still impacted by a lower yield paidon our FHLBB investment, this decrease was offset by a one-time fee forconsulting****services provided to clients.Operating revenue for the six months ended June 30, 2004 also included a$0.2 million gain on the sale of a mortgage-backed security from our availablefor sale portfolio.  No securities gainswere recorded during 2003.

 

*Net Interest Income*

 

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

 
| ** **                 | ** ** | **For the Six Months Ended  June 30,** | ** ** | **For the Three Months Ended  June 30,** | ** ** |
|----------------------------|------------|---------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                 | ** ** | **2004**                                    | ** ** | **2003**                                      | ** ** | **Change** | ** ** | **2004** | ** ** | **2003** | ** ** | **Change** | ** ** |
|                       |       |                                        |       |                                          |       |   |   |   |   |   |   |   |   |
| Interest  income           |       | $                                           | 142,533    |                                          | $          | 121,554 |   | 17 | % | $ | 71,357 |   | $ | 61,205 |   | 17 | % |
| Interest  expense          |       | 52,280                                      |       | 45,189                                        |       | 16 | % | 27,065 |   | 23,623 |   | 15 | % |
|                       |       |                                        |       |                                          |       |   |   |   |   |   |   |   |   |
| Total net  interest income |       | $                                           | 90,253     |                                          | $          | 76,365 |   | 18 | % | $ | 44,292 |   | $ | 37,582 |   | 18 | % |

 

Net interestincome was $90.3 million for the six months ended June 30, 2004, up 18%from the same period in 2003, and was $44.3 million for the three months endedJune 30, 2004, up 18% from the same period in 2003.  Net interest income is affected by the volumeand mix of assets and liabilities and the movement and level of interest rates.The improvement in our net interest income for both periods was the result ofbalance sheet growth driven by strong client funding and a steep yieldcurve.  We expect net interest income togrow in line with our balance sheet growth, despite an expected 275 basis pointincrease in rates by the FOMC over the next eighteen months. ** **We continue to run aclosely matched balance sheet by investing in low duration, variable-ratesecurities and adding interest rate swaps against client liabilities, includingclient repurchase agreements.

 

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During 2004,we continued to employ a strategy of prepaying high-rate borrowings andreplacing them with lower cost term funding in order to maintain our netinterest margin.  We do not expect toincur any further prepayment costs in 2004. Although the average funding balance increased for both the six monthsand three months ended June 30, 2004 compared to the same periods in 2003,the average rates paid on interest-bearing liabilities declined. Our averagerate paid on interest-bearing liabilities was 1.22% for the six months endedJune 30, 2004, a 17 basis point decline from 1.39% for the same period in2003.  Our average rate paid oninterest-bearing liabilities was 1.23% for the three months ended June 30,2004, a 16 basis point decline from 1.39% for the same period in 2003.  These decreases were primarily the result ofa lower Federal Funds rate from which the majority of our funding sources arepriced.

 

The tablebelow presents the changes in net interest income resulting from changes in thevolume of interest-earning assets or interest-bearing liabilities and changesin interest rates for the six months and the three months ended June 30,2004 compared to the same periods in 2003. Changes attributed to both volume and rate have been allocated based onthe proportion of change in each category (Dollars in thousands):

 
| ** **                          | ** ** | **For the Six Months Ended  June 30, 2004** | ** ** | **For the Three Months Ended  June 30, 2004** | ** ** |
|-------------------------------------|------------|--------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                          | ** ** | **Change  Due to  Volume**                       | ** ** | **Change  Due to  Rate**                           | ** ** | **Net** | ** ** | **Change  Due to  Volume** | ** ** | **Change  Due to  Rate** | ** ** | **Net** | ** ** |
|                                |       |                                             |       |                                               |       |   |   |   |   |   |   |   |   |
| Interest-earning assets:            |       |                                             |       |                                               |       |   |   |   |   |   |   |   |   |
| Federal  Funds sold                 |       | $                                                | 168        |                                               | $          | (36 | ) | $ | 132 |   | $ | 12 |   | $ | (26 | ) | $ | (14 | ) |
| Investment  securities              |       | 34,989                                           |       | (14,516                                            | )          | 20,473 |   | 16,676 |   | (6,607 | ) | 10,069 |   |
| Loans                               |       | 794                                              |       | (420                                               | )          | 374 |   | 276 |   | (179 | ) | 97 |   |
|                                |       |                                             |       |                                               |       |   |   |   |   |   |   |   |   |
| Total  interest-earning assets      |       | $                                                | 35,951     |                                               | $          | (14,972 | ) | $ | 20,979 |   | $ | 16,964 |   | $ | (6,812 | ) | $ | 10,152 |   |
|                                |       |                                             |       |                                               |       |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:       |       |                                             |       |                                               |       |   |   |   |   |   |   |   |   |
| Deposits                            |       | $                                                | 10,769     |                                               | $          | (6,726 | ) | $ | 4,043 |   | $ | 5,175 |   | $ | (3,385 | ) | $ | 1,790 |   |
| Borrowings                          |       | 1,063                                            |       | 1,985                                              |       | 3,048 |   | 341 |   | 1,311 |   | 1,652 |   |
|                                |       |                                             |       |                                               |       |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities |       | $                                                | 11,832     |                                               | $          | (4,741 | ) | $ | 7,091 |   | $ | 5,516 |   | $ | (2,074 | ) | $ | 3,442 |   |
|                                |       |                                             |       |                                               |       |   |   |   |   |   |   |   |   |
| Change in  net interest income      |       | $                                                | 24,119     |                                               | $          | (10,231 | ) | $ | 13,888 |   | $ | 11,448 |   | $ | (4,738 | ) | $ | 6,710 |   |

 

In addition toinvesting in both variable and fixed-rate securities, we use derivativeinstruments to manage exposure to interest rate risks.  We routinely enter into interest rate swapagreements in which we pay a fixed interest rate and receive a floatinginterest rate.  These transactions aredesigned to hedge a portion of our client liabilities, including clientrepurchase agreements.  By entering intoa pay fixed/receive floating interest rate swap, a portion of our liabilitiesis effectively converted to a fixed-rate liability for the term of the interestrate swap agreement.  Our derivatives aredesignated as highly effective cash flow hedges.  To the extent there is hedge ineffectivenessit is included as a component of the net interest margin.  Hedge ineffectiveness did not have a materialimpact on earnings for the six months and the three months ended June 30,2004 and 2003.  We expect that hedgeineffectiveness will continue to have an insignificant effect on our netinterest margin in 2004.

 

In May 2004, we terminated $280.0 million ofour interest rate swap agreements discussed above.  As a result, an after-tax net loss of $0.4million was included in other comprehensive income and will be amortized overthe life of the underlying contracts through 2006.  The Company estimates that net derivativegains and losses reclassified into earnings within the next twelve months willbe immaterial. ** **Theseterminated interest rate swap agreements were replaced with new interest rateswap agreements and term borrowings in order to more favorably manage exposureto changes in interest rates.

 

We regularlyrun interest rate simulation models to understand the effect of variousinterest rate scenarios on our capital and net income, with a policy limit of a10% change in net interest income.  Theresults of the income simulation model as of June 30, 2004 indicated thatan upward shift of interest rates by 200 basis points over a twelve-monthperiod would result in a change in projected net interest income within this10% range.  We also simulate a 200 basispoint rate reduction over a twelve-month period, however, in the simulation wedo not reduce rates below 0%. This modified simulation would change projectednet interest income by more than the 10% policy limit, however, our Board ofDirectors approved this exception because of the low likelihood that rates willdecrease to 0%.  More relevant to ourearnings is that we expect that there will be additional increases in interestrates by the FOMC during the next eighteen months.  While our simulation model projects a slight decreasein our net interest margin percentage in a rising rate environment, wegenerally expect the absolute dollar amount of net interest income to increaseover the next eighteen months, driven

 

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by higher levels of client funding andcapital.  Refer to the ‘Market Risk’section of this document for more detailed information regarding ourincome simulation methodology and policies.

 

The following tables present average balances, interest income andexpense, and yields earned or paid on the major categories of assets andliabilities for the periods indicated (Dollars in thousands):

 
| ** **                                                           | ** ** | **Six Months Ended June 30,  2004** | ** ** | **Six Months Ended June 30,  2003** | ** ** |
|----------------------------------------------------------------------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                           | ** ** | **Average  Balance**                     | ** ** | **Interest**                             | ** ** | **Average  Yield/Cost** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Average  Yield/Cost** | ** ** |
|                                                                 |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| **Interest-earning assets:**                                         |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Federal  Funds sold and securities purchased under resale agreements |       | $                                        | 64,110     |                                     | $          | 314 |   | 0.98 | % | $ | 30,790 |   | $ | 182 |   | 1.18 | % |
| Investment  securities(1)                                            |       | 9,093,146                                |       | 140,067                                  |       | 3.08 | % | 6,893,885 |   | 119,594 |   | 3.47 | % |
| Loans                                                                |       | 180,998                                  |       | 2,152                                    |       | 2.38 | % | 118,775 |   | 1,778 |   | 2.99 | % |
| Total  interest-earning assets                                       |       | 9,338,254                                |       | 142,533                                  |       | 3.05 | % | 7,043,450 |   | 121,554 |   | 3.45 | % |
| Allowance  for loan losses                                           |       | (100                                     | )          |                                     |       |   |   | (100 | ) |   |   |   |   |
| Noninterest-earning  assets                                          |       | 521,070                                  |       |                                     |       |   |   | 611,820 |   |   |   |   |   |
|                                                                 |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Total assets                                                         |       | $                                        | 9,859,224  |                                     |       |   |   |   | $ | 7,655,170 |   |   |   |   |   |
|                                                                 |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| **Interest-bearing liabilities:**                                    |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Deposits:                                                            |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Savings                                                              |       | $                                        | 4,050,597  |                                     | $          | 22,198 |   | 1.10 | % | $ | 2,314,517 |   | $ | 18,231 |   | 1.58 | % |
| Time                                                                 |       | 15,151                                   |       | 76                                       |       | 1.00 | % | — |   | — |   | — |   |
| Securities  sold under repurchase agreements(2)                      |       | 3,726,235                                |       | 19,086                                   |       | 1.02 | % | 3,261,185 |   | 15,415 |   | 0.95 | % |
| Trust  preferred stock (3)                                           |       | 24,774                                   |       | 1,210                                    |       | 9.77 | % | 24,000 |   | 1,172 |   | 9.77 | % |
| Other  borrowings (4)                                                |       | 783,422                                  |       | 9,710                                    |       | 2.48 | % | 887,063 |   | 10,371 |   | 2.34 | % |
| Total  interest-bearing liabilities                                  |       | 8,600,179                                |       | 52,280                                   |       | 1.22 | % | 6,486,765 |   | 45,189 |   | 1.39 | % |
| Noninterest-bearing  liabilities:                                    |       |                                     |       |                                     |       |   |   |   |   |   |   |   |   |
| Demand  deposits                                                     |       | 289,415                                  |       |                                     |       |   |   | 247,829 |   |   |   |   |   |
| Savings                                                              |       | 77,897                                   |       |                                     |       |   |   | 129,590 |   |   |   |   |   |
| Noninterest-bearing  time deposits                                   |       | 165,852                                  |       |                                     |       |   |   | 93,950 |   |   |   |   |   |
| Other  liabilities                                                   |       | 136,929                                  |       |                                     |       |   |   | 229,250 |   |   |   |   |   |
| Total liabilities                                                    |       | 9,270,272                                |       |                                     |       |   |   | 7,187,384 |   |   |   |   |   |
| Equity                                                               |       | 588,952                                  |       |                                     |       |   |   | 467,786 |   |   |   |   |   |
| Total  liabilities and equity                                        |       | $                                        | 9,859,224  |                                     |       |   |   |   | $ | 7,655,170 |   |   |   |   |   |
| Net interest  income                                                 |       |                                     |       | $                                        | 90,253     |   |   |   |   |   | $ | 76,365 |   |   |   |
| Net interest  margin (5)                                             |       |                                     |       |                                     |       | 1.93 | % |   |   |   |   | 2.17 | % |
| Average  interest rate spread (6)                                    |       |                                     |       |                                     |       | 1.83 | % |   |   |   |   | 2.06 | % |
| Ratio of  interest-earning assets to interest-bearing liabilities    |       |                                     |       |                                     |       | 108.58 | % |   |   |   |   | 108.58 | % |

** **

----

(1)          Averageyield/cost on available for sale securities is based on amortized cost.

(2)          Interestexpense includes a penalty of $2.9 million for the six months endedJune 30, 2004 for prepayment of two repurchase agreements.

(3)          EffectiveOctober 1, 2003, the Company adopted provisions of FIN 46 (revisedDecember 2003), which resulted in a deconsolidation of Investors CapitalTrust I, the trust that holds the trust preferred securities.

(4)          Interestexpense includes a penalty of $3.9 million and $1.1 million for the six monthsended June 30, 2004 and 2003, respectively, for prepayment of FHLBB borrowings.

(5)          Netinterest income divided by total interest-earning assets.

(6)          Yieldon interest-earning assets less rate paid on interest-bearing liabilities.

 

27

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*Operating Expenses*

 

Total operating expenses were $200.8 millionfor the six months ended June 30, 2004 and were $100.7 million for thethree months ended June 30, 2004, up 14% and 11%, respectively, from thesame periods in 2003. It is expected that incremental expense for the remainderof 2004 will primarily be associated with new business as well as commitmentsrelated to depreciation and technology and telecommunications.  The components of operating expenses were asfollows (Dollars in thousands):

 
| ** **                         | ** ** | **For the Six Months Ended  June 30,** | ** ** | **For the Three Months Ended  June 30,** | ** ** |
|------------------------------------|------------|---------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                         | ** ** | **2004**                                    | ** ** | **2003**                                      | ** ** | **Change** | ** ** | **2004** | ** ** | **2003** | ** ** | **Change** | ** ** |
|                               |       |                                        |       |                                          |       |   |   |   |   |   |   |   |   |
| Compensation  and benefits         |       | $                                           | 109,094    |                                          | $          | 100,735 |   | 8 | % | $ | 53,771 |   | $ | 50,964 |   | 6 | % |
| Transaction  processing services   |       | 21,138                                      |       | 16,339                                        |       | 29 | % | 10,198 |   | 9,531 |   | 7 | % |
| Technology  and telecommunications |       | 20,722                                      |       | 18,850                                        |       | 10 | % | 10,456 |   | 9,559 |   | 9 | % |
| Depreciation  and amortization     |       | 16,721                                      |       | 12,685                                        |       | 32 | % | 8,767 |   | 6,606 |   | 33 | % |
| Occupancy                          |       | 14,260                                      |       | 14,530                                        |       | (2 | )% | 6,869 |   | 7,205 |   | (5 | )% |
| Professional  fees                 |       | 7,256                                       |       | 6,255                                         |       | 16 | % | 4,018 |   | 3,304 |   | 22 | % |
| Travel and  sales promotion        |       | 2,579                                       |       | 2,068                                         |       | 25 | % | 1,497 |   | 1,083 |   | 38 | % |
| Insurance                          |       | 2,360                                       |       | 796                                           |       | 196 | % | 1,164 |   | 572 |   | 103 | % |
| Other  operating expenses          |       | 6,704                                       |       | 4,414                                         |       | 52 | % | 3,960 |   | 2,129 |   | 86 | % |
|                               |       |                                        |       |                                          |       |   |   |   |   |   |   |   |   |
| Total  operating expenses          |       | $                                           | 200,834    |                                          | $          | 176,672 |   | 14 | % | $ | 100,700 |   | $ | 90,953 |   | 11 | % |

 

Compensationand benefits expense was $109.1 million for the six months ended June 30,2004 and was $53.8 million for the three months ended June 30, 2004, up 8%and 6%, respectively, from the same periods last year due to higher headcount,payroll taxes and incentive accruals. Further increases in compensation expense in 2004 will be primarilydependent upon new business wins.

 

Transactionprocessing services expense was $21.1 million for the six months endedJune 30, 2004 and was $10.2 million for the three months endedJune 30, 2004, up 29% and 7%, respectively, from the same periods lastyear as a result of higher subcustodian fees driven by increased asset valuesand transaction volumes. Future transaction processing services expense will bedependent upon asset levels and the volume of client transaction activity.

 

Technology andtelecommunications expense was $20.7 million for the six months endedJune 30, 2004 and was $10.5 million for the three months endedJune 30, 2004, up 10% and 9%, respectively, from the same periods lastyear.  These increases resulted fromincreased hardware and telecommunications expenditures, increased softwarelicense and maintenance fees, as well as higher contract programming costs inboth periods in 2004. Future technology and telecommunications expense will bedependent on the amount of new business we win, ongoing improvement to ourinfrastructure and client integrations. Generally, we expect technology reinvestment to equal approximately18-20% of net operating revenue.

 

Depreciationand amortization expense was $16.7 million for the six months endedJune 30, 2004 and was $8.8 million for the three months endedJune 30, 2004, up 32% and 33%, respectively, from the same periods lastyear. These increases resulted from the completion of capitalized softwareprojects in late 2003 and early 2004 and their placement into service.  We expect that depreciation expense will decreasefor the remainder of 2004 due to the full depreciation of assets purchased fromBGI in 2001.

 

Professionalfees expense was $7.3 million for the six months ended June 30, 2004 andwas $4.0 million for the three months ended June 30, 2004, up 16% and 22%,respectively, from the same periods last year. These increases are attributed primarily to increased fees associatedwith the Merrimac Master Portfolios.  TheMerrimac fees are asset-based and the increase results from growth in the sizeof the portfolios.

 

Travel andsales promotion expense was $2.6 million for the six months ended June 30,2004 and was $1.5 million for the three months ended June 30, 2004, up 25%and 38%, respectively, compared to the same periods last year.  Travel and sales promotion expense consistsof expenses incurred by the sales force, client management staff and otheremployees in connection with sales calls on potential clients, traveling toexisting client sites, to our offices in New York and California, and to ourforeign subsidiaries.

 

Insuranceexpense was $2.4 million for the six months ended June 30, 2004 and was$1.2 million for the three months ended June 30, 2004, up 196% and 103%,respectively, from the same periods last year. In May 2003, our favorable five-year fixed-rate insurance policyexpired, resulting in the increased premiums for the 2004 periods discussedabove. Our insurance

 

28

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policies are renewed annually and we expectinsurance expense for the remainder of the year to continue at approximatelythe same run rate as in the second quarter of 2004.

 

Otheroperating expense was $6.7 million for the six months ended June 30, 2004and was $4.0 million for the three months ended June 30, 2004, up 52% and86%, respectively, compared to the same periods last year as a result of higherFDIC insurance premiums due to higher deposit liabilities, higher recruitingexpense, increased advertising expense and higher miscellaneous office expensesin both periods.  We expect thatincremental expense for the remainder of 2004 will be primarily associated withnew business.

 

*Income Taxes*

 

Income taxes were $35.5 million and $17.9million for the six months and three months ended June 30, 2004,respectively, up 39% and 497%, respectively, from the same periods in 2003.  These increases are attributable to increasedpretax earnings and an increase in the effective tax rate in 2004 toapproximately****33.5%, offset by the net effectof the first quarter 2003 tax accrual and its later partial reversal resultingfrom our settlement with the Commonwealth of Massachusetts.

 

In March 2003, a retroactive tax change in theCommonwealth of Massachusetts tax law disallowed a dividends received deductiontaken by the Bank on dividends it received since 1999 from a wholly-owned realestate investment trust.  In the secondquarter of 2003, we settled this disputed tax matter with the MassachusettsDepartment of Revenue, pursuant to an agreement to pay 50% of the liability.

 

**Financial Condition**

 

At June 30, 2004, our total assets were$10.9 billion, up 18% from $9.2 billion at December 31, 2003, primarily asa result of strong client funding and additional capital generated from netincome.  Average interest-earning assetsincreased $2.3 billion, or 33%, for the six months ended June 30, 2004compared to the same period in 2003. Average interest-earning assets increased $2.2 billion, or 30% for thethree months ended June 30, 2004. Funding for our asset growth was provided by an increase in averageclient balances of approximately $2.7 billion and $2.5 billion for the sixmonths and three months ended June 30, 2004 and 2003, respectively.  These increases were partially offset bydecreases in average external borrowings of approximately $0.5 billion for bothof the above-mentioned periods compared to the same periods in 2003.

 

*Investment Portfolio*

 

Our investment portfolio is used to investdepositors’ funds and the net interest income generated from our investmentportfolio is a component of our compensation for our asset processing business.  In addition, we use the investment portfolioto secure open positions at securities clearing institutions in connection withour custody services. The following table summarizes our investment portfolioas of the dates indicated (Dollars in thousands):

 
| ** **                           | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|--------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| **Securities held to maturity**      |       |                    |       |                        |       |
| Mortgage-backed  securities          |       | $                       | 2,875,683  |                        | $          | 2,273,466 |   |
| Federal  agency securities           |       | 2,091,904               |       | 1,906,512                   |       |
| State and  political subdivisions    |       | 129,343                 |       | 127,632                     |       |
|                                 |       |                    |       |                        |       |
| Total  securities held to maturity   |       | $                       | 5,096,930  |                        | $          | 4,307,610 |   |
|                                 |       |                    |       |                        |       |
| **Securities available for sale**    |       |                    |       |                        |       |
| Mortgage-backed  securities          |       | $                       | 3,910,599  |                        | $          | 3,611,980 |   |
| State and  political subdivisions    |       | 393,767                 |       | 355,828                     |       |
| Corporate  debt                      |       | 177,174                 |       | 175,816                     |       |
| U.S.  Treasury securities            |       | 114,465                 |       | 113,701                     |       |
| Federal  agency securities           |       | —                  |       | 29,609                      |       |
| Foreign  government securities       |       | 9,274                   |       | 9,703                       |       |
|                                 |       |                    |       |                        |       |
| Total  securities available for sale |       | $                       | 4,605,279  |                        | $          | 4,296,637 |   |

 

Theoverall increases in our held to maturity and available for sale portfolios areattributable to investing client deposits, including client repurchaseagreements, and borrowed funds to effectively utilize IBT’s capital and toaccommodate client fund flows.  Since netinterest income is an integral part of our compensation for asset processingservices, we purchase

 

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investment securitiesthat will protect our net interest margin, while maintaining both an acceptablecredit and interest rate risk profile.

 

Ourheld to maturity portfolio increased $789.3 million, or 18%, to $5.1 billion atJune 30, 2004 from $4.3 billion at December 31, 2003.  This increase stems primarily from purchasesof floating-rate mortgage-backed and Small Business Administration securities,which offer an attractive effective yield and reprice as interest ratesincrease.

 

Ouravailable for sale portfolio remained relatively flat at $4.6 billion atJune 30, 2004 and $4.3 billion at December 31, 2003.  We reinvested cash flow in adjustable-ratemortgage-backed securities and insured, AAA-rated municipal bonds.  These investments allow us to maintain ournet interest margin, diversify our portfolio with assets that reprice morefrequently, and take advantage of attractive yield and limited extension risk,which aligns with our overall asset-liability strategy.  Refer to the gap analysis under the ‘MarketRisk’ section for additional details regarding the matching of ourinterest-earning assets and interest-bearing liabilities.

 

The averagebalance of our combined investment portfolios for the six months endedJune 30, 2004 was $9.1 billion, with an average yield of 3.08%, comparedto an average balance of $6.9 billion with an average yield of 3.47% during thesame period in 2003.  For the threemonths ended June 30, 2004, the average balance of our combined investmentportfolios was $9.3 billion, with an average yield of 3.01%, compared to anaverage balance of $7.2 billion with an average yield of 3.35% during the sameperiod in 2003.  The declines in yieldsare primarily due to the overall low interest rate environment coupled with theproceeds of securities that matured or paid down that were originally purchasedin a higher interest rate environment, now being reinvested at lower interestrates.  In addition, prepayments havecaused us to recognize a greater amount of premium amortization associated withthe larger population of affected securities purchased through June 30,2004. We recognized net amortization of $22.2 million for the six months endedJune 30, 2004 compared to $17.2 million of net amortization in the sameperiod of 2003.  The effect of thisadditional amortization was a lower effective yield on the investmentportfolio. A significant portion of our investment portfolio is variable ratein nature.  If interest rates were torise during the balance of 2004, we would expect slower prepayments and ouroverall yield to increase as our variable-rate securities reprice.  Conversely, if interest rates were to declineduring the second half of 2004, we would expect that prepayments wouldaccelerate, with the cash flows from these prepayments being reinvested inlower-yielding assets of equal quality and risk.

 

We invest in mortgage-backed securities,Federal agency bonds and corporate debt to increase the total return of theinvestment portfolio.  Mortgage-backedsecurities generally have a higher yield than U.S. Treasury securities due tocredit and prepayment risk.  Credit riskresults from the possibility that a loss may occur if an issuer is unable tomeet the terms of the security. Prepayment risk results from the possibility that changes in interestrates may cause mortgage-backed securities to be paid off prior to theirmaturity dates.  Federal agency bondsgenerally have a higher yield than U.S. Treasury securities due to credit andcall risk.  Credit risk results from thepossibility that the Federal agency issuing the bonds may be unable to meet theterms of the bond.  Call risk is similarto prepayment risk and results from the possibility that fluctuating interestrates and other factors may result in the exercise of the call option by theFederal agency prior to the maturity date of the bond.  Credit risk related to mortgage-backedsecurities and Federal agency bonds is substantially reduced by paymentguarantees and credit enhancements.

 

Weinvest in municipal securities to generate stable, tax-advantaged income.  Municipal securities generally have lowerstated yields than Federal agency and U.S. Treasury securities, but theirafter-tax yields are more favorable. Municipal securities are subject to credit risk.  However, all municipal securities that weinvest in are insured and AAA rated.

 

*Loan Portfolio*

 

Our loan portfolio decreased $7.3 million, or4%, to $192.2 million at June 30, 2004 from $199.5 million atDecember 31, 2003. The majority of the decrease relates to repayments ofadvances on clients’ lines of credit, partially offset by an increase in clientoverdrafts. At June 30, 2004, client overdrafts were $101.0 millioncompared to $54.3 million at December 31, 2003.

 

We make loansto individually managed account customers and to mutual funds and other pooledproduct clients.  We offer overdraftprotection and lines of credit to our clients for the purpose of fundingredemptions, covering overnight cash shortfalls, leveraging portfolios andmeeting other client borrowing needs. Virtually all loans to individually managed account customers arewritten on a demand basis, bear variable interest rates tied to the Prime rateor the Federal Funds rate and are fully secured by liquid collateral, primarilyfreely tradable securities held in custody by us for the borrower.  Loans to mutual funds and other pooledproduct clients include unsecured lines of credit that may, in the event ofdefault, be collateralized at our option by securities held in custody by usfor those clients.  Loans to individuallymanaged account customers, mutual funds and other pooled

 

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product clients also include advances that wemake to certain clients pursuant to the terms of our custody agreements withthose clients to facilitate securities transactions and redemptions.

 

AtJune 30, 2004, our only lending concentrations that exceeded 10% of totalloan balances were the lines of credit to mutual fund clients discussedabove.  These loans were made in theordinary course of business on the same terms and conditions prevailing at thetime for comparable transactions.

 

Our creditloss experience has been excellent. There have been no loan charge-offs in the last five years, or in thehistory of our Company.  It is our policyto place a loan on nonaccrual status when either principal or interest becomes60 days past due and the loan’s collateral is not sufficient to cover bothprincipal and accrued interest.  As ofJune 30, 2004, there were no loans on nonaccrual status, no loans greaterthan 90 days past due, and no troubled debt restructurings.  Although virtually all of our loans are fullycollateralized with freely tradable securities, management recognizes somecredit risk inherent in the loan portfolio, and has an allowance for loanlosses of $0.1 million at June 30, 2004, a level which has remainedconsistent for the past five years.  Thisamount is not allocated to any particular loan, but is intended to absorb anyrisk of loss inherent in the loan portfolio. Management actively monitors theloan portfolio and the underlying collateral and regularly assesses theadequacy of the allowance for loan losses.

 

*Repurchase Agreements and Short-Term andOther Borrowings*

 

Asset growth was funded in part by increasedsecurities sold under repurchase agreements. Repurchase agreements increased $1.0 billion, or 32%, to $4.3 billion atJune 30, 2004 from $3.3 billion at December 31, 2003.  Repurchase agreements provide for the sale ofsecurities for cash coupled with the obligation to repurchase those securitieson a set date or on demand.  The majorityof our repurchase agreements are with clients. We use repurchase agreements,including client repurchase agreements, because they provide a lower costsource of funding than other short-term borrowings and allow our clients theextra benefit of collateralization of their deposits.  The average balance of securities sold underrepurchase agreements for the six months ended June 30, 2004 was $3.7billion with an average cost of approximately 1.02%, compared to an averagebalance of $3.3 billion and an average cost of approximately 0.95% for the sameperiod in 2003.  The average balance ofsecurities sold under repurchase agreements for the three months endedJune 30, 2004 was $3.8 billion with an average cost of approximately1.22%, compared to an average balance of $3.4 billion and an average cost ofapproximately 0.94% for the same period in 2003. The average cost of repurchaseagreements for the six months and three months ended June 30, 2004included prepayment fees of $2.9 million. These fees were incurred to employ an asset-liability strategy in whichwe replaced high rate borrowings with lower cost term funding.

 

Short-term andother borrowings decreased $309.0 million, or 28%, to $789.1 million atJune 30, 2004 from $1.1 billion at December 31, 2003.  We use short-term and other borrowings tooffset variability of deposit flow.  Theaverage balance of short-term and other borrowings for the six months endedJune 30, 2004 was $783.4 million with an average cost of approximately2.48%, compared to an average balance of $887.1 million and an average cost of approximately2.34% for the same period last year.  Theaverage balance of short-term and other borrowings for the three months endedJune 30, 2004 was $834.3 million with an average cost of approximately1.97%, compared to an average balance of $918.5 million and an average cost ofapproximately 2.55% for the same period last year.  The average cost of borrowing for the sixmonths ended June 30, 2004 included prepayment fees of $3.9 million.  The average cost of borrowing for the threemonths ended June 30, 2004 and 2003 included prepayment fees of $1.3million and $1.1 million, respectively. Again, these fees were incurred to employ an asset-liability strategy inwhich we replaced high rate borrowings with lower cost term funding.

 

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**MarketRisk**

 

We engage ininvestment activities to accommodate clients’ cash management needs and tocontribute to overall corporate earnings. Our clients, in the course of their financial asset management, maintaincash balances, which they can deposit with us on a short-term basis ininterest-bearing accounts or client repurchase agreements.  We either directly invest these cash balancesto earn interest income, or place these deposits in third-party vehicles andremit a portion of the earnings on these investments to our clients afterdeducting a fee as our compensation for the investment. In the conduct of theseactivities, we are subject to market risk. Market risk is the risk of an adverse financial impact resulting fromchanges in market prices and interest rates. The level of risk we assume is a function of our overall strategicobjectives and liquidity needs, client requirements and market volatility.

 

The activemanagement of market risk is integral to our operations.  The objective of interest rate sensitivitymanagement is to provide sustainable net interest revenue under variouseconomic conditions.  We manage thestructure of interest-earning assets and interest-bearing liabilities byadjusting their mix, yield, maturity and/or repricing characteristics based onmarket conditions.  Since client depositsand repurchase agreements, our primary sources of funds, are predominantlyshort term, we maintain a generally short-term interest rate repricingstructure for our interest-earning assets. We also use term borrowings and interest rate swap agreements to augmentour management of interest rate exposure. The effect of the interest rate swap agreements is to lengthenshort-term variable-rate liabilities into longer-term fixed-rate liabilities.

 

Our Board ofDirectors has set asset and liability management policies that define theoverall framework for managing interest rate sensitivity, includingaccountabilities and controls over investment activities.  These policies delineate investment limitsand strategies that are appropriate, given our liquidity and regulatoryrequirements.  For example, we haveestablished a policy limit stating that projected net interest income over the nexttwelve months will not change by more than 10% given a change in interest ratesof up to 200 basis points (+ or -) over twelve months.  Each quarter, our Board of Directors reviewsour asset and liability positions, including simulations of the effect ofvarious interest rate scenarios on our capital. Due to current interest rate levels, the Company’s Board of Directorshas approved a temporary exception to the 10% limit for decreases in interestrates.  The Board of Directors approvedthe policy exception because, with the Federal Funds target rate currently at1.25%, a 200 basis point further reduction would move rates into a negativeposition and is therefore not likely to occur.

 

Our Board ofDirectors has delegated day-to-day responsibility for oversight of the Assetand Liability Management function to our Asset and Liability Committee(‘ALCO’).  ALCO is a senior managementcommittee consisting of the Chief Executive Officer, the President, the ChiefFinancial Officer, the Chief Risk Officer and members of the Treasury function.ALCO meets twice monthly.  Our primarytool in managing interest rate sensitivity is an income simulation model. Keyassumptions in the simulation model include the timing of cash flows,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 assetsand liabilities existing at the beginning of a period will change periodicallyover the period being measured.  Themodel also assumes that a particular change in interest rates is reflecteduniformly across the yield curve regardless of the duration to maturity orrepricing of specific assets and liabilities. These assumptions are inherently uncertain, and as a result, the modelcannot precisely predict the effect of changes in interest rates on our netinterest income.  Actual results maydiffer from simulated results due to the timing, magnitude and frequency ofinterest rate changes and changes in market conditions and management strategies.

 

The results ofthe income simulation model as of June 30, 2004 and 2003 indicated that anupward shift of interest rates by 200 basis points over a twelve-month periodwould result in a change in projected net interest income within our 10% policylimit.  We also simulate a 200 basispoint rate reduction over a twelve-month period, however, in the simulation wedo not reduce rates below 0%.  Thismodified simulation results in a change in projected net interest income whichexceeds the policy limit of 10%, however, our Board of Directors approved thisexception because of the low likelihood that rates will decrease to 0%.

 

We also usegap analysis as a secondary tool to manage our interest rate sensitivity.  Gap analysis involves measurement of the differencein asset and liability repricing on a cumulative basis within a specified timeframe.  A positive gap indicates thatmore interest-earning assets than interest-bearing liabilities mature in a timeframe, and a negative gap indicates the opposite.  By seeking to minimize the net amount ofassets and liabilities that could reprice in the same time frame, we attempt toreduce the risk of significant adverse effects on net interest income caused byinterest rate changes.  As shown in thecumulative gap position in the table presented below, at June 30, 2004,interest-bearing liabilities repriced faster than interest-earning assets inthe short term, as has been typical for us. Generally speaking, during a period of falling interest rates, netinterest income would be higher than it would have been until interest ratesstabilize.  During a period of risinginterest rates, net interest income would be lower than it would have beenuntil interest rates stabilize.  However,at the current absolute level of interest rates, lower interest rates may alsolead to lower net interest income due to a diminished ability to lower therates paid on interest-bearing liabilities, including certain client funds, asrates approach zero.  Other importantdeterminants of net interest income are general interest rate levels, balancesheet growth and mix, and interest rate spreads.

 

32

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The following table presents the repricingschedule of our interest-earning assets and interest-bearing liabilitiesat June 30, 2004 (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)                                                          |       |                     |       |                     |       |                      |       |                        |       |                 |       |       |       |
| Federal  Funds sold                                                                    |       | $                        | 425,000    |                     | $          | —                    |       | $                           | —     |                 | $          | —     |       | $ | — |   | $ | 425,000 |   |
| Investment  securities (2),(3)                                                         |       | 4,850,413                |       | 569,724                  |       | 868,426                   |       | 2,802,936                   |       | 474,844              |       | 9,566,343  |       |
| Loans -  variable rate                                                                 |       | 192,271                  |       | —                   |       | —                    |       | —                      |       | —               |       | 192,271    |       |
| Loans -  fixed rate                                                                    |       | —                   |       | —                   |       | —                    |       | 12                          |       | —               |       | 12         |       |
| Total  interest-earning assets                                                         |       | $                        | 5,467,684  |                     | $          | 569,724                   |       | $                           | 868,426    |                 | $          | 2,802,948  |       | $ | 474,844 |   | $ | 10,183,626 |   |
| Interest-bearing  liabilities:                                                         |       |                     |       |                     |       |                      |       |                        |       |                 |       |       |       |
| Savings  accounts                                                                      |       | $                        | 3,540,163  |                     | $          | —                    |       | $                           | —     |                 | $          | 35,349     |       | $ | — |   | $ | 3,575,512 |   |
| Time deposits                                                                          |       | 130,169                  |       | —                   |       | —                    |       | —                      |       | —               |       | 130,169    |       |
| Interest  rate contracts                                                               |       | (1,240,000               | )          | 90,000                   |       | 180,000                   |       | 970,000                     |       | —               |       | —     |       |
| Securities  sold under repurchase agreements                                           |       | 3,587,675                |       | —                   |       | —                    |       | 700,000                     |       | —               |       | 4,287,675  |       |
| Short-term  and other borrowings                                                       |       | 739,119                  |       | —                   |       | —                    |       | 50,000                      |       | —               |       | 789,119    |       |
| Trust  preferred stock                                                                 |       | —                   |       | —                   |       | —                    |       | 24,774                      |       | —               |       | 24,774     |       |
| Total  interest-bearing liabilities                                                    |       | $                        | 6,757,126  |                     | $          | 90,000                    |       | $                           | 180,000    |                 | $          | 1,780,123  |       | $ | — |   | $ | 8,807,249 |   |
| Net  interest-sensitivity gap during the period                                        |       | $                        | (1,289,442 | )                        | $          | 479,724                   |       | $                           | 688,426    |                 | $          | 1,022,825  |       | $ | 474,844 |   | $ | 1,376,377 |   |
| Cumulative  gap                                                                        |       | $                        | (1,289,442 | )                        | $          | (809,718                  | )          | $                           | (121,292   | )                    | $          | 901,533    |       | $ | 1,376,377 |   |   |   |
| Interest-sensitive  assets as a percent of interest-sensitive liabilities (cumulative) |       | 80.92                    | %          | 88.17                    | %          | 98.27                     | %          | 110.24                      | %          | 115.63               | %          |       |       |
| Interest-sensitive  assets as a percent of total assets (cumulative)                   |       | 50.06                    | %          | 55.28                    | %          | 63.23                     | %          | 88.90                       | %          | 93.24                | %          |       |       |
|                                                                                   |       |                     |       |                     |       |                      |       |                        |       |                 |       |       |       |
| Net  interest-sensitivity gap as a percent of total assets                             |       | (11.81                   | )%         | 4.39                     | %          | 6.30                      | %          | 9.37                        | %          | 4.35                 | %          |       |       |
| Cumulative  gap as a percent of total assets                                           |       | (11.81                   | )%         | (7.41                    | )%         | 1.11                      | %          | 8.25                        | %          | 12.60                | %          |       |       |

 

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(1)                     Adjustablerate assets are included in the period in which interest rates are nextscheduled to adjust rather than in the period in which they are due.  Fixed-rate loans are included in the periodin which they are scheduled to be repaid.

(2)                     Mortgage-backedsecurities are included in the pricing category that corresponds with theearlier of their first repricing date or principal paydown schedule generatedfrom industry sourced prepayment projections.

(3)                     Excludes$135.9 million of unsettled securities purchases as of June 30, 2004.

 

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**Liquidity**

 

Liquidity represents the ability of aninstitution to meet present and future financial obligations through either thesale or maturity of existing assets or the acquisition of additional fundsthrough liability management.  For afinancial institution such as ours, these obligations arise from the withdrawalsof deposits and the payment of operating expenses.

 

Our primary sources of liquidity include cashand cash equivalents, Federal Funds sold, Federal Reserve Discount Window,client deposits, short-term borrowings, interest and principal payments on securitiesheld to maturity and available for sale, and fees collected from assetadministration clients.  As a result ofour management of liquid assets and the ability to generate liquidity throughdeposits and repurchase agreements, management believes that we maintainoverall liquidity sufficient to meet our depositors’ needs, to satisfy ouroperating requirements and to fund the payment of an anticipated annual cashdividend of $0.07 per share for 2004 (approximately $4.6 million basedupon 66,224,998 shares outstanding as of June 30, 2004).

 

Our ability to pay dividends on Common Stockmay depend on the receipt of dividends from IBT. Any dividend payments by IBTare subject to certain restrictions imposed by the Massachusetts Commissionerof Banks.  During all periods presentedin this report, the Company did not require dividends from IBT in order to fundthe Company’s own dividends.  Inaddition, we may not pay dividends on our Common Stock if we are in defaultunder certain agreements entered into in connection with the sale of ourCapital Securities.  The CapitalSecurities were issued by Investors Capital Trust I, a Delaware statutorybusiness trust sponsored by us, and qualify as Tier 1 capital under the capitalguidelines of the Federal Reserve.

 

We have informal borrowing arrangements withvarious counterparties.  Eachcounterparty has agreed to make funds available to us at the Federal Fundsovernight rate.  The aggregate amount ofthese borrowing arrangements as of June 30, 2004 was$2.9 billion.  Each bank mayterminate its arrangement at any time and is under no contractual obligation toprovide us with requested funding.  Ourborrowings under these arrangements are typically on an overnight basis.  We cannot be certain, however, that suchfunding will be available.  Lack ofavailability of liquid funds could have a material adverse impact on ouroperations.

 

We also have Master Repurchase Agreements inplace with various counterparties.  Eachbroker has agreed to make funds available to us at various rates in exchangefor collateral consisting of marketable securities. The aggregate amount ofavailable borrowings under these arrangements at June 30, 2004 was $4.3billion.

 

OnApril 19, 2004, the FHLBB implemented a new capital structure mandated forall Federal Home Loan Banks by the Gramm-Leach-Bliley Act of 1999 andregulations that were subsequently promulgated in 2001 by the FHLBB’sregulator, the Federal Housing Finance Board. IBT’s capital stock investment in the FHLBB totaled $50 million as ofJune 30, 2004.  The $50 millioncapital stock investment includes both a $25 million membership component and a$25 million activity-based component. The Bank’s $50 million capital stock investment in the FHLBB provides aborrowing capacity of approximately $555 million. Under the new capital plan,FHLBB capital stock investments require a five-year advance notice ofwithdrawal.  The amount outstanding underthis arrangement at June 30, 2004 was $50 million.  Additional borrowing is available to IBT basedon prescribed collateral levels and increased investment in FHLBB capitalstock.

 

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**CapitalResources**

 

Historically, we have financed our operationsprincipally through internally generated cash flows.  We incur capital expenditures for furniture,fixtures, capitalized software and miscellaneous equipment needs.  Capital expenditures have been incurred andoperating leases entered into on an as-required basis, primarily to meet ourgrowing operating needs.  As a result,our capital expenditures were $11.8 million and $17.0 million for the sixmonths ended June 30, 2004 and 2003, respectively.  For the six months ended June 30, 2004,capital expenditures were comprised of approximately $3.8 million in capitalizedsoftware and projects in process, $7.9 million in fixed assets and $0.1 millionin leasehold improvements.  For the sixmonths ended June 30, 2003, capital expenditures were comprised ofapproximately $7.8 million in capitalized software and projects in process,$4.3 million in fixed assets and $4.9 million in leasehold improvements.  Leasehold improvement expenditures for thesix months ended June 30, 2003 were related to increased space in ourDublin office, which was needed to support new business.

 

Stockholders’ equity at June 30, 2004was $601.5 million, up 11% from December 31, 2003, primarily due tonet income growth.  The ratio of averagestockholders’ equity to average assets remained constant at approximately 6%for June 30, 2004 and December 31, 2003.

 

The FRB hasadopted a system using internationally consistent risk-based capital adequacyguidelines to evaluate the capital adequacy of banks and bank holdingcompanies. Under the risk-based capital guidelines, different categories ofassets are assigned different risk weights, based generally upon the perceivedcredit risk of the asset. These risk weights are multiplied by correspondingasset balances to determine a “risk-weighted” asset base. Certain off-balancesheet items are added to the risk-weighted asset base by converting them to abalance sheet equivalent and assigning them the appropriate risk weight.

 

FRB and FDICguidelines require that banking organizations have a minimum ratio of totalcapital to risk-adjusted assets and off-balance sheet items of 8.0%. Totalcapital is defined as the sum of “Tier 1” and “Tier 2” capital elements, withat least half of the total capital required to be Tier 1. Tier 1 capitalincludes, with certain restrictions, the sum of common stockholders’ equity,noncumulative perpetual preferred stock, a limited amount of cumulativeperpetual preferred stock, and minority interests in consolidated subsidiaries,less certain intangible assets. Tier 2 capital includes, with certainlimitations, subordinated debt meeting certain requirements, intermediate-termpreferred stock, certain hybrid capital instruments, certain forms of perpetualpreferred stock, as well as maturing capital instruments and general allowancesfor loan losses.  Our Total and Tier 1capital ratios at June 30, 2004 were 18.04% and 18.03%, respectively,which are in excess of minimum requirements. IBT’s Total and Tier 1 capital ratios at June 30, 2004 were each17.61%, which are in excess of minimum requirements.

 

In addition to the risk-based capital guidelines, theFRB and the FDIC use a “Leverage Ratio” as an additional tool to evaluatecapital adequacy.  The Leverage Ratio isdefined to be a company’s Tier 1 capital divided by its adjusted average totalassets.  The Leverage Ratio adopted bythe federal banking agencies requires a ratio of 3.0% Tier 1 capital toadjusted average total assets for top-rated banking institutions.  All other banking institutions are expectedto maintain a Leverage Ratio of 4.0% to 5.0%. The computation of the risk-basedcapital ratios and the Leverage Ratio requires that our capital and that of IBTbe reduced by most intangible assets. Our Leverage Ratio at June 30, 2004 was 5.58%, which is in excessof regulatory minimums.  IBT’s LeverageRatio at June 30, 2004 was 5.45%, which is also in excess of regulatoryminimums.

 

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**Item 3.****                                   Quantitativeand Qualitative Disclosures about Market Risk**

 

The information required by this item iscontained in the ‘Market Risk’ section in the ‘Management’s Discussion andAnalysis of Financial Condition and Results of Operations,’ as part of thisReport.

 

**Item 4.****                                   Controlsand Procedures**

 

We evaluated the effectiveness of the designand operation of our disclosure controls and procedures as of June 30,2004.  Our disclosure controls andprocedures are the controls and other procedures that we designed to ensurethat we record, process, summarize and report in a timely manner theinformation we must disclose in reports that we file or submit to the SEC.  Kevin J. Sheehan, our Chairman and ChiefExecutive Officer, and John N. Spinney, Jr., our Senior Vice President andChief Financial Officer, reviewed and participated in this evaluation.  Based on this evaluation, Messrs. Sheehan andSpinney concluded that, as of the date of the evaluation, our disclosurecontrols and procedures were effective.

 

As a result of the evaluation completed byus, and in which Messrs. Sheehan and Spinney participated, we have concludedthat no changes occurred during our fiscal quarter ended June 30, 2004 inour internal controls over financial reporting, which changes have materiallyaffected, or are reasonably likely to materially affect, our internal controlsover financial reporting.

 

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**PARTII.****  OTHER INFORMATION**

 

**Item1.  Legal Proceedings.**

 

As previously reported, 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 fairdealing in a subadvisory contract with Opus Investment Management, Inc.(‘Opus’) and that our individual employee engaged in a breach of fiduciaryduties and tortious interference with a contract.  Opus had been a subadviser to the MerrimacFunds, for which we act as investment adviser. Upon the expiration of Opus’ contract on June 1, 2003, the MerrimacFunds elected not to re-appoint Opus as subadviser.  The lawsuit was filed in Superior Court inWorcester, Massachusetts and seeks unspecified damages.  In September 2003, we filed a motion todismiss all claims against us under the complaint, but our motion was recentlydenied.  The case is now proceeding tothe discovery stage.  We believe that theclaims are without merit and intend to defend our rights vigorously.

 

**Item2.  Changes in****Securities, Use of Proceeds and Issuer Purchases ofEquity Securities.**

 

(e) STOCKREPURCHASED

 
| **Period(shares in thousands)**   | ** ** | **(a) Total  Number of  Shares  Purchased (1)** | ** ** | **(b) Average  Price Paid Per  Share** | ** ** |
|-----------------------------------|------------|-------------------------------------------------|------------|----------------------------------------|------------|
| ** **                        | ** ** | ** **                                      | ** ** | ** **                             | ** ** |
| April 1-April 30,  2004 | ** ** | 193                                             |       | $                                      | 40.59      | ** ** |
| May 1-May  31, 2004               | ** ** | 2                                               |       | 37.44                                  | ** ** |
| June 1-June 30,  2004   | ** ** | —                                          |       | —                                 | ** ** |
| ** **                        | ** ** | 195                                             |       | $                                      | 39.94      | ** ** |

 

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(1)  All of the shares set forthin the above table were purchased by the Company in connection with theexercise of outstanding options issued by the Company.

 

The Company does not maintain publicly announced repurchase plans orprograms.

 

**Item 4.****Submission****of Mattersto a Vote of Security Holders.**

 

Our annualmeeting of stockholders was held on Tuesday, April 13, 2004.  A vote was proposed to:

 

•                  Electthree (3) Class III directors;

•                  Approvean amendment of the Company’s Certificate of Incorporation to increase thenumber of authorized shares of the Company’s Common Stock;

•                  Approvean amendment of the Company’s 1997 Employee Stock Purchase Plan (‘ESPP’) toincrease the number of shares available for issuance pursuant to the plan;

•                  Ratifythe selection of Deloitte & Touche LLP as independent auditors for thefiscal year ending December 31, 2004.

 

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All proposals were approved.  Thevoting results were as follows:

 
| ** ** | ** ** | ** **                                               | ** ** | **Votes  For** | ** ** | **Votes  Against** | ** ** | **Votes  Withheld** | ** ** | **Abstained** | ** ** |
|------------|------------|----------------------------------------------------------|------------|----------------|------------|--------------------|------------|---------------------|------------|---------------|------------|
| ** ** | ** ** | ** **                                               | ** ** | ** **     | ** ** | ** **         | ** ** | ** **          | ** ** | ** **    | ** ** |
| (1)        |       | Election of Kevin J. Sheehan as  a Class III director    |       | 56,780,728     |       | N/A                |       | 1,861,333           |       | N/A           |       |
|       |       |                                                     |       |           |       |               |       |                |       |          |       |
|       |       | Election of James M. Oates as a  Class III director      |       | 57,800,884     |       | N/A                |       | 841,177             |       | N/A           |       |
|       |       |                                                     |       |           |       |               |       |                |       |          |       |
|       |       | Election of Thomas P. McDermott  as a Class III director |       | 57,975,591     |       | N/A                |       | 666,470             |       | N/A           |       |
| (2)        |       | Increase in number of authorized  shares of Common Stock |       | 55,345,471     |       | 3,217,953          |       | N/A                 |       | 78,637        |       |
|       |       |                                                     |       |           |       |               |       |                |       |          |       |
| (3)        |       | Increase in number of available  shares for ESPP         |       | 50,143,589     |       | 8,202,544          |       | N/A                 |       | 295,928       |       |
|       |       |                                                     |       |           |       |               |       |                |       |          |       |
| (4)        |       | Ratify the selection of  Deloitte & Touche LLP       |       | 58,155,849     |       | 382,198            |       | N/A                 |       | 104,014       |       |

 

The Amendment to the Company’s Certificate of Incorporation approvedunder Proposal 2 and the Amended 1997 Employee Stock Purchase Plan approvedunder Proposal 3 are attached as exhibits to this Report.

 

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**Item6.**  Exhibitsand Reports on Form 8-K.

 

(a)               Exhibits
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                        |
|-----------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1             |       | Certificate of Amendment to the Certificate  of Incorporation of Investors Financial Services Corp. , filed with the  Delaware Secretary of State on May 5, 2004.                                                                      |
|            |       |                                                                                                                                                                                                                                   |
| 10.1            |       | Amendment to Investors Financial Services  Corp. 1997 Employee Stock Purchase Plan approved April 13, 2004 by the  stockholders of Investors Financial Services Corp.                                                             |
|            |       |                                                                                                                                                                                                                                   |
| 10.2            |       | Information Technology Services Agreement  dated July 1, 2004 between the Company and International Business  Machines Corporation.*                                                                                              |
|            |       |                                                                                                                                                                                                                                   |
| 31.1            |       | Certification of Kevin J. Sheehan, Chief  Executive Officer.                                                                                                                                                                           |
|            |       |                                                                                                                                                                                                                                   |
| 31.2            |       | Certification 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. |

 

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* Confidential treatment requested for certainportions of this Exhibit pursuant to Rule 24b-2 promulgated under theSecurities Exchange Act, which portions are omitted and filed separately withthe Securities and Exchange Commission.

 

(b)              A Form 8-K wasfurnished to the Securities and Exchange Commission (‘SEC’) on April 12,2004 furnishing information pursuant to Item 12 (Results of Operation andFinancial Condition) relating to the press release of Investors FinancialServices Corp. dated April 12, 2004 reporting Investors Financial ServicesCorp.’s financial results for the fiscal quarter ended March 31, 2004.

 

A Form 8-Kwas furnished to the SEC on June 7, 2004 furnishing information pursuantto Item 9 (Regulation FD Disclosure) relating to estimated operating earningsof and other financial matters affecting Investors Financial Services Corp.

 

A Form 8-Kwas furnished to the SEC on June 28, 2004 furnishing information pursuantto Item 9 (Regulation FD Disclosure) reporting the election of Edward F. Hinesto the Board of Directors of Investors Financial Services Corp.

 

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**SIGNATURES**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 
| ** **                      | ** ** | **INVESTORS  FINANCIAL SERVICES CORP.**                                                          |
|---------------------------------|------------|--------------------------------------------------------------------------------------------------|
| ** **                      | ** ** | ** **                                                                                       |
| Date:  August 6, 2004 | By:        | /s/ Kevin J.  Sheehan                                                                            |   |
|                            |       | Kevin J. Sheehan                                                                                 |
|                            |       | Chairman and  Chief Executive Officer                                                            |
| ** **                      | ** ** | ** **                                                                                       |
| ** **                      | ** ** | ** **                                                                                       |
|                            | By:        | /s/ John N.  Spinney, Jr.                                                                        |   |
|                            |       | John N. Spinney,  Jr.                                                                            |
|                            |       | Senior Vice  President and Chief Financial Officer  (Principal Financial and Accounting Officer) |

 

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