**United States**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

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**FORM 10-Q**

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(Mark One)

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

**For the Quarterly periodended March 31, 2007**

**or**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

**For theTransition period from          to             **

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

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**INVESTORS FINANCIAL SERVICES CORP.**

(Exact name of registrantas specified in its charter)

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| **Delaware**  (State or other jurisdiction of  incorporation or organization)                  |   | **04-3279817**  (IRS Employer Identification No.) |
|------------------------------------------------------------------------------------------------|--------|---------------------------------------------------|
| **200 Clarendon Street,  P.O. Box 9130, Boston, MA**  (Address of principal executive offices) |   | **02116-9130**  (Zip Code)                        |

 

**(617) 937-6700**

(Registrant’s telephonenumber, including area code)

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. Yes xNo o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. See definitionof “accelerated filer and large accelerated filer” in Rule 12b-2 of theExchange Act. (Check one):

| Large accelerated filer x |   | Accelerated  filer o |   | Non-accelerated  filer o |
|---------------------------|--------|----------------------|--------|--------------------------|

 

Indicate by check mark whether the registrant is ashell company (as defined by Rule 12b-2 of the Exchange Act). Yes o  No x

Asof April 30, 2007 there were 67,032,629 shares of common stock outstanding.

 

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**INVESTORSFINANCIAL SERVICES CORP.**

**INDEX**
|                | ** ** | ** **                                                                                                        | ** ** | **Page**   | ** ** |
|----------------|------------|-------------------------------------------------------------------------------------------------------------------|------------|------------|------------|
| ** **     | ** ** | ** **                                                                                                        | ** ** | ** ** | ** ** |
| **PART I.**    | ** ** | **FINANCIAL  INFORMATION**                                                                                        |       |       |       |
| Item 1.        |       | Unaudited  Consolidated Financial Statements                                                                      |       |       |       |
|           |       | Unaudited  Consolidated Balance Sheets March 31, 2007 and December 31, 2006                                       |       | 3          |       |
|           |       | Unaudited  Consolidated Statements of Income and Comprehensive Income Three months ended  March 31, 2007 and 2006 |       | 4          |       |
|           |       | Unaudited  Consolidated Statements of Stockholders’ Equity Three months ended March 31,  2007 and 2006       |       | 5          |       |
|           |       | Unaudited  Consolidated Statements of Cash Flows Three months ended March 31, 2007 and  2006                      |       | 6          |       |
|           |       | Notes to  Unaudited Consolidated Financial Statements                                                             |       | 7          |       |
|           |       | Report of  Independent Registered Public Accounting Firm                                                          |       | 22         |       |
| Item 2.        |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                       |       | 23         |       |
| Item 3.        |       | Quantitative and  Qualitative Disclosures about Market Risk                                                       |       | 35         |       |
| Item 4.        |       | Controls and  Procedures                                                                                          |       | 35         |       |
| **PART II.**   | ** ** | **OTHER  INFORMATION**                                                                                            |       |       |       |
| Item 1.        |       | Legal  Proceedings                                                                                                |       | 36         |       |
| Item 1A.       |       | Risk Factors                                                                                                      |       | 36         |       |
| Item 6.        |       | Exhibits                                                                                                          |       | 40         |       |
|           |       |                                                                                                              |       |       |       |
| **SIGNATURES** |       | 40                                                                                                                |       |

 

2

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**PART I.  FINANCIAL INFORMATION**

**Item 1.    UnauditedConsolidated Financial Statements**

**InvestorsFinancial Services Corp.****Unaudited Consolidated Balance Sheets****March 31, 2007 and December 31, 2006 (Dollars inthousands, except share data)**
| ** **                                                                                                                                                                                                                                                             | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                             | ** ** | **2007**           | ** ** | **2006**              | ** ** |
| ** **                                                                                                                                                                                                                                                             | ** ** | ** **         | ** ** | ** **            | ** ** |
| **Assets**                                                                                                                                                                                                                                                             | ** ** | ** **         | ** ** | ** **            | ** ** |
| Cash and due from banks                                                                                                                                                                                                                                                |       | $                  | 142,448    |                  | $          | 92,776 |   |
| Interest-bearing  deposits with other banks                                                                                                                                                                                                                            |       | 20,868             |       | 21,218                |       |
| Other short-term  investments                                                                                                                                                                                                                                          |       | 1,134              |       | 1,971                 |       |
| Federal funds sold and  securities purchased under resale agreements                                                                                                                                                                                                   |       | 2,950,000          |       | 300,000               |       |
| Securities held to  maturity (including securities pledged of $4,169,418 and $4,096,013 at March  31, 2007 and December 31, 2006, respectively) (approximate fair value of $5,222,865  and $5,508,788 at March 31, 2007 and December 31, 2006, respectively) (Note  3) |       | 5,248,480          |       | 5,532,330             |       |
| Securities available  for sale (including securities pledged of $3,730,234 and $3,071,503 at March  31, 2007 and December 31, 2006, respectively) (Note 3)                                                                                                             |       | 5,050,836          |       | 4,799,740             |       |
| Nonmarketable equity  securities                                                                                                                                                                                                                                       |       | 38,962             |       | 40,054                |       |
| Loans, less allowance  for loan losses of $100 at March 31, 2007 and December 31, 2006 (Note 4)                                                                                                                                                                        |       | 258,955            |       | 270,693               |       |
| Accrued interest and  fees receivable                                                                                                                                                                                                                                  |       | 142,106            |       | 134,748               |       |
| Equipment and leasehold  improvements, less accumulated depreciation of $66,477 and $64,290 at March  31, 2007 and December 31, 2006, respectively                                                                                                                     |       | 131,768            |       | 113,287               |       |
| Goodwill, net                                                                                                                                                                                                                                                          |       | 79,969             |       | 79,969                |       |
| Other assets                                                                                                                                                                                                                                                           |       | 139,822            |       | 171,420               |       |
| **Total Assets**                                                                                                                                                                                                                                                       |       | $                  | 14,205,348 |                  | $          | 11,558,206 |   |
| ** **                                                                                                                                                                                                                                                             | ** ** | ** **         | ** ** | ** **            | ** ** |
| **Liabilities and Stockholders’  Equity**                                                                                                                                                                                                                         | ** ** | ** **         | ** ** | ** **            | ** ** |
| ** **                                                                                                                                                                                                                                                             | ** ** | ** **         | ** ** | ** **            | ** ** |
| **Liabilities:**                                                                                                                                                                                                                                                       | ** ** | ** **         | ** ** | ** **            | ** ** |
| Deposits (Note 5):                                                                                                                                                                                                                                                     |       |               |       |                  |       |
| Demand                                                                                                                                                                                                                                                                 |       | $                  | 1,353,144  |                  | $          | 695,821 |   |
| Savings                                                                                                                                                                                                                                                                |       | 6,499,626          |       | 4,924,735             |       |
| Time                                                                                                                                                                                                                                                                   |       | 630,260            |       | 524,386               |       |
| Total deposits                                                                                                                                                                                                                                                         |       | 8,483,030          |       | 6,144,942             |       |
|                                                                                                                                                                                                                                                                   |       |               |       |                  |       |
| Securities sold under  repurchase agreements (Note 6)                                                                                                                                                                                                                  |       | 4,424,073          |       | 3,727,800             |       |
| Short-term and other  borrowings (Note 7)                                                                                                                                                                                                                              |       | 62,497             |       | 517,051               |       |
| Due to brokers for open  trades payable                                                                                                                                                                                                                                |       | —             |       | 26,359                |       |
| Junior subordinated  deferrable interest debentures                                                                                                                                                                                                                    |       | 24,774             |       | 24,774                |       |
| Accrued taxes and other  expenses                                                                                                                                                                                                                                      |       | 76,067             |       | 77,821                |       |
| Other liabilities                                                                                                                                                                                                                                                      |       | 110,648            |       | 100,721               |       |
| Total  liabilities                                                                                                                                                                                                                                                     |       | 13,181,089         |       | 10,619,468            |       |
|                                                                                                                                                                                                                                                                   |       |               |       |                  |       |
| Commitments and  contingencies (Note 12)                                                                                                                                                                                                                               |       | —             |       | —                |       |
|                                                                                                                                                                                                                                                                   |       |               |       |                  |       |
| **Stockholders’ Equity:**                                                                                                                                                                                                                                         | ** ** | ** **         | ** ** | ** **            | ** ** |
| Preferred stock, par  value $0.01 (shares authorized: 1,000,000; issued: none at March 31, 2007 and  December 31, 2006)                                                                                                                                                |       | —             |       | —                |       |
| Common stock, par value  $0.01 (shares authorized: 175,000,000; issued: 69,660,108 and 68,523,129 at  March 31, 2007 and December 31, 2006, respectively)                                                                                                              |       | 697                |       | 685                   |       |
| Surplus                                                                                                                                                                                                                                                                |       | 372,773            |       | 334,929               |       |
| Retained earnings                                                                                                                                                                                                                                                      |       | 759,284            |       | 720,433               |       |
| Accumulated other  comprehensive loss, net                                                                                                                                                                                                                             |       | (5,700             | )          | (14,514               | )          |
| Treasury stock, at cost  (2,895,021 shares at March 31, 2007 and December 31, 2006)                                                                                                                                                                                    |       | (102,795           | )          | (102,795              | )          |
| Total  stockholders’ equity                                                                                                                                                                                                                                       |       | 1,024,259          |       | 938,738               |       |
|                                                                                                                                                                                                                                                                   |       |               |       |                  |       |
| **Total Liabilities and Stockholders’ Equity**                                                                                                                                                                                                                    |       | $                  | 14,205,348 |                  | $          | 11,558,206 |   |

*See Notes to Unaudited Consolidated FinancialStatements.*

3

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**Investors Financial Services Corp.****Unaudited Consolidated Statements of Income andComprehensive Income****Three Months Ended March 31, 2007 and 2006(Dollars in thousands, except per share data)**
| ** **                                        | ** ** | **March 31,** | ** ** | **March 31,** | ** ** |
|---------------------------------------------------|------------|--------------------|------------|--------------------|------------|
| ** **                                        | ** ** | **2007**           | ** ** | **2006**           | ** ** |
| **Fees and Other Revenue:**                       | ** ** | ** **         | ** ** | ** **         | ** ** |
| Asset servicing fees:                             |       |               |       |               |       |
| Core service  fees                                |       | $                  | 129,026    |               | $          | 107,759 |   |
| Value-added service  fees                         |       | 40,627             |       | 40,544             |       |
| Total asset  servicing fees                       |       | 169,653            |       | 148,303            |       |
| Other operating income                            |       | 1,479              |       | 1,164              |       |
| Total fees and  other revenue                     |       | 171,132            |       | 149,467            |       |
|                                              |       |               |       |               |       |
| Interest income                                   |       | 157,985            |       | 134,437            |       |
| Interest expense                                  |       | 108,819            |       | 91,116             |       |
| Net interest  income                              |       | 49,166             |       | 43,321             |       |
| Net operating  revenue                            |       | 220,298            |       | 192,788            |       |
|                                              |       |               |       |               |       |
| **Operating Expenses:**                           | ** ** | ** **         | ** ** | ** **         | ** ** |
| Compensation and  benefits                        |       | 97,420             |       | 76,998             |       |
| Technology and  telecommunications                |       | 18,535             |       | 17,338             |       |
| Transaction processing  services                  |       | 15,341             |       | 13,672             |       |
| Occupancy                                         |       | 10,018             |       | 7,551              |       |
| Depreciation and  amortization                    |       | 9,691              |       | 7,806              |       |
| Professional fees                                 |       | 2,273              |       | 3,461              |       |
| Travel and sales  promotion                       |       | 2,126              |       | 1,931              |       |
| Insurance                                         |       | 980                |       | 973                |       |
| Other operating  expenses                         |       | 3,010              |       | 5,954              |       |
| Total  operating expenses                         |       | 159,394            |       | 135,684            |       |
| ** **                                        | ** ** | ** **         | ** ** | ** **         | ** ** |
| **Income Before Income Taxes**                    |       | 60,904             |       | 57,104             |       |
|                                              |       |               |       |               |       |
| Provision for income  taxes                       |       | 20,403             |       | 19,701             |       |
|                                              |       |               |       |               |       |
| **Net Income**                                    |       | $                  | 40,501     |               | $          | 37,403 |   |
| ** **                                        |       |               |       |               |       |
| **Basic Earnings Per Share**                      |       | $                  | 0.61       |               | $          | 0.57 |   |
| ** **                                        |       |               |       |               |       |
| **Diluted Earnings Per Share**                    |       | $                  | 0.60       |               | $          | 0.56 |   |
|                                              |       |               |       |               |       |
| **Comprehensive Income:**                         |       |               |       |               |       |
| Net income                                        |       | $                  | 40,501     |               | $          | 37,403 |   |
| Other comprehensive  income (loss):               |       |               |       |               |       |
| Net unrealized  investment gain (loss)            |       | 11,329             |       | (9,197             | )          |
| Net unrealized  derivative instrument (loss) gain |       | (2,577             | )          | 2,691              |       |
| Cumulative  translation adjustment                |       | 62                 |       | 129                |       |
| Other  comprehensive income (loss)                |       | 8,814              |       | (6,377             | )          |
| Comprehensive income                              |       | $                  | 49,315     |               | $          | 31,026 |   |

 

***See Notes to Unaudited Consolidated Financial Statements.***

4

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**InvestorsFinancial Services Corp.****Unaudited Consolidated Statements of Stockholders’Equity****Three Months Ended March 31, 2007 and 2006(Dollars in thousands, except share data)**
| ** **                                                                                                                 | ** ** | **March 31,** | ** ** | **March 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|--------------------|------------|
| ** **                                                                                                                 | ** ** | **2007**           | ** ** | **2006**           | ** ** |
| **Common shares**                                                                                                          | ** ** | ** **         | ** ** | ** **         | ** ** |
| Balance, beginning of  period                                                                                              |       | 68,523,129         |       | 67,177,306         |       |
| Exercise of stock  options                                                                                                 |       | 863,175            |       | 478,635            |       |
| Restricted stock  issuance                                                                                                 |       | 273,804            |       | —             |       |
| Balance, end of period                                                                                                     |       | 69,660,108         |       | 67,655,941         |       |
| ** **                                                                                                                 | ** ** | ** **         | ** ** | ** **         | ** ** |
| **Treasury shares**                                                                                                        | ** ** | ** **         | ** ** | ** **         | ** ** |
| Balance, beginning of  period                                                                                              |       | 2,895,021          |       | 2,124,669          |       |
| Balance, end of period                                                                                                     |       | 2,895,021          |       | 2,124,669          |       |
| ** **                                                                                                                 | ** ** | ** **         | ** ** | ** **         | ** ** |
| **Common stock**                                                                                                           | ** ** | ** **         | ** ** | ** **         | ** ** |
| Balance, beginning of  period                                                                                              |       | $                  | 685        |               | $          | 672 |   |
| Exercise of stock  options                                                                                                 |       | 12                 |       | 5                  |       |
| Balance, end of period                                                                                                     |       | 697                |       | 677                |       |
| ** **                                                                                                                 | ** ** | ** **         | ** ** | ** **         | ** ** |
| **Surplus**                                                                                                                | ** ** | ** **         | ** ** | ** **         | ** ** |
| Balance, beginning of  period                                                                                              |       | 334,929            |       | 286,265            |       |
| Share-based awards and  exercise of stock options                                                                          |       | 31,326             |       | 15,314             |       |
| Tax benefit from  exercise of stock options                                                                                |       | 6,518              |       | 2,361              |       |
| Transfer of deferred  compensation to surplus                                                                              |       | —             |       | (311               | )          |
| Amortization of  deferred compensation                                                                                     |       | —             |       | 104                |       |
| Balance, end of period                                                                                                     |       | 372,773            |       | 303,733            |       |
| ** **                                                                                                                 | ** ** | ** **         | ** ** | ** **         | ** ** |
| **Deferred compensation**                                                                                                  | ** ** | ** **         | ** ** | ** **         | ** ** |
| Balance, beginning of  period                                                                                              |       | —             |       | (311               | )          |
| Transfer of deferred  compensation to surplus                                                                              |       | —             |       | 311                |       |
| Balance, end of period                                                                                                     |       | —             |       | —             |       |
| ** **                                                                                                                 | ** ** | ** **         | ** ** | ** **         | ** ** |
| **Retained earnings**                                                                                                      | ** ** | ** **         | ** ** | ** **         | ** ** |
| Balance, beginning of  period                                                                                              |       | 720,433            |       | 572,549            |       |
| Net income                                                                                                                 |       | 40,501             |       | 37,403             |       |
| Cash dividend, $0.0250  and $0.0225 per share in the three-month periods ended March 31, 2007  and 2006, respectively |       | (1,650             | )          | (1,469             | )          |
| Balance, end of period                                                                                                     |       | 759,284            |       | 608,483            |       |
| ** **                                                                                                                 | ** ** | ** **         | ** ** | ** **         | ** ** |
| **Accumulated other comprehensive  (loss) income, net**                                                                    | ** ** | ** **         | ** ** | ** **         | ** ** |
| Balance, beginning of  period                                                                                              |       | (14,514            | )          | (13,369            | )          |
| Net unrealized  investment gain (loss)                                                                                     |       | 11,329             |       | (9,197             | )          |
| Net unrealized  derivative instrument (loss) gain                                                                          |       | (2,436             | )          | 3,164              |       |
| Amortization of  terminated interest rate swap agreements                                                                  |       | (141               | )          | (473               | )          |
| Cumulative translation  adjustment                                                                                         |       | 62                 |       | 129                |       |
| Balance, end of period                                                                                                     |       | (5,700             | )          | (19,746            | )          |
| ** **                                                                                                                 | ** ** | ** **         | ** ** | ** **         | ** ** |
| **Treasury stock**                                                                                                         | ** ** | ** **         | ** ** | ** **         | ** ** |
| Balance, beginning of  period                                                                                              |       | (102,795           | )          | (72,948            | )          |
| Balance, end of period                                                                                                     |       | (102,795           | )          | (72,948            | )          |
| ** **                                                                                                                 |       |               |       |               | ** ** |
| **Total Stockholders’ Equity**                                                                                        |       | $                  | 1,024,259  |               | $          | 820,199 | ** ** |
| ** **                                                                                                                 | ** ** | ** **         | ** ** | ** **         | ** ** |

 

***See Notes to Unaudited Consolidated Financial Statements.***

5

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**Investors Financial Services Corp.Unaudited Consolidated Statements of Cash Flows Three Months Ended March 31, 2007 and 2006 (Dollars in thousands)**
| ** **                                                                           | ** ** | **March 31,** | ** ** | **March 31,** | ** ** |
|--------------------------------------------------------------------------------------|------------|---------------|------------|---------------|------------|
| ** **                                                                           | ** ** | **2007**      | ** ** | **2006**      | ** ** |
| ** **                                                                           | ** ** | ** **    | ** ** | ** **    | ** ** |
| **Cash Flows From Operating Activities:**                                            | ** ** | ** **    | ** ** | ** **    | ** ** |
| Net income                                                                           |       | $40,501       |       | $37,403       |       |
| Adjustments to reconcile net income to net cash provided by operating  activities:   |       |          |       |          |       |
| Equity in undistributed  loss of unconsolidated subsidiary                           |       | 7             |       | 7             |       |
| Depreciation and  amortization                                                       |       | 9,691         |       | 7,806         |       |
| Share-based  compensation                                                            |       | 2,096         |       | 1,155         |       |
| Amortization of  premiums on securities, net of accretion of discounts               |       | 12,119        |       | 10,267        |       |
| Excess tax benefit  related to share-based compensation                              |       | (7,826        | )          | (1,633        | )          |
| Changes in assets and  liabilities:                                                  |       |          |       |          |       |
| Accrued interest and  fees receivable                                                |       | (7,358        | )          | (4,187        | )          |
| Other assets                                                                         |       | 31,591        |       | 5,509         |       |
| Accrued taxes and other  expenses                                                    |       | (1,754        | )          | 16,271        |       |
| Other liabilities                                                                    |       | 5,518         |       | 29,895        |       |
| Net cash provided by  operating activities                                           |       | 84,585        |       | 102,493       |       |
| ** **                                                                           | ** ** | ** **    | ** ** | ** **    | ** ** |
| **Cash Flows From Investing Activities:**                                            |       |          |       |          |       |
| Proceeds from maturities and paydowns of securities available for  sale              |       | 638,958       |       | 251,050       |       |
| Proceeds from maturities and paydowns of securities held to maturity                 |       | 273,459       |       | 302,247       |       |
| Proceeds from the redemption of non-marketable equity securities                     |       | 1,092         |       | —        |       |
| Purchases of securities available for sale                                           |       | (871,332      | )          | (392,764      | )          |
| Purchases of securities held to maturity                                             |       | (970          | )          | (48,363       | )          |
| Purchases of non-marketable equity securities                                        |       | —        |       | (750          | )          |
| Net decrease in due to brokers for open trades payable                               |       | (26,359       | )          | (9,344        | )          |
| Net increase in Federal funds sold and securities purchased under  resale agreements |       | (2,650,000    | )          | (525,000      | )          |
| Net decrease (increase) in other short-term investments                              |       | 837           |       | (6,089        | )          |
| Net decrease in loans                                                                |       | 11,738        |       | 94,449        |       |
| Purchases of equipment, software and leasehold improvements                          |       | (28,165       | )          | (17,704       | )          |
| Net cash used for  investing activities                                              |       | (2,650,742    | )          | (352,268      | )          |
| ** **                                                                           | ** ** | ** **    | ** ** | ** **    | ** ** |
| **Cash Flows From Financing Activities:**                                            | ** ** | ** **    | ** ** | ** **    | ** ** |
| Net increase in demand deposits                                                      |       | 657,323       |       | 107,326       |       |
| Net increase in time and savings deposits                                            |       | 1,680,765     |       | 324,775       |       |
| Net increase (decrease) in securities sold under repurchase  agreements              |       | 696,273       |       | (5,857        | )          |
| Net decrease in short-term and other borrowings                                      |       | (454,554      | )          | (169,446      | )          |
| Proceeds from exercise of stock options                                              |       | 29,461        |       | 14,164        |       |
| Excess tax benefit related to share-based compensation                               |       | 7,826         |       | 1,633         |       |
| Dividends paid to stockholders                                                       |       | (1,650        | )          | (1,469        | )          |
| Net cash provided by  financing activities                                           |       | 2,615,444     |       | 271,126       |       |
|                                                                                 |       |          |       |          |       |
| **Effect of exchange rates on cash**                                                 |       | 35            |       | 450           |       |
| ** **                                                                           | ** ** | ** **    | ** ** | ** **    | ** ** |
| **Net Increase in Cash and Due From Banks**                                          |       | 49,322        |       | 21,801        |       |
| ** **                                                                           |       |          |       |          |       |
| **Cash and Due From Banks, Beginning of Period**                                     |       | 113,994       |       | 79,637        |       |
| ** **                                                                           |       |          |       |          |       |
| **Cash and Due From Banks, End of Period**                                           |       | $163,316      |       | $101,438      |       |

*See Notes to Unaudited Consolidated FinancialStatements.*

6

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** **

**Investors FinancialServices Corp.Notes to Unaudited Consolidated Financial Statements**

**1.     Description of Business**

Investors FinancialServices Corp. (‘IFSC’) provides asset administration services for thefinancial services industry through its wholly-owned subsidiary, Investors Bank& Trust Company (‘the Bank’).  Asused herein, the defined term “the Company” shall mean IFSC together with theBank and its domestic and foreign subsidiaries. The Company provides core services and value-added services to a variety of financial asset managers,including mutual fund complexes, investment advisors, family offices, hedgefunds, banks and insurance companies. Core services include global custody, multicurrency accounting, fundadministration and middle office outsourcing. Value-added services include foreign exchange, cash management,securities lending, investment advisory, performance measurement, institutionaltransfer agency, lines of credit and brokerage and transition managementservices.  The Company is subjectto regulation by the Federal Reserve Board of Governors (‘FRB’), the FederalDeposit Insurance Corporation (‘FDIC’), the Office of the Commissioner of Banksof the Commonwealth of Massachusetts (‘Commissioner’), the Securities andExchange Commission (‘SEC’), the National Association of Securities Dealers,Inc. (‘NASD’), the State of Vermont Department of Banking, Insurance,Securities & Health Care Administration (‘BISHCA’), the Office of theSuperintendent of Financial Institutions in Canada (‘OSFI’), the IrishFinancial Services Regulatory Authority (‘IFSRA’), the Cayman Islands MonetaryAuthority (‘CIMA’), the Financial Services Authority in the United Kingdom (‘FSA’)and the Commission de Surveillance du Secteur Financier in Luxembourg (‘CSSF’).

On February 4, 2007, theCompany entered into an Agreement and Plan of Merger (the ‘Merger Agreement’)with State Street Corporation (‘State Street’). At the closing of the transaction contemplated by the Merger Agreement,the Company will merge into State Street and the Company’s shareholders willreceive 0.906 shares of State Street common stock for each share of the Company’scommon stock.  Each company’s Board ofDirectors has approved the Merger Agreement. The Company expects to complete the transaction in the third quarter of2007, subject to customary closing conditions, including regulatory andshareholder approval.

**2.     Interim Financial Statements**

The unauditedconsolidated interim financial statements of the Company as of March 31, 2007and December 31, 2006, and for the three-month periods ended March 31, 2007 and2006 have been prepared by the Company pursuant to the rules and regulations ofthe SEC.  Certain information andfootnote disclosures normally included in annual financial statements preparedin accordance with accounting principles generally accepted in the UnitedStates of America (‘GAAP’) have been omitted as permitted by such rules andregulations.  All adjustments, consistingof normal recurring adjustments, necessary for their fair presentation inconformity with GAAP are included.  Allsignificant intercompany accounts and transactions have been eliminated.  The Company’s management believes that thedisclosures are adequate to present fairly the financial position, results ofoperations and cash flows at the dates and for the periods presented.  The preparation of the financial statementsrequires management to make estimates and assumptions that affect the amountsreported in the financial statements and accompanying notes.  Actual results may differ from thoseestimates.  It is suggested that theseinterim 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 interimperiods are not necessarily indicative of those to be expected for the fullfiscal year.  Certain amounts in prioryears’ financial statements have been reclassified to conform to the currentyears’ presentation.

***Cashand Cash Equivalents —***For purposes of reporting cashflows and amounts on the consolidated balance sheets, the Company defines cashand cash equivalents to include cash, due from banks, and interest-bearingdeposits with other banks that have original maturities of 90 days or less.

***Securities—***The Company classifies all equity securities that havereadily determinable fair values and all investments in debt securities intoone of three categories.  Debt securitiesthat the Company has the positive intent and ability to hold to maturity are classifiedas held to maturity and carried at amortized cost.  Debt and equity securities that are boughtand held principally for the purpose of selling them in the near term areclassified as trading securities and carried at fair value, with unrealized gainsand losses included in earnings.  Allother debt and equity securities not classified as either held to maturity ortrading are classified as available for sale and carried at fair value, withunrealized gains and losses excluded from earnings and reported in othercomprehensive income.

Non-marketable securitiesprimarily consist of stock of the Federal Home Loan Bank of Boston (‘FHLBB’)and stock of the Federal Reserve Bank of Boston (‘FRBB’).  The FHLBB stock is carried at cost andredeemable at par value.  The Company isrequired to hold this stock under its borrowingarrangement with the FHLBB.  The Companywas required to purchase stock of the FRBB in connection with its membershipwith the FRBB.

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An investment isconsidered impaired if the fair value of the investment is less than itscost.  The Company recognizes animpairment charge if, based on the facts and circumstances, managementdetermines the impairment to be other than temporary.  For example, the Company will record an otherthan temporary impairment charge on a debt security if it is determined that itis probable that the Company will be unable to recover all amounts due underthe contractual obligations of the security.

Amortizationand accretion of debt securities purchased at a premium or discount areamortized or accreted into income using a method which approximates theconstant effective yield method.  TheCompany applies Statement of Financial Accounting Standards No. 91, *Accounting for Nonrefundable Fees and CostsAssociated with Originating or Acquiring Loans and Initial Direct Costs ofLeases* (‘SFAS 91’) for the amortization of premiums and accretion ofdiscounts.  In calculating the effectiveyield for securities that represent holdings of large numbers of similar loansfor which prepayments are probable and the timing and amount of prepayments canbe reasonably estimated, prepayments are anticipated using the Company’s actualthree-month prepayment experience.

Theamount of amortization or accretion to recognize in income is driven by thecalculation of the constant effective yield. When calculating this yield, the Company assumes that prepayments willcontinue from the analysis date to the date of the security’s expected maturityat its most recent three-month prepayment rate. The prepayment rate is updated monthly based on the Company’s previousthree-month actual prepayment experience.

TheCompany utilizes three-month prepayment rates to anticipate prepayments becausesuch rates are based on its own actual prepayment experience and because theCompany believes three-month rates are a better estimate of future experiencethan either one-month or six-month or longer rates.  In the opinion of management, a one-monthrate does not capture enough experience to predict future prepayment behaviorand may create undue volatility in interest income due to one-time fluctuationsin prepayment activity.  Conversely, inthe opinion of management, a six-month or longer rate would not capture enoughvolatility to predict future prepayment behavior.

If a difference arisesbetween the Company’s estimated prepayments and its actual prepaymentsreceived, the constant effective yield is recalculated based on the Company’sactual payments to date and anticipated future payments.  This monthly recalculation results in thecarrying value of the security being adjusted to the amount that would haveexisted had the new effective yield been applied since the purchase date, and acorresponding charge or credit is recognized to interest income.

Forsecurities that do not represent holdings of large numbers of similar loans forwhich prepayments are probable and the timing and amount of prepayments can bereasonably estimated, the associated premiums and discounts are amortized oraccreted over their contractual term using the constant effective yield.  Actual prepayment experience for suchsecurities is reviewed monthly and a proportionate amount of premium ordiscount is recognized in income at that time such that the effective yield onthe remaining portion of the securities continues unchanged.

Asof and for the periods ended March 31, 2007 and 2006, the Company anticipatedprepayments on its residential mortgage-backed securities.  All other securities do not meet the SFAS 91criteria for anticipating prepayments. Accordingly, no prepayments were anticipated for these securities.

***IncomeTaxes*****—** Income taxexpense is based on estimated taxes payable or refundable on a tax return basisfor the current year and the changes in deferred tax assets and liabilitiesduring the year.  Deferred tax assets and liabilities are established fortemporary differences between the accounting bases and the tax bases of theCompany’s assets and liabilities at enacted tax rates expected to be in effectwhen the amounts related to such temporary differences are realized orsettled.  If the Company determines that it is “more likely than not” thatsome portion or all of a deferred tax asset will not be realized, the Companyrecords a valuation allowance in accordance with the provisions of Statement ofFinancial Accounting Standards No. 109, *Accountingfor Income Taxes*(‘SFAS 109’).

The Company presentstaxes collected from customers and remitted to government authorities (such assales and value added taxes) on a net basis in the consolidated statement ofincome and comprehensive income.

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In accordance withAccounting Principles Board Opinion No. 23, *Accounting for IncomeTaxes — Special Areas* (‘APB 23’), the Company presumes theundistributed earnings of its foreign subsidiaries will be distributed to itsparent company unless the Company adopts the indefinite reversal provisions ofAPB 23, which would require the Company to provide sufficient evidence tosupport that the subsidiary has invested or will invest the undistributed earningsindefinitely.  The Company recognizes theindefinite reversal provision of APB 23 for its Irish and Cayman Islandssubsidiaries due to the projected capital needs necessary to support thecontinued growth of these entities.  Assuch, the Company does not record U.S. income taxes on the undistributedearnings of its Irish and Cayman Island subsidiaries.

On January 1, 2007, theCompany adopted Statement of Financial Accounting Standards BoardInterpretation No. 48, *Accounting for Uncertaintyin Income Taxes — an interpretation of FASB Statement No. 109* (‘FIN48’).  FIN 48 establishes a recognitionthreshold and measurement attribute for the financial statement recognition andmeasurement of a tax position taken or expected to be taken in a tax return.  Pursuant to FIN 48, the effects of a taxposition are recognized in the financial statements when it is more likely thannot, based on the technical merits, that the position will be sustained uponexamination by the taxing authority. Conversely, previously recognized tax positions are derecognized when itis no longer more likely than not that the tax position would be sustained uponexamination.  FIN 48 also requirescertain disclosures regarding unrecognized tax benefits and the amounts andclassification of the related interest and penalties.  There was no material impact to the financialcondition or results of operations of the Company upon adoption of FIN 48.

As of January 1, 2007,the Company’s unrecognized tax benefit totaled $2.1 million.  The amount of unrecognized tax benefit which,if recognized, would affect the effective tax rate was $1.4 million, of which$0.4 million related to interest and penalties. The Company does not anticipate recognizing any unrecognized taxbenefits during the next twelve months. In accordance with the Company’s policy, any tax-related interest and/orpenalties are classified as a component of income taxes in the consolidatedstatement of financial position.  The taxyears ended December 31, 2003, 2004 and 2005 remain subject to examination byvarious state jurisdictions.

***Share-BasedCompensation* —**On January 1, 2006, the Company adoptedStatement of Financial Accounting Standards No. 123 (revised 2004), *Share-Based Payment*(‘SFAS 123R’).  SFAS 123R requires that compensation costrelating to share-based payment transactions be recognized in the financialstatements, with measurement based upon the fair value of the equity orliability instruments issued.  TheCompany adopted SFAS 123R using the modified prospective applicationmethod.  Under that method, compensationcost for equity awards granted after January 1, 2006 is recognized over theservice period based on the grant date fair value.  In addition,compensation cost for the portion of awards for which the requisite service hasnot been rendered that are outstanding as of January 1, 2006 is recognizedprospectively as the requisite service is rendered.  The compensation costfor that portion of awards is based on the grant date fair value of thoseawards as calculated under the pro forma disclosures of Statement of FinancialAccounting Standards No. 123, *Accounting for Stock-basedCompensation* (‘SFAS 123’).  Inaccordance with the modified prospective application method, the financialstatements of interim periods prior to the adoption of SFAS 123R have not beenrestated.

The followingtable sets forth share-based compensation cost and the related tax benefitrecognized in the income statement for all of the Company’s share-basedcompensation plans (Dollars in thousands):
| ** **                     | ** ** | **For the Three Months  Ended March 31,** | ** ** |
|--------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                     | ** ** | **2007**                                                           | ** ** | **2006** | ** ** |
| Share-based  compensation cost |       | $                                                                  | 2,096      |   | $ | 1,155 |   |
| Income tax benefit             |       | $                                                                  | 660        |   | $ | 230 |   |

 

Certain of the Company’sshare-based awards contain terms that provide for a graded vesting schedule wherebyportions of the awards vest in increments over the requisite serviceperiod.  As provided for under SFAS 123R,the Company has elected to recognize compensation cost for awards granted on orafter January 1, 2006 with graded vesting schedules on a straight-line basisover the requisite service period for the entire award.

The fair value of eachoption grant under the Director Plan, the Stock Plan, and the 2005 Plan (asdescribed further in Note 8) was estimated on the date of grant using theBlack-Scholes valuation model with the following weighted-average assumptionsfor the three months ended March 31, 2007 and 2006, respectively:  an average assumed risk-free interest rate of4.67% and 4.52%, an average expected term of seven years and five years, anexpected volatility of 50.42% and 42.82%, and an average dividend yield of0.20% and 0.21%.

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** **

The Company bases itsestimate of expected term on the historical exercise and post-vestingemployment termination behavior for similar grants. The Company’s volatilityassumption is based on the historical volatility of the Company’s stock over aperiod equating to the expected term of the employee share option, using weeklyprice observations and looking backward from the date of grant.

The fair value of the optionfeature of grants under the 1997 Employee Stock Purchase Plan (‘ESPP’) (asdescribed further in Note 8) was estimated on the grant date using theBlack-Scholes valuation model with the following weighted-average assumptionsfor the three months ended March 31, 2007 and 2006, respectively:  an average assumed risk-free rate of 4.95%and 4.40%, an expected term of 0.5 years, an expected volatility of 28.84% and36.96%, and an average dividend yield of 0.21% and 0.25%.

The expected term for theESPP is equal to the six-month payment period. The Company estimates expected volatility for the ESPP in the samemanner as for employee stock options, except that daily volatility is usedinstead of weekly volatility.  TheCompany uses daily volatility for the ESPP because weekly volatility over sixmonths does not result in a statistically significant number of data pointsupon which to base the volatility calculation.

***EarningsPer Share —***Basic earnings per share (‘EPS’) is computedby dividing net income by the weighted-average number of common sharesoutstanding during the quarter.  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 EPS to Diluted EPS is as follows (Dollars in thousands, except per sharedata):

|                                              | ** ** | **For the Three Months** | ** ** |
|----------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                   | ** ** | **Ended March 31,**           | ** ** |
| ** **                                   | ** ** | **2007**                                | ** ** | **2006** | ** ** |
|                                         |       |                                    |       |   |   |
| Income available  to common stockholders     |       | $                                       | 40,501     |   | $ | 37,403 |   |
|                                         |       |                                    |       |   |   |
| Basic  weighted-average shares outstanding   |       | 66,068,993                              |       | 65,313,068 |   |
| Dilutive effect  of stock options            |       | 1,951,443                               |       | 1,911,009 |   |
| Diluted  weighted-average shares outstanding |       | 68,020,436                              |       | 67,224,077 |   |
|                                         |       |                                    |       |   |   |
| Earnings per  share:                         |       |                                    |       |   |   |
| Basic                                        |       | $                                       | 0.61       |   | $ | 0.57 |   |
|                                         |       |                                    |       |   |   |
| Diluted                                      |       | $                                       | 0.60       |   | $ | 0.56 |   |

 

There were 843,717 and91,737 options which were not considered dilutive for purposes of EPScalculations for the three-month periods ended March 31, 2007 and 2006,respectively.

***RecentlyIssued Accounting Pronouncements —***In September 2006, theFASB issued Statement of Financial Accounting Standards No. 157, *Fair Value Measurements*(‘SFAS 157’).  SFAS 157 defines fair value, establishes aframework for measuring fair value, and expands upon existing disclosures aboutfair value measurements.  SFAS 157 doesnot require any new fair value measurements. Rather, the guidance contained in SFAS 157 applies to assets,liabilities, and certain equity instruments that are already measured at fairvalue under existing accounting pronouncements. SFAS 157 is effective for fiscal years beginning after November 15,2007.  We do not anticipate any materialimpact to our financial condition or results of operations as a result of theadoption of SFAS 157.

In February 2007, the FASBissued Statement of Financial Accounting Standards No. 159, *The Fair Value Option for Financial Assets and Financial Liabilities*(‘SFAS 159’).  SFAS 159 permits entitiesto elect to measure certain financial instruments and other items at fair valuethrough earnings.  The fair value optionmay be applied on an instrument by instrument basis, is irrevocable and isapplied only to entire instruments.  SFAS159 requires additional financial statement presentation and disclosurerequirements for those entities that elect to adopt the standard and iseffective for fiscal years beginning after November 15, 2007.  We do not anticipate any material impact toour financial condition or results of operations as a result of the adoption ofSFAS 159.

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**3.     Securities**

Amortized cost amountsand fair values of securities are summarized as follows as of March 31, 2007(Dollars in thousands):
| ** **                        | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair**  | ** ** |
|-----------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|-----------|------------|
| **Held to Maturity**    | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **(Losses)**   | ** ** | **Value** | ** ** |
|                              |       |          |       |           |       |           |       |      |       |
| Mortgage-backed  securities       |       | $             | 3,611,327  |           | $          | 9,784          |       | $         | (20,895    | ) | $ | 3,600,216 |   |
| Federal agency  securities        |       | 1,542,336     |       | 1,551          |       | (19,971        | )          | 1,523,916 |       |
| State and political  subdivisions |       | 94,817        |       | 3,972          |       | (56            | )          | 98,733    |       |
|                              |       |          |       |           |       |           |       |      |       |
| Total                             |       | $             | 5,248,480  |           | $          | 15,307         |       | $         | (40,922    | ) | $ | 5,222,865 |   |

 
| ** **                        | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair**  | ** ** |
|-----------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|-----------|------------|
| **Available for Sale**  | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **(Losses)**   | ** ** | **Value** | ** ** |
|                              |       |          |       |           |       |           |       |      |       |
| Mortgage-backed  securities       |       | $             | 4,137,289  |           | $          | 11,880         |       | $         | (21,522    | ) | $ | 4,127,647 |   |
| Federal agency  securities        |       | 398,954       |       | 42             |       | (46            | )          | 398,950   |       |
| State and political  subdivisions |       | 343,905       |       | 2,539          |       | (453           | )          | 345,991   |       |
| Corporate debt                    |       | 168,404       |       | 127            |       | (818           | )          | 167,713   |       |
| Foreign government  securities    |       | 10,556        |       | —         |       | (21            | )          | 10,535    |       |
|                              |       |          |       |           |       |           |       |      |       |
| Total                             |       | $             | 5,059,108  |           | $          | 14,588         |       | $         | (22,860    | ) | $ | 5,050,836 |   |

 

Amortized cost amountsand fair values of securities are summarized as follows as of December 31, 2006(Dollars in thousands):
| ** **                        | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | ** **          | ** ** |
|-----------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|---------------------|------------|
| **Held to Maturity**    | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **(Losses)**   | ** ** | **Fair Value** | ** ** |
|                              |       |          |       |           |       |           |       |                |       |
| Mortgage-backed  securities       |       | $             | 3,753,497  |           | $          | 7,271          |       | $                   | (25,584    | ) | $ | 3,735,184 |   |
| Federal agency  securities        |       | 1,680,458     |       | 2,956          |       | (12,328        | )          | 1,671,086           |       |
| State and political  subdivisions |       | 98,375        |       | 4,206          |       | (63            | )          | 102,518             |       |
|                              |       |          |       |           |       |           |       |                |       |
| Total                             |       | $             | 5,532,330  |           | $          | 14,433         |       | $                   | (37,975    | ) | $ | 5,508,788 |   |

 
| ** **                        | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | ** **          | ** ** |
|-----------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|---------------------|------------|
| **Available for Sale**  | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **(Losses)**   | ** ** | **Fair Value** | ** ** |
|                              |       |          |       |           |       |           |       |                |       |
| Mortgage-backed  securities       |       | $             | 4,302,932  |           | $          | 7,400          |       | $                   | (35,281    | ) | $ | 4,275,051 |   |
| State and  political subdivisions |       | 343,204       |       | 2,090          |       | (990           | )          | 344,304             |       |
| Corporate debt                    |       | 170,797       |       | 226            |       | (1,173         | )          | 169,850             |       |
| Foreign  government securities    |       | 10,559        |       | —         |       | (24            | )          | 10,535              |       |
|                              |       |          |       |           |       |           |       |                |       |
| Total                             |       | $             | 4,827,492  |           | $          | 9,716          |       | $                   | (37,468    | ) | $ | 4,799,740 |   |

 

Excluded from the abovetables are nonmarketable equity securities, which consisted primarily of stockof the FRBB and FHLBB at March 31, 2007 and December 31, 2006.  TheCompany’s capital stock investment in the FHLBB totaled $28.4 million as ofMarch 31, 2007, which represents a $1.0 million decrease from December 31,2006.  The $28.4 million capital stock investment includes both a$25.0 million membership component and a $3.4 million activity-basedcomponent.  The membership component ofthe FHLBB capital stock investment requires a five-year advance noticeof withdrawal.  The Company’s $28.4million capital stock investment in the FHLBB provides an overnight borrowingcapacity of up to $114.5 million.  Therewas no outstanding balance under this arrangement as of March 31,2007.  The Company currently has the ability to purchase up to $25.0million of activity-based capital, which would provide a total overnightborrowing capacity of $833.3 million.

The Company had no salesof securities during the three-month periods ended March 31, 2007 and March 31,2006.

The carrying value ofsecurities pledged amounted to approximately $7.9 billion and $7.2 billion atMarch 31, 2007 and December 31, 2006, respectively.  Securities are pledged primarily to secureclearings with other depository institutions, to secure repurchase agreementsand to secure outstanding FHLBB and Federal Reserve Discount Window borrowings.

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** **

On a quarterly basis theCompany reviews its investment portfolio on a security by security basis forany investment that may be other than temporarily impaired.  In its evaluation, the Company considers thelength of time the security has been impaired, the severity of the impairment,the financial condition and future prospects of the issuer and the Company’sability and intent to hold the security to maturity or until it recovers invalue.  At March 31, 2007, no securitieswere considered to be other-than-temporarily impaired.

**4.     Loans**

Loans consist of demandloans to custody clients of the Company, including individuals, not-for-profitinstitutions and mutual fund clients. The loans to mutual funds and other pooled product clients include linesof credit and advances pursuant to the terms of the custody agreements betweenthe Company and those clients to facilitate securities transactions andredemptions.  Almost all of the Company’scommitments to fund loans are at variable rates.  The credit risk associated with these loansis considered low since the loans are, or may be, in the event of default,collateralized with marketable securities held by the Company as custodian.  However,management recognizes some credit risk inherent in the portfolio, and thereforethe Company has recorded an allowance for loan losses of $0.1 million atMarch 31, 2007, a level which has remained consistent for the past fiveyears.  This allowance is not allocated to any particular loan, but isintended to absorb any risk of loss inherent in the loan portfolio at thebalance sheet date that is not captured in the Company’s historical lossrates.  Management actively monitors theloan portfolio and the underlying collateral and regularly assesses theadequacy of the allowance for loan losses. There were no impaired loans, nonperforming loans or loans onnonaccrual status at March 31, 2007 or December 31, 2006.  In addition, there were no loan charge-offsor recoveries during the three months ended March 31, 2007 or 2006.  Loans are summarized as follows (Dollars inthousands):

|                                 | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **2007**           | ** ** | **2006**              | ** ** |
|                            |       |               |       |                  |       |
| Loans to mutual  funds          |       | $                  | 110,218    |                  | $          | 152,491 |   |
| Loans to  individuals           |       | 94,312             |       | 64,118                |       |
| Commercial and  industrial      |       | 5,618              |       | 6,634                 |       |
| Other                           |       | 48,907             |       | 47,550                |       |
|                            |       | 259,055            |       | 270,793               |       |
| Less allowance  for loan losses |       | (100               | )          | (100                  | )          |
|                            |       |               |       |                  |       |
| Total                           |       | $                  | 258,955    |                  | $          | 270,693 |   |

 

**5.     Deposits**

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

|                                     | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                          | ** ** | **2007**           | ** ** | **2006**              | ** ** |
| Interest-bearing  deposits:         |       |               |       |                  |       |
| Demand                              |       | $                  | 121,218    |                  | $          | 110,647 |   |
| Savings                             |       | 6,453,385          |       | 4,854,711             |       |
| Time                                |       | 255,260            |       | 224,386               |       |
| Total  interest-bearing deposits    |       | 6,829,863          |       | 5,189,744             |       |
|                                |       |               |       |                  |       |
| Noninterest-bearing  deposits:      |       |               |       |                  |       |
| Demand                              |       | 1,231,926          |       | 585,174               |       |
| Savings                             |       | 46,241             |       | 70,024                |       |
| Time                                |       | 375,000            |       | 300,000               |       |
| Total  noninterest-bearing deposits |       | 1,653,167          |       | 955,198               |       |
| Total                               |       | $                  | 8,483,030  |                  | $          | 6,144,942 |   |

 

Time deposits withbalances greater than $100,000 totaled $630.3 million and $524.4 million atMarch 31, 2007 and December 31, 2006, respectively.  All time deposits had a maturity of less thanthree months at March 31, 2007 and December 31, 2006.  The aggregate amounts of overdraft depositsthat have been reclassified as loan balances were $131.3 million and $86.2million at March 31, 2007 and December 31, 2006, respectively.

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**6.     Securities Sold Under Repurchase Agreements**

The components ofsecurities sold under repurchase agreements are as follows (Dollars inthousands):

|                                     | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                          | ** ** | **2007**           | ** ** | **2006**              | ** ** |
|                                |       |               |       |                  |       |
| Repurchase  agreements - short term |       | $                  | 4,424,073  |                  | $          | 3,627,800 |   |
| Repurchase  agreements - long term  |       | —             |       | 100,000               |       |
| Total                               |       | $                  | 4,424,073  |                  | $          | 3,727,800 |   |

 

Approximately $4.6 billionand $3.9 billion of securities were pledged to collateralize repurchaseagreements as of March 31, 2007 and December 31, 2006, respectively.

**7.     Short-term and Other Borrowings**

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

|                                 | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **2007**           | ** ** | **2006**              | ** ** |
|                            |       |               |       |                  |       |
| Federal funds  purchased        |       | $                  | 62,497     |                  | $          | 391,967 |   |
| FHLBB overnight  advances       |       | —             |       | 125,000               |       |
| Treasury, Tax  and Loan account |       | —             |       | 84                    |       |
| Total                           |       | $                  | 62,497     |                  | $          | 517,051 |   |

 

The Company has borrowingarrangements with the Federal Reserve Discount Window and the FHLBB, which havebeen utilized on an overnight and short-term basis to satisfy fundingrequirements.  A summary of the borrowingarrangements are as follows (Dollars in thousands):

|                                    | ** ** | **March 31,  2007** | ** ** | **December 31,  2006** | ** ** |
|------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                         | ** ** | ** **               | ** ** | ** **                  | ** ** |
| Federal Reserve  Discount Window:  |       |                     |       |                        |       |
| Borrowing capacity                 |       | $                        | 1,997,442  |                        | $          | 1,984,499 |   |
| Borrowing utilized                 |       | —                   |       | —                      |       |
| Maturity range                     |       | —                   |       | —                      |       |
| Securities pledged                 |       | 2,086,828                |       | 2,077,291                   |       |
|                               |       |                     |       |                        |       |
| Federal Home  Loan Bank of Boston: |       |                     |       |                        |       |
| Borrowing capacity                 |       | $                        | 114,523    |                        | $          | 146,430 |   |
| Borrowing utilized                 |       | —                   |       | 125,000                     |       |
| Maturity range                     |       | —                   |       | Overnight                   |       |
| Securities  pledged                |       | 932,399                  |       | 925,286                     |       |

 

**8.     Stockholders’ Equity**

As of March 31, 2007, theCompany’s capital stock consisted of 1,000,000 authorized shares of preferredstock, of which no shares were issued, and 175,000,000 authorized shares ofcommon stock, of which 69,660,108 shares were issued.  All shares have a par value of $0.01 pershare.

The Company has fourequity incentive plans:  the Amended andRestated 1995 Stock Plan (‘Stock Plan’), the Amended and Restated 1995Non-Employee Director Stock Option Plan (‘Director Plan’), the 1997 EmployeeStock Purchase Plan (‘ESPP’) and the 2005 Equity Incentive Plan (the ‘2005 Plan’).  The 2005 Plan supersedes both the Stock Planand the Director Plan, both of which continue in effect only with regard tooptions outstanding under those plans. Options awarded under the Stock Plan, the Director Plan and the 2005Plan generally vest over zero to nine years of continuous service and generallyhave ten-year contractual terms.  Theexercise prices of these awards are generally equal to the fair market value ofthe Company’s common stock on the date the awards are granted.  There were no amendments to any plans duringthe three months ended March 31, 2007.

13

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** **

Cash received fromoptions exercised under all share-based payment arrangements for the threemonths ended March 31, 2007 was $29.5 million.  The actual tax benefit realized for the taxdeductions related to these exercises amounted to $6.6 million for the threemonths ended March 31, 2007.

In June 2006, the Company announced that its Board ofDirectors authorized a repurchase plan of up to $150.0 million of the Company’scommon stock over the twelve months following the announcement.  As of March 31, 2007, the Company hasrepurchased $29.3 million of its common stock.  The plan expires in June 2007.

*The Stock Plan, the Director Plan, and the 2005Plan*

Effective with the start of the 2005 Plan, 45,703shares of the Director Plan and 3,439,197 shares of the Stock Plan weretransferred to the 2005 Plan.  On April14, 2005, the shareholders authorized an additional 2,000,000 shares of commonstock for issuance under the 2005 Plan.

A summary of optionactivity under the Stock Plan, the Director Plan and the 2005 Plan for thethree months ended March 31, 2007 is as follows:

| Options                         | ** ** | **Number of  Options** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Weighted-Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value  ($000)** | ** ** |
|---------------------------------|------------|-----------------------------|------------|-----------------------------------------|------------|----------------------------------------------------|------------|-----------------------------------------|------------|
| Outstanding at  January 1, 2007 |       | 5,707,273                   |       | $                                       | 31         |                                               |       |                                    |       |   |
| Granted                         |       | 828,057                     |       | 47                                      |       |                                               |       |                                    |       |
| Exercised                       |       | (873,349                    | )          | 34                                      |       |                                               |       |                                    |       |
| Forfeited or  expired           |       | (14,223                     | )          | 43                                      |       |                                               |       |                                    |       |
| Outstanding at  March 31, 2007  |       | 5,647,758                   |       | 33                                      |       | 5.9 years                                          |       | $                                       | 140,937    |   |
| Exercisable at March  31, 2007  |       | 4,717,320                   |       | $                                       | 31         |                                               | 5.2 years  |                                    | $          | 129,150 |   |

 

The weighted-average grant-date fair values per optionof options granted during the three months ended March 31, 2007 and 2006 were$26.37 and $19.24, respectively.  Thetotal intrinsic values of options exercised during the three months ended March31, 2007 and 2006 were $22.1 million and $7.1 million, respectively.

As of March 31, 2007, there was $21.5 million of totalunrecognized compensation cost related to nonvested share-based compensationarrangements granted under the Stock Plan, the Director Plan and the 2005Plan.  That cost is expected to berecognized over a weighted-average period of 4.2 years.

A summary of the statusof the Company’s nonvested shares for the three months ended March 31, 2007 ispresented below:

| Nonvested Shares         | ** ** | **Number of  Shares** | ** ** | **Weighted-Average  Grant-Date  Fair Value** | ** ** |
|-------------------------------|------------|----------------------------|------------|---------------------------------------------------|------------|
| Nonvested at  January 1, 2007 |       | 4,000                      |       | $                                                 | 34         |   |
| Granted                       |       | 278,225                    |       | 47                                                |       |
| Vested                        |       | —                     |       | —                                            |       |
| Forfeited                     |       | (4,421                     | )          | 47                                                |       |
| Nonvested at March 31,  2007  |       | 277,804                    |       | $                                                 | 47         |   |

 

As of March 31, 2007,there was $12.7 million of total unrecognized compensation cost related tononvested shares granted under the Stock Plan, the Director Plan and the 2005Plan.  That cost is expected to berecognized over a weighted-average period of 4.6 years.

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** **

*ESPP*

Under the terms of theESPP, the Company may issue up to 1,620,000 shares of common stock pursuant tothe exercise of nontransferable options granted to participatingemployees.  The ESPP permits eligibleemployees to purchase up to 8,000 shares of common stock per payment period,subject to limitations provided by Section 423(b) of the Internal RevenueCode, through accumulated payroll deductions. The purchases are made twice a year at a price equal to the lesser of(i) 90% of the market value of the Company’s common stock on the firstbusiness day of the payment period or (ii) 90% of the market value of theCompany’s common stock on the last business day of the payment period.  The payment periods consist of two six-monthperiods, January 1 through June 30 and July 1 throughDecember 31.  The NASDAQ StockMarket became a registered national securities exchange with the SEC in August2006.  In accordance with the terms ofthe plan, because the Company is now traded on a national securities exchange,the Company will calculate the market value on a measurement day to be theaverage of the high and low prices of the Company’s common stock on that day.  This calculation method applies toall purchases made during and after the six-month period ended December 31,2006.

A summary of activityunder the ESPP is as follows:

|                                                            | ** ** | **For the Three** | ** ** | **For the**      | ** ** |
|------------------------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                 | ** ** | **Months Ended**  | ** ** | **Year Ended**   | ** ** |
| ** **                                                 | ** ** | **March 31,**     | ** ** | **December 31,** | ** ** |
| ** **                                                 | ** ** | **2007**          | ** ** | **2006**         | ** ** |
|                                                       |       |              |       |             |       |
| Total shares available under the plan, beginning of period |       | 387,255           |       | 521,563          |       |
| Issued at June 30                                          |       | —            |       | (68,506          | )          |
| Issued at December 31                                      |       | —            |       | (65,802          | )          |
| Total shares available under the plan, end of period       |       | 387,255           |       | 387,255          |       |

 

For the first paymentperiod in the year ended December 31, 2006, the purchase price of the stock was$33.52, or 90% of the market value of the Company’s common stock on the firstbusiness day of the payment period ending June 30, 2006.  For the second payment period in the yearended December 31, 2006, the purchase price of the stock was $38.45, or 90% ofthe market value of the average of the high and low price of the Company’scommon stock on the last business day of the payment  period ending December 31, 2006.

Prior to the adoption ofSFAS 123R, the ESPP was considered a non-compensatory plan and, therefore, nocompensation cost was recognized. However, pursuant to SFAS 123R, the ESPP is considered a compensatoryplan, effective January 1, 2006. Accordingly, compensation cost is computed as the sum of:  (a) 10% of the fair market value of theCompany’s common stock on the first day of the purchase period and (b) the fairvalue of the option features, calculated using the Black-Scholes valuationmodel.  Compensation cost is recognizedratably over the payment period based on the components of fair value in thepreceding sentence and the number of shares that could be purchased at grantdate based on the estimated total withholdings and the discounted market priceof the stock on grant date.  Theweighted-average grant-date fair value of awards granted under the ESPP was$8.17 per share for the three months ended March 31, 2007.

Compensation cost related to the ESPP was $0.3 millionand $0.2 million for the three months ended March 31, 2007 and 2006,respectively.  As of March 31, 2007,there was $0.3 million of total unrecognized compensation cost related to thenonvested awards granted under the ESPP.

**9.     Employee Benefit Plans**

***PensionPlan —***The Company has a trusteed, noncontributory,qualified defined benefit pension plan (‘Pension Plan’) covering substantiallyall of its employees who were hired before January 1, 1997.  The benefits are based on years of serviceand the employee’s compensation during employment.  Generally, the Company’s funding policy is tocontribute annually the maximum amount that can be deducted for federal incometax purposes.  Contributions are intendedto provide not only for benefits attributed to service to date, but also forbenefits expected to be earned in the future. The plan document was amended in December 2001 and December 2004 tofreeze benefit accruals for certain highly compensated participants.  Effective December 31, 2005, all Pension Planparticipant’s accounts were frozen and effective January 1, 2006, no furtherPension Plan benefit will accrue on behalf of any Pension Planparticipant.   The Company uses aDecember 31 measurement date for this plan.

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** **

Net periodic pensionbenefit for the Company’s Pension Plan included the following components(Dollars in thousands):

|                                                    | ** ** | **For the Three Months Ended** | ** ** |
|----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                         | ** ** | **March 31,  2007**                           | ** ** | **March 31,  2006** | ** ** |
|                                               |       |                                               |       |   |   |
| Interest cost on  projected benefit obligations    |       | $                                                  | 252        |   | $ | 235 |   |
| Expected return  on plan assets                    |       | (378                                               | )          | (349 | ) |
| Amortization of  net transition (asset) obligation |       | —                                             |       | (7 | ) |
| Amortization of  net loss                          |       | 6                                                  |       | 25 |   |
| Net periodic  pension benefit                      |       | $                                                  | (120       | ) | $ | (96 | ) |

 

The Company does notexpect to contribute to its Pension Plan during 2007, and no contributions weremade during the three-month period ended March 31, 2007.

***SupplementalRetirement Plan*** — The Company also has a nonqualified,unfunded, supplemental retirement plan (‘SERP’) which was established in 1994and covers certain employees and pays benefits that supplement any benefitspaid under the Pension Plan.  Benefitsunder the SERP are generally based on compensation not includable in thecalculation of benefits to be paid under the Pension Plan.  The plan document was amended in April 2000to eliminate the compensation cap and include bonuses and commissions ofcertain employees.  The Company uses aDecember 31 measurement date for this plan.

Net periodic pension costfor the Company’s SERP included the following components (Dollars inthousands):

|                                                     | ** ** | **For the Three Months Ended** | ** ** |
|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                          | ** ** | **March 31,  2007**                           | ** ** | **March 31,  2006** | ** ** |
|                                                |       |                                               |       |   |   |
| Service  cost-benefits earned / benefit obligations |       | $                                                  | 424        |   | $ | 462 |   |
| Interest cost on  projected benefit obligations     |       | 440                                                |       | 396 |   |
| Amortization of  net transition (asset) obligation  |       | 1                                                  |       | 1 |   |
| Amortization of  prior service cost                 |       | 36                                                 |       | 36 |   |
| Amortization of  net loss                           |       | 160                                                |       | 202 |   |
| Net periodic  pension cost                          |       | $                                                  | 1,061      |   | $ | 1,097 |   |

 

During the three-monthperiod ended, March 31, 2007, the Company contributed $0.03 million to theSERP, and the SERP distributed $0.03 million to its plan participants.  The Company does not anticipate making anycontributions during the remainder of 2007.

Effective December 31,2006, the Company adopted the provisions of FASB Statement No. 158, *Employers’ Accounting for Defined Benefit Pension and OtherPostretirement Plans*(‘SFAS 158’). SFAS 158 changes current practice by requiring employers torecognize the overfunded or underfunded positions of defined benefitpostretirement plans, including pension plans, on the balance sheet.  Thefunded status is defined as the difference between the projected benefitobligation and the fair value of plan assets.  SFAS 158 also requiresemployers to recognize the change in funded status in other comprehensiveincome (a component of shareholders’ equity). Upon adopting SFAS 158, the Company recognized the funded status of itsSERP and pension plans on its consolidated balance sheet.

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**10.  Off-Balance Sheet Financial Instruments**

***Lines of Credit —***At March 31, 2007,the Company had commitments to mutual funds, individuals and others undercollateralized open lines of credit totaling $1.3 billion, against which$127.7 million in loans were drawn. The credit risk involved in issuinglines of credit is essentially the same as that involved in extending demandloans. The Company does not anticipate any loss as a result of these lines ofcredit.

***Securities Lending —***On behalf of itsclients, the Company lends securities to creditworthy broker-dealers. Incertain circumstances, the Company may indemnify its clients for the fairmarket value of those securities against a failure of the borrower to returnsuch securities. The Company requires the borrowers to provide collateral in anamount equal to, or in excess of, 102% of the fair market value of U.S.dollar-denominated securities borrowed and 105% of the fair market value ofnon-U.S. dollar-denominated securities borrowed. The borrowed securities arerevalued daily to determine whether additional collateral is necessary. Asguarantor, the Company is required to recognize, at the inception of aguarantee, a liability for the fair value of the obligation undertaken inissuing 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 fair value of the indemnification obligationto be recorded would be the deficiency of collateral as compared to the valueof the securities out on loan.

With respect to theindemnified securities lending portfolio, the cash and U.S. governmentsecurities held by the Company as collateral at March 31, 2007 totaled $11.8billion, while the fair value of the indemnified securities lending portfoliototaled approximately $11.3 billion. Given that the collateral held was inexcess of the value of the securities that the Company would be required to replaceif the borrower defaulted and failed to return such securities, the Company’sindemnification obligation was zero and no liability was recorded.

All securities loans arecategorized as overnight loans. The maximum potential amount of future paymentsthat the Company could be required to make would be equal to the market valueof the securities borrowed. Since the securities loans are over collateralizedby 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. Inaddition, each borrowing agreement includes “set-off” language that allows theCompany to use any excess collateral on other loans to that borrower to coverany collateral shortfall of that borrower. However, there is a potential riskthat the collateral would not be sufficient to cover such an obligation if thesecurity on loan increased in value between the time the borrower defaulted andthe time the security is “bought-in”. In those instances, the Company would “buy-in”the security using all available collateral and a loss would result from thedifference between the value of the security “bought-in” and the value of thecollateral held. The Company has never experienced a broker default.

**11.  Derivative Financial Instruments**

***InterestRate Contracts*** — Interest rate contracts involve anagreement with a counterparty to exchange cash flows based on an underlyinginterest rate index. A swap agreement involves the exchange of a series ofinterest payments, either at a fixed or variable-rate, based upon the notionalamount without the exchange of the underlying principal amount. The Company’sexposure from these interest rate contracts results from the possibility thatone party may default on its contractual obligation when the contracts are in again position. The Company has experienced no terminations by counterparties ofinterest rate swaps. Credit risk is limited to the positive fair value of thederivative financial instrument, which is significantly less than the notionalvalue. The positive fair values related to the Company’s interest ratecontracts was approximately $9.0 million and $13.8 million at March 31, 2007and December 31, 2006, respectively, which are included in other assets on theCompany’s consolidated balance sheet.

The Company enters intopay-fixed/receive-floating interest rate swap agreements. These instrumentshave been designated as cash flow hedges of variable-rate liabilities and aforecasted series of fixed-rate overnight liabilities incurred at differentdaily fixed rates (thereby resulting in a variable interest expense pattern). Thecontractual or notional amounts of the interest rate swap agreements held by theCompany were approximately $1.3 billion at March 31, 2007 and $1.6 billion atDecember 31, 2006, respectively. These contracts had net fair values ofapproximately $8.9 million and $13.8 million at March 31, 2007 and December 31,2006, respectively. These fair values are included in the respective otherassets and other liabilities categories on the Company’s consolidated balancesheets.

For the three monthsended March 31, 2007, the Company recognized net pre-tax losses of $0.7million, which represented the total ineffectiveness for all cash flow hedges. Hedgeineffectiveness did not have a material impact on earnings for the three monthsended March 31, 2006.

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As of March 31, 2007, theCompany expects that approximately $3.4 million of deferred net after-tax gainson derivative contracts included in other comprehensive income will bereclassified to net interest income within the next twelve months. Thisexpectation is based on the net discounted cash flows from existing cash flowhedging derivatives, as well as the amortization of gains from the terminatedcash flow hedging derivatives.

***ForeignExchange Contracts*** — Foreign exchange contracts involvean agreement to exchange the currency of one country for the currency ofanother country at an agreed-upon rate and settlement date. Foreign exchangecontracts consist of spot, forward and swap contracts. Spot contracts call forthe exchange of one currency for another and usually settle in two businessdays. Forward contracts call for the exchange of one currency for another at adate beyond spot. In a currency swap, the holder of a currency transactssimultaneously both a spot and a forward transaction in that currency for anequivalent amount of another currency to get temporary liquidity in thecurrency owned. The Company’s risk from foreign exchange contracts results fromthe possibility that one party may default on its contractual obligation orfrom 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 value of the Company’s foreign exchangecontracts at March 31, 2007 and December 31, 2006 was $17.0 billion and $13.5billion, respectively. Unrealized gains or losses resulting from purchases andsales of foreign exchange contracts are included within the respective otherassets and other liabilities categories on the Company’s consolidated balancesheets. Unrealized gains in other assets were $24.8 million and $27.5 millionat March 31, 2007 and December 31, 2006, respectively. Unrealized losses inother liabilities were $23.2 million and $27.0 million at March 31, 2007 andDecember 31, 2006, respectively. Foreign exchange contracts with the samecounterparty are netted in the Company’s consolidated balance sheets when amaster netting agreement exists. These contracts have not been designated ashedging instruments; therefore, all changes in fair value are included in assetservicing fees.

***Other***— The Company also enters into fixed price purchase contracts that are designedto hedge the variability of the consideration to be paid for the purchase ofinvestment securities. By entering into these contracts, the Company is fixingthe price to be paid at a future date for certain investment securities. Changesin fair value of these cash flow hedges are included as a component of othercomprehensive income. The Company had no fixed price purchase contractsoutstanding to purchase investment securities at March 31, 2007 and December31, 2006.

**12.  Commitments and Contingencies**

***Restrictionson Cash Balances*** — The Company is required to maintaincertain average cash reserve balances. The average required reserve balancewith the FRBB for the two-week period including March 31, 2007 wasapproximately $55.4 million. In addition, the Company’s consolidated balancesheet includes deposits totaling $32.8 million, which were pledged to secureclearings with depository institutions as of March 31, 2007.

***Contingencies***— Assets held by the Company in a fiduciary capacity are not included in theconsolidated balance sheets since these items are not assets of the Company. Managementconducts regular reviews of its fiduciary responsibilities and considers theresults in preparing its consolidated financial statements. In the opinion ofmanagement, there were no contingent liabilities related to its fiduciarycapacity at March 31, 2007 that were material to the consolidated financialposition or consolidated results of operations of the Company.

**13.  Regulatory Matters**

The Company and the Bankare subject to various regulatory capital requirements administered by thefederal banking agencies. Failure to meet minimum capital requirements caninitiate certain mandatory and possibly additional discretionary actions byregulators that, if undertaken, could have a direct material effect on theCompany’s and the Bank’s financial statements. 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 capitalamounts and classification are also subject to qualitative judgments by theregulators about components, risk weightings, and other factors.

Quantitative measuresestablished by regulation to ensure capital adequacy require the Company andthe Bank to maintain minimum amounts and ratios (set forth in the table below)of Total and Tier 1 capital (as defined in the regulations) to risk-weightedassets (as defined), and of Tier 1 capital (as defined) to average assets (asdefined). Management believes, as of March 31, 2007, that the Company and the Bankmeet all capital adequacy requirements to which they are subject.

18

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As of March 31, 2007, themost recent notification from the Federal Deposit Insurance Corporationcategorized the Company and the Bank as well-capitalized under the regulatoryframework for prompt corrective action. To be categorized as well-capitalized,the Company and the Bank must maintain minimum Total risk-based, Tier 1risk-based, and Tier 1 leverage ratios as set forth in the table. There are noconditions or events since that notification that management believes havechanged the Company’s or the Bank’s category.

The followingtable presents the capital ratios for the Company and the Bank (Dollars inthousands):
| ** **                                            | ** ** | **Actual**     | ** ** | **For Capital  Adequacy Purposes** | ** ** | **To Be  Well-Capitalized  Under Prompt  Corrective Action  Provisions** | ** ** |
|-------------------------------------------------------|------------|----------------|------------|----------------------------------------------|------------|------------------------------------------------------------------------------------|------------|
| ** **                                            | ** ** | **Amount**     | ** ** | **Ratio**                                    | ** ** | **Amount**                                                                         | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **As of  March 31, 2007:**                            | ** ** | ** **     | ** ** | ** **                                   | ** ** | ** **                                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total Capital  (to Risk-Weighted Assets-the Company)  |       | $ 977,070 |       | 17.95                                        | %          | $ 435,496                                                                     |       | 8.00 | % | N/A |   | N/A |   |
| Total Capital  (to Risk-Weighted Assets-the Bank)     |       | $ 905,151 |       | 16.63                                        | %          | $ 435,355                                                                     |       | 8.00 | % | $ 544,194 |   | 10.00 | % |
| Tier 1 Capital  (to Risk-Weighted Assets-the Company) |       | $ 976,970 |       | 17.95                                        | %          | $ 217,748                                                                     |       | 4.00 | % | N/A |   | N/A |   |
| Tier 1 Capital  (to Risk-Weighted Assets-the Bank)    |       | $ 905,051 |       | 16.63                                        | %          | $ 217,677                                                                     |       | 4.00 | % | $ 326,516 |   | 6.00 | % |
| Tier 1 Capital  (to Average Assets-the Company)       |       | $ 976,970 |       | 7.66                                         | %          | $ 510,029                                                                     |       | 4.00 | % | N/A |   | N/A |   |
| Tier 1 Capital  (to Average Assets-the Bank)          |       | $ 905,051 |       | 7.10                                         | %          | $ 509,821                                                                     |       | 4.00 | % | $ 637,276 |   | 5.00 | % |
| **As of December 31, 2006:**                          | ** ** | ** **     | ** ** | ** **                                   | ** ** | ** **                                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total Capital  (to Risk-Weighted Assets-the Company)  |       | $ 900,299 |       | 19.04                                        | %          | $ 378,305                                                                     |       | 8.00 | % | N/A |   | N/A |   |
| Total Capital  (to Risk-Weighted Assets-the Bank)     |       | $ 863,841 |       | 18.28                                        | %          | $ 378,048                                                                     |       | 8.00 | % | $ 472,560 |   | 10.00 | % |
| Tier 1 Capital  (to Risk-Weighted Assets-the Company) |       | $ 900,199 |       | 19.04                                        | %          | $ 189,152                                                                     |       | 4.00 | % | N/A |   | N/A |   |
| Tier 1 Capital  (to Risk-Weighted Assets-the Bank)    |       | $ 863,741 |       | 18.28                                        | %          | $ 189,024                                                                     |       | 4.00 | % | $ 283,536 |   | 6.00 | % |
| Tier 1 Capital  (to Average Assets-the Company)       |       | $ 900,199 |       | 7.63                                         | %          | $ 472,082                                                                     |       | 4.00 | % | N/A |   | N/A |   |
| Tier 1 Capital  (to Average Assets-the Bank)          |       | $ 863,741 |       | 7.32                                         | %          | $ 471,715                                                                     |       | 4.00 | % | $ 589,643 |   | 5.00 | % |

 

Under Massachusetts law,trust companies such as the Bank, like national banks, may pay dividends nomore often than quarterly and only out of net profits and to the extent thatsuch payments will not impair the Bank’s capital stock and surplus account. Moreover,prior Commissioner approval is required if the total dividends for a calendaryear would exceed net profits for that year combined with retained net profitsfor the previous two years. These restrictions on the ability of the Bank topay dividends to the Company may restrict the ability of the Company to paydividends to its stockholders.

The operations of theCompany’s securities broker affiliate, Investors Securities Services, LLC (‘ISS’),are subject to federal and state securities laws, as well as the rules of boththe SEC and the NASD. Management believes, as of March 31, 2007, that ISS is inmaterial compliance with all of the foregoing requirements to which it issubject.

The operations of theCompany’s captive insurance affiliate, Investors Vermont Insurance Company(‘IVIC’), are subject to the laws and regulations of the BISHCA. Managementbelieves, as of March 31, 2007, that IVIC is in material compliance with all ofthe foregoing requirements to which it is subject.

The operations of theCompany’s affiliated international subsidiaries are subject to laws andregulations of various regulators, including the OSFI, the IFSRA, the CIMA, theFSA and the CSSF. Management believes, as of March 31, 2007, that itsaffiliated international subsidiaries are all in compliance with all of theforegoing requirements to which each is subject.

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InJune 2004, the Basel Committee on Banking Supervision (‘Basel Committee’)released the document “International Convergence of Capital Measurement andCapital Standards: A Revised Framework.” The Framework, also referred to asBasel II, is designed to secure international convergence on regulations andstandards governing the capital adequacy of internationally active bankingorganizations. In September 2006, the U.S. banking and thrift supervisoryagencies issued a notice of Proposed Rulemaking setting forth a proposedframework for the timing and qualification process for U.S. banks that areeither required (“core banks”) or choose (“opt-in banks”) to be subject toBasel II. As currently proposed, the new rules as applied in the U.S. areexpected to become effective on January 1, 2009, subject to transitionalparallel testing beginning on January 1, 2008. Although the Bank is notrequired to be compliant with the new rules, the Bank is in the process ofdeveloping and implementing a program to achieve Basel II compliance. Ultimately,U.S. implementation of Basel II will depend on, and will be subject to, finalregulations and related policies promulgated by the U.S. supervisory agencies. TheBank cannot predict the final form of the rules, nor their impact on itsrisk-based capital.

**14.  Geographic Reporting and Service Lines**

The Company doesnot utilize segment information for internal reporting, as management views theCompany as one segment. The following represents net operating revenue andlong-lived assets (including goodwill) by geographic area (Dollars inthousands):
| ** **                      | ** ** | **Net Operating Revenue**    | ** ** | **Long-Lived Assets**             | ** ** |
|---------------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|
| ** **                      | ** ** | **Three Months Ended**       | ** ** | ** **                             | ** ** | ** ** | ** ** |
| ** **                      | ** ** | **March 31,**                     | ** ** | **March 31,**                     | ** ** | **December 31,** | ** ** |
| **Geographic Information** | ** ** | **2007**                               | ** ** | **2006**                               | ** ** | **2007** | ** ** | **2006** | ** ** |
| United States                   |       | $     204,304 |       | $     180,758 |       | $     196,984 |   | $     182,276 |   |
| Ireland                         |       | 14,063                                 |       | 10,411                                 |       | 13,128 |   | 9,269 |   |
| Canada                          |       | 1,689                                  |       | 1,508                                  |       | 125 |   | 116 |   |
| Luxembourg                      |       | 127                                    |       | —                                 |       | 83 |   | 75 |   |
| United Kingdom                  |       | 81                                     |       | 70                                     |       | 1,417 |   | 1,520 |   |
| Cayman Islands                  |       | 34                                     |       | 41                                     |       | — |   | — |   |
| Total                           |       | $     220,298 |       | $     192,788 |       | $     211,737 |   | $     193,256 |   |

 

Barclays GlobalInvestors, N.A. (‘BGI’) accounted for approximately 18% of the Company’sconsolidated net operating revenues for the three-month periods ended March 31,2007 and 2006. No client other than BGI accounted for more than 10% of theCompany’s consolidated net operating revenues for the three-month periods endedMarch 31, 2007 and 2006.

The followingrepresents the Company’s asset servicing fees by service lines (Dollars inthousands):

|                                        | ** ** | **For the Three Months Ended** | ** ** |
|----------------------------------------|------------|----------------------------------------------------|------------|
| ** **                             | ** ** | **March 31,**                                 | ** ** |
|                                   |       | 2007                                               |       | 2006 |   |
| Core service  fees:                    |       |                                               |       |   |   |
| Custody, accounting and administration |       | $     129,026             |       | $     107,759 |   |
| Value-added service fees:              |       |                                               |       |   |   |
| Foreign exchange                       |       | 17,594                                             |       | 20,334 |   |
| Cash management                        |       | 14,343                                             |       | 11,312 |   |
| Securities lending                     |       | 6,060                                              |       | 6,162 |   |
| Investment advisory                    |       | 1,839                                              |       | 1,936 |   |
| Other service fees                     |       | 791                                                |       | 800 |   |
| Total value-added service fees         |       | 40,627                                             |       | 40,544 |   |
| Total asset servicing  fees            |       | $     169,653             |       | $     148,303 |   |

 

20

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** **

**15.  NetInterest Income**

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

|                                                                                                                                                   | ** ** | **For the Three Months Ended** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                                                                                        | ** ** | **March 31,**                                 | ** ** |
| ** **                                                                                                                                        | ** ** | **2007**                                           | ** ** | **2006** | ** ** |
| **Interest  income:**                                                                                                                             |       |                                               |       |   |   |
| Federal funds sold and securities purchased under resale  agreements, interest-bearing deposits with other banksand other short-term  investments |       | $       20,762  |       | $            478 |   |
| Investment securities:                                                                                                                            |       |                                               |       |   |   |
| Mortgage-backed securities                                                                                                                        |       | 102,838                                            |       | 96,777 |   |
| Federal agency securities                                                                                                                         |       | 20,964                                             |       | 24,663 |   |
| State and political subdivisions (exempt from  federal tax)                                                                                       |       | 4,600                                              |       | 5,503 |   |
| Other securities                                                                                                                                  |       | 2,665                                              |       | 2,807 |   |
| Loans                                                                                                                                             |       | 6,156                                              |       | 4,209 |   |
| Total interest income                                                                                                                             |       | 157,985                                            |       | 134,437 |   |
| **Interest expense:**                                                                                                                             |       |                                               |       |   |   |
| Deposits                                                                                                                                          |       | 62,444                                             |       | 33,687 |   |
| Securities sold under repurchase agreements                                                                                                       |       | 43,993                                             |       | 40,954 |   |
| Short-term and other borrowings                                                                                                                   |       | 1,777                                              |       | 15,870 |   |
| Junior subordinated debentures                                                                                                                    |       | 605                                                |       | 605 |   |
| Total interest expense                                                                                                                            |       | 108,819                                            |       | 91,116 |   |
| Net interest  income                                                                                                                              |       | $       49,166  |       | $       43,321 |   |

 

21

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** **

**REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

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

We have reviewed the accompanying consolidated balancesheet of Investors Financial Services Corp. and subsidiaries (the “Company”) asof March 31, 2007, and the related consolidated statements of income andcomprehensive income, stockholders’ equity and cash flows for the three-monthperiods ended March 31, 2007 and 2006. These interim financial statements arethe responsibility of the Company’s management.

We conducted our reviews in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Areview of interim financial information consists principally of applyinganalytical procedures and making inquiries of persons responsible for financialand accounting matters. It is substantially less in scope than an auditconducted in accordance with the standards of the Public Company AccountingOversight Board (United States), the objective of which is the expression of anopinion regarding the financial statements taken as a whole. Accordingly, we donot express such an opinion.

Based on our reviews, we are not aware of any materialmodifications that should be made to such consolidated interim financialstatements for them to be in conformity with accounting principles generallyaccepted in the United States of America.

We have previously audited, in accordance with thestandards of the Public Company Accounting Oversight Board (United States), theconsolidated balance sheet of Investors Financial Services Corp. andsubsidiaries as of December 31, 2006, and the related consolidated statementsof income and comprehensive income, stockholders’ equity, and cash flows forthe year then ended (not presented herein); and in our report dated February26, 2007, we expressed an unqualified opinion on those consolidated financialstatements. In our opinion, the information set forth in the accompanyingconsolidated balance sheet as of December 31, 2006 is fairly stated, in allmaterial respects, in relation to the consolidated balance sheet from which ithas been derived.

*DELOITTE & TOUCHE LLP*

Boston, MassachusettsMay 2, 2007

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** **

**Item 2.**           Management’s Discussion and Analysis ofFinancial Condition and Results of Operations

*Youshould read the following discussion together with our Unaudited ConsolidatedFinancial Statements and related Notes to Unaudited Consolidated Financial Statements,which are included elsewhere in this Report. The following discussion containsforward-looking statements that reflect plans, estimates and beliefs. Ouractual results could differ materially from those discussed in theforward-looking statements. See “Certain Factors That May Affect FutureResults.”*

*Unless otherwise indicated orunless the context requires otherwise, all references in this Report to “InvestorsFinancial,” “we,” “us,” “our,” or similar references mean Investors FinancialServices Corp., together with our subsidiaries. “Investors Bank” or the “Bank”means our subsidiary, Investors Bank & Trust Company, alone.*

**Overview**

We provide asset administrationservices for the financial services industry through our wholly-ownedsubsidiary, Investors Bank & Trust Company. We provide core services andvalue-added services to a variety of financial asset managers, including mutualfund complexes, investment advisors, family offices, hedge funds, banks andinsurance companies. Core services include global custody, multicurrencyaccounting, fund administration and middle office outsourcing. Value-addedservices include foreign exchange, cash management, securities lending,investment advisory, performance measurement, institutional transfer agency, linesof credit and brokerage and transition management services. We have officeslocated in the United States, Ireland, Canada, the Cayman Islands, the UnitedKingdom and Luxembourg with a vast global subcustodian network established toaccommodate the international needs of our clients. At March 31, 2007, weprovided services for approximately $2.3 trillion in net assets, includingapproximately $0.5 trillion in foreign net assets.

We grow our business by sellingour services to new clients and by further penetrating our existing clients. Webelieve that we service approximately 10% of the assets managed by our existingclients, and we have traditionally achieved significant success in growingclient relationships. Our ability to service new clients and expand ourrelationships with existing clients depends on our provision of superior clientservice. Our growth is also affected by conditions in the global securitiesmarkets, the interest rate environment, the regulatory environment for us andour clients and the success of our clients in marketing their products.

We derive our asset servicing revenue from providing core andvalue-added services. We derive our net interest income by investing the cashbalances our clients leave on deposit with us. Since we price our serviceofferings on a bundled basis, our share of earnings from these investments isviewed as part of the total compensation that our clients pay us for servicingtheir assets. In establishing a fee structure for a specific client, we analyzeall expected revenue and expenses. We believe net operating revenue (netinterest income plus noninterest income) and net income are the most meaningfulmeasures of our financial results.

As an asset administrationservices company, the amount of net operating revenue that we generate isimpacted by overall market conditions, client activity and the prevailinginterest rate environment. A significant portion of our core services revenueis based upon the amount of assets we process. As market values of underlyingassets fluctuate, so will our revenue. We have managed this volatility byoffering a tiered pricing structure for our asset-based fees. As asset valuesincrease, the basis point fee is reduced for the incremental assets. When assetvalues decrease, revenue is only impacted at the then marginal rate. Many ofour value-added services are transactional based, and we receive a fee for eachtransaction processed. Thehigher net interest margin experienced during the first three months of 2007 ascompared to the same period in 2006 is primarily a result of higher levels ofclient based funding relative to external borrowings. The yield curve hasremained inverted throughout the first quarter of 2007, impacting reinvestmentand purchase spreads on investments. The majority of our liability basereprices to overnight or short-term rates, which have remained stable duringthe first quarter 2007. The market implied forward yield curve, which is usedas a basis in our net interest income forecasting, incorporates a modeststeepening during the second half of 2007 which would positively impact ourforecasted net interest income.

On February 4,2007, we entered into an Agreement and Plan of Merger (the ‘Merger Agreement’)with State Street Corporation (‘State Street’). At the closing of thetransaction contemplated by the Merger Agreement, we will merge into StateStreet and our shareholders will receive 0.906 shares of State Street commonstock for each share of our common stock. Each company’s Board of Directors hasapproved the Merger Agreement. We expect to complete the transaction in thethird quarter of 2007, subject to customary closing conditions, includingregulatory and shareholder approval.

23

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**Certain Factors That May Affect Future Results**

From time to time,information provided by us, statements made by our employees, or informationincluded in our filings with the Securities Exchange Commission (‘SEC’)(including this Form 10-Q) may contain statements which are not historicalfacts, so-called “forward-looking statements,” which are made under Section 21Eof the Securities Exchange Act of 1934 and which involve risks anduncertainties. These statements relate tofuture events or our future financial performance and are identified by wordssuch as “may,” “could,” “should,” “expect,” “plan,” “intend,” “seek,” “anticipate,”“believe,” “estimate,” “potential,” or “continue” or other comparable terms orthe negative of those terms. Forward-looking statements in this Form10-Q include certain statements regarding the anticipated closing of ouracquisition by State Street Corporation, recognition of tax benefits,liquidity, capital resources, growth rate, annual dividend payments, interestrate conditions, the shape of the yield curve, interest rate sensitivity,compliance with capital adequacy guidelines, loss exposure on lines of credit,foreign exchange revenue, cash management revenue, securities lending revenue,net interest income, operating margin, operating expenses, includinginvestments in technology, investments in Federal Home Loan Bank of Boston (‘FHLBB’)capital stock, the effect on earnings of changes in equity values or fixedincome values, the effects of increased prepayments and reduced investmentopportunities for our net interest income, the effect of any anticipatedactivity under our stock repurchase plan, contributions to our supplementalretirement plan, the effect of new accounting pronouncements, the effect ofamortization and the effect of certain legal claims against us. Our actualfuture results may differ significantly from those stated in anyforward-looking statements. Factors that may cause such differences include,but are not limited to, the factors discussed in Item 1A of this Form 10-Q andour Form 10-K filed on February 27, 2007.

**Statementsof Income**

***Comparisonof Operating Results for the Three Months Ended March 31, 2007 and 2006***

Net income for thethree months ended March 31, 2007 increased 8% to $40.5 million from the sameperiod in 2006. The increase primarily resulted from increased net interestincome and asset servicing fees, which reflect our ability to sell to new andexisting clients, combined with market appreciation and strong client fundflows.

*Fees and Other Revenue*

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

|                               | ** ** | **For the Three Months Ended  March 31,** | ** ** |
|-------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                    | ** ** | **2007**                                                           | ** ** | **2006** | ** ** | **Change** | ** ** |
| Total asset  servicing fees   |       | $                                                                  | 169,653    |   | $ | 148,303 |   | 14 | % |
| Other operating  income       |       | 1,479                                                              |       | 1,164 |   | 27 | % |
| Total fees and other  revenue |       | $                                                                  | 171,132    |   | $ | 149,467 |   | 14 | % |

 

The largestcomponents of asset servicing fees are custody, accounting and administrationfees, which increased 20% to $129.0 million for the three-month period endedMarch 31, 2007 from $107.8 million for the same period in 2006. Custody, multicurrencyaccounting and fund administration fees are based in part on the value ofassets processed. Assets processed is the total dollar value of financialassets on the reported date for which we provide one or more of the following services: global custody, multicurrencyaccounting, fund administration, middle office outsourcing, foreign exchange,cash management, securities lending, investment advisory, performancemeasurement, institutional transfer agency, lines of credit and brokerage andtransition management services.

24

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The change in net assetsprocessed includes the following components(Dollars in billions):
| ** **                                 | ** ** | **For the Three Months Ended  March 31, 2007** | ** ** |
|--------------------------------------------|------------|------------------------------------------------------------------------------|------------|
|                                       |       |                                                                         |       |
| Net assets  processed, beginning of period |       | $                                                                            | 2,212      |   |
| Change in net  assets processed:           |       |                                                                         |       |
| Sales to new clients                       |       | 1                                                                            |       |
| Further penetration of existing clients    |       | 12                                                                           |       |
| Lost clients                               |       | —                                                                       |       |
| Fund flows and market gain                 |       | 51                                                                           |       |
| Total change in  net assets processed      |       | 64                                                                           |       |
| Net assets processed,  end of period       |       | $                                                                            | 2,276      |   |

 

The majority of the increase in assets processed for the three monthsended March 31, 2007 was due to client fund flows and market movements. Asindicated in the ‘Overview’ section, our core services fees are primarilygenerated by charging a fee based upon the value of assets processed. As marketvalues or clients’ asset levels fluctuate, so will our revenue. Our tieredpricing structure, coupled with minimum and flat fees, allow us to manage thisvolatility to a certain extent. As asset values increase, the basis point feetypically lowers. When asset values decrease, revenue is only impacted by theasset decline at the then marginal rate.

If the value of equity or fixed income assets held by our clients wereto increase or decrease by 10% for a sustained period of time, we estimatecurrently that this market movement, by itself, would cause a correspondingchange of less than 5% in our earnings per share. Earnings per share do nottrack precisely to the value of the equity and fixed-income markets becauseconditions present in a market increase or decrease may generate offsettingincreases or decreases in other revenue and expense items that are influencedby the value of the assets we administer. For example, increased marketvolatility often results in higher transaction fee revenue. Also, market valuedeclines may result in increased interest income and sweep fee income asclients move larger amounts of assets into the cash management vehicles that weoffer. In addition, our tiered pricing structure reduces the impact ofvolatility in asset values to a certain extent. However, there can be noassurance that any of these offsetting revenue and expense movements will occurduring any future upturn or downturn in the equity or fixed-income markets, orthat our tiered pricing structure will reduce the impact on us of a sustainedchange in asset values.

Transaction-driven incomeincludes our value-added services, such as foreign exchange, cash management,securities lending and investment advisory services.

·                  Foreignexchange fees were $17.6 million for the three-month period ended March 31,2007, down 13% from the same period in 2006. The decrease in foreign exchangefees is attributable to decreased volatility in currency markets. Futureforeign exchange income is dependent on the volume of new and existing clientactivity and overall volatility in the currencies traded.

·                  Cash management fees, which consist of sweep fees,were $14.3 million for the three-month period ended March 31, 2007, up 27% fromthe same period in 2006. The increase is primarily due to higher balancesplaced by our clients in the cash management products we offer. Cash managementfees will continue to depend on the level of client balances and

25

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interest rate volatility. If ourclients’ investment products continue to maintain higher cash balances thanthey did in comparable periods, we expect our cash management revenue to bepositively impacted.

·                  Securities lending fees were $6.1 million for thethree-month period ended March 31, 2007, down 2% from the same period in 2006,primarily due to lower transaction spreads in the first three months of 2007. Securitieslending transaction volume and spreads are positively affected by the marketvalue of securities on loan, merger and acquisition activity, increased IPOactivity, the seasonality of international dividend arbitrage and a steepershort-end of the yield curve. If the capital markets experience any of theaforementioned activity, it is likely that our securities lending revenue willbe positively impacted. If we experience any of the following: 1) a reductionin our securities lending portfolio volume, 2) lower market values or 3)compression of the spreads earned on securities lending activity, oursecurities lending revenue will likely be negatively impacted.

·                  Investment advisory fees were $1.8 million for thethree-month period ended March 31, 2007, down 5% for the same period in 2006due to lower asset values in our proprietary Merrimac money market funds. Futureinvestment advisory fee income is dependent upon asset levels within theMerrimac money market funds, which are driven by overall market conditions,client activity and transaction volumes.

·                  Other service fees were $0.8 million for thethree-month period ended March 31, 2007, down 1% from the same period in 2006. Otherservice fees include income earned on compliance advisory, brokerage andtransition management services. The decrease in other service fees is primarilydue to a decrease in transition management service fees.

·                  Other operating income for the three-month periodended March 31, 2007 was $1.5 million, up 27% from the same period in 2006,primarily due to an increase in interest earned on clearing agency deposits.

*Net Interest Income*

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

|                     | ** ** | **For the Three Months Ended March 31,** | ** ** |
|---------------------|------------|------------------------------------------------------------------------|------------|
| ** **          | ** ** | **2007**                                                               | ** ** | **2006** | ** ** | **Change** | ** ** |
| Interest income     |       | $                                                                      | 157,985    |   | $ | 134,437 |   | 18 | % |
| Interest expense    |       | 108,819                                                                |       | 91,116 |   | 19 | % |
| Net interest income |       | $                                                                      | 49,166     |   | $ | 43,321 |   | 13 | % |

 

Net interest income is affectedby the volume and mix of assets and liabilities and the movement and level ofinterest rates. Theincrease in our net interest income for the three-month period ended March 31,2007 was primarily due to strong client funding. Average investment securitybalances were down $0.8 billion for the three-month period ended March 31, 2007compared to the same period in 2006, primarily due to lower reinvestment.

The table below presents the changes in net interest income resultingfrom changes in the volume of interest-earning assets or interest-bearingliabilities and changes in interest rates for the three months ended March 31,2007 compared to the same period in 2006. Changes attributed to both volume andrate have been allocated based on the proportion of change in each category(Dollars in thousands):

|                                                                                                                                             | ** ** | **For the Three Months Ended  March 31, 2007** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------|------------|
| ** **                                                                                                                                  | ** ** | **Change**                                                                   | ** ** | **Change** | ** ** | ** ** | ** ** |
| ** **                                                                                                                                  | ** ** | **Due to**                                                              | ** ** | **Due to** | ** ** | ** ** | ** ** |
| ** **                                                                                                                                  | ** ** | **Volume**                                                                   | ** ** | **Rate** | ** ** | **Net** | ** ** |
| Interest-earning  assets:                                                                                                                   |       |                                                                         |       |   |   |   |   |
| Federal funds sold and securitiespurchased under  resale agreements, interest-bearing deposits with other banks and short-term  investments |       | $                                                                            | 20,187     |   | $ | 97 |   | $ | 20,284 |   |
| Investment securities                                                                                                                       |       | (9,807                                                                       | )          | 11,124 |   | 1,317 |   |
| Loans                                                                                                                                       |       | 109                                                                          |       | 1,838 |   | 1,947 |   |
| Total interest-earning assets                                                                                                               |       | 10,489                                                                       |       | 13,059 |   | 23,548 |   |
| Interest-bearing liabilities:                                                                                                               | ** ** | ** **                                                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Deposits                                                                                                                                    |       | 18,656                                                                       |       | 10,101 |   | 28,757 |   |
| Borrowings                                                                                                                                  |       | (21,809                                                                      | )          | 10,755 |   | (11,054 | ) |
|                                                                                                                                        |       |                                                                         |       |   |   |   |   |
| Total interest-bearing liabilities                                                                                                          |       | (3,153                                                                       | )          | 20,856 |   | 17,703 |   |
| Change in net interest  income                                                                                                              |       | $                                                                            | 13,642     |   | $ | (7,797 | ) | $ | 5,845 |   |

 

In addition to investing in bothvariable and fixed-rate securities, we use derivative instruments to manage ourexposure to interest rate risk. See the ‘Market Risk’ section for more detailedinformation.

26

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The followingtables present average balances, interest income and expense, and yields earnedor paid on the major categories of assets and liabilities for the periodsindicated (Dollars in thousands):
| ** **                                                                                                                                         | ** ** | **Three Months Ended  March 31, 2007** | ** ** | **Three Months Ended  March 31, 2006** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|------------------------------------------------------------|------------|
| ** **                                                                                                                                         | ** ** | **Average**                                                | ** ** | ** **                                                 | ** ** | **Average** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                                                                                                                         | ** ** | **Balance**                                                | ** ** | **Interest**                                               | ** ** | **Yield/Cost** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Yield/Cost** | ** ** |
| **Interest-earning assets:**                                                                                                                       |       |                                                       |       |                                                       |       |   |   |   |   |   |   |   |   |
| Federal funds  sold and securities purchased under resale agreements, interest-bearing  deposits with other banks and other short-term investments |       | $                                                          | 1,584,121  |                                                       | $          | 20,762 |   | 5.24 | % | $ | 42,784 |   | $ | 478 |   | 4.47 | % |
| Investment  securities(1)                                                                                                                          |       |                                                       |       |                                                       |       |   |   |   |   |   |   |   |   |
| Mortgage-backed  securities                                                                                                                        |       | 7,924,358                                                  |       | 102,838                                                    |       | 5.19 | % | 8,160,279 |   | 96,777 |   | 4.74 | % |
| Federal agency  securities                                                                                                                         |       | 1,717,695                                                  |       | 20,964                                                     |       | 4.88 | % | 2,210,833 |   | 24,663 |   | 4.46 | % |
| State and  political subdivisions                                                                                                                  |       | 438,942                                                    |       | 4,600                                                      |       | 4.19 | % | 505,096 |   | 5,503 |   | 4.36 | % |
| Other securities                                                                                                                                   |       | 180,016                                                    |       | 2,665                                                      |       | 5.92 | % | 212,146 |   | 2,807 |   | 5.29 | % |
| Total investment  securities                                                                                                                       |       | 10,261,011                                                 |       | 131,067                                                    |       | 5.11 | % | 11,088,354 |   | 129,750 |   | 4.68 | % |
| Loans                                                                                                                                              |       | 324,997                                                    |       | 6,156                                                      |       | 7.58 | % | 316,996 |   | 4,209 |   | 5.31 | % |
| Total  interest-earning assets                                                                                                                     |       | 12,170,129                                                 |       | 157,985                                                    |       | 5.19 | % | 11,448,134 |   | 134,437 |   | 4.70 | % |
| Allowance for  loan losses                                                                                                                         |       | (100                                                       | )          |                                                       |       |   |   | (100 | ) |   |   |   |   |
| Noninterest-earning  assets                                                                                                                        |       | 639,557                                                    |       |                                                       |       |   |   | 641,002 |   |   |   |   |   |
| Total assets                                                                                                                                       |       | $                                                          | 12,809,586 |                                                       |       |   |   |   | $ | 12,089,036 |   |   |   |   |   |
| **Interest-bearing  liabilities:**                                                                                                                 |       |                                                       |       |                                                       |       |   |   |   |   |   |   |   |   |
| Deposits:                                                                                                                                          |       |                                                       |       |                                                       |       |   |   |   |   |   |   |   |   |
| Demand                                                                                                                                             |       | $                                                          | 136,494    |                                                       | $          | 1,565 |   | 4.65 | % | $ | 95,778 |   | $ | 919 |   | 3.84 | % |
| Savings                                                                                                                                            |       | 5,821,103                                                  |       | 57,035                                                     |       | 3.97 | % | 4,078,497 |   | 31,922 |   | 3.13 | % |
| Time                                                                                                                                               |       | 294,892                                                    |       | 3,844                                                      |       | 5.21 | % | 75,974 |   | 846 |   | 4.45 | % |
| Securities sold  under repurchaseagreements                                                                                                        |       | 4,491,610                                                  |       | 43,993                                                     |       | 3.92 | % | 4,826,124 |   | 40,954 |   | 3.39 | % |
| Junior  subordinated debentures                                                                                                                    |       | 24,774                                                     |       | 605                                                        |       | 9.77 | % | 24,774 |   | 605 |   | 9.77 | % |
| Other borrowings                                                                                                                                   |       | 104,651                                                    |       | 1,777                                                      |       | 6.79 | % | 1,401,077 |   | 15,870 |   | 4.53 | % |
| Total  interest-bearing liabilities                                                                                                                |       | 10,873,524                                                 |       | 108,819                                                    |       | 4.00 | % | 10,502,224 |   | 91,116 |   | 3.47 | % |
| Noninterest-bearing  liabilities:                                                                                                                  |       |                                                       |       |                                                       |       |   |   |   |   |   |   |   |   |
| Demand deposits                                                                                                                                    |       | 412,091                                                    |       |                                                       |       |   |   | 342,368 |   |   |   |   |   |
| Savings                                                                                                                                            |       | 95,162                                                     |       |                                                       |       |   |   | 56,212 |   |   |   |   |   |
| Time deposits                                                                                                                                      |       | 306,111                                                    |       |                                                       |       |   |   | 215,000 |   |   |   |   |   |
| Other liabilities                                                                                                                                  |       | 143,616                                                    |       |                                                       |       |   |   | 174,591 |   |   |   |   |   |
| Total liabilities                                                                                                                                  |       | 11,830,504                                                 |       |                                                       |       |   |   | 11,290,395 |   |   |   |   |   |
| Equity                                                                                                                                             |       | 979,082                                                    |       |                                                       |       |   |   | 798,641 |   |   |   |   |   |
| Total liabilities  and equity                                                                                                                      |       | $                                                          | 12,809,586 |                                                       |       |   |   |   | $ | 12,089,036 |   |   |   |   |   |
| Net interest  income                                                                                                                               |       |                                                       |       | $                                                          | 49,166     |   |   |   |   |   | $ | 43,321 |   |   |   |
| Net interest  margin (2)                                                                                                                           |       |                                                       |       |                                                       |       | 1.62 | % |   |   |   |   | 1.51 | % |
| Average interest  rate spread (3)                                                                                                                  |       |                                                       |       |                                                       |       | 1.19 | % |   |   |   |   | 1.23 | % |
| Ratio of  interest-earning assets to interest-bearing liabilities                                                                                  |       |                                                       |       |                                                       |       | 111.92 | % |   |   |   |   | 109.01 | % |

----

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

(2)             Annualizednet interest income divided by total interest-earning assets.

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

27

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*Operating Expenses*

Total operatingexpenses were $159.4 million for the three months ended March 31, 2007, up 17%from the same period in 2006.  Theincrease in total operating expenses for the three-month period ended March 31,2007 was primarily due to increased compensation and benefits, transactionprocessing services, occupancy and depreciation and amortization, as detailedbelow.  The components of operatingexpenses were as follows (Dollars in thousands):

|                                    | ** ** | **For the Three Months Ended March 31,** | ** ** |
|------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                         | ** ** | **2007**                                                               | ** ** | **2006** | ** ** | **Change** | ** ** |
| Compensation and  benefits         |       | $                                                                      | 97,420     |   | $ | 76,998 |   | 27 | % |
| Technology and  telecommunications |       | 18,535                                                                 |       | 17,338 |   | 7 | % |
| Transaction processing  services   |       | 15,341                                                                 |       | 13,672 |   | 12 | % |
| Occupancy                          |       | 10,018                                                                 |       | 7,551 |   | 33 | % |
| Depreciation and  amortization     |       | 9,691                                                                  |       | 7,806 |   | 24 | % |
| Professional fees                  |       | 2,273                                                                  |       | 3,461 |   | (34 | %) |
| Travel and sales  promotion        |       | 2,126                                                                  |       | 1,931 |   | 10 | % |
| Insurance                          |       | 980                                                                    |       | 973 |   | 1 | % |
| Other operating  expenses          |       | 3,010                                                                  |       | 5,954 |   | (49 | %) |
|                               |       |                                                                   |       |   |   |   |   |
|  Total operating expenses     |       | $                                                                      | 159,394    |   | $ | 135,684 |   | 17 | % |

 

Compensation and benefitsexpense was $97.4 million for the three months ended March 31, 2007, up 27%from the same period last year due to higher headcount in our Boston andEuropean offices.  Annual salary increasesand option expense also contributed to the growth in the compensation andbenefits expense.

Technology andtelecommunications expense was $18.5 million for the three months ended March31, 2007, up 7% from the same period last year. The increase is primarily due to our investment in enhancing our globalintegrated technology platform, which we view as a significant competitiveadvantage and growth in new business and existing customer volumes.  Generally, we expect technology reinvestmentto equal approximately 18-20% of net operating revenue each year, includingrelated compensation costs.

Transaction processing servicesexpense was $15.3 million for the three months ended March 31, 2007, up 12%from the same period last year due to increases in transaction volumes, highermarket values and new business.  Futuretransaction processing services expense will be dependent upon asset levels andthe volume of client transaction activity.

Occupancy expense was $10.0million for the three months ended March 31, 2007, up 33% from the same periodlast year due to the addition of our new office space worldwide.

Depreciation and amortizationexpense was $9.7 million for the three months ended March 31, 2007, up 24% fromthe same period last year due to new computer equipment and to the increased amortizationof leasehold improvements from our office space build-outs in 2006.

Professional fees expense was$2.3 million for the three months ended March 31, 2007, down 34% from the sameperiod last year.  The decrease isprimarily attributed to lower legal fees.

Travel and sales promotionexpense was $2.1 million for the three months ended March 31, 2007, up 10% fromthe same period last year.  Travel andsales promotion expense consists of expenses incurred by the sales force,client management staff and other employees in connection with sales calls onpotential clients, traveling to existing client sites and our foreign offices,and attendance at industry conferences.

Other operating expense was $3.0million for the three months ended March 31, 2007, down 49% from the sameperiod last year as a result of lower temporary staffing expenses and thepartial reversal of a previously accrued loss contingency.

*Income Taxes*

Income taxes were$20.4 million for the three-month period ended March 31, 2007, up 4% from thesame period in 2006.  This increase inincome taxes is primarily related to an increase in pretax earnings, partiallyoffset by a 1% decrease in the 2007 effective tax rate resulting from a changein the recognition threshold of a tax position, which occurred in the secondquarter of 2006.

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**Financial Condition**

At March 31, 2007,our total assets were $14.2 billion, up 23% from $11.6 billion at December 31,2006, primarily due to an increase in Federal funds sold and securitiespurchased under resale agreements. Average interest-earning assets increased $0.7 billion, or 6%, for thethree-month period ended March 31, 2007 as compared to the same period in2006.  Our asset growth, particularly inFederal funds sold, was primarily driven by strong client funding during thefirst three months of 2007.

*Investment Portfolio*

Theincome we derive from our investment portfolio is generated primarily byinvesting client cash balances and is a component of our asset processingbusiness.  In addition, we use our investmentportfolio to secure open positions at securities clearing institutions inconnection with our custody services. The following table summarizes our investment portfolio as of the datesindicated (Dollars in thousands):

|                                     | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                          | ** ** | **2007**           | ** ** | **2006**              | ** ** |
| **Securities held to maturity:**    | ** ** | ** **         | ** ** | ** **            | ** ** |
| Mortgage-backed  securities         |       | $                  | 3,611,327  |                  | $          | 3,753,497 |   |
| Federal agency  securities          |       | 1,542,336          |       | 1,680,458             |       |
| State and  political subdivisions   |       | 94,817             |       | 98,375                |       |
| Total securities held to  maturity  |       | $                  | 5,248,480  |                  | $          | 5,532,330 |   |
| ** **                          | ** ** | ** **         | ** ** | ** **            | ** ** |
| **Securities available for sale:**  | ** ** | ** **         | ** ** | ** **            | ** ** |
| Mortgage-backed  securities         |       | $                  | 4,127,647  |                  | $          | 4,275,051 |   |
| Federal agency  securities          |       | 398,950            |       | —                |       |
| State and  political subdivisions   |       | 345,991            |       | 344,304               |       |
| Corporate debt                      |       | 167,713            |       | 169,850               |       |
| Foreign  government securities      |       | 10,535             |       | 10,535                |       |
| Total securities available for sale |       | $                  | 5,050,836  |                  | $          | 4,799,740 |   |

 

Our held tomaturity securities portfolio decreased $0.3 billion, or 5%, from December 31,2006 to March 31, 2007.  The decrease wasprimarily due to paydowns and slower reinvestment.  Our held to maturity portfolio securities arepurchased with the intent and ability to hold them to maturity.

Our available forsale securities portfolio increased $0.3 billion, or 5%, from December 31, 2006to March 31, 2007.  The increase wasmainly due to purchases of new Federal agency securities, offset by maturitiesand prepayments.  Our investment securitypurchases included mortgage-backed securities and municipal securities.  We believe that purchasing these securitiesallows us to take advantage of attractive yields and limited extension riskwhich aligns with our asset and 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 investment securities for the three-month period ended March 31,2007 was $10.3 billion, with an average yield of 5.11%, compared to an averagebalance of $11.1 billion with an average yield of 4.68% during the same periodin 2006.  The increased portfolio yieldis primarily due to higher rates on our variable-rate securities.  Anticipating prepayments in calculating theconstant effective yield for mortgage-backed securities may result in moremonthly earnings volatility due to the impact of changing interest rates andthe resulting adjustments to the amount of amortization.  We do not expect changes to the amount ofamortization resulting from anticipating prepayments to have a material effecton our future reported financial results or financial condition.

Prepayment cashflow levels on our investment portfolio decreased in the first three months of2007, which we believe is primarily due to decreased refinancing opportunities.

We invest inmortgage-backed securities and Federal agency securities to increase the totalreturn of the investment portfolio. Mortgage-backed securities and Federal agency securities generally havea higher yield than U.S. Treasury securities due to credit and prepaymentrisk.  Credit risk results from the possibility that a loss may occur if acounterparty, such as the Federal agency issuing the securities, is unable tomeet the terms of the contract.  Credit risk related to mortgage-backedsecurities and Federal agency securities is substantially reduced by paymentguarantees and credit enhancements.  Prepayment risk results from thepossibility that changes in interest rates and other economic factors willresult in investment securities being paid off earlier than the scheduledmaturity date.  Refer to the ‘Market Risk’ section for additional detailsregarding our 

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net interest incomesimulation model, which includes the impact of changes in interest rates, andtherefore prepayment risk, on our net interest income.

We invest in AAArated, insured municipal securities to generate stable, tax-advantagedincome.  Municipal securities generally have lower stated yields thanFederal agency and U.S. Treasury securities, but their after-tax yields arecomparable.  Municipal securities are subject to call risk.  Callrisk is similar to prepayment risk and results from the possibility thatfluctuating interest rates and other factors may result in the exercise of thecall option by the issuing municipality prior to the maturity date of thesecurity.

*Loan Portfolio*

The balance in ourloan portfolio was $259.0 million, down 4% from December 31, 2006.  The decrease was primarily due to repaymentsof lines of credit, partially offset by new loan originations.

We make loans to individually managed accountcustomers and to mutual funds and other pooled product clients.  We offeroverdraft protection and lines of credit to our clients for the purpose offunding redemptions, covering overnight cash shortfalls, leveraging portfoliosand meeting other client borrowing needs.  The majority of loans toindividually managed account customers are written on a demand basis, bearvariable interest rates tied to the Prime rate or the Federal funds rate andare fully secured by liquid collateral, primarily freely tradable securitiesheld in custody by us for the borrower.  We monitor the value ofcollateral daily to ensure the amount of collateral held by us exceeds the loanbalance by a certain threshold.  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 individually managed account customers, mutualfunds and other pooled product clients also include advances that we make tocertain clients pursuant to the terms of our custody agreements with thoseclients to facilitate securities transactions and redemptions.

At March 31, 2007, our onlylending concentrations that exceeded 10% of total loan balances were the linesof credit to mutual fund clients discussed above.  These loans were made in the ordinary courseof business on substantially similar terms and conditions prevailing at thetime for comparable transactions.

Our loan portfolio creditperformance has been excellent.  Therehave been no loan charge-offs in the history of our Company.  It is our policy to place a loan onnonaccrual status when either principal or interest becomes 90 days pastdue and the loan’s collateral is not sufficient to cover both principal andaccrued interest.  As of March 31, 2007,there were no loans on nonaccrual status and no troubled debtrestructurings.  Although virtually allof our loans are fully collateralized with freely tradable securities,management recognizes some credit risk inherent in the loan portfolio, andtherefore we have recorded an allowance for loan losses of $0.1 million atMarch 31, 2007, a level which has remained consistent for the past five years.  This allowance is not allocated to anyparticular loan, but is intended to absorb any risk of loss inherent in theloan portfolio at the balance sheet date that is not captured in our historicalloss rate.  Management actively monitorsthe loan portfolio and the underlying collateral and regularly assesses theadequacy of the allowance for loan losses.

*Deposits*

Total depositswere $8.5 billion at March 31, 2007, up 38% from December 31, 2006.  The increase in our deposit balances is aresult of new business and our clients holding larger cash positions in theirportfolios.

Time deposits withbalances greater than $100,000 totaled $630.3 million and $524.4 million atMarch 31, 2007 and December 31, 2006, respectively.  All time deposits had a maturity of less thanthree months at March 31, 2007 and December 31, 2006.

*Repurchase Agreements andShort-Term and Other Borrowings*

Repurchaseagreements increased $0.7 billion, or 19%, from December 31, 2006 to March 31,2007.  The majority of our repurchaseagreements are with clients who prefer a more collateralized form ofdeposit.  Repurchase agreements providefor the sale of securities for cash coupled with the obligation to repurchasethose securities on a set date or on demand. We use repurchase agreements, including client repurchase agreements,because they provide a lower cost source of funding than other short-termborrowings and allow our clients the extra benefit of collateralization oftheir deposits.  The average balance ofsecurities sold under repurchase agreements for the three months ended March31, 2007 was $4.5 billion with an average cost of approximately 3.92%, comparedto an average balance of $4.8 billion and an average cost of approximately3.39% for the same period in 2006.  Theincrease in the average cost of repurchase agreements was due to highershort-term interest rates in the first three months of 2007 compared to thesame period in 2006.

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Short-term andother borrowings decreased $0.5 billion, or 88%, from December 31, 2006 toMarch 31, 2007, primarily due to increased client funding.  We use short-term and other borrowings tooffset the variability of deposit flow. The average balance of short-term and other borrowings for the threemonths ended March 31, 2007 was $0.1 billion with an average cost ofapproximately 6.79%, compared to an average balance of $1.4 billion and anaverage cost of approximately 4.53% for the same period in 2006.  The increase in the average cost ofshort-term and other borrowings was due to higher short-term interest rates inthe first three months of 2007 compared to the same period in 2006.

**Market Risk**

Our clients, in the course oftheir financial asset management, maintain cash balances, which they candeposit with us on a short-term basis in interest-bearing accounts or clientrepurchase agreements.  We eitherdirectly invest these cash balances to earn interest income, or place thesedeposits in third-party vehicles and remit a portion of the earnings on theseinvestments to our clients after deducting a fee as our compensation forinvesting clients’ funds in these investment vehicles.  In the conduct of these activities, we aresubject to market risk.

Market risk is the risk of an adverse financial impactfrom changes in market prices.  The levelof risk we assume is a function of our overall strategic objectives andliquidity needs, client requirements and market volatility.  The active management of market risk isintegral to our operations.

Our balance sheet is primarily subject to interestrate risk, which is the risk of loss due to movements in interest rates.  Prepayment risk, which is the risk thatchanges in interest rates and other economic factors will result in investmentsecurities being paid off earlier than the scheduled maturity date, is inherentin our investment securities, mainly our mortgage-backed securities andvariable-rate Federal agency securities. Prepayment levels for mortgage-backed securities are primarily driven bychanges in interest rates.  Prepaymentlevels for Federal agency securities are driven by a number of factors,including expiration of prepayment penalty provisions, the economic conditionof the borrower, borrower refinancing alternatives and interest rates.  Theobjective of interest rate sensitivity management is to provide sustainable netinterest income under various economic conditions.

Our Board of Directors has setasset and liability management policies that define the overall framework formanaging interest rate sensitivity, including accountabilities and controlsover investment activities.  Thesepolicies delineate investment limits and strategies that are appropriate, givenour liquidity and regulatory requirements. For example, we have established a policy limit stating that projectednet interest income will not be impacted by more than 10% given a change ininterest rates of up to 200 basis points (+ or -) over a twelve-monthperiod.  Each quarter, our Board ofDirectors reviews our asset and liability positions, including simulations ofthe effect of various interest rate scenarios on our net interest income.

The day-to-day responsibilityfor oversight of the Asset and Liability Management function has been delegatedby our Board of Directors to our Asset and Liability Committee (‘ALCO’).  ALCO is a senior management committeeconsisting of the Chief Executive Officer, the President, the Chief FinancialOfficer, the Chief Risk Officer and members of the Treasury function.  ALCO meets twice monthly.  Our primary tool in managing interest ratesensitivity is an income simulation model. Key assumptions in the simulation model include the timing of cashflows, which include forecasted prepayment speeds that are based on market andindustry data, maturities and repricing of financial instruments, changes inmarket conditions, capital planning and deposit sensitivity.  The model assumes that the composition of ourinterest-sensitive assets and liabilities will change over the period beingmeasured.  The model also assumes thatthe change in interest rates is a parallel shift of the yield curve across allmaturities.  These assumptions areinherently uncertain, and as a result, the model cannot precisely predict theeffect of changes in interest rates on our net interest income.  Actual results may differ from simulatedresults due to the timing, magnitude and frequency of interest rate changes,and changes in market conditions and management strategies.

The results of the incomesimulation model as of March 31, 2007 and 2006 indicated that an upward shiftof interest rates by 200 basis points over a twelve-month period would resultin a reduction in projected net interest income of approximately 4.6% and 6.9%,respectively, which are both within our 10% policy limit.  We also simulate a 200 basis point ratereduction over a twelve-month period. This simulation would result in an increase in projected net interestincome of approximately 1.5% and 3.3% as of March 31, 2007 and 2006,respectively, both within our 10% policy limit.

We also use gap analysis as asecondary tool to manage our interest rate sensitivity.  Gap analysis involves measurement of thedifference in asset and liability repricing on a cumulative basis within aspecified time frame.  A positive gapindicates that more interest-earning assets than interest-bearing liabilitiesreprice/mature in a time frame, and a negative gap indicates the opposite.  As shown in the cumulative gap position inthe table presented on the following page, at March 31, 2007, interest-bearingliabilities repriced faster than interest-earning assets in the shortterm.  This implies that a rising rateenvironment would negatively impact forecasted net interest income; however,the gap analysis does not quantify the impact. Other important determinants of net interest income are the shape of theyield curve, general rate levels, reinvestment spreads, balance sheet growthand mix, and interest rate spreads.  Wecontinue to run a closely matched balance sheet by investing the majority ofour assets in short duration, variable-rate securities and executing interestrate swaps against client liabilities, including client repurchase agreements.

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We manage the structure of interest-earning assets and interest-bearingliabilities by adjusting their mix, yield, maturity and/or repricing characteristicsbased on market conditions.  Clientdeposits and repurchase agreements, which are predominantly short term, are ourprimary sources of funds.  We also useterm borrowings and interest rate swap agreements to augment our management ofinterest rate exposure.  The effect ofthe swap agreements is to lengthen both a forecasted series of fixed-rateovernight liabilities incurred at different daily fixed rates and short-termvariable-rate liabilities into longer-term fixed-rate liabilities.  The weighted-average fixed-payment rates onour swap agreements were 3.88% and 3.66% at March 31, 2007 and 2006,respectively.  Variable-interest paymentsreceived are currently indexed to the overnight Federal funds rate.  At March 31, 2007 and 2006, the weighted-averagerates of variable market-indexed interest payment obligations to us were 5.26%and 4.44%, respectively.  The remainingterms of swaps at March 31, 2007 range from 1 to 20 months.  These contracts had net fair values ofapproximately $8.9 million and $29.5 million at March 31, 2007 and 2006,respectively.

The following table presents the repricing schedule ofour interest-earning assets and interest-bearing liabilities at March 31, 2007(Dollars in thousands):
| ** **                                                                                                                                       | ** ** | **Within Three** | ** ** | **Three to Six** | ** ** | **Six to Twelve** | ** ** | **One Year to** | ** ** | **Over Five** | ** ** | ** ** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|----------------------------|------------|-----------------------------|------------|---------------------------|------------|--------------------|------------|------------|------------|
| ** **                                                                                                                                       | ** ** | **Months**            | ** ** | **Months**                 | ** ** | **Months**                  | ** ** | **Five Years**       | ** ** | **Years**          | ** ** | **Total**  | ** ** |
| ** **                                                                                                                                       | ** ** | ** **            | ** ** | ** **                 | ** ** | ** **                  | ** ** | ** **                | ** ** | ** **         | ** ** | ** ** | ** ** |
| Interest-earning assets:  (1)                                                                                                                    |       |                  |       |                       |       |                        |       |                      |       |               |       |       |       |
| Investment  securities (2, 3)                                                                                                                    |       | $                     | 6,179,381  |                       | $          | 476,668                     |       | $                         | 799,927    |               | $          | 2,121,526  |       | $ | 730,087 |   | $ | 10,307,589 |   |
| Federal funds  sold and securities purchased and under resale agreements, interest bearing  deposits with other banks and short-term investments |       | 2,972,002             |       | —                     |       | —                      |       | —                    |       | —             |       | 2,972,002  |       |
| Loans - variable  rate                                                                                                                           |       | 227,654               |       | 31,388                     |       | —                      |       | —                    |       | —             |       | 259,042    |       |
| Loans - fixed  rate                                                                                                                              |       | —                |       | —                     |       | —                      |       | 13                        |       | —             |       | 13         |       |
| Total  interest-earning assets                                                                                                                   |       | $                     | 9,379,037  |                       | $          | 508,056                     |       | $                         | 799,927    |               | $          | 2,121,539  |       | $ | 730,087 |   | $ | 13,538,646 |   |
| Interest-bearing  liabilities:                                                                                                                   |       |                  |       |                       |       |                        |       |                      |       |               |       |       |       |
| Demand  deposits                                                                                                                                 |       | $                     | 121,218    |                       | $          | —                      |       | $                         | —     |               | $          | —     |       | $ | — |   | $ | 121,218 |   |
| Savings  accounts                                                                                                                                |       | 6,453,385             |       | —                     |       | —                      |       | —                    |       | —             |       | 6,453,385  |       |
| Time  deposits                                                                                                                                   |       | 255,260               |       | —                     |       | —                      |       | —                    |       | —             |       | 255,260    |       |
| Interest  rate contracts                                                                                                                         |       | (1,070,000            | )          | 250,000                    |       | 340,000                     |       | 480,000                   |       | —             |       | —     |       |
| Securities  sold under repurchase agreements                                                                                                     |       | 4,124,073             |       | 150,000                    |       | 150,000                     |       | —                    |       | —             |       | 4,424,073  |       |
| Short-term  and other borrowings                                                                                                                 |       | 62,497                |       | —                     |       | —                      |       | —                    |       | —             |       | 62,497     |       |
| Junior  subordinated debentures                                                                                                                  |       | 24,774                |       | —                     |       | —                      |       | —                    |       | —             |       | 24,774     |       |
| Total  interest-bearing liabilities                                                                                                              |       | $                | 9,971,207  |                       | $     | 400,000                     |       | $                    | 490,000    |               | $     | 480,000    |       | $  | — |   | $  | 11,341,207 |   |
| Net  interest-sensitivity gap during the period                                                                                                  |       | $                | (592,170   | )                          | $     | 108,056                     |       | $                    | 309,927    |               | $     | 1,641,539  |       | $  | 730,087 |   | $  | 2,197,439 |   |
|                                                                                                                                             |       |                  |       |                       |       |                        |       |                      |       |               |       |       |       |
| Cumulative  gap                                                                                                                                  |       | $                     | (592,170   | )                          | $          | (484,114                    | )          | $                         | (174,187   | )                  | $          | 1,467,352  |       | $ | 2,197,439 |   |   |   |
| Interest-earning assets  as a percent of interest-bearing liabilities (cumulative)                                                               |       | 94.06                 | %          | 95.33                      | %          | 98.40                       | %          | 112.94                    | %          | 119.38             | %          |       |       |
| Interest-earning assets  as a percent of total assets (cumulative)                                                                               |       | 66.02                 | %          | 69.60                      | %          | 73.23                       | %          | 90.17                     | %          | 95.31              | %          |       |       |
| Net interest-sensitivity  gap as a percent of total assets                                                                                       |       | (4.17                 | %)         | 0.76                       | %          | 2.18                        | %          | 11.56                     | %          | 5.14               | %          |       |       |
| Cumulative gap as a percent of total assets                                                                                                      |       | (3.17                 | %)         | (3.41                      | %)         | (1.23                       | %)         | 10.33                     | %          | 15.47              | %          |       |       |

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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$8.3 million of net unrealized losses as of March 31, 2007.

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** **

**Liquidity**

Liquidity represents the abilityof an institution to meet present and future financial obligations througheither runoff due to prepayments, asset sales, maturity of existing assets orthe acquisition of additional funds through liability management.  These obligations arise from the withdrawalsof deposits, the payment of operating expenses, and the inclusion of capitalexpenditures for fixed assets and leasehold improvements.

Our primary sources of liquidityinclude cash and cash equivalents, Federal funds sold, new deposits, short-termborrowings, interest and principal payments on securities held to maturity andavailable for sale, fees collected from asset administration clients, FHLBBborrowings and the Federal Reserve Discount Window.  As a result of our management of liquidassets and our ability to generate liquidity through liability funds,management believes that we maintain overall liquidity sufficient to meet ourdepositors’ needs, to satisfy our operating requirements and to fund thepayment of an anticipated annual cash dividend of $0.10 per share for 2007(approximately $6.7 million based upon 66,765,087 shares outstanding as ofMarch 31, 2007).

Our ability to pay dividends oncommon stock may depend on the receipt of dividends from the Bank.  Any dividend payments by the Bank are subjectto certain restrictions imposed by the Massachusetts Commissioner ofBanks.  During all periods presented inthis report, the Company did not require dividends from the Bank in order tofund the 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 in 1997 by Investors Capital Trust I, a Delawarestatutory business trust sponsored by us, and qualify as Tier 1 capital underthe capital guidelines of the Federal Reserve Board of Governors (‘FRB’).

In June 2006, we announced that our Board ofDirectors had authorized a new repurchase plan of up to $150.0 million of ourcommon stock over the twelve months following the announcement.  We do not expect our stock repurchase programto have a material impact on our capital resources, such as maintainingrisk-based capital ratios in excess of capital adequacy guidelines and ourability to pay dividends on our common stock. We did not repurchase any shares during the three months ended March 31,2007.  As of March 31, 2007, we haverepurchased $29.3 million of our common stock under this plan.

We have informal borrowingarrangements with various counterparties. Each counterparty has agreed to make funds available to us at theFederal funds overnight rate.  Eachcounterparty may terminate its arrangement at any time and is under nocontractual obligation to provide us with requested funding.  Our borrowings under these arrangements aretypically on a short-term basis.  Wecannot be certain, however, that such funding will be available.  Lack of availability of liquid funds couldhave a material adverse impact on our operations.

We also have Master RepurchaseAgreements in place with various counterparties.  Each counterparty has agreed on anuncommitted basis to make funds available to us at various rates in exchangefor collateral consisting of marketable securities.

Our capital stock investment inthe FHLBB totaled $28.4 million as of March 31, 2007, which represents a $1.0million decrease from December 31, 2006.  The $28.4 million capital stockinvestment includes both a $25.0 million membership component and a $3.4 millionactivity-based component.  Themembership component of the FHLBB capital stock investment requires a five-yearadvance notice of withdrawal.  Our$28.4 million capital stock investment in the FHLBB provides an overnightborrowing capacity of up to $114.5 million.  There was no outstanding balance under thisarrangement as of March 31, 2007.  Additional borrowing is available to usbased on prescribed collateral levels and increased investment in FHLBB capitalstock.  We currently have the ability to purchaseup to $25.0 million of activity-based capital, which would provide a totalovernight borrowing capacity of $833.3 million.

In October 2006, webecame a member of the Federal Reserve Bank of Boston (‘FRBB’).  In connection with our membership, we wererequired to subscribe to purchase stock of the FRBB totaling 6% of the Bank’scapital and surplus.  We fulfilled ourobligation to purchase 50% of the subscribed amount by purchasing $7.4 millionof FRBB stock.  The remainingsubscription amount is subject to purchase upon the request of the FRBB.  The Bank’s capital stock investment in theFRBB is $7.4 million at March 31, 2007.

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** **

**Capital Resources**

Historically, we have financed our operations principally throughinternally generated cash flows.  We incurcapital expenditures for furniture, fixtures, capitalized software andmiscellaneous equipment needs.  We leaseoffice space and computing equipment through operating leases.  Capital expenditures have been incurred andleases entered into on an as-required basis, primarily to meet our growingoperating needs.  As a result, ourcapital expenditures were $28.2 million and $17.7 million for the three monthsended March 31, 2007 and 2006, respectively. For the three months ended March 31, 2007, capital expenditures werecomprised of $6.9 million in leasehold improvements, $11.2 million incapitalized software and projects in process and $10.1 million in fixedassets.  For the three months ended March31, 2006, capital expenditures were comprised of $7.3 million in leaseholdimprovements, $6.0 million in capitalized software and projects in process and$4.4 million in fixed assets.

Stockholders’ equity at March31, 2007 was $1.0 billion, up 9% from December 31, 2006, primarily due to netincome earned and the exercise of stock options.  The ratio of average stockholders’ equity toaverage assets was approximately 8% for March 31, 2007, compared to 7% forDecember 31, 2006.

The FRB has adopted capital adequacy guidelinesapplicable to United States banking organizations.  The FRB’s capitaladequacy guidelines generally require bank holding companies (‘BHCs’) tomaintain total capital equal to 8% of total risk-adjusted assets andoff-balance sheet items (the ‘Total Risk-Based Capital Ratio’), with at least50% of that amount consisting of Tier 1, or core capital, and the remainingamount consisting of Tier 2, or supplementary capital.  Tier 1 capital forBHCs generally consists of the sum of common stockholders’ equity and perpetualpreferred stock (subject to certain limitations), less goodwill and othernonqualifying intangible assets.  Tier 2 capital generally consists ofhybrid capital instruments, perpetual debt and mandatory convertible debtsecurities; perpetual preferred stock, not included as Tier 1 capital; termsubordinated debt and intermediate-term preferred stock; and, subject tolimitations, general allowances for loan and lease losses.  Assets areadjusted under the risk-based guidelines to take into account different riskcharacteristics.

In addition to the risk-based capital requirements,the FRB requires BHCs to maintain a minimum leverage capital ratio of Tier 1capital to its average total consolidated assets (the ‘Leverage Ratio’) of3%.  Total average consolidated assets for this purpose does not includegoodwill and any other intangible assets and investments that the FRBdetermines should be deducted from Tier 1 capital.  The FRB has announcedthat the 3% Leverage Ratio requirement is the minimum for the top-ratedBHCs.  All other BHCs are required to maintain a minimum Leverage Ratio of4%.  BHCs with supervisory, financial, operational or managerialweaknesses, as well as BHCs that are anticipating or experiencing significantgrowth, are expected to maintain capital ratios well above the minimumlevels.  Because we anticipate significant future growth, we will berequired to maintain a Leverage Ratio of 4% or higher.

We are currentlyin compliance with both the Total Risk-Based Capital Ratio and the LeverageRatio requirements, and management expects these ratios to remain in compliancewith the FRB’s capital adequacy guidelines. At March 31, 2007, our Total Risk-Based Capital Ratio and Leverage Ratiowere 17.95% and 7.66%, respectively.

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

The information required by this item is contained inthe ‘Market Risk’ section in the ‘Management’s Discussion and Analysis ofFinancial Condition and Results of Operations,’ as part of this Report.

**Item 4.            Controlsand Procedures**

**Evaluationof Disclosure Controls and Procedures**

As required by Rule 13a-15 under the SecuritiesExchange Act of 1934, as of March 31, 2007, the end of the quarter covered bythis report, the Company carried out an evaluation under the supervision andwith the participation of the Company’s management, including the Company’sChief Executive Officer and Chief Financial Officer, of the effectiveness ofthe design and operation of the Company’s disclosure controls andprocedures.  In designing and evaluatingthe Company’s disclosure controls and procedures, the Company and itsmanagement recognize that any controls and procedures, no matter how welldesigned and operated, can provide only reasonable assurance of achieving thedesired control objectives, and the Company’s management necessarily wasrequired to apply its judgment in evaluating and implementing possible controlsand procedures.  Based upon thatevaluation, the Chief Executive Officer and Chief Financial Officer concludedthat the Company’s disclosure controls and procedures were effective at thereasonable assurance level to ensure that information required to be disclosedby the Company in the reports it files or submits under the Exchange Act isaccumulated and communicated to our management, including our Chief ExecutiveOfficer and Chief Financial Officer, as appropriate, to allow timely decisionsregarding required disclosure, and is recorded, processed, summarized andreported, within the time periods specified in the Securities and ExchangeCommission’s rules and forms.  There wasno change in the Company’s internal control over financial reporting thatoccurred during the quarter ended March 31, 2007 that has materially affected,or is reasonably likely to materially affect, the Company’s internal controlover financial reporting.  The Companyreviews, on an ongoing basis, its disclosure controls and procedures, which mayinclude its internal controls over financial reporting, and may from time totime make changes aimed at enhancing their effectiveness and to ensure that theCompany’s systems evolve with its business.

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**PART II. OTHERINFORMATION**

**Item 1.**                          LegalProceedings

We and certain ofour officers were named as defendants in three purported class actioncomplaints that were filed on or about August 4, 2005, August 15, 2005, andSeptember 30, 2005 in the United States District Court for the District ofMassachusetts, Boston, Massachusetts.  The U.S. District Court hasconsolidated those cases and appointed lead plaintiffs, who filed aconsolidated complaint against us and seven of our current and former officerson February 3, 2006.  Among other things, the consolidated complaintasserts that the defendants violated Sections 10(b) and 20(a) of the SecuritiesExchange Act of 1934 during the period April 10, 2001 until July 15,2005.  The allegations in the consolidated complaint predominantly relateto: (1) our October 2004 restatement of our financial results, and (2) our July2005 revision of public guidance regarding our future financialperformance.  The consolidated complaint seeks unspecified damages, interest,fees, and costs.  On May 14, 2006, we filed a motion to dismiss all claimsasserted in the consolidated complaint. That motion is currently pending before the Court.  We stronglybelieve that the lawsuit lacks merit and we intend to defend against the claimsvigorously.  However, we cannot predict the outcome of the lawsuit at thistime, and we can give no assurance that it will not materially adversely affectour financial condition or results of operations.

We and nine of ourofficers and directors are named as defendants in two shareholder derivativecomplaints that were filed on or about September 22, 2005 and October 17, 2005in the United States District Court for the District of Massachusetts, Boston,Massachusetts.  Among other things, the complaints assert that thedefendants are liable for breach of fiduciary duty, unjust enrichment, abuse ofcontrol, mismanagement, misappropriation of information, insider trading, andviolation of Section 14(a) of the Securities Exchange Act of 1934.  Thecomplaint filed on September 22, 2005 also seeks reimbursement under theSarbanes-Oxley Act of 2002.  The allegations in the complaintspredominantly relate to: (1) our October 2004 restatement of our financialresults, and (2) our July 2005 revision of public guidance regarding our futurefinancial performance.  The complaints seek unspecified damages, attorneys’fees, accountant and expert fees, and costs.  We are also named as anominal defendant in these complaints, although the actions are derivative innature and purportedly asserted on behalf of us.  We are in the process of evaluating theseclaims.  However, we cannot predict the outcome of the lawsuits at thistime, and we can give no assurance that they will not materially adverselyaffect our financial condition or results of operations.

**Item 1A.**                 Risk Factors

*Our operating results are subjectto fluctuations in interest rates and the securities markets.*

A significant portion of our fees is based on themarket value of the assets we process. Accordingly, our operating results are subject to fluctuations ininterest rates and securities markets as these fluctuations affect the marketvalue of assets processed.  Our netinterest income is primarily driven by the spread between earnings on ourinvestments and loan portfolios relative to our cost of funds.  The relationship between short-term andlong-term interest rates, referred to as the shape of the yield curve, affectsthe market value of, and the earnings produced by, our investment and loanportfolios, and thus could impact our net interest income.  In addition, narrower investment portfolioreinvestment and purchase spreads have impacted, and could potentially continueto impact, our net interest income.

Volatility in the equity markets can have a material effecton our asset-based fees.  Whilereductions in asset servicing fees may be offset by increases in other sourcesof revenue, a sustained downward movement of the broad equity markets willlikely have an adverse impact on our earnings.

Our growth depends in part on the ability of ourclients to generate fund flows by selling their investment products to new andexisting investors.  Fluctuations ininterest rates or the securities markets can lead to investors seekingalternatives to the investment offerings of our clients, which could result ina lesser amount of assets processed and correspondingly lower fees.  For example, if the value of equity or fixed income assets held by our clients wereto increase or decrease by 10% for a sustained period of time, we estimatecurrently that this market movement, by itself, would cause a correspondingchange of less than 5% in our earnings per share.

*We may not consummate our mergerwith State Street Corporation*.

Consummation ofthe transaction contemplated by the Merger Agreement is subject to customaryclosing conditions, including stockholder and regulatory approval.  Failure to complete the merger could have amaterial adverse impact on our ability to sell our services to new clients.

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*A material portion of our revenueis derived from our relationship with Barclays Global Investors, N.A. (‘BGI’)and related entities.*

As a result of our ongoing relationship with BGI’s iShares and MasterInvestment Portfolios, our assumption of the operations of the U.S. asset administrationunit of BGI in 2001 and our servicing assets for Barclays Global InvestorsCanada, Ltd., BGI accounted for approximately 18% of our net operating revenuefor both the three months ended March 31, 2007 and the three months ended March31, 2006.  We recently renewed our U.S.asset administration outsourcing agreement and our iShares and MasterInvestment Portfolio custody and fund accounting agreements with BGI, and weexpect that BGI will continue to account for a significant portion of our net operatingrevenue.  We provide services to BGIunder long-term contracts that may be terminated before the expiration of thecontracts under certain circumstances. Further information regarding the terms of certain BGI contracts,including early termination provisions, was disclosed in Item 8.01 on our Form8-K filed on January 25, 2006.

*We may incur losses due tooperational errors.*

The services that we providerequire complex processes and interaction with numerous third parties.  While we maintain sophisticated computersystems and a comprehensive system of internal 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 asignificant liability to us and may have a material adverse effect on ourresults of operations.

*We face significant competitionfrom other financial services companies, which could negatively affect ouroperating results.*

We are part of an extremelycompetitive asset servicing industry. Many of our current and potential competitors have longer operatinghistories, greater name recognition and substantially greater financial,marketing and other resources than we do. These greater resources could, for example, allow our competitors todevelop technology superior to our own. In addition, we face the risk that large mutual fund complexes may buildin-house asset servicing capabilities and no longer outsource these services tous.  As a result, we may not be able tocompete effectively with current or future competitors, which could result in aloss of existing clients or difficulty in gaining new clients.

*We may incur significant costsdefending legal claims.*

We have been named in lawsuitsin U.S. District Court in Massachusetts alleging, among other things,violations of securities laws.  While webelieve these claims are without merit, we cannot be sure that we will prevailin the defense of these claims.  We arealso party to other litigation and we may become subject to other legal claimsin the future.  Litigation is costly andcould divert the attention of management. For a more detailed discussion of our ongoing lawsuits, please see Item1, Legal Proceedings, in Part II of this report and Item 3, Legal Proceedings,in Part 1 of our Annual Report on Form 10-K for the year ended December 31,2006.

*The failure to properly manageour growth could adversely affect the quality of our services and result in theloss of clients.*

We have experienced a period ofrapid growth that has required the dedication of significant management andother resources.  Continued growth couldplace a strain on our management and other resources.  To manage future growth effectively, we mustcontinue to invest in our operational, financial and other internal systems,and our human resources, which could affect our profitability.

*We must hire and retain skilledpersonnel in order to succeed.*

Qualified personnel, inparticular managers and other senior personnel, are in great demand throughoutthe financial services industry.  As aresult, we could find it increasingly difficult to continue to attract andretain sufficient numbers of these highly skilled employees, which could affectour ability to attract and retain clients. In addition, uncertainty regarding integration in our merger with StateStreet Corporation could cause key employees to seek employment elsewhere.

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*We may not reap all or anyof the expected benefits of our recent increased spending.*

To position us for futuregrowth, we accelerated some disciplined investments during 2006 and the firstthree months of 2007.  We believe ourinvestments in personnel, technology and office space are necessary to supportour future growth in areas such as Europe, technology, alternative investments,middle office outsourcing and fund services. While these investments have and will continue to decrease ourshort-term operating margins, we believe they are necessary to build thefoundation for future growth.  However,we may not reap any or all of the expected benefits of our recent investments.

*We may not be able toprotect our proprietary technology.*

Our proprietary technology isimportant to our business.  We rely ontrade secret, copyright and trademark laws and confidentiality agreements withemployees and third parties to protect our proprietary technology, all of whichoffer only limited protection.  Theseintellectual property rights may be invalidated or our competitors may developsimilar technology independently.  Legalproceedings to enforce our intellectual property rights may be unsuccessful andcould also be expensive and divert management’s attention.

*Our quarterly and annualoperating results may fluctuate.*

Our quarterly and annualoperating results are difficult to predict and may fluctuate from quarter toquarter and annually for several reasons, including:

·                  The timing of commencement or termination ofclient engagements;

·                  Changes in interest rates, the relationshipbetween different interest rates or equity values;

·                  The rate of net inflows and outflows of investorfunds in the investment vehicles offered by our clients; and

·                  The timing and magnitude of share repurchasesunder our share repurchase plan.

Most of our expenses, such asemployee 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 extensivefederal, state and international regulations that impose complex restraints onour business.*

Federal and state laws andregulations applicable to financial institutions and their parent companiesapply to us.  Our primary regulators arethe Federal Reserve Board of Governors (‘FRB’), the Federal Deposit InsuranceCorporation (‘FDIC’), the Office of the Commissioner of Banks of theCommonwealth of Massachusetts, the Securities and Exchange Commission, theNational Association of Securities Dealers, Inc. (‘NASD’), the State of VermontDepartment of Banking, Insurance, Securities, Health Care Administration (‘BISHCA’),the Office of the Superintendent of Financial Institutions in Canada (‘OSFI’),the Irish Financial Services Regulatory Authority (‘IFSRA’), the Cayman IslandsMonetary Authority (‘CIMA’), the Financial Services Authority in theUnited Kingdom (‘FSA’) and the Commission de Surveillance du Secteur Financierin Luxembourg (‘CSSF’).  Virtually all aspects of our operations aresubject to specific requirements or restrictions and general regulatoryoversight including the following:

·                  The FRB and the FDIC maintain capitalrequirements that we must meet.  Failureto meet those requirements could lead to severe regulatory action or evenreceivership.  We are currentlyconsidered to be “well-capitalized”;

·                  Under Massachusetts law, the Bank may berestricted in its ability to pay dividends to Investors Financial ServicesCorp., which may in turn restrict our ability to pay dividends to our stockholders;

·                  The FRB and the FDIC are empowered to assessmonetary penalties against, and to order termination of activities by,companies or individuals who violate the law;

·                  The NASD maintains certain regulatoryrequirements that our securities broker affiliate, Investors SecuritiesServices, LLC, must meet.  Failure tomeet those requirements could lead to severe regulatory action;

·                  BISHCA maintains certain regulatory requirementsthat our insurance captive affiliate, Investors Vermont Insurance Company, mustmeet.  Failure to meet those requirementscould lead to regulatory action; and

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·                  Our international operations are subject toregulatory oversight by regulators in the jurisdictions in which we operate,including the OSFI, the IFSRA, the CIMA, the FSA and the CSSF.  Failureto comply with applicable international regulatory requirements, includingcapital requirements that we must meet, could result in regulatory action andimpact our ability to provide services in those jurisdictions.

Banking law restricts our ability to own the stock of certain companiesand also makes it more difficult for us to be acquired.  Also, we have not elected financial holdingcompany status under the federal Gramm-Leach-Bliley Act of 1999.  This may place us at a competitivedisadvantage with respect to other organizations.

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**Item 6.**                          Exhibits

**(a)**          Exhibits

| Exhibit No. | ** ** | **Description**                                                                                                                                                                                                              |
|-------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 15          |       | Letter of awareness  from Deloitte & Touche LLP.                                                                                                                                                                         |
| 31.1        |       | Certification of Kevin  J. Sheehan, Chief Executive Officer, pursuant to Rule 13a-14(a) and Rule  15d-14(a) of the Securities Exchange Act, as amended.                                                                      |
| 31.2        |       | Certification of John  N. Spinney, Jr., Chief Financial Officer, pursuant to Rule 13a-14(a) and Rule  15d-14(a) of the Securities Exchange Act, as amended.                                                                  |
| 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. |

 

**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
|                   |   |   | ** ** | **INVESTORS FINANCIAL SERVICES CORP.**                                                                                     |
|-------------------|--------|--------|------------|----------------------------------------------------------------------------------------------------------------------------|
|              |   |   | ** ** | ** **                                                                                                                 |
| Date: May 2, 2007 |   | 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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