**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

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**FORM 10-Q**

** **

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| **(Mark One)**                                                                                                                                                                                                                 |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                           |
| **ý**                                                                                                                                                                                                                     | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                                           |
| **For the Quarterly period ended March 31,  2003**                                                                                                                                                                             |
|                                                                                                                                                                                                                           |
| **or**                                                                                                                                                                                                                         |
|                                                                                                                                                                                                                           |
| **o**                                                                                                                                                                                                                          | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                                           |
| **For the Transition period from                   to                 ** |
|                                                                                                                                                                                                                           |
| **0-26996**                                                                                                                                                                                                                    |
| **(Commission File Number)**                                                                                                                                                                                                   |

 

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**INVESTORS FINANCIAL SERVICES CORP.**

(Exact name of registrant as specified in itscharter)

** **

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

 

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

 

Indicate bycheck mark whether the registrant is an accelerated filer (as defined inExchange Act Rule 12b-2).  Yes ý      No o

 

As of April30, 2003 there were 65,026,821 shares of Common Stock outstanding.

 

 

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**INVESTORS FINANCIAL SERVICES CORP.**

** **

**INDEX**

** **
| **PART I.**        |   | **FINANCIAL INFORMATION**                                                                                         |
|--------------------|--------|-------------------------------------------------------------------------------------------------------------------|
|               |   |                                                                                                              |
| Item 1.            |   | Unaudited  Condensed Consolidated Financial Statements                                                            |
|               |   |                                                                                                              |
|               |   | Condensed Consolidated Balance Sheets  March 31, 2003 and December 31, 2002                                       |
|               |   |                                                                                                              |
|               |   | Condensed Consolidated Statements of Income  and Comprehensive Income  Three months ended March 31, 2003 and 2002 |
|               |   |                                                                                                              |
|               |   | Condensed Consolidated Statements of Stockholders’ Equity  Three months ended March 31, 2003 and 2002        |
|               |   |                                                                                                              |
|               |   | Condensed Consolidated Statements of Cash  Flows  Three months ended March 31, 2003 and 2002                      |
|               |   |                                                                                                              |
|               |   | Notes to Condensed Consolidated Financial Statements                                                              |
|               |   |                                                                                                              |
|               |   | Independent Accountants’ Report                                                                              |
|               |   |                                                                                                              |
| Item 2             |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                       |
|               |   |                                                                                                              |
| Item 3.            |   | Quantitative  and Qualitative Disclosure about Market Risk                                                        |
|               |   |                                                                                                              |
| Item 4.            |   | Controls  and Procedures                                                                                          |
|               |   |                                                                                                              |
| **PART II.**       |   | **OTHER INFORMATION**                                                                                             |
|               |   |                                                                                                              |
| Item 1.            |   | Legal Proceedings                                                                                                 |
|               |   |                                                                                                              |
| Item 6.            |   | Exhibits and Reports on Form 8-K                                                                                  |
|               |
| **SIGNATURES**     |
|               |
| **CERTIFICATIONS** |

 

2

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**PART I.**  **FINANCIALINFORMATION**

 

**Item1****.****                UnauditedCondensed Consolidated Financial Statements**

 

**INVESTORS FINANCIAL SERVICES CORP.****CONDENSED CONSOLIDATED BALANCE SHEETS March 31, 2003 and December 31, 2002(Dollars in thousands, except per share data)**

 
|                                                                                                                                                                                                                |   | **March 31,  2003** |      | **December  31,  2002** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|-----------|-------------------------|--------|
|                                                                                                                                                                                                                |   |                |      |                    |   |
| **Assets**                                                                                                                                                                                                          |   |                |      |                    |   |
| Cash and due from banks                                                                                                                                                                                             |   | $                   | 48,893    |                    | $      | 14,568 |   |
| Securities held to maturity (approximate  fair value of $3,698,998 and $3,460,754 at March 31, 2003 and  December 31, 2002, respectively)                                                                      |   | 3,683,457           |      | 3,438,689               |   |
| Securities available for sale                                                                                                                                                                                       |   | 3,512,795           |      | 3,272,465               |   |
| Non-marketable equity securities                                                                                                                                                                                    |   | 50,000              |      | 50,000                  |   |
| Loans, less allowance for loan losses of  $100 at March 31, 2003 and December 31, 2002                                                                                                                         |   | 107,182             |      | 143,737                 |   |
| Accrued interest and fees receivable                                                                                                                                                                                |   | 66,126              |      | 67,261                  |   |
| Equipment and leasehold improvements, less  accumulated depreciation of $30,959 and $25,402 at March 31, 2003 and  December 31, 2002, respectively                                                             |   | 77,591              |      | 74,869                  |   |
| Goodwill, net                                                                                                                                                                                                       |   | 79,969              |      | 79,969                  |   |
| Other assets                                                                                                                                                                                                        |   | 74,364              |      | 73,219                  |   |
|                                                                                                                                                                                                                |   |                |      |                    |   |
| **Total Assets**                                                                                                                                                                                                    |   | $                   | 7,700,377 |                    | $      | 7,214,777 |   |
|                                                                                                                                                                                                                |   |                |      |                    |   |
| **Liabilities and Stockholders’ Equity**                                                                                                                                                                       |   |                |      |                    |   |
| **Liabilities:**                                                                                                                                                                                                    |   |                |      |                    |   |
| Deposits:                                                                                                                                                                                                           |   |                |      |                    |   |
| Demand                                                                                                                                                                                                              |   | $                   | 438,050   |                    | $      | 384,461 |   |
| Savings                                                                                                                                                                                                             |   | 2,331,111           |      | 2,858,457               |   |
| Time                                                                                                                                                                                                                |   | 90,000              |      | 90,000                  |   |
| Total deposits                                                                                                                                                                                                      |   | 2,859,161           |      | 3,332,918               |   |
|                                                                                                                                                                                                                |   |                |      |                    |   |
| Securities sold under repurchase agreements                                                                                                                                                                         |   | 2,988,916           |      | 2,301,974               |   |
| Short-term and other borrowings                                                                                                                                                                                     |   | 1,178,477           |      | 741,107                 |   |
| Due to brokers for open trades payable                                                                                                                                                                              |   | 83,366              |      | 286,843                 |   |
| Other liabilities                                                                                                                                                                                                   |   | 109,924             |      | 85,676                  |   |
| Total liabilities                                                                                                                                                                                                   |   | 7,219,844           |      | 6,748,518               |   |
|                                                                                                                                                                                                                |   |                |      |                    |   |
| Commitments and contingencies                                                                                                                                                                                       |   | —              |      | —                  |   |
|                                                                                                                                                                                                                |   |                |      |                    |   |
| Company-obligated, mandatorily redeemable,  preferred securities of subsidiary trust holding solely junior subordinated  deferrable interest debentures of the Company                                              |   | 23,310              |      | 23,303                  |   |
|                                                                                                                                                                                                                |   |                |      |                    |   |
| **Stockholders’ Equity:**                                                                                                                                                                                      |   |                |      |                    |   |
| Preferred stock, par value $0.01 (shares  authorized: 1,000,000; issued and outstanding: none at March 31, 2003 and  December 31, 2002)                                                                        |   | —              |      | —                  |   |
| Common stock, par value $0.01 (shares  authorized: 100,000,000 at March 31, 2003 and December 31, 2002; issued  and outstanding:  64,992,847 at March  31, 2003 and 64,775,042 at December 31, 2002) |   | 650                 |      | 648                     |   |
| Surplus                                                                                                                                                                                                             |   | 234,766             |      | 233,337                 |   |
| Deferred compensation                                                                                                                                                                                               |   | (1,458              | )         | (1,599                  | )      |
| Retained earnings                                                                                                                                                                                                   |   | 202,722             |      | 198,282                 |   |
| Cumulative translation adjustments, net of  tax                                                                                                                                                                     |   | (9                  | )         | —                  |   |
| Accumulated other comprehensive income, net                                                                                                                                                                         |   | 20,552              |      | 12,288                  |   |
| Treasury stock, par value $0.01 (10,814  shares at March 31, 2003 and December 31, 2002)                                                                                                                       |   | —              |      | —                  |   |
| Total stockholders’ equity                                                                                                                                                                                     |   | 457,223             |      | 442,956                 |   |
| **Total Liabilities and Stockholders’ Equity**                                                                                                                                                                 |   | $                   | 7,700,377 |                    | $      | 7,214,777 |   |

 

*See Notes to Unaudited Condensed ConsolidatedFinancial Statements.*

 

3

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**INVESTORSFINANCIAL SERVICES CORP.CONDENSED CONSOLIDATED STATEMENTS OF INCOME ANDCOMPREHENSIVE INCOME Three Months Ended March 31, 2003 and 2002(Dollars in thousands, except per share data)**

 
|                                                                                                                         |   | **March 31,  2003** |   | **March 31,  2002** |   |
|------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|--------|---------------------|--------|
| **Operating Revenue:**                                                                                                       |   |                |   |                |   |
| Interest income:                                                                                                             |   |                |   |                |   |
| Federal funds sold and securities purchased  under resale agreements                                                         |   | $                   | 16     |                | $      | 67 |   |
| Investment securities held to maturity and  available for sale                                                               |   | 59,485              |   | 57,560              |   |
| Loans                                                                                                                        |   | 848                 |   | 1,005               |   |
| Total interest income                                                                                                        |   | 60,349              |   | 58,632              |   |
| Interest expense:                                                                                                            |   |                |   |                |   |
| Deposits                                                                                                                     |   | 9,117               |   | 10,594              |   |
| Short-term and other borrowings                                                                                              |   | 11,863              |   | 12,301              |   |
| Total interest expense                                                                                                       |   | 20,980              |   | 22,895              |   |
| Net interest income                                                                                                          |   | 39,369              |   | 35,737              |   |
|                                                                                                                         |   |                |   |                |   |
| Noninterest income:                                                                                                          |   |                |   |                |   |
| Asset servicing fees                                                                                                         |   | 72,874              |   | 69,333              |   |
| Other operating income                                                                                                       |   | 770                 |   | 584                 |   |
|                                                                                                                         |   |                |   |                |   |
| Net operating revenue                                                                                                        |   | 113,013             |   | 105,654             |   |
| **Operating Expenses:**                                                                                                      |   |                |   |                |   |
| Compensation and benefits                                                                                                    |   | 49,771              |   | 49,930              |   |
| Technology and telecommunications                                                                                            |   | 9,291               |   | 9,962               |   |
| Occupancy                                                                                                                    |   | 7,325               |   | 5,763               |   |
| Transaction processing services                                                                                              |   | 6,808               |   | 7,489               |   |
| Depreciation and amortization                                                                                                |   | 6,079               |   | 3,136               |   |
| Professional fees                                                                                                            |   | 1,679               |   | 1,678               |   |
| Travel and sales promotion                                                                                                   |   | 985                 |   | 1,234               |   |
| Other operating expenses                                                                                                     |   | 2,509               |   | 2,916               |   |
| Total operating expenses                                                                                                     |   | 84,447              |   | 82,108              |   |
|                                                                                                                         |   |                |   |                |   |
| **Income Before Income Taxes and Minority  Interest**                                                                        |   | 28,566              |   | 23,546              |   |
|                                                                                                                         |   |                |   |                |   |
| Provision for income taxes  (Note 10)                                                                                   |   | 22,773              |   | 7,094               |   |
| Minority interest expense, net of income  taxes                                                                              |   | 381                 |   | 397                 |   |
|                                                                                                                         |   |                |   |                |   |
| **Net Income**                                                                                                               |   | $                   | 5,412  |                | $      | 16,055 |   |
|                                                                                                                         |   |                |   |                |   |
| **Basic Earnings Per Share**                                                                                                 |   | $                   | 0.08   |                | $      | 0.25 |   |
|                                                                                                                         |   |                |   |                |   |
| **Diluted Earnings Per Share**                                                                                               |   | $                   | 0.08   |                | $      | 0.24 |   |
|                                                                                                                         |   |                |   |                |   |
| **Comprehensive Income:**                                                                                                    |   |                |   |                |   |
| Net income                                                                                                                   |   | $                   | 5,412  |                | $      | 16,055 |   |
| Other comprehensive income net of tax of  $4,450 and $799 for the three months ended March 31, 2003 and 2002,  respectively: |   |                |   |                |   |
| Net unrealized investment gain (loss)                                                                                        |   | 6,721               |   | (2,988              | )      |
| Net unrealized derivative instrument gain                                                                                    |   | 1,543               |   | 4,472               |   |
| Other comprehensive income                                                                                                   |   | 8,264               |   | 1,484               |   |
| Comprehensive income                                                                                                         |   | $                   | 13,676 |                | $      | 17,539 |   |

 

*See Notes to Unaudited Condensed ConsolidatedFinancial Statements.*

 

4

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**INVESTORSFINANCIAL SERVICES CORP.CONDENSED CONSOLIDATED STATEMENTS OFSTOCKHOLDERS’ EQUITY Three Months Ended March 31, 2003 and 2002(Dollars in thousands, except share data)**

 
|                                                                                                     |   | **March 31,  2003** |       | **March 31,  2002** |       |
|----------------------------------------------------------------------------------------------------------|--------|---------------------|------------|---------------------|------------|
| **Common shares**                                                                                        |   |                | ** ** |                | ** ** |
| Balance, beginning of period                                                                             |   | 64,775,042          |       | 31,971,404          |       |
| Exercise of stock options                                                                                |   | 217,805             |       | 158,628             |       |
| Balance, end of period                                                                                   |   | 64,992,847          |       | 32,130,032          |       |
|                                                                                                     |   |                |       |                |       |
| **Treasury shares**                                                                                      |   |                | ** ** |                | ** ** |
| Balance, beginning of period                                                                             |   | 10,814              |       | 10,814              |       |
| Balance, end of period                                                                                   |   | 10,814              |       | 10,814              |       |
|                                                                                                     |   |                |       |                |       |
| **Common stock**                                                                                         |   |                | ** ** |                | ** ** |
| Balance, beginning of period                                                                             |   | $                   | 648        |                | $          | 320 |   |
| Exercise of stock options                                                                                |   | 2                   |       | 2                   |       |
| Balance, end of period                                                                                   |   | 650                 |       | 322                 |       |
|                                                                                                     |   |                |       |                |       |
| **Surplus**                                                                                              |   |                |       |                |       |
| Balance, beginning of period                                                                             |   | 233,337             |       | 222,440             |       |
| Exercise of stock options                                                                                |   | 516                 |       | 1,112               |       |
| Tax benefit from exercise of stock options                                                               |   | 913                 |       | 2,037               |       |
| Balance, end of period                                                                                   |   | 234,766             |       | 225,589             |       |
|                                                                                                     |   |                |       |                |       |
| **Deferred compensation**                                                                                |   |                |       |                |       |
| Balance, beginning of the period                                                                         |   | (1,599              | )          | (2,563              | )          |
| Amortization of deferred compensation                                                                    |   | 141                 |       | 411                 |       |
| Balance, end of period                                                                                   |   | (1,458              | )          | (2,152              | )          |
|                                                                                                     |   |                |       |                |       |
| **Retained earnings**                                                                                    |   |                |       |                |       |
| Balance, beginning of period                                                                             |   | 198,282             |       | 132,877             |       |
| Net income                                                                                               |   | 5,412               |       | 16,055              |       |
| Cash dividend, $0.015 and $0.0125 per share  in the periods ending March 31, 2003 and 2002, respectively |   | (972                | )          | (802                | )          |
| Balance, end of period                                                                                   |   | 202,722             |       | 148,130             |       |
|                                                                                                     |   |                |       |                |       |
| **Cumulative translation adjustments, net of  tax**                                                      |   |                |       |                |       |
| Balance, beginning of the period                                                                         |   | —              |       | —              |       |
| Effect of foreign currency translation                                                                   |   | (9                  | )          | —              |       |
| Balance, end of period                                                                                   |   | (9                  | )          | —              |       |
|                                                                                                     |   |                |       |                |       |
| **Accumulated other comprehensive income  (loss), net**                                                  |   |                |       |                |       |
| Balance, beginning of period                                                                             |   | 12,288              |       | (10,296             | )          |
| Net unrealized investment gain (loss)                                                                    |   | 6,721               |       | (2,988              | )          |
| Net unrealized derivative instrument gain                                                                |   | 1,343               |       | 3,665               |       |
| Amortization of transition-related  adjustment                                                           |   | 200                 |       | 807                 |       |
| Balance, end of period                                                                                   |   | 20,552              |       | (8,812              | )          |
|                                                                                                     |   |                |       |                |       |
| **Treasury stock**                                                                                       |   |                |       |                |       |
| Balance, beginning of period                                                                             |   | —              |       | —              |       |
| Balance, end of period                                                                                   |   | —              |       | —              |       |
|                                                                                                     |   |                |       |                |       |
| **Total Stockholders’ Equity**                                                                      |   | $                   | 457,223    |                | $          | 363,077 |   |

 

*See Notes to Unaudited Condensed ConsolidatedFinancial Statements.*

 

5

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**INVESTORSFINANCIAL SERVICES CORP.CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS Three Months Ended March 31, 2003 and 2002(Dollars in thousands)**

 
|                                                                               |   | **March 31,  2003** |   | **March 31,  2002** |   |
|------------------------------------------------------------------------------------|--------|---------------------|--------|---------------------|--------|
|                                                                               |   |                |   |                |   |
| **Cash Flows From Operating Activities:**                                          |   |                |   |                |   |
| Net income                                                                         |   | $                   | 5,412  |                | $      | 16,055 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |   |                |   |                |   |
| Depreciation and amortization                                                      |   | 6,079               |   | 3,136               |   |
| Amortization of deferred compensation                                              |   | 141                 |   | 411                 |   |
| Amortization of premiums on securities, net  of accretion of discounts             |   | 7,097               |   | 699                 |   |
| Changes in assets and liabilities:                                                 |   |                |   |                |   |
| Accrued interest and fees receivable                                               |   | 1,135               |   | (4,114              | )      |
| Other assets                                                                       |   | (1,145              | )      | 22,052              |   |
| Other liabilities                                                                  |   | 21,089              |   | (10,660             | )      |
| Net cash provided by operating activities                                          |   | 39,808              |   | 27,579              |   |
|                                                                               |   |                |   |                |   |
| **Cash Flows From Investing Activities:**                                          |   |                |   |                |   |
| Proceeds from maturities of securities  available for sale                         |   | 311,514             |   | 125,033             |   |
| Proceeds from maturities of securities held  to maturity                           |   | 533,650             |   | 469,286             |   |
| Purchases of securities available for sale                                         |   | (542,353            | )      | (498,771            | )      |
| Purchases of securities held to maturity                                           |   | (782,669            | )      | (640,334            | )      |
| Net decrease in due to brokers for open  trades payable                            |   | (203,477            | )      | —              |   |
| Net decrease in loans                                                              |   | 36,555              |   | 96,936              |   |
| Purchases of fixed assets, capitalized  software and leasehold improvements        |   | (8,795              | )      | (9,890              | )      |
| Net cash used for investing activities                                             |   | (655,575            | )      | (457,740            | )      |
|                                                                               |   |                |   |                |   |
| **Cash Flows From Financing Activities:**                                          |   |                |   |                |   |
| Net increase (decrease) in demand deposits                                         |   | 53,589              |   | (256,039            | )      |
| Net (decrease) increase in time and savings  deposits                              |   | (527,346            | )      | 142,197             |   |
| Net increase in securities sold under  repurchase agreements                       |   | 686,942             |   | 445,592             |   |
| Net increase in short-term and other  borrowings                                   |   | 437,370             |   | 95,444              |   |
| Proceeds from exercise of stock options                                            |   | 518                 |   | 1,114               |   |
| Cash dividends to shareholders                                                     |   | (972                | )      | (802                | )      |
| Net cash provided by financing activities                                          |   | 650,101             |   | 427,506             |   |
|                                                                               |   |                |   |                |   |
| **Effect of foreign currency translation**                                         |   | (9                  | )      | —              |   |
|                                                                               |   |                |   |                |   |
| **Net Increase (Decrease) In Cash And Due  From Banks**                            |   | 34,325              |   | (2,655              | )      |
|                                                                               |   |                |   |                |   |
| **Cash and Due From Banks, Beginning of  Period**                                  |   | 14,568              |   | 15,605              |   |
|                                                                               |   |                |   |                |   |
| **Cash and Due From Banks, End of Period**                                         |   | $                   | 48,893 |                | $      | 12,950 |   |
|                                                                               |   |                |   |                |   |
| **Supplemental Disclosure of Cash Flow  Information:**                             |   |                |   |                |   |
| Cash paid for interest                                                             |   | $                   | 20,509 |                | $      | 22,470 |   |
| Cash paid for income taxes                                                         |   | $                   | 1,212  |                | $      | 5,941 |   |

 

*See Notes to Unaudited Condensed ConsolidatedFinancial Statements.*

 

6

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**INVESTORS FINANCIAL SERVICES CORP.**

**NOTES TO UNAUDITED CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS****(Information isas of and for the three monthsended March 31, 2003 and 2002)**

 

**1.****                                   Descriptionof Business**

 

InvestorsFinancial Services Corp. (‘IFSC’) provides asset servicing for the financialservices industry through its wholly-owned subsidiary, Investors Bank &Trust Company (the ‘Bank’).  As usedherein, the defined term “the Company” shall mean IFSC together with the Bankand its domestic and foreign subsidiaries. The Company provides global custody,multicurrency accounting, mutual fund administration, securities lending,foreign exchange, cash management, performance measurement, institutionaltransfer agency, investment advisory services, lines of credit and brokerageservices to a variety of financial asset managers, including mutual fund complexes,investment advisors, banks and insurance companies.  The Company is subject to regulation by the FederalReserve Board of Governors, the Office of the Commissioner of Banks of theCommonwealth of Massachusetts, the Federal Deposit Insurance Corporation andthe National Association of Securities Dealers.

 

On April 23,2002, the Board of Directors approved a two-for-one stock split in the form ofa 100% stock dividend to stockholders of record as of May 24, 2002.  All share numbers in the notes to the unauditedcondensed consolidated financial statements have been restated to reflect thetwo-for-one stock split paid June 14, 2002, where applicable.

 

**2****                                      InterimFinancial Statements**

 

The unauditedcondensed consolidated interim financial statements of the Company andsubsidiaries as of March 31, 2003 and December 31, 2002, and for thethree-month periods ended March 31, 2003 and 2002 have been prepared by theCompany pursuant to the rules and regulations of the Securities and ExchangeCommission.  Certain information andfootnote disclosures normally included in annual financial statements preparedin accordance with accounting principles generally accepted in the UnitedStates of America have been condensed or omitted as permitted by such rules andregulations.  All adjustments,consisting of normal recurring adjustments, necessary for their fairpresentation in conformity with accounting principles generally accepted in theUnited States of America are included. Management believes that the disclosures are adequate to present fairlythe financial position, results of operations and cash flows at the dates andfor the periods presented. It is suggested that these interim financialstatements be read in conjunction with the financial statements and the notes theretoincluded in the Company’s latest annual report on Form 10-K. Results forinterim periods are not necessarily indicative of those to be expected for thefull fiscal year. Certain amounts in prior financial statements have beenreclassified to conform to the current presentation.

 

7

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***Employee Stock-BasedCompensation*** - The Company measures compensation cost for stock-basedcompensation plans using the intrinsic value method. The intrinsic value methodmeasures compensation cost as the difference of the option exercise price andthe fair market value of the common stock on the measurement date, which isgenerally the date of grant.  Generally,options granted have an exercise price equivalent to the fair market value atthe measurement date.  Accordingly, nocompensation cost has been recorded.  Ifstock-based compensation were recognized using the fair value method, stock optionswould be valued at grant date using the Black-Scholes valuation model and compensationcosts would have decreased net income as indicated below (Dollars inthousands):

 
|                                                                                                                                          |   | **For the  Three  Months Ended  March 31,  2003** |   | **For the  Three  Months Ended  March 31,  2002** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------|--------|---------------------------------------------------|--------|
|                                                                                                                                          |   |                                              |   |                                              |   |
|                                                                                                                                          |   |                                              |   |                                              |   |
| Net income as reported                                                                                                                        |   | $                                                 | 5,412  |                                              | $      | 16,055 |   |
| Deduct: Total stock-based employee  compensation expense determined under fair value based method for all awards,  net of related tax effects |   | (1,684                                            | )      | (3,000                                            | )      |
| Pro forma net income                                                                                                                          |   | $                                                 | 3,728  |                                              | $      | 13,055 |   |
|                                                                                                                                          |   |                                              |   |                                              |   |
| Earnings per share:                                                                                                                           |   |                                              |   |                                              |   |
| Basic-as reported                                                                                                                             |   | $                                                 | 0.08   |                                              | $      | 0.25 |   |
| Basic-pro forma                                                                                                                               |   | 0.06                                              |   | 0.20                                              |   |
|                                                                                                                                          |   |                                              |   |                                              |   |
| Diluted-as reported                                                                                                                           |   | $                                                 | 0.08   |                                              | $      | 0.24 |   |
| Diluted-pro forma                                                                                                                             |   | 0.06                                              |   | 0.20                                              |   |

 

The fair valueof each option grant under the employee stock option plan was estimated on thedate of grant using the Black-Scholes valuation model with the followingassumptions for the three months ended March 31, 2003 and 2002, respectively:an assumed risk-free interest rate of 2.30% and 2.40%, an expected life of fouryears, an expected volatility of 56.18% and 56.20%, and a dividend yield of0.25% and 0.22%.

*** ***

***New AccountingPrinciples*** – The Company has adopted FASBInterpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements forGuarantees, Including Indirect Guarantees of Indebtedness of Others.”  This interpretation elaborates ondisclosures to be made by a guarantor about its obligations and requiresrecognition of a liability for the fair value of the obligation undertaken inissuing guarantees. On behalf of its clients, the Company lends securities tocreditworthy broker-dealers.  In certaincircumstances, the Company may indemnify its clients for the fair market valueof those securities against a failure of the borrower to return suchsecurities.  The Company requires theborrowers to provide collateral in an amount equal to or in excess of 102% ofthe fair market value of U.S. dollar denominated securities borrowed and 105%of the fair market value of non-U.S. dollar denominated securitiesborrowed.  The borrowed securities arerevalued daily to determine if additional collateral is necessary.  As guarantor, the Company is required torecognize, at the inception of a guarantee, a liability for the fair value ofthe obligation undertaken in issuing the guarantee.  The Company measures the fair value of its indemnificationobligation by marking its securities to market on a daily basis and comparesthe value of the portfolio to the collateral holdings position.  The fair value to be recorded would be thedeficiency of collateral to the value of the securities lending portfolio.  At March 31, 2003, the collateral receivedby the Company was in excess of the value of the securities that the Companywould be required to replace if the borrower defaulted and failed to return suchsecurities.  Therefore, the fair valueof the indemnification obligation was zero. The Company has recorded no liability for the indemnificationobligation.

 

The Companyhas adopted SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64,Amendment of FASB Statement No. 13, and Technical Corrections.”  Among its provisions, this Statementrescinds Statement No. 4, “Reporting Gains and Losses from Extinguishment ofDebt,” and an amendment of that

 

8

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Statement,Statement No. 64, “Extinguishments of Debt Made to Satisfy Sinking-FundRequirements,” and eliminates the extraordinary item treatment of reportinggains and losses from extinguishments of debt.   The adoption of this Statement did not have a material impact onthe Company’s financial position or results of operations.

 

The Companyhas adopted SFAS No. 146, “Accounting for Costs Associated with Exit orDisposal Activities.”  This Statementaddresses financial accounting and reporting for costs associated with exit ordisposal activities by requiring that a liability for a cost associated with anexit or disposal activity be recognized and measured initially at fair valueonly when the liability is incurred. The adoption of this Statement did not have a material impact on theCompany’s financial position or results of operations.

 

In April 2003,the FASB issued SFAS No. 149, “Amendment of Statement 133 on DerivativeInstruments and Hedging Activities.” SFAS No. 149 amends and clarifiesfinancial accounting and reporting for derivative instruments, includingcertain derivative instruments embedded in other contracts and for hedgingactivities under SFAS No. 133, “Accounting for Derivative Instruments andHedging Activities,” resulting in more consistent reporting of contracts aseither derivatives or hybrid instruments. SFAS No. 149 is effective forcontracts entered into or modified after June 30, 2003, and should be appliedprospectively. Implementation issues that have been effective for fiscalquarters that began prior to June 15, 2003 should continue to be applied inaccordance with their respective effective dates. The Company is currentlyassessing the impact of this statement on its financial statements.

 

 

**3.****                                      Securities**

 

Amortized costamounts and fair values of securities are summarized as follows as of March 31,2003 (Dollars in thousands):

 
| **Held to Maturity**             |   | **Amortized  Cost** |      | **Unrealized  Gains** |   | **Unrealized  (Losses)** |   | **Fair  Value** |   |
|----------------------------------|--------|---------------------|-----------|-----------------------|--------|--------------------------|--------|-----------------|--------|
|                             |   |                |      |                  |   |                     |   |            |   |
| Mortgage-backed securities       |   | $                   | 2,170,504 |                  | $      | 15,898                   |   | $               | (4,074 | ) | $ | 2,182,328 |   |
| Federal agency securities        |   | 1,394,912           |      | 2,345                 |   | (5,138                   | )      | 1,392,119       |   |
| State and political subdivisions |   | 118,041             |      | 6,514                 |   | (4                       | )      | 124,551         |   |
|                             |   |                |      |                  |   |                     |   |            |   |
| Total                            |   | $                   | 3,683,457 |                  | $      | 24,757                   |   | $               | (9,216 | ) | $ | 3,698,998 |   |

 
| **Available for Sale**           |   | **Amortized  Cost** |      | **Unrealized  Gains** |   | **Unrealized  (Losses)** |   | **Fair  Value** | ** ** |
|----------------------------------|--------|---------------------|-----------|-----------------------|--------|--------------------------|--------|-----------------|------------|
|                             |   |                |      |                  |   |                     |   |            |       |
| Mortgage-backed securities       |   | $                   | 2,929,688 |                  | $      | 47,998                   |   | $               | (251       | ) | $ | 2,977,435 |   |
| State and political subdivisions |   | 312,483             |      | 18,313                |   | (58                      | )      | 330,738         |       |
| Corporate debt                   |   | 179,378             |      | 15                    |   | (5,373                   | )      | 174,020         |       |
| Federal agency securities        |   | 29,601              |      | 1,001                 |   | —                   |   | 30,602          |       |
|                             |   |                |      |                  |   |                     |   |            |       |
| Total                            |   | $                   | 3,451,150 |                  | $      | 67,327                   |   | $               | (5,682     | ) | $ | 3,512,795 |   |

 

9

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Amortized costamounts and fair values of securities are summarized as follows as of December31, 2002 (Dollars in thousands):

 
| **Held to Maturity**             |   | **Amortized  Cost** |      | **Unrealized  Gains** |   | **Unrealized  (Losses)** |   | **Fair  Value** | ** ** |
|----------------------------------|--------|---------------------|-----------|-----------------------|--------|--------------------------|--------|-----------------|------------|
|                             |   |                |      |                  |   |                     |   |            |       |
| Mortgage-backed securities       |   | $                   | 2,034,430 |                  | $      | 19,702                   |   | $               | (664       | ) | $ | 2,053,468 |   |
| Federal agency securities        |   | 1,287,238           |      | 2,520                 |   | (4,999                   | )      | 1,284,759       |       |
| State and political subdivisions |   | 117,021             |      | 5,566                 |   | (60                      | )      | 122,527         |       |
|                             |   |                |      |                  |   |                     |   |            |       |
| Total                            |   | $                   | 3,438,689 |                  | $      | 27,788                   |   | $               | (5,723     | ) | $ | 3,460,754 |   |

 
| **Available for Sale**           |   | **Amortized  Cost** |      | **Unrealized  Gains** |   | **Unrealized  (Losses)** |   | **Fair  Value** | ** ** |
|----------------------------------|--------|---------------------|-----------|-----------------------|--------|--------------------------|--------|-----------------|------------|
|                             |   |                |      |                  |   |                     |   |            |       |
| Mortgage-backed securities       |   | $                   | 2,723,703 |                  | $      | 36,294                   |   | $               | (204       | ) | $ | 2,759,793 |   |
| State and political subdivisions |   | 290,241             |      | 17,090                |   | (39                      | )      | 307,292         |       |
| Corporate debt                   |   | 179,612             |      | 21                    |   | (5,134                   | )      | 174,499         |       |
| Federal agency securities        |   | 29,602              |      | 1,279                 |   | —                   |   | 30,881          |       |
|                             |   |                |      |                  |   |                     |   |            |       |
| Total                            |   | $                   | 3,223,158 |                  | $      | 54,684                   |   | $               | (5,377     | ) | $ | 3,272,465 |   |

 

**4.****                                      Loans**

 

Loans consistof demand loans to custody clients of the Company, including individuals andnot-for-profit institutions and loans to mutual fund clients. The loans tomutual funds and other pooled product clients include lines of credit andadvances pursuant to the terms of the custody agreements between the Companyand those mutual fund clients to facilitate securities transactions andredemptions. Generally, the loans are, or may be, in the event of default,collateralized with marketable securities held by the Company as custodian.There were no impaired or nonperforming loans at March 31, 2003 and December31, 2002.  In addition, there were no loancharge-offs or recoveries during the three months ended March 31, 2003 and theyear ended December 31, 2002. Loans are summarized as follows (Dollars inthousands):

 
|                           |   | **March 31,  2003** |    | **December  31,  2002** |   |
|--------------------------------|--------|---------------------|---------|-------------------------|--------|
| Loans to individuals           |   | $                   | 53,877  |                    | $      | 76,263 |   |
| Loans to mutual funds          |   | 28,503              |    | 49,372                  |   |
| Loans to others                |   | 24,902              |    | 18,202                  |   |
|                           |   | 107,282             |    | 143,837                 |   |
| Less allowance for loan losses |   | (100                | )       | (100                    | )      |
| Total                          |   | $                   | 107,182 |                    | $      | 143,737 |   |

 

**5.****                                      SecuritiesSold Under Repurchase Agreements**

 

The componentsof securities sold under repurchase agreements are as follows (Dollars inthousands):

 
|                                    |   | **March 31,  2003** |      | **December  31,  2002** |   |
|-----------------------------------------|--------|---------------------|-----------|-------------------------|--------|
|                                    |   |                |      |                    |   |
| Repurchase agreements – short-term |   | $                   | 2,838,916 |                    | $      | 2,101,849 |   |
| Repurchase agreements – long-term  |   | 150,000             |      | 200,125                 |   |
| Total                                   |   | $                   | 2,988,916 |                    | $      | 2,301,974 |   |

 

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**6.****                                      Short-termand Other Borrowings**

 

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

 
|                                                  |   | **March 31,  2003** |      | **December  31,  2002** |   |
|-------------------------------------------------------|--------|---------------------|-----------|-------------------------|--------|
|                                                  |   |                |      |                    |   |
| Federal funds purchased – overnight              |   | $                   | 498,098   |                    | $      | 130,648 |   |
| Federal Home Loan Bank of Boston long-term  advances  |   | 250,000             |      | 250,000                 |   |
| Federal Home Loan Bank of Boston overnight  advances  |   | 200,000             |      | 360,000                 |   |
| Federal Home Loan Bank of Boston short-term  advances |   | 200,000             |      | —                  |   |
| Federal funds purchased – short-term             |   | 30,000              |      | —                  |   |
| Treasury, Tax and Loan account                        |   | 379                 |      | 459                     |   |
| Total                                                 |   | $                   | 1,178,477 |                    | $      | 741,107 |   |

 

The Companyhas a borrowing arrangement with the Federal Home Loan Bank of Boston(‘FHLBB’), which has been utilized on an overnight, short-term and long-termbasis to satisfy funding requirements.

 

**7.****                                      Stockholders’Equity**

 

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

 

During thethree months ended March 31, 2003, the following activity occurred under theDirector Plan and Stock Plan:

 
|                                       |   | **March 31,  2003** |   |
|--------------------------------------------|--------|---------------------|--------|
|                                       |   | **Shares**          |   | **Weighted-  Average  Exercise  Price** |   |
|                                       |   |                |   |   |   |
| Outstanding at December 31, 2002           |   | 6,621,157           |   | $ | 22 |   |
| Granted                                    |   | 33,575              |   | 25 |   |
| Exercised                                  |   | (271,810            | )      | 7 |   |
| Canceled                                   |   | (43,550             | )      | 31 |   |
| Outstanding at March 31, 2003              |   | 6,339,372           |   | $ | 23 |   |
|                                       |   |                |   |   |   |
| Outstanding and exercisable March 31, 2003 |   | 4,071,848           |   |   |   |

 

There was no activity under the Employee Stock Purchase Plan for thethree months ended March 31, 2003.

 

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***Earnings Per Share****—*Reconciliationfrom Basic EPS to Diluted EPS is as follows (Dollars in thousands, except pershare data):

 
|                                    |   | **For the  Three Months Ended  March 31,** |   |
|-----------------------------------------|--------|--------------------------------------------|--------|
|                                    |   | **2003**                                   |   | **2002** |   |
|                                    |   |                                       |   |   |   |
| Income available to common stockholders |   | $                                          | 5,412  |   | $ | 16,055 |   |
|                                    |   |                                       |   |   |   |
| Basic average shares                    |   | 64,885,852                                 |   | 64,148,986 |   |
| Dilutive effect of stock options        |   | 1,433,396                                  |   | 2,317,350 |   |
| Diluted average shares                  |   | 66,319,248                                 |   | 66,466,336 |   |
|                                    |   |                                       |   |   |   |
| Earnings per share:                     |   |                                       |   |   |   |
| Basic                                   |   | $                                          | 0.08   |   | $ | 0.25 |   |
|                                    |   |                                       |   |   |   |
| Diluted                                 |   | $                                          | 0.08   |   | $ | 0.24 |   |

 

At March 31,2003, there were 3,620,549 option shares which were not considered dilutive forpurposes of earnings per share calculations.

 

**8.****                                      Off-BalanceSheet Financial Instruments**

 

***Lines of Credit*****—At March 31, 2003, the Company had commitments to individuals and mutual fundsunder collateralized open lines of credit totaling $857 million, against which$67 million in loans were drawn. The credit risk involved in issuing lines ofcredit is essentially the same as that involved in extending loan facilities.The Company does not anticipate any loss as a result of these lines of credit.

 

***Securities Lending*****—On behalf of its clients, the Company lends securities to creditworthybroker-dealers.  In certaincircumstances, the Company may indemnify its clients for the fair market valueof those securities against a failure of the borrower to return suchsecurities.  The Company requires theborrowers to provide collateral in an amount equal to or in excess of 102% ofthe fair market value of U.S. dollar denominated securities borrowed and 105%of the fair market value of non-U.S. dollar denominated securitiesborrowed.  The borrowed securities arerevalued daily to determine if additional collateral is necessary.  As guarantor, the Company is required torecognize, at the inception of a guarantee, a liability for the fair value ofthe obligation undertaken in issuing the guarantee.  The Company measures the fair value of its indemnificationobligation by marking its securities lending portfolio to market on a dailybasis and compares the value of the portfolio to the collateral holdingsposition.  The fair value to be recordedwould be the deficiency of collateral to the value of the securities lendingportfolio.  At March 31, 2003, thecollateral received by the Company was in excess of the value of the securitiesthat the Company would be required to replace if the borrower defaulted andfailed to return such securities, therefore, the fair value of theindemnification obligation was zero. The Company has recorded no liability for the indemnificationobligation.  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 thesecurities loans are over-collateralized by 2% (for U.S. dollar denominatedsecurities) to 5% (for non-U.S. dollar denominated securities) of the fairmarket value of the loan made, the collateral held by the Company would be usedto satisfy the obligation.  In addition,each borrowing agreement includes “set-off” language that allows the Company touse any excess collateral on other loans of that obligation to cover anydefaults.  However, there is a potentialrisk that the collateral would not be sufficient to cover such an obligation ifthe security on loan increased in value between the time the borrower defaultedand the time the security is “bought-in.” In such instances, the Company would “buy-in” the security using allavailable collateral and a loss would result from the difference between the valueof the security “bought-in” and the value of the collateral held.  The Company has never experienced a brokerdefault.  The Company held, ascollateral, cash

 

12

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and U.S.government securities totaling approximately $2.9 billion and $4.8 billion forindemnified securities on loan at March 31, 2003 and December 31, 2002,respectively.

 

**9.****                                      DerivativeFinancial Instruments**

 

***Foreign ExchangeContracts –*** Foreign exchange contracts involve anagreement to exchange the currency of one country for the currency of anothercountry at an agreed-upon rate and settlement date.  Foreign exchange contracts consist of spot, forward and swapcontracts.  Spot contracts call for theexchange of one currency for another and usually settle in two businessdays.  Forward contracts call for theexchange of one currency for another at a date beyond spot.  In a currency swap, the holder of a currencytransacts simultaneously both a spot and a forward transaction in that currencyfor an equivalent amount of another currency to get temporary liquidity in thecurrency owned.  Unrealized gains orlosses resulting from purchases and sales of foreign exchange contracts areincluded within the respective other assets and other liabilities categories onthe Company’s consolidated balance sheet. Unrealized gains in other assets were $4.5 million and $4.4 million asof March 31, 2003 and December 31, 2002, respectively.  Unrealized losses in other liabilities were$4.2 million and $4.5 million as of March 31, 2003 and December 31, 2002,respectively.  These gains and losseswere reduced by offsetting balances with the same counterparty where a masternetting agreement exists.  Thesecontracts have not been designated as hedging instruments, therefore allchanges in fair value are included in asset servicing fees.  The notional value of the Company’s foreignexchange contracts as of March 31, 2003 and December 31, 2002 were $1.1 billionand $0.7 billion, respectively.

 

***Interest-RateContracts*** - Interest rate contracts involve anagreement with a counterparty to exchange cash flows based on an underlyinginterest rate index.  A swap agreementinvolves the exchange of a series of interest payments, either at a fixed orvariable rate, based upon the notional amount without the exchange of theunderlying principal amount. The Company’s exposure from these interest ratecontracts results from the possibility that one party may default on itscontractual obligation when the contracts are in a gain position. The Companyexperienced no terminations by counterparties of interest rate swaps designatedas hedges. Credit risk is limited to the positive fair value of the derivativefinancial instrument, which is significantly less than the notional value. Theeffect of these agreements was to lengthen short-term variable rate liabilitiesinto longer-term fixed rate liabilities. The contractual or notional amounts ofinterest rate swap agreements held by the Company were approximately $1.0billion at both March 31, 2003 and December 31, 2002.  These contracts had no cost and the fair values wereapproximately $(30.3) million and $(33.1) million at March 31, 2003 andDecember 31, 2002, respectively.  Thesefair values are included in the other liabilities category on the Company’sconsolidated balance sheet.  Theseinstruments have been designated as cash flow hedges.  Changes in fair value of effective portions are included as acomponent of other comprehensive income. Changes in fair value of ineffective portions are included in netinterest income.

 

***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 intothese contracts, we are fixing the price to be paid at a future date forcertain investment securities. At March 31, 2003 and December 31, 2002, theCompany had $423.3 million and $432.6 million, respectively, of fixed pricepurchase contracts outstanding to purchase investment securities.  As of December 31, 2002, the associatedunrealized gain of $1.9 million was included within the other assets categoryon the Company’s consolidated balance sheet. As of March 31, 2003, there was no associated unrealized gain or loss.  Changes in fair value of these cash flowhedges are included as a component of other comprehensive income.

 

**10.****                               Commitmentsand Contingencies**

 

*Restrictions**on CashBalances*—The Company is required to maintain certain average cashreserve balances. The average required reserve balance with the Federal ReserveBank (‘FRB’) for the two-week period including March 31, 2003 was approximately$20.3 million.  In addition, other cashbalances in the amount of approximately $12.2 million were pledged to secureclearings with a depository institution, Depository Trust Company, as of March31, 2003.

 

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*Contingencies*—TheCompany provides a broad range of services to financial asset managers, such asmutual fund complexes, investment advisors, banks and insurance companies.  The core services include global custody,multicurrency accounting and mutual fund administration.  The value-added services include securitieslending, foreign exchange and cash management. Assets under custody and management, held by the Company in a fiduciarycapacity, are not included in the consolidated balance sheets since such itemsare not assets of the Company. Management conducts regular reviews of its fiduciary responsibilitiesand considers the results in preparing its consolidated financialstatements.  In the opinion ofmanagement, there are no contingent liabilities at March 31, 2003 that arematerial to the consolidated financial position or results of operations of theCompany.

 

On March 5,2003, the Governor of Massachusetts signed into law new retroactive legislationthat amended Massachusetts law to expressly disallow, for periods commencing in1999 onwards, the deduction for dividends received from a real estateinvestment trust.  The Company believesthat this imposition of a retroactive tax is unconstitutional and intends tochallenge the legality of this new legislation and continue to appeal andcontest the assessment.  However,accounting principles generally accepted in the United States of Americarequire the Company to account for the taxes and interest imposed by the newlaw at the time of its enactment. Accordingly, the Company accrued a tax liability on its balance sheetand a tax expense on its income statement for the three months ended March 31,2003 totaling $13.9 million, net of federal tax benefit, related to thepotential tax liabilities of the Bank under the new statute for its tax years1999 through 2002.

 

**11.****                               RegulatoryMatters**

 

The Companyand the Bank are subject to various regulatory capital requirementsadministered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certainmandatory and possibly additional discretionary actions by regulators that, ifundertaken, could have a direct material adverse effect on the Company’s andthe Bank’s results of operations and financial condition.  Under capital adequacy guidelines and theregulatory framework for prompt corrective action, the Bank must meet specificcapital guidelines that involve quantitative measures of the Bank’s assets,liabilities, and certain off-balance sheet items as calculated under regulatoryaccounting practices.  The Company’s andthe Bank’s capital amounts and classification are also subject to qualitativejudgments by the regulators about components, risk weightings, and otherfactors.

 

Quantitativemeasures established by regulation to ensure capital adequacy require theCompany and the Bank to maintain minimum amounts and ratios (set forth in the tablebelow) of Total and Tier 1 capital (as defined in the regulations) torisk-weighted assets (as defined), and of Tier 1 capital (as defined) toaverage assets (as defined). Management believes, as of March 31, 2003, thatthe Company and the Bank meet all capital adequacy requirements to which theyare subject.

 

14

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As of March31, 2003, the most recent notification from the FDIC categorized the Companyand the Bank as “well capitalized” under the regulatory framework for promptcorrective action. To be categorized as well capitalized, the Company and theBank must maintain minimum Total risk-based, Tier 1 risk-based, and Tier 1leverage ratios as set forth in the following table. There are no conditions orevents since that notification that management believes have changed theCompany’s or the Bank’s category.  Thefollowing table presents the capital ratios for the Company and the Bank(Dollars in thousands):

 
|                                                       |   | **Actual** |    | **For  Capital  Adequacy Purposes** |   | **To Be Well  Capitalized  Under Prompt  Corrective Action  Provisions** |   |
|------------------------------------------------------------|--------|------------|---------|-------------------------------------|--------|--------------------------------------------------------------------------|--------|
|                                                       |   | **Amount** |    | **Ratio**                           |   | **Amount**                                                               |   | **Ratio** |   | **Amount** |   | **Ratio** |   |
| **As of March 31,  2003:**                                 |   |       |    |                                |   |                                                                     |   |   |   |   |   |   |   |
| Total Capital  (to Risk Weighted Assets—the Company)  |   | $          | 380,120 |                                | 18.31  | %                                                                        | $      | 166,120 |   | 8.00 | % | N/A |   | N/A |   |
| Total Capital  (to Risk Weighted Assets—the Bank)     |   | $          | 376,478 |                                | 18.13  | %                                                                        | $      | 166,110 |   | 8.00 | % | $ | 207,637 |   | 10.00 | % |
| Tier 1 Capital  (to Risk Weighted Assets—the Company) |   | $          | 380,020 |                                | 18.30  | %                                                                        | $      | 83,060 |   | 4.00 | % | N/A |   | N/A |   |
| Tier 1 Capital  (to Risk Weighted Assets—the Bank)    |   | $          | 376,378 |                                | 18.13  | %                                                                        | $      | 83,055 |   | 4.00 | % | $ | 124,582 |   | 6.00 | % |
| Tier 1 Capital  (to Average Assets—the Company)       |   | $          | 380,020 |                                | 5.40   | %                                                                        | $      | 281,754 |   | 4.00 | % | N/A |   | N/A |   |
| Tier 1 Capital  (to Average Assets—the Bank)          |   | $          | 376,378 |                                | 5.34   | %                                                                        | $      | 281,785 |   | 4.00 | % | $ | 352,231 |   | 5.00 | % |
|                                                       |   |       |    |                                |   |                                                                     |   |   |   |   |   |   |   |   |   |   |
| **As of December 31,  2002:**                              |   |       |    |                                |   |                                                                     |   |   |   |   |   |   |   |
| Total Capital  (to Risk Weighted Assets—the Company)  |   | $          | 374,102 |                                | 15.51  | %                                                                        | $      | 192,915 |   | 8.00 | % | N/A |   | N/A |   |
| Total Capital  (to Risk Weighted Assets—the Bank)     |   | $          | 369,498 |                                | 15.32  | %                                                                        | $      | 192,915 |   | 8.00 | % | $ | 241,143 |   | 10.00 | % |
| Tier 1 Capital  (to Risk Weighted Assets—the Company) |   | $          | 374,002 |                                | 15.51  | %                                                                        | $      | 96,457 |   | 4.00 | % | N/A |   | N/A |   |
| Tier 1 Capital  (to Risk Weighted Assets—the Bank)    |   | $          | 369,398 |                                | 15.32  | %                                                                        | $      | 96,457 |   | 4.00 | % | $ | 144,686 |   | 6.00 | % |
| Tier 1 Capital  (to Average Assets—the Company)       |   | $          | 374,002 |                                | 5.50   | %                                                                        | $      | 272,132 |   | 4.00 | % | N/A |   | N/A |   |
| Tier 1 Capital  (to Average Assets—the Bank)          |   | $          | 369,398 |                                | 5.43   | %                                                                        | $      | 272,104 |   | 4.00 | % | $ | 340,130 |   | 5.00 | % |

 

UnderMassachusetts law, trust companies such as the Bank, like national banks, maypay dividends no more often than quarterly, and only out of “net profits” andto the extent that such payments will not impair the Bank’s capital stock andsurplus account. Moreover, prior approval of the Commissioner of Banks of theCommonwealth of Massachusetts 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 operationsof the Company’s securities broker affiliate, Investors Securities Services,Inc., are subject to federal and state securities laws, as well as the rules ofboth the Securities and Exchange Commission and the National Association ofSecurities Dealers, Inc.  Managementbelieves, as of March 31, 2003, that Investors Securities Services, Inc. metall regulatory requirements to which it is subject.

 

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**12.****                               GeographicReporting**

 

The Companydoes not utilize segment information for internal reporting as management viewsthe Company 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** |   |
|-----------------------------|--------|--------------------------------------------|---------|------------------------|--------|
|                        |   | **For the  Three Months  Ended March 31,** |    | **March 31,**          |   | **December  31,** |   |
| **Geographic Information:** |   | **2003**                                   |    | **2002**               |   | **2003** |   | **2002** | ** ** |
|                        |   |                                       |    |                   |   |   |   |   |   |
| United States               |   | $                                          | 108,810 |                   | $      | 102,641 |   | $ | 152,507 |   | $ | 154,060 |   |
| Ireland                     |   | 3,759                                      |    | 2,458                  |   | 5,048 |   | 773 |   |
| Canada                      |   | 427                                        |    | 534                    |   | 5 |   | 5 |   |
| Cayman Islands              |   | 17                                         |    | 21                     |   | — |   | — |   |
|                        |   |                                       |    |                   |   |   |   |   |   |
| Total                       |   | $                                          | 113,013 |                   | $      | 105,654 |   | $ | 157,560 |   | $ | 154,838 |   |

 

BarclaysGlobal Investors, N.A. accounted for 14.97% and 15.85% of the Company’sconsolidated net operating revenues for the three months ended March 31, 2003and 2002, respectively.

 

16

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INDEPENDENTACCOUNTANTS’ REPORT

 

To the Board of Directors and Stockholders of

Investors Financial Services Corp.

Boston, Massachusetts

 

We have reviewed the accompanying condensed consolidated balance sheetof Investors Financial Services Corp. and subsidiaries (the “Company”) as ofMarch 31, 2003, and the related condensed consolidated statements of income andcomprehensive income, stockholders’ equity and cash flows for the three-monthperiods ended March 31, 2003 and 2002. These financial statements are the responsibility of the Company’s management.

 

We conducted our review in accordance with standards established by theAmerican Institute of Certified Public Accountants.  A review of interim financial information consists principally ofapplying analytical procedures to financial data and of making inquiries ofpersons responsible for financial and accounting matters.  It is substantially less in scope than anaudit conducted in accordance with auditing standards generally accepted in theUnited States of America, the objective of which is the expression of anopinion regarding the financial statements taken as a whole.  Accordingly, we do not express such anopinion.

 

Based on our review, we are not aware of any material modificationsthat should be made to such condensed consolidated financial statements forthem to be in conformity with accounting principles generally accepted in theUnited States of America.

 

We have previously audited, in accordance with auditing standardsgenerally accepted in the United States of America, the consolidated balancesheet of Investors Financial Services Corp. and subsidiaries as of December 31,2002, and the consolidated statements of income and comprehensive income,stockholders’ equity and cash flows for the year then ended, and in our reportdated February 14, 2003, we expressed an unqualified opinion on thoseconsolidated financial statements.  Inour opinion, the information set forth in the accompanying condensedconsolidated balance sheet as of December 31, 2002 is fairly stated, in allmaterial respects, in relation to the consolidated balance sheet from which ithas been derived.

 

DELOITTE & TOUCHE LLP

Boston, Massachusetts

May 1, 2003

 

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

** **

**Overview**

 

*You should read the following discussion together with our UnauditedCondensed Consolidated Financial Statements**and relatedNotes to Unaudited Condensed Consolidated Financial Statements, which areincluded elsewhere in this Report.  Thefollowing discussion contains forward-looking statements that reflect plans,estimates and beliefs.  Our actualresults could differ materially from those discussed in the forward-lookingstatements.*

 

We provide a broad range of services to a variety of financial assetmanagers.  These include our coreservices of global custody, multicurrency accounting and mutual fundadministration, as well as our value-added services, which are securitieslending, foreign exchange, cash management, performance measurement,institutional transfer agency, investment advisory services, lines of creditand brokerage services.  At March 31,2003, we provided services for approximately $784 billion in net assets,including approximately $82 billion of foreign net assets.

 

On April 23,2002, the Board of Directors approved a two-for-one stock split in the form ofa 100% stock dividend payable to shareholders of record as of May 24,2002.  The dividend was paid on June 14,2002.

 

On January 31, 2003, we were named in a class action lawsuit alleging,among other things, violations of California wage and hour laws at ourSacramento and Walnut Creek facilities. The lawsuit was filed in the SuperiorCourt of California, County of Sacramento. While we are in the early stages ofinvestigating this complaint, we believe that we have complied at all timeswith applicable law and we intend to defend this lawsuit vigorously. We do notyet know the amount of damages that the plaintiffs are seeking to recover.However, the defense of class action lawsuits can be costly and time consuming,and can divert the attention of management. A determination that we violatedapplicable wage and hour laws could have a material adverse effect on ourbusiness, financial condition and results of operations.

 

On March 5, 2003, the Governor of Massachusetts signed into law newretroactive legislation that amended Massachusetts law to expressly disallow,for periods commencing in 1999 onwards, the deduction for dividends receivedfrom a real estate investment trust (‘REIT’). We believe that this imposition of a retroactive tax is unconstitutionaland intend to challenge the legality of this new legislation and continue toappeal and contest the assessment. However, accounting principles generally accepted in the United Statesof America require us to account for the taxes and interest imposed by the newlaw at the time of its enactment. Accordingly, we accrued a tax liability on our balance sheet and a taxexpense on our income statement for the three months ended March 31, 2003totaling $13.9 million, net of federal tax benefit, related to the potentialtax liabilities of the Bank under the new statute for its tax years 1999through 2002.  During 2003, the Bankceased deducting the dividends it receives from the REIT resulting in a furtherreduction of consolidated net income in 2003 of approximately $0.8 million or$0.012 per share.

 

18

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** **

**Revenue and Expense Overview**

 

We derive our revenue from financial asset servicing.  Although interest income and noninterestincome are reported separately for financial statement presentation purposes,our service offerings are priced on a bundled basis.  In establishing a fee structure for a specific client, managementanalyzes all expected revenue and related expenses.  Accordingly, we believe net operating revenue (net interestincome plus noninterest income) and net income are the most meaningful measuresof our financial results. Net operating revenue increased 7% to$113.0 million from $105.7 million for the three months ended March 31,2003 compared to the same period last year. Net income decreased 66% to $5.4 million from $16.1 million for thethree months ended March 31, 2003 compared to the same period last year.  Net income, excluding the $13.9 millionadditional tax expense due to state tax law changes, would have increased 20%to $19.3 million for the three months ended March 31, 2003 compared to the sameperiod last year.

 

Noninterest income consists primarily of fees for financial assetservicing and is principally derived from global custody, multicurrencyaccounting, mutual fund administration and institutional transfer agencyservices for financial asset managers and the assets they control. Our clientspay fees based on the volume of assets processed, portfolio transactions,income collected and whether other value-added services such as foreignexchange, securities lending and cash management are needed.  Asset-based fees are usually charged on asliding scale and are subject to minimum fees. As such, when the assets in a portfolio under custody grow as a resultof changes in market values or cash inflows, our fees may be a smallerpercentage of those assets.  Conversely,as asset values fall, our revenue decreases by the marginal rate charged on oursliding scale pricing model.  As aresult, as asset values decrease, fees will decrease, but at a smallerpercentage than the asset value decrease.

 

Net interest income represents the difference between income frominterest-earning assets and expense on interest-bearing liabilities.  Our clients, in the course of theirfinancial asset management, maintain interest-bearing cash balances, which theydeposit on a short-term basis with us. We either directly invest these cashbalances to earn interest income, or place these deposits in third-partyvehicles and remit a portion of the earnings on these investments to ourclients.  Our share of earnings from theseinvestments is viewed as part of the total package of compensation paid to usfrom our clients for performing asset servicing.

 

Operating expenses consist of costs incurred in support of our businessactivities.  As a service provider, ourlargest expenditures are staffing costs, including compensation andbenefits.  We rely heavily ontechnological tools and services for processing, communicating and storingdata.  As a result, our technology andtelecommunication expense is also a large percentage of our operatingexpenses.  We also rely on anestablished network of global subcustodians in order to service our clientsworldwide, which is reflected in our transaction processing service expense.

 

If the value of equity assets held by our clients were to increase ordecrease by 10%, we estimate that this, by itself, would currently cause acorresponding change of approximately 3% in our earnings per share.  If the value of fixed income assets held byour clients were to increase or decrease by 10%, we estimate that this, byitself, would currently cause a corresponding change of approximately 2% in ourearnings per share.  In practice,earnings per share do not track precisely to the value of the equity marketsbecause conditions present in a market decline may generate offsettingincreases in other revenue items.  Forexample, market volatility often results in increased transaction feerevenue.  Also, market declines mayresult in increased interest income and sweep fee income as clients move largeramounts of assets into cash management vehicles that we offer.  As a result, our earnings have remainedstrong despite the recent steep declines in the broad equity markets.  However, there can be no assurance thatthese offsetting revenue increases will continue.

 

# **Critical Accounting Policies**

 

Accounting policies involving significant judgments and assumptions bymanagement, which have, or could have, a material impact on the carrying valueof certain assets and impact income, are considered critical accountingpolicies.  We consider the following tobe our critical accounting policies: derivatives, valuation of goodwill,capitalized costs of software developed for internal use, other than temporaryimpairment of securities, accounting for stock options, and revenuerecognition.  There have been no significantchanges in the methods or assumptions used in the accounting policies thatrequired material estimates and assumptions during the three months ended March31, 2003.  Senior management hasdiscussed these critical accounting policies with the audit committee and theauditors.

 

# *Derivatives*

 

We do not purchase derivative instruments for trading purposes.  We use derivative instruments to manageexposures to interest rate risks.  Weroutinely enter into interest rate swap agreements in which we pay a fixedinterest rate and receive a floating interest rate.  These transactions are designed to hedge a portion of ourliabilities.  By entering into apay-fixed/receive-

 

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floating interest rate swap, aportion of our floating rate liabilities are effectively converted to a fixedrate liability for the term of the interest rate swap agreement.  We also enter into fixed price purchasecontracts that are designed to hedge the variability of the consideration to bepaid for the purchase of investment securities.  By entering into these contracts, we are fixing the price to bepaid at a future date for certain investment securities.

 

Allderivatives, whether designated in hedging relationships or not, are required tobe recorded on the balance sheet at fair value.  If the derivative is designated as a fair value hedge, the changein the fair value of the derivative and the item being hedged will berecognized in earnings.  If thederivative is designated as a cash flow hedge, the effective portions ofchanges in the fair value of the derivative are recorded as a component ofother comprehensive income.  Ineffectiveportions of changes in the fair value of the derivatives are recognized inearnings.  For derivatives that do notqualify as hedges changes in fair value are recognized in earnings.

 

We measure thechanges in fair value of our hedge-designated derivatives against the changesin expected cash flows of the underlying hedged transactions for each reportingperiod.  This process involves theestimation of the expected future cash flows of hedged transactions.  Interest rate swaps are valued using anationally recognized swap valuation model. The LIBOR (London Interbank Offered Rate) curve in this model serves asthe basis for computing the market value of the swap portfolio.  If interest rates increase, the swaps wouldgain in value.  Conversely, if interestrates decrease there would be a corresponding decline in the market value ofthe swaps portfolio.  Changes inconditions or the occurrence of unforeseen events could affect the timing ofthe recognition of changes in fair value of certain hedging derivatives.  The measurement of fair value is based uponmarket values; however, in the absence of quoted market values, measurementinvolves valuation estimates.  Theseestimates are based on methodologies deemed appropriate in thecircumstances.  However, the use ofalternative assumptions could have a significant effect on estimated fairvalues.

 

Hedgeineffectiveness had an insignificant impact on earnings for the quarter.   At March 31, 2003, the contractual ornotional amounts of our interest rate swap agreements were approximately $1.0billion.  These derivatives have a fairvalue of approximately $(30.3) million and are included in the otherliabilities category of our consolidated balance sheet.  These swaps have been designated as cashflow hedges and changes in fair value are recognized in other comprehensiveincome. At March 31, 2003, we had $423.3 million of fixed price purchasecontracts outstanding to purchase investments. There was no associated unrealized gain or loss for these purchasecontracts.   These contracts have beendesignated as cash flow hedges and changes in fair value are recognized in othercomprehensive income.

 

We also enterinto foreign exchange contracts with clients and seek to enter into matchedpositions with another bank.  Thesecontracts are subject to market valuations in foreign currencies.  Gains and losses from such fluctuations arenetted and recorded as an adjustment to asset servicing fees.  Unrealized gains or losses resulting frompurchases and sales of foreign exchange contracts are included within therespective other assets and other liabilities categories on our consolidatedbalance sheet.  The foreign exchangecontracts have been reduced by balances with the same counterparty where amaster netting agreement exists.  Thesecontracts have not been designated as hedging instruments.  Therefore, all changes in fair value areincluded in asset servicing fees.

 

*Valuation of goodwill*

 

For acquisitions accounted for under the purchase method, we arerequired to record assets acquired and liabilities assumed at their fair value,which is an estimate determined by the use of internal or other valuationtechniques. These valuation estimates may result in goodwill and otherintangible assets. Goodwill is subject to ongoing periodic impairment tests andis evaluated using various fair value techniques. In evaluating the recorded goodwillfor impairment, management must estimate the fair value of the reporting unitsthat have goodwill. We view the Company as one segment and one reporting unit;therefore, the valuation of the fair value of our entity is evaluated at theconsolidated level.  The estimatedvaluation requires estimates of future performance and is susceptible tochanges in the capital market environment.

 

*Capitalized costs of software developed forinternal use*

 

Costs of internally developed software, such as those related tosoftware licenses, programming, testing, configuration and integration, arecapitalized and included in equipment and leasehold improvements.  Assets are placed in service anddepreciation and/or amortization commences when successful testing has been achieved.  Capitalized software costs are amortizedover the estimated useful life of a given project, which can range from threeto five years.  These assets arereviewed on an ongoing basis for compliance with accounting standards.  In addition, management periodically reviewscapitalized costs for impairment. Significant judgment is exercised in these impairment reviews includingthe periodic evaluation of the

 

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cost/benefit analyses ofsoftware projects under development and in the determination of the remaininguseful life of the completed projects.

 

*Other than temporary impairment*

 

On a quarterlybasis, we evaluate our investment portfolio to determine whether there are anyother than temporary impairment valuation issues.  This analysis is performed by comparing quoted market prices toamortized cost and evaluating each identified security whose market value isless than amortized cost for a sustained period of time. Our accounting policyrequires recognition of an other than temporary impairment charge on a securityif it is determined that we are unable to recover all amounts due under thecontractual obligations of the security. Management uses its best estimate regarding the estimated future paymentson the contractual obligation by reviewing changes in security ratings andevaluating the financial performance of the underlying issuer.

 

*Accounting for stock options*

 

We measure compensation cost for stock-based plans using the intrinsicvalue method. The intrinsic value method measures compensation cost as thedifference between the exercise price of options granted and the fair marketvalue of our stock at the measurement date, which is generally the date ofgrant. Generally, options granted have an exercise price equivalent to the fairmarket value at the measurement date. Accordingly, no compensation cost has been recorded.  Alternatively, we could choose to record compensationexpense using the fair value method. The fair value method utilizes significant assumptions such asvolatility, expected life of the option, risk-free interest rates as well as adividend yield in a Black-Scholes valuation model to calculate the amount ofcompensation expense.  Under the fairvalue method, the compensation expense calculated is recognized over thevesting period of the options.  Theexpected life of an option and the volatility of the underlying stock determinea majority of the value of an option and its ultimate compensation cost.  As such, the longer the option life or thehigher the volatility of the underlying stock, the higher the value of theoption and the higher the related compensation cost to us.   If we had recognized compensation expenseunder the fair value method, compensation expense relating to stock optionswould have been $1.7 million for the three months ended March 31, 2003.

 

*Revenue recognition*

 

We recognize revenue from asset servicing and investment advisoryservices based on contractual terms signed by our clients.  Generally, revenue is accrued by multiplyingaverage or month-end net assets by contracted rates.  Revenue is considered earned daily as transactions are processedor services are provided and is accrued monthly.   We recognize revenue from our value-added services, such asforeign exchange, securities lending and cash management services based on thespecific type of transaction volume. Value-added service revenue is earned daily as transactions areprocessed or services are provided and is accrued monthly.  Revenue on interest earning assets isrecognized based on the effective yield of the financial instrument.

 

Revenue recognition for asset servicing and value-added servicesinvolves the use of estimates and assumptions, including components that arecalculated based on estimated asset valuations and transaction volumes.  While these estimates and assumptions couldbe considered complex, we have strong internal controls and processes in placeto ensure the accuracy of revenue accruals. Historically, revenue recognized using these processes has fairlymatched revenue billed and collected. Our revenue recognition process is promptly validated by timelyinvoicing and cash collection from clients and counterparties.

 

**CertainFactors That May Affect Future Results**

 

From time totime, information provided by us, statements made by our employees, orinformation included in our filings with the SEC (including this Form 10-Q) maycontain statements which are not historical facts, so-called “forward-lookingstatements,” and which involve risks and uncertainties.  Thesestatements relate to future events or our future financial performance and areidentified by words such as “may,” “will,” “could,” “should,” “expect,” “plan,”“intend,” “seek,” “anticipate,” “believe,” “estimate,” “potential,” or“continue” or other comparable terms or the negative of those terms.  Forward-looking statements in thisForm 10-Q include certain statements regarding liquidity, interest rateconditions, interest rate sensitivity, loss exposure on lines of credit, thetiming and effect on earnings of derivative gains and losses, the effect onearnings of changes in equity values, and the effect of certain tax and legalclaims against us.  Our actual futureresults may differ significantly from those stated in any forward-lookingstatements.  Factors that may cause suchdifferences include, but are not limited to, the factors discussed below.  Each of these factors, and others, are discussedfrom time to time in our filings with the SEC.

 

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

 

We base someof our fees on the market value of the assets we process.  Accordingly, our operating results aresubject to fluctuations in interest rates and securities markets as thesefluctuations affect the market value of assets processed.  Current market conditions, including therecent volatility in equity markets, adversely affect our asset-basedfees.  While reductions in these feesmay be offset by increases in other sources of revenue, a sustained downwardmovement of the broad equity markets will have an adverse impact on ourearnings.  Fluctuations in interestrates or the securities markets can also lead to investors seeking alternativesto the investment offerings of our clients, which could result in a lesseramount of assets processed and correspondingly lower fees.  Also, our net interest income is earned byinvesting depositors’ funds and making loans. Rapid changes in interest rates or changes in the relationship betweendifferent index rates could adversely affect the market value of, or theearnings produced by, our investment and loan portfolios, and could adverselyaffect our operating results.

 

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

 

As a result of our assumption of the operations of the U.S. assetadministration unit of BGI in 2001 and our ongoing relationship with BGI’siShares and Master Investment Portfolios, BGI accounted for approximately 15%and 16% of our net operating revenue during the three months ended March 31,2003 and 2002, respectively.  We expectthat BGI will continue to account for a significant portion of our net operatingrevenue.  While we provide services toBGI under long-term contracts, those contracts may be terminated for certainregulatory and fiduciary reasons.  Theloss of BGI’s business would cause our net operating revenue to decline andwould have a material adverse effect on our quarterly and annual results.

 

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

 

We are part of an extremely competitive asset servicing industry.  Many of our current and potentialcompetitors have longer operating histories, greater name recognition andsubstantially greater financial, marketing and other resources than we do.  These greater resources could, for example,allow our competitors to develop technology superior to our own. In addition,we face the risk that large mutual fund complexes may build in-house assetservicing capabilities and no longer outsource these services to us.  As a result, we may not be able to competeeffectively with current or future competitors, which could result in a loss ofexisting clients or difficulty in gaining new clients.

 

*We may incur significant costs defendinglegal claims.*

 

We have been named in a class action lawsuit in California state courtalleging violations of California laws, including wage and hour laws. While webelieve this claim is without merit, we cannot be sure that we will prevail inthe defense of this claim.  Class actionlitigation is costly and could divert the attention of management.  If we were found to have violated Californiawage and hour laws, we could be liable for back wages and other penalties.  As a result, a determination of violation ofCalifornia law could have a material adverse effect upon our business,financial condition and results of operations. We may become subject to other legal claims in the future.

 

*Our future results depend, in part, onsuccessful integration of pending and possible future acquisitions andoutsourcing transactions.*

 

Integration of acquisitions and outsourcing transactions is complicatedand frequently presents unforeseen difficulties and expenses which can affectwhether and when a particular acquisition will be accretive to our earnings pershare.  Any future acquisitions oroutsourcing transactions will present similar challenges.

 

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

 

We have been experiencing a period of rapid growth that has requiredthe dedication of significant management and other resources. Continued rapidgrowth could place 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.

 

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

 

Qualified personnel, in particular managers and other senior personnel,are in great demand throughout the financial services industry, even in today’sslower economy.  We could find itincreasingly difficult to continue to attract and retain sufficient numbers ofthese highly skilled employees, which could affect our ability to attract andretain clients.

 

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

 

Our proprietary technology is important to our business.  We rely on trade secret, copyright andtrademark laws and confidentiality agreements with employees and third partiesto protect our proprietary technology, all of which offer only limitedprotection.  These intellectual propertyrights may be invalidated or our competitors may develop similar technologyindependently.  Legal proceedings toenforce our intellectual property rights may be unsuccessful, and could also beexpensive and divert management’s attention.

 

*Our quarterly and annual operating resultsmay fluctuate.*

 

Our quarterly and annual operating results are difficult to predict andmay fluctuate from quarter to quarter and annually for several reasons, including:

 

•                                          The timing of commencement or termination ofclient engagements; and

 

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

 

Most of our expenses, like employee compensation and rent, are relativelyfixed.  As a result, any shortfall inrevenue relative to our expectations could significantly affect our operatingresults.

 

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

 

Federal and state laws and regulations applicable to financialinstitutions and their parent companies apply to us.  Our primary regulators are the Federal Reserve Board (‘FRB’), theFederal Deposit Insurance Corporation (‘FDIC’), the Massachusetts Commissioner of Banks and the NationalAssociation of Securities Dealers (‘NASD’). Virtually all aspects of our operations are subject to specificrequirements or restrictions and general regulatory oversight including thefollowing:

 

•                                          The FRB and the FDIC maintain capital requirementsthat we must meet. Failure to meet those requirements could lead to severeregulatory action or even receivership. We are currently considered to be “wellcapitalized”;

 

•                                          Under Massachusetts law, the Bank may berestricted in its ability to pay dividends to Investors Financial, which may inturn 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; and

 

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

 

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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**Results of Operations**

 

*Comparison of Operating Results for the ThreeMonths Ended March 31, 2003 and 2002*

** **

*Net Operating Revenue*

 

The componentsof net operating revenue are as follows (Dollars in thousands):

 
|                        |   | **For the  Three Months Ended March 31,** |    |
|-----------------------------|--------|-------------------------------------------|---------|
|                        |   | **2003**                                  |    | **2002** |   | **Change** |   |
|                        |   |                                      |    |   |   |   |   |
| Net interest income         |   | $                                         | 39,369  |   | $ | 35,737 |   | 10 | % |
| Noninterest income          |   | 73,644                                    |    | 69,917 |   | 5 | % |
|                        |   |                                      |    |   |   |   |   |
| Total net operating revenue |   | $                                         | 113,013 |   | $ | 105,654 |   | 7 | % |

 

*Net Interest Income*

 

Net interest income is affected by the volume and mix of assets andliabilities, and the movement and level of interest rates. The table belowpresents the change in net interest income resulting from change in the volumeof interest-earning assets or interest-bearing liabilities and change ininterest rates for the three months ended March 31, 2003 compared to the sameperiod in 2002. Changes attributed to both volume and rate have been allocatedbased on the proportion of change in each category (Dollars in thousands):

 
|                                                                |   | **For the Three Months Ended March 31,  2003** |   |
|---------------------------------------------------------------------|--------|------------------------------------------------|--------|
|                                                                |   | **Change  Due to  Volume**                     |   | **Change  Due to  Rate** |   | **Net** |   |
|                                                                |   |                                           |   |   |   |   |   |
| **Interest-earning assets:**                                        |   |                                           |   |   |   |   |   |
| Federal funds sold and securities purchased under resale agreements |   | $                                              | (38    | ) | $ | (13 | ) | $ | (51 | ) |
| Investment securities                                               |   | 16,382                                         |   | (14,457 | ) | 1,925 |   |
| Loans                                                               |   | 40                                             |   | (197 | ) | (157 | ) |
|                                                                |   |                                           |   |   |   |   |   |
| Total interest-earning assets                                       |   | $                                              | 16,384 |   | $ | (14,667 | ) | $ | 1,717 |   |
|                                                                |   |                                           |   |   |   |   |   |
| **Interest-bearing liabilities:**                                   |   |                                           |   |   |   |   |   |
| Deposits                                                            |   | $                                              | 2,259  |   | $ | (3,736 | ) | $ | (1,477 | ) |
| Borrowings                                                          |   | 3,561                                          |   | (3,999 | ) | (438 | ) |
|                                                                |   |                                           |   |   |   |   |   |
| Total interest-bearing liabilities                                  |   | $                                              | 5,820  |   | $ | (7,735 | ) | $ | (1,915 | ) |
|                                                                |   |                                           |   |   |   |   |   |
| Change in net interest income                                       |   | $                                              | 10,564 |   | $ | (6,932 | ) | $ | 3,632 |   |

 

Net interest income was $39.4 million for the three months endedMarch 31, 2003, up 10% from the same period in 2002.  The improvement in net interest income primarily reflects thepositive effect of balance sheet growth.

Average interest-earning assets, primarilyinvestment securities, increased $1.6 billion or 32% for the three months endedMarch 31, 2003 compared to the same period last year.  Funding for the asset growth was provided by a combination ofclient balances of $1.1 billion and external borrowings of $0.5 billion.  The effect of changes in volume ofinterest-earning assets and interest-bearing liabilities was an increase in netinterest income of approximately $10.6 million for the three months ended March31, 2003.

 

As indicated in the net interest margin table below, the average yieldon interest-earning assets was 3.59% for the three months ended March 31, 2003,down 100 basis points from the same period in 2002.  The average rate paid on interest-bearing liabilities was 1.37%for the three months ended March 31, 2003, down 63 basis points from the sameperiod in 2002.  The decrease reflectsthe lower interest rate environment for the three months ended March 31, 2003compared to the same period in 2002. The effect on net interest income due to changes in rates for the threemonths ended March 31, 2003 was a decrease of $6.9 million.

 

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The net interest margin decreased 46 basis points to 2.34% for thethree months ended March 31, 2003, compared to the same period last year.  During the past two years, ournet interest margin has been unusually favorable.  While interest rates remain low, the yield curve is flattening,meaning the difference between short-term interest rates and long-term interestrates is decreasing.  In addition, withmortgage rates at historic lows, refinancing activities increase, resulting inprepayments of higher yielding mortgage-backed securities that we hold, theproceeds of which are reinvested at current market rates.  These factors, among others, may decreaseour net interest margin to more traditional levels and reduce the unusuallyhigh growth rates in net interest income that we have experienced during thelast two years.

 

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, 2003** |      | **Three  Months Ended March 31, 2002** |   |
|----------------------------------------------------------------------|--------|----------------------------------------|-----------|----------------------------------------|--------|
|                                                                 |   | **Average  Balance**                   |      | **Interest**                           |   | **Average  Yield/Cost** |   | **Average  Balance** |   | **Interest** |   | **Average  Yield/Cost** |   |
| **Interest earning  assets:**                                        |   |                                   |      |                                   |   |   |   |   |   |   |   |   |   |
| Federal funds sold and securities purchased  under resale agreements |   | $                                      | 4,911     |                                   | $      | 16 |   | 1.30 | % | $ | 15,733 |   | $ | 67 |   | 1.70 | % |
| Investment securities (1)                                            |   | 6,611,391                              |      | 59,485                                 |   | 3.60 | % | 4,978,413 |   | 57,560 |   | 4.62 | % |
| Loans (2)                                                            |   | 115,489                                |      | 848                                    |   | 2.94 | % | 110,961 |   | 1,005 |   | 3.62 | % |
| Total interest-earning assets                                        |   | 6,731,791                              |      | 60,349                                 |   | 3.59 | % | 5,105,107 |   | 58,632 |   | 4.59 | % |
| Allowance for loan losses                                            |   | (100                                   | )         |                                   |   |   |   | (100 | ) |   |   |   |   |
| Noninterest-earning assets                                           |   | 445,310                                |      |                                   |   |   |   | 321,702 |   |   |   |   |   |
|                                                                 |   |                                   |      |                                   |   |   |   |   |   |   |   |   |   |
| Total assets                                                         |   | $                                      | 7,177,001 |                                   |   |   |   |   | $ | 5,426,709 |   |   |   |   |   |
| **Interest bearing liabilities:**                                    |   |                                   |      |                                   |   |   |   |   |   |   |   |   |   |
| Deposits:                                                            |   |                                   |      |                                   |   |   |   |   |   |   |   |   |   |
| Demand                                                               |   | $                                      | —    |                                   | $      | — |   | — |   | $ | 1,934 |   | $ | 2 |   | 0.41 | % |
| Savings                                                              |   | 2,193,981                              |      | 9,117                                  |   | 1.66 | % | 1,756,182 |   | 10,568 |   | 2.41 | % |
| Time                                                                 |   | —                                 |      | —                                 |   | — |   | 5,648 |   | 24 |   | 1.70 | % |
| Securities sold under repurchase agreements                          |   | 3,092,673                              |      | 7,337                                  |   | 0.95 | % | 2,090,818 |   | 6,795 |   | 1.30 | % |
| Other borrowings                                                     |   | 855,274                                |      | 4,526                                  |   | 2.12 | % | 730,700 |   | 5,506 |   | 3.01 | % |
| Total interest-bearing liabilities                                   |   | 6,141,928                              |      | 20,980                                 |   | 1.37 | % | 4,585,282 |   | 22,895 |   | 2.00 | % |
| Noninterest-bearing liabilities:                                     |   |                                   |      |                                   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                                      |   | 212,569                                |      |                                   |   |   |   | 230,090 |   |   |   |   |   |
| Savings                                                              |   | 166,897                                |      |                                   |   |   |   | 80,610 |   |   |   |   |   |
| Noninterest-bearing time deposits                                    |   | 90,000                                 |      |                                   |   |   |   | 90,000 |   |   |   |   |   |
| Other liabilities                                                    |   | 94,514                                 |      |                                   |   |   |   | 59,498 |   |   |   |   |   |
| Total liabilities                                                    |   | 6,705,908                              |      |                                   |   |   |   | 5,045,480 |   |   |   |   |   |
| Trust preferred stock                                                |   | 23,305                                 |      |                                   |   |   |   | 24,277 |   |   |   |   |   |
| Equity                                                               |   | 447,788                                |      |                                   |   |   |   | 356,952 |   |   |   |   |   |
| Total liabilities and equity                                         |   | $                                      | 7,177,001 |                                   |   |   |   |   | $ | 5,426,709 |   |   |   |   |   |
| Net interest income                                                  |   |                                   |      | $                                      | 39,369 |   |   |   |   |   | $ | 35,737 |   |   |   |
| Net interest margin (3)                                              |   |                                   |      |                                   |   | 2.34 | % |   |   |   |   | 2.80 | % |
| Average interest rate spread (4)                                     |   |                                   |      |                                   |   | 2.22 | % |   |   |   |   | 2.59 | % |
| Ratio of interest-earning assets to  interest-bearing liabilities    |   |                                   |      |                                   |   | 109.60 | % |   |   |   |   | 111.34 | % |

 

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

(2)                        Averageyield on loans includes accrual loan balances.

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

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

 

25

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*Noninterest Income*

 

Noninterestincome was $73.6 million for the three months ended March 31, 2003, up 5% fromthe same period in 2002.  Noninterestincome consists of the following items (Dollars in thousands):

 
|                                   |   | **For the Three Months Ended  March 31,** |   |
|----------------------------------------|--------|-------------------------------------------|--------|
|                                   |   | **2003**                                  |   | **2002** |   | **Change** |   |
| Asset servicing fees:                  |   |                                      |   |   |   |   |   |
| Custody, accounting and administration |   | $                                         | 56,761 |   | $ | 55,927 |   | 1 | % |
| Foreign exchange                       |   | 6,733                                     |   | 4,856 |   | 39 | % |
| Cash management                        |   | 5,035                                     |   | 4,194 |   | 20 | % |
| Securities lending                     |   | 2,188                                     |   | 2,638 |   | (17 | )% |
| Investment advisory                    |   | 1,943                                     |   | 1,718 |   | 13 | % |
| Other service fees                     |   | 214                                       |   | — |   | 100 | % |
| Total asset servicing fees             |   | 72,874                                    |   | 69,333 |   | 5 | % |
|                                   |   |                                      |   |   |   |   |   |
| Other operating income.                |   | 770                                       |   | 584 |   | 32 | % |
|                                   |   |                                      |   |   |   |   |   |
| Total noninterest income               |   | $                                         | 73,644 |   | $ | 69,917 |   | 5 | % |

 

Asset servicing fees for the three months ended March 31, 2003increased 5% to $72.9 million from the same period in 2002.  The largest components of asset servicingfees are custody, accounting and administration, which are based in part onassets processed.  Assets processed isthe total dollar value of financial assets on the reported date for which weprovide global custody or multicurrency accounting.  Total net assets processed at March 31, 2003 were essentiallyflat at $784 billion compared to $785 billion at December 31, 2002.  The change in net assets processed includes the following components (Dollars inbillions):

 

|                                     |   | **For the Three Months Ended  March 31, 2003** |   |
|------------------------------------------|--------|------------------------------------------------|--------|
|                                     |   |                                           |   |
| Further  penetration of existing clients |   | $                                              | 4      |   |
| Fund flows and  market loss              |   | (5                                             | )      |
|                                     |   |                                           |   |
| Net change in  assets processed          |   | $                                              | (1     | ) |

 

Our ability to win business and the abilityof our clients to sell additional product, thus generating fund flows, hasallowed us to continue to minimize the impact of the three-year marketdownturn.  Our tiered pricing structurefor asset-based fees has also helped us to stem the broader market turndown.  Because we have decremental pricingschedules for asset-based fees, whereby the higher percentage fee is charged onlower asset values, as asset values deteriorate, revenue is only impacted bythe asset decline at the then marginal rate.

 

Transaction-driven income includes ourancillary services, such as foreign exchange, securities lending and cashmanagement. Foreign exchange fees were $6.7 million for the three months endedMarch 31, 2003, up 39% from the same period in 2002, due to higher transactionvolumes.  Cash management fees were $5.0million for the three months ended March 31, 2003, up 20% from the same periodin 2002. The increase is primarily due to cross-selling to existing clients.  Securities lending fees were $2.2 millionfor the three months ended March 31, 2003, down 17% from the same period in2002.  The decrease is due to compressedspreads and depressed market conditions. Investment advisory service fees were $1.9 million, up 13% compared tothe same period in 2002, which is due to growth in the asset size of theMerrimac Master Portfolio, an investment company for which we act as advisor.

 

Otheroperating income consists of dividends received relating to the Federal HomeLoan Bank of Boston (‘FHLBB’) stock investment and miscellaneous fees forsystems consulting services.  Theincrease in other operating income for the three months ended March 31, 2003was the result of a client system customization project.

 

26

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*Operating Expenses*

 

Total operating expenses were $84.4 million for the three months endedMarch 31, 2003, up 3% from the same period in 2002.  The components of operating expenses were as follows (Dollars inthousands):

 
|                              |   | **For the Three Months Ended March 31,** |   |
|-----------------------------------|--------|------------------------------------------|--------|
|                              |   | **2003**                                 |   | **2002** |   | **Change** |   |
|                              |   |                                     |   |   |   |   |   |
| Compensation and benefits         |   | $                                        | 49,771 |   | $ | 49,930 |   | — |   |
| Technology and telecommunications |   | 9,291                                    |   | 9,962 |   | (7 | )% |
| Occupancy                         |   | 7,325                                    |   | 5,763 |   | 27 | % |
| Transaction processing services   |   | 6,808                                    |   | 7,489 |   | (9 | )% |
| Depreciation and amortization     |   | 6,079                                    |   | 3,136 |   | 94 | % |
| Professional fees                 |   | 1,679                                    |   | 1,678 |   | — |   |
| Travel and sales promotion        |   | 985                                      |   | 1,234 |   | (20 | )% |
| Other operating expenses          |   | 2,509                                    |   | 2,916 |   | (14 | )% |
|                              |   |                                     |   |   |   |   |   |
| Total operating expenses          |   | $                                        | 84,447 |   | $ | 82,108 |   | 3 | % |

 

Compensation and benefits expense was $49.8 million for the threemonths ended March 31, 2003, flat compared to the same period in 2002 due tocontrolled headcount and lower incentive accruals.  Occupancy expense was $7.3 million for the three monthsended March 31, 2003, up 27% from the same period in 2002.  This increase was primarily due to increasedspace in our Boston and Dublin offices to support the growth of ourbusiness.  Depreciation and amortizationexpense was $6.1 million for the three months ended March 31, 2003, up 94%from the same period in 2002.  Thisincrease resulted from completion of capitalized software projects in late 2002and 2003 and their placement into service. Other operating expenses, including travel and sales promotion decreasedsignificantly due to strict management of discretionary expenses.

 

*Income Taxes*

 

Taxes for the three months ended March 31, 2003 were $22.8 million, upfrom $7.1 million for the same period in 2002.   The increase is due to the accrual of $13.9 million, net offederal benefit, and relates to the retroactive tax law change in dividendsreceived deduction on the distributions paid from the REIT to the Bank.

 

Our effective tax rate for the three months ended March 31, 2003 was31.1%, exclusive of the accrual for the contested assessment.  During 2003, the Company ceased taking thededuction for dividends paid by the REIT and the effect of this action willincrease the effective tax rate to 31.5%.

 

27

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**Financial Condition**

* *

Total assets increased $486 million, or 7%, to $7.7 billion at March31, 2003 from $7.2 billion at December 31, 2002.  Asset growth is primarily attributable to the increases in theheld to maturity and available for sale investment portfolios, specificallymortgage-backed and federal agency securities. Average interest-earning assetsfor the three months ended March 31, 2003 increased $1.6 billion, or 32%,compared to the same period last year.

 

*Investment Portfolio*

 

Our held tomaturity portfolio increased $245 million, or 7%, to $3.7 billion at March 31,2003 from $3.4 billion at December 31, 2002. Our available for sale portfolio increased $240 million, or 7%, to $3.5billion at March 31, 2003 from $3.3 billion at December 31, 2002.  The increase in the portfolio isattributable to investing excess cash and borrowed funds to effectively utilizethe Bank’s capital.  The average balanceof our combined investment portfolio for the three months ended March 31, 2003was $6.6 billion, with an average yield of approximately 3.60%, compared to anaverage balance of $5.0 billion and an average approximate yield of 4.62% forthe same period last year.

 

The followingtable summarizes our investment portfolio as of the dates indicated (Dollars inthousands):

 
|                                |   | **March 31,  2003** |      | **December  31,  2002** |   |
|-------------------------------------|--------|---------------------|-----------|-------------------------|--------|
| **Securities held to maturity:**    |   |                |      |                    |   |
| Mortgage-backed securities          |   | $                   | 2,170,504 |                    | $      | 2,034,430 |   |
| Federal agency securities           |   | 1,394,912           |      | 1,287,238               |   |
| State and political subdivisions    |   | 118,041             |      | 117,021                 |   |
|                                |   |                |      |                    |   |
| Total securities held to maturity   |   | $                   | 3,683,457 |                    | $      | 3,438,689 |   |
|                                |   |                |      |                    |   |
| **Securities  available for sale:** |   |                |      |                    |   |
| Mortgage-backed securities          |   | $                   | 2,977,435 |                    | $      | 2,759,793 |   |
| State and political subdivisions    |   | 330,738             |      | 307,292                 |   |
| Corporate debt                      |   | 174,020             |      | 174,499                 |   |
| Federal agency securities           |   | 30,602              |      | 30,881                  |   |
|                                |   |                |      |                    |   |
| Total securities available for sale |   | $                   | 3,512,795 |                    | $      | 3,272,465 |   |

 

Our investmentportfolio is comprised of securities of state and political subdivisions(‘municipal securities’), mortgage-backed securities issued by the FederalNational Mortgage Association (‘FNMA’ or ‘Fannie Mae’), the Federal Home LoanMortgage Corporation (‘FHLMC’ or ‘Freddie Mac’) and the Government NationalMortgage Association (‘GNMA’ or ‘Ginnie Mae’), Federal agency bonds, securitiesissued by the Small Business Administration (‘SBA’), corporate debt securitiesand securities issued by the Federal Home Loan Bank of Boston.

 

Our investment portfolio is used to invest depositors’ funds and is acomponent of our asset processing business. In addition, we use the investment portfolio to secure open positions atsecurities clearing institutions in connection with our custody services.  During the three months ended March 31,2003, we primarily invested in mortgage-backed securities.  Mortgage-backed securities generally have ahigher yield than U.S. Treasury securities due to credit and prepaymentrisk.  Credit risk related tomortgage-backed securities is substantially reduced by payment guarantees andcredit enhancements.

 

We alsoincreased our investments in Federal agency securities, such as those issued bythe SBA, during the three months ended March 31, 2003.  Generally, Federal agency securities have ahigher yield than U.S. Treasury securities due to credit and call risk. Creditrisk related to Federal agency bonds is substantially reduced by paymentguarantees and credit enhancements.

 

We invest inmunicipal securities to generate stable, tax advantaged income.  Municipal securities generally have lowerstated yields than Federal agency and U.S. Treasury securities, but theafter-tax yields at current tax rates

 

28

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are more favorable.  Municipal securities are subject to creditrisk.  However, all municipal securitiesthat we invest in are insured and are therefore rated AAA.

 

*Loan Portfolio*

 

Our loanportfolio decreased $37 million, or 25%, to $107 million at March 31, 2003 from$144 million at December 31, 2002. The overall decrease in the loan portfoliois primarily attributable to the decrease in the volume of client overdraftsfrom December 31, 2002 to March 31, 2003. The balance of client overdraft loansat March 31, 2003 was $36 million compared to $73 million at December 31,2002.  These extensions of credit aresecured by freely tradable securities heldin custody by us for the borrower.

 

We make loans to individually managed account customers and to mutualfunds and other pooled product clients. We offer overdraft protection and lines of credit to ourclients for the purpose of funding redemptions, covering overnight cashshortfalls, leveraging portfolios and meeting other client borrowingneeds.  Virtually all loans to individually managed account customers arewritten on a demand basis, bear variable interest rates tied to the prime rateor the Federal Funds rate and are fully secured by liquid collateral, primarilyfreely tradable securities held in custody by us for the borrower.  Loans to mutual funds and other pooledproduct clients include unsecured lines of credit that may, in the event ofdefault, be collateralized at our option by securities held in custody by usfor those mutual funds.  Loans toindividually managed account customers, mutual funds and other pooled productclients also include advances that we make to certain clients pursuant to theterms of our custody agreements with those clients to facilitate securitiestransactions and redemptions.

 

At March 31, 2003, our only lending concentrations that exceeded 10% oftotal loan balances were the lines of credit to mutual fund clients discussedabove.  These loans were made in theordinary course of business on the same terms and conditions prevailing at thetime for comparable transactions.

 

Our credit loss experience has been excellent.  There have been no loan charge-offs in our history.  It is our policy to place a loan onnonaccrual status when either principal or interest becomes 60 days pastdue and the loan’s collateral is not sufficient to cover both principal andaccrued interest.  As of March 31, 2003,there were no loans on nonaccrual status, no loans greater than 90 dayspast due, and no troubled debt restructurings. Although virtually all of our loans are fully collateralized with freelytradable securities, management recognizes some credit risk inherent in theloan portfolio, and has recorded an allowance for loan losses of$0.1 million at March 31, 2003. This amount is not allocated to any particular loan, but is intended toabsorb any risk of loss inherent in the loan portfolio. Management activelymonitors the loan portfolio and the underlying collateral and regularlyassesses the adequacy of the allowance for loan losses.

 

*Repurchase Agreements and Short-Term andOther Borrowings*

 

Asset growthwas primarily funded by increased securities sold under repurchase agreementsand other borrowings.  Repurchaseagreements increased $687 million, or 30%, to $3.0 billion at March 31, 2003from $2.3 billion at December 31, 2002. We use repurchase agreements because they provide a more favorablesource of funding than other short-term borrowings in terms of the cost ofthese borrowings.  The average balanceof securities sold under repurchase agreements for the three months ended March31, 2003 was $3.1 billion with an average cost of approximately 0.95%, comparedto an average balance of $2.1 billion and an average cost of approximately1.30% for the same period last year.

 

Short-term andother borrowings increased $437 million, or 59%, to $1.2 billion at March 31,2003 from $0.7 billion at December 31, 2002. We use advances to offset variability of deposit flow.  The average balance of short-term and otherborrowings for the three months ended March 31, 2003 was $0.9 billion with anaverage cost of approximately 2.12%, compared to an average balance of $0.7billion and an average cost of approximately 3.01% for the same period lastyear.

 

**MarketRisk**

 

We engage in investment activities to accommodate clients’ cashmanagement needs and to contribute to overall corporate earnings.  Our clients, in the course of theirfinancial asset management, maintain interest-bearing cash balances, which theydeposit on a short-term basis with us. We either directly invest

 

29

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these cash balances to earninterest income, or place these deposits in third-party vehicles and remit aportion of the earnings on these investments to our clients. In the conduct ofthese activities, we are subject to market risk.  Market risk is the risk of an adverse financial impact fromchanges in market prices and interest rates. The level of risk we assume is a function of our overall strategicobjectives and liquidity needs, client requirements and market volatility.

 

The active management of market risk is integral to ouroperations.  The objective of interestrate sensitivity management is to provide sustainable net interest revenueunder various economic conditions.  Wemanage the structure of interest-earning assets and interest-bearingliabilities by adjusting their mix, yield, maturity and/or repricing characteristics,based on market conditions.  Sinceclient deposits and repurchase agreements, our primary sources of funds, arepredominantly short term, we maintain a generally short-term structure for ourinterest-earning assets, including money-market assets and investments.  We also use term borrowings and interestrate swap agreements to augment our management of interest rate exposure.  The effect of the swap agreements is to lengthenshort-term variable-rate liabilities into longer-term fixed-rate liabilities.

 

Our Board of Directors has set asset and liability management policiesthat define the overall framework for managing interest rate sensitivity,including accountabilities and controls over investment activities.  These policies delineate investment limitsand strategies that are appropriate, given our liquidity and regulatoryrequirements.  For example, we haveestablished a policy limit stating that projected net interest income over thenext 12 months will not be reduced by more than 10% given a change in interestrates of up to 200 basis points (+ or -) over 12 months.  Each quarter, our Board of Directors reviewsour asset and liability positions, including simulations of the effect ofvarious interest rate scenarios on our capital.  Due to current interest rate levels, the Company’s Board ofDirectors has approved a temporary exception to the 10% limit for decreases ininterest rates.  The Board of Directorsapproved the policy exception because, with the Federal Funds target ratecurrently at 1.25%, a 200 basis point further reduction would move rates into anegative position and is therefore not likely to occur.

 

Our Board of Directors has delegated day-to-day responsibility foroversight of the Asset and Liability Management function to our Asset andLiability Committee (‘ALCO’).  ALCO is asenior management committee consisting of the Chief Executive Officer, thePresident, the Chief Financial Officer and members of the Treasury function.ALCO meets twice monthly.  Our primarytool in managing interest rate sensitivity is an income simulation model. Keyassumptions in the simulation model include the timing of cash flows,maturities and repricing of financial instruments, changes in marketconditions, capital planning and deposit sensitivity.  The model assumes that the composition of our interest-sensitiveassets and liabilities existing at the beginning of a period will changeperiodically over the period being measured. The model also assumes that a particular change in interest rates isreflected uniformly across the yield curve regardless of the duration tomaturity or repricing of specific assets and liabilities.  These assumptions are inherently uncertain,and as a result, the model cannot precisely predict the effect of changes ininterest rates on our net interest income. Actual results may differ from simulated results due to the timing,magnitude and frequency of interest rate changes and changes in marketconditions and management strategies.

 

The results of the income simulation model as of March 31, 2003 and2002 indicated that an upward shift of interest rates by 200 basis points wouldresult in a reduction in projected net interest income of 5.97% and 5.39%,respectively.  A downward shift of 200basis points would result in a decrease in projected net interest income of13.64% and 11.73% at March 31, 2003 and 2002, respectively.  As discussed above, these exceptions topolicy were approved by the Board of Directors.

 

We also use gap analysis as a secondary tool to manage our interestrate sensitivity.  Gap analysis involvesmeasurement of the difference in asset and liability repricing on a cumulativebasis within a specified time frame.  Apositive gap indicates that more interest-earning assets than interest-bearingliabilities mature in a time frame, and a negative gap indicates theopposite.  By seeking to minimize theamount of assets and liabilities that could reprice in the same time frame, weattempt to reduce the risk of significant adverse effects on net interestincome caused by interest rate changes. As shown in the table below, at March 31, 2003, interest-bearingliabilities repriced faster than interest-earning assets in the short term, ashas been typical for us.  Generallyspeaking, falling interest rates would lead to net interest income that ishigher than it would have been; rising rates would lead to lower net interestincome.  However, at the currentabsolute level of interest rates, lower interest rates may also lead to lowernet interest income due to a diminished ability to lower the rates paid oninterest-bearing liabilities, including certain client funds, as rates approachzero.  Other important determinants ofnet interest income are rate levels, balance sheet growth and mix, and interestrate spreads.

 

30

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The followingtable presents the repricing schedule of our interest-earning assets andinterest-bearing liabilities at March 31, 2003 (Dollars in thousands):

 
|                                                                                   |   | **Within  Three  Months** |       | **Three to  Six  Months** |   | **Six to  Twelve  Months** |   | **One Year  to  Five Years** |     | **Over Five  Years** |   | **Total** |   |
|----------------------------------------------------------------------------------------|--------|---------------------------|------------|---------------------------|--------|----------------------------|--------|------------------------------|----------|----------------------|--------|-----------|--------|
|                                                                                   |   |                      |       |                      |   |                       |   |                         |     |                 |   |      |   |
| Interest-earning assets (1):                                                           |   |                      |       |                      |   |                       |   |                         |     |                 |   |      |   |
| Investment securities (2,3)                                                            |   | $                         | 3,590,675  |                      | $      | 519,689                    |   | $                            | 810,828  |                 | $      | 1,824,130 |   | $ | 367,564 |   | $ | 7,112,886 |   |
| Loans—variable rate                                                               |   | 107,270                   |       | —                    |   | —                     |   | —                       |     | —               |   | 107,270   |   |
| Loans—fixed rate                                                                  |   | 12                        |       | —                    |   | —                     |   | —                       |     | —               |   | 12        |   |
| Total interest-earning assets                                                          |   | $                         | 3,697,957  |                      | $      | 519,689                    |   | $                            | 810,828  |                 | $      | 1,824,130 |   | $ | 367,564 |   | $ | 7,220,168 |   |
| Interest-bearing liabilities:                                                          |   |                      |       |                      |   |                       |   |                         |     |                 |   |      |   |
| Savings accounts                                                                       |   | $                         | 2,205,814  |                      | $      | —                     |   | $                            | —   |                 | $      | 24,890    |   | $ | — |   | $ | 2,230,704 |   |
| Interest rate contracts                                                                |   | (980,000                  | )          | 70,000                    |   | 180,000                    |   | 730,000                      |     | —               |   | —    |   |
| Securities sold under repurchase agreements                                            |   | 2,838,916                 |       | —                    |   | —                     |   | 150,000                      |     | —               |   | 2,988,916 |   |
| Short-term and other borrowings                                                        |   | 928,477                   |       | —                    |   | —                     |   | 250,000                      |     | —               |   | 1,178,477 |   |
| Total interest-bearing liabilities                                                     |   | $                         | 4,993,207  |                      | $      | 70,000                     |   | $                            | 180,000  |                 | $      | 1,154,890 |   | $ | — |   | $ | 6,398,097 |   |
| Net interest-sensitivity gap during the  period                                        |   | $                         | (1,295,250 | )                         | $      | 449,689                    |   | $                            | 630,828  |                 | $      | 669,240   |   | $ | 367,564 |   | $ | 822,071 |   |
| Cumulative gap                                                                         |   | $                         | (1,295,250 | )                         | $      | (845,561                   | )      | $                            | (214,733 | )                    | $      | 454,507   |   | $ | 822,071 |   |   |   |
| Interest-sensitive assets as a percent of  interest sensitive liabilities (cumulative) |   | 74.06                     | %          | 83.30                     | %      | 95.90                      | %      | 107.10                       | %        | 112.85               | %      |      |   |
| Interest-sensitive assets as a percent of  total assets (cumulative)                   |   | 48.02                     | %          | 54.77                     | %      | 65.30                      | %      | 88.99                        | %        | 93.76                | %      |      |   |
|                                                                                   |   |                      |       |                      |   |                       |   |                         |     |                 |   |      |   |
| Net interest-sensitivity gap as a percent  of total assets                             |   | (16.82                    | )%         | 5.84                      | %      | 8.19                       | %      | 8.69                         | %        | 4.77                 | %      |      |   |
| Cumulative gap as a percent of total assets                                            |   | (16.82                    | )%         | (10.98                    | )%     | (2.79%                     | )      | 5.90                         | %        | 10.68                | %      |      |   |

 

----

(1)                         Adjustable rate assets areincluded in the period in which interest rates are next scheduled to adjustrather than in the period in which they are due.  Fixed-rate loans are included in the period in which they arescheduled to be repaid.

(2)                        Mortgage-backedsecurities are included in the pricing category that corresponds with theireffective maturity.

(3)                        Excludes$83.3 million of unsettled securities purchases as of March 31, 2003.

 

31

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**Liquidity**

 

Liquidity represents the ability of an institution to meet present andfuture financial obligations through either the sale or maturity of existingassets or the acquisition of additional funds through liabilitymanagement.  For a financial institutionsuch as ours, these obligations arise from the withdrawals of deposits and thepayment of operating expenses.

 

Our primary sources of liquidity include cash and cash equivalents,Federal Funds sold, new deposits, securities sold under repurchase agreements,short-term borrowings, interest payments on securities held to maturity andavailable for sale, and fees collected from asset administration clients.  As a result of our management of liquidassets and the ability to generate liquidity through funding, managementbelieves that we maintain overall liquidity sufficient to meet our depositors’needs, to satisfy our operating requirements and to fund the payment of ananticipated annual cash dividend of $0.06 per share for 2003 (approximately$3.9 million based upon 64,992,847 shares outstanding as of March 31,2003).

 

Our ability to pay dividends on Common Stock may depend on the receiptof dividends from the Bank. Any dividend payments by the Bank are subject tocertain restrictions imposed by the Massachusetts Commissioner of Banks.  In addition, we may not pay dividends on ourCommon Stock if we are in default under certain agreements entered into in connectionwith the sale of our Capital Securities. The Capital Securities were issued by Investors Capital Trust I, aDelaware statutory business trust sponsored by us, and qualify as Tier 1capital under the capital guidelines of the Federal Reserve.

 

We have informal borrowing arrangements with variouscounterparties.  Each counterparty hasagreed to make funds available to us at the Federal funds overnight rate.  The aggregate amount of these borrowingarrangements as of March 31, 2003 was $1.6 billion.  Each bank may terminate its arrangement atany time and is under no contractual obligation to provide us with requestedfunding.  Our borrowings under thesearrangements are typically on an overnight basis.  We cannot be certain, however, that such funding will beavailable.  Lack of availability ofliquid funds could have a material adverse impact on our operations.

 

We also have Master Repurchase Agreements in place with variouscounterparties.  Each broker has agreedto make funds available to us at various rates in exchange for collateral consistingof marketable securities. The aggregate amount of these borrowing arrangementsat March 31, 2003 was $3.1 billion.

 

We also have a borrowing arrangement with the FHLBB.  We may borrow amounts determined byprescribed collateral levels and the amount of FHLBB stock we hold.  We are required to hold FHLBB stock equal tono less than (i) 1% of our outstanding residential mortgage loan principal(including mortgage pool securities), (ii) 0.3% of total assets, or(iii) total advances from the FHLBB, divided by a leverage factor of20.  The aggregate amount of borrowingavailable to us under this arrangement at March 31, 2003 was $1.8 billion.  The amount outstanding under thisarrangement at March 31, 2003 was $0.7 billion.

 

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**Capital Resources**

 

Historically, we have financed our operations principally throughinternally generated cash flows.  Weincur capital expenditures for furniture, fixtures, capitalized software andmiscellaneous equipment needs.  We leasemicrocomputers and servers through operating leases.  Capital expenditures have been incurred and leases entered intoon an as-required basis, primarily to meet our growing operating needs.  As a result, our capital expenditures were$8.8 million and $9.9 million for the three months ended March 31, 2003and 2002, respectively.  For the threemonths ended March 31, 2003, capital expenditures were comprised ofapproximately $4.1 million in leasehold improvements, $3.5 million incapitalized software and projects in process and $1.2 million in fixedassets.  For the three months endedMarch 31, 2002, capital expenditures were comprised of approximately $8.0million in capitalized software and projects in process and $1.9 million infixed assets.

 

Stockholders’ equity at March 31, 2003 was $457.2 million, up 3%from December 31, 2002.  The ratio ofstockholders’ equity to assets decreased to 5.9% at March 31, 2003 from 6.1% atDecember 31, 2002, primarily as a result of the tax accrual of $13.9 million inthe first quarter of 2003.

 

We are subject to various regulatory capital requirementsadministered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certainmandatory and possibly additional discretionary actions by regulators that, ifundertaken, could have a direct material adverse effect on our results ofoperations and financial condition. Under capital adequacy guidelines and the regulatory framework forprompt corrective action, we must meet specific capital guidelines that involvequantitative measures of our assets, liabilities, and certain off-balance sheetitems as calculated under regulatory accounting practices.  Our capital amounts and classification arealso subject to qualitative judgments by regulators about components, riskweightings, and other factors.

 

Quantitative measures established by regulation to ensure capitaladequacy require us to maintain minimum amounts and ratios (set forth in thetable below) of Total and Tier 1 capital (as defined in the regulations) torisk-weighted assets (as defined), and of Tier 1 capital (as defined) toaverage assets (as defined). Management believes, as of March 31, 2003, that wemeet all capital adequacy requirements to which we are subject.

 

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As of March 31, 2003, the most recent notification from the FDICcategorized us as “well capitalized” under the regulatory framework for promptcorrective action. To be categorized as well capitalized, we mustmaintain minimum Total risk-based, Tier 1 risk-based, and Tier 1 leverageratios as set forth in the following table. There are no conditions or eventssince that notification that management believes have changed ourcategory.  The following table presents the capital ratios for Investors Financialand Investors Bank (Dollars in thousands):

 
|                                                       |   | **Actual** |    | **For  Capital  Adequacy Purposes** |   | **To Be Well  Capitalized  Under Prompt  Corrective Action  Provisions** |   |
|------------------------------------------------------------|--------|------------|---------|-------------------------------------|--------|--------------------------------------------------------------------------|--------|
|                                                       |   | **Amount** |    | **Ratio**                           |   | **Amount**                                                               |   | **Ratio** |   | **Amount** |   | **Ratio** |   |
| **As of March 31,  2003:**                                 |   |       |    |                                |   |                                                                     |   |   |   |   |   |   |   |
| Total Capital  (to Risk Weighted Assets—the Company)  |   | $          | 380,120 |                                | 18.31  | %                                                                        | $      | 166,120 |   | 8.00 | % | N/A |   | N/A |   |
| Total Capital  (to Risk Weighted Assets—the Bank)     |   | $          | 376,478 |                                | 18.13  | %                                                                        | $      | 166,110 |   | 8.00 | % | $ | 207,637 |   | 10.00 | % |
| Tier 1 Capital  (to Risk Weighted Assets—the Company) |   | $          | 380,020 |                                | 18.30  | %                                                                        | $      | 83,060 |   | 4.00 | % | N/A |   | N/A |   |
| Tier 1 Capital  (to Risk Weighted Assets—the Bank)    |   | $          | 376,378 |                                | 18.13  | %                                                                        | $      | 83,055 |   | 4.00 | % | $ | 124,582 |   | 6.00 | % |
| Tier 1 Capital  (to Average Assets—the Company)       |   | $          | 380,020 |                                | 5.40   | %                                                                        | $      | 281,754 |   | 4.00 | % | N/A |   | N/A |   |
| Tier 1 Capital  (to Average Assets—the Bank)          |   | $          | 376,378 |                                | 5.34   | %                                                                        | $      | 281,785 |   | 4.00 | % | $ | 352,231 |   | 5.00 | % |
|                                                       |   |       |    |                                |   |                                                                     |   |   |   |   |   |   |   |
| **As of December 31,  2002:**                              |   |       |    |                                |   |                                                                     |   |   |   |   |   |   |   |
| Total Capital  (to Risk Weighted Assets—the Company)  |   | $          | 374,102 |                                | 15.51  | %                                                                        | $      | 192,915 |   | 8.00 | % | N/A |   | N/A |   |
| Total Capital  (to Risk Weighted Assets—the Bank)     |   | $          | 369,498 |                                | 15.32  | %                                                                        | $      | 192,915 |   | 8.00 | % | $ | 241,143 |   | 10.00 | % |
| Tier 1 Capital  (to Risk Weighted Assets—the Company) |   | $          | 374,002 |                                | 15.51  | %                                                                        | $      | 96,457 |   | 4.00 | % | N/A |   | N/A |   |
| Tier 1 Capital  (to Risk Weighted Assets—the Bank)    |   | $          | 369,398 |                                | 15.32  | %                                                                        | $      | 96,457 |   | 4.00 | % | $ | 144,686 |   | 6.00 | % |
| Tier 1 Capital  (to Average Assets—the Company)       |   | $          | 374,002 |                                | 5.50   | %                                                                        | $      | 272,132 |   | 4.00 | % | N/A |   | N/A |   |
| Tier 1 Capital  (to Average Assets—the Bank)          |   | $          | 369,398 |                                | 5.43   | %                                                                        | $      | 272,104 |   | 4.00 | % | $ | 340,130 |   | 5.00 | % |

 

UnderMassachusetts law, trust companies such as Investors Bank, like national banks,may pay dividends no more often than quarterly, and only out of “net profits”and to the extent that such payments will not impair Investors Bank’s capitalstock and surplus account. Moreover, prior approval of the Commissioner ofBanks of the Commonwealth of Massachusetts is required if the total dividendsfor a calendar year would exceed net profits for that year combined withretained net profits for the previous two years. These restrictions on theability of Investors Bank to pay dividends to us may restrict our ability topay dividends to our stockholders.

 

The operationsof our securities broker affiliate, Investors Securities Services, Inc., aresubject to federal and state securities laws, as well as the rules of both theSecurities and Exchange Commission and the National Association of SecuritiesDealers, Inc.  Management believes, asof March 31, 2003, that Investors Securities Services, Inc. met all regulatoryrequirements to which it is subject.

 

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**Item 3****.****        Quantitative and Qualitative Disclosure aboutMarket Risk**

** **

Theinformation required by this item is contained in the ‘Market Risk’ section inthe ‘Management’s Discussion and Analysis of Financial Condition and Results ofOperations,’ as part of this Report.

 

**Item 4****.****        Controls and Procedures**

 

(a)          Evaluation of disclosure controls andprocedures.

 

Within 90 days before filing this report, we evaluated theeffectiveness of the design and operation of our disclosure controls andprocedures.  Our disclosure controls andprocedures are the controls and other procedures that we designed to ensurethat we record, process, summarize and report in a timely manner theinformation we must disclose in reports that we file or submit to the SEC.  Kevin J. Sheehan, our Chairman and ChiefExecutive Officer, and John N. Spinney, Jr., our Senior Vice President and ChiefFinancial Officer, reviewed and participated in this evaluation.  Based on this evaluation, Messrs. Sheehanand Spinney concluded that, as of the date of the evaluation, our disclosurecontrols were effective.

 

(b)         Internal controls.

 

Since the date of the evaluation described above, there have not beenany significant changes in our internal accounting controls or in other factorsthat could significantly affect those controls.

 

**PARTII.  OTHER INFORMATION**

 

**Item1.  Legal Proceedings**

 

On January 31, 2003, we were named in a class action lawsuit alleging,among other things, violations of California wage and hour laws at ourSacramento and Walnut Creek facilities. The lawsuit was filed in the SuperiorCourt of California, County of Sacramento. While we are in the early stages of investigating this complaint, webelieve that we have complied at all times with applicable law and we intend todefend this lawsuit vigorously. We do not yet know the amount of damages thatthe plaintiffs are seeking to recover. However, the defense of class actionlawsuits can be costly and time consuming, and can divert the attention ofmanagement. A determination that we violated applicable wage and hour lawscould result in the payment of damages and could have a material adverse effecton our results of operations for the period in which we must pay any awardeddamages.

 

In January 2001, as previously reported, we were named as a defendantin an action entitled Mopex, Inc. v. Chicago Stock Exchange, Inc., et al.,Civil Action No. 01 C 0302 (the ‘Complaint’), in the United States DistrictCourt for the Northern District of Illinois. In the Complaint, Mopex alleged that the Bank and numerous otherentities, including Barclays Global Investors, State Street Bank and TrustCompany, and Merrill Lynch, Pierce, Fenner & Smith, Inc., infringed U.S.Patent No. 6,088,685, entitled, “Open End Mutual Fund Securitization Process,”assigned to Mopex.  On or about May 9,2003, the parties to the action executed a settlement agreement and filed ajoint stipulated order of dismissal.  OnMay 13, 2003, the court entered the order of dismissal, terminating thecase.  The order of dismissal entered bythe court provided for the dismissal of Mopex's claims with prejudice. We didnot pay or promise to pay any money to Mopex to obtain the dismissal. Moreover,our counterclaims against Mopex were dismissed without prejudice, keeping aliveour defenses in the event of any further litigation involving this patent.

 

**Item6.  Exhibits and Repo****rts on Form 8-K.**

 

(a)          Exhibits

99.1Certification of Kevin J. Sheehan, Chief Executive Officer, and John N.Spinney, Jr., Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, asadopted, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

(b)         Reports on Form 8-K

On January23, 2003, the Company filed a current report on Form 8-K providing informationtherein under Item 9 (Regulation FD Disclosure).

 

On March 6,2003, the Company filed a current report on Form 8-K providing informationtherein under Item 5 (Other Events) regarding the amendment signed into lawMarch 5, 2003 to Massachusetts tax laws disallowing the deduction for dividendsreceived from a real estate investment trust.

 

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**SIGNATURES**

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|   |                                                                                                                  |   | **INVESTORS FINANCIAL  SERVICES CORP.** |
|--------|-----------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------|
|   |                                                                                                                  |   |                                    |
| Date:  | May 14, 2003                                                                                                          | 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) |
|        |                                                                                                                       |        |                                         |  |

 

 

**Certifications**

 

I, Kevin J. Sheehan, Chairman and Chief Executive Officer, certifythat:

 

1.                                       Ihave reviewed this Quarterly Report on Form 10-Q of Investors FinancialServices Corp.;

 

2.                                       Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;

 

3.                                       Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report;

 

4.                                       Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

(a)                                  designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

 

(b)                                 evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

(c)                                  presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation as of the EvaluationDate;

 

5.                                       Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

(a)                                  allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

(b)                                 anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.                                       Theregistrant’s other certifying officers and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 
| Date:  | May 14, 2003 |                                 |
|--------|--------------|--------------------------------------|
|   |         | /s/ Kevin J. Sheehan                 |   |
|   |         | Kevin J. Sheehan                     |
|   |         | Chairman and Chief Executive Officer |

 

 

I, John N. Spinney, Jr., Senior Vice President and Chief FinancialOfficer, certify that:

 

1.                                       Ihave reviewed this Quarterly Report on Form 10-Q of Investors FinancialServices Corp.;

 

2.                                       Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;

 

3.                                       Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report;

 

4.                                       Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

(a)                                  designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

 

(b)                                 evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

(c)                                  presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation as of the EvaluationDate;

 

5.                                       Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

(a)                                  allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

(b)                                 anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.                                       Theregistrant’s other certifying officers and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 
| Date:  | May 14, 2003 |                                               |
|--------|--------------|----------------------------------------------------|
|   |         | /s/ John N. Spinney, Jr.                           |   |
|   |         | John N. Spinney, Jr.                               |
|   |         | Senior Vice President and  Chief Financial Officer |

 

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