** **

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

** **

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** **

**FORM 10-Q**

** **

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** **

**(Mark One)**

 

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

** **

**For the Quarterlyperiod ended March 31, 2005**

** **

**or**

 

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

** **

**For the Transitionperiod from             to             **

** **

**0-26996**

**(CommissionFile Number)**

 

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** **

**INVESTORS FINANCIAL SERVICES CORP.**

(Exact name ofregistrant as specified in its charter)

 
| **Delaware**                                                     | ** ** | **04-3279817**                    |
|------------------------------------------------------------------|------------|-----------------------------------|
| (State or other jurisdiction of   incorporation or organization) |       | (IRS Employer Identification No.) |
|                                                             |       |                              |
| **200 Clarendon Street,  P.O. Box 9130, Boston, MA**        | ** ** | **02117-9130**                    |
| (Address of principal executive offices)                         |       | (Zip Code)                        |

 

**(617) 937-6700**

(Registrant’stelephone number, including area code)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes ýNo o

 

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

 

As of April 30, 2005 there were 66,798,478 shares of Common Stockoutstanding.

 

 

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**INVESTORS FINANCIAL SERVICES CORP.**

** **

**INDEX**

** **
| **PART I.**  | **FINANCIAL  INFORMATION**                                                                                                       |   |
|-------------------|----------------------------------------------------------------------------------------------------------------------------------|--------|
| ** **        | ** **                                                                                                                       |   |
| Item  1.          | Unaudited  Condensed Consolidated Financial Statements                                                                           |   |
|              |                                                                                                                             |   |
|              | Unaudited  Condensed Consolidated Balance Sheets  March 31, 2005 and December 31, 2004                                 | 3      |
|              |                                                                                                                             |   |
|              | Unaudited  Condensed Consolidated Statements of Income and Comprehensive Income  Three months ended March 31, 2005 and 2004 | 4      |
|              |                                                                                                                             |   |
|              | Unaudited  Condensed Consolidated Statements of Stockholders’ Equity  Three months ended March 31, 2005 and 2004       | 5      |
|              |                                                                                                                             |   |
|              | Unaudited  Condensed Consolidated Statements of Cash Flows  Three months ended March 31, 2005 and 2004                      | 6      |
|              |                                                                                                                             |   |
|              | Notes  to Unaudited Condensed Consolidated Financial Statements                                                                  | 7      |
|              |                                                                                                                             |   |
|              | Report  of Independent Registered Public Accounting Firm                                                                         | 17     |
|              |                                                                                                                             |   |
| Item  2.          | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                      | 18     |
|              |                                                                                                                             |   |
| Item  3.          | Quantitative  and Qualitative Disclosures about Market Risk                                                                      | 34     |
|              |                                                                                                                             |   |
| Item  4.          | Controls  and Procedures                                                                                                         | 34     |
|              |                                                                                                                             |   |
| **PART II.** | **OTHER INFORMATION**                                                                                                            |   |
| ** **        | ** **                                                                                                                       |   |
| Item 2.           | Purchases of Equity Securities by  the Issuer and Affiliated Purchasers                                                          | 35     |
|              |                                                                                                                             |   |
| Item  6.          | Exhibits                                                                                                                         | 35     |
|              |                                                                                                                             |   |
| **SIGNATURES**    | 36                                                                                                                               |

 

2

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**PART I.  FINANCIAL INFORMATION**

**Item 1.**    UnauditedCondensed Consolidated Financial Statements

** **

**INVESTORS FINANCIAL SERVICES CORP.**

**UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS**

**March 31, 2005 and December 31, 2004 (Dollars in thousands,except share data)**

 
| ** **                                                                                                                                                                          | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                          | ** ** | ** **               | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                                                                                          |       |                     |       |                        |       |
| Cash and due from banks                                                                                                                                                             |       | $                        | 35,553     |                        | $          | 49,059 |   |
| Securities held to maturity (approximate  fair value of $6,599,128 and $5,937,462 at March 31, 2005 and  December 31, 2004, respectively)                                 |       | 6,609,230                |       | 5,942,717                   |       |
| Securities available for sale                                                                                                                                                       |       | 4,490,398                |       | 4,565,505                   |       |
| Nonmarketable equity securities                                                                                                                                                     |       | 50,000                   |       | 50,000                      |       |
| Loans, less allowance for loan losses of  $100 at March 31, 2005 and December 31, 2004                                                                                    |       | 265,758                  |       | 134,530                     |       |
| Accrued interest and fees receivable                                                                                                                                                |       | 99,608                   |       | 89,292                      |       |
| Equipment and leasehold improvements, less  accumulated depreciation of $60,769 and $61,017 at March 31, 2005 and  December 31, 2004, respectively                        |       | 66,862                   |       | 67,883                      |       |
| Goodwill, net                                                                                                                                                                       |       | 79,969                   |       | 79,969                      |       |
| Other assets                                                                                                                                                                        |       | 187,699                  |       | 188,870                     |       |
|                                                                                                                                                                                |       |                     |       |                        |       |
| **Total  Assets**                                                                                                                                                                   |       | $                        | 11,885,077 |                        | $          | 11,167,825 |   |
|                                                                                                                                                                                |       |                     |       |                        |       |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                      |       |                     |       |                        |       |
|                                                                                                                                                                                |       |                     |       |                        |       |
| **Liabilities:**                                                                                                                                                                    |       |                     |       |                        |       |
| Deposits:                                                                                                                                                                           |       |                     |       |                        |       |
| Demand                                                                                                                                                                              |       | $                        | 541,252    |                        | $          | 690,308 |   |
| Savings                                                                                                                                                                             |       | 3,659,996                |       | 4,448,405                   |       |
| Time                                                                                                                                                                                |       | 662,669                  |       | 257,669                     |       |
| Total deposits                                                                                                                                                                      |       | 4,863,917                |       | 5,396,382                   |       |
|                                                                                                                                                                                |       |                     |       |                        |       |
| Securities sold under repurchase agreements                                                                                                                                         |       | 4,640,959                |       | 4,255,497                   |       |
| Short-term and other borrowings                                                                                                                                                     |       | 1,319,712                |       | 594,681                     |       |
| Due to brokers for open trades payable                                                                                                                                              |       | 112,805                  |       | 5,475                       |       |
| Junior subordinated deferrable interest  debentures                                                                                                                                 |       | 24,774                   |       | 24,774                      |       |
| Accrued taxes and other expenses                                                                                                                                                    |       | 71,143                   |       | 54,967                      |       |
| Other liabilities                                                                                                                                                                   |       | 110,639                  |       | 123,787                     |       |
| Total liabilities                                                                                                                                                                   |       | 11,143,949               |       | 10,455,563                  |       |
|                                                                                                                                                                                |       |                     |       |                        |       |
| Commitments and contingencies                                                                                                                                                       |       | —                   |       | —                      |       |
|                                                                                                                                                                                |       |                     |       |                        |       |
| **Stockholders’  Equity:**                                                                                                                                                     |       |                     |       |                        |       |
| Preferred stock, par value $0.01 (shares  authorized: 1,000,000; issued and outstanding: none at March 31, 2005  and December 31, 2004)                                   |       | —                   |       | —                      |       |
| Common stock, par value $0.01 (shares  authorized: 175,000,000; issued and outstanding: 66,796,243 and 66,595,349 at  March 31, 2005 and December 31, 2004, respectively) |       | 669                      |       | 667                         |       |
| Surplus                                                                                                                                                                             |       | 279,353                  |       | 272,536                     |       |
| Deferred compensation                                                                                                                                                               |       | (465                     | )          | (572                        | )          |
| Retained earnings                                                                                                                                                                   |       | 457,650                  |       | 418,034                     |       |
| Accumulated other comprehensive income, net                                                                                                                                         |       | 6,212                    |       | 23,888                      |       |
| Treasury stock, at cost (73,235 shares at  March 31, 2005 and December 31, 2004)                                                                                          |       | (2,291                   | )          | (2,291                      | )          |
| Total stockholders’ equity                                                                                                                                                     |       | 741,128                  |       | 712,262                     |       |
|                                                                                                                                                                                |       |                     |       |                        |       |
| **Total  Liabilities and Stockholders’ Equity**                                                                                                                                |       | $                        | 11,885,077 |                        | $          | 11,167,825 |   |

* *

*See Notes to Unaudited Condensed ConsolidatedFinancial Statements.*

 

3

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**INVESTORS FINANCIAL SERVICES CORP.**

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

**Three Months Ended March 31, 2005 and 2004 (Dollars in thousands,except per share data)**

 
| ** **                                        | ** ** | **March 31,  2005** | ** ** | **March 31,  2004** | ** ** |
|---------------------------------------------------|------------|--------------------------|------------|--------------------------|------------|
| **Fees  and Other Revenue:**                      | ** ** | ** **               | ** ** | ** **               | ** ** |
| Asset servicing fees:                             |       |                     |       |                     |       |
| Core service fees                                 |       | $                        | 88,544     |                     | $          | 76,094 |   |
| Ancillary service fees                            |       | 26,659                   |       | 30,093                   |       |
| Total asset servicing fees                        |       | 115,203                  |       | 106,187                  |       |
| Other operating income                            |       | 785                      |       | 349                      |       |
| Gain on sale of investments                       |       | 4,188                    |       | 234                      |       |
| Total fees and other revenue                      |       | 120,176                  |       | 106,770                  |       |
|                                              |       |                     |       |                     |       |
| Interest income                                   |       | 98,055                   |       | 73,636                   |       |
| Interest expense                                  |       | 50,442                   |       | 25,215                   |       |
| Net interest income                               |       | 47,613                   |       | 48,421                   |       |
| Net operating revenue                             |       | 167,789                  |       | 155,191                  |       |
|                                              |       |                     |       |                     |       |
| **Operating  Expenses:**                          |       |                     |       |                     |       |
| Compensation and benefits                         |       | 56,919                   |       | 55,323                   |       |
| Technology and telecommunications                 |       | 12,836                   |       | 10,266                   |       |
| Transaction processing services                   |       | 11,120                   |       | 10,940                   |       |
| Depreciation and amortization                     |       | 7,891                    |       | 7,954                    |       |
| Occupancy                                         |       | 6,613                    |       | 7,391                    |       |
| Professional fees                                 |       | 2,973                    |       | 3,238                    |       |
| Travel and sales promotion                        |       | 1,349                    |       | 1,082                    |       |
| Insurance                                         |       | 1,129                    |       | 1,196                    |       |
| Other operating expenses                          |       | 3,962                    |       | 2,744                    |       |
| Total operating expenses                          |       | 104,792                  |       | 100,134                  |       |
|                                              |       |                     |       |                     |       |
| **Income  Before Income Taxes**                   |       | 62,997                   |       | 55,057                   |       |
|                                              |       |                     |       |                     |       |
| Provision for income taxes                        |       | 22,049                   |       | 18,504                   |       |
|                                              |       |                     |       |                     |       |
| **Net  Income**                                   |       | $                        | 40,948     |                     | $          | 36,553 |   |
| ** **                                        |       |                     |       |                     |       |   |   |
| **Basic  Earnings Per Share**                     |       | $                        | 0.61       |                     | $          | 0.56 |   |
| ** **                                        |       |                     |       |                     |       |   |   |
| **Diluted  Earnings Per Share**                   |       | $                        | 0.60       |                     | $          | 0.54 |   |
|                                              |       |                     |       |                     |       |
| **Comprehensive  Income:**                        |       |                     |       |                     |       |
| Net income                                        |       | $                        | 40,948     |                     | $          | 36,553 |   |
| Other comprehensive (loss) income:                |       |                     |       |                     |       |
| Net unrealized investment (loss) gain             |       | (26,239                  | )          | 21,913                   |       |
| Net unrealized derivative instrument gain  (loss) |       | 8,683                    |       | (1,162                   | )          |
| Cumulative translation adjustment                 |       | (120                     | )          | (83                      | )          |
| Other comprehensive (loss) income                 |       | (17,676                  | )          | 20,668                   |       |
| Comprehensive income                              |       | $                        | 23,272     |                     | $          | 57,221 |   |

 

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

 

4

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**INVESTORS FINANCIAL SERVICES CORP.**

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

**Three Months Ended March 31, 2005 and 2004 (Dollars in thousands,except share data)**

 
| ** **                                                                                                    | ** ** | **March 31,  2005** | ** ** | **March 31,  2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|--------------------------|------------|
| **Common  shares**                                                                                            |       |                     |       |                     |       |
| Balance, beginning of period                                                                                  |       | 66,595,349               |       | 65,436,788               |       |
| Exercise of stock options                                                                                     |       | 200,894                  |       | 590,946                  |       |
| Balance, end of period                                                                                        |       | 66,796,243               |       | 66,027,734               |       |
|                                                                                                          |       |                     |       |                     |       |
| **Treasury  shares**                                                                                          |       |                     |       |                     |       |
| Balance, beginning of period                                                                                  |       | 73,235                   |       | 26,508                   |       |
| Balance, end of period                                                                                        |       | 73,235                   |       | 26,508                   |       |
|                                                                                                          |       |                     |       |                     |       |
| **Common  stock**                                                                                             |       |                     |       |                     |       |
| Balance, beginning of period                                                                                  |       | $                        | 667        |                     | $          | 655 |   |
| Exercise of stock options                                                                                     |       | 2                        |       | 6                        |       |
| Balance, end of period                                                                                        |       | 669                      |       | 661                      |       |
|                                                                                                          |       |                     |       |                     |       |
| **Surplus**                                                                                                   |       |                     |       |                     |       |
| Balance, beginning of period                                                                                  |       | 272,536                  |       | 242,662                  |       |
| Exercise of stock options                                                                                     |       | 5,638                    |       | 8,578                    |       |
| Tax benefit from exercise of stock options                                                                    |       | 1,179                    |       | 5,343                    |       |
| Balance, end of period                                                                                        |       | 279,353                  |       | 256,583                  |       |
|                                                                                                          |       |                     |       |                     |       |
| **Deferred  compensation**                                                                                    |       |                     |       |                     |       |
| Balance, beginning of period                                                                                  |       | (572                     | )          | (1,076                   | )          |
| Amortization of deferred compensation                                                                         |       | 107                      |       | 114                      |       |
| Balance, end of period                                                                                        |       | (465                     | )          | (962                     | )          |
|                                                                                                          |       |                     |       |                     |       |
| **Retained  earnings**                                                                                        |       |                     |       |                     |       |
| Balance, beginning of period                                                                                  |       | 418,034                  |       | 280,701                  |       |
| Net income                                                                                                    |       | 40,948                   |       | 36,553                   |       |
| Cash dividend, $0.02 and $0.0175 per share  in the periods ending  March 31, 2005 and 2004, respectively |       | (1,332                   | )          | (1,152                   | )          |
| Balance, end of period                                                                                        |       | 457,650                  |       | 316,102                  |       |
|                                                                                                          |       |                     |       |                     |       |
| **Accumulated  other comprehensive income, net**                                                              |       |                     |       |                     |       |
| Balance, beginning of period                                                                                  |       | 23,888                   |       | 17,865                   |       |
| Net unrealized investment (loss) gain                                                                         |       | (26,239                  | )          | 21,913                   |       |
| Net unrealized derivative instrument gain  (loss)                                                             |       | 8,659                    |       | (1,162                   | )          |
| Amortization of terminated interest rate  swap agreements                                                     |       | 24                       |       | —                   |       |
| Effect of foreign currency translation                                                                        |       | (120                     | )          | (83                      | )          |
| Balance, end of period                                                                                        |       | 6,212                    |       | 38,533                   |       |
|                                                                                                          |       |                     |       |                     |       |
| **Treasury  stock**                                                                                           |       |                     |       |                     |       |
| Balance, beginning of period                                                                                  |       | (2,291                   | )          | (550                     | )          |
| Balance, end of period                                                                                        |       | (2,291                   | )          | (550                     | )          |
|                                                                                                          |       |                     |       |                     |       |
| **Total  Stockholders’ Equity**                                                                          |       | $                        | 741,128    |                     | $          | 610,367 |   |

*** ***

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

 

5

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**INVESTORS FINANCIAL SERVICES CORP.**

**UNAUDITEDCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**Three Months Ended March 31, 2005 and 2004 (Dollars in thousands)**

 
| ** **                                                                         | ** ** | **March 31,  2005** | ** ** | **March 31,  2004** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------|------------|--------------------------|------------|
| ** **                                                                         | ** ** | ** **               | ** ** | ** **               | ** ** |
| **Cash  Flows From Operating Activities:**                                         |       |                     |       |                     |       |
| Net income                                                                         |       | $                        | 40,948     |                     | $          | 36,553 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                     |       |                     |       |
| Equity in undistributed loss of  unconsolidated subsidiary                         |       | 7                        |       | 7                        |       |
| Depreciation and amortization                                                      |       | 7,891                    |       | 7,954                    |       |
| Amortization of deferred compensation                                              |       | 107                      |       | 114                      |       |
| Amortization of premiums on securities, net  of accretion of discounts             |       | 11,119                   |       | 7,005                    |       |
| Gain on sale of investments                                                        |       | (4,188                   | )          | (234                     | )          |
| Changes in assets and liabilities:                                                 |       |                     |       |                     |       |
| Accrued interest and fees receivable                                               |       | (10,316                  | )          | (3,635                   | )          |
| Other assets                                                                       |       | 1,116                    |       | (39,906                  | )          |
| Accrued taxes and other expenses                                                   |       | 16,176                   |       | 23,825                   |       |
| Other liabilities                                                                  |       | 11,225                   |       | (922                     | )          |
| Net cash provided by operating activities                                          |       | 74,085                   |       | 30,761                   |       |
|                                                                               |       |                     |       |                     |       |
| **Cash  Flows From Investing Activities:**                                         |       |                     |       |                     |       |
| Proceeds from maturities and paydowns of  securities available for sale            |       | 281,095                  |       | 291,797                  |       |
| Proceeds from maturities and paydowns of  securities held to maturity              |       | 363,292                  |       | 281,471                  |       |
| Proceeds from sale of securities available  for sale                               |       | 110,595                  |       | 25,041                   |       |
| Purchases of securities available for sale                                         |       | (354,490                 | )          | (373,214                 | )          |
| Purchases of securities held to maturity                                           |       | (1,039,657               | )          | (887,838                 | )          |
| Net increase in due to brokers for open  trades payable                            |       | 107,330                  |       | 32,870                   |       |
| Net increase in Federal Funds sold                                                 |       | —                   |       | (185,000                 | )          |
| Net (increase) decrease in loans                                                   |       | (131,228                 | )          | 46,426                   |       |
| Purchases of fixed assets, capitalized  software and leasehold improvements        |       | (6,862                   | )          | (5,470                   | )          |
| Net cash used for investing activities                                             |       | (669,925                 | )          | (773,917                 | )          |
|                                                                               |       |                     |       |                     |       |
| **Cash  Flows From Financing Activities:**                                         |       |                     |       |                     |       |
| Net (decrease) increase in demand deposits                                         |       | (149,056                 | )          | 520,873                  |       |
| Net (decrease) increase in time and savings  deposits                              |       | (383,409                 | )          | 247,297                  |       |
| Net increase in securities sold under  repurchase agreements                       |       | 385,462                  |       | 221,680                  |       |
| Net increase (decrease) in short-term and  other borrowings                        |       | 725,031                  |       | (248,383                 | )          |
| Proceeds from exercise of stock options                                            |       | 5,640                    |       | 8,584                    |       |
| Dividends paid to stockholders                                                     |       | (1,332                   | )          | (1,152                   | )          |
| Net cash provided by financing activities                                          |       | 582,336                  |       | 748,899                  |       |
|                                                                               |       |                     |       |                     |       |
| **Effect  of exchange rates on cash**                                              |       | (2                       | )          | (3                       | )          |
|                                                                               |       |                     |       |                     |       |
| **Net  (Decrease) Increase in Cash and Due From Banks**                            |       | (13,506                  | )          | 5,740                    |       |
| ** **                                                                         |       |                     |       |                     |       |
| **Cash and  Due From Banks, Beginning of Period**                                  |       | 49,059                   |       | 39,689                   |       |
| ** **                                                                         |       |                     |       |                     |       |
| **Cash and  Due From Banks, End of Period**                                        |       | $                        | 35,553     |                     | $          | 45,429 |   |

* *

*See Notes to Unaudited Condensed ConsolidatedFinancial Statements.*

 

6

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**INVESTORS FINANCIALSERVICES CORP.**

**NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Information is as of and for the three months ended March 31,2005 and 2004)**

 

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

 

Investors Financial Services Corp. (‘IFSC’) provides assetadministration services for the financial services industry through itswholly-owned subsidiary, Investors Bank & Trust Company (‘the Bank’).  As used herein, the defined term “the Company”shall mean IFSC together with the Bank and its domestic and foreignsubsidiaries.  The Company provides coreservices and value-added services to a variety of financial asset managers,including mutual fund complexes, investment advisors, family offices, banks andinsurance companies.  Core servicesinclude middle office outsourcing, global custody, multicurrency accounting andfund administration.  Value-addedservices include securities lending, foreign exchange, cash management,performance measurement, institutional transfer agency, investment advisoryservices, lines of credit and brokerage and transition managementservices.  The Company and/or itsaffiliates are subject to regulation by the Federal Deposit InsuranceCorporation, the Federal Reserve Board of Governors, the Office of theCommissioner of Banks of the Commonwealth of Massachusetts, the Securities andExchange Commission (‘SEC’), the National Association of Securities Dealers, Inc.(‘NASD’), the Office of the Superintendent of Financial Institutions in Canada,the Irish Financial Services Regulatory Authority, the Cayman Islands MonetaryAuthority and the State of Vermont Department of Banking, Insurance, Securities &Health Care Administration.

 

**2.****             Interim FinancialStatements**

 

The unaudited condensed consolidated interim financial statements ofthe Company and its subsidiaries as of March 31, 2005 and December 31,2004, and for the three-month periods ended March 31, 2005 and 2004 havebeen prepared by the Company pursuant to the rules and regulations of theSEC.  Certain information and footnotedisclosures normally included in annual financial statements prepared inaccordance with accounting principles generally accepted in the United Statesof America (‘GAAP’) have been condensed or omitted as permitted by such rules andregulations.  All adjustments, consistingof normal recurring adjustments, necessary for their fair presentation inconformity with GAAP are included.  TheCompany’s management believes that the disclosures are adequate to presentfairly the financial position, results of operations and cash flows at thedates and for the periods presented. It is suggested that these interimfinancial statements be read in conjunction with the financial statements andthe notes thereto included in the Company’s latest annual report on Form 10-K.Results for interim periods are not necessarily indicative of those to beexpected for the full fiscal year. Certain amounts in prior financialstatements have been reclassified to conform to the current presentation.

 

***Share-Based Compensation******–*** The Company measurescompensation expense for share-based compensation plans using the intrinsicvalue method.  The intrinsic value methodmeasures compensation cost as the amount by which the fair market value of thecommon stock exceeds the option exercise price on the measurement date, whichis typically the date of grant. Generally, options granted have an exercise price equivalent to the fairmarket value at the measurement date. Accordingly, no compensation cost has been recorded.  If share-based compensation were recognizedusing the fair value method, stock options would be valued at grant date usingthe Black-Scholes valuation model and resulting compensation costs would havedecreased net income as indicated below (Dollars in thousands, except per sharedata):

 
| ** **                                                                                                                                  | ** ** | **For the Three Months  Ended March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                                                                                  | ** ** | **2005**                                       | ** ** | **2004** | ** ** |
|                                                                                                                                        |       |                                           |       |   |   |
| Net income as reported                                                                                                                      |       | $                                              | 40,948     |   | $ | 36,553 |   |
| Deduct: Total share-based employee  compensation expense determined under the fair value method for all awards,  net of related tax effects |       | (808                                           | )          | (1,485 | ) |
| Pro forma net income                                                                                                                        |       | $                                              | 40,140     |   | $ | 35,068 |   |
|                                                                                                                                        |       |                                           |       |   |   |
| Earnings per share:                                                                                                                         |       |                                           |       |   |   |
| Basic-as reported                                                                                                                           |       | $                                              | 0.61       |   | $ | 0.56 |   |
| Basic-pro forma                                                                                                                             |       | $                                              | 0.60       |   | $ | 0.53 |   |
|                                                                                                                                        |       |                                           |       |   |   |
| Diluted-as reported                                                                                                                         |       | $                                              | 0.60       |   | $ | 0.54 |   |
| Diluted-pro forma                                                                                                                           |       | $                                              | 0.58       |   | $ | 0.52 |   |

 

7

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The fair value of each option grant was estimated on the date of grantusing the Black-Scholes valuation model with the following assumptions for the threemonths ended March 31, 2005 and 2004, respectively: an average assumedrisk-free interest rate of 4.13% and 2.38%, an expected life of four years, anaverage expected volatility of 44.16% and 53.95%, and an average dividend yieldof 0.16% and 0.17%.

 

***Earnings Per Share –***Basicearnings per share (‘EPS’) were computed by dividing net income by theweighted-average number of common shares outstanding during the quarter.Diluted EPS reflects the potential dilution that could occur if contracts toissue common stock were exercised into common stock that then shared in theearnings of the Company.  Thereconciliation from Basic to Diluted EPS is as follows (Dollars in thousands,except per share data):

 
| ** **                                  | ** ** | **For the Three Months Ended  March 31,** | ** ** |
|---------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                  | ** ** | **2005**                                       | ** ** | **2004** | ** ** |
|                                        |       |                                           |       |   |   |
| Income available to common stockholders     |       | $                                              | 40,948     |   | $ | 36,553 |   |
|                                        |       |                                           |       |   |   |
| Basic weighted-average shares outstanding   |       | 66,718,362                                     |       | 65,837,110 |   |
| Dilutive effect of stock options            |       | 1,899,129                                      |       | 1,875,842 |   |
| Diluted weighted-average shares outstanding |       | 68,617,491                                     |       | 67,712,952 |   |
|                                        |       |                                           |       |   |   |
| Earnings per share:                         |       |                                           |       |   |   |
| Basic                                       |       | $                                              | 0.61       |   | $ | 0.56 |   |
|                                        |       |                                           |       |   |   |
| Diluted                                     |       | $                                              | 0.60       |   | $ | 0.54 |   |

 

There were 5,950 and 722 option shares which were not considereddilutive for purposes of EPS calculations for the three-month periods ended March 31,2005 and 2004, respectively.

 

***Recently Issued Accounting Pronouncements*-** InDecember 2004, the Financial Accounting Standards Board (‘FASB’) issuedSFAS No. 123 (revised 2004), *Share-BasedPayment*.  SFAS 123R requires that compensation cost relating toshare-based payment transactions be recognized in the financial statements withmeasurement based upon the fair value of the equity or liability instrumentsissued. The Company currently uses the intrinsic value method to measurecompensation cost related to its share-based transactions. The Statementreplaces SFAS No. 123, *Accounting forStock-Based Compensation*, and supersedes APB Opinion No. 25, *Accounting for Stock Issued to Employees.*

 

InMarch 2005, the SEC issued Staff Accounting Bulletin (‘SAB’) No. 107,which expresses the views of the SEC regarding the interaction of SFAS 123R andcertain SEC regulations and provides the SEC’s views regarding the valuation ofshare-based payment arrangements for public companies.  In addition, in April 2005,the SEC issued Release 2005-57, which delays the effective date for SFAS 123Rto January 1, 2006.

 

TheCompany expects to adopt SFAS 123R and follow the guidance of SAB 107 beginningon January 1, 2006.  The Company is in the process of determining thevaluation methodology it will use under the fair value method and is assessing theimpact the adoption of  SFAS 123R willhave on its results of operations and financial condition.  The Company does not anticipate any materialimpact to its financial condition or results of operations as a result of theadoption of SFAS 123R.

 

8

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**3.****             Securities**

 

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

 
| **Held  to Maturity**            | ** ** | **Amortized  Cost** | ** ** | **Unrealized  Gains** | ** ** | **Unrealized  (Losses)** | ** ** | **Fair  Value** | ** ** |
|----------------------------------|------------|---------------------|------------|-----------------------|------------|--------------------------|------------|-----------------|------------|
|                             |       |                |       |                  |       |                     |       |            |       |
| Mortgage-backed securities       |       | $                   | 4,182,043  |                  | $          | 16,389                   |       | $               | (13,721    | ) | $ | 4,184,711 |   |
| Federal agency securities        |       | 2,307,273           |       | 1,361                 |       | (18,814                  | )          | 2,289,820       |       |
| State and political subdivisions |       | 119,914             |       | 4,762                 |       | (79                      | )          | 124,597         |       |
|                             |       |                |       |                  |       |                     |       |            |       |
| Total                            |       | $                   | 6,609,230  |                  | $          | 22,512                   |       | $               | (32,614    | ) | $ | 6,599,128 |   |
|                             |       |                |       |                  |       |                     |       |            |       |
| **Available  for Sale**          | ** ** | **Amortized  Cost** | ** ** | **Unrealized  Gains** | ** ** | **Unrealized  (Losses)** | ** ** | **Fair  Value** | ** ** |
|                             |       |                |       |                  |       |                     |       |            |       |
| Mortgage-backed securities       |       | $                   | 3,878,559  |                  | $          | 12,710                   |       | $               | (34,381    | ) | $ | 3,856,888 |   |
| State and political subdivisions |       | 320,937             |       | 8,732                 |       | (176                     | )          | 329,493         |       |
| Corporate debt                   |       | 177,031             |       | 1,017                 |       | (1,265                   | )          | 176,783         |       |
| U.S. Treasury securities         |       | 113,469             |       | 3,467                 |       | —                   |       | 116,936         |       |
| Foreign government securities    |       | 10,184              |       | 114                   |       | —                   |       | 10,298          |       |
|                             |       |                |       |                  |       |                     |       |            |       |
| Total                            |       | $                   | 4,500,180  |                  | $          | 26,040                   |       | $               | (35,822    | ) | $ | 4,490,398 |   |

 

Amortized cost amounts and fair values of securities are summarized asfollows as of December 31, 2004 (Dollars in thousands):

 
| **Held  to Maturity**            | ** ** | **Amortized  Cost** | ** ** | **Unrealized  Gains** | ** ** | **Unrealized  (Losses)** | ** ** | **Fair Value** | ** ** |
|----------------------------------|------------|---------------------|------------|-----------------------|------------|--------------------------|------------|----------------|------------|
|                             |       |                |       |                  |       |                     |       |           |       |
| Mortgage-backed securities       |       | $                   | 3,543,961  |                  | $          | 13,269                   |       | $              | (7,802     | ) | $ | 3,549,428 |   |
| Federal agency securities        |       | 2,274,665           |       | 1,658                 |       | (18,443                  | )          | 2,257,880      |       |
| State and political subdivisions |       | 124,091             |       | 6,090                 |       | (27                      | )          | 130,154        |       |
|                             |       |                |       |                  |       |                     |       |           |       |
| Total                            |       | $                   | 5,942,717  |                  | $          | 21,017                   |       | $              | (26,272    | ) | $ | 5,937,462 |   |
|                             |       |                |       |                  |       |                     |       |           |       |
| **Available  for Sale**          | ** ** | **Amortized  Cost** | ** ** | **Unrealized  Gains** | ** ** | **Unrealized  (Losses)** | ** ** | **Fair Value** | ** ** |
|                             |       |                |       |                  |       |                     |       |           |       |
| Mortgage-backed securities       |       | $                   | 3,848,255  |                  | $          | 21,596                   |       | $              | (14,951    | ) | $ | 3,854,900 |   |
| State and political subdivisions |       | 384,859             |       | 20,110                |       | (60                      | )          | 404,909        |       |
| Corporate debt                   |       | 177,201             |       | 911                   |       | (1,566                   | )          | 176,546        |       |
| U.S. Treasury securities         |       | 113,843             |       | 4,845                 |       | —                   |       | 118,688        |       |
| Foreign government securities    |       | 10,302              |       | 160                   |       | —                   |       | 10,462         |       |
|                             |       |                |       |                  |       |                     |       |           |       |
| Total                            |       | $                   | 4,534,460  |                  | $          | 47,622                   |       | $              | (16,577    | ) | $ | 4,565,505 |   |

 

The carrying value of securities pledged amounted to approximately $6.9billion and $6.3 billion at March 31, 2005 and December 31, 2004,respectively.  Securities are pledgedprimarily to secure clearings with other depository institutions, to securerepurchase agreements and to secure outstanding Federal Home Loan Bank ofBoston (‘FHLBB’) borrowings.

 

On a quarterly basis the Company reviews its investment portfolio on asecurity by security basis for any investment that may be other-than-temporarilyimpaired.  In its evaluation, the Companyconsiders the length of time the security has been impaired, the severity ofthe impairment, the financial condition and future prospects of the issuer, andthe Company’s ability and intent to hold the security to maturity or until itrecovers in value.  At March 31,2005, no securities were considered to be other-than-temporarily impaired.

 

9

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**4.****             Loans**

 

Loans consist of demand loans to custody clients of the Company,including individuals, not-for-profit institutions and mutual fund clients. Theloans to mutual funds and other pooled product clients include lines of creditand advances pursuant to the terms of the custody agreements between theCompany and those clients to facilitate securities transactions andredemptions. Generally, the loans are, or may be, in the event of default,collateralized with marketable securities held by the Company as custodian.There were no impaired or nonperforming loans at March 31, 2005 and December 31,2004.  In addition, there were no loancharge-offs or recoveries during the three months ended March 31, 2005 andthe year ended December 31, 2004. Loans are summarized as follows (Dollarsin thousands):

 
| ** **                     | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|--------------------------------|------------|--------------------------|------------|-----------------------------|------------|
|                           |       |                     |       |                        |       |
| Loans to mutual funds          |       | $                        | 152,386    |                        | $          | 22,520 |   |
| Loans to individuals           |       | 77,588                   |       | 69,402                      |       |
| Loans to others                |       | 35,884                   |       | 42,708                      |       |
| Gross loans                    |       | 265,858                  |       | 134,630                     |       |
| Less allowance for loan losses |       | (100                     | )          | (100                        | )          |
|                           |       |                     |       |                        |       |
| Total                          |       | $                        | 265,758    |                        | $          | 134,530 |   |

 

**5.****             Deposits**

 

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

 
| ** **                         | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Interest-bearing deposits:         |       |                     |       |                        |       |
| Savings                            |       | $                        | 3,642,901  |                        | $          | 4,362,895 |   |
| Time                               |       | 412,669                  |       | 97,669                      |       |
| Total interest-bearing deposits    |       | 4,055,570                |       | 4,460,564                   |       |
|                               |       |                     |       |                        |       |
| Noninterest-bearing deposits:      |       |                     |       |                        |       |
| Demand                             |       | 541,252                  |       | 690,308                     |       |
| Savings                            |       | 17,095                   |       | 85,510                      |       |
| Time                               |       | 250,000                  |       | 160,000                     |       |
| Total noninterest-bearing deposits |       | 808,347                  |       | 935,818                     |       |
|                               |       |                     |       |                        |       |
| Total                              |       | $                        | 4,863,917  |                        | $          | 5,396,382 |   |

 

Time deposits with balances greater than $100,000 totaled $662.6million and $257.6 million at March 31, 2005 and December 31, 2004,respectively.  All time deposits had amaturity of less than three months at March 31, 2005 and December 31,2004.

 

**6.****             Securities Sold UnderRepurchase Agreements**

 

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

 
| ** **                         | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
|                               |       |                     |       |                        |       |
| Repurchase agreements - short term |       | $                        | 4,040,959  |                        | $          | 3,655,497 |   |
| Repurchase agreements - long term  |       | 600,000                  |       | 600,000                     |       |
| Total                              |       | $                        | 4,640,959  |                        | $          | 4,255,497 |   |

 

Approximately $4.7 billion and $4.3 billion of securities were pledgedto collateralize repurchase agreements as of March 31, 2005 and December 31,2004, respectively.

 

10

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**7.****             Short-term and OtherBorrowings**

 

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

 
| ** **                                            | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
|                                                  |       |                     |       |                        |       |
| Federal Funds purchased                               |       | $                        | 944,555    |                        | $          | 344,491 |   |
| Federal Home Loan Bank of Boston overnight  advances  |       | 325,000                  |       | —                      |       |
| Federal Home Loan Bank of Boston short-term  advances |       | —                   |       | 200,000                     |       |
| Federal Home Loan Bank of Boston long-term  advances  |       | 50,000                   |       | 50,000                      |       |
| Treasury, Tax and Loan account                        |       | 157                      |       | 190                         |       |
|                                                  |       |                     |       |                        |       |
| Total                                                 |       | $                        | 1,319,712  |                        | $          | 594,681 |   |

 

The Company has borrowing arrangements with the FHLBB and the FederalReserve Discount Window, which have been utilized on an overnight, short-termand long-term basis to satisfy funding requirements.  Approximately $1.8 billion and $1.6 billionof securities were pledged to collateralize these advances as of March 31,2005 and December 31, 2004, respectively.

 

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

 

As of March 31, 2005, the Company’s authorized capital stockconsisted of 1,000,000 shares of Preferred Stock and 175,000,000 shares ofCommon Stock, all with a par value of $0.01 per share.

 

The Company has four equity incentive plans: the Amended and Restated1995 Stock Plan (‘Stock Plan’), the Amended and Restated 1995 Non-EmployeeDirector Stock Option Plan (‘Director Plan’), the 1997 Employee Stock PurchasePlan (‘ESPP’) and the 2005 Equity Incentive Plan, which was approved by ourstockholders on April 14, 2005 (the ‘2005 Plan’).  There were no amendments to these plansduring the three months ended March 31, 2005.  No shares were granted under the 2005 Plan asof March 31, 2005.

 

During the three months ended March 31, 2005, the followingactivity occurred under the Director Plan and the Stock Plan:

 
| ** **                                          | ** ** | **March 31, 2005** | ** ** |
|-----------------------------------------------------|------------|-------------------------|------------|
| ** **                                          | ** ** | **Shares**              | ** ** | **Weighted-Average  Exercise Price** | ** ** |
|                                                |       |                    |       |   |   |
| Outstanding at December 31, 2004               |       | 5,929,352               |       | $ | 28 |   |
| Granted                                             |       | 16,432                  |       | 50 |   |
| Exercised                                           |       | (222,996                | )          | 30 |   |
| Canceled                                            |       | (14,800                 | )          | 33 |   |
| Outstanding at March 31, 2005                  |       | 5,707,988               |       | $ | 28 |   |
|                                                |       |                    |       |   |   |
| Outstanding and Exercisable at  March 31, 2005 |       | 4,811,503               |       |   |   |

 

11

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A summary of activity under the ESPP is as follows:

 
| ** **                                                  | ** ** | **For the Three  Months Ended  March 31,  2005** | ** ** | **For the  Year Ended  December 31,  2004** | ** ** |
|-------------------------------------------------------------|------------|-------------------------------------------------------|------------|--------------------------------------------------|------------|
|                                                        |       |                                                  |       |                                             |       |
| Total shares available under the ESPP,  beginning of period |       | 636,267                                               |       | 227,504                                          |       |
| Approved increase in shares available                       |       | —                                                |       | 500,000                                          |       |
| Issued at June 30                                      |       | —                                                |       | (47,681                                          | )          |
| Issued at December 31                                  |       | —                                                |       | (43,556                                          | )          |
|                                                        |       |                                                  |       |                                             |       |
| Total shares available under the ESPP, end  of period       |       | 636,267                                               |       | 636,267                                          |       |

 

During the year ended December 31, 2004, the purchase prices ofthe stock were $35.00 and $38.75, or 90% of the market value of the CommonStock on the first business day of the payment periods ending June 30,2004 and December 31, 2004, respectively.

 

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

 

***Pension Plan -*** The Company has a trusteed, noncontributory,qualified defined benefit pension plan covering substantially all of itsemployees who were hired before January 1, 1997.  The benefits are based on years of serviceand the employee’s compensation during employment.  Generally, the Company’s funding policy is tocontribute annually the maximum amount that can be deducted for federal incometax purposes.  Contributions are intendedto provide not only for benefits attributed to service to date, but also forbenefits expected to be earned in the future. The plan document was amended in December 2004 to freeze benefitaccruals for certain highly compensated participants as of December 31,2004.  The Company uses a December 31measurement date for this plan.

 

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

 

Net periodic pension cost for the Company’s qualified defined benefitpension plan and SERP included the following components (Dollars in thousands):

 
| ** **                                          | ** ** | **March 31, 2005** | ** ** | **March 31, 2004** | ** ** |
|-----------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                          | ** ** | **Pension Plan**        | ** ** | **SERP**                | ** ** | **Pension Plan** | ** ** | **SERP** | ** ** |
|                                                |       |                    |       |                    |       |   |   |   |   |
| Service cost-benefits earned / benefit  obligations |       | $                       | 186        |                    | $          | 444 |   | $ | 286 |   | $ | 238 |   |
| Interest cost on projected benefit  obligations     |       | 286                     |       | 368                     |       | 351 |   | 242 |   |
| Expected return on plan assets                      |       | (359                    | )          | —                  |       | (367 | ) | — |   |
| Net amortization and deferral                       |       | 78                      |       | 272                     |       | 62 |   | 148 |   |
| Net periodic pension cost                           |       | $                       | 191        |                    | $          | 1,084 |   | $ | 332 |   | $ | 628 |   |

 

The Company expects to contribute up to $4 million to its pension planduring 2005.  During the three-month periodended March 31, 2005, the Company did not make any contributions to theplan.

 

At March 31, 2005, the SERP remained an unfunded plan.  Consistent with the Company’s expectations atDecember 31, 2004, no contributions to the SERP are anticipated during 2005.

 

**10.****          Off-BalanceSheet Financial Instruments**

 

***Lines of Credit****-* At March 31, 2005, the Company had commitments tomutual funds under collateralized open lines of credit totaling $850.0 million,against which $100.1 million in loans were drawn. The credit risk involved inissuing lines of credit is essentially the same as that involved in extendingdemand loans. The Company does not anticipate any loss as a result of theselines of credit.

 

12

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***Securities Lending*** - Onbehalf of its clients, the Company lends securities to creditworthybroker-dealers. In certain circumstances, the Company may indemnify its clientsfor the fair market value of those securities against a failure of the borrowerto return such securities. The Company requires the borrowers to providecollateral in an amount equal to, or in excess of, 102% of the fair marketvalue of U.S. dollar-denominated securities borrowed and 105% of the fairmarket value of non-U.S. dollar-denominated securities borrowed. The borrowedsecurities are revalued daily to determine whether additional collateral isnecessary. As guarantor, the Company is required to recognize, at the inceptionof a guarantee, a liability for the fair value of the obligation undertaken inissuing the guarantee. The Company measures the fair value of itsindemnification obligation by marking its securities lending portfolio tomarket on a daily basis and comparing the value of the portfolio to thecollateral holdings position. The fair value of the indemnification obligationto be recorded would be the deficiency of collateral as compared to the valueof the securities out on loan.

 

With respect to the indemnified securities lending portfolio, the cashand U.S. government securities held by the Company as collateral at March 31,2005 totaled $5.5 billion while the fair value of the portfolio totaledapproximately $5.3 billion. Given that the collateral held was in excessof the value of the securities that the Company would be required to replace ifthe borrower defaulted and failed to return such securities, the Company’sindemnification obligation was zero and no liability was recorded.

 

All securities loans are categorized as overnight loans. The maximumpotential amount of future payments that the Company could be required to makewould be equal to the market value of the securities borrowed. Since thesecurities loans are overcollateralized 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 to use any excess collateral on other loans tothat borrower to cover any collateral shortfall of that borrower. However,there is a potential risk that the collateral would not be sufficient to coversuch an obligation if the security on loan increased in value between the timethe borrower defaulted and the time the security is “bought-in.” In thoseinstances, the Company would “buy-in” the security using all availablecollateral and a loss would result from the difference between the value of thesecurity “bought-in” and the value of the collateral held. The Company hasnever experienced a broker default.

 

**11.**          DerivativeFinancial Instruments

** **

***Interest Rate Contracts***- Interest rate contracts involve an agreement with a counterparty to exchangecash flows based on an underlying interest rate index.  A swap agreement involves the exchange of aseries of interest payments, either at a fixed or variable rate, based upon thenotional amount without the exchange of the underlying principal amount. TheCompany’s exposure from these interest rate contracts results from thepossibility that one party may default on its contractual obligation when thecontracts are in a gain position.  TheCompany has experienced no terminations by counterparties of interest rateswaps.  Credit risk is limited to thepositive fair value of the derivative financial instrument, which issignificantly less than the notional value. As of March 31, 2005, the credit risk related to the Company’sinterest rate contracts was approximately $19.2 million.

 

The Company enters into pay-fixed/receive-floating interest rate swapagreements.  These instruments have beendesignated as cash flow hedges of variable-rate liabilities.  The contractual or notional amounts of theinterest rate swap agreements held by the Company were approximately $1.8billion and $1.6 billion at March 31, 2005 and December 31, 2004,respectively.  These contracts had netfair values of approximately $19.2 million and $1.5 million at March 31,2005 and December 31, 2004, respectively. These fair values are includedin the respective other assets and other liabilities categories on the Company’sconsolidated balance sheet.

 

For the three months ended March 31, 2005, the Company recognizednet pre-tax gains of $2.3 million, which represented the total ineffectivenessfor all cash flow hedges. For the three months ended March 31, 2004, totalineffectiveness related to cash flow hedges had an insignificant impact onearnings.

 

As of March 31, 2005, the Company expects that approximately $6.5million of deferred net after-tax gains on derivative contracts included inother comprehensive income will be reclassified to net interest income withinthe next twelve months. This expectation is based on the net discounted cashflows from derivative instruments hedging short-term variable-rate liabilities,as well as the amortization of gains from the termination of cash flow hedgingderivatives.

 

13

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***Foreign Exchange Contracts***- Foreign exchange contracts involve an agreement to exchange the currency ofone country for the currency of another country at an agreed-upon rate andsettlement date.  Foreign exchangecontracts consist of spot, forward and swap contracts.  Spot contracts call for the exchange of onecurrency for another and usually settle in two business days.  Forward contracts call for the exchange ofone currency for another at a date beyond spot. In a currency swap, the holder of a currency transacts simultaneouslyboth a spot and a forward transaction in that currency for an equivalent amountof another currency to get temporary liquidity in the currency owned.  The Company’s risk from foreign exchangecontracts results from the possibility that one party may default on itscontractual obligation or from movements in exchange rates.  Credit risk is limited to the positive marketvalue of the derivative financial instrument, which is significantly less thanthe notional value. The notional value of the Company’s foreign exchangecontracts as of March 31, 2005 and December 31, 2004 was $9.3 billionand $6.9 billion, respectively. Unrealized gains or losses resulting from purchases and sales of foreignexchange contracts are included within the respective other assets and otherliabilities categories on the Company’s consolidated balance sheet.  Unrealized gains in other assets were $74.4million and $99.6 million as of March 31, 2005 and December 31, 2004,respectively.  Unrealized losses in otherliabilities were $73.6 million and $98.5 million as of March 31, 2005 and December 31,2004, respectively.  Foreign exchangecontracts with the same counterparty are netted in the Company’s consolidatedbalance sheet when a master netting agreement exists.  These contracts have not been designated ashedging instruments; therefore, all changes in fair value are included in assetservicing fees.

 

***Other*** - TheCompany also enters into fixed price purchase contracts that are designed tohedge the variability of the consideration to be paid for the purchase ofinvestment securities.  By entering intothese contracts, the Company is fixing the price to be paid at a future datefor certain investment securities. At March 31, 2005 and December 31,2004, the Company had $573.0 million and $672.2 million, respectively, of fixedprice purchase contracts outstanding to purchase investment securities. The netfair value of the contracts was approximately $1.7 million at March 31,2005 and was insignificant at December 31, 2004.  Changes in fair value of these cash flowhedges are included as a component of other comprehensive income.

 

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

 

***Restrictions on Cash Balances***- The Company is required to maintain certain average cash reservebalances.  The average required reservebalance with the Federal Reserve Bank (‘FRB’) for the two-week period including March 31, 2005 was approximately$34.4 million.  In addition, the Company’sother assets category includes deposits totaling $35.4 million, which werepledged to secure clearings with depository institutions.

 

***Contingencies*** -Assets held by the Company in a fiduciary capacity are not included in theconsolidated balance sheets since these items are not assets of theCompany.  Management conducts regularreviews of its fiduciary responsibilities and considers the results inpreparing its consolidated financial statements.  In the opinion of management, there were nocontingent liabilities at March 31, 2005 that were material to the consolidatedfinancial position or results of operations of the Company.

 

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

 

The Company and the Bank are subject to various regulatory capitalrequirements administered by the federal banking agencies.  Failure to meet minimum capital requirementscan initiate certain mandatory and possibly additional discretionary actions byregulators that, if undertaken, could have a direct material effect on theCompany’s and the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework forprompt corrective action, the Bank must meet specific capital guidelines thatinvolve quantitative measures of the Bank’s assets, liabilities, and certainoff-balance sheet items as calculated under regulatory accountingpractices.  The Company’s and the Bank’scapital amounts and classification are also subject to qualitative judgments bythe regulators about components, risk weightings, and other factors.

 

Quantitative measures established by regulation to ensure capitaladequacy require the Company and the Bank to maintain minimum amounts andratios (set forth in the table below) of Total and Tier 1 capital (as definedin the regulations) to risk-weighted assets (as defined), and of Tier 1 capital(as defined) to average assets (as defined). Management believes, as of March 31, 2005, that the Company and theBank meet all capital adequacy requirements to which they are subject.

 

As of March 31, 2005, the most recent notification from theFederal Deposit Insurance Corporation categorized the Company and the Bank aswell-capitalized under the regulatory framework for prompt correctiveaction.  To be categorized aswell-capitalized, the Company and the Bank must maintain minimum Totalrisk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in thetable.  There are no conditions or eventssince that notification that management believes have changed the

 

14

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Company’s or the Bank’s category. The following table presents the capital ratios for the Company and theBank (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, 2005:**                       | ** ** | ** ** | ** ** | ** **                         | ** ** | ** **                                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total Capital  (to Risk-Weighted Assets-the Company)  |       | $          | 682,641    |                               | 20.22      | %                                                                       | $          | 270,099 |   | 8.00 | % | N/A |   | N/A |   |
| Total Capital  (to Risk-Weighted Assets-the Bank)     |       | $          | 660,939    |                               | 19.58      | %                                                                       | $          | 270,062 |   | 8.00 | % | $ | 337,578 |   | 10.00 | % |
| Tier 1 Capital  (to Risk-Weighted Assets-the Company) |       | $          | 682,541    |                               | 20.22      | %                                                                       | $          | 135,049 |   | 4.00 | % | N/A |   | N/A |   |
| Tier 1 Capital  (to Risk-Weighted Assets-the Bank)    |       | $          | 660,839    |                               | 19.58      | %                                                                       | $          | 135,031 |   | 4.00 | % | $ | 202,547 |   | 6.00 | % |
| Tier 1 Capital  (to Average Assets-the Company)       |       | $          | 682,541    |                               | 6.00       | %                                                                       | $          | 455,007 |   | 4.00 | % | N/A |   | N/A |   |
| Tier 1 Capital  (to Average Assets-the Bank)          |       | $          | 660,839    |                               | 5.81       | %                                                                       | $          | 454,919 |   | 4.00 | % | $ | 568,648 |   | 5.00 | % |
|                                                  |       |       |       |                               |       |                                                                    |       |   |   |   |   |   |   |
| **As of  December 31, 2004:**                    | ** ** | ** ** | ** ** | ** **                         | ** ** | ** **                                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total Capital  (to Risk-Weighted Assets-the Company)  |       | $          | 636,219    |                               | 20.54      | %                                                                       | $          | 247,782 |   | 8.00 | % | N/A |   | N/A |   |
| Total Capital  (to Risk-Weighted Assets-the Bank)     |       | $          | 618,166    |                               | 19.98      | %                                                                       | $          | 247,572 |   | 8.00 | % | $ | 309,465 |   | 10.00 | % |
| Tier 1 Capital  (to Risk-Weighted Assets-the Company) |       | $          | 636,119    |                               | 20.54      | %                                                                       | $          | 123,891 |   | 4.00 | % | N/A |   | N/A |   |
| Tier 1 Capital  (to Risk-Weighted Assets-the Bank)    |       | $          | 618,066    |                               | 19.97      | %                                                                       | $          | 123,786 |   | 4.00 | % | $ | 185,679 |   | 6.00 | % |
| Tier 1 Capital  (to Average Assets-the Company)       |       | $          | 636,119    |                               | 5.85       | %                                                                       | $          | 435,080 |   | 4.00 | % | N/A |   | N/A |   |
| Tier 1 Capital  (to Average Assets-the Bank)          |       | $          | 618,066    |                               | 5.68       | %                                                                       | $          | 435,017 |   | 4.00 | % | $ | 543,772 |   | 5.00 | % |

 

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

 

The operations of the Company’s securities broker affiliate, InvestorsSecurities Services, Inc., are subject to federal and state securitieslaws, as well as the rules of both the SEC and the NASD.  Management believes, as of March 31,2005, that Investors Securities Services, Inc. is in material compliancewith all of the foregoing requirements to which it is subject.

 

15

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**14.****          Geographic Reporting andService Lines**

 

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

 
| ** **                   | ** ** | **Net Operating Revenue**      | ** ** | ** **            | ** ** |
|------------------------------|------------|--------------------------------|------------|-----------------------|------------|
| ** **                   | ** ** | **For the Three Months Ended** | ** ** | **Long-Lived Assets** | ** ** |
| ** **                   | ** ** | **March 31,**             | ** ** | **March 31,**    | ** ** | **December 31,** | ** ** |
| **Geographic  Information:** | ** ** | **2005**                       | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
|                         |       |                           |       |                  |       |   |   |   |   |
| United States                |       | $                              | 157,739    |                  | $          | 148,043 |   | $ | 140,950 |   | $ | 141,801 |   |
| Ireland                      |       | 8,641                          |       | 6,098                 |       | 5,775 |   | 5,930 |   |
| Canada                       |       | 1,367                          |       | 1,006                 |       | 106 |   | 121 |   |
| Cayman Islands               |       | 42                             |       | 44                    |       | — |   | — |   |
|                         |       |                           |       |                  |       |   |   |   |   |
| Total                        |       | $                              | 167,789    |                  | $          | 155,191 |   | $ | 146,831 |   | $ | 147,852 |   |
|                              |            |                                |            |                       |            |  |  |  |  |  |  |  |  |  |

 

Barclays Global Investors, N.A. (‘BGI’) accounted for approximately 17%of the Company’s consolidated net operating revenues for the three-monthperiods ended March 31, 2005 and 2004. No client other than BGI accounted for more than 10% of the Company’sconsolidated net operating revenues for the three-month periods ended March 31,2005 and 2004.

 

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

 
| ** **                             | ** ** | **For the Three Months Ended  March 31,** | ** ** |
|----------------------------------------|------------|------------------------------------------------|------------|
| ** **                             | ** ** | **2005**                                       | ** ** | **2004** | ** ** |
|                                   |       |                                           |       |   |   |
| Core service fees:                     |       |                                           |       |   |   |
| Custody, accounting and administration |       | $                                              | 88,544     |   | $ | 76,094 |   |
|                                   |       |                                           |       |   |   |
| Ancillary service fees:                |       |                                           |       |   |   |
| Foreign exchange                       |       | 13,249                                         |       | 18,495 |   |
| Cash management                        |       | 7,364                                          |       | 5,600 |   |
| Securities lending                     |       | 3,680                                          |       | 2,143 |   |
| Investment advisory                    |       | 1,715                                          |       | 3,470 |   |
| Other service fees                     |       | 651                                            |       | 385 |   |
| Total ancillary service fees           |       | 26,659                                         |       | 30,093 |   |
|                                   |       |                                           |       |   |   |
| Total asset servicing fees             |       | $                                              | 115,203    |   | $ | 106,187 |   |

 

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

 

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

 
| ** **                                                          | ** ** | **For the Three Months Ended  March 31,** | ** ** |
|---------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                          | ** ** | **2005**                                       | ** ** | **2004** | ** ** |
| Interest income:                                                    |       |                                           |       |   |   |
| Federal funds sold and securities sold  under repurchase agreements |       | $                                              | 363        |   | $ | 162 |   |
| Investment securities held to maturity and  available for sale      |       | 96,132                                         |       | 72,350 |   |
| Loans                                                               |       | 1,560                                          |       | 1,124 |   |
| Total interest income                                               |       | 98,055                                         |       | 73,636 |   |
| Interest expense:                                                   |       |                                           |       |   |   |
| Deposits                                                            |       | 15,245                                         |       | 11,369 |   |
| Short-term and other borrowings                                     |       | 8,843                                          |       | 6,197 |   |
| Securities sold under repurchase agreements                         |       | 26,354                                         |       | 7,649 |   |
| Total interest expense                                              |       | 50,442                                         |       | 25,215 |   |
|                                                                |       |                                           |       |   |   |
| Net interest income                                                 |       | $                                              | 47,613     |   | $ | 48,421 |   |

 

16

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REPORT OF INDEPENDENT REGISTERED PUBLICACCOUNTING FIRM

 

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

 

We have reviewed the accompanying condensedconsolidated balance sheet of Investors Financial Services Corp. andsubsidiaries (the “Company”) as of March 31, 2005, and the relatedcondensed consolidated statements of income and comprehensive income for thethree-month periods ended March 31, 2005 and 2004, and the condensed consolidatedstatements of stockholders’ equity and cash flows for the three-month periodsended March 31, 2005 and 2004. These interim financial statements are theresponsibility of the Company’s management.

 

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

 

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

 

We have previously audited, in accordancewith the standards of the PublicCompany Accounting Oversight Board (United States), the consolidated balancesheet of Investors Financial Services Corp. and subsidiaries as of December 31,2004, and the related consolidated statements of income and other comprehensiveincome, stockholders’ equity, and cash flows for the year then ended (notpresented herein); and in our report dated February 28, 2005, we expressedan unqualified opinion on those consolidated financial statements. In ouropinion, the information set forth in the accompanying condensed consolidatedbalance sheet as of December 31, 2004 is fairly stated, in all materialrespects, in relation to the consolidated balance sheet from which it has beenderived.

 

*DELOITTE & TOUCHELLP*

 

Boston, Massachusetts May 3, 2005

 

17

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**Item 2.**    Management’sDiscussion and Analysis of Financial Condition and Results of Operations

** **

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

 

**Overview**

 

We provide asset administration services for the financial servicesindustry through our wholly-owned subsidiary, Investors Bank & TrustCompany.  We provide core services andvalue-added services to a variety of financial asset managers, including mutualfund complexes, investment advisors, family offices, banks and insurancecompanies.  Core services include middleoffice outsourcing, global custody, multicurrency accounting and fund administration.  Value-added services include securitieslending, foreign exchange, cash management, performance measurement,institutional transfer agency, investment advisory services, lines of creditand brokerage and transition management services.  We have offices located in the United States,Ireland, Canada, and the Cayman Islands with a vast global subcustodian networkestablished to accommodate the international needs of our clients.  At March 31, 2005, we provided servicesfor approximately $1.5 trillion in net assets, including approximately $247billion in foreign net assets.

 

We grow our business by selling our services to new clients and byfurther penetrating our existing clients. We believe that we service less than 10% of the assets managed by ourexisting clients, and we have traditionally achieved significant success ingrowing client relationships.  Ourability to service new clients and expand our relationships with existingclients depends on our provision of superior client service.  Our growth is also affected by overall marketconditions, the regulatory environment for us and our clients and the successof our clients in marketing their products.

 

We derive our asset servicing revenue from providing core andvalue-added services.  We derive our netinterest income by investing the cash balances our clients leave on depositwith us.  Since we price our serviceofferings on a bundled basis, our share of earnings from these investments isviewed as part of the total compensation that our clients pay us for servicingtheir assets.  In establishing a feestructure for a specific client, we analyze all expected revenue andexpenses.  We believe net operatingrevenue (net interest income plus noninterest income) and net income are themost meaningful measures of our financial results.

 

As an asset administration services company, the amount of netoperating revenue that we generate is impacted by overall market conditions,client activity and the prevailing interest rate environment.  Over the course of the past two years, wehave benefited from the appreciation of the market values of the assets weservice for our clients and additional fund flows into client products. Asignificant portion of our core services revenue is based upon the amount ofassets under administration.  As marketvalues of underlying assets fluctuate, so will our revenue.  We have managed this volatility by offering atiered pricing structure for our asset-based fees.  As asset values increase, the basis point feeis reduced for the incremental assets.  Whenasset values decrease, revenue is only impacted at the then marginal rate.  Many of our value-added services aretransactional based, and we receive a fee for each transaction processed.  We have continued to experience net interestmargin compression during the first quarter of 2005 versus 2004 due to lowerspreads. The lower spreads were primarily due to the narrowing of marketspreads on reinvestment and purchase opportunities of fixed and floating-rateinvestment assets.

 

We remain focused on our sales efforts, prudent expense management andincreasing our operating efficiency. These goals are complicated by the need to build infrastructure tosupport our rapid growth, by the need to maintain state-of-the-art systems andby the need to retain and motivate our workforce.

 

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**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 Securities and Exchange Commission(including this Form 10-Q) may contain statements which are not historicalfacts, so-called “forward-looking statements,” which are made under Section 21Eof the Securities Exchange Act of 1934 and which involve risks anduncertainties.  These statements relateto future events or our future financial performance and are identified bywords such as “may,” “will,” “could,” “should,” “expect,” “plan,” “intend,” “seek,”“anticipate,” “believe,” “estimate,” “potential,” or “continue” or othercomparable terms or the negative of those terms.  Forward-looking statements in this Form 10-Qinclude certain statements regarding liquidity, annual dividend payments,interest rate conditions, interest rate sensitivity, compliance with capitaladequacy guidelines, loss exposure on lines of credit, the timing and effect onearnings of derivative gains and losses, securities lending revenue, netinterest income, operating expenses, compensation expense, pension plan andsupplemental pension expense, depreciation expense, effective tax rate, theeffect on earnings of changes in equity values and the effect of certain legalclaims against us.  Our actual futureresults may differ significantly from those stated in any forward-lookingstatements.  Factors that may cause suchdifferences include, but are not limited to, the factors discussed below.  Each of these factors, and others, arediscussed from time to time in our filings with the SEC.

 

*Ouroperating results are subject to fluctuations in interest rates and thesecurities markets.*

 

A significantportion of our fees is based 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 the equity markets, can have a material effect on ourasset-based fees.  While reductions inasset servicing fees may be offset by increases in other sources of revenue, asustained downward movement of the broad equity markets will likely have anadverse impact on our earnings. Fluctuations in interest rates or the securities markets can also leadto investors seeking alternatives to the investment offerings of our clients,which could result in a lesser amount of assets processed and correspondinglylower fees.  Also, our net interestincome is earned by investing depositors’ funds in our investment portfolioand, in small part, by making loans. Changes in interest rates and/or the relationship between short-term andlong-term interest rates could adversely affect the market value of, or theearnings produced by, our investment and loan portfolios, and thus couldadversely affect our operating results.

 

*A materialportion of our revenue is derived from our relationship with Barclays GlobalInvestors, N.A. (‘BGI’) and related entities.*

 

As a result ofour selection to service assets for Barclays Global Investors Canada, Ltd., ourassumption of the operations of the U.S. asset administration unit of BGI in2001 and our ongoing relationship with BGI’s iShares and Master InvestmentPortfolios, BGI accounted for approximately 17% of our net operating revenueduring the three months ended March 31, 2005 and 2004.  We expect that BGI will continue to accountfor a significant portion of our net operating revenue.  While we provide services to BGI underlong-term contracts, those contracts may be terminated for certain regulatoryand fiduciary reasons.  The loss of BGI’sbusiness would cause our net operating revenue to decline significantly and mayhave an adverse effect on our quarterly and annual results.

 

*We may incur losses dueto operational errors.*

 

The servicesthat we provide require complex processes and interaction with numerous thirdparties.  While we maintain sophisticatedcomputer systems and a comprehensive system of internal controls, and ouroperational history has been excellent, from time to time we may makeoperational errors for which we are responsible to our clients.  In addition, even though we maintain appropriateerrors and omissions and other insurance policies, an operational error couldresult in a significant liability to us and may have a material adverse effecton our results of operations.

 

*We facesignificant competition from other financial services companies, which couldnegatively affect our operating results.*

 

We are part ofan extremely competitive asset servicing industry.  Many of our current and potential competitorshave longer operating histories, greater name recognition and substantially greaterfinancial, 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 mayincur significant costs defending legal claims.*

 

We have beennamed in a lawsuit in Massachusetts state court alleging, among other things,violations of a covenant of good faith and fair dealing in a contract. While webelieve this claim is without merit, we cannot be sure that we will prevail inthe

 

19

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defense of this claim. We arealso party to other litigation and we may become subject to other legal claimsin the future. Litigation is costly and could divert the attention ofmanagement.

 

*Our futureresults depend, in part, on successful integration of pending and possiblefuture acquisitions and outsourcing transactions.*

 

Integration ofacquisitions and outsourcing transactions is complicated and frequentlypresents unforeseen difficulties and expenses which can affect whether and whena particular acquisition or outsourcing transaction will be accretive to ourearnings per share.  Any futureacquisitions or outsourcing transactions will present similar challenges. Theseacquisitions or outsourcing transactions can also consume a significant amountof management’s time.

 

*The failureto properly manage our growth could adversely affect the quality of ourservices and result in the loss of clients.*

 

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

 

*We musthire and retain skilled personnel in order to succeed.*

 

Qualifiedpersonnel, in particular managers and other senior personnel, are in greatdemand throughout the financial services industry, especially if the recenteconomic recovery proves sustainable.  Wecould find it increasingly difficult to continue to attract and retainsufficient numbers of these highly skilled employees, which could affect ourability to attract and retain clients.

 

*We may notbe able to protect our proprietary technology.*

 

Ourproprietary 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 technology independently.  Legal proceedings to enforce our intellectualproperty rights may be unsuccessful, and could also be expensive and divertmanagement’s attention.

 

*Ourquarterly and annual operating results may fluctuate.*

 

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

 

•      Thetiming of commencement or termination of client engagements;

 

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

 

•      Changesin interest rates and equity values.

 

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

 

*We aresubject to extensive federal and state regulations that impose complexrestraints on our business.*

 

Federal andstate laws and regulations applicable to financial institutions and theirparent companies apply to us.  Ourprimary regulators are the Federal Reserve Board (‘FRB’), the Federal DepositInsurance Corporation (‘FDIC’), the Massachusetts Commissioner of Banks and theNational Association of Securities Dealers, Inc. (‘NASD’).  Virtually all aspects of our operations aresubject to specific requirements or restrictions and general regulatoryoversight including the following:

 

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

 

•      UnderMassachusetts law, the Bank may be restricted in its ability to pay dividendsto Investors Financial Services Corp., which may in turn restrict our ability topay dividends to our stockholders;

 

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

 

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

 

•      Ourinternational operations are subject to regulatory oversight by regulators inthe jurisdictions in which we operate, including the Office of theSuperintendent of Financial Institutions in Canada, the Irish FinancialServices Regulatory Authorityand the Cayman Islands Monetary Authority. Failure to comply with applicable international regulatory requirementscould result in regulatory action and impact our ability to provide services inthose jurisdictions.

 

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

 

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**Statementsof Income**

 

***Comparisonof Operating Results for the Three Months Ended March 31, 2005 and 2004***

 

Net income forthe three months ended March 31, 2005 was $40.9 million, up 12% from $36.6million for the same period in 2004.  Theoverall increase in net income resulted from higher asset servicing fees,reflecting strong client fund flows combined with our continued ability to sellto new and existing clients. Net operating revenue for the three months endedMarch 31, 2005 grew 8% while operating expenses increased only 5%.

 

*Feesand Other Revenue*

 

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

 
| ** **                   | ** ** | **For the Three Months Ended March 31,** | ** ** |
|------------------------------|------------|------------------------------------------|------------|
| ** **                   | ** ** | **2005**                                 | ** ** | **2004** | ** ** | **Change** | ** ** |
|                         |       |                                     |       |   |   |   |   |
| Total asset servicing fees   |       | $                                        | 115,203    |   | $ | 106,187 |   | 8 | % |
| Other operating income       |       | 785                                      |       | 349 |   | 125 | % |
| Gain on sale of investment   |       | 4,188                                    |       | 234 |   | 1,690 | % |
|                         |       |                                     |       |   |   |   |   |
| Total fees and other revenue |       | $                                        | 120,176    |   | $ | 106,770 |   | 13 | % |

 

The largestcomponents of asset servicing fees are custody, accounting and administration,which increased 16% to $88.5 million for the three months ended March 31, 2005from $76.1 million for the same period in 2004. Custody, accounting and administration fees are based in part on thevalue of assets processed. Assets processed is the total dollar value offinancial assets on the reported date for which we provide one or more of thefollowing services: middle office outsourcing, global custody, multicurrencyaccounting, fund administration, securities lending, foreign exchange, cashmanagement, performance measurement, institutional transfer agency, investmentadvisory services, lines of credit and brokerage and transition managementservices.  The change in net assetsprocessed includes the following components (Dollars in billions):

 
| ** **                                | ** ** | **For the Three Months  Ended March 31, 2005** | ** ** |
|-------------------------------------------|------------|------------------------------------------------|------------|
|                                      |       |                                           |       |
| Net assets processed, beginning of period |       | $                                              | 1,430      |   |
| Change in net assets processed:           |       |                                           |       |
| Sales to new clients                      |       | 1                                              |       |
| Further penetration of existing clients   |       | 7                                              |       |
| Lost clients                              |       | (9                                             | )          |
| Fund flows and market gain                |       | 40                                             |       |
| Total change in net assets processed      |       | 39                                             |       |
| Net assets processed, end of period       |       | $                                              | 1,469      |   |

 

The majorityof the increase in assets processed was due to the ability of our clients todevelop and sell product, which generates fund flows that have a direct,positive impact on our business.  Asindicated in the ‘Overview’ section, our core services fees are generated bycharging a fee based upon the value of assets processed.  As market values or clients’ asset levelsfluctuate, so will our revenue.  Ourtiered pricing structure, coupled with minimum and flat fees, allow us tomanage this volatility to a certain extent. As asset values increase, the basis point fee typically lowers.  When asset values decrease, revenue is onlyimpacted by the asset decline at the then marginal rate.

 

If the valueof equity assets held by our clients were to increase or decrease by 10%, weestimate currently that this, by itself, would cause a corresponding change ofapproximately 3% in our earnings per share. If the value of fixed-income assets held by our clients were to increaseor decrease by 10%, we estimate currently that this, by itself, would cause acorresponding change of approximately 2% in our earnings per share.  In practice, earnings per share do not trackprecisely to the value of the equity and fixed-income markets becauseconditions present in a market increase or decrease may generate offsettingincreases or decreases in other revenue items. For example, market volatility often results in increased transactionfee revenue.  Also, market declines mayresult in increased interest income and sweep fee income as clients move largeramounts of assets into the cash management vehicles that we offer. However, therecan be no assurance that these offsetting revenue increases will occur duringany future downturn in the equity or fixed-income markets.

 

Transaction-drivenincome includes our ancillary services, such as foreign exchange, cashmanagement, securities lending and investment advisory services.  Foreign exchange fees were $13.2 million forthe three months ended March 31, 2005,

 

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down 28% from the same periodin 2004.  The decrease in foreignexchange fees is primarily attributable to lower volatility in currencymarkets.  Future foreign exchange incomeis dependent on the volume of client activity and the overall volatility in thecurrencies traded.  Cash management fees,which consist of sweep fees, were $7.4 million for the three months ended March31, 2005, up 32% from the same period in 2004. The increase is primarily due tohigher domestic and foreign balances held by our clients.  Cash management revenue will continue todepend on the level of client balances maintained in the cash managementproducts we offer.  If our clients’investment products continue to maintain increasing cash balances, our cashmanagement revenue will be positively impacted.

 

Investmentadvisory fees were $1.7 million for the three months ended March 31, 2005, down51% from the same period in 2004.  The decreasein investment advisory fees is attributable to lower asset levels among ourproprietary Merrimac money market funds combined with advisory fee waivers oncertain of the funds.  Future investmentadvisory fee income is dependent upon asset levels within the Merrimac moneymarket funds, which are driven by overall market conditions, client activityand transaction volumes, as well as our decision on whether or not to continue towaive advisory fees.  Securities lendingfees were $3.7 million for the three months ended March 31, 2005, up 72% fromthe same period in 2004 due to higher volumes and improved market conditions.  Securities lending transaction volume ispositively affected by the market value of the securities on loan, merger andacquisition activity, increased IPO activity and a steeper short-end of theyield curve.  If the capital marketsexperience any of the aforementioned activity, it is likely that our securitieslending revenue will be positively impacted. If we experience a reduction in our securities lending portfolio, lowermarket values and continued compression of the spreads earned on securitieslending activity, our securities lending revenue will likely be negativelyimpacted.  Other service fees for thethree months ended March 31, 2005 were $0.7 million, up 69% from the sameperiod last year.  Other service fees areearned on brokerage and transition management services, which were provided ingreater volume in the first quarter of 2005 compared to 2004.

 

During thefirst quarter of 2005, we sold municipal securities held in our available forsale portfolio, resulting in the recognition of a $4.2 million gain.  These securities were replaced with municipalsecurities that offered a more attractive after-tax yield than those securitiessold.

 

*NetInterest Income*

 

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

 
| ** **                | ** ** | **For the Three Months Ended March 31,** | ** ** |
|---------------------------|------------|------------------------------------------|------------|
| ** **                | ** ** | **2005**                                 | ** ** | **2004** | ** ** | **Change** | ** ** |
|                      |       |                                     |       |   |   |   |   |
| Interest income           |       | $                                        | 98,055     |   | $ | 73,636 |   | 33 | % |
| Interest expense          |       | 50,442                                   |       | 25,215 |   | 100 | % |
| Total net interest income |       | $                                        | 47,613     |   | $ | 48,421 |   | (2 | )% |

 

Net interestincome is affected by the volume and mix of assets and liabilities and themovement and level of interest rates.  Theslight decline in our net interest income was primarily driven by lowerinterest rate spreads, offset by balance sheet growth. Short-term interestrates have been steadily increasing since the second half of 2004 without aconcurrent increase in longer-term rates, resulting in a flattening yieldcurve. Consequently, our interest-bearing liabilities, of which the majority ispriced based on floating rates, have repriced faster than our interest-earningassets, resulting in lower spreads.  Theaverage interest rate spreads for the periods ended March 31, 2005 and 2004 were1.58% and 2.03%, respectively.  Inaddition, reinvestment and purchase spreads on fixed and floating-rate assets werelower than expected due to higher market demand, especially for shorter-term andfloating-rate fixed income investments during this rising interest rateenvironment.

 

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The table below presents thechanges in net interest income resulting from changes in the volume ofinterest-earning assets or interest-bearing liabilities and changes in interestrates for the three months ended March 31, 2005 compared to the same period in2004.  Changes attributed to both volumeand rate have been allocated based on the proportion of change in each category(Dollars in thousands):

 
| ** **                                                           | ** ** | **For the Three Months Ended  March 31, 2005** | ** ** |
|----------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                           | ** ** | **Change  Due to  Volume**                     | ** ** | **Change  Due to  Rate** | ** ** | **Net** | ** ** |
| Interest-earning assets:                                             |       |                                           |       |   |   |   |   |
| Federal Funds sold and securities purchased  under resale agreements |       | $                                              | (19        | ) | $ | 220 |   | $ | 201 |   |
| Investment securities                                                |       | 15,784                                         |       | 7,998 |   | 23,782 |   |
| Loans                                                                |       | (231                                           | )          | 667 |   | 436 |   |
|                                                                 |       |                                           |       |   |   |   |   |
| Total interest-earning assets                                        |       | $                                              | 15,534     |   | $ | 8,885 |   | $ | 24,419 |   |
|                                                                 |       |                                           |       |   |   |   |   |
| Interest-bearing liabilities:                                        |       |                                           |       |   |   |   |   |
| Deposits                                                             |       | $                                              | (1,218     | ) | $ | 5,094 |   | $ | 3,876 |   |
| Borrowings                                                           |       | 8,516                                          |       | 12,835 |   | 21,351 |   |
|                                                                 |       |                                           |       |   |   |   |   |
| Total interest-bearing liabilities                                   |       | $                                              | 7,298      |   | $ | 17,929 |   | $ | 25,227 |   |
|                                                                 |       |                                           |       |   |   |   |   |
| Change in net interest income                                        |       | $                                              | 8,236      |   | $ | (9,044 | ) | $ | (808 | ) |

 

In addition toinvesting in both variable and fixed-rate securities, we use derivativeinstruments to manage our exposure to interest rate risks. See the ‘Market Risk’section for more detailed information.

 

24

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The following tables presentaverage balances, interest income and expense, and yields earned or paid on themajor categories of assets and liabilities for the periods indicated (Dollarsin thousands):

 
| ** **                                                           | ** ** | **Three Months Ended March 31, 2005** | ** ** | **Three Months Ended March 31, 2004** | ** ** |
|----------------------------------------------------------------------|------------|---------------------------------------|------------|---------------------------------------|------------|
| ** **                                                           | ** ** | **Average  Balance**                  | ** ** | **Interest**                          | ** ** | **Average  Yield/Cost** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Average  Yield/Cost** | ** ** |
| **Interest-earning assets:**                                         |       |                                  |       |                                  |       |   |   |   |   |   |   |   |   |
| Federal Funds sold and securities purchased  under resale agreements |       | $                                     | 60,611     |                                  | $          | 363 |   | 2.40 | % | $ | 67,560 |   | $ | 162 |   | 0.96 | % |
| Investment securities(1)                                             |       | 10,658,090                            |       | 96,132                                |       | 3.61 | % | 8,851,155 |   | 72,350 |   | 3.27 | % |
| Loans                                                                |       | 163,177                               |       | 1,560                                 |       | 3.82 | % | 198,970 |   | 1,124 |   | 2.26 | % |
| Total interest-earning assets                                        |       | 10,881,878                            |       | 98,055                                |       | 3.60 | % | 9,117,685 |   | 73,636 |   | 3.23 | % |
| Allowance for loan losses                                            |       | (100                                  | )          |                                  |       |   |   | (100 | ) |   |   |   |   |
| Noninterest-earning assets                                           |       | 604,181                               |       |                                  |       |   |   | 487,392 |   |   |   |   |   |
| Total assets                                                         |       | $                                     | 11,485,959 |                                  |       |   |   |   | $ | 9,604,977 |   |   |   |   |   |
| **Interest-bearing liabilities:**                                    |       |                                  |       |                                  |       |   |   |   |   |   |   |   |   |
| Deposits:                                                            |       |                                  |       |                                  |       |   |   |   |   |   |   |   |   |
| Savings                                                              |       | $                                     | 3,496,407  |                                  | $          | 14,581 |   | 1.67 | % | $ | 3,924,863 |   | $ | 11,369 |   | 1.16 | % |
| Time                                                                 |       | 107,334                               |       | 664                                   |       | 2.47 | % | 129 |   | — |   | — |   |
| Securities sold under repurchase agreements                          |       | 5,055,797                             |       | 26,354                                |       | 2.09 | % | 3,691,117 |   | 7,649 |   | 0.83 | % |
| Junior subordinated debentures                                       |       | 24,774                                |       | 605                                   |       | 9.77 | % | 24,774 |   | 605 |   | 9.77 | % |
| Other borrowings (2)                                                 |       | 1,290,073                             |       | 8,238                                 |       | 2.55 | % | 732,527 |   | 5,592 |   | 3.05 | % |
| Total interest-bearing liabilities                                   |       | 9,974,385                             |       | 50,442                                |       | 2.02 | % | 8,373,410 |   | 25,215 |   | 1.20 | % |
| Noninterest-bearing liabilities:                                     |       |                                  |       |                                  |       |   |   |   |   |   |   |   |   |
| Demand deposits                                                      |       | 334,974                               |       |                                  |       |   |   | 308,916 |   |   |   |   |   |
| Savings                                                              |       | 77,766                                |       |                                  |       |   |   | 80,953 |   |   |   |   |   |
| Noninterest-bearing time deposits                                    |       | 165,444                               |       |                                  |       |   |   | 164,121 |   |   |   |   |   |
| Other liabilities                                                    |       | 195,776                               |       |                                  |       |   |   | 105,964 |   |   |   |   |   |
| Total liabilities                                                    |       | 10,748,345                            |       |                                  |       |   |   | 9,033,364 |   |   |   |   |   |
| Equity                                                               |       | 737,614                               |       |                                  |       |   |   | 571,613 |   |   |   |   |   |
| Total liabilities and equity                                         |       | $                                     | 11,485,959 |                                  |       |   |   |   | $ | 9,604,977 |   |   |   |   |   |
| Net interest income                                                  |       |                                  |       | $                                     | 47,613     |   |   |   |   |   | $ | 48,421 |   |   |   |
| Net interest margin (3)                                              |       |                                  |       |                                  |       | 1.75 | % |   |   |   |   | 2.12 | % |
| Average interest rate spread (4)                                     |       |                                  |       |                                  |       | 1.58 | % |   |   |   |   | 2.03 | % |
| Ratio of interest-earning assets to interest-bearing  liabilities    |       |                                  |       |                                  |       | 109.10 | % |   |   |   |   | 108.89 | % |

** **

----

(1)     Average yield/cost onavailable for sale securities is based on amortized cost.

(2)     Interestexpense includes a contractual prepayment penalty of $2.6 million for the threemonths ended March 31, 2004 for prepayment of certain FHLBB borrowings.

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

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

 

25

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*OperatingExpenses*

 

Totaloperating expenses were $104.8 million for the three months ended March 31,2005, up 5% from the same period in 2004. The increase in operating expenseswas due primarily to increased compensation and benefits, technology andtelecommunications, travel and sales, and other operating expenses, as detailedbelow.  It is expected that incrementalexpense for the remainder of 2005 will primarily be associated with newbusiness wins as well as higher depreciation and commitments to technology andtelecommunications.  The components ofoperating expenses were as follows (Dollars in thousands):

 
| ** **                        | ** ** | **For the Three Months Ended March 31,** | ** ** |
|-----------------------------------|------------|------------------------------------------|------------|
| ** **                        | ** ** | **2005**                                 | ** ** | **2004** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
|                              |       |                                     |       |   |   |   |   |   |   |
| Compensation and benefits         |       | $                                        | 56,919     |   | $ | 55,323 |   | $ | 1,596 |   | 3 | % |
| Technology and telecommunications |       | 12,836                                   |       | 10,266 |   | 2,570 |   | 25 | % |
| Transaction processing services   |       | 11,120                                   |       | 10,940 |   | 180 |   | 2 | % |
| Depreciation and amortization     |       | 7,891                                    |       | 7,954 |   | (63 | ) | (1 | )% |
| Occupancy                         |       | 6,613                                    |       | 7,391 |   | (778 | ) | (11 | )% |
| Professional fees                 |       | 2,973                                    |       | 3,238 |   | (265 | ) | (8 | )% |
| Travel and sales promotion        |       | 1,349                                    |       | 1,082 |   | 267 |   | 25 | % |
| Insurance                         |       | 1,129                                    |       | 1,196 |   | (67 | ) | (6 | )% |
| Other operating expenses          |       | 3,962                                    |       | 2,744 |   | 1,218 |   | 44 | % |
|                              |       |                                     |       |   |   |   |   |   |   |
| Total operating expenses          |       | $                                        | 104,792    |   | $ | 100,134 |   | $ | 4,658 |   | 5 | % |

 

Compensationand benefits expense was $56.9 million for the three months ended March 31,2005, up 3% from the same period last year due to higher headcount and annualsalary increases.  Further increases incompensation expense in 2005 will be primarily dependent upon new businesswins.

 

Technology andtelecommunications expense was $12.8 million for the three months ended March31, 2005, up 25% from the same period last year.  This increase resulted from higherinfrastructure investments made in the second half of 2004, including anagreement with IBM to outsource certain technical infrastructure services.  The costs of these services were partially offsetby decreases in other technology and telecommunications expenses, as theservices were previously performed by the Bank or other service providers.  Future technology and telecommunicationsexpense will be dependent on client integrations associated with new business andongoing improvement to our infrastructure. Generally, we expect technology reinvestment to equal approximately18-20% of net operating revenue each year, including the related compensationcosts.

 

Occupancyexpense was $6.6 million for the three months ended March 31, 2005, down 11%from the same period last year.  Thedecrease is attributed to new favorably renegotiated ten-year lease agreementsfor our 505,000 square feet of office space in Boston.  Occupancy expense should remain relativelystable until the fourth quarter of 2005 when we expect to add additional spaceto support our growth.

 

Professionalfees expense was $3.0 million for the three months ended March 31, 2005, down8% from the same period last year.  Thedecrease is attributed primarily to lower subadvisory expense associated with ourMerrimac Master Portfolios, resulting from lower fund balances and advisory feewaivers.  This decrease was partiallyoffset by increased legal fees incurred for ongoing litigation matters.  We expect this expense to rise in the secondquarter of 2005 as we remove waivers of advisory fees on the Merrimac portfolios.

 

Travel andsales promotion expense was $1.3 million for the three months ended March 31,2005, up 25% compared to the same period last year.  Travel and sales promotion expense consistsof expenses incurred by the sales force, client management staff and otheremployees in connection with sales calls on potential clients and traveling toexisting client sites and our foreign offices.  The increase in 2005 resulted from a higherlevel of travel to client sites and industry conferences.  We expect travel and sales expense to remainconsistent with the first quarter of 2005.

 

Insuranceexpense for the three months ended March 31, 2005 remained relatively stable atapproximately $1.1 million compared to $1.2 million for the same period lastyear. Our insurance policies are renewed annually and we expect insuranceexpense for the remainder of the year to continue at approximately the same runrate as in the first quarter of 2005.

 

Otheroperating expense was $4.0 million for the three months ended March 31, 2005,up 44% compared to the same period last year as a result of clientaccommodations, higher recruiting expense and higher miscellaneous officeexpenses.  We expect that incrementalexpense for the remainder of 2005 will be primarily associated with newbusiness.

 

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*IncomeTaxes*

 

Income taxeswere $22.0 million for the three months ended March 31, 2005, up 19% from thesame period in 2004.  This increase isattributable to increased pretax earnings and an increase in the effective taxrate from 33.5% at March 31, 2004 to 35% at March 31, 2005, primarily due to thedecreased percentage of tax-exempt income, net of any interest expensedisallowed, to pretax earnings.

 

**Financial Condition**

 

At March 31,2005, our total assets were $11.9 billion, up 6% from $11.2 billion at December31, 2004, due to increased investment securities.  Average interest-earning assets increased$1.8 billion, or 19% for the three months ended March 31, 2005 compared to thesame period in 2004.  Our asset growthwas primarily funded by increases in average external borrowings ofapproximately $1.7 billion for the three months ended March 31, 2005.

 

*Investment Portfolio*

 

Our investmentportfolio is used to invest depositors’ funds and is a component of our assetprocessing business.  In addition, we usethe investment portfolio to secure open positions at securities clearinginstitutions in connection with our custody services.  The following table summarizes our investmentportfolio as of the dates indicated (Dollars in thousands):

 
| ** **                          | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------------|------------|---------------------|------------|------------------------|------------|
| **Securities held to maturity**     |       |                |       |                   |       |
| Mortgage-backed securities          |       | $                   | 4,182,043  |                   | $          | 3,543,961 |   |
| Federal agency securities           |       | 2,307,273           |       | 2,274,665              |       |
| State and political subdivisions    |       | 119,914             |       | 124,091                |       |
|                                |       |                |       |                   |       |
| Total securities held to maturity   |       | $                   | 6,609,230  |                   | $          | 5,942,717 |   |
| ** **                          | ** ** | ** **          | ** ** | ** **             | ** ** |
| **Securities available for sale**   | ** ** | ** **          | ** ** | ** **             | ** ** |
| Mortgage-backed securities          |       | $                   | 3,856,888  |                   | $          | 3,854,900 |   |
| State and political subdivisions    |       | 329,493             |       | 404,909                |       |
| Corporate debt                      |       | 176,783             |       | 176,546                |       |
| U.S. Treasury securities            |       | 116,936             |       | 118,688                |       |
| Foreign government securities       |       | 10,298              |       | 10,462                 |       |
|                                |       |                |       |                   |       |
| Total securities available for sale |       | $                   | 4,490,398  |                   | $          | 4,565,505 |   |

 

The $0.7billion, or 11%, increase in our held to maturity securities portfolio from December31, 2004 to March 31, 2005 is due to investment security purchases that allowus to continue to grow our balance sheet, while maintaining an acceptable riskprofile. Our investment security purchases primarily included floating interestrate mortgage-backed securities and Small Business Administration (‘SBA’)securities, which offer an attractive yield and reprice as interest ratesincrease.  Our held to maturity portfoliosecurities are purchased with the intent and ability to hold to maturity andare not viewed as our primary source of funds to satisfy liquidity needs.

 

The $0.1 billion, or 2%, decrease in our available forsale securities portfolio from December 31, 2004 to March 31, 2005 is due tosales of municipal securities in March 2005 partially offset by purchases of newinvestment securities.  Our investmentsecurity purchases included municipal securities that offer a more attractiveafter-tax yield than those that we sold, along with mortgage-backedsecurities.  We believe that purchasingthese securities allows us to take advantage of attractive yield and limitedextension risk which aligns with our asset and liability strategy.  Refer to the gap analysis under the ‘MarketRisk’ section for additional details regarding the matching of ourinterest-earning assets and interest-bearing liabilities.

 

The averagebalance of our investment portfolios for the three months ended March 31, 2005was $10.7 billion, with an average yield of 3.61%, compared to an averagebalance of $8.9 billion with an average yield of 3.27% during the same periodin 2004. The increase in yield is primarily due to our variable rate securitiesrepricing at higher interest rates. If interest rates continue to rise during2005, we would expect slower prepayments and our overall yield to increase asour variable rate securities reprice. Conversely, if interest rates were todecline during 2005, we would expect that prepayments would

 

27

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accelerate, with the cash flowsfrom these prepayments being reinvested in lower-yielding assets of equalquality and similar risk.

 

We invest inmortgage-backed securities and Federal agency securities to increase the totalreturn of the investment portfolio. Mortgage-backed securities generally have a higher yield than U.S.Treasury securities due to credit and prepayment risk.  Credit risk results from the possibility thata loss may occur if a counterparty is unable to meet the terms of thecontract.  Prepayment risk results fromthe possibility that changes in interest rates may cause mortgage-backedsecurities to be paid off prior to their maturity dates.  Federal agency bonds generally have a higheryield than U.S. Treasury securities due to credit and prepayment risk.  Credit risk results from the possibility thatthe Federal agency issuing the securities may be unable to meet the terms ofthe security.  Credit risk related tomortgage-backed securities and Federal agency bonds is substantially reduced bypayment guarantees and credit enhancements.

 

We invest in municipal securities to generate stable,tax advantaged income.  Municipalsecurities generally have lower stated yields than Federal agency and U.S.Treasury securities, but their after-tax yields are comparable.  Municipal securities are subject to callrisk.  However, all municipal securitiesthat we invest in are insured and AAA rated. Call risk is similar to prepayment risk and results from the possibilitythat fluctuating interest rates and other factors may result in the exercise ofthe call option by the issuing municipality prior to the maturity date of thebond.

 

*Loan Portfolio*

 

Our loanportfolio increased $131.2 million, or 98%, from December 31, 2004 to March 31,2005 primarily due to an increase in line of credit advances.

 

We make loansto individually managed account customers and to mutual funds and other pooledproduct clients.  We offer overdraftprotection and lines of credit to our clients for the purpose of fundingredemptions, covering overnight cash shortfalls, leveraging portfolios andmeeting other client borrowing needs. Virtually all loans to individually managed account customers arewritten on a demand basis, bear variable interest rates tied to the Prime rateor the Federal Funds rate and are fully secured by liquid collateral, primarilyfreely tradable securities held in custody by us for the borrower.  We monitor the value of collateral daily toensure the amount of collateral held by us exceeds the loan balance by acertain threshold.  Loans to mutual fundsand other pooled product clients include unsecured lines of credit that may, inthe event of default, be collateralized at our option by securities held incustody by us for those clients.  Loansto individually managed account customers, mutual funds and other pooledproduct clients also include advances that we make to certain clients pursuantto the terms of our custody agreements with those clients to facilitatesecurities transactions and redemptions.

 

At March 31,2005, our only lending concentrations that exceeded 10% of total loan balanceswere the lines of credit to mutual fund clients discussed above.  These loans were made in the ordinary courseof business on the same terms and conditions prevailing at the time forcomparable transactions.

 

Our creditloss experience has been excellent. There have been no loan charge-offs in the history of our Company.  It is our policy to place a loan onnonaccrual status when either principal or interest becomes 60 days pastdue and the loan’s collateral is not sufficient to cover both principal andaccrued interest.  As of March 31, 2005,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 an allowance for loan losses of $0.1 million atMarch 31, 2005, a level which has remained consistent for the past fiveyears.  This amount is not allocated toany particular loan, but is intended to absorb any risk of loss inherent in theloan portfolio. Management actively monitors the loan portfolio and theunderlying collateral and regularly assesses the adequacy of the allowance forloan losses.

 

*RepurchaseAgreements and Short-Term and Other Borrowings*

 

Asset growthwas funded in part by increased securities sold under repurchaseagreements.  Repurchase agreementsincreased $0.4 billion, or 9%, from December 31, 2004 to March 31, 2005.  The majority of our repurchase agreements arewith clients who prefer a more collateralized form of deposit.  Repurchase agreements provide for the sale ofsecurities for cash coupled with the obligation to repurchase those securitieson a set date or on demand.  We userepurchase agreements, including client repurchase agreements, because theyprovide a lower cost source of funding than other short-term borrowings andallow our clients the extra benefit of collateralization of theirdeposits.  The average balance ofsecurities sold under repurchase agreements for the three months ended March31, 2005 was $5.1 billion with an average cost of approximately 2.09%, comparedto an average balance of $3.7 billion and an average cost of approximately0.83% for the same period last year.  Therate increase is due to higher short-term interest rates in the first quarterof 2005 versus the first quarter of 2004.

 

28

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Short-term andother borrowings increased $0.7 billion, or 122%, from December 31, 2004 to March31, 2005.  We use short-term and otherborrowings to offset the variability of deposit flow.  The average balance of short-term and otherborrowings for the three months ended March 31, 2005 was $1.3 billion with anaverage cost of approximately 2.55%, compared to an average balance of $0.7 billionand an average cost of approximately 3.05% for the same period last year.  The average cost of borrowings for the threemonths ended March 31, 2004 included prepayment fees of $2.6 million.  These fees were incurred to employ an assetand liability strategy in which we replaced high cost borrowings with newborrowings at lower rates.

 

**MarketRisk**

 

Our clients,in the course of their financial asset management, maintain cash balances,which they can deposit with us on a short-term basis in interest-bearingaccounts or client repurchase agreements. We either directly invest these cash balances to earn interest income,or place these deposits in third-party vehicles and remit a portion of theearnings on these investments to our clients after deducting a fee as ourcompensation for investing clients’ funds in these investment vehicles. In theconduct of these activities, we are subject to market risk.

 

Market risk isthe risk of an adverse financial impact from changes in market prices andinterest rates.  The level of risk weassume is a function of our overall strategic objectives and liquidity needs,client requirements and market volatility. The active management of market riskis integral to our operations.  Theobjective of interest rate sensitivity management is to provide sustainable netinterest income under various economic conditions.

 

Our Board ofDirectors has set asset and liability management policies that define theoverall framework for managing interest rate sensitivity, includingaccountabilities and controls over investment activities.  These policies delineate investment limitsand strategies that are appropriate, given our liquidity and regulatoryrequirements.  For example, we haveestablished a policy limit stating that projected net interest income over thenext twelve months will not change by more than 10% given a change in interestrates of up to 200 basis points (+ or -) over twelve months.  Each quarter, our Board of Directors reviewsour asset and liability positions, including simulations of the effect ofvarious interest rate scenarios on our capital.

 

The day-to-dayresponsibility for oversight of the Asset and Liability Management function hasbeen delegated by our Board of Directors to our Asset and Liability Committee (‘ALCO’).  ALCO is a senior management committeeconsisting of the Chief Executive Officer, the President, the Chief FinancialOfficer, the Chief Risk Officer and members of the Treasury function. ALCOmeets twice monthly.  Our primary tool inmanaging 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 ourinterest-sensitive assets and liabilities existing at the beginning of a periodwill change periodically over the period being measured.  The model also assumes that a particularchange in interest rates is reflected uniformly across the yield curveregardless of the duration to maturity or repricing of specific assets andliabilities.  These assumptions areinherently uncertain, and as a result, the model cannot precisely predict theeffect of changes in interest rates on our net interest income.  Actual results may differ from simulatedresults due to the timing, magnitude and frequency of interest rate changes andchanges in market conditions and management strategies.

 

The results ofthe income simulation model as of March 31, 2005 and 2004 indicated that anupward shift of interest rates by 200 basis points over a twelve-month periodwould result in a reduction in projected net interest income of 7.8% and 6.2%,respectively, which is within our 10% policy limit.  We also simulate a 200 basis point rate reductionover a twelve-month period, however, in the simulation we do not reduce ratesbelow 0% because of the low likelihood that rates will decrease to below0%.  This modified simulation wouldresult in an increase in projected net interest income of 1.2% and a reductionof 10.4% as of March 31, 2005 and 2004, respectively.  In 2004, our Board of Directorsapproved a temporary exception to the 10% limit for decreases in interestrates, as a 200 basis point reduction would have moved interest rates into anegative position.

 

We also usegap analysis as a secondary tool to manage our interest rate sensitivity.  Gap analysis involves measurement of thedifference in asset and liability repricing on a cumulative basis within aspecified time frame.  A positive gapindicates that more interest-earning assets than interest-bearing liabilitiesmature in a time frame, and a negative gap indicates the opposite.  By seeking to minimize the net amount ofassets and liabilities that could reprice in the same time frame, we attempt toreduce the risk of significant adverse effects on net interest income caused byinterest rate changes.  As shown in thecumulative gap position in the table presented below, at March 31, 2005,interest-bearing liabilities repriced faster than interest-earning assets inthe short term, as has been typical for us. Generally speaking, during a period of falling interest rates, netinterest income would be higher than it would have been until interest rates stabilize.  During a period of rising interest rates, netinterest income would be lower than it would have been until interest ratesstabilize.  Other important determinantsof net interest income are general rate levels, balance sheet growth and mix,and interest rate spreads. We continue to run a closely matched balance sheetby investing the majority of our assets in short duration, variable-ratesecurities and adding interest rate swaps against client liabilities, includingclient repurchase agreements.

 

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We manage thestructure of interest-earning assets and interest-bearing liabilities byadjusting their mix, yield, maturity and/or repricing characteristics based onmarket conditions.  Client deposits andrepurchase agreements, which are predominantly short term, are our primarysources of funds.  We also use termborrowings and interest rate swap agreements to augment our management ofinterest rate exposure.  The effect ofthe swap agreements is to lengthen short-term variable-rate liabilities intolonger-term fixed-rate liabilities.  Theweighted-average fixed-payment rates were 3.17% and 3.67% at March 31, 2005 and2004, respectively.  Variable-interestpayments received are currently indexed to the overnight Federal Fundsrate.  At March 31, 2005 and 2004, theweighted-average rate of variable market-indexed interest payment obligationsto the Company were 2.60% and 1.67%, respectively.  The remaining terms of swaps at March 31,2005 range from 0 to 38 months. These contracts had net fair values ofapproximately $19.2 million and $(16.8) million at March 31, 2005 and 2004,respectively.

 

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The following tablepresents the repricing schedule of our interest-earning assets andinterest-bearing liabilities at March 31, 2005 (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)                                                          |       | $                        | 6,209,088  |                     | $          | 715,836                   |       | $                           | 1,199,476  |                 | $          | 2,553,308 |       | $ | 318,899 |   | $ | 10,996,607 |   |
| Loans - variable rate                                                                  |       | 265,846                  |       | —                   |       | —                    |       | —                      |       | —               |       | 265,846   |       |
| Loans - fixed rate                                                                     |       | —                   |       | —                   |       | —                    |       | 12                          |       | —               |       | 12        |       |
| Total interest-earning assets                                                          |       | $                        | 6,474,934  |                     | $          | 715,836                   |       | $                           | 1,199,476  |                 | $          | 2,553,320 |       | $ | 318,899 |   | $ | 11,262,465 |   |
| Interest-bearing liabilities:                                                          |       |                     |       |                     |       |                      |       |                        |       |                 |       |      |       |
| Savings accounts                                                                       |       | $                        | 3,642,901  |                     | $          | —                    |       | $                           | —     |                 | $          | —    |       | $ | — |   | $ | 3,642,901 |   |
| Time deposits                                                                          |       | 412,669                  |       | —                   |       | —                    |       | —                      |       | —               |       | 412,669   |       |
| Interest rate contracts                                                                |       | (1,670,000               | )          | 120,000                  |       | 240,000                   |       | 1,310,000                   |       | —               |       | —    |       |
| Securities sold under repurchase agreements                                            |       | 3,890,959                |       | 50,000                   |       | 100,000                   |       | 600,000                     |       | —               |       | 4,640,959 |       |
| Short-term and other borrowings                                                        |       | 1,269,712                |       | —                   |       | —                    |       | 50,000                      |       | —               |       | 1,319,712 |       |
| Junior subordinated debentures                                                         |       | —                   |       | —                   |       | —                    |       | 24,774                      |       | —               |       | 24,774    |       |
| Total interest-bearing liabilities                                                     |       | $                        | 7,546,241  |                     | $          | 170,000                   |       | $                           | 340,000    |                 | $          | 1,984,774 |       | $ | — |   | $ | 10,041,015 |   |
| Net interest-sensitivity gap during the  period                                        |       | $                        | (1,071,307 | )                        | $          | 545,836                   |       | $                           | 859,476    |                 | $          | 568,546   |       | $ | 318,899 |   | $ | 1,221,450 |   |
|                                                                                   |       |                     |       |                     |       |                      |       |                        |       |                 |       |      |       |
| Cumulative gap                                                                         |       | $                        | (1,071,307 | )                        | $          | (525,471                  | )          | $                           | 334,005    |                 | $          | 902,551   |       | $ | 1,221,450 |   |   |   |
| Interest-sensitive assets as a percent of  interest-sensitive liabilities (cumulative) |       | 85.80                    | %          | 93.19                    | %          | 104.15                    | %          | 108.99                      | %          | 112.16               | %          |      |       |
| Interest-sensitive assets as a percent of  total assets (cumulative)                   |       | 54.48                    | %          | 60.50                    | %          | 70.59                     | %          | 92.08                       | %          | 94.76                | %          |      |       |
| Net interest-sensitivity gap as a percent  of total assets                             |       | (9.01                    | )%         | 4.59                     | %          | 7.23                      | %          | 4.78                        | %          | 2.68                 | %          |      |       |
| Cumulative gap as a percent of total assets                                            |       | (9.01                    | )%         | (4.42                    | )%         | 2.81                      | %          | 7.59                        | %          | 10.28                | %          |      |       |

 

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

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

(3)     Excludes$112.8 million of unsettled securities purchases and $9.8 million of netunrealized losses as of March 31, 2005.

 

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**Liquidity**

 

Liquidityrepresents the ability of an institution to meet present and future financialobligations through either the sale or maturity of existing assets or theacquisition of additional funds through liability management.  For a financial institution such as ours,these obligations arise from the withdrawals of deposits and the payment ofoperating expenses.

 

Our primarysources of liquidity include cash and cash equivalents, Federal Funds sold,Federal Reserve Discount Window, new deposits, short-term borrowings, interestand principal payments on securities held to maturity and available for sale,and fees collected from asset administration clients.  As a result of our management of liquidassets and our ability to generate liquidity through liability funds,management believes that we maintain overall liquidity sufficient to meet ourdepositors’ needs, to satisfy our operating requirements and to fund thepayment of an anticipated annual cash dividend of $0.08 per share for 2005(approximately $5.3 million based upon 66,796,243 shares outstanding as ofMarch 31, 2005).

 

Our ability topay dividends on Common Stock may depend on the receipt of dividends from theBank. Any dividend payments by the Bank are subject to certain restrictionsimposed by the Massachusetts Commissioner of Banks.  During all periods presented in this report,the Company did not require dividends from the Bank in order to fund theCompany’s own dividends.  In addition, wemay not pay dividends on our Common Stock if we are in default under certainagreements entered into in connection with the sale of our CapitalSecurities.  Our Capital Securities wereissued by Investors Capital Trust I, (‘ICTI’), a Delaware statutory businesstrust sponsored by us, and qualify as Tier 1 capital under the capitalguidelines of the Federal Reserve.

 

We haveinformal borrowing arrangements with various counterparties.  Each counterparty has agreed to make fundsavailable to us at the Federal Funds overnight rate.  The aggregate amount of these borrowingarrangements as of March 31, 2005 was $4.0 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 suchfunding will be available.  Lack ofavailability of liquid funds could have a material adverse impact on ouroperations.

 

We also haveMaster Repurchase Agreements in place with various counterparties.  Each counterparty has agreed to make fundsavailable to us at various rates in exchange for collateral consisting ofmarketable securities. The aggregate amount of these borrowing arrangements atMarch 31, 2005 was $5.6 billion.

 

On April 19,2004, the Federal Home Loan Bank of Boston (‘FHLBB’) implemented a new capitalstructure mandated for all Federal Home Loan Banks by the Gramm-Leach-BlileyAct of 1999 and regulations that were subsequently promulgated in 2001 by theFHLBB’s regulator, the Federal Housing Finance Board.  The Bank’s capital stock investment in theFHLBB totaled $50 million as of March 31, 2005. The $50 million capital stock investment includes both a $25 millionmembership component and a $25 million activity-based component.  The Bank’s $50 million capital stockinvestment in the FHLBB provides a borrowing capacity of approximately $555million. Under the new capital plan, FHLBB capital stock investments require afive-year advance notice of withdrawal. The amount outstanding under this arrangement at March 31, 2005 was $375million.  Additional borrowing isavailable to the Bank based on prescribed collateral levels and increasedinvestment in FHLBB capital stock.  TheBank currently has no plans to increase its investment in FHLBB capital stock.

 

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**CapitalResources**

 

Historically,we have financed our operations principally through internally generated cashflows.  We incur capital expenditures forfurniture, fixtures, capitalized software and miscellaneous equipment needs.  We lease computing equipment throughoperating leases.  Capital expenditureshave been incurred and leases entered into on an as-required basis, primarilyto meet our growing operating needs.  Asa result, our capital expenditures were $6.9 million and $5.5 million for thethree months ended March 31, 2005 and 2004, respectively.  For the three months ended March 31, 2005,capital expenditures were comprised of approximately $5.6 million incapitalized software and projects in process, $1.2 million in fixed assets, and$0.1 million in leasehold improvements. For the three months ended March 31, 2004, capital expenditures werecomprised of approximately $3.0 million in capitalized software and projects inprocess and $2.5 million in fixed assets.

 

Stockholders’equity at March 31, 2005 was $741.1 million, up 4% from December 31, 2004,primarily due to net income growth.  Thisincrease was partially offset by an increase in the net unrealized loss onavailable for sale securities, which is due to increases in interest rates.  The ratio of average stockholders’ equity toaverage assets remained constant at approximately 6% for March 31, 2005 andDecember 31, 2004.

 

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

 

Inaddition to the risk-based capital requirements, the FRB requires BHCs tomaintain a minimum leverage capital ratio of Tier 1 capital to its averagetotal consolidated assets (the ‘Leverage Ratio’) of 3.0%.  Total averageconsolidated assets for this purpose does not include goodwill and any otherintangible assets and investments that the FRB determines should be deductedfrom Tier 1 capital.  The FRB has announced that the 3.0% Leverage Ratiorequirement is the minimum for the top-rated BHCs.  All other BHCs arerequired to maintain a minimum Leverage Ratio of 4.0%.  BHCs withsupervisory, financial, operational or managerial weaknesses, as well as BHCsthat are anticipating or experiencing significant growth, are expected tomaintain capital ratios well above the minimum levels.  Because weanticipate significant future growth, we will be required to maintain aLeverage Ratio of 4.0% or higher.

 

We arecurrently in compliance with both the Total Risk-Based Capital Ratio and theLeverage Ratio requirements, and management expects these ratios to remain incompliance with the FRB’s capital adequacy guidelines.  At March 31, 2005, our Total Risk-BasedCapital Ratio and Leverage Ratio were 20.22% and 6.00%, respectively.

 

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

** **

**Evaluation of Disclosure Controlsand Procedures**

 

As required by Rule13a-15 under the Securities Exchange Act of 1934, as of March 31, 2005, the endof the quarter covered by this report, the Company carried out an evaluationunder the supervision and with the participation of the Company’s management,including the Company’s Chief Executive Officer and Chief Financial Officer, ofthe effectiveness of the design and operation of the Company’s disclosurecontrols and procedures.  In designingand evaluating the Company’s disclosure controls and procedures, the Companyand its management recognize that any controls and procedures, no matter howwell designed and operated, can provide only reasonable assurance of achievingthe desired control objectives, and the Company’s management necessarily wasrequired to apply its judgment in evaluating and implementing possible controlsand procedures.  Based upon thatevaluation, the Chief Executive Officer and Chief Financial Officer concludedthat the Company’s disclosure controls and procedures were effective at thereasonable assurance level to ensure that information required to be disclosedby the Company in the reports it files or submits under the Exchange Act isrecorded, processed, summarized and reported, within the time periods specifiedin the Securities and Exchange Commission’s rules and forms.  There was no change in the Company’s internalcontrol over financial reporting that occurred during the quarter ended March31, 2005 that has materially affected, or is reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.  The Company reviews its disclosure controlsand procedures, which may include its internal controls over financialreporting on an ongoing basis, and may from time to time make changes aimed atenhancing their effectiveness and to ensure that the Company’s systems evolvewith its business.

 

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**PART II.  OTHER INFORMATION**

 

**Item 2.**            Purchases of EquitySecurities by the Issuer and Affiliated Purchasers

 
| **Period  (shares in thousands)** | ** ** | **Total  Number of  Shares  Purchased (1)** | ** ** | **Average  Price Paid Per  Share** | ** ** |
|-----------------------------------|------------|---------------------------------------------|------------|------------------------------------|------------|
|                              |       |                                        |       |                               |       |
| **January 1-January 31, 2005**    |       | 4                                           |       | $                                  | 47.66      |   |
| **February 1-February 28, 2005**  |       | 2                                           |       | 50.68                              |       |
| **March 1-March 31, 2005**        |       | 17                                          |       | 49.44                              |       |
|                              |       | 23                                          |       | $                                  | 49.24      |   |

 

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(1)    All of the shares set forth in the abovetable were purchased by the Company in connection with the exercise ofoutstanding options issued by the Company.

 

The Company does not currently maintainpublicly announced repurchase plans or programs.

 

**Item6.**            Exhibits

 

**(a)**     Exhibits

 
| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                                  |
|------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **       | ** ** | ** **                                                                                                                                                                                                                       |
| **10.1***        | ** ** | **Amendment to Lease between Investors Financial Services  Corp. and 100 & 200 Clarendon, LLC dated as of January 1, 2005.**                                                                                                 |
| ** **       | ** ** | ** **                                                                                                                                                                                                                       |
| **10.2**         | ** ** | **2005 Equity Compensation Plan.**                                                                                                                                                                                               |
| ** **       | ** ** | ** **                                                                                                                                                                                                                       |
| **15**           | ** ** | **Letter of awareness from Deloitte & Touche LLP**                                                                                                                                                                           |
| ** **       | ** ** | ** **                                                                                                                                                                                                                       |
| **31.1**         | ** ** | **Certification of Kevin J. Sheehan, Chief Executive  Officer.**                                                                                                                                                                 |
| ** **       | ** ** | ** **                                                                                                                                                                                                                       |
| **31.2**         | ** ** | **Certification of John N. Spinney, Jr., Chief Financial  Officer.**                                                                                                                                                             |
| ** **       | ** ** | ** **                                                                                                                                                                                                                       |
| **32.1**         | ** ** | **Certification of Kevin J. Sheehan, Chief Executive  Officer, and John N. Spinney, Jr., Chief Financial Officer, pursuant to 18  U.S.C. Section 1350, as adopted, pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.** |

 

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* Confidential treatmentrequested pursuant to Rule 24b-2 promulgated under the Securities Exchange Actof 1934, as amended.

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|                     |   |   | **INVESTORS FINANCIAL SERVICES CORP.**                 |
|--------------------------|--------|--------|--------------------------------------------------------|
|                     |   |   | ** **                                             |
| Date:  May 9,  2005 |   | By:    | /s/ Kevin J. Sheehan                                   |
|                     |   |   | Kevin J. Sheehan  Chairman and Chief Executive Officer |

 

 
|   |   | By:    | /s/ John N. Spinney, Jr.                                                                                               |
|--------|--------|--------|------------------------------------------------------------------------------------------------------------------------|
|   |   |   | John N. Spinney, Jr.  Senior Vice President and Chief Financial Officer   (Principal Financial and Accounting Officer) |
|        |        |        |                                                                                                                        |  |

 

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