**SECURITIES ANDEXCHANGE 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 ACT OF 1934

 

**For the Quarterlyperiod ended March 31, 2006**

 

**or**

 

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

 

**For the Transitionperiod from            to           **

 

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

 

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**INVESTORS FINANCIAL SERVICES CORP.**

(Exact name ofregistrant as specified in its charter)

 

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

 

**(617) 937-6700**(Registrant’s telephone number, including area code)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days. Yes ý No o

 

Indicate by check markwhether the registrant is a shell company (as defined by Rule 12b-2 of theExchange Act). Yes o No ý

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer.  See definition of“accelerated filer and large accelerated filer” in Rule 12b-2 of the ExchangeAct. (Check one):

 

Largeaccelerated filer ý Accelerated filer o Non-accelerated filer o

 

As of April 30, 2006 there were 65,754,953 shares of common stockoutstanding.

 

 

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**INVESTORS FINANCIAL SERVICES CORP.**

 

**INDEX**

 
| ** **     | ** **                                                                                                         | ** ** | **Page** |
|----------------|--------------------------------------------------------------------------------------------------------------------|------------|----------|
|           |                                                                                                               |       |     |
| **PART I.**    | **FINANCIAL INFORMATION**                                                                                          |       |     |
| ** **     | ** **                                                                                                         |       |     |
| Item 1.        | Unaudited Consolidated  Financial Statements                                                                       |       |     |
|           |                                                                                                               |       |     |
|           | Unaudited Consolidated  Balance Sheets   March 31, 2006 and December 31, 2005                                      |       | 3        |
|           |                                                                                                               |       |     |
|           | Unaudited Consolidated  Statements of Income and Comprehensive Income   Three months ended March 31, 2006 and 2005 |       | 4        |
|           |                                                                                                               |       |     |
|           | Unaudited Consolidated  Statements of Stockholders’ Equity   Three months ended March 31, 2006 and 2005       |       | 5        |
|           |                                                                                                               |       |     |
|           | Unaudited Consolidated  Statements of Cash Flows   Three months ended March 31, 2006 and 2005                      |       | 6        |
|           |                                                                                                               |       |     |
|           | Notes to Unaudited  Consolidated Financial Statements                                                              |       | 7        |
|           |                                                                                                               |       |     |
|           | Report of  Independent Registered Public Accounting Firm                                                           |       | 21       |
|           |                                                                                                               |       |     |
| Item  2.       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                        |       | 22       |
|           |                                                                                                               |       |     |
| Item  3.       | Quantitative  and Qualitative Disclosures about Market Risk                                                        |       | 34       |
|           |                                                                                                               |       |     |
| Item 4.        | Controls  and Procedures                                                                                           |       | 34       |
|           |                                                                                                               |       |     |
| **PART II.**   | **OTHER INFORMATION**                                                                                              |       |     |
| ** **     | ** **                                                                                                         |       |     |
| Item 1.        | Legal proceedings                                                                                                  |       | 35       |
|           |                                                                                                               |       |     |
| Item 1A.       | Risk Factors                                                                                                       |       | 35       |
|           |                                                                                                               |       |     |
| Item 6.        | Exhibits                                                                                                           |       | 38       |
|           |                                                                                                               |       |     |
| **SIGNATURES** |                                                                                                               | 38         |

 

2

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**PART I. FINANCIAL INFORMATION**

**Item 1.    UnauditedConsolidated Financial Statements**

** **

**Investors Financial Services Corp.**

**Unaudited Consolidated Balance Sheets**

**March 31, 2006 and December 31, 2005 (Dollarsin thousands, except share data)**

 
| ** **                                                                                                                                                                                                                                                            | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                                                                                                            | ** ** | ** **          | ** ** | ** **             | ** ** |
| **Assets**                                                                                                                                                                                                                                                            | ** ** | ** **          | ** ** | ** **             | ** ** |
| Cash and due from banks                                                                                                                                                                                                                                               |       | $                   | 101,438    |                   | $          | 79,637 |   |
| Federal Funds sold                                                                                                                                                                                                                                                    |       | 525,000             |       | —                 |       |
| Other short-term investments                                                                                                                                                                                                                                          |       | 6,089               |       | —                 |       |
| Securities held to maturity (including  securities pledged of $4,940,848 and $4,529,421 at March 31, 2006 and  December 31, 2005, respectively) (approximate fair value of $6,444,686 and  $6,725,729 at March 31, 2006 and December 31, 2005, respectively) (Note 3) |       | 6,496,151           |       | 6,761,930              |       |
| Securities available for sale (including  securities pledged of $2,756,971 and $2,997,958 at March 31, 2006 and  December 31, 2005, respectively) (Note 3)                                                                                                            |       | 4,498,151           |       | 4,369,720              |       |
| Nonmarketable equity securities (Note 3)                                                                                                                                                                                                                              |       | 50,000              |       | 50,000                 |       |
| Loans, less allowance for loan losses of  $100 at March 31, 2006 and December 31, 2005 (Note 4)                                                                                                                                                                  |       | 307,921             |       | 402,370                |       |
| Accrued interest and fees receivable                                                                                                                                                                                                                                  |       | 123,770             |       | 119,583                |       |
| Equipment and leasehold improvements, less  accumulated depreciation of $54,390 and $59,156 at March 31, 2006 and  December 31, 2005, respectively                                                                                                                    |       | 79,307              |       | 69,401                 |       |
| Goodwill, net                                                                                                                                                                                                                                                         |       | 79,969              |       | 79,969                 |       |
| Other assets                                                                                                                                                                                                                                                          |       | 159,008             |       | 163,783                |       |
|                                                                                                                                                                                                                                                                  |       |                |       |                   |       |
| **Total  Assets**                                                                                                                                                                                                                                                     |       | $                   | 12,426,804 |                   | $          | 12,096,393 |   |
| ** **                                                                                                                                                                                                                                                            | ** ** | ** **          | ** ** | ** **             | ** ** |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                                                                                                        | ** ** | ** **          | ** ** | ** **             | ** ** |
| ** **                                                                                                                                                                                                                                                            | ** ** | ** **          | ** ** | ** **             | ** ** |
| **Liabilities:**                                                                                                                                                                                                                                                      | ** ** | ** **          | ** ** | ** **             | ** ** |
| Deposits (Note 5):                                                                                                                                                                                                                                                    |       |                |       |                   |       |
| Demand                                                                                                                                                                                                                                                                |       | $                   | 644,884    |                   | $          | 537,558 |   |
| Savings                                                                                                                                                                                                                                                               |       | 4,511,666           |       | 4,224,908              |       |
| Time                                                                                                                                                                                                                                                                  |       | 268,141             |       | 230,124                |       |
| Total deposits                                                                                                                                                                                                                                                        |       | 5,424,691           |       | 4,992,590              |       |
|                                                                                                                                                                                                                                                                  |       |                |       |                   |       |
| Securities sold under repurchase agreements  (Note 6)                                                                                                                                                                                                                 |       | 4,792,011           |       | 4,797,868              |       |
| Short-term and other borrowings (Note 7)                                                                                                                                                                                                                              |       | 1,187,203           |       | 1,356,649              |       |
| Due to brokers for open trades payable                                                                                                                                                                                                                                |       | 11,949              |       | 21,293                 |       |
| Junior subordinated deferrable interest  debentures                                                                                                                                                                                                                   |       | 24,774              |       | 24,774                 |       |
| Accrued taxes and other expenses                                                                                                                                                                                                                                      |       | 61,348              |       | 45,077                 |       |
| Other liabilities                                                                                                                                                                                                                                                     |       | 104,629             |       | 85,284                 |       |
| Total liabilities                                                                                                                                                                                                                                                     |       | 11,606,605          |       | 11,323,535             |       |
|                                                                                                                                                                                                                                                                  |       |                |       |                   |       |
| Commitments and contingencies (Note 12)                                                                                                                                                                                                                               |       | —              |       | —                 |       |
|                                                                                                                                                                                                                                                                  |       |                |       |                   |       |
| **Stockholders’  Equity:**                                                                                                                                                                                                                                       | ** ** | ** **          | ** ** | ** **             | ** ** |
| Preferred stock, par value $0.01 (shares  authorized: 1,000,000; issued: none at March 31, 2006 and December 31, 2005)                                                                                                                                                |       | —              |       | —                 |       |
| Common stock, par value $0.01 (shares  authorized: 175,000,000; issued: 65,531,272 and 65,052,637 at March 31, 2006  and December 31, 2005, respectively)                                                                                                             |       | 677                 |       | 672                    |       |
| Surplus                                                                                                                                                                                                                                                               |       | 303,733             |       | 286,265                |       |
| Deferred compensation                                                                                                                                                                                                                                                 |       | —              |       | (311                   | )          |
| Retained earnings                                                                                                                                                                                                                                                     |       | 608,483             |       | 572,549                |       |
| Accumulated other comprehensive loss, net                                                                                                                                                                                                                             |       | (19,746             | )          | (13,369                | )          |
| Treasury stock, at cost (2,124,669 shares  at March 31, 2006 and December 31, 2005)                                                                                                                                                                                   |       | (72,948             | )          | (72,948                | )          |
| Total stockholders’ equity                                                                                                                                                                                                                                       |       | 820,199             |       | 772,858                |       |
| **Total  Liabilities and Stockholders’ Equity**                                                                                                                                                                                                                  |       | $                   | 12,426,804 |                   | $          | 12,096,393 |   |

 

*See Notes to Unaudited Consolidated FinancialStatements.*

 

3

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**Investors Financial Services Corp.**

**Unaudited Consolidated Statements of Income andComprehensive Income**

**Three Months Ended March 31, 2006 and 2005(Dollars in thousands, except per share data)**

 
| ** **                                | ** ** | **March 31,  2006** | ** ** | **March 31,  2005** | ** ** |
|-------------------------------------------|------------|---------------------|------------|---------------------|------------|
| **Fees and Other Revenue:**               | ** ** | ** **          | ** ** | ** **          | ** ** |
| Asset servicing fees:                     |       |                |       |                |       |
| Core service fees                         |       | $                   | 107,759    |                | $          | 88,544 |   |
| Value-added service fees                  |       | 40,544              |       | 26,659              |       |
| Total asset servicing fees                |       | 148,303             |       | 115,203             |       |
| Other operating income                    |       | 1,164               |       | 785                 |       |
| Gain on sale of investments               |       | —              |       | 4,188               |       |
| Total fees and other revenue              |       | 149,467             |       | 120,176             |       |
|                                      |       |                |       |                |       |
| Interest income                           |       | 134,437             |       | 98,055              |       |
| Interest expense                          |       | 91,116              |       | 50,442              |       |
| Net interest income                       |       | 43,321              |       | 47,613              |       |
| Net operating revenue                     |       | 192,788             |       | 167,789             |       |
|                                      |       |                |       |                |       |
| **Operating Expenses:**                   | ** ** | ** **          | ** ** | ** **          | ** ** |
| Compensation and benefits                 |       | 76,998              |       | 56,919              |       |
| Technology and telecommunications         |       | 17,338              |       | 12,836              |       |
| Transaction processing services           |       | 13,672              |       | 11,120              |       |
| Depreciation and amortization             |       | 7,806               |       | 7,891               |       |
| Occupancy                                 |       | 7,551               |       | 6,613               |       |
| Professional fees                         |       | 3,461               |       | 2,973               |       |
| Travel and sales promotion                |       | 1,931               |       | 1,349               |       |
| Insurance                                 |       | 973                 |       | 1,129               |       |
| Other operating expenses                  |       | 5,954               |       | 3,962               |       |
| Total operating expenses                  |       | 135,684             |       | 104,792             |       |
| ** **                                | ** ** | ** **          | ** ** | ** **          | ** ** |
| **Income Before Income Taxes**            |       | 57,104              |       | 62,997              |       |
|                                      |       |                |       |                |       |
| Provision for income taxes                |       | 19,701              |       | 22,049              |       |
|                                      |       |                |       |                |       |
| **Net Income**                            |       | $                   | 37,403     |                | $          | 40,948 |   |
| **Basic Earnings Per Share**              |       | $                   | 0.57       |                | $          | 0.61 |   |
| **Diluted Earnings Per Share**            |       | $                   | 0.56       |                | $          | 0.60 |   |
|                                      |       |                |       |                |       |
| **Comprehensive Income:**                 |       |                |       |                |       |
| Net income                                |       | $                   | 37,403     |                | $          | 40,948 |   |
| Other comprehensive loss:                 |       |                |       |                |       |
| Net unrealized investment loss            |       | (9,197              | )          | (26,239             | )          |
| Net unrealized derivative instrument gain |       | 2,691               |       | 8,683               |       |
| Cumulative translation adjustment         |       | 129                 |       | (120                | )          |
| Other comprehensive loss                  |       | (6,377              | )          | (17,676             | )          |
| Comprehensive income                      |       | $                   | 31,026     |                | $          | 23,272 |   |

 

***See Notes to UnauditedConsolidated Financial Statements.***

 

4

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**Investors Financial Services Corp.**

**Unaudited Consolidated Statements of Stockholders’Equity**

**Three Months Ended March 31, 2006 and 2005(Dollars in thousands, except share data)**

 
| ** **                                                                                                            | ** ** | **March 31,** | ** ** | **March 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|---------------|------------|---------------|------------|
| ** **                                                                                                            | ** ** | **2006**      | ** ** | **2005**      | ** ** |
| **Common shares**                                                                                                     | ** ** | ** **    | ** ** | ** **    | ** ** |
| Balance, beginning of period                                                                                          |       | 65,052,637    |       | 66,595,349    |       |
| Exercise of stock options                                                                                             |       | 478,635       |       | 200,894       |       |
| Balance, end of period                                                                                                |       | 65,531,272    |       | 66,796,243    |       |
|                                                                                                                  |       |          |       |          |       |
| **Treasury shares**                                                                                                   | ** ** | ** **    | ** ** | ** **    | ** ** |
| Balance, beginning of period                                                                                          |       | 2,124,669     |       | 73,235        |       |
| Balance, end of period                                                                                                |       | 2,124,669     |       | 73,235        |       |
|                                                                                                                  |       |          |       |          |       |
| **Common stock**                                                                                                      | ** ** | ** **    | ** ** | ** **    | ** ** |
| Balance, beginning of period                                                                                          |       | $             | 672        |          | $          | 667 |   |
| Exercise of stock options                                                                                             |       | 5             |       | 2             |       |
| Balance, end of period                                                                                                |       | 677           |       | 669           |       |
|                                                                                                                  |       |          |       |          |       |
| **Surplus**                                                                                                           | ** ** | ** **    | ** ** | ** **    | ** ** |
| Balance, beginning of period                                                                                          |       | 286,265       |       | 272,536       |       |
| Exercise of stock options                                                                                             |       | 15,314        |       | 5,638         |       |
| Tax benefit from exercise of stock options                                                                            |       | 2,361         |       | 1,179         |       |
| Transfer of deferred compensation to surplus                                                                          |       | (311          | )          | —        |       |
| Amortization of deferred compensation                                                                                 |       | 104           |       | —        |       |
| Balance, end of period                                                                                                |       | 303,733       |       | 279,353       |       |
|                                                                                                                  |       |          |       |          |       |
| **Deferred compensation**                                                                                             | ** ** | ** **    | ** ** | ** **    | ** ** |
| Balance, beginning of period                                                                                          |       | (311          | )          | (572          | )          |
| Transfer of deferred compensation to surplus                                                                          |       | 311           |       | —        |       |
| Amortization of deferred compensation                                                                                 |       | —        |       | 107           |       |
| Balance, end of period                                                                                                |       | —        |       | (465          | )          |
|                                                                                                                  |       |          |       |          |       |
| **Retained earnings**                                                                                                 | ** ** | ** **    | ** ** | ** **    | ** ** |
| Balance, beginning of period                                                                                          |       | 572,549       |       | 418,034       |       |
| Net income                                                                                                            |       | 37,403        |       | 40,948        |       |
| Cash dividend, $0.0225 and $0.0200 per  share in the three-month periods ending March 31, 2006 and 2005, respectively |       | (1,469        | )          | (1,332        | )          |
| Balance, end of period                                                                                                |       | 608,483       |       | 457,650       |       |
|                                                                                                                  |       |          |       |          |       |
| **Accumulated other comprehensive (loss) income, net**                                                                | ** ** | ** **    | ** ** | ** **    | ** ** |
| Balance, beginning of period                                                                                          |       | (13,369       | )          | 23,888        |       |
| Net unrealized investment loss                                                                                        |       | (9,197        | )          | (26,239       | )          |
| Net unrealized derivative instrument gain                                                                             |       | 3,164         |       | 8,794         |       |
| Amortization of terminated interest rate swap agreements                                                              |       | (473          | )          | (111          | )          |
| Cumulative translation adjustment                                                                                     |       | 129           |       | (120          | )          |
| Balance, end of period                                                                                                |       | (19,746       | )          | 6,212         |       |
|                                                                                                                  |       |          |       |          |       |
| **Treasury stock**                                                                                                    | ** ** | ** **    | ** ** | ** **    | ** ** |
| Balance, beginning of period                                                                                          |       | (72,948       | )          | (2,291        | )          |
| Balance, end of period                                                                                                |       | (72,948       | )          | (2,291        | )          |
|                                                                                                                  |       |          |       |          |       |
| **Total Stockholders’ Equity**                                                                                   |       | $             | 820,199    |          | $          | 741,128 |   |

 

***See Notes to UnauditedConsolidated Financial Statements.***

 

5

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**Investors Financial Services Corp.**

**Unaudited Consolidated Statements of Cash Flows**

**Three Months Ended March 31, 2006 and 2005(Dollars in thousands)**

 
| ** **                                                                         | ** ** | **March 31,** | ** ** | **March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------|------------|---------------|------------|
| ** **                                                                         | ** ** | **2006**      | ** ** | **2005**      | ** ** |
| ** **                                                                         | ** ** | ** **    | ** ** | ** **    | ** ** |
| **Cash Flows From Operating Activities:**                                          | ** ** | ** **    | ** ** | ** **    | ** ** |
| Net income                                                                         |       | $             | 37,403     |          | $          | 40,948 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities: |       |          |       |          |       |
| Equity in undistributed loss of  unconsolidated subsidiary                         |       | 7             |       | 7             |       |
| Depreciation and amortization                                                      |       | 7,806         |       | 7,891         |       |
| Amortization of deferred compensation                                              |       | —        |       | 107           |       |
| Amortization of premiums on securities, net  of accretion of discounts             |       | 10,267        |       | 11,119        |       |
| Gain on sale of investments                                                        |       | —        |       | (4,188        | )          |
| Excess tax benefit related to share-based  compensation                            |       | (1,633        | )          | —        |       |
| Changes in assets and liabilities:                                                 |       |          |       |          |       |
| Accrued interest and fees receivable                                               |       | (4,187        | )          | (10,316       | )          |
| Other assets                                                                       |       | 4,759         |       | 1,116         |       |
| Accrued taxes and other expenses                                                   |       | 16,271        |       | 16,176        |       |
| Other liabilities                                                                  |       | 29,895        |       | 11,225        |       |
| Net cash provided by operating activities                                          |       | 100,588       |       | 74,085        |       |
| ** **                                                                         | ** ** | ** **    | ** ** | ** **    | ** ** |
| **Cash Flows From Investing Activities:**                                          |       |          |       |          |       |
| Proceeds from maturities and paydowns of securities available for  sale            |       | 251,050       |       | 281,095       |       |
| Proceeds from maturities and paydowns of securities held to maturity               |       | 302,247       |       | 363,292       |       |
| Proceeds from sale of securities available for sale                                |       | —        |       | 110,595       |       |
| Purchases of securities available for sale                                         |       | (392,764      | )          | (354,490      | )          |
| Purchases of securities held to maturity                                           |       | (48,363       | )          | (1,039,657    | )          |
| Net (decrease) increase in due to brokers for open trades payable                  |       | (9,344        | )          | 107,330       |       |
| Net increase in Federal Funds sold                                                 |       | (525,000      | )          | —        |       |
| Net increase in other short-term investments                                       |       | (6,089        | )          | —        |       |
| Net decrease (increase) in loans                                                   |       | 94,449        |       | (131,228      | )          |
| Purchases of equipment, software and leasehold improvements                        |       | (17,704       | )          | (6,862        | )          |
| Net cash used for investing activities                                             |       | (351,518      | )          | (669,925      | )          |
| ** **                                                                         | ** ** | ** **    | ** ** | ** **    | ** ** |
| **Cash Flows From Financing Activities:**                                          | ** ** | ** **    | ** ** | ** **    | ** ** |
| Net increase (decrease) in demand deposits                                         |       | 107,326       |       | (149,056      | )          |
| Net increase (decrease) in time and savings deposits                               |       | 324,775       |       | (383,409      | )          |
| Net (decrease) increase in securities sold under repurchase  agreements            |       | (5,857        | )          | 385,462       |       |
| Net (decrease) increase in short-term and other borrowings                         |       | (169,446      | )          | 725,031       |       |
| Proceeds from exercise of stock options                                            |       | 15,319        |       | 5,640         |       |
| Excess tax benefit related to share-based compensation                             |       | 1,633         |       | —        |       |
| Dividends paid to stockholders                                                     |       | (1,469        | )          | (1,332        | )          |
| Net cash provided by financing activities                                          |       | 272,281       |       | 582,336       |       |
|                                                                               |       |          |       |          |       |
| **Effect of exchange rates on cash**                                               |       | 450           |       | (2            | )          |
| ** **                                                                         | ** ** | ** **    | ** ** | ** **    | ** ** |
| **Net Increase (Decrease) in Cash and Due From Banks**                             |       | 21,801        |       | (13,506       | )          |
| **Cash and Due From Banks, Beginning of Period**                                   |       | 79,637        |       | 49,059        |       |
| **Cash and Due From Banks, End of Period**                                         |       | $             | 101,438    |          | $          | 35,553 |   |

 

*See Notes to Unaudited Consolidated FinancialStatements.*

 

6

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**Investors FinancialServices Corp.**

**Notes to Unaudited Consolidated FinancialStatements**

 

**1.             Description ofBusiness**

 

Investors Financial Services Corp. (‘IFSC’) provides assetadministration services for the financial services industry through its wholly-ownedsubsidiary, 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 is subject toregulation by the Federal Deposit Insurance Corporation (‘FDIC’), the FederalReserve Board of Governors (‘FRB’), the Office of the Commissioner of Banks ofthe Commonwealth of Massachusetts (‘Commissioner’), the Securities and ExchangeCommission (‘SEC’), the National Association of Securities Dealers, Inc. (‘NASD’),the Office of the Superintendent of Financial Institutions in Canada, the IrishFinancial Services Regulatory Authority, the State of Vermont Department ofBanking, Insurance, Securities & Health Care Administration, the FinancialServices Authority in the United Kingdom and the Commission deSurveillance du Secteur Financier in Luxembourg.

 

**2.             Interim FinancialStatements**

 

The unaudited consolidated interim financial statements of the Companyas of March 31, 2006 and December 31, 2005, and for the three-month periodsended March 31, 2006 and 2005 have been prepared by the Company pursuant to therules and regulations of the SEC. Certain information and footnote disclosures normally included in annualfinancial statements prepared in accordance with accounting principlesgenerally accepted in the United States of America (‘GAAP’) have been omittedas permitted by such rules and regulations. All adjustments, consisting of normal recurring adjustments, necessaryfor their fair presentation in conformity with GAAP are included.  All significant intercompany accounts andtransactions have been eliminated.  TheCompany’s management believes that the disclosures are adequate to present fairlythe financial position, results of operations and cash flows at the dates andfor the periods presented.  Thepreparation of the financial statements requires management to make estimatesand assumptions that affect the amounts reported in the financial statementsand accompanying notes.  Actual resultsmay differ from those estimates.  It issuggested that these interim financial statements be read in conjunction withthe financial statements and the notes thereto included in the Company’s latestannual report on Form 10-K.  Resultsfor interim periods are not necessarily indicative of those to be expected forthe full fiscal year. Certain amounts in prior financial statements have beenreclassified to conform to the current presentation.

 

***Securities –***TheCompany classifies all equity securities that have readily determinable fairvalues and all investments in debt securities into one of threecategories.  Debt securities that theCompany has the positive intent and ability to hold to maturity are classifiedas held to maturity and carried at amortized cost.  Debt and equity securities that are boughtand held principally for the purpose of selling them in the near term areclassified as trading securities and carried at fair value, with unrealized gainsand losses included in earnings.  Allother debt and equity securities not classified as either held to maturity ortrading are classified as available for sale and carried at fair value, withunrealized gains and losses excluded from earnings and reported in othercomprehensive income.

 

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

 

An investment is considered impaired if the fair value of theinvestment is less than its cost.  TheCompany recognizes an impairment charge if, based on the facts andcircumstances, management determines the impairment to be other than temporary.  For example, the Company will record an otherthan temporary impairment charge on a debt security if it is determined that itis probable that the Company will be unable to recover all amounts due under thecontractual obligations of the security.

 

Amortization and accretion of debt securitiespurchased at a premium or discount are amortized or accreted into income usinga method which approximates the constant effective yield method.  The Company applies Statement of FinancialAccounting Standard No. 91, *Accounting forNonrefundable Fees and Costs Associated with Originating or Acquiring Loans andInitial Direct Costs of Leases* (‘SFAS 91’) for the amortization ofpremiums and accretion of discounts.  Incalculating the effective yield for securities that represent holdings of largenumbers of similar loans for which prepayments are probable and the timing andamount of prepayments can be reasonably estimated, prepayments are anticipatedusing the Company’s actual three-month prepayment experience.

 

7

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The amount of amortization or accretion torecognize in income is driven by the calculation of the constant effectiveyield.  When calculating this yield, theCompany assumes that prepayments will continue from the analysis date to thedate of the security’s expected maturity at its most recent three-monthprepayment rate.  The prepayment rate isupdated monthly based on the Company’s previous three-month actual prepaymentexperience.

 

The Company utilizes three-month prepaymentrates to anticipate prepayments because such rates are based on its own actualprepayment experience and because the Company believes three-month rates are abetter estimate of future experience than either one-month or six-month orlonger rates.  In the opinion ofmanagement, a one-month rate does not capture enough experience to predictfuture prepayment behavior and may create undue volatility in interest incomedue to one-time fluctuations in prepayment activity.  Conversely, in the opinion of management, asix-month or longer rate would not capture enough volatility to predict futureprepayment behavior.

 

If a difference arises between the Company’s estimated prepayments andits actual prepayments received, the constant effective yield is recalculatedbased on the Company’s actual payments to date and anticipated futurepayments.  This monthly recalculationresults in the carrying value of the security being adjusted to the amount thatwould have existed had the new effective yield been applied since the purchasedate, and a corresponding charge or credit is recognized to interest income.

 

For securities that do not represent holdingsof large numbers of similar loans for which prepayments are probable and thetiming and amount of prepayments can be reasonably estimated, the associatedpremiums and discounts are amortized or accreted over their contractual termusing the constant effective yield. Actual prepayment experience for such securities is reviewed monthly anda proportionate amount of premium or discount is recognized in income at thattime such that the effective yield on the remaining portion of the securitiescontinues unchanged.

 

***Income Taxes*****–** Income tax expense is based on estimated taxes payable orrefundable on a tax return basis for the current year and the changes indeferred tax assets and liabilities during the year.  Deferred tax assetsand liabilities are established for temporary differences between theaccounting bases and the tax bases of the Company’s assets and liabilities atenacted tax rates expected to be in effect when the amounts related to suchtemporary differences are realized or settled.  If the Company determinesthat it is “more likely than not” that some portion or all of a deferred taxasset will not be realized, the Company records a valuation allowance inaccordance with the provisions of Statement of Financial Accounting StandardsNo. 109, *Accounting for Income Taxes*(‘SFAS 109’).

 

***Share-Based Compensation******–*** On January 1, 2006, theCompany adopted Statement of Financial Accounting Standards No. 123 (revised2004), *Share-Based Payment*(‘SFAS 123R’).  SFAS 123R requires that compensation costrelating to share-based payment transactions be recognized in the financialstatements, with measurement based upon the fair value of the equity orliability instruments issued. The Company adopted SFAS 123R using the modifiedprospective application method.  Underthat method, compensation cost for equity awards granted after January 1, 2006is recognized over the service period based on the grant date fair value. In addition, compensation cost for the portion of awards for which therequisite service has not been rendered that are outstanding as of January 1,2006 is recognized prospectively as the requisite service is rendered. The compensation cost for that portion of awards is based on the grant datefair value of those awards as calculated under the pro forma disclosures of Statementof Financial Accounting Standards No. 123, *Accounting for Stock-basedCompensation* (‘SFAS 123’).  Inaccordance with the modified prospective application method, the financialstatements of interim periods prior to the three months ended March 31, 2006have not been restated.

 

Compensation cost recognized for the three months ended March 31, 2006and 2005 for all share-based compensation plans was $1.1 million and $0.1million, respectively.  The total incometax benefit recognized in the income statement related to these plans was $0.2million for the three months ended March 31, 2006. The total income tax benefitrecognized in the income statement related to these plans for the three monthsended March 31, 2005 was not material.

 

Certain of theCompany’s share-based awards contain terms that provide for a graded vesting schedulewhereby portions of the award vest in increments over the requisite serviceperiod.  As provided for under SFAS 123R,the Company has elected to recognize compensation expense for awards granted onor after January 1, 2006 with graded vesting schedules on a straight-line basisover the requisite service period for the entire award.

 

Prior to adopting SFAS 123R, the Company measured compensation cost forshare-based compensation plans using the intrinsic value method underAccounting Principles Board Opinion No. 25, *Accounting for StockIssued to Employees*(‘APB 25’),**and made proforma disclosures of the fair value method under SFAS 123.  The intrinsic value method measurescompensation cost as the amount by which the fair market value of the common stockexceeds the option exercise price on the measurement date, which is typicallythe date of grant.  Generally, optionsgranted had an exercise price equivalent to the fair market value at themeasurement date.  Accordingly, nocompensation cost was recorded.  Ifshare-based compensation cost

 

8

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were recognized using the fair value method, stock options would havebeen valued at grant date using the Black-Scholes valuation model and theresulting compensation cost would have decreased net income as indicated below(Dollars in thousands, except per share data):

 

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

 

The fair value of each option grant was estimated on the date of grantusing the Black-Scholes valuation model with the following weighted averageassumptions for the three months ended March 31, 2005:  an average assumed risk-free interest rate of4.13%, an expected term of four years, an average expected volatility of44.16%, and an average dividend yield of 0.16%.  For the three months ended March 31, 2005, theamount of share-based compensation cost (net of tax) included in net income asreported was $0.1 million.

 

The followingtable represents the effect of changing from the intrinsic value method underAPB 25 to the fair value method under SFAS 123R for the three months endedMarch 31, 2006 (Dollars in thousands, except per share data):

 

| ** **                           | ** ** | **For the Three Months Ended** | ** ** |
|--------------------------------------|------------|--------------------------------|------------|
| ** **                           | ** ** | **March 31, 2006**             | ** ** |
|                                 |       |                           |       |
| Increase/(Decrease)  in:             |       |                           |       |
|                                 |       |                           |       |
| Income from  continuing operations   |       | $                              | (1,033     | ) |
| Income  before income taxes          |       | (1,033                         | )          |
| Net income                           |       | (680                           | )          |
| Cash flow  from operations           |       | (1,633                         | )          |
| Cash flow  from financing activities |       | 1,633                          |       |
|                                 |       |                           |       |
| Basic EPS                            |       | $                              | (0.01      | ) |
| Diluted EPS                          |       | $                              | (0.01      | ) |

 

The fair value of each option grant under the Director Plan, the StockPlan, and the 2005 Plan (as described in Note 8) was estimated on the grantdate using the Black-Scholes valuation model with the following weightedaverage assumptions for the three months ended March 31, 2006:  an average assumed risk-free interest rate of4.52%, an expected term of five years, an average expected volatility of 42.82%,and an average dividend yield of 0.21%.

 

The Company bases its estimate of expected term on the historicalexercise and post-vesting employment termination behavior for similargrants.  The Company’s volatilityassumption is based on the historical volatility of the Company’s stock over aperiod equating to the expected term of the employee share option, using weeklyprice observations and looking backward from the date of grant.

 

The fair value of the option feature of grants under the 1997 EmployeeStock Purchase Plan (‘ESPP’) was estimated on the grant date using theBlack-Scholes valuation model with the following weighted average assumptionsfor the three months ended March 31, 2006: an average assumed risk-free interest rate of 4.40%, an expected term of0.5 years, an average expected volatility of 36.96%, and an average dividendyield of 0.25%.

 

9

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The expectedterm for the ESPP is equal to the six-month payment period.  The Company estimates expected volatility forthe ESPP in the same manner as for employee stock options, except that dailyvolatility is used instead of weekly volatility.  The Company uses daily volatility for theESPP because weekly volatility over six months does not result in astatistically significant number of data points upon which to base thevolatility calculation.

 

SFAS 123R alsorequires that any deferred compensation related to share-based awards grantedprior to January 1, 2006 must be eliminated against the appropriate equityaccounts.  In connection with the Company’sadoption of SFAS 123R, the presentation in the consolidated statement of stockholders’equity for the three months ended March 31, 2006 was revised to reflect thetransfer of balances previously reported in deferred compensation to surplus.

 

***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 dilutionthat could occur if contracts to issue common stock were exercised into commonstock that then shared in the earnings of the Company.  The reconciliation from Basic to Diluted EPSis as follows (Dollars in thousands, except per share data):

 

| ** **                                   | ** ** | **For the Three Months  Ended March 31,** | ** ** |
|----------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                   | ** ** | **2006**                                  | ** ** | **2005** | ** ** |
|                                         |       |                                      |       |   |   |
| Income  available to common stockholders     |       | $                                         | 37,403     |   | $ | 40,948 |   |
|                                         |       |                                      |       |   |   |
| Basic  weighted-average shares outstanding   |       | 65,313,068                                |       | 66,718,362 |   |
| Dilutive  effect of stock options            |       | 1,911,009                                 |       | 1,899,129 |   |
| Diluted  weighted-average shares outstanding |       | 67,224,077                                |       | 68,617,491 |   |
|                                         |       |                                      |       |   |   |
| Earnings per  share:                         |       |                                      |       |   |   |
| Basic                                        |       | $                                         | 0.57       |   | $ | 0.61 |   |
|                                         |       |                                      |       |   |   |
| Diluted                                      |       | $                                         | 0.56       |   | $ | 0.60 |   |

 

There were 91,737 and 5,950 options which were not considered dilutivefor purposes of EPS calculations for the three-month periods ended March 31,2006 and 2005, respectively.

 

**3.             Securities**

 

Amortized cost amounts and fair values of securities are summarized asfollows as of March 31, 2006 (Dollars in thousands):

 
| **Held to Maturity**              | ** ** | **Amortized  Cost** | ** ** | **Unrealized  Gains** | ** ** | **Unrealized  (Losses)** | ** ** | **Fair  Value** | ** ** |
|-----------------------------------|------------|---------------------|------------|-----------------------|------------|--------------------------|------------|-----------------|------------|
|                              |       |                |       |                  |       |                     |       |            |       |
| Mortgage-backed  securities       |       | $                   | 4,223,936  |                  | $          | 10,676                   |       | $               | (44,121    | ) | $ | 4,190,491 |   |
| Federal  agency securities        |       | 2,162,731           |       | 1,396                 |       | (23,280                  | )          | 2,140,847       |       |
| State and  political subdivisions |       | 109,484             |       | 3,974                 |       | (110                     | )          | 113,348         |       |
|                              |       |                |       |                  |       |                     |       |            |       |
| Total                             |       | $                   | 6,496,151  |                  | $          | 16,046                   |       | $               | (67,511    | ) | $ | 6,444,686 |   |

 
| ** **                        | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair**  | ** ** |
|-----------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|-----------|------------|
| **Available for Sale**            | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **(Losses)**   | ** ** | **Value** | ** ** |
|                              |       |          |       |           |       |           |       |      |       |
| Mortgage-backed  securities       |       | $             | 3,913,360  |           | $          | 3,522          |       | $         | (58,244    | ) | $ | 3,858,638 |   |
| State and  political subdivisions |       | 429,646       |       | 3,773          |       | (5,097         | )          | 428,322   |       |
| Corporate  debt                   |       | 201,410       |       | 624            |       | (1,367         | )          | 200,667   |       |
| Foreign  government securities    |       | 10,550        |       | —         |       | (26            | )          | 10,524    |       |
|                              |       |          |       |           |       |           |       |      |       |
| Total                             |       | $             | 4,554,966  |           | $          | 7,919          |       | $         | (64,734    | ) | $ | 4,498,151 |   |

 

10

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

 
| ** **                        | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | ** **     | ** ** |
|-----------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|----------------|------------|
| **Held to Maturity**              | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **(Losses)**   | ** ** | **Fair Value** | ** ** |
|                              |       |          |       |           |       |           |       |           |       |
| Mortgage-backed  securities       |       | $             | 4,342,254  |           | $          | 11,420         |       | $              | (29,818    | ) | $ | 4,323,856 |   |
| Federal  agency securities        |       | 2,305,331     |       | 1,560          |       | (23,914        | )          | 2,282,977      |       |
| State and  political subdivisions |       | 114,345       |       | 4,646          |       | (95            | )          | 118,896        |       |
|                              |       |          |       |           |       |           |       |           |       |
| Total                             |       | $             | 6,761,930  |           | $          | 17,626         |       | $              | (53,827    | ) | $ | 6,725,729 |   |

 
| ** **                        | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | ** **     | ** ** |
|-----------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|----------------|------------|
| **Available for Sale**            | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **(Losses)**   | ** ** | **Fair Value** | ** ** |
|                              |       |          |       |           |       |           |       |           |       |
| Mortgage-backed  securities       |       | $             | 3,810,797  |           | $          | 3,882          |       | $              | (48,578    | ) | $ | 3,766,101 |   |
| State and  political subdivisions |       | 388,789       |       | 5,515          |       | (1,913         | )          | 392,391        |       |
| Corporate  debt                   |       | 201,499       |       | 736            |       | (1,543         | )          | 200,692        |       |
| Foreign  government securities    |       | 10,539        |       | —         |       | (3             | )          | 10,536         |       |
|                              |       |          |       |           |       |           |       |           |       |
| Total                             |       | $             | 4,411,624  |           | $          | 10,133         |       | $              | (52,037    | ) | $ | 4,369,720 |   |

 

The carrying value of securities pledged amounted to approximately $7.7billion and $7.5 billion at March 31, 2006 and December 31, 2005, respectively.  Securities are pledged primarily to secureclearings with other depository institutions, to secure repurchase agreementsand to secure outstanding 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, 2006, nosecurities were considered to be other-than-temporarily impaired.

 

**4.             Loans**

 

Loans consist of demand loans to custody clients of the Company,including individuals, not-for-profit institutions and mutual fundclients. The loans to mutual funds and other pooled product clients includelines of credit and advances pursuant to the terms of the custody agreementsbetween the Company and those clients to facilitate securities transactions andredemptions. Almost all of the Company’s commitments to fund loans are atvariable rates.  Generally, the loansare, or may be, in the event of default, collateralized with marketablesecurities held by the Company as custodian.  There were no impaired loans, nonperformingloans or loans on nonaccrual status at March 31, 2006 and December 31, 2005.  In addition, there were no loan charge-offsor recoveries during the three months ended March 31, 2006 or 2005.  Loans are summarized as follows (Dollars inthousands):

 

| ** **                      | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|---------------------------------|------------|---------------------|------------|------------------------|------------|
|                            |       |                |       |                   |       |
| Loans to  mutual funds          |       | $                   | 217,129    |                   | $          | 286,144 |   |
| Loans to  individuals           |       | 55,531              |       | 81,392                 |       |
| Loans to  others                |       | 35,361              |       | 34,934                 |       |
|                            |       | 308,021             |       | 402,470                |       |
| Less  allowance for loan losses |       | (100                | )          | (100                   | )          |
|                            |       |                |       |                   |       |
| Total                           |       | $                   | 307,921    |                   | $          | 402,370 |   |

 

In January 2006, the Company entered into a $30.0 million committedline of credit agreement with a series of trusts (‘the trusts’).  Edward F. Hines, a member of the Company’sBoard of Directors, is a trustee of the trusts and is a partner in the firmthat manages the assets held in the trusts. The line of credit is secured by assets of the trusts, which are held bythe Bank as custodian.  The primarysource of repayment of the loans is the proceeds from the sale of investmentsin the normal course of the trusts’ business. The terms and conditions of the Company’s contractual agreement with thetrusts, including collateral requirements, lending limits and fees, areconsistent with other lending clients that have similar composition, size andoverall

 

11

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business relationships with the Company.  Mr. Hines abstains from voting on any boardmatter involving the proposed transactions with the trusts.  There were no amounts outstanding on thiscommitted line of credit agreement at March 31, 2006.

 

**5.             Deposits**

 

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

 
| ** **                         | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|------------------------------------|------------|---------------|------------|------------------|------------|
| ** **                         | ** ** | **2006**      | ** ** | **2005**         | ** ** |
| Interest-bearing deposits:         |       |          |       |             |       |
| Demand                             |       | $             | 85,746     |             | $          | 85,157 |   |
| Savings                            |       | 4,448,167     |       | 4,195,486        |       |
| Time                               |       | 68,141        |       | 55,124           |       |
| Total interest-bearing deposits    |       | 4,602,054     |       | 4,335,767        |       |
|                               |       |          |       |             |       |
| Noninterest-bearing deposits:      |       |          |       |             |       |
| Demand                             |       | 559,138       |       | 452,401          |       |
| Savings                            |       | 63,499        |       | 29,422           |       |
| Time                               |       | 200,000       |       | 175,000          |       |
| Total noninterest-bearing deposits |       | 822,637       |       | 656,823          |       |
|                               |       |          |       |             |       |
| Total                              |       | $             | 5,424,691  |             | $          | 4,992,590 |   |

 

Time deposits with balances greater than $100,000 totaled $268.1 millionand $230.1 million at March 31, 2006 and December 31, 2005, respectively.  All time deposits had a maturity of less thanthree months at March 31, 2006 and December 31, 2005. The aggregate amounts ofoverdraft deposits that have been reclassified as loan balances were $135.9million and $162.2 million at March 31, 2006 and December 31, 2005,respectively.

 

**6.             Securities SoldUnder Repurchase Agreements**

 

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

 
| ** **                          | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|---------------|------------|------------------|------------|
| ** **                          | ** ** | **2006**      | ** ** | **2005**         | ** ** |
|                                |       |          |       |             |       |
| Repurchase  agreements - short term |       | $             | 4,342,011  |             | $          | 4,297,868 |   |
| Repurchase  agreements - long term  |       | 450,000       |       | 500,000          |       |
| Total                               |       | $             | 4,792,011  |             | $          | 4,797,868 |   |

 

Approximately $4.9 billion of securities were pledged to collateralizerepurchase agreements as of March 31, 2006 and December 31, 2005.

 

**7.             Short-term andOther Borrowings**

 

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

 
| ** **                                            | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------|------------|---------------|------------|------------------|------------|
| ** **                                            | ** ** | **2006**      | ** ** | **2005**         | ** ** |
|                                                  |       |          |       |             |       |
| Federal  Funds purchased                              |       | $             | 1,137,189  |             | $          | 810,511 |   |
| Federal Home  Loan Bank of Boston overnight           |       | —        |       | 400,000          |       |
| Federal Home  Loan Bank of Boston short-term advances |       | 50,000        |       | 146,000          |       |
| Treasury,  Tax and Loan account                       |       | 14            |       | 138              |       |
| Total                                                 |       | $             | 1,187,203  |             | $          | 1,356,649 |   |

 

The Company has borrowing arrangements with the FHLBB and the FederalReserve Discount Window, which have been utilized on an overnight andshort-term basis to satisfy funding requirements.  Approximately $1.0 billion of securities werepledged to collateralize FHLBB advances as of March 31, 2006 and December 31,2005, and approximately $1.6 and $1.4 billion of securities were pledged tocollateralize Federal Reserve Discount Window borrowings as of March 31, 2006and December 31, 2005, respectively.

 

12

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**8.             Stockholders’ Equity**

 

As of March 31, 2006, the Company’s capital stock consisted of1,000,000 shares of preferred stock and 175,000,000 shares of common stock, allwith 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 (the ‘2005 Plan’).  The 2005 Plan supersedes both the Stock Planand the Director Plan, both of which continue in effect only with regard tooptions outstanding under these plans.  Therewere no amendments to any plans during the three months ended March 31, 2006.

 

Cash receivedfrom options exercised under all share-based payment arrangements for the threemonths ended March 31, 2006 was $14.9 million. The actual tax benefit realized for the tax deductions related to theseexercises amounted to $2.5 million for the three months ended March 31, 2006.

 

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

 

Effective withthe start of the 2005 Plan, 45,703 shares of the Director Plan and 3,439,197shares of the Stock Plan were transferred to the 2005 Plan.  On April 14, 2005, the shareholders authorizedan additional 2,000,000 shares of common stock for issuance under the 2005Plan.

 

A summary of option activity under the Director Plan, the Stock Plan,and the 2005 Plan for the three months ended March 31, 2006, is as follows:

 
| **Options**                    | ** ** | **Number of  Options** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Weighted-  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|--------------------------------|------------|------------------------|------------|-----------------------------------------|------------|------------------------------------------------------|------------|---------------------------------|------------|
| ** **                     | ** ** | ** **             | ** ** | ** **                              | ** ** | ** **                                           | ** ** | ** **                      | **($000)** | ** ** |
| Outstanding at January 1, 2006 |       | 6,919,316              |       | $                                       | 31         |                                                 |       |                            |       |   |
| Granted                        |       | 18,107                 |       | 45                                      |       |                                                 |       |                            |       |
| Exercised                      |       | (492,805               | )          | 30                                      |       |                                                 |       |                            |       |
| Forfeited or expired           |       | (5,400                 | )          | 37                                      |       |                                                 |       |                            |       |
| Outstanding at March 31, 2006  |       | 6,439,218              |       | 31                                      |       | 6.1 years                                            |       | $                               | 104,170    |   |
|                           |       |                   |       |                                    |       |                                                 |       |                            |       |
| Exercisable at March 31, 2006  |       | 6,051,883              |       | $                                       | 30         |                                                 | 6.1 years  |                            | $          |  99,441 |   |

 

Theweighted-average grant-date fair values per option of options granted duringthe three months ended March 31, 2006 and 2005 were $19.24 and $19.71,respectively.  The total intrinsic valuesof options exercised during the three months ended March 31, 2006 and 2005 were$7.1 million and $4.0 million, respectively.

 

As of March31, 2006, there was $1.8 million of total unrecognized compensation costrelated to nonvested share-based compensation arrangements granted under theStock Plan, the Director Plan, and the 2005 Plan.  That cost is expected to be recognized over aweighted-average period of 9 months.

 

A summary of the status of the Company’s nonvested shares for the threemonths ended March 31, 2006 is presented below:

 

| **Nonvested Shares**          | ** ** | **Number of  Shares** | ** ** | **Weighted-Average  Grant-Date  Fair Value** | ** ** |
|-------------------------------|------------|-----------------------|------------|----------------------------------------------|------------|
| Nonvested at  January 1, 2006 |       | 5,000                 |       | $                                            | 34         |   |
| Granted                       |       | —                |       | —                                       |       |
| Vested                        |       | —                |       | —                                       |       |
| Forfeited                     |       | —                |       | —                                       |       |
| Nonvested at  March 31, 2006  |       | 5,000                 |       | $                                            | 34         |   |

 

13

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*ESPP*

 

Under the terms of the ESPP, the Company may issue up to 1,620,000shares of common stock pursuant to the exercise of nontransferable optionsgranted to participating employees.  TheESPP permits eligible employees to purchase up to 8,000 shares of common stockper payment period, subject to limitations provided by Section 423(b) ofthe Internal Revenue Code, through accumulated payroll deductions.  The purchases are made twice a year at a priceequal to the lesser of (i) 90% of the market value of the common stock onthe first business day of the payment period, or (ii) 90% of the marketvalue of the common stock on the last business day of the payment period.  The payment periods consist of two six-monthperiods, January 1 through June 30 and July 1 throughDecember 31.  During the year endedDecember 31, 2005, the purchase prices of the stock were $34.25 and $33.25, or90% of the market value of the Company’s common stock on the last business dayof the payment periods ending June 30, 2005 and December 31, 2005,respectively.

 

A summary of activity under the ESPP is as follows:

 
| ** **                                                  | ** ** | **For the Three** | ** ** | **For the**      | ** ** |
|-------------------------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                  | ** ** | **Months Ended**  | ** ** | **Year Ended**   | ** ** |
| ** **                                                  | ** ** | **March 31,**     | ** ** | **December 31,** | ** ** |
| ** **                                                  | ** ** | **2006**          | ** ** | **2005**         | ** ** |
|                                                        |       |              |       |             |       |
| Total shares  available under the plan, beginning of period |       | 521,563           |       | 636,267          |       |
| Issued at June 30                                           |       | —            |       | (54,862          | )          |
| Issued at December 31                                       |       | —            |       | (59,842          | )          |
|                                                        |       |              |       |             |       |
| Total shares  available under the plan, end of period       |       | 521,563           |       | 521,563          |       |

 

Prior to the adoption of SFAS 123R, the ESPP was considered anon-compensatory plan and, therefore, no compensation expense was recognized.  However, pursuant to SFAS 123R, the ESPP isconsidered a compensatory plan, effective January 1, 2006.  Accordingly, compensation cost is computed asthe sum of: (a) 10% of the fair market value of the Company’s common stock onthe first day of the purchase period; and (b) the fair value of the optionfeature, calculated using the Black-Scholes valuation model.  Compensation cost is recognized ratably overthe payment period based on the components of fair value in the precedingsentence and the number of shares that could be purchased at grant date basedon the estimated total withholdings and the discounted market price of thestock on grant date.  The weightedaverage grant date fair value of awards granted under the ESPP was $7.86 pershare for the three months ended March 31, 2006.

 

Compensation cost related to the ESPP was $0.2 million and $0 for thethree months ended March 31, 2006 and 2005, respectively.  As of March 31, 2006, there was $0.2 millionof total unrecognized compensation cost related to the nonvested awards grantedunder the ESPP.  That cost is expected tobe recognized over a weighted-average period of three months.

 

In July 2005, the Company announced that its Board of Directorsauthorized a repurchase plan of up to $150.0 million of the Company’s commonstock in the open market over the twelve months following theannouncement.  During the year endedDecember 31, 2005, the Company repurchased $70.7 million of its commonstock.  No shares were repurchased by theCompany during the three months ended March 31, 2006, and the Company does notanticipate repurchasing any additional shares before the plan expires in June2006.

 

**9.             Employee BenefitPlans**

 

***Pension Plan -***TheCompany has a trusteed, noncontributory, qualified defined benefit pension plan(‘Pension Plan’) covering substantially all of its employees who were hiredbefore January 1, 1997.  The benefits arebased on years of service and the employee’s compensation duringemployment.  Generally, the Company’sfunding policy is to contribute annually the maximum amount that can bededucted for federal income tax purposes. Contributions are intended to provide not only for benefits attributedto service to date, but also for benefits expected to be earned in the future.  The plan document was amended in December 2001and December 2004 to freeze benefit accruals for certain highly compensatedparticipants.  Effective January 1, 2006,no further Pension Plan benefit will accrue on behalf of any Pension Planparticipant, and effective December 31, 2005, all Pension Plan participant’saccounts were frozen.  The Company uses aDecember 31 measurement date for this plan.

 

14

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

 

| ** **                                          | ** ** | **For the Three Months Ended** | ** ** |
|-----------------------------------------------------|------------|--------------------------------|------------|
| ** **                                          | ** ** | **March 31, 2006**             | ** ** | **March 31, 2005** | ** ** |
|                                                |       |                           |       |   |   |
| Service  cost-benefits earned / benefit obligations |       | $                              | —     |   | $ | 186 |   |
| Interest  cost on projected benefit obligations     |       | 235                            |       | 286 |   |
| Expected  return on plan assets                     |       | (349                           | )          | (359 | ) |
| Net  amortization and deferral                      |       | 18                             |       | 78 |   |
| Net periodic  pension (benefit) cost                |       | $                              | (96        | ) | $ | 191 |   |

 

The Company does not expect to contribute to its Pension Plan during2006, and no contributions have been made as of March 31, 2006.

 

***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 Pension Plan.  Benefits under the SERP are generally basedon compensation not includable in the calculation of benefits to be paid underthe Pension Plan.  The plan document wasamended in April 2000 to eliminate the compensation cap and include bonuses andcommissions of certain employees.  TheCompany uses a December 31 measurement date for this plan.

 

Net periodic pension cost for the Company’s SERP included the followingcomponents (Dollars in thousands):

 

| ** **                                          | ** ** | **For the Three Months Ended** | ** ** |
|-----------------------------------------------------|------------|--------------------------------|------------|
| ** **                                          | ** ** | **March 31, 2006**             | ** ** | **March 31, 2005** | ** ** |
|                                                |       |                           |       |   |   |
| Service  cost-benefits earned / benefit obligations |       | $                              | 462        |   | $ | 444 |   |
| Interest  cost on projected benefit obligations     |       | 396                            |       | 368 |   |
| Net  amortization and deferral                      |       | 239                            |       | 272 |   |
| Net periodic  pension cost                          |       | $                              | 1,097      |   | $ | 1,084 |   |

 

At March 31, 2006, the SERP remained an unfunded plan.  The Company does not expect to contribute tothe SERP in 2006.

 

**10.          Off-BalanceSheet Financial Instruments**

 

***Lines of Credit -***AtMarch 31, 2006, the Company had commitments to mutual funds and individualsunder collateralized open lines of credit totaling $1.2 billion, against which$172.1 million in loans were drawn. The credit risk involved in issuing lines of credit is essentially thesame as that involved in extending demand loans.  The Company does not anticipate any loss as aresult of these lines of credit.

 

***Securities Lending -***On behalf of its clients, the Company lendssecurities to creditworthy broker-dealers. In certain circumstances, the Company may indemnify its clients for thefair market value of those securities against a failure of the borrower toreturn such securities.  The Companyrequires the borrowers to provide collateral in an amount equal to, or inexcess of, 102% of the fair market value of U.S. dollar-denominated securitiesborrowed and 105% of the fair market value of non-U.S. dollar-denominatedsecurities borrowed.  The borrowedsecurities are revalued daily to determine whether additional collateral isnecessary.  As guarantor, the Company isrequired to recognize, at the inception of a guarantee, a liability for thefair value of the obligation undertaken in issuing the guarantee.  The Company measures the fair value of itsindemnification obligation by marking its securities lending portfolio tomarket on a daily basis and comparing the value of the portfolio to thecollateral holdings position.  The fairvalue of the indemnification obligation to be recorded would be the deficiencyof collateral as compared to the value of the securities out on loan.

 

With respect to the indemnified securities lending portfolio, the cashand U.S. government securities held by the Company as collateral at March 31,2006 totaled $8.4 billion, while the fair value of the indemnified securitieslending portfolio totaled approximately $8.1 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 maximum potential amount of futurepayments that the Company could be required to make would be equal to themarket value of the securities borrowed.  Since the securities loans areovercollateralized by 2% (for U.S. dollar- denominated securities) to 5% (fornon-U.S. dollar-denominated securities) of the fair market value of the loanmade, the collateral held by the Company would be used to satisfy theobligation.  In addition,

 

15

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each borrowing agreement includes “set-off” language that allows theCompany to use any excess collateral on other loans to that borrower to coverany collateral shortfall of that borrower. However, there is a potential risk that the collateral would not besufficient to cover such an obligation if the security on loan increased invalue between the time the borrower defaulted and the time the security is “bought-in.”  In those instances, the Company would “buy-in”the security using all available collateral and a loss would result from thedifference between the value of the security “bought-in” and the value of thecollateral held.  The Company has neverexperienced a broker default.

 

**11.          Derivative Financial 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.  The Company’s exposure from these interestrate contracts results from the possibility that one party may default on itscontractual obligation when the contracts are in a gain position.  The Company has experienced no terminationsby counterparties of interest rate swaps. Credit risk is limited to the positive fair value of the derivativefinancial instrument, which is significantly less than the notional value.  As of March 31, 2006, the positive fair valuerelated to the Company’s interest rate contracts was approximately $29.5million.

 

The Company enters into pay-fixed/receive-floating interest rate swapagreements.  These instruments have beendesignated as cash flow hedges of variable-rate liabilities and a forecastedseries of fixed-rate overnight liabilities incurred at different daily fixedrates (thereby resulting in a variable interest expense pattern).  The contractual or notional amounts of theinterest rate swap agreements held by the Company were approximately $1.9billion at March 31, 2006 and December 31, 2005.  These contracts had net fair values ofapproximately $29.5 million and $24.2 million at March 31, 2006 and December31, 2005, respectively.  These fairvalues are included in the respective other assets and other liabilitiescategories on the Company’s consolidated balance sheets.

 

Hedge ineffectiveness did not have a material impact on earnings forthe three months ended March 31, 2006.  Forthe three months ended March 31, 2005, the Company recognized net pre-tax gainsof $2.3 million, respectively, which represented the total ineffectiveness forall cash flow hedges.

 

As of March 31, 2006, the Company expects that approximately $11.6million 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 expectationis based on the net discounted cash flows from existing cash flow hedging derivatives,as well as the amortization of gains from the terminated cash flow hedgingderivatives.

 

***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 valueof the Company’s foreign exchange contracts at March 31, 2006 and December 31, 2005was $8.1 billion and $6.3 billion, respectively.  Unrealized gains or losses resulting frompurchases and sales of foreign exchange contracts are included within therespective other assets and other liabilities categories on the Company’sconsolidated balance sheets.  Unrealized gainsin other assets were $22.1 million and $20.8 million at March 31, 2006 and December31, 2005, respectively.  Unrealizedlosses in other liabilities were $21.0 million and $19.7 million at March 31,2006 and December 31, 2005, respectively. Foreign exchange contracts with the same counterparty are netted in theCompany’s consolidated balance sheets when a master netting agreementexists.  These contracts have not beendesignated as hedging instruments; therefore, all changes in fair value areincluded in asset servicing fees.

 

***Other*** - The Companyalso enters into fixed price purchase contracts that are designed to hedge thevariability of the consideration to be paid for the purchase of investmentsecurities.  By entering into thesecontracts, the Company is fixing the price to be paid at a future date forcertain investment securities.  At March31, 2006 the Company had no fixed price purchase contracts outstanding topurchase investment securities.  At December31, 2005, the Company had $97.5 million of fixed price purchase contractsoutstanding to purchase investment securities. Changes in fair value of these cash flow hedges are included as acomponent of other comprehensive income.

 

16

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

 

***Restrictions on Cash Balances***- The Company is required to maintain certain average cash reservebalances.  The average required reservebalance with the FRB for the two-week period including March 31, 2006 wasapproximately $33.7 million.  Inaddition, the Company’s balance sheet includes deposits totaling $39.6 million,which were pledged to secure clearings with depository institutions as of March31, 2006.

 

***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, 2006 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, 2006, that the Company and the Bankmeet all capital adequacy requirements to which they are subject.

 

As of March 31, 2006, the most recent notification from the FederalDeposit Insurance Corporation categorized the Company and the Bank aswell-capitalized under the regulatory framework for prompt correctiveaction.  To be categorized as well-capitalized,the Company and the Bank must maintain minimum Total risk-based, Tier 1risk-based, and Tier 1 leverage ratios as set forth in the table.  There are no conditions or events since thatnotification that management believes have changed the Company’s or the Bank’scategory.

 

17

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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, 2006:**                              | ** ** | ** ** | ** ** | ** **                         | ** ** | ** **                                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total Capital  (to Risk-Weighted Assets-the Company)   |       | $          | 785,679    |                               | 19.01      | %                                                                       |       | $ | 330,651 |   | 8.00 | % |   | N/A |   | N/A |   |
| Total Capital  (to Risk-Weighted Assets-the Bank)      |       | $          | 760,757    |                               | 18.41      | %                                                                       |       | $ | 330,597 |   | 8.00 | % |   | $ | 413,246 |   | 10.00 | % |
| Tier 1 Capital  (to Risk-Weighted Assets-the Company)  |       | $          | 785,579    |                               | 19.01      | %                                                                       |       | $ | 165,326 |   | 4.00 | % |   | N/A |   | N/A |   |
| Tier 1 Capital  (to Risk-Weighted Assets-the Bank)     |       | $          | 760,657    |                               | 18.41      | %                                                                       |       | $ | 165,299 |   | 4.00 | % |   | $ | 247,948 |   | 6.00 | % |
| Tier 1 Capital  (to Average Assets-the Company)        |       | $          | 785,579    |                               | 6.52       | %                                                                       |       | $ | 482,082 |   | 4.00 | % |   | N/A |   | N/A |   |
| Tier 1 Capital  (to Average Assets-the Bank)           |       | $          | 760,657    |                               | 6.31       | %                                                                       |       | $ | 482,001 |   | 4.00 | % |   | $ | 602,501 |   | 5.00 | % |
|                                                   |       |       |       |                               |       |                                                                    |       |   |   |   |   |   |   |   |   |
| **As of December 31, 2005:**                           | ** ** | ** ** | ** ** | ** **                         | ** ** | ** **                                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total Capital  (to Risk-Weighted Assets-the Company)   |       | $          | 731,833    |                               | 18.50      | %                                                                       |       | $ | 316,553 |   | 8.00 | % |   | N/A |   | N/A |   |
| Total Capital  (to Risk-Weighted Assets-the Bank)      |       | $          | 720,113    |                               | 18.21      | %                                                                       |       | $ | 316,349 |   | 8.00 | % |   | $ | 395,436 |   | 10.00 | % |
| Tier 1 Capital   (to Risk-Weighted Assets-the Company) |       | $          | 731,733    |                               | 18.49      | %                                                                       |       | $ | 158,276 |   | 4.00 | % |   | N/A |   | N/A |   |
| Tier 1 Capital   (to Risk-Weighted Assets-the Bank)    |       | $          | 720,013    |                               | 18.21      | %                                                                       |       | $ | 158,174 |   | 4.00 | % |   | $ | 237,262 |   | 6.00 | % |
| Tier 1 Capital   (to Average Assets-the Company)       |       | $          | 731,733    |                               | 5.95       | %                                                                       |       | $ | 491,685 |   | 4.00 | % |   | N/A |   | N/A |   |
| Tier 1 Capital   (to Average Assets-the Bank)          |       | $          | 720,013    |                               | 5.86       | %                                                                       |       | $ | 491,549 |   | 4.00 | % |   | $ | 614,437 |   | 5.00 | % |

 

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, LLC (‘ISS’), 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, 2006,that ISS is in material compliance with all of the foregoing requirements towhich it is subject.

 

The operations of the Company’s captive insurance affiliate, InvestorsVermont Insurance Company (‘IVIC’), are subject to the laws and regulations ofthe State of Vermont Department of Banking, Insurance, Securities and Health CareAdministration.  Management believes, asof March 31, 2006, that IVIC is in material compliance with all of the foregoingrequirements to which it is subject.

 

In June 2004, theBasel Committee on Banking Supervision (‘Basel Committee’) released thedocument “International Convergence of Capital Measurement and CapitalStandards: A Revised Framework”.  TheFramework, also referred to as Basel II, is designed to secure internationalconvergence on regulations and standards governing the capital adequacy ofinternationally active banking organizations. In September 2005, the FFIEC (U.S. banking and thrift supervisoryagencies) revised guidance on the timing and qualification process for U.S.banks that will become subject to Basel II. The new rules as applied in the U.S. are expected to becomeeffective on January 1, 2009, subject to transitional parallel testingbeginning on January 1, 2008. Although the Company is not required to be compliant with the new rules,the Company has developed an implementation program to achieve Basel IIcompliance.  Ultimately, U.S.implementation of Basel II will depend on, and will be subject to, final regulationsand related policies promulgated by the FFIEC supervisory agencies.  The Company cannot predict the final form ofthe rules, nor their impact on the Company’s risk-based capital.

 

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

 

The Company does not utilize segment information for internal reporting,as 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**         | ** ** | **Long-Lived Assets** | ** ** |
|----------------------------|------------|-----------------------------------|------------|-----------------------|------------|
| ** **                 | ** ** | **Three Months Ended  March 31,** | ** ** | **March 31,**         | ** ** | **December 31,** | ** ** |
| **Geographic Information** | ** ** | **2006**                          | ** ** | **2005**              | ** ** | **2006** | ** ** | **2005** | ** ** |
| United  States             |       | $                                 | 180,758    |                  | $          | 157,739 |   | $ | 149,244 |   | $ | 141,810 |   |
| Ireland                    |       | 10,411                            |       | 8,641                 |       | 8,170 |   | 6,325 |   |
| Canada                     |       | 1,508                             |       | 1,367                 |       | 331 |   | 385 |   |
| Cayman  Islands            |       | 41                                |       | 42                    |       | — |   | — |   |
| United  Kingdom            |       | 70                                |       | —                |       | 1,531 |   | 850 |   |
| Luxembourg                 |       | —                            |       | —                |       | — |   | — |   |
|                       |       |                              |       |                  |       |   |   |   |   |
| Total                      |       | $                                 | 192,788    |                  | $          | 167,789 |   | $ | 159,276 |   | $ | 149,370 |   |

 

Barclays Global Investors, N.A. (‘BGI’) accounted for approximately 18%and 17% of the Company’s consolidated net operating revenues for the three-monthperiods ended March 31, 2006 and 2005, respectively.  No client other than BGI accounted for morethan 10% of the Company’s consolidated net operating revenues for the three-monthperiods ended March 31, 2006 and 2005.

 

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

 
| ** **                             | ** ** | **For the Three Months Ended  March 31,** | ** ** |
|----------------------------------------|------------|-------------------------------------------|------------|
| ** **                             | ** ** | **2006**                                  | ** ** | **2005** | ** ** |
| Core service  fees:                    |       |                                      |       |   |   |
| Custody, accounting and administration |       | $                                         | 107,759    |   | $ | 88,544 |   |
|                                   |       |                                      |       |   |   |
| Value-added  service fees:             |       |                                      |       |   |   |
| Foreign exchange                       |       | 20,334                                    |       | 13,249 |   |
| Cash management                        |       | 11,312                                    |       | 7,364 |   |
| Securities lending                     |       | 6,162                                     |       | 3,680 |   |
| Investment advisory                    |       | 1,936                                     |       | 1,715 |   |
| Other service fees                     |       | 800                                       |       | 651 |   |
| Total value-added service fees         |       | 40,544                                    |       | 26,659 |   |
|                                   |       |                                      |       |   |   |
| Total asset  servicing fees            |       | $                                         | 148,303    |   | $ | 115,203 |   |

 

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**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,** | ** ** |
|----------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                     | ** ** | **2006**                                  | ** ** | **2005** | ** ** |
| Interest  income:                                              |       |                                      |       |   |   |
| Federal Funds sold and other short-term  investments           |       | $                                         | 478        |   | $ | 363 |   |
| Investment securities held to maturity and  available for sale |       | 129,750                                   |       | 96,132 |   |
| Loans                                                          |       | 4,209                                     |       | 1,560 |   |
| Total interest income                                          |       | 134,437                                   |       | 98,055 |   |
| Interest expense:                                              |       |                                      |       |   |   |
| Deposits                                                       |       | 33,687                                    |       | 15,245 |   |
| Securities sold under repurchase agreements                    |       | 40,954                                    |       | 26,354 |   |
| Short-term and other borrowings                                |       | 15,870                                    |       | 8,238 |   |
| Junior subordinated debentures                                 |       | 605                                       |       | 605 |   |
| Total interest expense                                         |       | 91,116                                    |       | 50,442 |   |
|                                                           |       |                                      |       |   |   |
| Net interest income                                            |       | $                                         | 43,321     |   | $ | 47,613 |   |

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Stockholders

of Investors Financial Services Corp.

 

We have reviewed the accompanying consolidated balance sheet ofInvestors Financial Services Corp. and subsidiaries (the “Company”) as of March31, 2006, and the related consolidated statements of income and comprehensiveincome, stockholders’ equity and cash flows for the three-month periods endedMarch 31, 2006 and 2005.  These interimfinancial statements are the responsibility of the Company’s management.

 

We conducted our reviews in accordance with the standards of the PublicCompany Accounting Oversight Board (United States).  A review of interim financial informationconsists principally of applying analytical procedures and making inquiries ofpersons responsible for financial and accounting matters.  It is substantially less in scope than anaudit conducted in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the objective of which is theexpression of an opinion regarding the financial statements taken as awhole.  Accordingly, we do not expresssuch an opinion.

 

Based on our reviews, we are not aware of any material modificationsthat should be made to such consolidated interim financial statements for themto be in conformity with accounting principles generally accepted in the UnitedStates of America.

 

As discussed in Note 2 to the consolidated financial statements, theCompany changed its method of accounting for share-based compensation.

 

We have previously audited, in accordance with the standards of thePublic Company Accounting Oversight Board (United States), the consolidatedbalance sheet of the Company and subsidiaries as of December 31, 2005, and therelated consolidated statements of income, stockholders’ equity, and cash flowsfor the year then ended (not presented herein); and in our report dated March2, 2006, we expressed an unqualified opinion on those consolidated financialstatements.  In our opinion, the informationset forth in the accompanying consolidated balance sheet as of December 31,2005 is fairly stated, in all material respects, in relation to theconsolidated balance sheet from which it has been derived.

 

DELOITTE & TOUCHE LLP

 
| s/Deloitte & Touche LLP |   |
|-----------------------------|--------|
| Boston, Massachusetts       |
| May 4, 2006                 |

 

21

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

** **

*You shouldread the following discussion together with our Unaudited ConsolidatedFinancial Statements and related Notes to Unaudited Consolidated FinancialStatements, which are included elsewhere in this Report.  The following discussion containsforward-looking statements that reflect plans, estimates and beliefs.  Our actual results could differ materiallyfrom those discussed in the forward-looking statements.  See “Certain Factors That May Affect FutureResults.”*

 

*Unlessotherwise indicated or unless the context requires otherwise, all references inthis Report to “Investors Financial,” “we,” “us,” “our,” or similar referencesmean Investors Financial Services Corp., together with our subsidiaries. “InvestorsBank” or the “Bank” means our subsidiary, Investors Bank & Trust Company,alone.*

 

**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 fundadministration.  Value-added servicesinclude securities lending, foreign exchange, cash management, performancemeasurement, institutional transfer agency, investment advisory services, linesof credit and brokerage and transition management services.  We have offices located in the United States,Ireland, Canada, the Cayman Islands, the United Kingdom and Luxembourg with avast global subcustodian network established to accommodate the internationalneeds of our clients.  At March 31, 2006,we provided services for approximately $1.9 trillion in net assets, includingapproximately $0.4 trillion in foreign net assets.

 

Wegrow our business by selling our services to new clients and by furtherpenetrating our existing clients.  We believe that we serviceapproximately 10% of the assets managed by our existing clients, and we havetraditionally achieved significant success in growing clientrelationships.  Our ability to service new clients and expand ourrelationships with existing clients depends on our provision of superior clientservice.  Our growth is also affected by conditions in the global securitiesmarkets, the interest rate environment, the regulatory environment for us andour clients and the success of our clients in marketing their products.

 

We derive our asset servicing revenue from providing core andvalue-added services.  We derive our net interest income by investing thecash balances our clients leave on deposit with us.  Since we price ourservice offerings on a bundled basis, our share of earnings from theseinvestments is viewed as part of the total compensation that our clients pay usfor servicing their assets.  In establishing a fee structure for aspecific client, we analyze all expected revenue and expenses.  We believenet operating revenue (net interest income plus noninterest income) and netincome are the most meaningful measures of our financial results.

 

As anasset administration services company, the amount of net operating revenue thatwe generate is impacted by overall market conditions, client activity and theprevailing interest rate environment.  A significant portion of our coreservices revenue is based upon the amount of assets we process.  As marketvalues of underlying assets fluctuate, so will our revenue.  We havemanaged this volatility by offering a tiered pricing structure for ourasset-based fees.  As asset values increase, the basis point fee isreduced for the incremental assets.  When asset values decrease, revenueis only impacted at the then marginal rate.  Many of our value-addedservices are transactional based, and we receive a fee for each transactionprocessed.  We have continued to experience net interest margin pressure duringthe first three months of 2006 due to a relatively flat yield curve, lowerreinvestment spreads and the liability sensitive nature of our balancesheet.  Because we are a liability sensitive institution, as overnightinterest rates rise, most of our liabilities reprice but our assets take longerto reprice due to the nature of their reset provisions (i.e., monthly,quarterly and annually).  The lower interest rate spreads were also due tothe narrowing of market spreads on reinvestment and purchase opportunities forfixed and floating-rate investment assets.  In the next three months of 2006, we expect tosee short-term rates continue to rise and the yield curve to remain flat,without a sustained inversion.

 

Weremain focused on our sales efforts, prudent expense management and increasingour operating efficiency.  These goals are complicated by the need tobuild infrastructure to support our growth, the need to maintain state-of-the-artsystems and the need to retain and motivate our workforce.  Due to this need to invest for future growth,our operating margins are expected to decrease in the short term from theirprior historical levels.

 

22

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**CertainFactors That May Affect Future Results**

 

From time to time, information provided by us, statements made by ouremployees, or information included in our filings with the Securities ExchangeCommission (‘SEC’) (including this Form 10-Q) may contain statements which arenot historical facts, so-called “forward-looking statements,” which are madeunder Section 21E of the Securities Exchange Act of 1934 and which involverisks and uncertainties.  Thesestatements relate to future events or our future financial performance and areidentified by words such as “may,” “could,” “should,” “expect,” “plan,” “intend,”“seek,” “anticipate,” “believe,” “estimate,” “potential,” or “continue” orother comparable terms or the negative of those terms.  Forward-looking statements in this Form 10-Qinclude certain statements regarding liquidity, capital resources, growth rate,annual dividend payments, interest rate conditions, the shape of the yieldcurve, interest rate sensitivity, compliance with capital adequacy guidelines,loss exposure on lines of credit, foreign exchange revenue, cash managementrevenue, securities lending revenue, net interest income, operating margin, operatingexpenses, including occupancy expenses and needs, transaction processingservices expense, professional fee expense, compensation expense, travel andsales expense, investments in technology, pension plan and supplemental pensionexpense, depreciation expense, investments in Federal Home Loan Bank of Boston(‘FHLBB’) capital stock, the effect on earnings of changes in equity values orfixed income values, the effects of increased prepayments and reducedinvestment opportunities for our net interest income, the effect of anyanticipated activity under our stock repurchase plan, contributing to oursupplemental retirement plan and the effect of certain legal claims againstus.  Our actual future results may differsignificantly from those stated in any forward-looking statements.  Factors that may cause such differences include,but are not limited to, the factors discussed in Item 1A of this Form 10-Q andour Form 10-K filed on March 2, 2006.

 

**Statements of Income**

 

***Comparisonof Operating Results for the Three Months Ended March 31, 2006 and 2005***

 

Net income for the three months ended March 31, 2006 decreased 9% to $37.4million from the same period in 2005.  Thedecrease primarily resulted from continued pressure on our net interest marginas well as increased operating expenses. The decrease in net income for the three-month period was partiallyoffset by increased asset servicing fees, reflecting our ability to sell to newand existing clients combined with market appreciation and strong client fundflows.

 

*Fees and Other Revenue*

 

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

 

| ** **                    | ** ** | **For the Three Months Ended  March 31,** | ** ** |
|-------------------------------|------------|-------------------------------------------|------------|
| ** **                    | ** ** | **2006**                                  | ** ** | **2005** | ** ** | **Change** | ** ** |
|                          |       |                                      |       |   |   |   |   |
| Total asset  servicing fees   |       | $                                         | 148,303    |   | $ | 115,203 |   | 29 | % |
| Other  operating income       |       | 1,164                                     |       | 785 |   | 48 | % |
| Gain on sale  of investments  |       | —                                    |       | 4,188 |   | (100 | )% |
|                          |       |                                      |       |   |   |   |   |
| Total fees  and other revenue |       | $                                         | 149,467    |   | $ | 120,176 |   | 24 | % |

 

The largest components ofasset servicing fees are custody, accounting and administration fees, whichincreased 22% to $107.8 million for the three-month period ended March 31, 2006from $88.5 million for the same period in 2005. Custody, multicurrency accounting and fund administration fees are basedin part on the value of assets processed. Assets processed is the total dollar value of financial assets on thereported date for which we provide one or more of the following services:middle office outsourcing, global custody, multicurrency accounting, fundadministration, securities lending, foreign exchange, cash management,performance measurement, institutional transfer agency, investment advisoryservices, lines of credit and brokerage and transition management services.

 

23

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

 

 

| ** **                                 | ** ** | **For the Three Months Ended** | ** ** |
|--------------------------------------------|------------|--------------------------------|------------|
| ** **                                 | ** ** | **March 31, 2006**             | ** ** |
| Net assets  processed, beginning of period |       | $                              | 1,793      |   |
| Change in  net assets processed:           |       |                           |       |
| Sales to new clients                       |       | 1                              |       |
| Further penetration of existing clients    |       | 2                              |       |
| Lost clients                               |       | —                         |       |
| Fund flows and market gain                 |       | 134                            |       |
| Total change in net assets processed       |       | 137                            |       |
| Net assets  processed, end of period       |       | $                              | 1,930      |   |

 

The majority of the increase in assets processed for the three-monthperiod ended March 31, 2006 was due to client fund flows and market movements.  As indicated in the ‘Overview’ section, ourcore services fees are primarily generated by charging a fee based upon thevalue of assets processed.  As marketvalues or clients’ asset levels fluctuate, so will our revenue.  Our tiered pricing structure, coupled withminimum and flat fees, allow us to manage this volatility to a certainextent.  As asset values increase, thebasis point fee typically lowers.  Whenasset values decrease, revenue is only impacted by the asset decline at thethen marginal rate.

 

If the value of equity or fixed income assets held by our clients wereto increase or decrease by 10% for a sustained period of time, we estimatecurrently that this market movement, by itself, would cause a correspondingchange of less than 5% in our earnings per share.  Earnings per share do not track precisely tothe value of the equity and fixed-income markets because conditions present ina market increase or decrease may generate offsetting increases or decreases inother revenue and expense items that are influenced by the value of the assetswe administer.  For example, increasedmarket volatility often results in higher transaction fee revenue.  Also, market value declines may result inincreased interest income and sweep fee income as clients move larger amountsof assets into the cash management vehicles that we offer.  In addition, our tiered pricing structurereduces the impact of volatility in asset values to a certain extent.  However, there can be no assurance that anyof these offsetting revenue and expense movements will occur during any futureupturn or downturn in the equity or fixed-income markets, or that our tieredpricing structure will reduce the impact on us of a sustained change in assetvalues.

 

Transaction-driven income includes our value-added services, such asforeign exchange, cash management, securities lending and investment advisoryservices.

 

•                  Foreignexchange fees were $20.3 million for the three-month period ended March 31, 2006,up 53% from the same period in 2005.  Theincrease in foreign exchange fees is attributable to new business, increasedvolume of client activity and volatility in currency markets.  Future foreign exchange income is dependenton the volume of new and existing client activity and overall volatility in thecurrencies traded.  Although we expectsome growth in foreign exchange fees, we do not expect them to remain this highon a quarterly basis for 2006.

 

•                  Cash managementfees, which consist of sweep fees, were $11.3 million for the three monthsended March 31, 2006, up 54% from the same period in 2005.  The increase is primarily due to higher balancesplaced by our clients in the cash management products we offer.  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 higher cash balances than they did incomparable periods, we expect our cash management revenue to be positivelyimpacted.

 

•                  Securitieslending fees were $6.2 million for the three-month period ended March 31, 2006,up 67% from the same period in 2005, primarily due to new business, highervolumes and improved market conditions.  Securitieslending transaction volume is positively affected by the market value ofsecurities on loan, merger and acquisition activity, increased IPO activity anda steeper short end of the yield curve. If the capital markets experience any of the aforementioned activity, itis likely that our securities lending revenue will be positively impacted.  If we experience a reduction in oursecurities lending portfolio, lower market values and compression of thespreads earned on securities lending activity, our securities lending revenuewill likely be negatively impacted.

 

•                  Investment advisoryfees were $1.9 million for the three-month period ended March 31, 2006, up 13%from the same period in 2005.  The increasein investment advisory fees is attributable to higher asset levels in ourproprietary Merrimac money market funds as well as discontinuing advisory feewaivers during the second quarter of 2005. Future investment advisory fee income is dependent upon asset levelswithin the Merrimac money market funds, which are driven by overall marketconditions, client activity and transaction volumes.

 

24

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•                  Other servicefees were $0.8 million for the three months ended March 31, 2006, up 23% fromthe same period in 2005.  Other servicefees include income earned on compliance advisory, brokerage and transitionmanagement services.  The increase inother service fees for the three-month period is primarily due to an increasein transition management service fees.

 

•                  Other operatingincome for the three months ended March 31, 2006 was $1.2 million, up 48% fromthe same period in 2005.  The increase isprimarily due to an increase in stock dividend income from FHLBB stock, due tohigher interest rates.

 

During the first three months of 2005, we sold municipal securitiesheld in our available for sale portfolio, resulting in the recognition of $4.2million in gains for the three-month period ended March 31, 2005.  The proceeds of the sales were reinvested insecurities that offer a more attractive after-tax yield.

 

*Net Interest Income*

 

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

 

| ** **           | ** ** | **For the Three Months Ended  March 31,** | ** ** |
|----------------------|------------|-------------------------------------------|------------|
| ** **           | ** ** | **2006**                                  | ** ** | **2005** | ** ** | **Change** | ** ** |
|                 |       |                                      |       |   |   |   |   |
| Interest  income     |       | $                                         | 134,437    |   | $ | 98,055 |   | 37 | % |
| Interest  expense    |       | 91,116                                    |       | 50,442 |   | 81 | % |
| Net interest  income |       | $                                         | 43,321     |   | $ | 47,613 |   | (9 | )% |

 

Netinterest income is affected by the volume and mix of assets and liabilities andthe movement and level of interest rates.  The decrease in our netinterest income was primarily driven by lower interest rate spreads, which werepartially offset by growth in our investment portfolio.  Lower interestrate spreads were due to the continued increasing short-term interest rateswithout a concurrent increase in longer-term rates, which resulted in arelatively flat yield curve. Consequently, our interest-bearing liabilities, of which the majority ispriced based on overnight floating rates, have repriced at higher rates fasterthan our interest-earning assets have repriced, resulting in a lower netinterest margin as compared to the same period in 2005.  In addition,reinvestment and purchase spreads on fixed and floating-rate assets were lowerthan expected due to higher market demand, especially for shorter-term andfloating-rate fixed income investments.  Theflat yield curve, with higher short-term rates relative to long-term rates,also contributed to lower net interest margin. Average investment security balances were up approximately $0.4 billionfor the three months ended March 31, 2006, compared to the same period in 2005.

 

The table below presents the changes in net interest income resultingfrom changes in the volume of interest-earning assets or interest-bearingliabilities and changes in interest rates for the three months ended March 31,2006 compared to the same period in 2005. Changes attributed to both volume and rate have been allocated based onthe proportion of change in each category (Dollars in thousands):

 

| ** **                                           | ** ** | **For the Three Months Ended  March 31, 2006** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                           | ** ** | **Change  Due to  Volume**                     | ** ** | **Change  Due to  Rate** | ** ** | **Net** | ** ** |
| **Interest-earning  assets:**                        |       |                                           |       |   |   |   |   |
|  Federal Funds sold and short-term  investments |       | $                                              | (130       | ) | $ | 245 |   | $ | 115 |   |
|  Investment securities                          |       | 4,362                                          |       | 29,256 |   | 33,618 |   |
|  Loans                                          |       | 1,875                                          |       | 774 |   | 2,649 |   |
|                                                 |       |                                           |       |   |   |   |   |
|  Total interest-earning assets                  |       | 6,107                                          |       | 30,275 |   | 36,382 |   |
|                                                 |       |                                           |       |   |   |   |   |
| **Interest-bearing  liabilities:**                   | ** ** | ** **                                     | ** ** | ** ** | ** ** | ** ** | ** ** |
|  Deposits                                       |       | 2,648                                          |       | 15,794 |   | 18,442 |   |
|  Borrowings                                     |       | (492                                           | )          | 22,724 |   | 22,232 |   |
|                                                 |       |                                           |       |   |   |   |   |
| Total interest-bearing liabilities                   |       | 2,156                                          |       | 38,518 |   | 40,674 |   |
|                                                 |       |                                           |       |   |   |   |   |
| Change in  net interest income                       |       | $                                              | 3,951      |   | $ | (8,243 | ) | $ | (4,292 | ) |

 

25

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In addition to investing in both variable and fixed-rate securities, weuse derivative instruments to manage our exposure to interest rate risk. Seethe ‘Market Risk’ section for more detailed information.

 

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

 
| ** **                                                        | ** ** | **Three Months Ended  March 31, 2006** | ** ** | **Three Months Ended  March 31, 2005** | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|
| ** **                                                        | ** ** | **Average  Balance**                   | ** ** | **Interest**                           | ** ** | **Average  Yield/Cost** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Average  Yield/Cost** | ** ** |
| **Interest-earning assets:**                                      | ** ** | ** **                             | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Federal Funds  sold and short-term investments                    |       | $                                      | 42,784     |                                   | $          | 478 |   | 4.47 | % |   | $ | 60,611 |   | $ | 363 |   | 2.40 | % |   |
| Investment  securities(1)                                         |       |                                   |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Mortgage-backed  securities                                       |       | 8,160,279                              |       | 96,777                                 |       | 4.74 | % |   | 7,570,372 |   | 69,333 |   | 3.66 | % |   |
| Federal agency  securities                                        |       | 2,210,833                              |       | 24,663                                 |       | 4.46 | % |   | 2,297,884 |   | 19,159 |   | 3.34 | % |   |
| State and  political subdivisions                                 |       | 505,096                                |       | 5,503                                  |       | 4.36 | % |   | 488,818 |   | 5,605 |   | 4.59 | % |   |
| Other securities                                                  |       | 212,146                                |       | 2,807                                  |       | 5.29 | % |   | 301,016 |   | 2,035 |   | 2.70 | % |   |
| Total investment  securities                                      |       | 11,088,354                             |       | 129,750                                |       | 4.68 | % |   | 10,658,090 |   | 96,132 |   | 3.61 | % |   |
| Loans                                                             |       | 316,996                                |       | 4,209                                  |       | 5.31 | % |   | 163,177 |   | 1,560 |   | 3.82 | % |   |
| Total  interest-earning assets                                    |       | 11,448,134                             |       | 134,437                                |       | 4.70 | % |   | 10,881,878 |   | 98,055 |   | 3.60 | % |   |
| Allowance for  loan losses                                        |       | (100                                   | )          |                                   |       |   |   |   | (100 | ) |   |   |   |   |   |
| Noninterest-earning  assets                                       |       | 641,002                                |       |                                   |       |   |   |   | 604,181 |   |   |   |   |   |   |
| Total assets                                                      |       | $                                      | 12,089,036 |                                   |       |   |   |   |   | $ | 11,485,959 |   |   |   |   |   |   |
| **Interest-bearing liabilities:**                                 | ** ** | ** **                             | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Deposits:                                                         |       |                                   |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Demand                                                            |       | $                                      | 95,778     |                                   | $          | 919 | % | 3.84 | % |   | $ | — |   | $ | — |   | — |   |   |
| Savings                                                           |       | 4,078,497                              |       | 31,922                                 |       | 3.13 | % |   | 3,496,407 |   | 14,581 |   | 1.67 | % |   |
| Time                                                              |       | 75,974                                 |       | 846                                    |       | 4.45 | % |   | 107,334 |   | 664 |   | 2.47 | % |   |
| Securities sold  under repurchase agreements                      |       | 4,826,124                              |       | 40,954                                 |       | 3.39 | % |   | 5,055,797 |   | 26,354 |   | 2.09 | % |   |
| Junior  subordinated debentures                                   |       | 24,774                                 |       | 605                                    |       | 9.77 | % |   | 24,774 |   | 605 |   | 9.77 | % |   |
| Other borrowings                                                  |       | 1,401,077                              |       | 15,870                                 |       | 4.53 | % |   | 1,290,073 |   | 8,238 |   | 2.55 | % |   |
| Total  interest-bearing liabilities                               |       | 10,502,224                             |       | 91,116                                 |       | 3.47 | % |   | 9,974,385 |   | 50,442 |   | 2.02 | % |   |
| Noninterest-bearing  liabilities:                                 |       |                                   |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                                   |       | 342,368                                |       |                                   |       |   |   |   | 334,974 |   |   |   |   |   |   |
| Savings                                                           |       | 56,212                                 |       |                                   |       |   |   |   | 77,766 |   |   |   |   |   |   |
| Noninterest-bearing  time deposits                                |       | 215,000                                |       |                                   |       |   |   |   | 165,444 |   |   |   |   |   |   |
| Other liabilities                                                 |       | 174,591                                |       |                                   |       |   |   |   | 195,776 |   |   |   |   |   |   |
| Total liabilities                                                 |       | 11,290,395                             |       |                                   |       |   |   |   | 10,748,345 |   |   |   |   |   |   |
| Equity                                                            |       | 798,641                                |       |                                   |       |   |   |   | 737,614 |   |   |   |   |   |   |
| Total liabilities  and equity                                     |       | $                                      | 12,089,036 |                                   |       |   |   |   |   | $ | 11,485,959 |   |   |   |   |   |   |
| Net interest  income                                              |       |                                   |       | $                                      | 43,321     |   |   |   |   |   |   | $ | 47,613 |   |   |   |   |
| Net interest  margin (2)                                          |       |                                   |       |                                   |       | 1.51 | % |   |   |   |   |   | 1.75 | % |   |
| Average interest  rate spread (3)                                 |       |                                   |       |                                   |       | 1.23 | % |   |   |   |   |   | 1.58 | % |   |
| Ratio of  interest-earning assets to interest-bearing liabilities |       |                                   |       |                                   |       | 109.01 | % |   |   |   |   |   | 109.10 | % |   |

 

----

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

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

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

 

26

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*Operating Expenses*

 

Total operating expenses were $135.7 million for the three months endedMarch 31, 2006, up 29% from the same period in 2005.  The increase in total operating expenses wasprimarily due to increased compensation and benefits, technology andtelecommunications, transaction processing services and other operatingexpenses, as detailed below.  It is expected that incremental expense forthe remainder of 2006 will primarily be driven by continued investments inpersonnel, office space and in our integrated global technology platform.  The components of operating expenses were asfollows (Dollars in thousands):

 

| ** **                         | ** ** | **For the Three Months Ended  March 31,** | ** ** |
|------------------------------------|------------|-------------------------------------------|------------|
| ** **                         | ** ** | **2006**                                  | ** ** | **2005** | ** ** | **Change** | ** ** |
|                               |       |                                      |       |   |   |   |   |
| Compensation  and benefits         |       | $                                         | 76,998     |   | $ | 56,919 |   | 35 | % |
| Technology  and telecommunications |       | 17,338                                    |       | 12,836 |   | 35 | % |
| Transaction  processing services   |       | 13,672                                    |       | 11,120 |   | 23 | % |
| Depreciation  and amortization     |       | 7,806                                     |       | 7,891 |   | (1 | )% |
| Occupancy                          |       | 7,551                                     |       | 6,613 |   | 14 | % |
| Professional  fees                 |       | 3,461                                     |       | 2,973 |   | 16 | % |
| Travel and  sales promotion        |       | 1,931                                     |       | 1,349 |   | 43 | % |
| Insurance                          |       | 973                                       |       | 1,129 |   | (14 | )% |
| Other  operating expenses          |       | 5,954                                     |       | 3,962 |   | 50 | % |
|                               |       |                                      |       |   |   |   |   |
|  Total operating expenses     |       | $                                         | 135,684    |   | $ | 104,792 |   | 29 | % |

 

Compensation and benefits expense was $77.0 million for the threemonths ended March 31, 2006, up 35% from the same period last year due tohigher headcount in our Boston and European offices, including additionalmanagement personnel.  Further increasesin compensation expense in 2006 will be primarily dependent upon sales to newand existing clients and the full year effect of the adoption of FAS 123R.

 

Technology and telecommunications expense was $17.3 million for the threemonths ended March 31, 2006, up 35% from the same period last year.  The increase is primarily due to our investmentin enhancing our global integrated technology platform.  Generally, we expect technology reinvestmentto equal approximately 18-20% of net operating revenue each year, includingrelated compensation costs.

 

Transaction processing services expense was $13.7 million for the threemonths ended March 31, 2006, up 23% from the same period last year due toincreases in transaction volumes with our subcustodians and higher marketvalues.  Future transaction processingservices expense will be dependent upon asset levels and the volume of clienttransaction activity.

 

Occupancy expense was $7.6 million for the three months ended March 31,2006, up 14% from the same period last year. This increase is due to new office space in Boston, London andLuxembourg.  Occupancy expense isexpected to increase throughout 2006 due to the addition of new space needed toaccommodate growth.

 

Professional fees expense was $3.5 million for the three months ended March31, 2006, up 16% from the same period last year.  The increase is primarily attributed to higherlegal and consulting services related to the implementation of Basel II and theformation of our new European offices.

 

Travel and sales promotion expense was $1.9 million for the threemonths ended March 31, 2006, up 43% from 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, as well as travelingto existing client sites and our foreign offices.  The increase resulted from a higher level oftravel to client sites and foreign offices, a higher level of sales calls topotential clients and attendance at industry conferences.

 

Other operating expense was $6.0 million for the three months ended March31, 2006, up 50% from the same period last year primarily as a result of higherrecruiting and staffing expense.  Otheroperating expense is expected to increase in 2006 due to higher staffing andrecruiting costs as a result of the growth of our business.

 

*Income Taxes*

 

Income taxes were $19.7 million for the three-month period ended March 31,2006, down 11% from the same period in 2005. The decrease in income taxes is primarily attributable to decreasedpretax earnings.

 

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**Financial Condition**

 

At March 31, 2006, our total assets were $12.4 billion, up 3% from $12.1billion at December 31, 2005, primarily due to an increase in Federal Fundssold.  Average interest-earning assetsincreased $0.6 billion, or 5%, for the three-month period ended March 31, 2006from the same period in 2005.  Our assetgrowth was primarily funded by increases in average client balances ofapproximately $0.8 billion for the three-month period ended March 31, 2006.

 

*Investment Portfolio*

* *

The income we derive from our investment portfolio is generatedprimarily by investing client cash balances 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,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------------------------|------------|---------------------|------------|------------------------|------------|
| **Securities  held to maturity**    | ** ** | ** **          | ** ** | ** **             | ** ** |
| Mortgage-backed  securities         |       | $                   | 4,223,936  |                   | $          | 4,342,254 |   |
| Federal  agency securities          |       | 2,162,731           |       | 2,305,331              |       |
| State and  political subdivisions   |       | 109,484             |       | 114,345                |       |
|                                |       |                |       |                   |       |
| Total securities held to maturity   |       | $                   | 6,496,151  |                   | $          | 6,761,930 |   |
| ** **                          | ** ** | ** **          | ** ** | ** **             | ** ** |
| **Securities  available for sale**  | ** ** | ** **          | ** ** | ** **             | ** ** |
| Mortgage-backed  securities         |       | $                   | 3,858,638  |                   | $          | 3,766,101 |   |
| State and  political subdivisions   |       | 428,322             |       | 392,391                |       |
| Corporate  debt                     |       | 200,667             |       | 200,692                |       |
| Foreign  government securities      |       | 10,524              |       | 10,536                 |       |
|                                |       |                |       |                   |       |
| Total securities available for sale |       | $                   | 4,498,151  |                   | $          | 4,369,720 |   |

 

Our held to maturity securities portfolio decreased $0.3 billion, or4%, from December 31, 2005 to March 31, 2006. The decrease is primarily due to paydowns.  Our held to maturity portfolio securities arepurchased with the intent and ability to hold to maturity.

 

Our available for salesecurities portfolio increased $0.1 billion, or 3%, from December 31, 2005 to March31, 2006.  The slight increase was mainlydue to purchases of new investment securities, offset by maturities and prepayments. Our investment security purchasesincluded mortgage-backed securities and municipal securities.  We believe that purchasing these securitiesallows us to take advantage of attractive yields and limited extension riskwhich aligns with our asset and liability strategy.  Refer to the gap analysis under the ‘MarketRisk’ section for additional details regarding the matching of ourinterest-earning assets and interest-bearing liabilities.

 

The average balance of our investment securities for the three-monthperiod ended March 31, 2006 was $11.1 billion, with an average yield of 4.68%,compared to an average balance of $10.7 billion with an average yield of 3.61%during the same period in 2005.  Theincrease in yield is primarily due to our variable-rate securities repricing athigher interest rates.  If long-term interestrates rise, we would expect slower prepayments and our overall yield toincrease as our variable-rate securities reprice.  Conversely, if long-term interest ratesdecline, we would expect that prepayments would accelerate, with the cash flowsfrom these prepayments being reinvested in lower-yielding assets of equalquality and similar risk.

 

Prepayment cash flow levels on our Federal agency securities increased slightlyin the first three months of 2006, which we believe were attributable to theexpiration of borrower prepayment penalties, refinancing and loan payoffactivity.  Mortgaged-backed securityprepayment cash flow levels decreased for the first three months of 2006,primarily attributable to decreased refinancing opportunities.

 

We invest in mortgage-backed securities and Federal agency securitiesto increase the total return of the investment portfolio.  Mortgage-backed securities and Federal agencysecurities generally have a higher yield than U.S. Treasury securities due tocredit and prepayment risk.  Credit risk results from the possibility thata loss may occur if a counterparty, such as the Federal agency issuing thesecurities, is unable to meet the terms of the contract.  Credit riskrelated to mortgage-backed securities and Federal agency securities issubstantially reduced by payment guarantees and credit enhancements. Prepayment risk results from the possibility that changes in interestrates and other economic factors will result in investment securities beingpaid off earlier than the scheduled maturity date.  Refer to the ‘MarketRisk’ section for additional details regarding our net interest incomesimulation model, which includes the impact of changes in interest rates, andtherefore prepayment risk, on our net interest income.

 

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We invest in AAA rated, insured municipal securities to generatestable, tax advantaged income.  Municipal securities generally have lowerstated yields than Federal agency and U.S. Treasury securities, but theirafter-tax yields are comparable.  Municipal securities are subject to callrisk.  Call risk is similar to prepayment risk and results from thepossibility that fluctuating interest rates and other factors may result in theexercise of the call option by the issuing municipality prior to the maturitydate of the security.

 

*Loan Portfolio*

* *

The balance inour loan portfolio was $307.9 million, down 23% from December 31, 2005.  The decrease was primarily due to a decreasein loans to mutual funds and individuals.

 

We make loansto individually managed account customers and to mutual funds and other pooledproduct clients.  We offer overdraft protection and lines of credit to ourclients for the purpose of funding redemptions, covering overnight cashshortfalls, leveraging portfolios and meeting other client borrowingneeds.  The majority of loans to individually managed account customersare written on a demand basis, bear variable interest rates tied to the Primerate or the Federal Funds rate and are fully secured by liquid collateral,primarily freely tradable securities held in custody by us for theborrower.  We monitor the value of collateral daily to ensure the amountof collateral held by us exceeds the loan balance by a certain threshold. Loans to mutual funds and other pooled product clients include unsecured linesof credit that may, in the event of default, be collateralized at our option bysecurities held in custody by us for those clients.  Loans to individuallymanaged account customers, mutual funds and other pooled product clients alsoinclude advances that we make to certain clients pursuant to the terms of ourcustody agreements with those clients to facilitate securities transactions andredemptions.

 

At March 31,2006, 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 loanportfolio credit performance has been excellent.  There have been no loan charge-offs in thehistory of our Company.  It is our policyto place a loan on nonaccrual status when either principal or interest becomes60 days past due and the loan’s collateral is not sufficient to cover bothprincipal and accrued interest.  As of March31, 2006, there were no loans on nonaccrual status, no loans greater than90 days past due, and no troubled debt restructurings.  Although virtually all of our loans are fullycollateralized with freely tradable securities, management recognizes somecredit risk inherent in the loan portfolio, and therefore has recorded anallowance for loan losses of $0.1 million at March 31, 2006, a level whichhas remained consistent for the past five years.  This amount is not allocated to anyparticular loan, but is intended to absorb any risk of loss inherent in theloan portfolio.  Management activelymonitors the loan portfolio and the underlying collateral and regularlyassesses the adequacy of the allowance for loan losses.

 

*Deposits*

 

Total deposits were $5.4 billion at March 31, 2006, up 9% from December31, 2005.  The increase in our depositbalances is a result of possessing higher amounts of assets for our clients.

 

Time deposits with balances greater than $100,000 totaled $268.1million and $230.1 million at March 31, 2006 and December 31, 2005,respectively.  All time deposits had amaturity of less than three months at March 31, 2006 and 2005.

 

*Repurchase Agreements and Short-Term and Other Borrowings*

 

Repurchaseagreements remained consistent at $4.8 billion from December 31, 2005 to March31, 2006.  The majority of our repurchaseagreements are with clients who prefer a more collateralized form ofdeposit.  Repurchase agreements providefor the sale of securities for cash coupled with the obligation to repurchasethose securities on a set date or on demand. We use repurchase agreements, including client repurchase agreements,because they provide a lower cost source of funding than other short-termborrowings and allow our clients the extra benefit of collateralization oftheir deposits.  The average balance ofsecurities sold under repurchase agreements for the three months ended March 31,2006 was $4.8 billion with an average cost of approximately 3.39%, compared toan average balance of $5.1 billion and an average cost of approximately 2.09%for the same period in 2005.  The increasein the average cost of repurchase agreements was due to higher short-terminterest rates in the first three months of 2006 compared to the same period in2005.

 

Short-term andother borrowings decreased $0.2 billion, or 12%, from December 31, 2005 to March31, 2006.  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, 2006 was $1.4 billion with anaverage cost of approximately 4.53%, compared to an average balance of $1.3billion and an average cost of approximately 2.55% for the same period in 2005.

 

29

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**Market Risk**

 

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 the conduct of these activities, we aresubject 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 risk isintegral to our operations.  Theobjective of interest rate sensitivity management is to provide sustainable netinterest income under various economic conditions.

 

Our balancesheet is primarily subject to interest rate risk, which is the risk of loss dueto movements in interest rates. Prepayment risk, which is the risk that changes in interest rates andother economic factors will result in investment securities being paid offearlier than the scheduled maturity date, is inherent in our investmentsecurities, mainly our mortgage-backed securities and variable-rate Federalagency securities.  Prepayment levels formortgage-backed securities are primarily driven by changes in interestrates.  Prepayment levels for Federalagency securities are driven by a number of factors, including expiration ofprepayment penalty provisions, the economic condition of the borrower, borrowerrefinancing alternatives, and interest rates.

 

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 regulatory requirements.  For example, we have established a policylimit stating that projected net interest income over the next twelve monthswill not be impacted by more than 10% given a change in interest rates of up to200 basis points (+ or -) over twelve months. Each quarter, our Board of Directors reviews our asset and liabilitypositions, including simulations of the effect of various interest ratescenarios 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.  ALCO meets twice monthly.  Our primary tool in managing interest ratesensitivity is an income simulation model.  Key assumptions in the simulation modelinclude the timing of cash flows, which include forecasted prepayment speedsthat are based on market and industry data, maturities and repricing offinancial instruments, changes in market conditions, capital planning anddeposit sensitivity.  The model assumesthat the composition of our interest-sensitive assets and liabilities willchange over the period being measured. The model also assumes that the change in interest rates is a parallelshift of the yield curve across all maturities. These assumptions are inherently uncertain, and as a result, the modelcannot precisely predict the effect of changes in interest rates on our netinterest income.  Actual results maydiffer from simulated results due to the timing, magnitude and frequency ofinterest rate changes, and changes in market conditions and managementstrategies.

 

The results ofthe income simulation model as of March 31, 2006 and 2005 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 6.9% and 7.8%,respectively, which is within our 10% policy limit.  We also simulate a 200 basis point ratereduction over a twelve-month period. This simulation would result in an increase in projected net interestincome of 3.3% and 1.2% as of March 31, 2006 and 2005, respectively, bothwithin our 10% policy limit.

 

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, 2006,interest-bearing liabilities repriced faster than interest-earning assets inthe short term.  Generally speaking,during a period of falling interest rates, net interest income would be higherthan 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 the shape of the yield curve, general rate levels,reinvestment spreads, balance sheet growth and mix, and interest ratespreads.  We continue to run a closelymatched balance sheet by investing the majority of our assets in shortduration, variable-rate securities and adding interest rate swaps againstclient liabilities, including client repurchase agreements.

 

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 

 

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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 of theswap agreements is to lengthen both a forecasted series of fixed-rate overnightliabilities incurred at different daily fixed rates and short-termvariable-rate liabilities into longer-term fixed-rate liabilities.  The weighted-average fixed-payment rates were3.66% and 3.17% at March 31, 2006 and 2005, respectively.  Variable-interest payments received arecurrently indexed to the overnight Federal Funds rate.  At March 31, 2006 and 2005, theweighted-average rates of variable market-indexed interest payment obligationsto the Company were 4.44% and 2.60%, respectively.  The remaining terms of swaps at March 31, 2006range from 1 to 30 months.  Thesecontracts had net fair values of approximately $29.5 million and $19.2 millionat March 31, 2006 and 2005, respectively.

 

The followingtable presents the repricing schedule of our interest-earning assets andinterest-bearing liabilities at March 31, 2006 (Dollars in thousands):

 
| ** **                                                                         | ** ** | **Within Three** | ** ** | **Three to Six** | ** ** | **Six to Twelve** | ** ** | **One Year to** | ** ** | **Over Five** | ** ** | ** ** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------|------------|------------------|------------|-------------------|------------|-----------------|------------|---------------|------------|------------|------------|
| ** **                                                                         | ** ** | **Months**       | ** ** | **Months**       | ** ** | **Months**        | ** ** | **Five Years**  | ** ** | **Years**     | ** ** | **Total**  | ** ** |
| ** **                                                                         | ** ** | ** **       | ** ** | ** **       | ** ** | ** **        | ** ** | ** **      | ** ** | ** **    | ** ** | ** ** | ** ** |
| Interest-earning assets:  (1)                                                 |       |             |       |             |       |              |       |            |       |          |       |       |       |
| Investment securities (2),(3)                                                      |       | $                | 6,277,087  |             | $          | 525,186           |       | $               | 924,322    |          | $          | 2,721,232  |       | $ | 591,341 |   | $ | 11,039,168 |   |
| Federal funds sold and other short-term  investment                                |       | 531,089          |       | —           |       | —            |       | —          |       | —        |       | 531,089    |       |
| Loans - variable rate                                                              |       | 308,009          |       | —           |       | —            |       | —          |       | —        |       | 308,009    |       |
| Loans - fixed rate                                                                 |       | 12               |       | —           |       | —            |       | —          |       | —        |       | 12         |       |
| Total interest-earning assets                                                      |       | $                | 7,116,197  |             | $          | 525,186           |       | $               | 924,322    |          | $          | 2,721,232  |       | $ | 591,341 |   | $ | 11,878,278 |   |
| Interest-bearing liabilities:                                                      |       |             |       |             |       |              |       |            |       |          |       |       |       |
| Demand deposits                                                                    |       | $                | 85,746     |             | $          | —            |       | $               | —     |          | $          | —     |       | $ | — |   | $ | 85,746 |   |
| Savings accounts                                                                   |       | 4,385,757        |       | —           |       | —            |       | 62,410          |       | —        |       | 4,448,167  |       |
| Time deposits                                                                      |       | 68,141           |       | —           |       | —            |       | —          |       | —        |       | 68,141     |       |
| Interest rate contracts                                                            |       | (1,765,000       | )          | 145,000          |       | 340,000           |       | 1,280,000       |       | —        |       | —     |       |
| Securities sold under                                                              |       |             |       |             |       |              |       |            |       |          |       |       |       |
| repurchase agreements                                                              |       | 4,092,011        |       | 50,000           |       | 200,000           |       | 450,000         |       | —        |       | 4,792,011  |       |
| Short-term and other                                                               |       |             |       |             |       |              |       |            |       |          |       |       |       |
| borrowings                                                                         |       | 1,137,203        |       | 50,000           |       |              |       | —          |       | —        |       | 1,187,203  |       |
| Junior subordinated debentures                                                     |       | —           |       | —           |       | 24,774            |       | —          |       | —        |       | 24,774     |       |
| Total interest-bearing liabilities                                                 |       | $                | 8,003,858  |             | $          | 245,000           |       | $               | 564,774    |          | $          | 1,792,410  |       | $ | — |   | $ | 10,606,042 |   |
| Net interest-sensitivity gap during the  period                                    |       | $                | (887,661   | )                | $          | 280,186           |       | $               | 359,548    |          | $          | 928,822    |       | $ | 591,341 |   | $ | 1,272,236 |   |
|                                                                               |       |             |       |             |       |              |       |            |       |          |       |       |       |
| Cumulative gap                                                                     |       | $                | (887,661   | )                | $          | (607,475          | )          | $               | (247,927   | )             | $          | 680,895    |       | $ | 1,272,236 |   |   |   |
| Interest-earning assets as a percent of  interest-bearing liabilities (cumulative) |       | 88.91            | %          | 92.64            | %          | 97.19             | %          | 106.42          | %          | 112.00        | %          |       |       |
| Interest-earning assets as a percent of  total assets (cumulative)                 |       | 57.26            | %          | 61.49            | %          | 68.93             | %          | 90.83           | %          | 95.59         | %          |       |       |
| Net interest-sensitivity gap as a percent  of total assets                         |       | (7.14            | )%         | 2.25             | %          | 2.89              | %          | 7.47            | %          | 4.76          | %          |       |       |
| Cumulative gap as a percent of total assets                                        |       | (7.14            | )%         | (4.89            | )%         | (2.00             | )%         | 5.48            | %          | 10.24         | %          |       |       |

** **

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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 period inwhich 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 $12.0million of unsettled securities purchases and $56.8 million of net unrealizedlosses as of March 31, 2006.

 

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**Liquidity**

 

Liquidityrepresents the ability of an institution to meet present and future financialobligations through either runoff due to prepayments, asset sales, maturity ofexisting assets or the acquisition of additional funds through liabilitymanagement.  For a financial institutionsuch as ours, these obligations arise from the withdrawals of deposits, thepayment of operating expenses, and the inclusion of capital expenditures forfixed assets and leasehold improvements.

 

Our primarysources of liquidity include cash and cash equivalents, Federal Funds sold, newdeposits, short-term borrowings, interest and principal payments on securitiesheld to maturity and available for sale, fees collected from assetadministration clients, FHLBB borrowings and Federal Reserve Discount Window.  As a result of our management of liquidassets and our ability to generate liquidity through liability funds,management believes that we maintain overall liquidity sufficient to meet ourdepositors’ needs, to satisfy our operating requirements and to fund thepayment of an anticipated annual cash dividend of $0.09 per share for 2006(approximately $5.9 million based upon 65,531,272 shares outstanding as ofMarch 31, 2006).

 

Our ability topay dividends on common stock may depend on the receipt of dividends from theBank.  Any dividend payments by the Bankare subject to certain restrictions imposed by the Massachusetts Commissionerof Banks.  During all periods presentedin this report, the Company did not require dividends from the Bank in order tofund the Company’s own dividends.  Inaddition, we may not pay dividends on our common stock if we are in defaultunder certain agreements entered into in connection with the sale of ourCapital Securities.  The CapitalSecurities were issued in 1997 by Investors Capital Trust I, a Delawarestatutory business trust sponsored by us, and qualify as Tier 1 capital underthe capital guidelines of the Federal Reserve Board of Governors (‘FRB’).

 

In July 2005, we announcedthat our Board of Directors authorized us to repurchase up to $150.0 million ofour common stock in the open market over the twelve months following theannouncement.  The purchase of our commonstock has been funded primarily by a dividend from the Bank to the Company.  We do not expect the stock repurchase programto have a material impact on our liquidity position, our risk-based capitalratios, including our leverage capital ratio, or our ability to pay dividendson our common stock.  We did not repurchaseany shares during the three months ended March 31, 2006.  As of March 31, 2006, we have repurchased$70.7 million of our common stock.

 

We haveinformal borrowing arrangements with various counterparties.  Each counterparty has agreed to make fundsavailable to us at the Federal Funds overnight rate.  Each counterparty may terminate itsarrangement at any time and is under no contractual obligation to provide uswith requested funding.  Our borrowingsunder these arrangements are typically on a short-term 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 on anuncommitted basis to make funds available to us at various rates in exchangefor collateral consisting of marketable securities.

 

The Bank’scapital stock investment in the FHLBB totaled $50.0 million as of March 31, 2006. The $50.0 million capital stock investment includes both a $25.0 millionmembership component and a $25.0 million activity-based component.  FHLBB capital stock investments require afive-year advance notice of withdrawal.  The Bank’s $50.0 million capitalstock investment in the FHLBB provides an overnight borrowing capacity of up to$833.0 million.  The amount outstandingunder this arrangement at March 31, 2006 was $50.0 million.  Additionalborrowing is available to the Bank based on prescribed collateral levels andincreased investment in FHLBB capital stock.  The Bank currently has noplans to increase its investment in FHLBB capital stock.

 

**Capital Resources**

 

Historically,we have financed our operations principally through internally generated cashflows.  We incur capital expenditures forfurniture, fixtures, capitalized software and miscellaneous equipmentneeds.  We lease office space and computingequipment through operating leases. Capital expenditures have been incurred and leases entered into on anas-required basis, primarily to meet our growing operating needs.  As a result, our capital expenditures were $17.7million and $6.9 million for the three months ended March 31, 2006 and 2005,respectively.  For the three months endedMarch 31, 2006, capital expenditures were comprised of approximately $7.3million in leasehold improvements, $6.0 million in capitalized software andprojects in process and $4.4 million in fixed assets.  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.

 

Stockholders’equity at March 31, 2006 was $820.2 million, up 6% from December 31, 2005, primarilydue to net income earned in the first three months of 2006.  The ratio of average stockholders’ equity toaverage assets was approximately 7% for March 31, 2006, compared to 6% forDecember 31, 2005.

 

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In July 2005, weannounced that our Board of Directors has authorized us to repurchase up to$150.0 million of our common stock in the open market over the twelve monthsfollowing the announcement.  We do not expect our stock repurchase programto have a material impact on our capital resources, such as maintainingrisk-based capital ratios in excess of capital adequacy guidelines and ourability to pay dividends on our common stock. We did not repurchase any shares during the three months ended March 31,2006.  As of March 31, 2006, we haverepurchased $70.7 million of our common stock.

 

The FRB has adoptedcapital adequacy guidelines applicable to United States bankingorganizations.  The FRB’s capital adequacy guidelines generally requirebank holding companies (‘BHCs’) to maintain total capital equal to 8% of totalrisk-adjusted assets and off-balance sheet items (the ‘Total Risk-Based CapitalRatio’), with at least 50% of that amount consisting of Tier 1, or corecapital, and the remaining amount consisting of Tier 2, or supplementarycapital.  Tier 1 capital for BHCs generally consists of the sum of commonstockholders’ equity and perpetual preferred stock (subject to certainlimitations), less goodwill and other nonqualifying intangible assets. Tier 2 capital generally consists of hybrid capital instruments, perpetual debtand mandatory convertible debt securities; perpetual preferred stock, notincluded as Tier 1 capital; term subordinated debt and intermediate-termpreferred stock; and, subject to limitations, general allowances for loan andlease losses.  Assets are adjusted under the risk-based guidelines to takeinto account different risk characteristics.

 

In addition to therisk-based capital requirements, the FRB requires BHCs to maintain a minimumleverage capital ratio of Tier 1 capital to its average total consolidatedassets (the ‘Leverage Ratio’) of 3%.  Total average consolidated assetsfor this purpose does not include goodwill and any other intangible assets andinvestments that the FRB determines should be deducted from Tier 1capital.  The FRB has announced that the 3% Leverage Ratio requirement isthe minimum for the top-rated BHCs.  All other BHCs are required tomaintain a minimum Leverage Ratio of 4%.  BHCs with supervisory,financial, operational or managerial weaknesses, as well as BHCs that areanticipating or experiencing significant growth, are expected to maintaincapital ratios well above the minimum levels.  Because we anticipatesignificant future growth, we will be required to maintain a Leverage Ratio of4% 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, 2006, our Total Risk-BasedCapital Ratio and Leverage Ratio were 19.01% and 6.52%, respectively.

 

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

 

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

 

**Item 4.**   Controlsand Procedures

** **

**Evaluationof Disclosure Controls and Procedures**

 

As required byRule 13a-15 under the Securities Exchange Act of 1934, as of March 31, 2006,the end of the quarter covered by this report, the Company carried out anevaluation under the supervision and with the participation of the Company’smanagement, including the Company’s Chief Executive Officer and Chief FinancialOfficer, of the effectiveness of the design and operation of the Company’sdisclosure controls and procedures.  Indesigning and evaluating the Company’s disclosure controls and procedures, theCompany and its management recognize that any controls and procedures, nomatter how well designed and operated, can provide only reasonable assurance ofachieving the desired control objectives, and the Company’s managementnecessarily was required to apply its judgment in evaluating and implementingpossible controls and procedures.  Basedupon that evaluation, the Chief Executive Officer and Chief Financial Officerconcluded that the Company’s disclosure controls and procedures were effectiveat the reasonable assurance level to ensure that information required to bedisclosed by the Company in the reports it files or submits under the ExchangeAct is accumulated and communicated to our management, including our ChiefExecutive Officer and Chief Financial Officer, as appropriate, to allow timelydecisions regarding required disclosure, and is recorded, processed, summarizedand reported, within the time periods specified in the Securities and ExchangeCommission’s rules and forms.  There wasno change in the Company’s internal control over financial reporting thatoccurred during the quarter ended March 31, 2006 that has materially affected,or is reasonably likely to materially affect, the Company’s internal controlover financial reporting.  The Companyreviews, on an ongoing basis, its disclosure controls and procedures, which mayinclude its internal controls over financial reporting, and may from time totime make changes aimed at enhancing their effectiveness and to ensure that theCompany’s systems evolve with its business.

 

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**PART II.  OTHER INFORMATION**

** **

**Item 1. Legal Proceedings**

 

InvestorsFinancial Services Corp. and certain of its officers were named as defendantsin three purported class action complaints that were filed on or about August4, 2005, August 15, 2005, and September 30, 2005 in the United States DistrictCourt for the District of Massachusetts, Boston, Massachusetts.  On November 2, 2005, the MassachusettsDistrict Court consolidated the complaints filed on August 4 and August 15,2005, and appointed a lead plaintiff.  OnDecember 22, 2005, the defendants filed an assented-to motion to consolidatethe complaint filed on September 30, 2005 with the previously consolidatedactions.  On February 3, 2006, the leadplaintiff filed a consolidated complaint against the Company and seven of itscurrent and former officers.  Among otherthings, the consolidated complaint asserts that the defendants violatedSections 10(b) and 20(a) of the Securities Exchange Act of 1934 during theperiod April 10, 2001 until July 15, 2005. The allegations in the consolidated complaint predominantly relate to:(1) the Company’s October 2004 restatement of its financial results, and (2)the Company’s July 2005 revision of public guidance regarding its futurefinancial performance.  The consolidatedcomplaint seeks unspecified damages, interest, fees, and costs.  We strongly believe that the lawsuit lacksmerit and we intend to defend against the claims vigorously.  However, we cannot predict the outcome of thelawsuit at this time, and we can give no assurance that it will not materiallyadversely affect our financial condition or results of operations.

 

InvestorsFinancial Services Corp. and nine of its officers and directors are named asdefendants in two shareholder derivative complaints that were filed on or aboutSeptember 22, 2005 and October 17, 2005 in the United States District Court forthe District of Massachusetts, Boston, Massachusetts.  Among other things, the complaints assertthat the defendants are liable for breach of fiduciary duty, unjust enrichment,abuse of control, mismanagement, misappropriation of information, insidertrading, and violation of Section 14(a) of the Securities Exchange Act of1934.  The complaint filed on September22, 2005 also seeks reimbursement under the Sarbanes-Oxley Act of 2002.  The allegations in the complaintspredominantly relate to: (1) the Company’s October 2004 restatement of itsfinancial results, and (2) the Company’s July 2005 revision of public guidanceregarding its future financial performance. The complaints seek unspecified damages, attorneys’ fees, accountant andexpert fees, and costs.  We stronglybelieve that the lawsuits lack merit and we intend to defend against the claimsvigorously.  However, we cannot predictthe outcome of the lawsuits at this time, and we can give no assurance thatthey will not materially adversely affect our financial condition or results ofoperations.

 

**Item 1A. Risk Factors**

 

*Our operating results are subject to fluctuations in interest rates andthe securities 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.  Our net interest income is earned byinvesting depositors’ funds in our investment portfolio and, in small part, bymaking loans.  A rising short-terminterest rate environment, such as we are now experiencing, generally causesdownward pressure on net interest income. Changes in the relationship between short-term and long-term interestrates, referred to as the yield curve, could also adversely affect the marketvalue of, or the earnings produced by, our investment and loan portfolios, andthus could adversely affect our operating results.  The current flat yield curve, whereshort-term rates have increased while long-term rates have failed to increase,has resulted in a decrease in our net interest margin that will continue tohave a material impact on our net interest income.

 

Volatility inthe equity markets can have a material effect on our asset-based fees.  While reductions in asset servicing fees maybe offset by increases in other sources of revenue, a sustained downwardmovement of the broad equity markets will likely have an adverse impact on ourearnings.

 

Our growthdepends in part on the ability of our clients to generate fund flows by sellingtheir investment products to new and existing investors.  Fluctuations in interest rates or thesecurities markets can lead to investors seeking alternatives to the investmentofferings of our clients, which could result in a lesser amount of assetsprocessed and correspondingly lower fees. For example, if the value of equity or fixed income assets held by ourclients were to increase or decrease by 10% for a sustained period of time, weestimate currently that this market movement, by itself, would cause acorresponding change of less than 5% in our earnings per share.

 

In addition,we are experiencing narrower investment portfolio reinvestment spreads, whichreduces our net interest income.  Ifreinvestments spreads on the security types we purchase remain narrow, orbecome narrower, our net interest income will continue to be impactednegatively.

 

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*A material portion of our revenue is derived from our relationship withBarclays Global Investors, N.A. (‘BGI’) and related entities.*

 

As a result of our ongoing relationship with BGI’s iShares and MasterInvestment Portfolios, our assumption of the operations of the U.S. assetadministration unit of BGI in 2001 and our servicing assets for Barclays GlobalInvestors Canada, Ltd., BGI accounted for approximately 18% and 17% of our netoperating revenue for the three months ended March 31, 2006 and 2005,respectively.  We recently renewed ourU.S. asset administration outsourcing agreement and our iShares and MasterInvestment Portfolio custody and fund accounting agreements with BGI and weexpect that BGI will continue to account for a significant portion of our netoperating revenue.  We provide servicesto BGI under long-term contracts that may be terminated before the expirationof the contracts under certain circumstances. Further information regarding the terms of certain BGI contracts,including early termination provisions, was disclosed in Item 8.01 on our Form8-K filed on January 25, 2006.

 

*We may incur losses 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 make operationalerrors for which we are responsible to our clients.  In addition, even though we maintainappropriate errors and omissions and other insurance policies, an operationalerror could result in a significant liability to us and may have a materialadverse effect on our results of operations.

 

*We face significant competition from other financial servicescompanies, which could negatively 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 substantiallygreater financial, marketing and other resources than we do.  These greater resources could, for example,allow our competitors to develop technology superior to our own.  In addition, we face the risk that largemutual fund complexes may build in-house asset servicing capabilities and nolonger outsource these services to us. As a result, we may not be able to compete effectively with current orfuture competitors, which could result in a loss of existing clients ordifficulty in gaining new clients.

 

*We may incur significant costs defending legal claims.*

 

We have beennamed in lawsuits in U.S. District Court in Massachusetts alleging, among otherthings, violations of securities laws. In addition, we have been named in a lawsuit in Massachusetts statecourt alleging, among other things, violations of a covenant of good faith andfair dealing in a contract.  While webelieve these claims are without merit, we cannot be sure that we will prevailin the defense of these claims.  We arealso party to other litigation and we may become subject to other legal claimsin the future.  Litigation is costly andcould divert the attention of management. For a more detailed discussion of our ongoing lawsuits, please see Item 1.Legal Proceedings, in Part II of this report.

 

*Our future results depend, in part, on successful integration of priorand possible future outsourcing transactions.*

 

Integration ofoutsourcing transactions is complicated and frequently presents unforeseendifficulties and expenses which can affect whether and when a particularoutsourcing transaction will be accretive to our earnings per share.  Any future outsourcing transactions willpresent similar challenges.  Theseoutsourcing transactions can also consume a significant amount of management’stime.

 

*The failure to properly manage our growth could adversely affect thequality of our services and result in the loss of clients.*

 

We haveexperienced a period of rapid growth that has required the dedication ofsignificant management and other resources. Continued growth could place a strain on our management and otherresources.  To manage future growtheffectively, we must continue to invest in our operational, financial and otherinternal systems, and our human resources, which could affect ourprofitability.

 

*We must hire and retain skilled personnel in order to succeed.*

 

Qualifiedpersonnel, in particular managers and other senior personnel, are in greatdemand throughout the financial services industry.  As a result, we could find it increasinglydifficult to continue to attract and retain sufficient numbers of these highlyskilled employees, which could affect our ability to attract and retain clients.

 

*We may not be 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 technologyindependently.  

 

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Legal proceedings to enforceour intellectual property rights may be unsuccessful, and could also beexpensive and divert management’s attention.

 

*Our quarterly 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;

 

•                  Changesin interest rates, the relationship between different interest rates or equityvalues;

 

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

 

•                  Thetiming and magnitude of share repurchases under our share repurchase plan.

 

Most of ourexpenses, such as employee compensation and rent, are relatively fixed and areexpected to increase in 2006 to support expected growth.  As a result, any shortfall in revenuerelative to our expectations could significantly affect our operating results.

 

*We are subject to extensive federal and state regulations that imposecomplex restraints on our business.*

 

Federal andstate laws and regulations applicable to financial institutions and theirparent companies apply to us.  Ourprimary regulators are the Federal Reserve Board (‘FRB’), the Federal DepositInsurance Corporation (‘FDIC’), the Massachusetts Commissioner of Banks, theNational Association of Securities Dealers, Inc. (‘NASD’), and the State ofVermont Department of Banking, Insurance, Securities and Health CareAdministration (‘BISHCA’).  Virtually allaspects of our operations are subject to specific requirements or restrictionsand general regulatory oversight including the following:

 

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

 

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

 

•                  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, LLC, must meet.  Failure to meet those requirements could leadto severe regulatory action;

 

•                  BISHCAmaintains certain regulatory requirements that our insurance captive affiliate,Investors Vermont Insurance Company, must meet. Failure to meet those requirements could lead to regulatory action; and

 

•                  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 Authority, the Cayman Islands Monetary Authority, theFinancial Services Authority in the United Kingdom and the Commission deSurveillance du Secteur Financier in Luxembourg.  Failure to comply with applicableinternational regulatory requirements could result in regulatory action andimpact our ability to provide services in those 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 thefederal Gramm-Leach-Bliley Act of 1999. This may place us at a competitive disadvantage with respect to otherorganizations.

 

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**Item 6. **  Exhibits

** **

**(a)**          Exhibits

** **
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                  |
|-----------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **      | ** ** | ** **                                                                                                                                                                                                                       |
| **15**          | ** ** | **Letter  of awareness from Deloitte & Touche LLP.**                                                                                                                                                                         |
| ** **      | ** ** | ** **                                                                                                                                                                                                                       |
| **31.1**        | ** ** | **Certification  of Kevin J. Sheehan, Chief Executive Officer, pursuant to Rule 13a-14(a) and  Rule 15d-14(a) of the Securities Exchange Act, as amended.**                                                                      |
| ** **      | ** ** | ** **                                                                                                                                                                                                                       |
| **31.2**        | ** ** | **Certification  of John N. Spinney, Jr., Chief Financial Officer, pursuant to Rule 13a-14(a)  and Rule 15d-14(a) of the Securities Exchange Act, as amended.**                                                                  |
| ** **      | ** ** | ** **                                                                                                                                                                                                                       |
| **32.1**        | ** ** | **Certification  of Kevin J. Sheehan, Chief Executive Officer, and John N. Spinney, Jr., Chief  Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted, pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002.** |

 

**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
| ** **        | ** ** | ** ** | **INVESTORS FINANCIAL SERVICES  CORP.**                                                                                 |
|-------------------|------------|------------|-------------------------------------------------------------------------------------------------------------------------|
| ** **        | ** ** | ** ** | ** **                                                                                                              |
| Date: May 4, 2006 |       | 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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