**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

 

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**FORM10-Q**

 

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| **(Mark One)**                                         |
|--------------------------------------------------------|
| ** **                                             |
| **ý**                                             | ** ** | **QUARTERLY REPORT PURSUANT  TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                             | ** ** | ** ** |
| **For the Quarterly  period ended September 30, 2005** |
| ** **                                             |
| **or**                                                 |
| ** **                                             |
| **o**                                                  | ** ** | **TRANSITION REPORT PURSUANT  TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

** **

**For the Transition periodfrom                 to                 **

 

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

** **

| **INVESTORS FINANCIAL SERVICES CORP.**                     |
|------------------------------------------------------------|
| (Exact name of  registrant as specified in its charter)    |
|                                                       |   |   |
| **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 mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. Yes xNo o

 

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

 

Indicate by check mark whether the registrant is a shell company (asdefined in Exchange Act Rule 12b-2).      Yes o     No ý

 

As of October 31, 2005 there were 64,982,015 shares of Common Stockoutstanding.

 

 

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**INVESTORS FINANCIAL SERVICES CORP.**

 

**INDEX**

 
| **PART I.**    | **FINANCIAL INFORMATION**                                                                                                        |   |   |
|----------------|----------------------------------------------------------------------------------------------------------------------------------|--------|--------|
| ** **     | ** **                                                                                                                       |   |   |
| Item 1.        | Unaudited  Condensed Consolidated Financial Statements                                                                           |   |   |
|           |                                                                                                                             |   |   |
|           | Unaudited  Condensed Consolidated Balance Sheets   September 30, 2005 and December 31, 2004                                      |   |   |
|           |                                                                                                                             |   |   |
|           | Unaudited  Condensed Consolidated Statements of Income and Comprehensive Income   Nine months ended September 30, 2005 and 2004  |   |   |
|           |                                                                                                                             |   |   |
|           | Unaudited  Condensed Consolidated Statements of Income and Comprehensive Income   Three months ended September 30, 2005 and 2004 |   |   |
|           |                                                                                                                             |   |   |
|           | Unaudited  Condensed Consolidated Statements of Stockholders’ Equity   Nine months ended September 30, 2005 and 2004        |   |   |
|           |                                                                                                                             |   |   |
|           | Unaudited  Condensed Consolidated Statements of Cash Flows   Nine months ended September 30, 2005 and 2004                       |   |   |
|           |                                                                                                                             |   |   |
|           | Notes  to Unaudited Condensed Consolidated Financial Statements                                                                  |   |   |
|           |                                                                                                                             |   |   |
|           | Report  of Independent Registered Public Accounting Firm                                                                         |   |   |
|           |                                                                                                                             |   |   |
| Item 2.        | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                      |   |   |
|           |                                                                                                                             |   |   |
| Item 3.        | Quantitative  and Qualitative Disclosures about Market Risk                                                                      |   |   |
|           |                                                                                                                             |   |   |
| Item 4.        | Controls and Procedures                                                                                                          |   |   |
|           |                                                                                                                             |   |   |
| **PART II.**   | **OTHER INFORMATION**                                                                                                            |   |   |
| ** **     | ** **                                                                                                                       |   |   |
| Item 1.        | Legal Proceedings                                                                                                                |   |   |
|           |                                                                                                                             |   |   |
| Item 2.        | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                     |   |   |
|           |                                                                                                                             |   |   |
| Item 6.        | Exhibits                                                                                                                         |   |   |
|           |                                                                                                                             |   |   |
| **SIGNATURES** |                                                                                                                             |   |

 

2

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**PART I.  FINANCIAL INFORMATION**

**Item1.    Unaudited Condensed ConsolidatedFinancial Statements**

 

**INVESTORSFINANCIAL SERVICES CORP.**

**UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS**

**September30, 2005 and December 31, 2004 (Dollars in thousands, except share data)**

** **
| ** **                                                                                                                                                     | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                                                                                                                     | ** ** | **2005**          | ** ** | **2004**         | ** ** |
| ** **                                                                                                                                                     | ** ** | ** **        | ** ** | ** **       | ** ** |
| **Assets**                                                                                                                                                     |       |              |       |             |       |
| Cash and due from banks                                                                                                                                        |       | $                 | 67,246     |             | $          | 49,059 |   |
| Federal Funds sold                                                                                                                                             |       | 1,000,000         |       | —           |       |
| Securities held to maturity (fair value of  $6,850,689 and $5,937,462   at September 30, 2005 and December 31, 2004, respectively)                             |       | 6,872,650         |       | 5,942,717        |       |
| Securities available for sale                                                                                                                                  |       | 4,362,913         |       | 4,565,505        |       |
| Nonmarketable equity securities                                                                                                                                |       | 50,000            |       | 50,000           |       |
| Loans, less allowance for loan losses of  $100 at September 30, 2005 and December 31, 2004                                                                     |       | 343,539           |       | 134,530          |       |
| Accrued interest and fees receivable                                                                                                                           |       | 109,006           |       | 89,292           |       |
| Equipment and leasehold improvements, less  accumulated depreciation of $57,285 and $61,017 at September 30, 2005 and  December 31, 2004, respectively         |       | 64,683            |       | 67,883           |       |
| Goodwill, net                                                                                                                                                  |       | 79,969            |       | 79,969           |       |
| Other assets                                                                                                                                                   |       | 278,043           |       | 188,870          |       |
|                                                                                                                                                           |       |              |       |             |       |
| **Total Assets**                                                                                                                                               |       | $                 | 13,228,049 |             | $          | 11,167,825 |   |
|                                                                                                                                                           |       |              |       |             |       |
| **Liabilities and Stockholders’ Equity**                                                                                                                  |       |              |       |             |       |
|                                                                                                                                                           |       |              |       |             |       |
| **Liabilities:**                                                                                                                                               |       |              |       |             |       |
| Deposits:                                                                                                                                                      |       |              |       |             |       |
| Demand                                                                                                                                                         |       | $                 | 383,701    |             | $          | 690,308 |   |
| Savings                                                                                                                                                        |       | 5,557,824         |       | 4,448,405        |       |
| Time                                                                                                                                                           |       | 271,997           |       | 257,669          |       |
| Total deposits                                                                                                                                                 |       | 6,213,522         |       | 5,396,382        |       |
|                                                                                                                                                           |       |              |       |             |       |
| Securities sold under repurchase agreements                                                                                                                    |       | 5,273,406         |       | 4,255,497        |       |
| Short-term and other borrowings                                                                                                                                |       | 645,032           |       | 594,681          |       |
| Due to brokers for open trades payable                                                                                                                         |       | 57,216            |       | 5,475            |       |
| Junior subordinated deferrable interest  debentures                                                                                                            |       | 24,774            |       | 24,774           |       |
| Accrued taxes and other expenses                                                                                                                               |       | 62,523            |       | 54,967           |       |
| Other liabilities                                                                                                                                              |       | 203,322           |       | 123,787          |       |
| Total liabilities                                                                                                                                              |       | 12,479,795        |       | 10,455,563       |       |
|                                                                                                                                                           |       |              |       |             |       |
| Commitments and contingencies                                                                                                                                  |       |              |       |             |       |
|                                                                                                                                                           |       | —            |       | —           |       |
| **Stockholders’ Equity:**                                                                                                                                 |       |              |       |             |       |
| Preferred Stock, par value $0.01 (shares  authorized: 1,000,000; issued: none at   September 30, 2005 and December 31, 2004)                                   |       | —            |       | —           |       |
| Common Stock, par value $0.01 (shares  authorized: 175,000,000; issued: 64,955,015   and 66,595,349 at September 30, 2005 and December 31, 2004, respectively) |       | 671               |       | 667              |       |
| Surplus                                                                                                                                                        |       | 283,835           |       | 272,536          |       |
| Deferred compensation                                                                                                                                          |       | (245              | )          | (572             | )          |
| Retained earnings                                                                                                                                              |       | 534,338           |       | 418,034          |       |
| Accumulated other comprehensive income, net                                                                                                                    |       | 2,603             |       | 23,888           |       |
| Treasury Stock, at cost (2,124,669 and  73,235 shares at September 30, 2005 and December 31, 2004, respectively)                                               |       | (72,948           | )          | (2,291           | )          |
| Total stockholders’ equity                                                                                                                                |       | 748,254           |       | 712,262          |       |
|                                                                                                                                                           |       |              |       |             |       |
| **Total Liabilities and Stockholders’ Equity**                                                                                                            |       | $                 | 13,228,049 |             | $          | 11,167,825 |   |

* *

*See Notes toUnaudited Condensed Consolidated Financial Statements.*

 

3

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**INVESTORSFINANCIAL SERVICES CORP.**

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

**Nine MonthsEnded September 30, 2005 and 2004 (Dollars in thousands, except per share data)**

** **
| ** **                                | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
|-------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                | ** ** | **2005**          | ** ** | **2004**          | ** ** |
| **Fees and  Other Revenue:**              | ** ** | ** **        | ** ** | ** **        | ** ** |
| Asset  servicing fees:                    |       |              |       |              |       |
| Core service fees                         |       | $                 | 274,150    |              | $          | 231,485 |   |
| Ancillary service fees                    |       | 92,370            |       | 83,849            |       |
| Total asset servicing fees                |       | 366,520           |       | 315,334           |       |
| Other  operating income                   |       | 2,424             |       | 1,515             |       |
| Gain on sale  of investments              |       | 11,123            |       | 234               |       |
| Total fees and other revenue              |       | 380,067           |       | 317,083           |       |
|                                      |       |              |       |              |       |
| Interest  income                          |       | 320,670           |       | 223,250           |       |
| Interest  expense                         |       | 192,970           |       | 84,487            |       |
| Net interest income                       |       | 127,700           |       | 138,763           |       |
| Net operating revenue                     |       | 507,767           |       | 455,846           |       |
|                                      |       |              |       |              |       |
| **Operating  Expenses:**                  |       |              |       |              |       |
| Compensation  and benefits                |       | 185,779           |       | 154,052           |       |
| Technology  and telecommunications        |       | 39,901            |       | 34,892            |       |
| Transaction  processing services          |       | 35,252            |       | 30,766            |       |
| Depreciation  and amortization            |       | 23,724            |       | 24,388            |       |
| Occupancy                                 |       | 19,409            |       | 21,613            |       |
| Professional  fees                        |       | 9,253             |       | 11,861            |       |
| Travel and  sales promotion               |       | 4,823             |       | 3,940             |       |
| Insurance                                 |       | 3,284             |       | 3,499             |       |
| Other  operating expenses                 |       | 12,734            |       | 10,314            |       |
| Total operating expenses                  |       | 334,159           |       | 295,325           |       |
|                                      |       |              |       |              |       |
| **Income  Before Income Taxes**           |       | 173,608           |       | 160,521           |       |
|                                      |       |              |       |              |       |
| Provision  for income taxes               |       | 53,301            |       | 53,838            |       |
|                                      |       |              |       |              |       |
| **Net  Income**                           |       | $                 | 120,307    |              | $          | 106,683 |   |
| ** **                                |       |              |       |              |       |
| **Basic  Earnings Per Share**             |       | $                 | 1.81       |              | $          | 1.61 |   |
| ** **                                |       |              |       |              |       |
| **Diluted  Earnings Per Share**           |       | $                 | 1.77       |              | $          | 1.57 |   |
|                                      |       |              |       |              |       |
| **Comprehensive  Income:**                |       |              |       |              |       |
| Net income                                |       | $                 | 120,307    |              | $          | 106,683 |   |
| Other  comprehensive (loss) income:       |       |              |       |              |       |
| Net unrealized investment loss            |       | (31,095           | )          | (240              | )          |
| Net unrealized derivative instrument gain |       | 9,462             |       | 6,591             |       |
| Cumulative translation adjustment         |       | 348               |       | 227               |       |
| Other comprehensive (loss) income         |       | (21,285           | )          | 6,578             |       |
| Comprehensive  income                     |       | $                 | 99,022     |              | $          | 113,261 |   |

 

*See Notes toUnaudited Condensed Consolidated Financial Statements.*

 

4

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**INVESTORSFINANCIAL SERVICES CORP.**

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

**ThreeMonths Ended September 30, 2005 and 2004 (Dollars in thousands, except pershare data)**

** **
| ** **                                        | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
|---------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                        | ** ** | **2005**          | ** ** | **2004**          | ** ** |
| **Fees and  Other Revenue:**                      | ** ** | ** **        | ** ** | ** **        | ** ** |
| Asset  servicing fees:                            |       |              |       |              |       |
| Core service fees                                 |       | $                 | 95,447     |              | $          | 76,636 |   |
| Ancillary service fees                            |       | 33,372            |       | 23,518            |       |
| Total asset servicing fees                        |       | 128,819           |       | 100,154           |       |
| Other  operating income                           |       | 1,013             |       | 418               |       |
| Gain on sale  of investments                      |       | 1,383             |       | —            |       |
| Total fees and other revenue                      |       | 131,215           |       | 100,572           |       |
|                                              |       |              |       |              |       |
| Interest  income                                  |       | 114,512           |       | 80,474            |       |
| Interest  expense                                 |       | 76,471            |       | 32,207            |       |
| Net interest income                               |       | 38,041            |       | 48,267            |       |
| Net operating revenue                             |       | 169,256           |       | 148,839           |       |
|                                              |       |              |       |              |       |
| **Operating  Expenses:**                          |       |              |       |              |       |
| Compensation  and benefits                        |       | 65,428            |       | 44,958            |       |
| Technology  and telecommunications                |       | 13,988            |       | 14,170            |       |
| Transaction  processing services                  |       | 12,476            |       | 9,628             |       |
| Depreciation  and amortization                    |       | 7,740             |       | 7,667             |       |
| Occupancy                                         |       | 6,569             |       | 7,353             |       |
| Professional  fees                                |       | 2,874             |       | 4,605             |       |
| Travel and  sales promotion                       |       | 1,649             |       | 1,361             |       |
| Insurance                                         |       | 1,009             |       | 1,139             |       |
| Other  operating expenses                         |       | 4,397             |       | 3,610             |       |
| Total operating expenses                          |       | 116,130           |       | 94,491            |       |
|                                              |       |              |       |              |       |
| **Income  Before Income Taxes**                   |       | 53,126            |       | 54,348            |       |
|                                              |       |              |       |              |       |
| Provision  for income taxes                       |       | 17,894            |       | 18,214            |       |
|                                              |       |              |       |              |       |
| **Net  Income**                                   |       | $                 | 35,232     |              | $          | 36,134 |   |
| ** **                                        |       |              |       |              |       |
| **Basic  Earnings Per Share**                     |       | $                 | 0.54       |              | $          | 0.54 |   |
| ** **                                        |       |              |       |              |       |
| **Diluted  Earnings Per Share**                   |       | $                 | 0.53       |              | $          | 0.53 |   |
|                                              |       |              |       |              |       |
| **Comprehensive  Income:**                        |       |              |       |              |       |
| Net income                                        |       | $                 | 35,232     |              | $          | 36,134 |   |
| Other  comprehensive (loss) income:               |       |              |       |              |       |
| Net unrealized investment (loss) gain             |       | (18,401           | )          | 36,836            |       |
| Net unrealized derivative instrument gain  (loss) |       | 6,770             |       | (5,263            | )          |
| Cumulative translation adjustment                 |       | 572               |       | 627               |       |
| Other comprehensive (loss) income                 |       | (11,059           | )          | 32,200            |       |
| Comprehensive  income                             |       | $                 | 24,173     |              | $          | 68,334 |   |

 

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

 

5

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**INVESTORSFINANCIAL SERVICES CORP.**

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

**Nine MonthsEnded September 30, 2005 and 2004 (Dollars in thousands, except share data)**

 
| ** **                                                                                                  | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                                                                                  | ** ** | **2005**          | ** ** | **2004**          | ** ** |
| **Common  shares**                                                                                          |       |              |       |              |       |
| Balance,  beginning of period                                                                               |       | 66,595,349        |       | 65,436,788        |       |
| Exercise of  stock options                                                                                  |       | 356,238           |       | 869,354           |       |
| Common Stock  issuance                                                                                      |       | 54,862            |       | 47,681            |       |
| Common Stock  repurchased                                                                                   |       | (2,051,434        | )          | —            |       |
| Balance, end  of period                                                                                     |       | 64,955,015        |       | 66,353,823        |       |
|                                                                                                        |       |              |       |              |       |
| **Treasury  shares**                                                                                        |       |              |       |              |       |
| Balance,  beginning of period                                                                               |       | 73,235            |       | 26,508            |       |
| Common Stock  repurchased                                                                                   |       | 2,051,434         |       | —            |       |
| Balance, end  of period                                                                                     |       | 2,124,669         |       | 26,508            |       |
|                                                                                                        |       |              |       |              |       |
| **Common  Stock**                                                                                           |       |              |       |              |       |
| Balance,  beginning of period                                                                               |       | $                 | 667        |              | $          | 655 |   |
| Exercise of  stock options                                                                                  |       | 4                 |       | 9                 |       |
| Balance, end  of period                                                                                     |       | 671               |       | 664               |       |
|                                                                                                        |       |              |       |              |       |
| **Surplus**                                                                                                 |       |              |       |              |       |
| Balance, beginning  of period                                                                               |       | 272,536           |       | 242,662           |       |
| Exercise of  stock options                                                                                  |       | 6,896             |       | 13,987            |       |
| Tax benefit  from exercise of stock options                                                                 |       | 2,525             |       | 7,248             |       |
| Common Stock  issuance                                                                                      |       | 1,878             |       | 1,668             |       |
| Stock option  forfeiture                                                                                    |       | —            |       | (188              | )          |
| Balance, end  of period                                                                                     |       | 283,835           |       | 265,377           |       |
|                                                                                                        |       |              |       |              |       |
| **Deferred  compensation**                                                                                  |       |              |       |              |       |
| Balance,  beginning of period                                                                               |       | (572              | )          | (1,076            | )          |
| Stock option  forfeiture                                                                                    |       | —            |       | 188               |       |
| Amortization  of deferred compensation                                                                      |       | 327               |       | 212               |       |
| Balance, end  of period                                                                                     |       | (245              | )          | (676              | )          |
|                                                                                                        |       |              |       |              |       |
| **Retained  earnings**                                                                                      |       |              |       |              |       |
| Balance,  beginning of period                                                                               |       | 418,034           |       | 280,701           |       |
| Net income                                                                                                  |       | 120,307           |       | 106,683           |       |
| Cash dividend, $0.060 and $0.053 per share  in the periods ending September 30, 2005 and 2004, respectively |       | (4,003            | )          | (3,469            | )          |
| Balance, end  of period                                                                                     |       | 534,338           |       | 383,915           |       |
|                                                                                                        |       |              |       |              |       |
| **Accumulated  other comprehensive income, net**                                                            |       |              |       |              |       |
| Balance,  beginning of period                                                                               |       | 23,888            |       | 17,865            |       |
| Net  unrealized investment loss                                                                             |       | (31,095           | )          | (240              | )          |
| Net  unrealized derivative instrument gain                                                                  |       | 10,741            |       | 6,565             |       |
| Amortization  of terminated interest rate swap agreements                                                   |       | (1,279            | )          | 26                |       |
| Cumulative  translation adjustment                                                                          |       | 348               |       | 227               |       |
| Balance, end  of period                                                                                     |       | 2,603             |       | 24,443            |       |
|                                                                                                        |       |              |       |              |       |
| **Treasury  Stock**                                                                                         |       |              |       |              |       |
| Balance,  beginning of period                                                                               |       | (2,291            | )          | (550              | )          |
| Common Stock  repurchased                                                                                   |       | (70,657           | )          | —            |       |
| Balance, end  of period                                                                                     |       | (72,948           | )          | (550              | )          |
|                                                                                                        |       |              |       |              |       |
| **Total  Stockholders’ Equity**                                                                        |       | $                 | 748,254    |              | $          | 673,173 |   |

 

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

 

6

----

 

**INVESTORSFINANCIAL SERVICES CORP.**

**UNAUDITEDCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**NineMonths Ended September 30, 2005 and 2004 (Dollars in thousands)**

 
| ** **                                                                         | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                                                         | ** ** | **2005**          | ** ** | **2004**          | ** ** |
| ** **                                                                         | ** ** | ** **        | ** ** | ** **        | ** ** |
| **Cash  Flows From Operating Activities:**                                         |       |              |       |              |       |
| Net income                                                                         |       | $                 | 120,307    |              | $          | 106,683 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |              |       |              |       |
| Equity in undistributed loss of  unconsolidated subsidiary                         |       | 21                |       | 21                |       |
| Depreciation and amortization                                                      |       | 23,724            |       | 24,388            |       |
| Amortization of deferred compensation                                              |       | 327               |       | 212               |       |
| Amortization of premiums on securities, net  of accretion of discounts             |       | 38,844            |       | 31,375            |       |
| Gain on sale of investments                                                        |       | (11,123           | )          | (234              | )          |
| Changes in assets and liabilities:                                                 |       |              |       |              |       |
| Accrued interest and fees receivable                                               |       | (19,714           | )          | (6,571            | )          |
| Other assets                                                                       |       | (89,147           | )          | (11,079           | )          |
| Accrued taxes and other expenses                                                   |       | 7,556             |       | 22,308            |       |
| Other liabilities                                                                  |       | 109,148           |       | 20,498            |       |
| Net cash provided by operating activities                                          |       | 179,943           |       | 187,601           |       |
|                                                                               |       |              |       |              |       |
| **Cash  Flows From Investing Activities:**                                         |       |              |       |              |       |
| Proceeds from  maturities and paydowns of securities available for sale            |       | 1,047,624         |       | 1,081,801         |       |
| Proceeds  from maturities and paydowns of securities held to maturity              |       | 1,199,301         |       | 1,067,873         |       |
| Proceeds  from sale of securities available for sale                               |       | 293,488           |       | 25,041            |       |
| Purchases of  securities available for sale                                        |       | (1,183,603        | )          | (1,404,590        | )          |
| Purchases of  securities held to maturity                                          |       | (2,160,300        | )          | (2,339,029        | )          |
| Net increase  in due to brokers for open trades payable                            |       | 51,741            |       | 75,172            |       |
| Net increase  in Federal Funds sold                                                |       | (1,000,000        | )          | —            |       |
| Net increase  in loans                                                             |       | (209,009          | )          | (13,878           | )          |
| Purchases of  fixed assets, capitalized software and leasehold improvements        |       | (20,502           | )          | (18,394           | )          |
| Net cash used for investing activities                                             |       | (1,981,260        | )          | (1,526,004        | )          |
|                                                                               |       |              |       |              |       |
| **Cash  Flows From Financing Activities:**                                         |       |              |       |              |       |
| Net decrease  in demand deposits                                                   |       | (306,607          | )          | (69,193           | )          |
| Net increase  in time and savings deposits                                         |       | 1,123,747         |       | 68,854            |       |
| Net increase  in securities sold under repurchase agreements                       |       | 1,017,909         |       | 1,298,580         |       |
| Net increase  in short-term and other borrowings                                   |       | 50,351            |       | 34,686            |       |
| Proceeds  from exercise of stock options                                           |       | 6,900             |       | 13,996            |       |
| Proceeds  from issuance of Common Stock                                            |       | 1,878             |       | 1,668             |       |
| Common Stock  repurchased                                                          |       | (70,657           | )          | —            |       |
| Dividends  paid to stockholders                                                    |       | (4,003            | )          | (3,469            | )          |
| Net cash provided by financing activities                                          |       | 1,819,518         |       | 1,345,122         |       |
|                                                                               |       |              |       |              |       |
| **Effect  of exchange rates on cash**                                              |       | (14               | )          | (11               | )          |
|                                                                               |       |              |       |              |       |
| **Net  Increase in Cash and Due From Banks**                                       |       | 18,187            |       | 6,708             |       |
| ** **                                                                         |       |              |       |              |       |
| **Cash and  Due From Banks, Beginning of Period**                                  |       | 49,059            |       | 39,689            |       |
| ** **                                                                         |       |              |       |              |       |
| **Cash and  Due From Banks, End of Period**                                        |       | $                 | 67,246     |              | $          | 46,397 |   |

 

*See Notes toUnaudited Condensed Consolidated Financial Statements.*

* *

*7*

----

* *

**INVESTORSFINANCIAL SERVICES CORP.**

**NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Informationis as of and for the nine months and the three months ended September 30, 2005and 2004)**

 

**1.       Description of Business**

 

Investors Financial ServicesCorp. (‘IFSC’) provides asset administration services for the financialservices industry through its wholly-owned subsidiary, Investors Bank &Trust Company (‘the Bank’).  As usedherein, the defined term “the Company” shall mean IFSC together with the Bankand its domestic and foreign subsidiaries. The Company provides core services and ancillary services to a variety of financial asset managers, including mutual fundcomplexes, investment advisors, family offices, banks and insurancecompanies.  Core services include middleoffice outsourcing, global custody, multicurrency accounting and fundadministration.  Ancillary servicesinclude securities lending, foreign exchange, cash management, performancemeasurement, institutional transfer agency, investment advisory services, linesof credit and brokerage and transition management services.  The Company and/or its affiliates aresubject to regulation by the Federal Deposit Insurance Corporation, the FederalReserve Board of Governors, the Office of the Commissioner of Banks of theCommonwealth of Massachusetts, the Securities and Exchange Commission (‘SEC’),the National Association of Securities Dealers, Inc. (‘NASD’), the Office ofthe Superintendent of Financial Institutions in Canada, the Irish FinancialServices Regulatory Authority, the Cayman Islands Monetary Authority, and theState of Vermont Department of Banking, Insurance, Securities & Health CareAdministration.

 

**2.       Interim FinancialStatements**

 

The unaudited condensedconsolidated interim financial statements of the Company and its subsidiariesas of September 30, 2005 and December 31, 2004, and for the nine-month and the three-monthperiods ended September 30, 2005 and 2004 have been prepared by the Companypursuant to the rules and regulations of the SEC.  Certain information and footnote disclosuresnormally included in annual financial statements prepared in accordance withaccounting principles generally accepted in the United States of America (‘GAAP’)have been condensed or omitted as permitted by such rules and regulations.  All adjustments, consisting of normalrecurring adjustments, necessary for their fair presentation in conformity withGAAP are included.  The Company’s managementbelieves that the disclosures are adequate to present fairly the financialposition, results of operations and cash flows at the dates and for the periodspresented. The preparation of the financial statements requires management tomake estimates and assumptions that affect the amounts reported in thefinancial statements and accompanying notes. Actual results may differ from those estimates.  It is suggested that these interim financialstatements be read in conjunction with the financial statements and the notesthereto included in the Company’s latest annual 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******–***Thespecific identification method is used to determine gains and losses on salesof securities.  Amortization and accretion of debtsecurities purchased at a premium or discount are amortized or accreted intoincome using a method which approximates the constant effective yield. TheCompany applies Financial Accounting Standard No. 91, *Accounting for Nonrefundable Fees and CostsAssociated with Originating or Acquiring Loans and Initial Direct Costs ofLeases* (‘FAS 91’) for the amortization of premiums and accretion ofdiscounts. Prepayments are anticipated using three-month actual prepaymentexperience for securities that represent holdings of large numbers of similarloans for which prepayments are probable and the timing and amount ofprepayments can be reasonably estimated.  Premiums and discounts onsecurities not meeting these criteria are amortized or accreted over theircontractual term using the constant effective yield.  Actual prepaymentexperience for all investment securities is reviewed monthly and the timing ofthe amortization and accretion is adjusted accordingly.

 

***Income Taxes******–***Income tax expense is based onestimated taxes payable or refundable on a tax return basis for the currentyear and the changes in deferred tax assets and liabilities during theyear.  Deferred tax assets and liabilitiesare established for temporary differences between the accounting basis and thetax basis of the Company’s assets and liabilities at enacted tax rates expectedto be in effect when the amounts related to such temporary differences arerealized or settled.  If the Companydetermines that it is “more likely than not” that some portion or all of adeferred tax asset will not be realized, the Company records a valuationallowance in accordance with the provisions of Financial Accounting StandardNo. 109, *Accounting for Income Taxes*.

 

The Company recorded a one-timebenefit of approximately $7 million in the second quarter of 2005 related tothe recognition of the indefinite reversal provision of Accounting PrinciplesBoard Opinion No. 23, *Accounting for IncomeTaxes – Special Areas*(‘APB 23’). The indefinite reversal provisionof APB 23 specifies that U.S. income taxes should not be accrued on theundistributed earnings of a foreign subsidiary if those earnings have been or willbe invested indefinitely in that subsidiary’s operations. The Company had previouslyaccrued U.S. income taxes on the undistributed earnings of its Irishsubsidiaries. In the second quarter of 2005, the Company recognized theindefinite reversal provision of APB 23 due to the projected capital

 

8

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needs of its Irish subsidiariesnecessary to support continued growth. As such, the Company will no longerrecord U.S. income taxes on the undistributed earnings of its Irishsubsidiaries.

 

***Share-Based Compensation******–*** The Company measurescompensation expense for share-based compensation plans using the intrinsicvalue method.  The intrinsic value methodmeasures compensation cost as the amount by which the fair market value of the Company’sCommon Stock exceeds the option exercise price on the measurement date, whichis typically the date of grant. Generally, options granted have an exercise price equivalent to the fairmarket value of the Common Stock at the measurement date.  Accordingly, no compensation cost has beenrecorded.  If share-based compensationwere recognized using the fair value method, stock options would be valued at thegrant date using the Black-Scholes valuation model and resulting compensationcosts would have decreased net income as indicated below (Dollars in thousands,except per share data):

 
| ** **                                                                                                                                  | ** ** | **For the Nine Months  Ended September 30,** | ** ** | **For the Three Months  Ended September 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                                                                  | ** ** | **2005**                                     | ** ** | **2004**                                      | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                                                                        |       |                                         |       |                                          |       |   |   |   |   |
| Net income  as reported                                                                                                                     |       | $                                            | 120,307    |                                          | $          | 106,683 |   | $ | 35,232 |   | $ | 36,134 |   |
| Deduct: Total share-based employee compensation  expense determined under the fair value method for all awards, net of related  tax effects |       | (2,806                                       | )          | (6,761                                        | )          | (1,014 | ) | (1,584 | ) |
| Pro forma  net income                                                                                                                       |       | $                                            | 117,501    |                                          | $          | 99,922 |   | $ | 34,218 |   | $ | 34,550 |   |
|                                                                                                                                        |       |                                         |       |                                          |       |   |   |   |   |
| Earnings per  share:                                                                                                                        |       |                                         |       |                                          |       |   |   |   |   |
| Basic-as reported                                                                                                                           |       | $                                            | 1.81       |                                          | $          | 1.61 |   | $ | 0.54 |   | $ | 0.54 |   |
| Basic-pro forma                                                                                                                             |       | $                                            | 1.77       |                                          | $          | 1.51 |   | $ | 0.52 |   | $ | 0.52 |   |
|                                                                                                                                        |       |                                         |       |                                          |       |   |   |   |   |
| Diluted-as reported                                                                                                                         |       | $                                            | 1.77       |                                          | $          | 1.57 |   | $ | 0.53 |   | $ | 0.53 |   |
| Diluted-pro forma                                                                                                                           |       | $                                            | 1.72       |                                          | $          | 1.47 |   | $ | 0.51 |   | $ | 0.51 |   |

 

The fair value of each optiongrant was estimated on the date of grant using the Black-Scholes valuationmodel with the following assumptions for the nine months ended September 30,2005 and 2004, respectively: an average assumed risk-free interest rate of 4.03%and 2.96%, an expected life of four years, an average expected volatility of 42.32%and 51.69%, and an average dividend yield of 0.20% and 0.16%.

 

For the three months ended September30, 2005 and 2004, respectively, the following assumptions were used in theBlack-Scholes valuation model: an assumed risk-free interest rate of 4.23% and3.12%, an expected life of four years, an average expected volatility of 41.21%and 49.40%, and a dividend yield of 0.24% and 0.16%.

 

9

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***Earnings Per Share –***Basicearnings per share (‘EPS’) were computed by dividing net income by theweighted-average number of common shares outstanding during the quarter.  Diluted EPS reflects the potential dilution thatcould occur if contracts to issue Common Stock were exercised into Common Stockthat 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 Nine Months  Ended September 30,** | ** ** | **For the Three Months  Ended September 30,** | ** ** |
|----------------------------------------------|------------|----------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                   | ** ** | **2005**                                     | ** ** | **2004**                                      | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                         |       |                                         |       |                                          |       |   |   |   |   |
| Income  available to common stockholders     |       | $                                            | 120,307    |                                          | $          | 106,683 |   | $ | 35,232 |   | $ | 36,134 |   |
|                                         |       |                                         |       |                                          |       |   |   |   |   |
| Basic  weighted-average shares outstanding   |       | 66,530,636                                   |       | 66,084,620                                    |       | 66,076,656 |   | 66,298,749 |   |
| Dilutive  effect of stock options            |       | 1,435,857                                    |       | 1,769,004                                     |       | 934,232 |   | 1,832,113 |   |
| Diluted  weighted-average shares outstanding |       | 67,966,493                                   |       | 67,853,624                                    |       | 67,010,888 |   | 68,130,862 |   |
|                                         |       |                                         |       |                                          |       |   |   |   |   |
| Earnings per  share:                         |       |                                         |       |                                          |       |   |   |   |   |
| Basic                                        |       | $                                            | 1.81       |                                          | $          | 1.61 |   | $ | 0.54 |   | $ | 0.54 |   |
|                                         |       |                                         |       |                                          |       |   |   |   |   |
| Diluted                                      |       | $                                            | 1.77       |                                          | $          | 1.57 |   | $ | 0.53 |   | $ | 0.53 |   |
|                                              |            |                                              |            |                                               |            |  |  |  |  |  |  |  |  |  |  |

 

 

There were 79,493 and 23,796options which were not considered dilutive for purposes of EPS calculations forthe nine-month periods ended September 30, 2005 and 2004, respectively.  For the three-month periods ended September30, 2005 and 2004, there were 1,121,058 and 436 options, respectively, whichwere not considered dilutive for purposes of EPS calculations.

 

***Recently Issued AccountingPronouncements***

 

In December 2004, the Financial AccountingStandards Board (‘FASB’) issued SFAS No. 123 (revised 2004), *Share-Based Payment* (‘SFAS No. 123R’).  SFAS No. 123R requires thatcompensation cost relating to share-based payment transactions be recognized inthe financial statements with measurement based upon the fair value of theequity or liability instruments issued. The Company currently uses theintrinsic value method to measure compensation cost related to its share-based transactions.SFAS No. 123R replaces SFAS No. 123, *Accountingfor Stock-Based Compensation*, and supersedes APB Opinion No. 25, *Accounting for Stock Issued to Employees.*

 

In March 2005, the SEC issued StaffAccounting Bulletin No. 107 (‘SAB 107’), which expresses the views of the SECregarding the interaction of SFAS No. 123R and certain SEC regulations andprovides the SEC’s views regarding the valuation of share-based paymentarrangements for public companies.

 

In April 2005, the SEC issued Release2005-57, which delayed the effective date for SFAS No. 123R to reportingperiods in the first fiscal year beginning after June 15, 2005.

 

Accordingly, the Company currently expects toadopt SFAS No. 123R and follow the guidance of SAB 107 beginning on January 1,2006.  The Company is in the process of determining the valuationmethodology it will use under the fair value method and is assessing the impactthe adoption of SFAS No. 123R will have on its results of operations andfinancial condition.  The Company does notanticipate any material impact to its financial condition or results ofoperations as a result of the adoption of SFAS No. 123R.

 

In May 2005, the FASB issued SFAS No. 154, *Accounting Changes and Error Corrections- areplacement of APB Opinion No. 20 and FASB Statement No. 3*(‘SFAS No. 154’).  SFAS No. 154replaces APB Opinion No. 20, *AccountingChanges,*and FASB Statement No. 3, *ReportingAccounting Changes in Interim Financial Statements,*and changes the accountingand reporting requirements for a change in accounting principle.  SFAS No.154 applies to all voluntary changes in an accounting principle, as well as tochanges required by a new accounting pronouncement in the unusual instance thatthe pronouncement does not include specific transition provisions.  SFASNo. 154 is effective for accounting changes and error corrections made infiscal years beginning after December 15, 2005 and requires retrospectiveapplication to prior periods’ financial statements for most voluntary changesin an accounting principle, unless it is impracticable to do so.  TheCompany does not anticipate any material impact to its financial condition orresults of operations as a result of the adoption of SFAS No. 154.

 

10

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**3.       Securities**

 

Amortized cost amounts and fairvalues of securities are summarized as follows as of September 30, 2005(Dollars in thousands):

 
| ** **                        | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair**  | ** ** |
|-----------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|-----------|------------|
| **Held to Maturity**              | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **(Losses)**   | ** ** | **Value** | ** ** |
|                              |       |          |       |           |       |           |       |      |       |
| Mortgage-backed  securities       |       | $             | 4,411,745  |           | $          | 11,369         |       | $         | (18,953    | ) | $ | 4,404,161 |   |
| Federal  agency securities        |       | 2,343,503     |       | 1,657          |       | (21,010        | )          | 2,324,150 |       |
| State and  political subdivisions |       | 117,402       |       | 5,057          |       | (81            | )          | 122,378   |       |
|                              |       |          |       |           |       |           |       |      |       |
| Total                             |       | $             | 6,872,650  |           | $          | 18,083         |       | $         | (40,044    | ) | $ | 6,850,689 |   |
|                              |       |          |       |           |       |           |       |      |       |
| ** **                        | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair**  | ** ** |
| **Available for Sale**            | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **(Losses)**   | ** ** | **Value** | ** ** |
|                              |       |          |       |           |       |           |       |      |       |
| Mortgage-backed  securities       |       | $             | 3,819,138  |           | $          | 7,988          |       | $         | (33,002    | ) | $ | 3,794,124 |   |
| State and  political subdivisions |       | 348,865       |       | 8,757          |       | (383           | )          | 357,239   |       |
| Corporate  debt                   |       | 201,743       |       | 828            |       | (1,669         | )          | 200,902   |       |
| Foreign  government securities    |       | 10,551        |       | 97             |       | —         |       | 10,648    |       |
|                              |       |          |       |           |       |           |       |      |       |
| Total                             |       | $             | 4,380,297  |           | $          | 17,670         |       | $         | (35,054    | ) | $ | 4,362,913 |   |

 

Amortized cost amounts and fair values ofsecurities are summarized as follows as of December 31, 2004 (Dollars inthousands):

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

 

During the nine-month periodended September 30, 2005, the Company sold fifty-six securities classified asavailable for sale totaling $293.5 million using the specific identificationmethod.  The book value of the securitieswas $282.4 million resulting in a gross realized gain of $11.1 million.  During the three-month period ended September30, 2005, the Company sold seventeen securities classified as available forsale totaling $45.1 million using the specific identification method.  The book value of the securities was $43.7million resulting in a gross realized gain of $1.4 million.

 

The carrying value ofsecurities pledged amounted to approximately $7.7 billion and $6.3 billion at September30, 2005 and December 31, 2004, respectively. Securities are pledged primarily to secure clearings with otherdepository institutions, to secure repurchase agreements and to secureoutstanding Federal Home Loan Bank of Boston (‘FHLBB’) borrowings.

 

On a quarterly basis theCompany reviews its investment portfolio on a security-by-security basis forany investment that may be other-than-temporarily impaired.  In its evaluation, the Company considers thelength of time the security has been impaired, the severity of the impairment,the financial condition and future prospects of the issuer, and the Company’sability and intent to hold the security to maturity or until it recovers invalue.  At September 30, 2005, nosecurities were considered to be other-than-temporarily impaired.

 

11

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**4.       Loans**

 

Loans consist of demand loansto custody clients of the Company, including individuals, not-for-profitinstitutions and mutual fund clients. The loans to mutual funds and otherpooled product clients include lines of credit and advances pursuant to theterms of the custody agreements between the Company and those clients tofacilitate securities transactions and redemptions. Generally, the loans are,or may be, in the event of default, collateralized with marketable securities heldby the Company as custodian. There were no impaired or nonperforming loans at September30, 2005 and December 31, 2004.  Inaddition, there were no loan charge-offs or recoveries during the nine monthsended September 30, 2005 nor the year ended December 31, 2004. Loans aresummarized as follows (Dollars in thousands):

 

| ** **                      | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                      | ** ** | **2005**          | ** ** | **2004**         | ** ** |
|                            |       |              |       |             |       |
| Loans to  mutual funds          |       | $                 | 210,172    |             | $          | 22,520 |   |
| Loans to  individuals           |       | 95,464            |       | 69,402           |       |
| Loans to  others                |       | 38,003            |       | 42,708           |       |
| Gross loans                     |       | 343,639           |       | 134,630          |       |
| Less  allowance for loan losses |       | (100              | )          | (100             | )          |
|                            |       |              |       |             |       |
| Total                           |       | $                 | 343,539    |             | $          | 134,530 |   |

 

**5.       Deposits**

 

The following is a summary ofdeposit balances by type (Dollars in thousands):

 

| ** **                         | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                         | ** ** | **2005**          | ** ** | **2004**         | ** ** |
| Interest-bearing deposits:         |       |              |       |             |       |
| Demand                             |       | $                 | 59,230     |             | $          | — |   |
| Savings                            |       | 5,509,106         |       | 4,362,895        |       |
| Time                               |       | 46,997            |       | 97,669           |       |
| Total interest-bearing deposits    |       | 5,615,333         |       | 4,460,564        |       |
|                               |       |              |       |             |       |
| Noninterest-bearing deposits:      |       |              |       |             |       |
| Demand                             |       | 324,471           |       | 690,308          |       |
| Savings                            |       | 48,718            |       | 85,510           |       |
| Time                               |       | 225,000           |       | 160,000          |       |
| Total noninterest-bearing deposits |       | 598,189           |       | 935,818          |       |
|                               |       |              |       |             |       |
| Total                              |       | $                 | 6,213,522  |             | $          | 5,396,382 |   |
|                                    |            |                   |            |                  |            |  |  |  |

 

Time deposits with balancesgreater than $100,000 totaled $271.9 million and $257.6 million at September 30,2005 and December 31, 2004, respectively. All time deposits had a maturity of less than three months at September30, 2005 and December 31, 2004.

 

**6.       Securities Sold UnderRepurchase Agreements**

 

The components of securitiessold under repurchase agreements are as follows (Dollars in thousands):

 

| ** **                          | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                          | ** ** | **2005**          | ** ** | **2004**         | ** ** |
|                                |       |              |       |             |       |
| Repurchase  agreements - short term |       | $                 | 4,673,406  |             | $          | 3,655,497 |   |
| Repurchase  agreements - long term  |       | 600,000           |       | 600,000          |       |
| Total                               |       | $                 | 5,273,406  |             | $          | 4,255,497 |   |

 

Approximately $5.4 billion and$4.3 billion of securities were pledged to collateralize repurchase agreementsas of September 30, 2005 and December 31, 2004, respectively.

 

12

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

 

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

 

| ** **                                            | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                            | ** ** | **2005**          | ** ** | **2004**         | ** ** |
|                                                  |       |              |       |             |       |
| Federal  Funds purchased                              |       | $                 | 595,001    |             | $          | 344,491 |   |
| Federal Home  Loan Bank of Boston short-term advances |       | 50,000            |       | 200,000          |       |
| Federal Home  Loan Bank of Boston long-term advances  |       | —            |       | 50,000           |       |
| Treasury,  Tax and Loan account                       |       | 31                |       | 190              |       |
| Total                                                 |       | $                 | 645,032    |             | $          | 594,681 |   |

 

The Company has borrowingarrangements with the FHLBB and the Federal Reserve Discount Window, which havebeen utilized on an overnight, short-term and long-term basis to satisfyfunding requirements.  Approximately $2.1billion and $1.6 billion of securities were pledged to collateralize theseadvances as of September 30, 2005 and December 31, 2004, respectively.

 

**8.       Stockholders’ Equity**

 

As of September 30, 2005, theCompany’s authorized capital stock consisted of 1,000,000 shares of PreferredStock and 175,000,000 shares of Common Stock, all with a par value of $0.01 pershare.

 

The Company has four equityincentive plans: the Amended and Restated 1995 Stock Plan (‘Stock Plan’), theAmended and Restated 1995 Non-Employee Director Stock Option Plan (‘DirectorPlan’), the 1997 Employee Stock Purchase Plan (‘ESPP’) and the 2005 EquityIncentive Plan, which was approved by the stockholders on April 14, 2005 (the ‘2005Plan’).  The 2005 Plan supersedes boththe Stock Plan and the Director Plan, both of which continue in effect onlywith regard to options outstanding under these plans. There were no amendmentsto any plans during the nine months ended September 30, 2005.

 

During the nine months ended September30, 2005, the following activity occurred under the Director Plan, the StockPlan and the 2005 Plan:

 

| ** **                                         | ** ** | **September 30, 2005** | ** ** |
|----------------------------------------------------|------------|------------------------|------------|
| ** **                                         | ** ** | ** **             | ** ** | **Weighted-Average** | ** ** |
| ** **                                         | ** ** | **Shares**             | ** ** | **Exercise Price** | ** ** |
|                                               |       |                   |       |   |   |
| Outstanding  at December 31, 2004                  |       | 5,929,352              |       | $ | 28 |   |
| Granted                                            |       | 81,466                 |       | 42 |   |
| Exercised                                          |       | (417,760               | )          | 22 |   |
| Canceled                                           |       | (62,445                | )          | 35 |   |
| Outstanding  at September 30, 2005                 |       | 5,530,613              |       | $ | 28 |   |
|                                               |       |                   |       |   |   |
| Outstanding  and Exercisable at September 30, 2005 |       | 4,781,108              |       |   |   |

 

13

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A summary of activity under theESPP is as follows:

 
| ** **                                                  | ** ** | **For the Nine**  | ** ** | **For the**      | ** ** |
|-------------------------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                  | ** ** | **Months Ended**  | ** ** | **Year Ended**   | ** ** |
| ** **                                                  | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| ** **                                                  | ** ** | **2005**          | ** ** | **2004**         | ** ** |
|                                                        |       |              |       |             |       |
| Total shares  available under the ESPP, beginning of period |       | 636,267           |       | 227,504          |       |
| Approved increase in shares available                       |       | —            |       | 500,000          |       |
| Issued at June 30                                           |       | (54,862           | )          | (47,681          | )          |
| Issued at December 31                                       |       | —            |       | (43,556          | )          |
|                                                        |       |              |       |             |       |
| Total shares  available under the ESPP, end of period       |       | 581,405           |       | 636,267          |       |

 

Purchases under the ESPP aremade two times a year on the last business day of each payment period.  The purchase price is equal to the lesser of(i) 90% of the market value of the Common Stock on the first business day ofthe payment period, or (ii) 90% of the market value of the Common Stock on thelast business day of the payment period. The payment periods consist of two six-month periods, January 1 throughJune 30 and July 1 through December 31.

 

During the six-month period endedJune 30, 2005, the purchase price of the stock was $34.25, or 90% of the marketvalue of the Common Stock on the last business day of the payment period endingJune 30, 2005.

 

During the year ended December31, 2004, the purchase prices of the stock were $35.00 and $35.75, or 90% ofthe market value of the Common Stock on the first business day of the paymentperiods ending June 30, 2004 and December 31, 2004, respectively.

 

In July 2005, the Company announced that itsBoard of Directors authorized a repurchase plan of up to $150 million of theCompany’s Common Stock over the twelve months following the announcement.  The plan expires in June 2006.  See Part II, Item 2 for further detail.

 

**9.     Employee Benefit Plans**

 

***Pension Plan -***TheCompany has a trusteed, noncontributory, qualified defined benefit pension plancovering substantially all of its employees who were hired before January 1,1997.  The benefits are based on years ofservice and the employee’s compensation during employment.  Generally, the Company’s funding policy is tocontribute annually the maximum amount that can be deducted for federal incometax purposes.  Contributions are intendedto provide not only for benefits attributed to service to date, but also forbenefits expected to be earned in the future. The plan document was amended in December 2004 to freeze benefitaccruals for certain highly compensated participants as of December 31, 2004.  The Company uses a December 31 measurementdate for this plan.  Net periodic pensioncost for the Company’s pension plan included the following components (Dollarsin thousands):

 
| ** **                                          | ** ** | **For the Nine Months Ended** | ** ** | **For the Three Months Ended** | ** ** |
|-----------------------------------------------------|------------|-------------------------------|------------|--------------------------------|------------|
| ** **                                          | ** ** | **September 30,  2005**       | ** ** | **September 30,  2004**        | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
|                                                |       |                          |       |                           |       |   |   |   |   |
| Service  cost-benefits earned / benefit obligations |       | $                             | 558        |                           | $          | 696 |   | $ | 186 |   | $ | 232 |   |
| Interest  cost on projected benefit obligations     |       | 858                           |       | 831                            |       | 286 |   | 277 |   |
| Expected  return on plan assets                     |       | (1,077                        | )          | (1,086                         | )          | (359 | ) | (362 | ) |
| Net  amortization and deferral                      |       | 234                           |       | 180                            |       | 78 |   | 60 |   |
| Net periodic  pension cost                          |       | $                             | 573        |                           | $          | 621 |   | $ | 191 |   | $ | 207 |   |

 

During 2005, the Companyexpects to contribute up to $4 million, but no more than the maximum deductiblecontribution the Company can make for the fiscal year, to its pensionplan.  During the nine-month period endedSeptember 30, 2005, the Company did not make any contributions to the plan.

 

***Supplemental Retirement Plan***- The Company also has a nonqualified, unfunded, supplemental retirement plan (‘SERP’)which was established in 1994 and covers certain employees and pays benefitsthat supplement any benefits paid under the

 

14

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qualified plan.  Benefits under the SERP are generally basedon compensation not includable in the calculation of benefits to be paid underthe qualified plan.  The Company uses aDecember 31 measurement date for this plan.

 

Net periodic pension cost forthe Company’s SERP included the following components (Dollars in thousands):

 
| ** **                                          | ** ** | **For the Nine Months Ended** | ** ** | **For the Three Months Ended** | ** ** |
|-----------------------------------------------------|------------|-------------------------------|------------|--------------------------------|------------|
| ** **                                          | ** ** | **September 30,  2005**       | ** ** | **September 30,  2004**        | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
|                                                |       |                          |       |                           |       |   |   |   |   |
| Service  cost-benefits earned / benefit obligations |       | $                             | 1,332      |                           | $          | 714 |   | $ | 444 |   | $ | 238 |   |
| Interest  cost on projected benefit obligations     |       | 1,104                         |       | 726                            |       | 368 |   | 242 |   |
| Net  amortization and deferral                      |       | 816                           |       | 444                            |       | 272 |   | 148 |   |
| Net periodic  pension cost                          |       | $                             | 3,252      |                           | $          | 1,884 |   | $ | 1,084 |   | $ | 628 |   |

 

At September 30, 2005, the SERPremained an unfunded plan.  Consistentwith the Company’s expectations at December 31, 2004, no contributions to theSERP are anticipated during 2005.

 

**10.    Off-Balance Sheet FinancialInstruments**

 

***Lines of Credit****-* At September 30, 2005, the Company had commitments tomutual funds under collateralized open lines of credit totaling $850.0 million,against which $0.1 million in loans were drawn. The credit risk involved inissuing lines of credit is essentially the same as that involved in extendingdemand loans. The Company does not anticipate any loss as a result of theselines of credit.

 

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

 

With respect to the indemnifiedsecurities lending portfolio, the cash and U.S. government securities held bythe Company as collateral at September 30, 2005 totaled $7.7 billion,while the fair value of the portfolio totaled approximately $7.4 billion.Given that the collateral held was in excess of the value of the securitiesthat the Company would be required to replace if the borrower defaulted andfailed to return such securities, the Company’s indemnification obligation waszero and no liability was recorded.

 

All securities loans arecategorized as overnight loans. The maximum potential amount of future paymentsthat the Company could be required to make would be equal to the market valueof the securities borrowed. Since the securities loans are overcollateralizedby 2% (for U.S. dollar-denominated securities) to 5% (for non-U.S.dollar-denominated securities) of the fair market value of the loan made, thecollateral held by the Company would be used to satisfy the obligation. Inaddition, each borrowing agreement includes “set-off” language that allows theCompany to use any excess collateral on other loans to that borrower to coverany collateral shortfall of that borrower. However, there is a potential riskthat the collateral would not be sufficient to cover such an obligation if thesecurity on loan increased in value between the time the borrower defaulted andthe time the security is “bought-in.” In those instances, the Company would “buy-in”the security using all available collateral and a loss would result from thedifference between the value of the security “bought-in” and the value of thecollateral held. The Company has never experienced a broker default.

 

15

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**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. TheCompany’s exposure from these interest rate contracts results from thepossibility that one party may default on its contractual obligation

when the contracts are in again position.  The Company has experiencedno terminations or defaults by counterparties of interest rate swaps.  Credit risk is limited to the positive fairvalue of the derivative financial instrument, which is significantly

less than the notionalvalue.  As of September 30, 2005, the positivefair value related to the Company’s interest rate contracts was approximately$22.3 million.

 

The Company enters intopay-fixed/receive-floating interest rate swap agreements.  These instruments have been designated ascash flow hedges of variable-rate liabilities and a forecasted series offixed-rate overnight liabilities incurred at different daily fixed rates(thereby resulting in a variable interest expense pattern).  The contractual or notional amounts of theinterest rate swap agreements held by the Company were approximately $1.8billion and $1.6 billion at September 30, 2005 and December 31, 2004,respectively.  These contracts had netfair values of approximately $22.3 million and $1.5 million at September 30,2005 and December 31, 2004, respectively. These fair values are included in therespective other assets and other liabilities categories on the Company’sconsolidated balance sheets.

 

For the nine months and thethree months ended September 30, 2005, the Company recognized net pre-tax gainsof $3.3 million and $0.4 million, respectively, which represented the totalineffectiveness for all cash flow hedges. For the nine months and the threemonths ended September 30, 2004, total ineffectiveness related to cash flowhedges was $2.5 million and $1.6 million, respectively.

 

As of September 30, 2005, theCompany expects that approximately $9.3 million of deferred net after-tax gainson derivative contracts included in other comprehensive income will bereclassified to net interest income within the next twelve months. Thisexpectation is based on the net discounted cash flows from existing cash flowhedging derivatives, as well as the amortization of gains from terminated cashflow hedging derivatives.

 

***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 its contractualobligation or from movements in exchange rates. Credit risk is limited to the positive market value of the derivativefinancial instrument, which is significantly less than the notional value. Thenotional value of the Company’s foreign exchange contracts as of September 30,2005 and December 31, 2004 was $9.6 billion and $6.9 billion,respectively.  Unrealized gains or lossesresulting from purchases and sales of foreign exchange contracts are includedwithin the respective other assets and other liabilities categories on theCompany’s consolidated balance sheets. Unrealized gains in other assets were $143.4 million and $99.6 millionas of September 30, 2005 and December 31, 2004, respectively.  Unrealized losses in other liabilities were$142.5 million and $98.5 million as of September 30, 2005 and December 31,2004, respectively.  Foreign exchangecontracts with the same counterparty are netted in the Company’s consolidatedbalance sheets when a master netting agreement exists.  These contracts have not been designated ashedging instruments; therefore, all changes in fair value are included in assetservicing fees.

 

***Other***- The Company also enters into fixed price purchase contracts that are designedto hedge the variability of the consideration to be paid for the purchase ofinvestment securities.  By entering intothese contracts, the Company is fixing the price to be paid at a future datefor certain investment securities. At September 30, 2005 and December 31, 2004,the Company had $94.2 million and $672.2 million, respectively, of fixed pricepurchase contracts outstanding to purchase investment securities. The net fairvalue of the contracts at September 30, 2005 and December 31, 2004 was notsignificant.  Changes in fair value ofthese cash flow hedges are included as a component of other comprehensiveincome.

 

**12.    Commitments andContingencies**

 

***Restrictions on Cash Balances***- The Company is required to maintain certain average cash reservebalances.  The average required reservebalance with the Federal Reserve Bank (‘FRB’) for the two-week period includingSeptember 30, 2005 was approximately $33.5 million.  In addition, the Company’s balance sheet includesdeposits totaling $28.5 million, which were pledged to secure clearings withdepository institutions as of September 30, 2005.

 

16

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***Contingencies***- Assets held by the Company in a fiduciary capacity are not included in theconsolidated balance sheets since these items are not assets of the Company.  Management conducts regular reviews of itsfiduciary responsibilities and considers the results in preparing itsconsolidated financial statements.  Inthe opinion of management, there were no contingent liabilities at September 30,2005 that were material to the consolidated financial position or results ofoperations of the Company.

 

**13.    Regulatory Matters**

 

The Company and the Bank aresubject to various regulatory capital requirements administered by the federalbanking agencies.  Failure to meetminimum capital requirements can initiate certain mandatory and possiblyadditional discretionary actions by regulators that, if undertaken, could havea direct material effect on the Company’s and the Bank’s financialstatements.  Under capital adequacy guidelinesand the regulatory framework for prompt corrective action, the Bank must meetspecific capital guidelines that involve quantitative measures of the Bank’sassets, liabilities, and certain off-balance sheet items as calculated underregulatory accounting practices.  TheCompany’s and the Bank’s capital amounts and classification are also subject toqualitative judgments by the regulators about components, risk weightings, andother factors.

 

Quantitative measuresestablished by regulation to ensure capital adequacy require the Company andthe Bank to maintain minimum amounts and ratios (set forth in the table below)of Total and Tier 1 capital (as defined in the regulations) to risk-weightedassets (as defined), and of Tier 1 capital (as defined) to average assets (asdefined).  Management believes, as of September30, 2005, that the Company and the Bank meet all capital adequacy requirementsto which they are subject.

 

As of September 30, 2005, themost recent notification from the Federal Deposit Insurance Corporationcategorized the Company and the Bank as well-capitalized under the regulatoryframework for prompt corrective action. To be categorized as well-capitalized, the Company and the Bank mustmaintain minimum Total risk-based, Tier 1 risk-based, and Tier 1 leverageratios as set forth in the table.  Thereare no conditions or events since that notification that management believeshave changed the Company’s or the Bank’s category.  The following table presents the capitalratios for the Company and the Bank (Dollars in thousands):

 
| ** **                                             | ** ** | ** ** | ** ** | ** **            | ** ** | ** **      | ** ** | ** **            | ** ** | **To Be Well-Capitalized** | ** ** |
|--------------------------------------------------------|------------|------------|------------|-----------------------|------------|-----------------|------------|-----------------------|------------|----------------------------|------------|
| ** **                                             | ** ** | ** ** | ** ** | ** **            | ** ** | ** **      | ** ** | ** **            | ** ** | **Under Prompt**           | ** ** |
| ** **                                             | ** ** | ** ** | ** ** | ** **            | ** ** | **For Capital** | ** ** | **Corrective Action** | ** ** |
| ** **                                             | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Provisions**  | ** ** |
| ** **                                             | ** ** | **Amount** | ** ** | **Ratio**             | ** ** | **Amount**      | ** ** | **Ratio**             | ** ** | **Amount**                 | ** ** | **Ratio** | ** ** |
| **As of September 30, 2005:**                          | ** ** | ** ** | ** ** | ** **            | ** ** | ** **      | ** ** | ** **            | ** ** | ** **                 | ** ** | ** ** | ** ** |
| Total Capital   (to Risk-Weighted Assets-the Company)  |       | $          | 691,553    |                  | 16.21      | %               | $          | 341,254               |       | 8.00                       | %          | N/A |   | N/A |   |
| Total Capital   (to Risk-Weighted Assets-the Bank)     |       | $          | 680,613    |                  | 15.96      | %               | $          | 341,208               |       | 8.00                       | %          | $ | 426,511 |   | 10.00 | % |
| Tier 1 Capital   (to Risk-Weighted Assets-the Company) |       | $          | 691,453    |                  | 16.21      | %               | $          | 170,627               |       | 4.00                       | %          | N/A |   | N/A |   |
| Tier 1 Capital   (to Risk-Weighted Assets-the Bank)    |       | $          | 680,513    |                  | 15.96      | %               | $          | 170,604               |       | 4.00                       | %          | $ | 255,906 |   | 6.00 | % |
| Tier 1 Capital   (to Average Assets-the Company)       |       | $          | 691,453    |                  | 5.65       | %               | $          | 489,561               |       | 4.00                       | %          | N/A |   | N/A |   |
| Tier 1 Capital   (to Average Assets-the Bank)          |       | $          | 680,513    |                  | 5.56       | %               | $          | 489,409               |       | 4.00                       | %          | $ | 611,761 |   | 5.00 | % |
|                                                   |       |       |       |                  |       |            |       |                  |       |                       |       |   |   |
| **As of December 31, 2004:**                           | ** ** | ** ** | ** ** | ** **            | ** ** | ** **      | ** ** | ** **            | ** ** | ** **                 | ** ** | ** ** | ** ** |
| Total Capital   (to Risk-Weighted Assets-the Company)  |       | $          | 636,219    |                  | 20.54      | %               | $          | 247,782               |       | 8.00                       | %          | N/A |   | N/A |   |
| Total Capital   (to Risk-Weighted Assets-the Bank)     |       | $          | 618,166    |                  | 19.98      | %               | $          | 247,572               |       | 8.00                       | %          | $ | 309,465 |   | 10.00 | % |
| Tier 1 Capital   (to Risk-Weighted Assets-the Company) |       | $          | 636,119    |                  | 20.54      | %               | $          | 123,891               |       | 4.00                       | %          | N/A |   | N/A |   |
| Tier 1 Capital   (to Risk-Weighted Assets-the Bank)    |       | $          | 618,066    |                  | 19.97      | %               | $          | 123,786               |       | 4.00                       | %          | $ | 185,679 |   | 6.00 | % |
| Tier 1 Capital   (to Average Assets-the Company)       |       | $          | 636,119    |                  | 5.85       | %               | $          | 435,080               |       | 4.00                       | %          | N/A |   | N/A |   |
| Tier 1 Capital   (to Average Assets-the Bank)          |       | $          | 618,066    |                  | 5.68       | %               | $          | 435,017               |       | 4.00                       | %          | $ | 543,772 |   | 5.00 | % |

 

17

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Under Massachusetts law, trustcompanies such as the Bank, like national banks, may pay dividends no moreoften than quarterly, and only out of net profits and to the extent that suchpayments will not impair the Bank’s capital stock and surplus account.  Moreover, prior Commissioner approval isrequired if the total dividends for a calendar year would exceed net profitsfor that year combined with retained net profits for the previous twoyears.  These restrictions on the abilityof the Bank to pay dividends to the Company may restrict the ability of theCompany to pay dividends to its stockholders.

 

The operations of the Company’ssecurities broker affiliate, Investors Securities Services, LLC, are subject tofederal and state securities laws, as well as the rules of both the SEC and theNASD.  Management believes, as of September30, 2005, that Investors Securities Services, LLC, is in material compliancewith all of the foregoing requirements to which it is subject.

 

The operations of the Company’scaptive insurance affiliate, Investors Vermont Insurance Company (‘IVIC’), aresubject to the laws and regulations of the State of Vermont Department ofBanking, Insurance, Securities and Health Care Administration.  Management believes, as of September 30,2005, that IVIC is in material compliance with all of the foregoing requirementsto which it is subject.

 

**14.    Geographic Reporting andService Lines**

 

The Company does not utilizesegment information for internal reporting, as management views the Company asone segment. The following represents net operating revenue and long-livedassets (including goodwill) by geographic area (Dollars in thousands):

 

 
| ** **                 | ** ** | **Net Operating Revenue**     | ** ** | ** **                     | ** ** |
|----------------------------|------------|-------------------------------|------------|--------------------------------|------------|
| ** **                 | ** ** | **For the Nine Months Ended** | ** ** | **For the Three Months Ended** | ** ** | **Long-Lived Assets** | ** ** |
| ** **                 | ** ** | **September 30,**             | ** ** | **September 30,**              | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| **Geographic Information** | ** ** | **2005**                      | ** ** | **2004**                       | ** ** | **2005** | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| United  States             |       | $                             | 476,283    |                           | $          | 430,961 |   | $ | 158,914 |   | $ | 139,721 |   | $ | 138,911 |   | $ | 141,801 |   |
| Ireland                    |       | 27,352                        |       | 21,112                         |       | 8,929 |   | 7,671 |   | 5,465 |   | 5,930 |   |
| Canada                     |       | 4,006                         |       | 3,639                          |       | 1,372 |   | 1,402 |   | 276 |   | 121 |   |
| Cayman  Islands            |       | 126                           |       | 134                            |       | 41 |   | 45 |   | — |   | — |   |
|                       |       |                          |       |                           |       |   |   |   |   |   |   |   |   |
| Total                      |       | $                             | 507,767    |                           | $          | 455,846 |   | $ | 169,256 |   | $ | 148,839 |   | $ | 144,652 |   | $ | 147,852 |   |

 

Barclays Global Investors, N.A.(‘BGI’) accounted for approximately 18% and 19% of the Company’s consolidatednet operating revenues for the nine-month and the three-month periods ended September30, 2005, respectively, and 17% and 16% of the Company’s consolidated netoperating revenues for the nine-month and the three-month periods ended September30, 2004, respectively.  No client otherthan BGI accounted for more than 10% of the Company’s consolidated netoperating revenues for the nine-month and the three-month periods ended September30, 2005 and 2004.

 

The following represents theCompany’s asset servicing fees by service lines (Dollars in thousands):

 
| ** **                             | ** ** | **For the Nine Months Ended** | ** ** | **For the Three Months Ended** | ** ** |
|----------------------------------------|------------|-------------------------------|------------|--------------------------------|------------|
| ** **                             | ** ** | **September 30,**             | ** ** | **September 30,**              | ** ** |
| ** **                             | ** ** | **2005**                      | ** ** | **2004**                       | ** ** | **2005** | ** ** | **2004** | ** ** |
| Core service  fees:                    |       |                          |       |                           |       |   |   |   |   |
| Custody, accounting and administration |       | $                             | 274,150    |                           | $          | 231,485 |   | $ | 95,447 |   | $ | 76,636 |   |
|                                   |       |                          |       |                           |       |   |   |   |   |
| Ancillary  service fees:               |       |                          |       |                           |       |   |   |   |   |
| Foreign exchange                       |       | 41,050                        |       | 42,334                         |       | 15,546 |   | 9,326 |   |
| Cash management                        |       | 25,956                        |       | 19,587                         |       | 9,419 |   | 7,249 |   |
| Securities lending                     |       | 17,162                        |       | 7,718                          |       | 5,312 |   | 1,994 |   |
| Investment advisory                    |       | 6,189                         |       | 12,346                         |       | 2,485 |   | 4,313 |   |
| Other service fees                     |       | 2,013                         |       | 1,864                          |       | 610 |   | 636 |   |
| Total ancillary service fees           |       | 92,370                        |       | 83,849                         |       | 33,372 |   | 23,518 |   |
|                                   |       |                          |       |                           |       |   |   |   |   |
| Total asset  servicing fees            |       | $                             | 366,520    |                           | $          | 315,334 |   | $ | 128,819 |   | $ | 100,154 |   |

 

18

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**15.    Net Interest Income**

 

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

 
| ** **                                                          | ** ** | **For the Nine Months Ended  September 30,** | ** ** | **For the Three Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                          | ** ** | **2005**                                     | ** ** | **2004**                                      | ** ** | **2005** | ** ** | **2004** | ** ** |
| Interest income:                                                    |       |                                         |       |                                          |       |   |   |   |   |
| Federal funds sold and securities sold under  repurchase agreements |       | $                                            | 1,318      |                                          | $          | 420 |   | $ | 565 |   | $ | 106 |   |
| Investment securities held to maturity and  available for sale      |       | 313,304                                      |       | 219,531                                       |       | 111,711 |   | 79,222 |   |
| Loans                                                               |       | 6,048                                        |       | 3,299                                         |       | 2,236 |   | 1,146 |   |
| Total interest income                                               |       | 320,670                                      |       | 223,250                                       |       | 114,512 |   | 80,474 |   |
| Interest expense:                                                   |       |                                         |       |                                          |       |   |   |   |   |
| Deposits                                                            |       | 49,237                                       |       | 35,542                                        |       | 20,010 |   | 13,269 |   |
| Securities sold under repurchase agreements                         |       | 103,031                                      |       | 33,386                                        |       | 40,344 |   | 14,300 |   |
| Short-term and other borrowings                                     |       | 38,887                                       |       | 13,744                                        |       | 15,512 |   | 4,033 |   |
| Junior subordinated debentures                                      |       | 1,815                                        |       | 1,815                                         |       | 605 |   | 605 |   |
| Total interest expense                                              |       | 192,970                                      |       | 84,487                                        |       | 76,471 |   | 32,207 |   |
|                                                                |       |                                         |       |                                          |       |   |   |   |   |
| Net interest income                                                 |       | $                                            | 127,700    |                                          | $          | 138,763 |   | $ | 38,041 |   | $ | 48,267 |   |

 

19

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REPORT OF INDEPENDENTREGISTERED PUBLIC ACCOUNTING FIRM

 

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

 

We have reviewed the accompanying condensedconsolidated balance sheet of Investors Financial Services Corp. andsubsidiaries (the “Company”) as of September 30, 2005, and the relatedcondensed consolidated statements of income and comprehensive income for thethree-month and nine-month periods ended September 30, 2005 and 2004, and thecondensed consolidated statements of stockholders’ equity and cash flows forthe nine-month periods ended September 30, 2005 and 2004. These interimfinancial statements are the responsibility of the Company’s management.

 

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

 

Based on our reviews, we are not aware of any materialmodifications that should be made to such condensed consolidated interimfinancial statements for them to be in conformity with accounting principlesgenerally accepted in the United States of America.

 

We have previously audited, in accordance with thestandards of the Public Company Accounting Oversight Board (United States), theconsolidated balance sheet of Investors Financial Services Corp. andsubsidiaries as of December 31, 2004, and the related consolidatedstatements of income and other comprehensive income, stockholders’ equity, andcash flows for the year then ended (not presented herein); and in our reportdated February 28, 2005, we expressed an unqualified opinion on thoseconsolidated financial statements. In our opinion, the information set forth inthe accompanying condensed consolidated balance sheet as of December 31,2004 is fairly stated, in all material respects, in relation to theconsolidated balance sheet from which it has been derived.

 

*DELOITTE &TOUCHE LLP*

 

 

Boston, Massachusetts November 2, 2005

 

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

 

*You shouldread the following discussion together with our Unaudited Condensed ConsolidatedFinancial Statements and related Notes to Unaudited Condensed ConsolidatedFinancial Statements, 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.”*

 

**Overview**

 

We provide asset administration services forthe financial services industry through our wholly-owned subsidiary, InvestorsBank & Trust Company.  We providecore services and ancillary 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.  Ancillary 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, and the Cayman Islands with a vast global subcustodian networkestablished to accommodate the international needs of our clients.  At September 30, 2005, we provided servicesfor approximately $1.7 trillion in net assets, including approximately $286billion in foreign net assets.

 

We grow our business by selling our servicesto new clients and by further penetrating our existing clients.  We believe that we service less than 10% of theassets managed by our existing clients, and we have traditionally achievedsignificant success in growing client relationships.  Our ability to service new clients and expandour relationships with existing clients depends on our provision of superior clientservice.  Our growth is also affected byconditions in the global securities markets, the interest rate environment, theregulatory environment for us and our clients and the success of our clients inmarketing their products.

 

We derive our asset servicing revenue fromproviding core and ancillary services. We derive our net interest income by investing the cash balances ourclients leave on deposit with us.  Sincewe price our service offerings on a bundled basis, our share of earnings fromthese investments is viewed as part of the total compensation that our clientspay us for servicing their assets.  Inestablishing a fee structure for a specific client, we analyze all expectedrevenue and expenses.  We believe netoperating revenue (net interest income plus noninterest income) and net incomeare the most meaningful measures of our financial results.

 

As an asset administration services company,the amount of net operating revenue that we generate is impacted by overallmarket conditions, client activity and the prevailing interest rateenvironment.  A significant portion ofour core services revenue is based upon the amount of assets underadministration.  As market values ofunderlying assets fluctuate, so will our revenue.  We have managed this volatility by offering atiered pricing structure for our asset-based fees.  As asset values increase, the basis point feeis reduced for the incremental assets.  Whenasset values decrease, revenue is only impacted at the then marginal rate.  Many of our ancillary services aretransactional based, and we receive a fee for each transaction processed.  We have continued to experience net interestmargin compression during the first nine months of 2005 versus 2004 due to aflatter yield curve, lower reinvestment spreads and the liability sensitivenature of our balance sheet.  Because weare a liability sensitive institution, as overnight interest rates rise, mostof our liabilities reprice but our assets take longer to reprice due to thenature of their reset provisions (i.e., monthly, quarterly and annually).  The lower interest rate spreads were also dueto the narrowing of market spreads on reinvestment and purchase opportunities forfixed and floating-rate investment assets. We expect to see short-term rates continuing to rise and a continuedflat, but not inverted, yield curve.

 

We remain focused on our sales efforts,prudent expense management and increasing our operating efficiency.  These goals are complicated by the need tobuild infrastructure to support our growth, the need to maintainstate-of-the-art systems and the need to retain and motivate our workforce.

 

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**Certain Factors That May Affect Future Results**

 

From time to time,information provided by us, statements made by our employees, or informationincluded in our filings with the Securities and Exchange Commission (includingthis Form 10-Q) may contain statements which are not historical facts,so-called “forward-looking statements,” which are made under Section 21E of theSecurities Exchange Act of 1934 and which involve risks and uncertainties.  Thesestatements relate to future events or our future financial performance and areidentified by words such as “may,” “will,” “could,” “should,” “expect,” “plan,”“intend,” “seek,” “anticipate,” “believe,” “estimate,” “potential,” or “continue”or other comparable terms or the negative of those terms.  Forward-looking statements in thisForm 10-Q include certain statements regarding liquidity, growth rate, annualdividend payments, interest rate conditions, interest rate sensitivity,compliance with capital adequacy guidelines, loss exposure on lines of credit,the timing and effect on earnings of derivative gains and losses and thereclassification of net after-tax gains on derivative contracts, securitieslending revenue, net interest income, operating expenses, including occupancy expensesand needs, transaction processing services expense, professional fee expense,travel and sales expense, investments in technology and compensation expense,pension plan and supplemental pension expense, depreciation expense, effectivetax rate, investments in FHLBB capital stock, the effect on earnings of changesin equity values or fixed income, the effects of increased prepayments andreduced investment opportunities for our net interest income, our ability toexecute our stock repurchase plan, and the effect of certain legal claimsagainst us.  Our actual future resultsmay differ significantly from those stated in any forward-lookingstatements.  Factors that may cause suchdifferences include, but are not limited to, the factors discussed below.  Each of these factors, and others, arediscussed from time to time in our filings with the SEC.

 

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

 

Asignificant portion of our fees is based on the market value of the assets weprocess.  Accordingly, our operatingresults are subject to fluctuations in interest rates and securities markets asthese fluctuations affect the market value of assets processed.  Our net interest income is earned byinvesting depositors’ funds in our investment portfolio and, in small part, bymaking loans.  A rising interest rateenvironment, such as we are now experiencing, generally causes downwardpressure on net interest income.  Changesin the relationship between short-term and long-term interest rates, referredto as the yield curve, could also adversely affect the market value of, or theearnings produced by, our investment and loan portfolios, and thus couldadversely affect our operating results. The current flat yield curve, where short-term rates have increasedwhile long-term rates have failed to increase, has resulted in a decrease inour net interest margin that will continue to have a material impact on our netinterest income.

 

Volatilityin the 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.

 

Ourgrowth depends in part on the ability of our clients to generate fund flows byselling their 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 assets held by our clients were toincrease or decrease by 10%, we estimate currently that this, by itself, wouldcause a corresponding change of approximately 3% in our earnings pershare.  If the value of fixed-incomeassets held by our clients were to increase or decrease by 10%, we estimatecurrently that this, by itself, would cause a corresponding change ofapproximately 2% in our earnings per share.

 

Inaddition, we are experiencing narrower investment portfolio reinvestmentspreads, which reduces our net interest income. If reinvestments spreads on the security types we purchase remainnarrow, or become narrower, our net interest income will continue to beimpacted negatively.

 

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

 

As a result of our ongoing relationship with BGI’siShares and Master Investment Portfolios, our assumption of the operations ofthe U.S. asset administration unit of BGI in 2001 and our servicing assets forBarclays Global Investors Canada, Ltd., BGI accounted for approximately 18% and19% of our net operating revenue during the nine months and the three monthsended September 30, 2005, respectively. We expect that BGI will continue to account for a significant portion ofour net operating revenue.  We provideservices to BGI under contracts that are scheduled to expire in 2006, and thosecontracts may be terminated earlier for certain regulatory and fiduciaryreasons.  While we believe that we willextend or renew our contracts with BGI, the loss of BGI’s business would causeour net operating revenue to decline significantly and would likely have anadverse effect on our quarterly and annual results.

 

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*Wemay incur losses due to operational errors.*

 

The services that we provide require complex processesand interaction with numerous third parties. While we maintain sophisticated computer systems and a comprehensivesystem of internal controls, and our operational history has been excellent,from time to time we may make operational errors for which we are responsibleto our clients.  In addition, even thoughwe maintain appropriate errors and omissions and other insurance policies, anoperational error could result in a significant liability to us and may have amaterial adverse effect on our results of operations.

 

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

 

We are part of an extremely competitive asset servicingindustry.  Many of our current andpotential competitors have longer operating histories, greater name recognitionand substantially greater financial, marketing and other resources than wedo.  These greater resources could, forexample, allow our competitors to develop technology superior to our own. Inaddition, we face the risk that large mutual fund complexes may build in-houseasset servicing capabilities and no longer outsource these services to us.  As a result, we may not be able to competeeffectively with current or future competitors, which could result in a loss ofexisting clients or difficulty in gaining new clients.

 

*We may incur significant costsdefending legal claims.*

 

We have been named in lawsuits in U.S. District Court inMassachusetts alleging, among other things, violations of securities laws.  In addition, we have been named in a lawsuitin Massachusetts state court alleging, among other things, violations of acovenant of good faith and fair dealing in a contract. While we believe theseclaims are without merit, we cannot be sure that we will prevail in the defenseof these claims. We are also party to other litigation and we may become subjectto other legal claims in the future. Litigation is costly and could divert theattention of management.  For a moredetailed discussion of our ongoing lawsuits, please see Item 1. LegalProceedings, in Part II of this report.

 

*Our future results depend, inpart, on successful integration of prior and possible future acquisitions andoutsourcing transactions.*

 

Integration of outsourcing transactions is complicatedand frequently presents unforeseen difficulties and expenses which can affectwhether and when a particular outsourcing transaction will be accretive to ourearnings per share.  Any futureoutsourcing transactions will present similar challenges. These outsourcingtransactions can also consume a significant amount of management’s time.

 

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

 

We have experienced a period of rapid growth that hasrequired the dedication of significant management and other resources. Continuedrapid growth could place a strain on our management and other resources.  To manage future growth effectively, we mustcontinue to invest in our operational, financial and other internal systems,and our human resources, which could affect our profitability.

 

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

 

Qualified personnel, in particular managers and othersenior personnel, are in great demand throughout the financial servicesindustry.  As a result, we could find itincreasingly difficult to continue to attract and retain sufficient numbers ofthese highly skilled employees, which could affect our ability to attract andretain clients.

 

*We may not be able to protect ourproprietary technology.*

 

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

 

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*Our quarterly and annualoperating results may fluctuate.*

 

Our quarterly and annual operating results are difficultto predict and may fluctuate from quarter to quarter and annually for severalreasons, including:

 

•                  The timing of commencementor termination of client engagements;

 

•                  Changes in interestrates, the relationship between different interest rates or equity values;

 

•                  The rate of net inflowsand outflows of investor funds in the investment vehicles offered by ourclients; and

 

•                  The timing andmagnitude of share repurchases under our share repurchase plan.

 

Most of our expenses, such as employee compensation andrent, are relatively fixed.  As a result,any shortfall in revenue relative to our expectations could significantlyaffect our operating results.

 

*We are subject to extensivefederal and state regulations that impose complex restraints on our business.*

 

Federal and state laws and regulations applicable tofinancial institutions and their parent companies apply to us.  Our primary regulators are the FederalReserve Board (‘FRB’), the Federal Deposit Insurance Corporation  (‘FDIC’), the Massachusetts Commissioner ofBanks, the National Association of Securities Dealers, Inc. (‘NASD’), and theState of Vermont 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:

 

•                  The FRB and the FDIC maintaincapital requirements that we must meet. Failure to meet those requirementscould lead to severe regulatory action or even receivership. We are currentlyconsidered to be “well-capitalized”;

 

•                  Under Massachusettslaw, the Bank may be restricted in its ability to pay dividends to InvestorsFinancial Services Corp., which may in turn restrict our ability to paydividends to our stockholders;

 

•                  The FRB and the FDICare empowered to assess monetary penalties against, and to order termination ofactivities by, companies or individuals who violate the law;

 

•                  The NASD maintainscertain regulatory requirements that our securities broker affiliate, InvestorsSecurities Services, LLC, must meet. Failure to meet those requirements could lead to severe regulatoryaction;

 

•                  BISHCA maintainscertain regulatory requirements that our insurance captive affiliate, InvestorsVermont Insurance Company, must meet. Failure to meet those requirements could lead to regulatory action; and

 

•                  Our internationaloperations are subject to regulatory oversight by regulators in thejurisdictions in which we operate, including the Office of the Superintendentof Financial Institutions in Canada, the Irish Financial Services RegulatoryAuthority and the Cayman Islands Monetary Authority.  Failure to comply with applicableinternational regulatory requirements could result in regulatory action andimpact our ability to provide services in those jurisdictions.

 

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

 

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**Statements of Income**

 

***Comparisonof Operating Results for the Nine and Three Months Ended September 30, 2005 and2004***

 

Net income forthe nine months ended September 30, 2005 increased 13% to $120.3 million from thesame period in 2004.  Growth in netincome resulted from higher asset servicing fees, reflecting our continuedability to sell to new and existing clients combined with strong client fundflows.  The increase for the nine-monthperiod is also due to gains from sales of investment securities, as well as aone-time tax benefit related to our recognition of the indefinite reversalprovisions of Accounting Principles Board Opinion No. 23, *Accountingfor Income Taxes — Special Area*s (‘APB 23’), in the second quarterof 2005. See Note 2 in ‘Notes to Unaudited Condensed Consolidated FinancialStatements’ for further discussion of the one-time tax benefit. The increase innet income for the nine-month period was partially offset by lower net interestincome, higher operating expenses, reflecting continued growth in headcount andtechnology investments to support new and existing clients.

 

Net income forthe three months ended September 30, 2005 decreased 2% to $35.2 million fromthe same period in 2004.  The decreaseprimarily resulted from compression in our net interest margin as well asincreased operating expenses.  Thedecrease in net income for the three-month period was partially offset byincreased asset servicing fees, reflecting our ability to sell to new andexisting clients combined with market appreciation and strong client fundflows.

 

*Fees andOther Revenue*

 

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

 
| ** **                    | ** ** | **For the Nine Months Ended  September 30,** | ** ** | **For the Three Months Ended  September 30,** | ** ** |
|-------------------------------|------------|----------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                    | ** ** | **2005**                                     | ** ** | **2004**                                      | ** ** | **Change** | ** ** | **2005** | ** ** | **2004** | ** ** | **Change** | ** ** |
|                          |       |                                         |       |                                          |       |   |   |   |   |   |   |   |   |
| Total asset  servicing fees   |       | $                                            | 366,520    |                                          | $          | 315,334 |   | 16 | % | $ | 128,819 |   | $ | 100,154 |   | 29 | % |
| Other  operating income       |       | 2,424                                        |       | 1,515                                         |       | 60 | % | 1,013 |   | 418 |   | 142 | % |
| Gain on sale  of investments  |       | 11,123                                       |       | 234                                           |       |   | * | 1,383 |   | — |   | 100 | % |
|                          |       |                                         |       |                                          |       |   |   |   |   |   |   |   |   |
| Total fees  and other revenue |       | $                                            | 380,067    |                                          | $          | 317,083 |   | 20 | % | $ | 131,215 |   | $ | 100,572 |   | 30 | % |

* *

** increase in gain on sale of investments is not meaningful.*

 

The largestcomponents of asset servicing fees are custody, accounting and administrationfees, which increased 18% to $274.2 million and 25% to $95.4 million for the nine-monthand three-month periods ended September 30, 2005, respectively, from the sameperiods in 2004.  The increase in custody,accounting and administration fees in both the nine-month and three-month periodsis primarily due to new client wins, further penetration of existing clientsand growth in assets processed resulting from fund flows and market value gains. Assets processed is the total dollarvalue of financial assets on the reported date for which we provide one or more of the following services: middleoffice 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.  The change in net assets processed includes the following components (Dollars inbillions):

 

| ** **                                 | ** ** | **For the Nine Months Ended** | ** ** | **For the Three Months Ended** | ** ** |
|--------------------------------------------|------------|-------------------------------|------------|--------------------------------|------------|
| ** **                                 | ** ** | **September 30, 2005**        | ** ** | **September 30, 2005**         | ** ** |
| Net assets  processed, beginning of period |       | $                             | 1,430      |                           | $          | 1,496 |   |
|                                       |       |                          |       |                           |       |
| Change in  net assets processed:           |       |                          |       |                           |       |
| Sales to new clients                       |       | 159                           |       | 157                            |       |
| Further penetration of existing clients    |       | 38                            |       | 17                             |       |
| Lost clients                               |       | (11                           | )          | —                         |       |
| Fund flows and market gain                 |       | 118                           |       | 64                             |       |
| Total change in net assets processed       |       | 304                           |       | 238                            |       |
| Net assets  processed, end of period       |       | $                             | 1,734      |                           | $          | 1,734 |   |

 

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The majority of the increase in assets processed for the both the nine-monthand three-month periods ended September 30, 2005 was due to sales to newand existing clients and client fund flows.  As indicated in the ‘Overview’ section, ourcore services fees are generated by charging a fee based upon the value ofassets processed.  As market values orclients’ 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 assets held by ourclients were to increase or decrease by 10%, we estimate currently that this,by itself, would cause a corresponding change of approximately 3% in ourearnings per share.  If the value offixed-income assets held by our clients were to increase or decrease by 10%, weestimate currently that this, by itself, would cause a corresponding change ofapproximately 2% in our earnings per share. In practice, earnings per share do not track precisely to the value ofthe equity and fixed-income markets because conditions present in a marketincrease or decrease may generate offsetting increases or decreases in otherrevenue items.  For example, marketvolatility often results in increased transaction fee revenue.  Also, market declines may result in increasedinterest income and sweep fee income as clients move larger amounts of assetsinto the cash management vehicles that we offer. However, there can be noassurance that these offsetting revenue increases will occur during any futuredownturn in the equity or fixed-income markets.

 

Transaction-driven income, a component of asset servicing fees,includes our ancillary services, such as foreign exchange, cash management,securities lending and investment advisory services.

 

•                  Foreign exchange fees were $41.1 million for the nine-monthperiod ended September 30, 2005, down 3% from the same period in 2004.  The decrease is primarily attributable tolower volatility in currency markets in 2005 compared to 2004.  Foreign exchange fees were $15.5 million forthe three-month period ended September 30, 2005, up 67% from the same period in2004.  This increase is primarily attributableto new business, increased volume of client activity and volatility in currencymarkets during the three months ended September 30, 2005 compared to the sameperiod in 2004.  Future foreign exchangeincome is dependent on the volume of new and existing client activity and theoverall volatility in the currencies traded.

 

•                  Cash management fees, which consist of sweep fees,were $26.0 million for the nine months ended September 30, 2005, up 33% fromthe same period in 2004, and were $9.4 million for the three months ended September30, 2005, up 30% from the same period in 2004.  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.

 

•                  Securities lending fees were $17.2 million for thenine months ended September 30, 2005, up 122% from the same period in 2004, andwere $5.3 million for the three-month period ended September 30, 2005, up 166%from the same period in 2004. The increase in securities lending fees in bothperiods was due to new business, higher volumes and improved market conditions.  Securities lending transaction volume ispositively affected by the market value of securities on loan, merger andacquisition activity, increased IPO activity and a steeper short end of theyield curve.  If the capital marketsexperience any of the aforementioned activity, it is likely that our securitieslending revenue will be positively impacted. If we experience a reduction in our securities lending portfolio, lowermarket values and compression of the spreads earned on securities lending activity,our securities lending revenue will likely be negatively impacted.

 

•                  Investment advisory fees were $6.2 million for thenine months ended September 30, 2005, down 50% from the same period in 2004,and were $2.5 million for the three-month period ended September 30, 2005, down42% from the same period in 2004.  Thedecrease in investment advisory fees is attributable to lower asset levels in ourproprietary Merrimac money market funds combined with advisory fee waivers oncertain of the funds.  Future investmentadvisory fee income is dependent upon asset levels within the Merrimac moneymarket funds, which are driven by overall market conditions, client activityand transaction volumes. The Company discontinued advisory fee waivers in the secondquarter of 2005.

 

•                  Other service fees for the nine months ended September30, 2005 were $2.0 million, up 8% from the same period last year and were $0.6million for the three months ended September 30, 2005, down 4% from the sameperiod in 2004.  Other service feesinclude income earned on compliance advisory, brokerage and transitionmanagement services.  The increase infees for the nine-month period is due to an increase in compliance andbrokerage services.  The decrease inother service fees for the three-month period is primarily due to a decrease inbrokerage services.

 

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Other operating income for the nine months ended September 30, 2005 was$2.4 million, up 60% from the same period in 2004, and was $1.0 million for thethree months ended September 30, 2005, up 142% from the same period in 2004.The increases in both periods are primarily due to an increase in stock dividendincome from Federal Home Loan Bank of Boston (‘FHLBB’) from 2004 due to higherinterest rates.

 

During the first nine months of 2005, we sold municipal securities and U.S.Treasury securities held in our available for sale portfolio, resulting in therecognition of $11.1 million and $1.4 million in gains for the nine-month andthree-month periods ended September 30, 2005, respectively.  We sold these securities as part of a strategyto improve the after-tax yield of our municipal securities portfolio byreplacing the sold municipal securities with those that offer a more attractiveafter-tax yield, as well as to capitalize on strong market conditions.

 

*NetInterest Income*

 

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

 
| ** **                 | ** ** | **For the Nine Months Ended  September 30,** | ** ** | **For the Three Months Ended  September 30,** | ** ** |
|----------------------------|------------|----------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                 | ** ** | **2005**                                     | ** ** | **2004**                                      | ** ** | **Change** | ** ** | **2005** | ** ** | **2004** | ** ** | **Change** | ** ** |
|                       |       |                                         |       |                                          |       |   |   |   |   |   |   |   |   |
| Interest  income           |       | $                                            | 320,670    |                                          | $          | 223,250 |   | 44 | % | $ | 114,512 |   | $ | 80,474 |   | 42 | % |
| Interest  expense          |       | 192,970                                      |       | 84,487                                        |       | 128 | % | 76,471 |   | 32,207 |   | 137 | % |
| Total net  interest income |       | $                                            | 127,700    |                                          | $          | 138,763 |   | (8 | )% | $ | 38,041 |   | $ | 48,267 |   | (21 | )% |

 

Net interest income is affected by the volume and mix of assets andliabilities and the movement and level of interest rates.  The decrease in our netinterest income for both the nine-month and three-month periods ended September30, 2005 was primarily driven by lower interest rate spreads, which was partiallyoffset by growth in our investment portfolio. Lower interest rate spreads were due to increasing short-term interestrates without a concurrent increase in longer-term rates, which resulted in aflattening yield curve. Consequently, our interest-bearing liabilities, ofwhich the majority is priced based on overnight floating rates, have repricedat higher rates faster than our interest-earning assets have repriced,resulting in a lower net interest margin. In addition, reinvestment and purchase spreads on fixed andfloating-rate assets were lower than expected due to higher market demand,especially for shorter-term and floating-rate fixed income investments. Averageinvestment security balances were up approximately $1.7 billion and $1.5billion for the nine-month and three-month periods ended September 30, 2005,respectively, compared to the same periods in 2004.

 

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 nine months and the threemonths ended September 30, 2005 compared to the same periods in 2004.  Changes attributed to both volume and ratehave been allocated based on the proportion of change in each category (Dollarsin thousands):

 
| ** **                                                           | ** ** | **For the Nine Months Ended  September 30, 2005** | ** ** | **For the Three Months Ended  September 30, 2005** | ** ** |
|----------------------------------------------------------------------|------------|---------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                           | ** ** | **Change**                                        | ** ** | **Change**                                         | ** ** | ** ** | ** ** | **Change** | ** ** | **Change** | ** ** | ** ** | ** ** |
| ** **                                                           | ** ** | **Due to**                                        | ** ** | **Due to**                                         | ** ** | ** ** | ** ** | **Due to** | ** ** | **Due to** | ** ** | ** ** | ** ** |
| ** **                                                           | ** ** | **Volume**                                        | ** ** | **Rate**                                           | ** ** | **Net** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Net** | ** ** |
| **Interest-earning  assets:**                                        |       |                                              |       |                                               |       |   |   |   |   |   |   |   |   |
| Federal Funds sold and securities purchased  under resale agreements |       | $                                                 | 46         |                                               | $          | 852 |   | $ | 898 |   | $ | 178 |   | $ | 281 |   | $ | 459 |   |
| Investment securities                                                |       | 44,240                                            |       | 49,533                                             |       | 93,773 |   | 13,038 |   | 19,451 |   | 32,489 |   |
| Loans                                                                |       | 943                                               |       | 1,806                                              |       | 2,749 |   | 897 |   | 193 |   | 1,090 |   |
|                                                                 |       |                                              |       |                                               |       |   |   |   |   |   |   |   |   |
| Total interest-earning assets                                        |       | $                                                 | 45,229     |                                               | $          | 52,191 |   | $ | 97,420 |   | $ | 14,113 |   | $ | 19,925 |   | $ | 34,038 |   |
|                                                                 |       |                                              |       |                                               |       |   |   |   |   |   |   |   |   |
| **Interest-bearing liabilities:**                                    |       |                                              |       |                                               |       |   |   |   |   |   |   |   |   |
| Deposits                                                             |       | $                                                 | (6,277     | )                                                  | $          | 19,972 |   | $ | 13,695 |   | $ | (2,053 | ) | $ | 8,794 |   | $ | 6,741 |   |
| Borrowings                                                           |       | 31,628                                            |       | 63,160                                             |       | 94,788 |   | 8,440 |   | 29,083 |   | 37,523 |   |
|                                                                 |       |                                              |       |                                               |       |   |   |   |   |   |   |   |   |
| Total interest-bearing liabilities                                   |       | $                                                 | 25,351     |                                               | $          | 83,132 |   | $ | 108,483 |   | $ | 6,387 |   | $ | 37,877 |   | $ | 44,264 |   |
|                                                                 |       |                                              |       |                                               |       |   |   |   |   |   |   |   |   |
| Change in  net interest income                                       |       | $                                                 | 19,878     |                                               | $          | (30,941 | ) | $ | (11,063 | ) | $ | 7,726 |   | $ | (17,952 | ) | $ | (10,226 | ) |

 

27

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In addition to investing in both variable andfixed-rate securities, we use derivative instruments to manage our exposure tointerest rate risk. See the ‘Market Risk’ section for more detailedinformation.

 

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

 
| ** **                                                          | ** ** | **Nine Months Ended  September 30, 2005** | ** ** | **Nine Months Ended  September 30, 2004** | ** ** |
|---------------------------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                          | ** ** | **Average**                               | ** ** | ** **                                | ** ** | **Average** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                                          | ** ** | **Balance**                               | ** ** | **Interest**                              | ** ** | **Yield/Cost** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Yield/Cost** | ** ** |
| **Interest-earning assets:**                                        |       |                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Federal Funds sold and securities purchased under resale agreements |       | $                                         | 58,227     |                                      | $          | 1,318 |   | 3.02 | % | $ | 52,953 |   | $ | 420 |   | 1.06 | % |
| Investment securities(1)                                            |       |                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Mortgage-backed securities                                          |       | 7,998,105                                 |       | 226,213                                   |       | 3.77 | % | 6,491,521 |   | 158,056 |   | 3.25 | % |
| Federal agency securities                                           |       | 2,330,004                                 |       | 64,255                                    |       | 3.68 | % | 2,046,658 |   | 37,469 |   | 2.44 | % |
| State and political subdivisions                                    |       | 468,945                                   |       | 16,106                                    |       | 4.58 | % | 484,450 |   | 16,480 |   | 4.54 | % |
| Other securities                                                    |       | 237,103                                   |       | 6,730                                     |       | 3.78 | % | 299,158 |   | 7,526 |   | 3.35 | % |
| Total investment securities                                         |       | 11,034,157                                |       | 313,304                                   |       | 3.79 | % | 9,321,787 |   | 219,531 |   | 3.14 | % |
| Loans                                                               |       | 209,407                                   |       | 6,048                                     |       | 3.85 | % | 168,051 |   | 3,299 |   | 2.62 | % |
| Total interest-earning assets                                       |       | 11,301,791                                |       | 320,670                                   |       | 3.78 | % | 9,542,791 |   | 223,250 |   | 3.12 | % |
| Allowance for loan losses                                           |       | (100                                      | )          |                                      |       |   |   | (100 | ) |   |   |   |   |
| Noninterest-earning assets                                          |       | 673,158                                   |       |                                      |       |   |   | 531,786 |   |   |   |   |   |
| Total assets                                                        |       | $                                         | 11,974,849 |                                      |       |   |   |   | $ | 10,074,477 |   |   |   |   |   |
|                                                                |       |                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| **Interest-bearing liabilities:**                                   |       |                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Deposits:                                                           |       |                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Demand                                                              |       | $                                         | 4,250      |                                      | $          | 103 |   | 3.23 | % | $ | — |   | $ | — |   | — |   |
| Savings                                                             |       | 3,277,370                                 |       | 47,231                                    |       | 1.92 | % | $ | 3,956,867 |   | $ | 35,000 |   | 1.18 | % |
| Time                                                                |       | 89,905                                    |       | 1,903                                     |       | 2.82 | % | 53,770 |   | 542 |   | 1.34 | % |
| Securities sold under repurchase agreements(2)                      |       | 5,312,310                                 |       | 103,031                                   |       | 2.59 | % | 3,955,944 |   | 33,386 |   | 1.13 | % |
| Junior subordinated debentures                                      |       | 24,774                                    |       | 1,815                                     |       | 9.77 | % | 24,774 |   | 1,815 |   | 9.77 | % |
| Other borrowings (3)                                                |       | 1,684,399                                 |       | 38,887                                    |       | 3.08 | % | 856,741 |   | 13,744 |   | 2.14 | % |
| Total interest-bearing liabilities                                  |       | 10,393,008                                |       | 192,970                                   |       | 2.48 | % | 8,848,096 |   | 84,487 |   | 1.27 | % |
| Noninterest-bearing liabilities:                                    |       |                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Demand deposits                                                     |       | 287,791                                   |       |                                      |       |   |   | 253,682 |   |   |   |   |   |
| Savings                                                             |       | 59,890                                    |       |                                      |       |   |   | 65,387 |   |   |   |   |   |
| Noninterest-bearing time deposits                                   |       | 203,205                                   |       |                                      |       |   |   | 158,394 |   |   |   |   |   |
| Other liabilities                                                   |       | 272,330                                   |       |                                      |       |   |   | 145,130 |   |   |   |   |   |
| Total liabilities                                                   |       | 11,216,224                                |       |                                      |       |   |   | 9,470,689 |   |   |   |   |   |
| Equity                                                              |       | 758,625                                   |       |                                      |       |   |   | 603,788 |   |   |   |   |   |
| Total liabilities and equity                                        |       | $                                         | 11,974,849 |                                      |       |   |   |   | $ | 10,074,477 |   |   |   |   |   |
| Net interest income                                                 |       |                                      |       | $                                         | 127,700    |   |   |   |   |   | $ | 138,763 |   |   |   |
| Net interest margin (4)                                             |       |                                      |       |                                      |       | 1.51 | % |   |   |   |   | 1.94 | % |
| Average interest rate spread (5)                                    |       |                                      |       |                                      |       | 1.30 | % |   |   |   |   | 1.85 | % |
| Ratio of interest-earning assets to interest-bearing liabilities    |       |                                      |       |                                      |       | 108.74 | % |   |   |   |   | 107.85 | % |

** **

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

(2)           Interestexpense includes penalties of $2.9 million for the nine months ended September30, 2004 for prepayment of two term repurchase agreements.

(3)           Interestexpense includes contractual prepayment penalties of $3.9 million for the ninemonths ended September 30, 2004 for prepayment of certain FHLBB borrowings.

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

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

 

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*OperatingExpenses*

 

Totaloperating expenses were $334.2 million for the nine months ended September 30,2005, up 13% from the same period in 2004. Total operating expenses were $116.1million for the three months ended September 30, 2005, up 23% from the sameperiod in 2004. The increases in operating expenses were primarily due toincreased compensation and benefits, technology and telecommunications, transactionprocessing services, travel and sales promotion and other operating expenses,as detailed below.  It is expected thatincremental expense for the remainder of 2005 will primarily be driven bycontinued investments in headcount and technology to support new and existingclients.  The components of operatingexpenses were as follows (Dollars in thousands):

 
| ** **                        | ** ** | **For the Nine Months Ended  September 30,** | ** ** | **For the Three Months Ended  September 30,** | ** ** |
|-----------------------------------|------------|----------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                        | ** ** | **2005**                                     | ** ** | **2004**                                      | ** ** | **Change** | ** ** | **2005** | ** ** | **2004** | ** ** | **Change** | ** ** |
|                              |       |                                         |       |                                          |       |   |   |   |   |   |   |   |   |
| Compensation and benefits         |       | $                                            | 185,779    |                                          | $          | 154,052 |   | 21 | % | $ | 65,428 |   | $ | 44,958 |   | 46 | % |
| Technology and telecommunications |       | 39,901                                       |       | 34,892                                        |       | 14 | % | 13,988 |   | 14,170 |   | (1 | )% |
| Transaction processing services   |       | 35,252                                       |       | 30,766                                        |       | 15 | % | 12,476 |   | 9,628 |   | 30 | % |
| Depreciation and amortization     |       | 23,724                                       |       | 24,388                                        |       | (3 | )% | 7,740 |   | 7,667 |   | 1 | % |
| Occupancy                         |       | 19,409                                       |       | 21,613                                        |       | (10 | )% | 6,569 |   | 7,353 |   | (11 | )% |
| Professional fees                 |       | 9,253                                        |       | 11,861                                        |       | (22 | )% | 2,874 |   | 4,605 |   | (38 | )% |
| Travel and sales promotion        |       | 4,823                                        |       | 3,940                                         |       | 22 | % | 1,649 |   | 1,361 |   | 21 | % |
| Insurance                         |       | 3,284                                        |       | 3,499                                         |       | (6 | )% | 1,009 |   | 1,139 |   | (11 | )% |
| Other operating expenses          |       | 12,734                                       |       | 10,314                                        |       | 23 | % | 4,397 |   | 3,610 |   | 22 | % |
|                              |       |                                         |       |                                          |       |   |   |   |   |   |   |   |   |
| Total operating expenses          |       | $                                            | 334,159    |                                          | $          | 295,325 |   | 13 | % | $ | 116,130 |   | $ | 94,491 |   | 23 | % |

 

Compensation and benefits expense was $185.8million for the nine months ended September 30, 2005 and was $65.4 million forthe three months ended September 30, 2005, up 21% and 46%, respectively, fromthe same periods last year due to higher headcount and annual salary increases.  Further increases in compensation expense in2005 will be primarily dependent upon sales to new and existing clients.

 

Technology and telecommunications expense was$39.9 million for the nine months ended September 30, 2005, up 14% from thesame period last year.  The increase forthe nine-month period is due to our outsourcing agreement with IBM, which weentered into in July of 2004.  A portionof the increase is offset by lower compensation costs due to employeestransferring to IBM.  Also, increases in ourprocessing volumes drove higher technology and telecommunications expense forthe nine months ended September 30, 2005. Technology and telecommunications expense was $14.0 million for thethree months ended September 30, 2005, down 1% from the same period lastyear.  Future technology andtelecommunications expense will be dependent on client integrations associatedwith new business and ongoing improvement to our infrastructure.  Generally, we expect technology reinvestmentto equal approximately 18-20% of net operating revenue each year, includingrelated compensation costs.

 

Transaction processing services expense was$35.3 million for the nine months ended September 30, 2005 and was $12.5million for the three months ended September 30, 2005, up 15% and 30%,respectively, from the same periods last year as a result of higher globalbalances and transactions with our subcustodians. Future transaction processingservices expense will be dependent upon asset levels and the volume of clienttransaction activity.

 

Occupancy expense was $19.4 million for the ninemonths ended September 30, 2005 and was $6.6 million for the three months endedSeptember 30, 2005, down 10% and 11%, respectively, from the same periods lastyear.  These decreases were due to favorablenew ten-year lease agreements for our 505,000 square feet of office space inBoston.  Occupancy expense is expected toincrease throughout 2006 due to the addition of new space needed to accommodategrowth.

 

Professional fees expense was $9.3 millionfor the nine months ended September 30, 2005 and was $2.9 million for the threemonths ended September 30, 2005, down 22% and 38%, respectively, from the sameperiods last year.  These decreases areattributed primarily to lower subadvisory expense associated with our MerrimacMaster Portfolios, resulting from lower average fund balances and fee waivers.  These fee waivers were discontinued during thesecond quarter of 2005.  We expectprofessional fees expense for the fourth quarter to remain consistent withthird quarter levels.

 

Travel and sales promotion expense was $4.8million for the nine months ended September 30, 2005 and was $1.6 million forthe three months ended September 30, 2005, up 22% and 21%, respectively, fromthe same periods last year.  Travel andsales promotion expense consists of expenses incurred by the sales force,client management staff and other employees in connection with sales calls onpotential clients and traveling to existing client sites and our foreign offices. The increases in 2005 resulted from

 

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a higher level of travel to client sites, a higher level of sales callsto potential clients and attendance at industry conferences.  We expect travel and sales expense for thefourth quarter to remain consistent with third quarter levels.

 

Other operating expense was $12.7 million forthe nine months ended September 30, 2005 and was $4.4 million for the threemonths ended September 30, 2005, up 23% and 22%, respectively, from the sameperiods last year primarily as a result of higher recruiting and staffing expense.  We expect that incrementalexpense for the remainder of 2005 will be primarily associated with newbusiness.

 

*IncomeTaxes*

 

Income taxes were$53.3 million for the nine-month period ended September 30, 2005, down 1% fromthe same period in 2004, and were $17.9 million for the three-month periodended September 30, 2005, down 2% from the same period in 2004.  The decrease in income taxes and theeffective tax rate for both periods is primarily attributable to the reversalof income tax accruals related to the undistributed earnings of our Irishsubsidiaries. During the second quarter of 2005, we recognized the indefinitereversal provision of Accounting Principles Board Opinion No. 23, *Accounting for Income Taxes – Special Area*s (‘APB 23’),which specifies that U.S. income taxes should not be recorded on the undistributedearnings of a foreign subsidiary if those undistributed earnings have been orwill be invested indefinitely in that subsidiary. We have determined that theundistributed earnings of our Irish subsidiaries will be permanently investedin our Irish operations to support continued growth. The decrease in incometaxes and the effective tax rate for both periods in 2005 was partially offset byincreased pretax earnings, as well as a decreased percentage of tax-exemptincome, resulting from the income generated by our municipal securitiesportfolio, in pretax earnings.  We expectour effective tax rate for the full fiscal year 2005 to be approximately 32%.

 

**FinancialCondition**

 

                At September 30, 2005, our total assets were$13.3 billion, up 18% from $11.2 billion at December 31, 2004, due to anincrease in Federal Funds sold and increased investment securities.  Average interest-earning assets increased$1.8 billion, or 18% for the nine-month period ended September 30, 2005 from thesame period in 2004, and increased $1.6 billion, or 16% for the three-monthperiod ended September 30, 2005 from the same period in 2004.  Our asset growth was primarily funded byincreases in average external borrowings of approximately $2.0 billion and $1.8billion for the nine-month and three-month periods ended September 30, 2005,respectively.

 

*Investment Portfolio*

 

The income we derive from our investmentportfolio is generated primarily by investing client cash balances and is acomponent of our asset processing business. In addition, we use the investment portfolio to secure open positions atsecurities clearing institutions in connection with our custody services.  The following table summarizes our investmentportfolio as of the dates indicated (Dollars in thousands):

 

 
| ** **                          | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                          | ** ** | **2005**          | ** ** | **2004**         | ** ** |
| **Securities  held to maturity**    |       |              |       |             |       |
| Mortgage-backed  securities         |       | $                 | 4,411,745  |             | $          | 3,543,961 |   |
| Federal  agency securities          |       | 2,343,503         |       | 2,274,665        |       |
| State and  political subdivisions   |       | 117,402           |       | 124,091          |       |
|                                |       |              |       |             |       |
| Total securities held to maturity   |       | $                 | 6,872,650  |             | $          | 5,942,717 |   |
| ** **                          | ** ** | ** **        | ** ** | ** **       | ** ** |
| **Securities  available for sale**  | ** ** | ** **        | ** ** | ** **       | ** ** |
| Mortgage-backed  securities         |       | $                 | 3,794,124  |             | $          | 3,854,900 |   |
| State and  political subdivisions   |       | 357,239           |       | 404,909          |       |
| Corporate  debt                     |       | 200,902           |       | 176,546          |       |
| U.S.  Treasury securities           |       | —            |       | 118,688          |       |
| Foreign  government securities      |       | 10,648            |       | 10,462           |       |
|                                |       |              |       |             |       |
| Total securities available for sale |       | $                 | 4,362,913  |             | $          | 4,565,505 |   |

 

The $0.9 billion,or 16%, increase in our held to maturity securities portfolio from December 31,2004 to September 30, 2005 is primarily due to investment security purchases allowingus to utilize our capital, while maintaining an acceptable risk profile. Our investmentsecurity purchases primarily included floating interest rate mortgage-backedsecurities which offer

 

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an attractive yield and repriceas interest rates increase.  Our held tomaturity portfolio securities are purchased with the intent and ability to holdto maturity and are not viewed as our primary source of funds to satisfyliquidity needs.

 

Our available for sale securities portfolio decreased$0.2 billion, or 4% from December 31, 2004 to September 30, 2005.  The decrease was mainly due to sales of U.S.Treasuries and municipal securities during 2005 and investment security maturitiesand prepayments, partially offset by purchases of investment securities. Ourinvestment security purchases included mortgage-backed securities, as well as municipalsecurities that offer a more attractive after-tax yield than those that we sold.  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 our interest-earningassets and interest-bearing liabilities.

 

The averagebalance of our investment securities for the nine-month period ended September30, 2005 was $11.0 billion, with an average yield of 3.79%, compared to anaverage balance of $9.3 billion with an average yield of 3.14% during the sameperiod in 2004. The average balance of our investment securities for thethree-month period ended September 30, 2005 was $11.3 billion, with an averageyield of 3.97%, compared to an average balance of $9.8 billion with an averageyield of 3.24% during the same period in 2004. The increase in yield is primarily due to our variable-rate securitiesrepricing at higher interest rates. If long-term interest rates rise, we wouldexpect slower prepayments and our overall yield to increase as our variable-ratesecurities reprice. Conversely, if long-term interest rates decline, we wouldexpect that prepayments would accelerate, with the cash flows from theseprepayments being reinvested in lower-yielding assets of equal quality and similarrisk.

 

We invest inmortgage-backed securities and Federal agency securities to increase the totalreturn of the investment portfolio. Mortgage-backed securities and Federalagency bonds generally have a higher yield than U.S. Treasury securities due tocredit and prepayment risk.  Credit risk resultsfrom the possibility that a loss may occur if a counterparty, such as theFederal agency issuing the securities, is unable to meet the terms of thecontract.  Credit risk related to mortgage-backedsecurities and Federal agency bonds is substantially reduced by paymentguarantees and credit enhancements.  Prepayment risk results from the possibilitythat changes in interest rates and other economic factors will result ininvestment securities being paid off earlier than the scheduled maturity date.  Refer to the ‘Market Risk’ section foradditional details regarding our net interest income simulation model, whichincludes the impact of changes in interest rates, and therefore prepayment risk,on our net interest income.

 

We invest in AAA rated, insured municipal securitiesto generate stable, tax advantaged income. Municipal securities generally have lower stated yields than Federalagency and U.S. Treasury securities, but their after-tax yields arecomparable.  Municipal securities aresubject to call risk.  Call risk issimilar to prepayment risk and results from the possibility that fluctuatinginterest rates and other factors may result in the exercise of the call optionby the issuing municipality prior to the maturity date of the bond.

 

*LoanPortfolio*

 

Our loanportfolio increased $209.0 million, or 155%, from December 31, 2004 to September30, 2005 primarily due to an increase in line of credit advances andoverdrafts.

 

We make loans to individually managed accountcustomers and to mutual funds and other pooled product clients.  We offer overdraft protectionand lines of credit to our clients for the purpose of funding redemptions,covering overnight cash shortfalls, leveraging portfolios and meeting otherclient borrowing needs.  Virtually all loans to individually managedaccount customers are written on a demand basis, bear variable interest ratestied to the Prime rate or the Federal Funds rate and are fully secured byliquid collateral, primarily freely tradable securities held in custody by usfor the borrower.  We monitor the valueof collateral daily to ensure the amount of collateral held by us exceeds theloan balance by a certain threshold. Loans to mutual funds and other pooled product clients include unsecuredlines of credit that may, in the event of default, be collateralized at ouroption by securities held in custody by us for those clients.  Loans to individually managed account customers,mutual funds and other pooled product clients also include advances that wemake to certain clients pursuant to the terms of our custody agreements withthose clients to facilitate securities transactions and redemptions.

 

At September 30, 2005, our only lendingconcentrations that exceeded 10% of total loan balances were the lines ofcredit to mutual fund clients discussed above. These loans were made in the ordinary course of business on the sameterms and conditions prevailing at the time for comparable transactions.

 

Our loan portfolio credit performance hasbeen excellent.  There have been no loancharge-offs in the history of our Company. It is our policy to place a loan on nonaccrual status when eitherprincipal or interest becomes 60 days past due and the loan’s collateralis not sufficient to cover both principal and accrued interest.  As of September 30, 2005, there were no loanson nonaccrual status, no

 

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loans greater than 90 days past due, and no troubled debtrestructurings.  Although virtually allof our loans are fully collateralized with freely tradable securities,management recognizes some credit risk inherent in the loan portfolio, and hasan allowance for loan losses of $0.1 million at September 30, 2005, alevel which has 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 actively monitors the loan portfolio and theunderlying collateral and regularly assesses the adequacy of the allowance forloan losses.

 

*Repurchase Agreements andShort-Term and Other Borrowings*

 

Asset growthwas funded in part by increased securities sold under repurchaseagreements.  Repurchase agreementsincreased $1.0 billion, or 24%, from December 31, 2004 to September 30, 2005.  The majority of our repurchase agreements arewith clients who prefer a more collateralized form of deposit.  Repurchase agreements provide for the sale ofsecurities for cash coupled with the obligation to repurchase those securitieson a set date or on demand.  We userepurchase agreements, including client repurchase agreements, because theyprovide a lower cost source of funding than other short-term borrowings andallow our clients the extra benefit of collateralization of theirdeposits.  The average balance ofsecurities sold under repurchase agreements for the nine months ended September30, 2005 was $5.3 billion with an average cost of approximately 2.59%, comparedto an average balance of $4.0 billion and an average cost of approximately 1.13%for the same period in 2004.  Theincrease in the average cost of repurchase agreements was due to highershort-term interest rates in the first nine months of 2005 compared to the sameperiod in 2004. The average cost of securities sold under repurchase agreementsfor the nine months ended September 30, 2004 included penalties of $2.9 millionfor the prepayment of two term repurchase agreements.  These penalties were incurred to employ anasset and liability strategy in which we replaced high rate borrowings withlower cost term funding.

 

Short-term and other borrowings increased $0.1 billion, or 8%, from December31, 2004 to September 30, 2005.  We useshort-term and other borrowings to offset the variability of deposit flow.  The average balance of short-term and otherborrowings for the nine months ended September 30, 2005 was $1.7 billion withan average cost of approximately 3.08%, compared to an average balance of $0.9billion and an average cost of approximately 2.14% for the same period in 2004.   The increase in the average cost ofshort-term and other borrowings was due to an increase in short-term ratesduring the first nine months of 2005 compared to the same period in 2004.  The average cost of borrowings for the ninemonths ended September 30, 2004 included penalties of $3.9 million for theprepayment of certain FHLBB borrowings.  Again,these penalties were incurred to employ an asset and liability strategy inwhich we replaced high rate borrowings with lower cost term funding.

 

**Market Risk**

 

Our clients, in the course of their financialasset management, maintain cash balances, which they can deposit with us on ashort-term basis in interest-bearing accounts or client repurchase agreements.  We either directly invest these cash balancesto earn interest income, or place these deposits in third-party vehicles andremit a portion of the earnings on these investments to our clients afterdeducting a fee as our compensation for investing clients’ funds in theseinvestment vehicles. In the conduct of these activities, we are subject tomarket risk.

 

Market risk is the risk of an adversefinancial impact from changes in market prices and interest rates.  The level of risk we assume is a function ofour overall strategic objectives and liquidity needs, client requirements andmarket volatility. The active management of market risk is integral to ouroperations.  The objective of interestrate sensitivity management is to provide sustainable net interest income undervarious economic conditions.

 

Our balance sheet is primarily subject to interest rate risk, which isthe risk of loss due to movements in interest rates. Prepayment risk, which isthe risk that changes in interest rates and other economic factors will resultin investment securities being paid off earlier than the scheduled maturitydate, is inherent in our investment securities, mainly our mortgage-backedsecurities and Federal agency bond portfolios. Prepayment levels for mortgage-backed securities are primarily driven bychanges in interest rates.  Prepaymentlevels for Federal agency securities are driven by a number of factors,including expiration of prepayment penalty provisions, economic condition ofthe borrower, borrower refinancing alternatives, and, to a lesser extent,interest rates.

 

Prepayment speeds formortgage-backed securities increased during the third quarter of 2005 dueto increased refinancing activity driven by declining mortgage rates.  Weexpect recent prepayment experience to continue subject to future interest ratemovements.  Prepayment experience for Federal agency securities (primarilySBA guaranteed loan pools) also increased over this period, which resulted in ashorter weighted average life of the securities.  We expect the combination of heightenedprepayment experience and, more significantly, reduced reinvestmentopportunities to continue to pressure our net interest income for the remainderof 2005.

 

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Our Board of Directors has set asset andliability management policies that define the overall framework for managinginterest rate sensitivity, including accountabilities and controls overinvestment activities.  These policiesdelineate investment limits and strategies that are appropriate, given ourliquidity and regulatory requirements. For example, we have established a policy limit stating that projectednet interest income over the next twelve months will not change by more than10% given a change in interest rates of up to 200 basis points (+ or -) overtwelve months.  Each quarter, our Boardof Directors reviews our asset and liability positions, including simulationsof the effect of various interest rate scenarios on our capital.

 

The day-to-day responsibility for oversightof the Asset and Liability Management function has been delegated by our Boardof Directors to our Asset and Liability Committee (‘ALCO’).  ALCO is a senior management committeeconsisting of the Chief Executive Officer, the President, the Chief FinancialOfficer, the Chief Risk Officer and members of the Treasury function. ALCOmeets twice monthly.  Our primary tool inmanaging interest rate sensitivity is an income simulation model. Keyassumptions in the simulation model include the timing of cash flows, whichinclude forecasted prepayment speeds that are based on market and industry data,maturities and repricing of financial instruments, changes in marketconditions, capital planning and deposit sensitivity.  The model assumes that the composition of ourinterest-sensitive assets and liabilities existing at the beginning of a periodwill change periodically over the period being measured.  The model also assumes that a particular changein interest rates is reflected uniformly across the yield curve regardless ofthe duration to maturity or repricing of specific assets and liabilities.  These assumptions are inherently uncertain,and as a result, the model cannot precisely predict the effect of changes ininterest rates on our net interest income. Actual results may differ from simulated results due to the timing,magnitude and frequency of interest rate changes and changes in marketconditions and management strategies.

 

The results of the income simulation model asof September 30, 2005 and 2004 indicated that an upward shift of interest ratesby 200 basis points over a twelve-month period would result in a reduction inprojected net interest income of 8.1% and 6.0%, respectively, which is withinour 10% policy limit.  We also simulate a200 basis point rate reduction over a twelve-month period.  This simulation would result in an increasein projected net interest income of 1.8% as of September 30, 2005 and areduction of 9.7% as of September 30, 2004, both within our 10% policy limit.

 

We also use gap analysis as a secondary toolto manage our interest rate sensitivity. Gap analysis involves measurement of the difference in asset andliability repricing on a cumulative basis within a specified time frame.  A positive gap indicates that moreinterest-earning assets than interest-bearing liabilities mature in a timeframe, and a negative gap indicates the opposite.  By seeking to minimize the net amount ofassets and liabilities that could reprice in the same time frame, we attempt toreduce the risk of significant adverse effects on net interest income caused byinterest rate changes.  As shown in thecumulative gap position in the table presented below, at September 30, 2005,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,balance sheet growth and mix, and interest rate spreads.  We continue to run a closely matched balancesheet by investing the majority of our assets in short duration, variable-ratesecurities and adding interest rate swaps against client liabilities, includingclient repurchase agreements.

 

We manage the structure of interest-earning assets and interest-bearingliabilities by adjusting their mix, yield, maturity and/or repricingcharacteristics based on market conditions. Client deposits and repurchase agreements, which are predominantly shortterm, are our primary sources of funds. We also use term borrowings and interest rate swap agreements to augmentour management of interest rate exposure. The effect of the swap agreements is to lengthen both a forecastedseries of fixed-rate overnight liabilities incurred at different daily fixedrates and short-term variable-rate liabilities into longer-term fixed-rateliabilities.  Theweighted-average fixed-payment rates were 3.36% and 2.93% at September 30, 2005and 2004, respectively. Variable-interest payments received are currently indexed to theovernight Federal Funds rate.  At September30, 2005 and 2004, the weighted-average rates of variable market-indexedinterest payment obligations to the Company were 3.72% and 1.59%,respectively.  The remaining terms ofswaps at September 30, 2005 range from 0 to 33 months. These contracts had netfair values of approximately $22.3 million and ($2.9) million at September 30,2005 and 2004, respectively.

 

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The following tablepresents the repricing schedule of our interest-earning assets andinterest-bearing liabilities at September 30, 2005 (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)                                                      |       | $                | 6,598,723  |             | $          | 619,641             |       | $               | 1,001,199  |          | $          | 2,551,955  |       | $ | 424,213 |   | $ | 11,195,731 |   |
| Federal funds sold                                                                 |       | 1,000,000        |       | —           |       | —              |       | —          |       | —        |       | 1,000,000  |       |
| Loans - variable rate                                                              |       | 343,627          |       | —           |       | —              |       | —          |       | —        |       | 343,627    |       |
| Loans - fixed rate                                                                 |       | —           |       | —           |       | 12                  |       | —          |       | —        |       | 12         |       |
| Total interest-earning assets                                                      |       | $                | 7,942,350  |             | $          | 619,641             |       | $               | 1,001,211  |          | $          | 2,551,955  |       | $ | 424,213 |   | $ | 12,539,370 |   |
| Interest-bearing liabilities:                                                      |       |             |       |             |       |                |       |            |       |          |       |       |       |
| Demand                                                                             |       | $                | 59,230     |             | $          | —              |       | $               | —     |          | $          | —     |       | $ | — |   | $ | 59,230 |   |
| Savings accounts                                                                   |       | 5,454,373        |       | —           |       | —              |       | 54,733          |       | —        |       | 5,509,106  |       |
| Time deposits                                                                      |       | 46,997           |       | —           |       | —              |       | —          |       | —        |       | 46,997     |       |
| Interest rate contracts                                                            |       | (1,685,000       | )          | 120,000          |       | 265,000             |       | 1,300,000       |       | —        |       | —     |       |
| Securities sold under repurchase agreements                                        |       | 4,473,406        |       | 50,000           |       | 150,000             |       | 600,000         |       | —        |       | 5,273,406  |       |
| Short-term and other borrowings                                                    |       | 595,032          |       | —           |       | 50,000              |       | —          |       | —        |       | 645,032    |       |
| Junior subordinated debentures                                                     |       | —           |       | —           |       | —              |       | 24,774          |       | —        |       | 24,774     |       |
| Total interest-bearing liabilities                                                 |       | $                | 8,944,038  |             | $          | 170,000             |       | $               | 465,000    |          | $          | 1,979,507  |       | $ | — |   | $ | 11,558,545 |   |
| Net interest-sensitivity gap during the  period                                    |       | $                | (1,001,688 | )                | $          | 449,641             |       | $               | 536,211    |          | $          | 572,448    |       | $ | 424,213 |   | $ | 980,825 |   |
|                                                                               |       |             |       |             |       |                |       |            |       |          |       |       |       |
| Cumulative gap                                                                     |       | $                | (1,001,688 | )                | $          | (552,047            | )          | $               | (15,836    | )             | $          | 556,612    |       | $ | 980,825 |   |   |   |
| Interest-earning assets as a percent of  interest-bearing liabilities (cumulative) |       | 88.80            | %          | 93.94            | %          | 99.83               | %          | 104.82          | %          | 108.49        | %          |       |       |
| Interest-earning assets as a percent of  total assets (cumulative)                 |       | 60.04            | %          | 64.73            | %          | 72.29               | %          | 91.59           | %          | 94.79         | %          |       |       |
| Net interest-sensitivity gap as a percent  of total assets                         |       | (7.57            | )%         | 3.40             | %          | 4.05                | %          | 4.33            | %          | 3.21          | %          |       |       |
| Cumulative gap as a percent of total assets                                        |       | (7.57            | )%         | (4.17            | )%         | (0.12               | )%         | 4.21            | %          | 7.41          | %          |       |       |

** **

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

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

(3)                     Excludes$57.2 million of unsettled securities purchases and $17.4 million of netunrealized losses as of September 30, 2005.

 

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**Liquidity**

 

Liquidity represents the ability of aninstitution to meet present and future financial obligations through either runoffdue to prepayments, asset sales, maturity of existing assets or the acquisitionof additional funds through liability management.  For a financial institution such as ours,these obligations arise from the withdrawals of deposits and the payment of operatingexpenses.

 

Our primary sources of liquidity include cashand cash equivalents, Federal Funds sold, new deposits, short-term borrowings,interest and principal payments on securities held to maturity and availablefor sale, fees collected from asset administration clients, Federal Home LoanBank of Boston 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 $0.08 per share for 2005(approximately $5.2 million based upon 64,955,015 shares outstanding as ofSeptember 30, 2005).

 

Our ability to pay dividends on Common Stockmay depend on the receipt of dividends from the Bank. Any dividend payments bythe Bank are subject to certain restrictions imposed by the MassachusettsCommissioner of Banks.  During allperiods presented in this report, the Company did not require dividends fromthe Bank in order to fund the Company’s own dividends.  In addition, we may not pay dividends on ourCommon Stock if we are in default under certain agreements entered into in connectionwith the sale of our Capital Securities. Our Capital Securities were issued by Investors Capital Trust I (‘ICTI’),a Delaware statutory business trust sponsored by us, and qualify as Tier 1capital under the capital guidelines of the Federal Reserve.

 

In July 2005, we announcedthat our Board of Directors authorized us to repurchase up to $150 million ofour Common Stock in the open market over the next twelve months.  The purchase of our Common Stock has been fundedprimarily by a dividend from the Bank to the Company.  We do not expect the stock purchase program tohave 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. As of September 30, 2005, we have repurchased $70.7million of our Common Stock.

 

We have informal borrowing arrangements withvarious counterparties.  Eachcounterparty has agreed to make funds available to us at the Federal Fundsovernight rate.  The aggregate amount availableon these borrowing arrangements as of September 30, 2005 was approximately $5.2 billion.  Each bank may terminate its arrangement atany time and is under no contractual obligation to provide us with requestedfunding.  Our borrowings under thesearrangements are typically on 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 have Master Repurchase Agreements inplace with various counterparties.  Eachcounterparty has agreed on an uncommitted basis to make funds available to usat various rates in exchange for collateral consisting of marketablesecurities. The aggregate amount available on these borrowing arrangements at September30, 2005 was approximately $6.7 billion.

 

On April 19, 2004, the Federal Home Loan Bankof Boston (‘FHLBB’) implemented a new capital structure mandated for allFederal Home Loan Banks subject to the Gramm-Leach-Bliley Act of 1999 andregulations that were subsequently promulgated in 2001 by the FHLBB’sregulator, the Federal Housing Finance Board. The Bank’s capital stock investment in the FHLBB totaled $50 million asof September 30, 2005.  The $50 millioncapital stock investment includes both a $25 million membership component and a$25 million activity-based component. Recent changes to the FHLBB capital planhave resulted in an increased borrowing capacity.  The Bank’s $50 million capital stockinvestment in the FHLBB provides an overnight borrowing capacity of up to $833million. Under the new capital plan, FHLBB capital stockinvestments require a five-year advance notice of withdrawal.  The amount outstanding under this arrangementat September 30, 2005 was $50 million.  Additionalborrowing is available to the Bank based on prescribed collateral levels andincreased investment in FHLBB capital stock. The Bank currently has no plans to increase its investment in FHLBBcapital stock.

 

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**Capital Resources**

 

Historically, we have financed our operations principally throughinternally generated cash flows.  Weincur capital expenditures for furniture, fixtures, capitalized software andmiscellaneous equipment needs.  We lease officespace and computing equipment through operating leases.  Capital expenditures have been incurred andleases entered into on an as-required basis, primarily to meet our growingoperating needs.  As a result, ourcapital expenditures were $20.5 million and $18.4 million for the nine monthsended September 30, 2005 and 2004, respectively.  For the nine months ended September 30, 2005,capital expenditures were comprised of approximately $15.2 million incapitalized software and projects in process, $5.2 million in fixed assets, and$0.1 million in leasehold improvements. For the nine months ended September 30, 2004, capital expenditures werecomprised of approximately $11.2 million in capitalized software and projectsin process, $7.1 million in fixed assets and $0.1 million in leaseholdimprovements.

 

Stockholders’ equity at September 30, 2005was $748.3 million, up 5% from December 31, 2004, primarily due to net incomeearned in the first nine months of 2005, net of our stock repurchase program.  The ratio of average stockholders’ equity toaverage assets remained constant at approximately 6% for September 30, 2005 andDecember 31, 2004.

 

In July 2005, we announcedthat our Board of Directors has authorized us to repurchase up to $150 millionof our Common Stock in the open market over the next twelve months.  We do not expect our stock purchase program tohave a material impact on our capital resources, such as maintaining risk-basedcapital ratios in excess of capital adequacy guidelines and our ability to paydividends on our Common Stock. As of September 30, 2005, we have repurchased$70.7 million of our Common Stock.

 

TheFRB has adopted capital adequacy guidelines applicable to United States bankingorganizations.  The FRB’s capital adequacy guidelines generally require bankholding 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 core capital,and the remaining amount consisting of Tier 2, or supplementary capital. Tier 1 capital for BHCs generally consists of the sum of common stockholders’equity and perpetual preferred stock (subject to certain limitations), lessgoodwill and other nonqualifying intangible assets.  Tier 2 capitalgenerally consists of hybrid capital instruments, perpetual debt and mandatoryconvertible debt securities; perpetual preferred stock, not included as Tier 1capital; term subordinated debt and intermediate-term preferred stock; and,subject to limitations, general allowances for loan and lease losses. Assets are adjusted under the risk-based guidelines to take into accountdifferent risk characteristics.

 

Inaddition to the risk-based capital requirements, the FRB requires BHCs tomaintain a minimum leverage capital ratio of Tier 1 capital to its averagetotal consolidated assets (the ‘Leverage Ratio’) of 3.0%.  Total averageconsolidated assets for this purpose does not include goodwill and any otherintangible assets and investments that the FRB determines should be deductedfrom Tier 1 capital.  The FRB has announced that the 3.0% Leverage Ratiorequirement is the minimum for the top-rated BHCs.  All other BHCs arerequired to maintain a minimum Leverage Ratio of 4.0%.  BHCs withsupervisory, financial, operational or managerial weaknesses, as well as BHCsthat are anticipating or experiencing significant growth, are expected tomaintain capital ratios well above the minimum levels.  Because we anticipatesignificant future growth, we will be required to maintain a Leverage Ratio of4.0% or higher.

 

We arecurrently in compliance with both the Total Risk-Based Capital Ratio and theLeverage Ratio requirements, and management expects these ratios to remain incompliance with the FRB’s capital adequacy guidelines.  At September 30, 2005, our Total Risk-BasedCapital Ratio and Leverage Ratio were 16.21% and 5.65%, respectively.

 

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**Item 3.            Quantitative and Qualitative Disclosuresabout Market Risk**

 

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

 

**Item 4.            Controls and Procedures**

 

**Evaluation of Disclosure Controlsand Procedures**

 

As required by Rule13a-15 under the Securities Exchange Act of 1934, as of September 30, 2005, theend 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 September 30, 2005 that has materiallyaffected, or is reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.  TheCompany reviews, on an ongoing basis, its disclosure controls and procedures,which may include its internal controls over financial reporting, and may fromtime to time make changes aimed at enhancing their effectiveness and to ensurethat the Company’s systems evolve with its business.

 

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**PART II.  OTHER INFORMATION**

 

**Item 1. Legal Proceedings**

 

InvestorsFinancial Services Corp. and five of its officers are named as defendants inthree purported class action complaints that were filed on or about August 4,2005, August 15, 2005, and September 30, 2005 in the United States DistrictCourt for the District of Massachusetts, Boston, Massachusetts.  Among other things, the complaints filed onAugust 4, 2005 and August 15, 2005 assert that the defendants violated Sections10(b) and 20(a) of the Securities Exchange Act of 1934 during the periodOctober 15, 2003 until July 15, 2005. Among other things, the complaint filed on September 30, 2005 assertsthat the defendants violated Sections 10(b) and 20(a) of the SecuritiesExchange Act of 1934 during the period July 16, 2003 until July 15, 2005.  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, interest, fees, and costs.  We strongly believe that the lawsuits lackmerit and we intend to defend against the claims vigorously.  However, we cannot predict the outcome of thelawsuits at this time, and we can give no assurance that they 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 2.  Unregistered Sales of Equity Securities andUse of Proceeds**

** **

**Purchases of Equity Securities bythe Issuer and Affiliated Purchasers**

 

 
| **Period**                      | ** ** | **a**     | ** ** | **b**  | ** ** | **c**  | ** ** | **d**  | ** ** |
|---------------------------------|------------|-----------|------------|--------|------------|--------|------------|--------|------------|
|                            |       |      |       |   |       |   |       |   |       |
| July 1-July  31, 2005           |       | 630,500   |       | $      | 34.35      |   | 630,500    |   | $          | 128,343,008 |   |
| August  1-August 31, 2005       |       | 456,934   |       | $      | 34.62      |   | 426,600    |   | $          | 113,580,512 |   |
| September  1-September 30, 2005 |       | 964,000   |       | $      | 34.42      |   | 964,000    |   | $          | 80,401,298 |   |
| Total                           |       | 2,051,434 |       | $      | 34.44      |   | 2,021,100  |   | $          | 80,401,298 |   |
|                                 |            |           |            |        |            |        |            |        |            |  |  |  |  |  |

 

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(a)  Total number of shares purchased

(b) Average price paid per share

(c) Total number of shares purchased as part of a publicly announced plan

(d)  Approximatedollar value that may yet be purchased under the plan

 

In July 2005, we announced thatour Board of Directors authorized a repurchase plan of up to $150.0 million ofour Common Stock during the twelve months following the announcement.  The plan expires in June 2006.

 

38

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**Item6.            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.** |

 

39

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**SIGNATURES**

 

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

 
| ** **             | ** ** | ** ** | **INVESTORS FINANCIAL SERVICES CORP.**                                                                                  |
|------------------------|------------|------------|-------------------------------------------------------------------------------------------------------------------------|
| ** **             | ** ** | ** ** | ** **                                                                                                              |
| Date: November 4, 2005 |       | By:        | /s/ Kevin J. Sheehan                                                                                                    |   |
|                   |       |       | Kevin J. Sheehan   Chairman and Chief Executive Officer                                                                 |
|                   |       |       |                                                                                                                    |
| ** **             | ** ** | ** ** | ** **                                                                                                              |
|                   |       | By:        | /s/ John N. Spinney, Jr.                                                                                                |   |
|                   |       |       | John N. Spinney, Jr.   Senior Vice President and Chief Financial Officer   (Principal Financial and Accounting Officer) |

** **

**40**

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