**United StatesSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-Q**

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**(Mark One)**

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

**For the Quarterly period ended September 30, 2006**

**or**

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

**For the Transition period from              to             **

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

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**INVESTORS FINANCIAL SERVICES CORP.**

(Exact name of registrant as specified in its charter)

| **Delaware**                                                     |   | **04-3279817**                     |
|------------------------------------------------------------------|--------|------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |   | (IRS Employer  Identification No.) |
|                                                             |   |                               |
| **200  Clarendon Street,  P.O. Box 9130, Boston, MA**            |   | **02116-9130**                     |
| (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 x No o

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

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

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

As of October 31, 2006there were 66,058,042 shares of common stock outstanding.

 

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**INVESTORSFINANCIAL SERVICES CORP.**

**INDEX**
|                | ** ** | ** **                                                                                                            | ** ** | **Page**   |
|----------------|------------|-----------------------------------------------------------------------------------------------------------------------|------------|------------|
| ** **     | ** ** | ** **                                                                                                            | ** ** | ** ** |
| **PART  I.**   | ** ** | **FINANCIAL  INFORMATION**                                                                                            |       |       |
| ** **     | ** ** | ** **                                                                                                            |       |       |
| Item  1.       |       | Unaudited  Consolidated Financial Statements                                                                          |       |       |
|           |       |                                                                                                                  |       |       |
|           |       | Unaudited Consolidated Balance  Sheets  September 30, 2006 and December 31, 2005                                      |       | 3          |
|           |       |                                                                                                                  |       |       |
|           |       | Unaudited Consolidated  Statements of Income and Comprehensive Income  Nine months ended September 30, 2006 and 2005  |       | 4          |
|           |       |                                                                                                                  |       |       |
|           |       | Unaudited Consolidated  Statements of Income and Comprehensive Income  Three months ended September 30, 2006 and 2005 |       | 5          |
|           |       |                                                                                                                  |       |       |
|           |       | Unaudited Consolidated  Statements of Stockholders’ Equity  Nine months ended September 30, 2006 and 2005        |       | 6          |
|           |       |                                                                                                                  |       |       |
|           |       | Unaudited Consolidated  Statements of Cash Flows  Nine months ended September 30, 2006 and 2005                       |       | 7          |
|           |       |                                                                                                                  |       |       |
|           |       | Notes  to Unaudited Consolidated Financial Statements                                                                 |       | 8          |
|           |       |                                                                                                                  |       |       |
|           |       | Report  of Independent Registered Public Accounting Firm                                                              |       | 24         |
|           |       |                                                                                                                  |       |       |
| Item  2.       |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                           |       | 25         |
|           |       |                                                                                                                  |       |       |
| Item  3.       |       | Quantitative  and Qualitative Disclosures about Market Risk                                                           |       | 39         |
|           |       |                                                                                                                  |       |       |
| Item  4.       |       | Controls  and Procedures                                                                                              |       | 39         |
|           |       |                                                                                                                  |       |       |
| **PART  II.**  | ** ** | **OTHER  INFORMATION**                                                                                                |       |       |
| ** **     | ** ** | ** **                                                                                                            |       |       |
| Item 1.        |       | Legal  Proceedings                                                                                                    |       | 40         |
|           |       |                                                                                                                  |       |       |
| Item 1A.       |       | Risk Factors                                                                                                          |       | 40         |
|           | ** ** | ** **                                                                                                            | ** ** | ** ** |
| Item  2.       |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                                          |       | 43         |
|           |       |                                                                                                                  |       |       |
| Item 6.        |       | Exhibits                                                                                                              |       | 44         |
|           |       |                                                                                                                  |       |       |
| **SIGNATURES** |       | 44                                                                                                                    |

 

2

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**PART I. FINANCIAL INFORMATION**

**Item 1.  UnauditedConsolidated Financial Statements**

**Investors Financial Services Corp.**

**Unaudited Consolidated BalanceSheets**

**September 30, 2006 and December31, 2005 (Dollars in thousands, except share data)**
| ** **                                                                                                                                                                                                                                                                          | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                                          | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| ** **                                                                                                                                                                                                                                                                          | ** ** | ** **             | ** ** | ** **            | ** ** |
| **Assets**                                                                                                                                                                                                                                                                          | ** ** | ** **             | ** ** | ** **            | ** ** |
| Cash and due from banks                                                                                                                                                                                                                                                             |       | $                      | 59,229     |                  | $          | 79,637 |   |
| Federal Funds sold                                                                                                                                                                                                                                                                  |       | 250,000                |       | —                |       |
| Other short-term  investments                                                                                                                                                                                                                                                       |       | 9,468                  |       | —                |       |
| Securities held to  maturity (including securities pledged of $4,498,296 and $4,529,421 at  September 30, 2006 and December 31, 2005, respectively) (approximate fair  value of $5,807,100 and $6,725,729 at September 30, 2006 and December 31,  2005, respectively) (Note 3) |       | 5,830,022              |       | 6,761,930             |       |
| Securities available  for sale (including securities pledged of $3,054,836 and $2,997,958 at  September 30, 2006 and December 31, 2005, respectively) (Note 3)                                                                                                                 |       | 4,623,393              |       | 4,369,720             |       |
| Nonmarketable equity  securities                                                                                                                                                                                                                                                    |       | 33,250                 |       | 50,000                |       |
| Loans, less allowance  for loan losses of $100 at September 30, 2006 and December 31, 2005 (Note 4)                                                                                                                                                                            |       | 286,378                |       | 402,370               |       |
| Accrued interest and  fees receivable                                                                                                                                                                                                                                               |       | 136,031                |       | 119,583               |       |
| Equipment and leasehold  improvements, less accumulated depreciation of $58,497 and $59,156 at  September 30, 2006 and December 31, 2005, respectively                                                                                                                              |       | 96,677                 |       | 69,401                |       |
| Goodwill, net                                                                                                                                                                                                                                                                       |       | 79,969                 |       | 79,969                |       |
| Other assets                                                                                                                                                                                                                                                                        |       | 168,164                |       | 163,783               |       |
|                                                                                                                                                                                                                                                                                |       |                   |       |                  |       |
| **Total Assets**                                                                                                                                                                                                                                                                    |       | $                      | 11,572,581 |                  | $          | 12,096,393 |   |
| ** **                                                                                                                                                                                                                                                                          | ** ** | ** **             | ** ** | ** **            | ** ** |
| **Liabilities and Stockholders’  Equity**                                                                                                                                                                                                                                      | ** ** | ** **             | ** ** | ** **            | ** ** |
| ** **                                                                                                                                                                                                                                                                          | ** ** | ** **             | ** ** | ** **            | ** ** |
| **Liabilities:**                                                                                                                                                                                                                                                                    | ** ** | ** **             | ** ** | ** **            | ** ** |
| Deposits (Note 5):                                                                                                                                                                                                                                                                  |       |                   |       |                  |       |
| Demand                                                                                                                                                                                                                                                                              |       | $                      | 830,810    |                  | $          | 537,558 |   |
| Savings                                                                                                                                                                                                                                                                             |       | 5,020,126              |       | 4,224,908             |       |
| Time                                                                                                                                                                                                                                                                                |       | 352,142                |       | 230,124               |       |
| Total deposits                                                                                                                                                                                                                                                                      |       | 6,203,078              |       | 4,992,590             |       |
|                                                                                                                                                                                                                                                                                |       |                   |       |                  |       |
| Securities sold under  repurchase agreements (Note 6)                                                                                                                                                                                                                               |       | 4,128,598              |       | 4,797,868             |       |
| Short-term and other  borrowings (Note 7)                                                                                                                                                                                                                                           |       | 44,685                 |       | 1,356,649             |       |
| Due to brokers for open  trades payable                                                                                                                                                                                                                                             |       | 72,920                 |       | 21,293                |       |
| Junior subordinated  deferrable interest debentures                                                                                                                                                                                                                                 |       | 24,774                 |       | 24,774                |       |
| Accrued taxes and other  expenses                                                                                                                                                                                                                                                   |       | 70,821                 |       | 45,077                |       |
| Other liabilities                                                                                                                                                                                                                                                                   |       | 93,864                 |       | 85,284                |       |
| Total  liabilities                                                                                                                                                                                                                                                                  |       | 10,638,740             |       | 11,323,535            |       |
|                                                                                                                                                                                                                                                                                |       |                   |       |                  |       |
| Commitments and  contingencies (Note 12)                                                                                                                                                                                                                                            |       | —                 |       | —                |       |
|                                                                                                                                                                                                                                                                                |       |                   |       |                  |       |
| **Stockholders’ Equity:**                                                                                                                                                                                                                                                      | ** ** | ** **             | ** ** | ** **            | ** ** |
| Preferred stock, par  value $0.01 (shares authorized: 1,000,000; issued: none at September 30, 2006  and December 31, 2005)                                                                                                                                                         |       | —                 |       | —                |       |
| Common stock, par value  $0.01 (shares authorized: 175,000,000; issued: 68,274,003 and 67,177,306 at  September 30, 2006 and December 31, 2005, respectively)                                                                                                                       |       | 683                    |       | 672                   |       |
| Surplus                                                                                                                                                                                                                                                                             |       | 326,724                |       | 286,265               |       |
| Deferred compensation                                                                                                                                                                                                                                                               |       | —                 |       | (311                  | )          |
| Retained earnings                                                                                                                                                                                                                                                                   |       | 686,201                |       | 572,549               |       |
| Accumulated other  comprehensive loss, net                                                                                                                                                                                                                                          |       | (6,805                 | )          | (13,369               | )          |
| Treasury stock, at cost  (2,124,987 shares and 2,124,669 shares at September 30, 2006 and December 31,  2005, respectively)                                                                                                                                                    |       | (72,962                | )          | (72,948               | )          |
| Total  stockholders’ equity                                                                                                                                                                                                                                                    |       | 933,841                |       | 772,858               |       |
| ** **                                                                                                                                                                                                                                                                          |       |                   |       |                  |       |
| **Total Liabilities and Stockholders’ Equity**                                                                                                                                                                                                                                 |       | $                      | 11,572,581 |                  | $          | 12,096,393 |   |

*See Notes to Unaudited Consolidated FinancialStatements.*

3

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**Investors Financial Services Corp.**

**Unaudited Consolidated Statementsof Income and Comprehensive Income**

**NineMonths ended September 30, 2006 and 2005 (Dollars in thousands, except pershare data)**
| ** **                                       | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
|--------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                       | ** ** | **2006**               | ** ** | **2005**               | ** ** |
| **Fees  and Other Revenue:**                     | ** ** | ** **             | ** ** | ** **             | ** ** |
| Asset servicing  fees:                           |       |                   |       |                   |       |
| Core service fees                                |       | $                      | 331,249    |                   | $          | 274,150 |   |
| Value-added service fees                         |       | 135,643                |       | 92,370                 |       |
| Total asset servicing fees                       |       | 466,892                |       | 366,520                |       |
| Other operating  income                          |       | 4,054                  |       | 2,424                  |       |
| Gain on sale of  investments                     |       | 2,523                  |       | 11,123                 |       |
| Total fees and other revenue                     |       | 473,469                |       | 380,067                |       |
|                                             |       |                   |       |                   |       |
| Interest income                                  |       | 412,696                |       | 320,670                |       |
| Interest expense                                 |       | 291,820                |       | 192,970                |       |
| Net interest income                              |       | 120,876                |       | 127,700                |       |
| Net operating revenue                            |       | 594,345                |       | 507,767                |       |
|                                             |       |                   |       |                   |       |
| **Operating  Expenses:**                         | ** ** | ** **             | ** ** | ** **             | ** ** |
| Compensation and  benefits                       |       | 238,846                |       | 185,779                |       |
| Technology and  telecommunications               |       | 54,750                 |       | 39,901                 |       |
| Transaction  processing services                 |       | 45,487                 |       | 35,252                 |       |
| Occupancy                                        |       | 24,163                 |       | 19,409                 |       |
| Depreciation and  amortization                   |       | 23,513                 |       | 23,724                 |       |
| Professional  fees                               |       | 9,881                  |       | 9,253                  |       |
| Travel and sales  promotion                      |       | 6,451                  |       | 4,823                  |       |
| Recruitment                                      |       | 3,388                  |       | 1,928                  |       |
| Insurance                                        |       | 2,944                  |       | 3,284                  |       |
| Other operating  expenses                        |       | 14,340                 |       | 10,806                 |       |
| Total operating expenses                         |       | 423,763                |       | 334,159                |       |
| ** **                                       | ** ** | ** **             | ** ** | ** **             | ** ** |
| **Income  Before Income Taxes**                  |       | 170,582                |       | 173,608                |       |
|                                             |       |                   |       |                   |       |
| Provision for  income taxes                      |       | 52,497                 |       | 53,301                 |       |
|                                             |       |                   |       |                   |       |
| **Net  Income**                                  |       | $                      | 118,085    |                   | $          | 120,307 |   |
| ** **                                       |       |                   |       |                   |       |
| **Basic  Earnings Per Share**                    |       | $                      | 1.80       |                   | $          | 1.81 |   |
| ** **                                       |       |                   |       |                   |       |
| **Diluted  Earnings Per Share**                  |       | $                      | 1.75       |                   | $          | 1.77 |   |
|                                             |       |                   |       |                   |       |
| **Comprehensive  Income:**                       |       |                   |       |                   |       |
| Net income                                       |       | $                      | 118,085    |                   | $          | 120,307 |   |
| Other  comprehensive income (loss):              |       |                   |       |                   |       |
| Net unrealized investment gain (loss)            |       | 9,436                  |       | (31,095                | )          |
| Net unrealized derivative instrument (loss) gain |       | (4,435                 | )          | 9,462                  |       |
| Cumulative translation adjustment                |       | 1,563                  |       | 348                    |       |
| Other comprehensive income (loss)                |       | 6,564                  |       | (21,285                | )          |
| Comprehensive income                             |       | $                      | 124,649    |                   | $          | 99,022 |   |

 

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

4

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**Investors Financial Services Corp.**

**Unaudited Consolidated Statementsof Income and Comprehensive Income**

**ThreeMonths Ended September 30, 2006 and 2005 (Dollars in thousands, except pershare data)**
| ** **                                       | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
|--------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                       | ** ** | **2006**               | ** ** | **2005**               | ** ** |
| **Fees  and Other Revenue:**                     | ** ** | ** **             | ** ** | ** **             | ** ** |
| Asset servicing  fees:                           |       |                   |       |                   |       |
| Core service fees                                |       | $                      | 111,247    |                   | $          | 95,447 |   |
| Value-added service fees                         |       | 41,207                 |       | 33,372                 |       |
| Total asset servicing fees                       |       | 152,454                |       | 128,819                |       |
| Other operating  income                          |       | 2,420                  |       | 1,013                  |       |
| Gain on sale of  investments                     |       | —                 |       | 1,383                  |       |
| Total fees and other revenue                     |       | 154,874                |       | 131,215                |       |
|                                             |       |                   |       |                   |       |
| Interest income                                  |       | 140,338                |       | 114,512                |       |
| Interest expense                                 |       | 101,348                |       | 76,471                 |       |
| Net interest income                              |       | 38,990                 |       | 38,041                 |       |
| Net operating revenue                            |       | 193,864                |       | 169,256                |       |
|                                             |       |                   |       |                   |       |
| **Operating  Expenses:**                         | ** ** | ** **             | ** ** | ** **             | ** ** |
| Compensation and  benefits                       |       | 74,639                 |       | 65,428                 |       |
| Technology and  telecommunications               |       | 19,625                 |       | 13,988                 |       |
| Transaction  processing services                 |       | 16,018                 |       | 12,476                 |       |
| Occupancy                                        |       | 8,600                  |       | 6,569                  |       |
| Depreciation and  amortization                   |       | 7,971                  |       | 7,740                  |       |
| Professional  fees                               |       | 4,477                  |       | 2,874                  |       |
| Travel and sales  promotion                      |       | 2,374                  |       | 1,649                  |       |
| Recruitment                                      |       | 1,568                  |       | 873                    |       |
| Insurance                                        |       | 977                    |       | 1,009                  |       |
| Other operating  expenses                        |       | 2,905                  |       | 3,524                  |       |
| Total operating expenses                         |       | 139,154                |       | 116,130                |       |
| ** **                                       | ** ** | ** **             | ** ** | ** **             | ** ** |
| **Income  Before Income Taxes**                  |       | 54,710                 |       | 53,126                 |       |
|                                             |       |                   |       |                   |       |
| Provision for  income taxes                      |       | 18,327                 |       | 17,894                 |       |
|                                             |       |                   |       |                   |       |
| **Net  Income**                                  |       | $                      | 36,383     |                   | $          | 35,232 |   |
| ** **                                       |       |                   |       |                   |       |
| **Basic  Earnings Per Share**                    |       | $                      | 0.55       |                   | $          | 0.54 |   |
| ** **                                       |       |                   |       |                   |       |
| **Diluted  Earnings Per Share**                  |       | $                      | 0.54       |                   | $          | 0.53 |   |
|                                             |       |                   |       |                   |       |
| **Comprehensive  Income:**                       |       |                   |       |                   |       |
| Net income                                       |       | $                      | 36,383     |                   | $          | 35,232 |   |
| Other  comprehensive income (loss):              |       |                   |       |                   |       |
| Net unrealized investment gain (loss)            |       | 30,266                 |       | (18,401                | )          |
| Net unrealized derivative instrument (loss) gain |       | (7,833                 | )          | 6,770                  |       |
| Cumulative translation adjustment                |       | 464                    |       | 572                    |       |
| Other comprehensive income (loss)                |       | 22,897                 |       | (11,059                | )          |
| Comprehensive income                             |       | $                      | 59,280     |                   | $          | 24,173 |   |

 

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

5

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**Investors Financial Services Corp.**

**Unaudited Consolidated Statementsof Stockholders’ Equity**

**Nine Months ended September 30,2006 and 2005 (Dollars in thousands, except share data)**
| ** **                                                                                                                     | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                                                                                     | ** ** | **2006**               | ** ** | **2005**               | ** ** |
| **Common  shares**                                                                                                             |       |                   |       |                   |       |
| Balance,  beginning of period                                                                                                  |       | 67,177,306             |       | 66,668,584             |       |
| Exercise of  stock options                                                                                                     |       | 1,028,194              |       | 356,238                |       |
| Common stock  issuance                                                                                                         |       | 68,503                 |       | 54,862                 |       |
| Balance, end of  period                                                                                                        |       | 68,274,003             |       | 67,079,684             |       |
|                                                                                                                           |       |                   |       |                   |       |
| **Treasury  shares**                                                                                                           |       |                   |       |                   |       |
| Balance, beginning  of period                                                                                                  |       | 2,124,669              |       | 73,235                 |       |
| Common stock  repurchased                                                                                                      |       | 318                    |       | 2,051,434              |       |
| Balance, end of  period                                                                                                        |       | 2,124,987              |       | 2,124,669              |       |
|                                                                                                                           |       |                   |       |                   |       |
| **Common  stock**                                                                                                              |       |                   |       |                   |       |
| Balance,  beginning of period                                                                                                  |       | $                      | 672        |                   | $          | 667 |   |
| Exercise of  stock options                                                                                                     |       | 11                     |       | 4                      |       |
| Balance, end of  period                                                                                                        |       | 683                    |       | 671                    |       |
|                                                                                                                           |       |                   |       |                   |       |
| **Surplus**                                                                                                                    |       |                   |       |                   |       |
| Balance,  beginning of period                                                                                                  |       | 286,265                |       | 272,536                |       |
| Share-based  awards and exercise of stock options                                                                              |       | 32,947                 |       | 6,896                  |       |
| Tax benefit from  exercise of stock options                                                                                    |       | 5,216                  |       | 2,525                  |       |
| Common stock  issuance                                                                                                         |       | 2,296                  |       | 1,878                  |       |
| Transfer of deferred  compensation to surplus                                                                                  |       | (311                   | )          | —                 |       |
| Amortization of  deferred compensation                                                                                         |       | 311                    |       | —                 |       |
| Balance, end of  period                                                                                                        |       | 326,724                |       | 283,835                |       |
|                                                                                                                           |       |                   |       |                   |       |
| **Deferred  compensation**                                                                                                     |       |                   |       |                   |       |
| Balance,  beginning of period                                                                                                  |       | (311                   | )          | (572                   | )          |
| Transfer of  deferred compensation to surplus                                                                                  |       | 311                    |       | —                 |       |
| Amortization of  deferred compensation                                                                                         |       | —                 |       | 327                    |       |
| Balance, end of  period                                                                                                        |       | —                 |       | (245                   | )          |
|                                                                                                                           |       |                   |       |                   |       |
| **Retained  earnings**                                                                                                         |       |                   |       |                   |       |
| Balance,  beginning of period                                                                                                  |       | 572,549                |       | 418,034                |       |
| Net income                                                                                                                     |       | 118,085                |       | 120,307                |       |
| Cash dividend,  $0.0675 and $0.0600 per share in the nine-month periods ending September 30,  2006 and 2005, respectively |       | (4,433                 | )          | (4,003                 | )          |
| Balance, end of  period                                                                                                        |       | 686,201                |       | 534,338                |       |
|                                                                                                                           |       |                   |       |                   |       |
| **Accumulated  other comprehensive (loss) income, net**                                                                        |       |                   |       |                   |       |
| Balance,  beginning of period                                                                                                  |       | (13,369                | )          | 23,888                 |       |
| Net unrealized  investment gain (loss)                                                                                         |       | 9,436                  |       | (31,095                | )          |
| Net unrealized  derivative instrument (loss) gain                                                                              |       | (3,285                 | )          | 10,607                 |       |
| Amortization of  terminated interest rate swap agreements                                                                      |       | (1,150                 | )          | (1,145                 | )          |
| Cumulative  translation adjustment                                                                                             |       | 1,563                  |       | 348                    |       |
| Balance, end of  period                                                                                                        |       | (6,805                 | )          | 2,603                  |       |
|                                                                                                                           |       |                   |       |                   |       |
| **Treasury  stock**                                                                                                            |       |                   |       |                   |       |
| Balance,  beginning of period                                                                                                  |       | (72,948                | )          | (2,291                 | )          |
| Common stock  repurchased                                                                                                      |       | (14                    | )          | (70,657                | )          |
| Balance, end of  period                                                                                                        |       | (72,962                | )          | (72,948                | )          |
|                                                                                                                           |       |                   |       |                   |       |
| **Total  Stockholders’ Equity**                                                                                           |       | $                      | 933,841    |                   | $          | 748,254 |   |

 

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

6

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**Investors Financial Services Corp.**

**UnauditedConsolidated Statements of Cash Flows**

**Nine Months ended September 30,2006 and 2005 (Dollars in thousands)**
| ** **                                                                         | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                                         | ** ** | **2006**               | ** ** | **2005**               | ** ** |
| ** **                                                                         | ** ** | ** **             | ** ** | ** **             | ** ** |
| **Cash  Flows From Operating Activities:**                                         | ** ** | ** **             | ** ** | ** **             | ** ** |
| Net income                                                                         |       | $                      | 118,085    |                   | $          | 120,307 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                   |       |                   |       |
| Equity in undistributed loss of unconsolidated  subsidiary                         |       | 21                     |       | 21                     |       |
| Depreciation and amortization                                                      |       | 23,513                 |       | 23,724                 |       |
| Share-based compensation                                                           |       | 3,093                  |       | —                 |       |
| Amortization of deferred compensation                                              |       | —                 |       | 327                    |       |
| Amortization of premiums on securities, net of  accretion of discounts             |       | 41,817                 |       | 38,844                 |       |
| Gain on sale of investments                                                        |       | (2,523                 | )          | (11,123                | )          |
| Excess tax benefit related to share-based  compensation                            |       | (5,736                 | )          | —                 |       |
| Changes in assets and liabilities:                                                 |       |                   |       |                   |       |
| Accrued interest and fees receivable                                               |       | (16,448                | )          | (19,714                | )          |
| Other assets                                                                       |       | (4,390                 | )          | (89,147                | )          |
| Accrued taxes and other expenses                                                   |       | 25,744                 |       | 7,556                  |       |
| Other liabilities                                                                  |       | 8,696                  |       | 109,148                |       |
| Net cash provided by operating activities                                          |       | 191,872                |       | 179,943                |       |
| ** **                                                                         | ** ** | ** **             | ** ** | ** **             | ** ** |
| **Cash  Flows From Investing Activities:**                                         |       |                   |       |                   |       |
| Proceeds from  maturities and paydowns of securities available for sale            |       | 827,928                |       | 1,047,624              |       |
| Proceeds from  maturities and paydowns of securities held to maturity              |       | 954,428                |       | 1,199,301              |       |
| Proceeds from  sale of securities available for sale                               |       | 134,131                |       | 293,488                |       |
| Proceeds from  sale of non-marketable equity securities                            |       | 16,750                 |       | —                 |       |
| Purchases of  securities available for sale                                        |       | (1,203,305             | )          | (1,183,603             | )          |
| Purchases of  securities held to maturity                                          |       | (62,088                | )          | (2,160,300             | )          |
| Net increase in  due to brokers for open trades payable                            |       | 51,627                 |       | 51,741                 |       |
| Net increase in  Federal Funds sold                                                |       | (250,000               | )          | (1,000,000             | )          |
| Net increase in  other short-term investments                                      |       | (9,468                 | )          | —                 |       |
| Net decrease  (increase) in loans                                                  |       | 115,992                |       | (209,009               | )          |
| Purchases of  equipment, software and leasehold improvements                       |       | (50,768                | )          | (20,502                | )          |
| Net cash provided by (used for) investing activities                               |       | 525,227                |       | (1,981,260             | )          |
| ** **                                                                         | ** ** | ** **             | ** ** | ** **             | ** ** |
| **Cash  Flows From Financing Activities:**                                         | ** ** | ** **             | ** ** | ** **             | ** ** |
| Net increase  (decrease) in demand deposits                                        |       | 293,252                |       | (306,607               | )          |
| Net increase in  time and savings deposits                                         |       | 917,236                |       | 1,123,747              |       |
| Net (decrease)  increase in securities sold under repurchase agreements            |       | (669,270               | )          | 1,017,909              |       |
| Net (decrease)  increase in short-term and other borrowings                        |       | (1,311,964             | )          | 50,351                 |       |
| Proceeds from  exercise of stock options                                           |       | 30,015                 |       | 6,900                  |       |
| Proceeds from  issuance of common stock                                            |       | 2,296                  |       | 1,878                  |       |
| Common stock  repurchase                                                           |       | (14                    | )          | (70,657                | )          |
| Excess tax  benefit related to share-based compensation                            |       | 5,736                  |       | —                 |       |
| Dividends paid  to stockholders                                                    |       | (4,433                 | )          | (4,003                 | )          |
| Net cash (used for) provided by financing activities                               |       | (737,146               | )          | 1,819,518              |       |
|                                                                               |       |                   |       |                   |       |
| **Effect  of exchange rates on cash**                                              |       | (361                   | )          | (14                    | )          |
| ** **                                                                         | ** ** | ** **             | ** ** | ** **             | ** ** |
| **Net  (Decrease) Increase in Cash and Due From Banks**                            |       | (20,408                | )          | 18,187                 |       |
| ** **                                                                         |       |                   |       |                   |       |
| **Cash  and Due From Banks, Beginning of Period**                                  |       | 79,637                 |       | 49,059                 |       |
| ** **                                                                         |       |                   |       |                   |       |
| **Cash  and Due From Banks, End of Period**                                        |       | $                      | 59,229     |                   | $          | 67,246 |   |

*See Notes to Unaudited Consolidated FinancialStatements.*

7

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

**1.     Description of Business**

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

**2.     Interim Financial Statements**

The unauditedconsolidated interim financial statements of the Company as of September 30,2006 and December 31, 2005, and for the nine-month and three-month periodsended September 30, 2006 and 2005 have been prepared by the Company pursuant tothe rules and regulations of the SEC. Certain information and footnote disclosures normally included in annualfinancial statements prepared in accordance with accounting principles generallyaccepted in the United States of America (‘GAAP’) have been omitted aspermitted by such rules and regulations. All adjustments, consisting of normal recurring adjustments, necessaryfor their fair presentation in conformity with GAAP are included.  All significant intercompany accounts andtransactions have been eliminated.  TheCompany’s management believes that the disclosures are adequate to presentfairly the financial position, results of operations and cash flows at thedates and for the periods presented.  Thepreparation of the financial statements requires management to make estimatesand assumptions that affect the amounts reported in the financial statementsand accompanying notes.  Actual resultsmay differ from those estimates.  It issuggested that these interim financial statements be read in conjunction withthe financial statements and the notes thereto included in the Company’s latestannual report on Form 10-K. Results for interim periods are not necessarily indicative of those tobe expected for the full fiscal year. Certain amounts in prior financialstatements have been reclassified to conform to the current presentation.

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

Nonmarketable securitiesconsist of stock of the Federal Home Loan Bank of Boston (‘FHLBB’) and arecarried at cost and redeemable at par value. The Company is required to hold this stock under its borrowing arrangement with the FHLBB.

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

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

8

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prepaymentscan be reasonably estimated, prepayments are anticipated using the Company’sactual three-month prepayment experience.

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

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

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

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

Asof and for the periods ended September 30, 2006, December 31, 2005 andSeptember 30, 2005, the Company anticipated prepayments on its residentialmortgage-backed securities.  All othersecurities do not meet the SFAS 91 criteria for anticipating prepayments.  Accordingly, no prepayments were anticipatedfor these securities.

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

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

Thefollowing table sets forth share-based compensation cost and the related taxbenefit recognized in the income statement for all of the Company’s share-basedcompensation plans (Dollars in thousands):

|                                | ** ** | **For the Nine Months  Ended September 30,** | ** ** | **For the Three Months  Ended September 30,** | ** ** |
|--------------------------------|------------|-----------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                     | ** ** | **2006**                                                              | ** ** | **2005**                                                               | ** ** | **2006** | ** ** | **2005** | ** ** |
| Share-based  compensation cost |       | $                                                                     | 3,093      |                                                                   | $          | 327 |   | $ | 809 |   | $ | 115 |   |
| Income tax benefit             |       | $                                                                     | 493        |                                                                   | $          | — |   | $ | 73 |   | $ | — |   |

 

9

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

Prior to adoptingSFAS 123R, the Company measured compensation cost for share-based compensationplans using the intrinsic value method under Accounting Principles BoardOpinion No. 25, *Accounting for Stock Issued to Employees*(‘APB25’),**and made pro forma disclosures of thefair value method under SFAS 123.  Theintrinsic value method measures compensation cost as the amount by which thefair market value of the Company’s common stock exceeds the option exerciseprice on the measurement date, which is typically the date of grant.  Generally, options granted had an exerciseprice equivalent to the fair market value at the measurement date.  Accordingly, no compensation cost wasrecorded.  If share-based compensationcost were recognized using the fair value method, stock options would be valuedat grant date using the Black-Scholes valuation model and the resultingcompensation cost would have decreased net income as indicated below (Dollarsin thousands, except per share data):

|                                                                                                                                          | ** ** | **For the Nine  Months Ended** | ** ** | **For the Three  Months Ended** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                                                                               | ** ** | **September 30,  2005**                  | ** ** | **September 30,  2005**                   | ** ** |
|                                                                                                                                     |       |                                          |       |                                           |       |
| Net income as  reported                                                                                                                  |       | $                                             | 120,307    |                                           | $          | 35,232 |   |
| Deduct: Total  share-based employee compensation cost determined under the fair value method  for all awards, net of related tax effects |       | (2,806                                        | )          | (1,014                                         | )          |
| Pro forma net  income                                                                                                                    |       | $                                             | 117,501    |                                           | $          | 34,218 |   |
|                                                                                                                                     |       |                                          |       |                                           |       |
| Earnings per  share:                                                                                                                     |       |                                          |       |                                           |       |
| Basic-as reported                                                                                                                        |       | $                                             | 1.81       |                                           | $          | 0.54 |   |
| Basic-pro forma                                                                                                                          |       | $                                             | 1.77       |                                           | $          | 0.52 |   |
|                                                                                                                                     |       |                                          |       |                                           |       |
| Diluted-as reported                                                                                                                      |       | $                                             | 1.77       |                                           | $          | 0.53 |   |
| Diluted-pro  forma                                                                                                                       |       | $                                             | 1.72       |                                           | $          | 0.51 |   |

 

The fair value of eachoption grant was estimated on the date of grant using the Black-Scholesvaluation model with the following weighted average assumptions for the ninemonths ended September 30, 2005:  anaverage assumed risk-free interest rate of 4.03%, an expected term of four years,an average expected volatility of 42.32%, and an average dividend yield of0.20%.

For the three monthsended September 30, 2005, the following assumptions were used in theBlack-Scholes valuation model:  anaverage assumed risk-free interest rate of 4.23%, an expected term of fouryears, an average expected volatility of 41.21%, and an average dividend yieldof 0.24%.

The amount of share-basedcompensation cost (net of tax) included in net income as reported for the ninemonths and three months ended September 30, 2005 was $0.2 million and $0.1million, respectively.

10

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The following table represents the effect of changingfrom the intrinsic value method under APB 25 to the fair value method underSFAS 123R for the nine months and three months ended September 30, 2006,respectively (Dollars in thousands, except per share data):

|                                      | ** ** | **For the Nine  Months Ended** | ** ** | **For the Three  Months Ended** | ** ** |
|--------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------|------------|
| ** **                           | ** ** | **September 30,  2006**                  | ** ** | **September 30,  2006**                   | ** ** |
| Increase/(Decrease)  in:             |       |                                          |       |                                           |       |
|                                 |       |                                          |       |                                           |       |
| Income from continuing  operations   |       | $                                             | (2,890     | )                                              | $          | (777 | ) |
| Income before  income taxes          |       | (2,890                                        | )          | (777                                           | )          |
| Net income                           |       | (2,397                                        | )          | (704                                           | )          |
| Cash flow from  operations           |       | (5,736                                        | )          | (630                                           | )          |
| Cash flow from  financing activities |       | 5,736                                         |       | 630                                            |       |
|                                 |       |                                          |       |                                           |       |
| Basic EPS                            |       | $                                             | (0.03      | )                                              | $          | (0.01 | ) |
| Diluted EPS                          |       | $                                             | (0.03      | )                                              | $          | (0.01 | ) |

 

The fair value of eachoption grant under the Director Plan, the Stock Plan, and the 2005 Plan (eachas described further in Note 8) was estimated on the grant date using theBlack-Scholes valuation model with the following weighted average assumptionsfor the nine months ended September 30, 2006: an average assumed risk-free interest rate of 4.78%, an expected term offive years, an average expected volatility of 42.19%, and an average dividendyield of 0.20%.  For the three monthsended September 30, 2006, the following assumptions were used in theBlack-Scholes valuation model:  anaverage assumed risk-free interest rate of 4.83%, an expected term of fiveyears, an average expected volatility of 41.30%, and an average dividend yieldof 0.21%.

The Company bases itsestimate of expected term on the historical exercise and post-vestingemployment termination behavior for similar grants.  The Company’s volatility assumption is basedon the historical volatility of the Company’s stock over a period equating tothe expected term of the employee share option, using weekly price observationsand looking backward from the date of grant.

The fair value of theoption feature of grants under the 1997 Employee Stock Purchase Plan (‘ESPP’)(as described further in Note 8) was estimated on the grant date using theBlack-Scholes valuation model with the following weighted average assumptionsfor the nine months ended September 30, 2006: an average assumed risk-free rate of 4.79 %, an expected term of 0.5years, an average volatility of 37.54%, and an average dividend yield of0.23%.  For the three months endedSeptember 30, 2006, the following assumptions were used for the fair value ofthe option grants under the ESPP:  anaverage assumed risk-free interest rate of 5.17%, an expected term of 0.5years, an average expected volatility of 38.12%, and an average dividend yieldof 0.20%.

The expected term for the ESPP is equal to thesix-month payment period.  The Companyestimates expected volatility for the ESPP in the same manner as for employeestock options, except that daily volatility is used instead of weeklyvolatility.  The Company uses dailyvolatility for the ESPP because weekly volatility over six months does notresult in a statistically significant number of data points upon which to basethe volatility calculation.

SFAS 123R also requires that any deferred compensationrelated to share-based awards granted prior to January 1, 2006 must beeliminated against the appropriate equity accounts.  In connection with the Company’s adoption ofSFAS 123R, the presentation in the consolidated statement of stockholders’equity for the nine months ended September 30, 2006 was revised to reflect thetransfer of balances previously reported in deferred compensation to surplus.

11

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***EarningsPer Share –***Basic earnings per share (‘EPS’) werecomputed by dividing net income by the weighted-average number of common sharesoutstanding during the quarter.  DilutedEPS reflects the potential dilution that could occur if contracts to issuecommon stock were exercised into common stock that then shared in the earningsof the Company.  The reconciliation fromBasic to Diluted EPS is as follows (Dollars in thousands, except per sharedata):
| ** **                                   | ** ** | **For the Nine Months** | ** ** | **For the Three Months** | ** ** |
|----------------------------------------------|------------|----------------------------------------|------------|-----------------------------------------|------------|
| ** **                                   | ** ** | **Ended September 30,**      | ** ** | **Ended September 30,**       | ** ** |
| ** **                                   | ** ** | **2006**                               | ** ** | **2005**                                | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                         |       |                                   |       |                                    |       |   |   |   |   |
| Income available  to common stockholders     |       | $                                      | 118,085    |                                    | $          | 120,307 |   | $ | 36,383 |   | $ | 35,232 |   |
|                                         |       |                                   |       |                                    |       |   |   |   |   |
| Basic  weighted-average shares outstanding   |       | 65,727,040                             |       | 66,530,636                              |       | 66,067,400 |   | 66,076,656 |   |
| Dilutive effect  of stock options            |       | 1,859,103                              |       | 1,435,857                               |       | 1,750,187 |   | 934,232 |   |
| Diluted  weighted-average shares outstanding |       | 67,586,143                             |       | 67,966,493                              |       | 67,817,587 |   | 67,010,888 |   |
|                                         |       |                                   |       |                                    |       |   |   |   |   |
| Earnings per  share:                         |       |                                   |       |                                    |       |   |   |   |   |
| Basic                                        |       | $                                      | 1.80       |                                    | $          | 1.81 |   | $ | 0.55 |   | $ | 0.54 |   |
|                                         |       |                                   |       |                                    |       |   |   |   |   |
| Diluted                                      |       | $                                      | 1.75       |                                    | $          | 1.77 |   | $ | 0.54 |   | $ | 0.53 |   |

 

There were 101,313 and79,493 options which were not considered dilutive for purposes of EPScalculations for the nine-month periods ended September 30, 2006 and 2005,respectively.  For the three-monthperiods ended September 30, 2006 and 2005, there were 102,533 and 1,121,058options, respectively, which were not considered dilutive for purposes of EPScalculations.

***RecentlyIssued Accounting Pronouncements -***In June 2006, theFinancial Accounting Standards Board (‘FASB’) issued FASB Interpretation No.48, *Accounting for Uncertainty in Income Taxes – aninterpretation of FASB Statement No. 109* (‘FIN 48’).  FIN 48 establishes a recognition thresholdand measurement attribute for the financial statement recognition andmeasurement of a tax position taken or expected to be taken in a taxreturn.  Pursuant to FIN 48, the effectsof a tax position are recognized in the financial statements when it is morelikely than not, based on the technical merits, that the position will besustained upon examination by the taxing authority.  Conversely, previously recognized taxpositions are derecognized when it is no longer more likely than not that thetax position would be sustained upon examination.  FIN 48 also requires certain disclosuresregarding unrecognized tax benefits and the amounts and classification of therelated interest and penalties.  FIN 48is effective for fiscal years beginning after December 15, 2006.  The Company does not anticipate any materialimpact to its financial condition or results of operations as a result of theadoption of FIN 48.

In September 2006, theFASB issued Statement of Financial Accounting Standards No. 157, *Fair Value Measurements*(‘SFAS 157’).  SFAS 157 defines fair value, establishes aframework for measuring fair value, and expands upon existing disclosures aboutfair value measurements.  SFAS 157 doesnot require any new fair value measurements. Rather, the guidance contained in SFAS 157 applies to assets,liabilities, and certain equity instruments that are already measured at fairvalue under existing accounting pronouncements. SFAS 157 is effective for fiscal years beginning after November 15,2007.  The Company does not anticipateany material impact to its financial condition or results of operations as aresult of the adoption of SFAS 157.

In September 2006, theFASB issued Statement of Financial Accounting Standards No. 158, *Employers’ Accounting for Defined Benefit Pension andOther Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106,and 132R* (‘SFAS 158’).  SFAS158 changes current practice by requiring employers to recognize theoverfunded or underfunded positions of defined benefit postretirement plans,including pension plans, on the balance sheet.  The funded status isdefined as the difference between the projected benefit obligation and the fairvalue of plan assets.  SFAS 158 alsorequires employers to recognize the change in funded status in othercomprehensive income (a component of shareholders’ equity).  SFAS 158 does not change the requirements forthe measurement and recognition of pension expense in the statement ofincome.  SFAS 158 is effective for fiscalyears ending after December 15, 2006. The Company does not anticipate any material impact to its financialcondition or results of operations as a result of the adoption of SFAS 158.

In September 2006, theSEC issued Staff Accounting Bulletin 108, *Considering the Effects ofPrior Year Misstatements When Quantifying Misstatements in Current YearFinancial Statements* (‘SAB 108’). SAB 108 provides interpretive guidance on how the effects of thecarryover or reversal of prior year financial statement misstatements should beconsidered in quantifying a current year misstatement.  SAB 108 iseffective for financial statements covering the first fiscal year ending afterNovember 15, 2006.  The Company does notanticipate any material impact to its financial condition or results ofoperations as a result of the adoption of SAB 108.

12

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**3.     Securities**

Amortized cost amountsand fair values of securities are summarized as follows as of September 30,2006 (Dollars in thousands):
| ** **                        | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair**  | ** ** |
|-----------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|-----------|------------|
| **Held to Maturity**    | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **(Losses)**   | ** ** | **Value** | ** ** |
|                              |       |          |       |           |       |           |       |      |       |
| Mortgage-backed  securities       |       | $             | 3,889,455  |           | $          | 8,402          |       | $         | (25,728    | ) | $ | 3,872,129 |   |
| Federal agency  securities        |       | 1,833,915     |       | 3,072          |       | (13,113        | )          | 1,823,874 |       |
| State and  political subdivisions |       | 106,652       |       | 4,531          |       | (86            | )          | 111,097   |       |
|                              |       |          |       |           |       |           |       |      |       |
| Total                             |       | $             | 5,830,022  |           | $          | 16,005         |       | $         | (38,927    | ) | $ | 5,807,100 |   |

 
| ** **                        | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair**  | ** ** |
|-----------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|-----------|------------|
| **Available for Sale**  | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **(Losses)**   | ** ** | **Value** | ** ** |
|                              |       |          |       |           |       |           |       |      |       |
| Mortgage-backed  securities       |       | $             | 4,116,606  |           | $          | 7,913          |       | $         | (41,121    | ) | $ | 4,083,398 |   |
| State and  political subdivisions |       | 343,562       |       | 4,423          |       | (125           | )          | 347,860   |       |
| Corporate debt                    |       | 181,955       |       | 340            |       | (1,158         | )          | 181,137   |       |
| Foreign  government securities    |       | 11,021        |       | —         |       | (23            | )          | 10,998    |       |
|                              |       |          |       |           |       |           |       |      |       |
| Total                             |       | $             | 4,653,144  |           | $          | 12,676         |       | $         | (42,427    | ) | $ | 4,623,393 |   |

 

Amortized cost amountsand fair values of securities are summarized as follows as of December 31, 2005(Dollars in thousands):
| ** **                        | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | ** **          | ** ** |
|-----------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|---------------------|------------|
| **Held to Maturity**    | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **(Losses)**   | ** ** | **Fair Value** | ** ** |
|                              |       |          |       |           |       |           |       |                |       |
| Mortgage-backed  securities       |       | $             | 4,342,254  |           | $          | 11,420         |       | $                   | (29,818    | ) | $ | 4,323,856 |   |
| Federal agency  securities        |       | 2,305,331     |       | 1,560          |       | (23,914        | )          | 2,282,977           |       |
| State and  political subdivisions |       | 114,345       |       | 4,646          |       | (95            | )          | 118,896             |       |
|                              |       |          |       |           |       |           |       |                |       |
| Total                             |       | $             | 6,761,930  |           | $          | 17,626         |       | $                   | (53,827    | ) | $ | 6,725,729 |   |

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

 

During the nine-monthperiod ended September 30, 2006, the Company sold forty-two securitiesclassified as available for sale totaling $134.1 million using the specificidentification method.  The book value ofthe securities was $131.6 million and resulted in a gross realized gain of $2.5million for the nine-month period ended September 30, 2006.  The Company had no sales of securities duringthe three-month period ended September 30, 2006.

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

The carrying value ofsecurities pledged amounted to approximately $7.6 billion and $7.5 billion atSeptember 30, 2006 and December 31, 2005, respectively.  Securities are pledged primarily to secureclearings with other depository institutions, to secure repurchase agreementsand to secure outstanding FHLBB borrowings.

On a quarterly basis 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, 2006, nosecurities were considered to be other-than-temporarily impaired.

**4.     Loans**

Loans consist of demandloans to custody clients of the Company, including individuals, not-for-profitinstitutions and mutual fund clients.  Theloans to mutual funds and other pooled product clients include lines of creditand advances pursuant to the terms of the custody agreements between theCompany and those clients to facilitate securities transactions andredemptions. Almost all of the Company’s commitments to fund loans are atvariable rates.  The credit riskassociated with these loans is considered low since the loans are, or may be,in the event of default, collateralized with marketable securities held by theCompany as custodian.  There were noimpaired loans, nonperforming loans or loans on nonaccrual status at September30, 2006 or December 31, 2005.  Inaddition, there were no loan charge-offs or recoveries during the nine monthsended September 30, 2006 or 2005.  Loansare summarized as follows (Dollars in thousands):

|                                 | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **2006**               | ** ** | **2005**              | ** ** |
|                            |       |                   |       |                  |       |
| Loans to mutual  funds          |       | $                      | 175,313    |                  | $          | 286,144 |   |
| Loans to  individuals           |       | 72,566                 |       | 81,392                |       |
| Commercial and  industrial      |       | 13,612                 |       | 15,697                |       |
| Other                           |       | 24,987                 |       | 19,237                |       |
|                            |       | 286,478                |       | 402,470               |       |
| Less allowance  for loan losses |       | (100                   | )          | (100                  | )          |
|                            |       |                   |       |                  |       |
| Total                           |       | $                      | 286,378    |                  | $          | 402,370 |   |

 

**5.     Deposits**

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

|                                    | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                         | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| Interest-bearing deposits:         |       |                   |       |                  |       |
| Demand                             |       | $                      | 95,019     |                  | $          | 85,157 |   |
| Savings                            |       | 4,971,050              |       | 4,195,486             |       |
| Time                               |       | 127,142                |       | 55,124                |       |
| Total interest-bearing deposits    |       | 5,193,211              |       | 4,335,767             |       |
|                               |       |                   |       |                  |       |
| Noninterest-bearing deposits:      |       |                   |       |                  |       |
| Demand                             |       | 735,791                |       | 452,401               |       |
| Savings                            |       | 49,076                 |       | 29,422                |       |
| Time                               |       | 225,000                |       | 175,000               |       |
| Total noninterest-bearing deposits |       | 1,009,867              |       | 656,823               |       |
|                               |       |                   |       |                  |       |
| Total                              |       | $                      | 6,203,078  |                  | $          | 4,992,590 |   |

 

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Time deposits withbalances greater than $100,000 totaled $352.1 million and $230.1 million atSeptember 30, 2006 and December 31, 2005, respectively.  All time deposits had a maturity of less thanthree months at September 30, 2006 and December 31, 2005.  The aggregate amounts of overdraft depositsthat have been reclassified as loan balances were $92.6 million and $162.2million at September 30, 2006 and December 31, 2005, respectively.

**6.     Securities Sold Under Repurchase Agreements**

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

|                                     | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                          | ** ** | **2006**               | ** ** | **2005**              | ** ** |
|                                |       |                   |       |                  |       |
| Repurchase agreements  - short term |       | $                      | 3,978,598  |                  | $          | 4,297,868 |   |
| Repurchase  agreements - long term  |       | 150,000                |       | 500,000               |       |
| Total                               |       | $                      | 4,128,598  |                  | $          | 4,797,868 |   |

 

Approximately $4.2billion and $4.9 billion of securities were pledged to collateralize repurchaseagreements as of September 30, 2006 and December 31, 2005, respectively.

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

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

|                                                       | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                            | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| Federal Funds  purchased                              |       | $                      | 44,710     |                  | $          | 810,511 |   |
| Federal Home  Loan Bank of Boston overnight advances  |       | —                 |       | 400,000               |       |
| Federal Home  Loan Bank of Boston short-term advances |       | —                 |       | 146,000               |       |
| Treasury, Tax  and Loan account                       |       | (25                    | )          | 138                   |       |
| Total                                                 |       | $                      | 44,685     |                  | $          | 1,356,649 |   |

 

The Company has borrowingarrangements with the FHLBB and the Federal Reserve Discount Window, which havebeen utilized on an overnight and short-term basis to satisfy fundingrequirements.  Approximately $1.0 billionof securities were pledged to collateralize FHLBB advances as of both September30, 2006 and December 31, 2005, and approximately $2.1 billion and $1.4 billionof securities were pledged to collateralize Federal Reserve Discount Windowborrowings as of September 30, 2006 and December 31, 2005, respectively.

**8.     Stockholders’ Equity**

As of September 30, 2006,the Company’s capital stock consisted of 1,000,000 authorized shares ofpreferred stock, of which no shares were issued, and 175,000,000 authorizedshares of common stock, of which 68,274,003 shares were issued.  All shares have a par value of $0.01 pershare.

The Company has fourequity incentive plans:  the Amended andRestated 1995 Stock Plan (‘Stock Plan’), the Amended and Restated 1995Non-Employee Director Stock Option Plan (‘Director Plan’), the 1997 EmployeeStock Purchase Plan (‘ESPP’) and the 2005 Equity Incentive Plan (the ‘2005 Plan’).  The 2005 Plan supersedes both the Stock Planand the Director Plan, both of which continue in effect only with regard tooptions outstanding under those plans. Options awarded under the Stock Plan, the Director Plan and the 2005Plan generally vest over zero to four years of continuous service and generallyhave ten-year contractual terms.  Theexercise prices of these awards are generally equal to the fair market value ofthe Company’s common stock on the date the awards are granted.  There were no amendments to any plans duringthe nine months ended September 30, 2006.

Cash received fromoptions exercised under all share-based payment arrangements for the ninemonths and three months ended September 30, 2006 was $30.0 million and $5.6million, respectively.  The actual taxbenefit realized for the tax deductions related to these exercises amounted to$5.9 million and $0.7 million for the nine months and three months endedSeptember 30, 2006, respectively.

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

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

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

A summary of optionactivity under the Director Plan, the Stock Plan and the 2005 Plan for the ninemonths ended September 30, 2006, is as follows:

| Options                            | ** ** | **Number of  Options** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Weighted-  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value  ($000)** | ** ** |
|------------------------------------|------------|-----------------------------|------------|-----------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------|------------|
| Outstanding at  January 1, 2006    |       | 6,919,316                   |       | $                                       | 31         |                                                 |       |                                    |       |   |
| Granted                            |       | 76,063                      |       | 47                                      |       |                                                 |       |                                    |       |
| Exercised                          |       | (1,056,398                  | )          | 29                                      |       |                                                 |       |                                    |       |
| Forfeited or  expired              |       | (31,757                     | )          | 40                                      |       |                                                 |       |                                    |       |
| Outstanding at  September 30, 2006 |       | 5,907,224                   |       | 31                                      |       | 5.7 years                                            |       | $                                       | 72,242     |   |
|                               |       |                        |       |                                    |       |                                                 |       |                                    |       |
| Exercisable at  September 30, 2006 |       | 5,589,410                   |       | $                                       | 31         |                                                 | 5.6 years  |                                    | $          | 70,064 |   |

 

The weighted-average grant-date fair values per optionof options granted during the nine months ended September 30, 2006 and 2005were $20.13 and $15.87, respectively. The total intrinsic value of options exercised during the nine monthsended September 30, 2006 and 2005 were $17.8 million and $7.9 million,respectively.

As of September 30, 2006, there was $1.7 million oftotal unrecognized compensation cost related to nonvested share-basedcompensation arrangements granted under the Stock Plan, the Director Plan andthe 2005 Plan.  That cost is expected tobe recognized over a weighted-average period of 1 year.

A summary of the statusof the Company’s nonvested shares for the nine months ended September 30, 2006is presented below:

| Nonvested Shares            | ** ** | **Number of  Shares** | ** ** | **Weighted-Average  Grant-Date  Fair Value** | ** ** |
|----------------------------------|------------|----------------------------|------------|---------------------------------------------------|------------|
| Nonvested at  January 1, 2006    |       | 5,000                      |       | $                                                 | 34         |   |
| Granted                          |       | —                     |       | —                                            |       |
| Vested                           |       | (1,000                     | )          | 34                                                |       |
| Forfeited                        |       | —                     |       | —                                            |       |
| Nonvested at September  30, 2006 |       | 4,000                      |       | $                                                 | 34         |   |

 

The total fairvalues of shares vested during the nine months ended September 30, 2006 and2005 were $34 thousand and $0, respectively.

*ESPP*

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

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For the six-month periodended June 30, 2006, the purchase price of stock was $33.52, or 90% of themarket value of the Company’s common stock on the first business day of thepayment period ending June 30, 2006.

During the year endedDecember 31, 2005, the purchase prices of the stock were $34.25 and $33.25, or90% of the market value of the Company’s common stock on the last business dayof the payment periods ending June 30, 2005 and December 31, 2005,respectively.

A summary of activityunder the ESPP is as follows:

|                                                             | ** ** | **For the Nine** | ** ** | **For the**    | ** ** |
|-------------------------------------------------------------|------------|----------------------------|------------|---------------------|------------|
| ** **                                                  | ** ** | **Months Ended**      | ** ** | **Year Ended** | ** ** |
| ** **                                                  | ** ** | **September 30,**          | ** ** | **December 31,**    | ** ** |
| ** **                                                  | ** ** | **2006**                   | ** ** | **2005**            | ** ** |
|                                                        |       |                       |       |                |       |
| Total shares  available under the plan, beginning of period |       | 521,563                    |       | 636,267             |       |
| Issued at June 30                                           |       | (68,506)                   |       | (54,862             | )          |
| Issued at December 31                                       |       | —                     |       | (59,842             | )          |
|                                                        |       |                       |       |                |       |
| Total shares available  under the plan, end of period       |       | 453,057                    |       | 521,563             |       |

 

Prior to the adoption ofSFAS 123R, the ESPP was considered a non-compensatory plan and, therefore, nocompensation cost was recognized. However, pursuant to SFAS 123R, the ESPP is considered a compensatoryplan, effective January 1, 2006. Accordingly, compensation cost is computed as the sum of:  (a) 10% of the fair market value of theCompany’s common stock on the first day of the purchase period and (b) the fairvalue of the option feature, calculated using the Black-Scholes valuationmodel.  Compensation cost is recognizedratably over the payment period based on the components of fair value in thepreceding sentence and the number of shares that could be purchased at grantdate based on the estimated total withholdings and the discounted market priceof the stock on grant date.  Theweighted-average grant-date fair value of awards granted under the ESPP was$7.86 per share for the payment period from January 1, 2006 through June 30,2006 and $9.86 per share during the first half of the payment period from July1, 2006 through December 31, 2006.

Compensation cost related to the ESPP was $0.9 millionand $0.3 million for the nine months and three months ended September 30, 2006,respectively.  Compensation cost relatedto the ESPP was $0 for both the nine months and three months ended September30, 2005.  As of September 30, 2006,there was $0.3 million of total unrecognized compensation cost related to thenonvested awards granted under the ESPP.

**9.     Employee Benefit Plans**

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

17

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

|                                                     | ** ** | **For the Nine Months Ended** | ** ** | **For the Three Months Ended** | ** ** |
|-----------------------------------------------------|------------|---------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                          | ** ** | **September 30,  2006**                      | ** ** | **September 30,  2005**                       | ** ** | **September 30,  2006** | ** ** | **September 30,  2005** | ** ** |
|                                                |       |                                              |       |                                               |       |   |   |   |   |
| Service  cost-benefits earned / benefit obligations |       | $                                                 | —     |                                               | $          | 558 |   | $ | — |   | $ | 186 |   |
| Interest cost on  projected benefit obligations     |       | 761                                               |       | 858                                                |       | 254 |   | 286 |   |
| Expected return  on plan assets                     |       | (1,059                                            | )          | (1,077                                             | )          | (353 | ) | (359 | ) |
| Net amortization  and deferral                      |       | 122                                               |       | 234                                                |       | 41 |   | 78 |   |
| Net periodic  pension (benefit) cost                |       | $                                                 | (176       | )                                                  | $          | 573 |   | $ | (58 | ) | $ | 191 |   |

 

The Company does notexpect to contribute to its Pension Plan during 2006, and no contributions weremade during the nine-month period ended September 30, 2006.

***SupplementalRetirement Plan*****-** The Companyalso has a nonqualified, unfunded, supplemental retirement plan (‘SERP’) whichwas established in 1994 and covers certain employees and pays benefits thatsupplement any benefits paid under the Pension Plan.  Benefits under the SERP are generally basedon compensation not includable in the calculation of benefits to be paid underthe Pension Plan.  The plan document wasamended in April 2000 to eliminate the compensation cap and include bonuses andcommissions of certain employees.  TheCompany uses a December 31 measurement date for this plan.

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

|                                                     | ** ** | **For the Nine Months Ended** | ** ** | **For the Three Months Ended** | ** ** |
|-----------------------------------------------------|------------|---------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                          | ** ** | **September 30,  2006**                      | ** ** | **September 30,  2005**                       | ** ** | **September 30,  2006** | ** ** | **September 30,  2005** | ** ** |
|                                                |       |                                              |       |                                               |       |   |   |   |   |
| Service  cost-benefits earned / benefit obligations |       | $                                                 | 1,384      |                                               | $          | 1,332 |   | $ | 461 |   | $ | 444 |   |
| Interest cost on  projected benefit obligations     |       | 1,189                                             |       | 1,104                                              |       | 406 |   | 368 |   |
| Net amortization  and deferral                      |       | 717                                               |       | 816                                                |       | 240 |   | 272 |   |
| Net periodic pension  cost                          |       | $                                                 | 3,290      |                                               | $          | 3,252 |   | $ | 1,107 |   | $ | 1,084 |   |

 

As of September 30, 2006,the Company has contributed $0.5 million to the SERP, and the SERP hasdistributed $0.5 million to its plan participants.  The Company does not anticipate making anycontributions during the remainder of 2006.

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

***Lines of Credit -***At September 30,2006, the Company had commitments to mutual funds, individuals and others undercollateralized open lines of credit totaling $1.2 billion, against which$193.8 million in loans were drawn. The credit risk involved in issuing lines of credit is essentially thesame as that involved in extending demand loans.  The Company does not anticipate any loss as aresult of these lines of credit.

***Securities Lending -***On behalf of itsclients, the Company lends securities to creditworthy broker-dealers.  In certain circumstances, the Company mayindemnify its clients for the fair market value of those securities against afailure of the borrower to return such securities.  The Company requires the borrowers to providecollateral in an amount equal to, or in excess of, 102% of the fair marketvalue of U.S. dollar-denominated securities borrowed and 105% of the fairmarket value of non-U.S. dollar-denominated securities borrowed.  The borrowed securities are revalued daily todetermine whether additional collateral is necessary.  As guarantor, the Company is required torecognize, at the inception of a guarantee, a liability for the fair value ofthe obligation undertaken in issuing the guarantee.  The Company measures the fair value of itsindemnification obligation by marking its securities lending portfolio tomarket on a daily basis and comparing the value of the portfolio to thecollateral holdings position.  The fairvalue of the indemnification obligation to be recorded would be the deficiencyof collateral as compared to the value of the securities out on loan.

With respect to theindemnified securities lending portfolio, the cash and U.S. governmentsecurities held by the Company as collateral at September 30, 2006 totaled $9.3billion, while the fair value of the indemnified securities lending portfoliototaled approximately $8.9 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.

18

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All securities loans arecategorized as overnight loans.  Themaximum potential amount of future payments that the Company could be requiredto make would be equal to the market value of the securities borrowed.  Since the securities loans are overcollateralized by 2% (for U.S. dollar-denominated securities) to 5% (fornon-U.S. dollar-denominated securities) of the fair market value of the loanmade, the collateral held by the Company would be used to satisfy theobligation.  In addition, each borrowingagreement includes “set-off” language that allows the Company to use any excesscollateral on other loans to that borrower to cover any collateral shortfall ofthat borrower.  However, there is apotential risk that the collateral would not be sufficient to cover such an obligationif the security on loan increased in value between the time the borrowerdefaulted and the time the security is “bought-in”.  In those instances, the Company would “buy-in”the security using all available collateral and a loss would result from thedifference between the value of the security “bought-in” and the value of thecollateral held.  The Company has neverexperienced a broker default.

**11.  Derivative Financial Instruments**

***InterestRate Contracts*****-** Interest ratecontracts involve an agreement with a counterparty to exchange cash flows basedon an underlying interest rate index.  Aswap agreement involves the exchange of a series of interest payments, eitherat a fixed or variable-rate, based upon the notional amount without theexchange of the underlying principal amount. The Company’s exposure from these interest rate contracts results fromthe possibility that one party may default on its contractual obligation whenthe contracts are in a gain position. The Company has experienced no terminations by counterparties ofinterest rate swaps.  Credit risk islimited to the positive fair value of the derivative financial instrument,which is significantly less than the notional value.  As of September 30, 2006, the positive fairvalue related to the Company’s interest rate contracts was approximately $17.9million, which is included in other assets on the Company’s consolidatedbalance sheet.

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 $1.7billion at September 30, 2006 and $1.9 billion at December 31, 2005.  These contracts had net fair values ofapproximately $17.6 million and $24.2 million at September 30, 2006 andDecember 31, 2005, respectively.  Thesefair values are included in the respective other assets and other liabilitiescategories on the Company’s consolidated balance sheets.

For the nine months andthree months ended September 30, 2006, the Company recognized net pre-taxlosses of $0.8 million and $0.7 million, respectively, which represented thetotal ineffectiveness for all cash flow hedges. For the nine months and three months ended September 30, 2005, totalineffectiveness related to cash flow hedges resulted in net pre-tax gains of$3.3 million and $0.4 million, respectively.

As of September 30, 2006,the Company expects that approximately $7.4 million of deferred net after-taxgains on derivative contracts included in other comprehensive income will bereclassified to net interest income within the next twelve months. Thisexpectation is based on the net discounted cash flows from existing cash flowhedging derivatives, as well as the amortization of gains from the terminatedcash flow hedging derivatives.

***ForeignExchange Contracts*****-** Foreignexchange contracts involve an agreement to exchange the currency of one countryfor the currency of another country at an agreed-upon rate and settlementdate.  Foreign exchange contracts consistof spot, forward and swap contracts. Spot contracts call for the exchange of one currency for another andusually settle in two business days. Forward contracts call for the exchange of one currency for another at adate beyond spot.  In a currency swap,the holder of a currency transacts simultaneously both a spot and a forwardtransaction in that currency for an equivalent amount of another currency toget temporary liquidity in the currency owned. The Company’s risk from foreign exchange contracts results from thepossibility that one party may default on its contractual obligation or frommovements in exchange rates. Credit risk is limited to the positive marketvalue of the derivative financial instrument, which is significantly less thanthe notional value.  The notional valueof the Company’s foreign exchange contracts at September 30, 2006 and December31, 2005 was $10.2 billion and $6.3 billion, respectively.  Unrealized gains or losses resulting frompurchases and sales of foreign exchange contracts are included within therespective other assets and other liabilities categories on the Company’sconsolidated balance sheets.  Unrealizedgains in other assets were $15.4 million and $20.8 million at September 30,2006 and December 31, 2005, respectively. Unrealized losses in other liabilities were $13.9 million and $19.7million at September 30, 2006 and December 31, 2005, respectively.  Foreign exchange contracts with the samecounterparty are netted in the Company’s consolidated balance sheets when amaster netting agreement exists.  These contractshave not been designated as hedging instruments; therefore, all changes in fairvalue are included in asset servicing fees.

19

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***Other*****-** The Company also enters into fixedprice purchase contracts that are designed to hedge the variability of the considerationto be paid for the purchase of investment securities.  By entering into these contracts, the Companyis fixing the price to be paid at a future date for certain investmentsecurities.  At September 30, 2006, theCompany had no fixed price purchase contracts outstanding to purchaseinvestment securities.  At December 31,2005, the Company had $97.5 million of fixed price purchase contractsoutstanding to purchase investment securities. Changes in fair value of these cash flow hedges are included as acomponent of other comprehensive income.

**12.  Commitments and Contingencies**

***Restrictionson Cash Balances*****-** The Companyis required to maintain certain average cash reserve balances.  The average required reserve balance with theFRB for the two-week period including September 30, 2006 was approximately$29.0 million.  In addition, the Company’sconsolidated balance sheet includes deposits totaling $46.0 million, which werepledged to secure clearings with depository institutions as of September 30,2006.

***Contingencies***- Assets held by the Company in a fiduciary capacity are not included in theconsolidated balance sheets since these items are not assets of theCompany.  Management conducts regularreviews of its fiduciary responsibilities and considers the results inpreparing its consolidated financial statements.  In the opinion of management, there were nocontingent liabilities related to its fiduciary capacity at September 30, 2006that were material to the consolidated financial position or consolidatedresults of operations of the Company.

On June 27, 2003, theCompany and an individual employee of the Company were named in a lawsuitalleging, among other things, that the Company breached an implied covenant ofgood faith and fair dealing in a subadvisory contract with Opus InvestmentManagement, Inc. and that the individual employee of the Company engaged in abreach of fiduciary duties and tortuous interference with a contract.  The lawsuit was filed in the Superior Courtof Worcester, Massachusetts and sought unspecified damages.  In October 2006, the parties settled thelawsuit.  Included in other liabilitiesin the Company’s consolidated balance sheet at September 30, 2006 and in otheroperating expenses in the Company’s consolidated statement of income for thenine months ended September 30, 2006 is approximately $1.8 million forsettlement costs, legal fees and administrative costs related to thesettlement.

**13.  Regulatory Matters**

The Company and the Bankare subject to various regulatory capital requirements administered by thefederal banking agencies.  Failure tomeet minimum 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 adequacyguidelines and the regulatory framework for prompt corrective action, the Bankmust meet specific capital guidelines that involve quantitative measures of theBank’s assets, liabilities, and certain off-balance sheet items as calculatedunder regulatory accounting practices. The Company’s and the Bank’s capital amounts and classification are alsosubject to qualitative judgments by the regulators about components, riskweightings, and other factors.

Quantitative measuresestablished by regulation to ensure capital adequacy require the Company andthe Bank to maintain minimum amounts and ratios (set forth in the table below)of Total and Tier 1 capital (as defined in the regulations) to risk-weightedassets (as defined), and of Tier 1 capital (as defined) to average assets (asdefined).  Management believes, as ofSeptember 30, 2006, that the Company and the Bank meet all capital adequacyrequirements to which they are subject.

Our most recentnotification from the Federal Deposit Insurance Corporation categorized theCompany and the Bank as well-capitalized under the regulatory framework forprompt corrective action.  To becategorized as well-capitalized, the Company and the Bank must maintain minimumTotal risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth inthe table.  There are no conditions orevents since that notification that management believes have changed the Company’sor the Bank’s category.

20

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The following tablepresents the capital ratios for the Company and the Bank (Dollars inthousands):
| ** **                                            | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **           | ** ** | ** **                 | ** ** | **To Be Well-Capitalized** | ** ** |
|-------------------------------------------------------|------------|------------|------------|----------------------------|------------|----------------------|------------|----------------------------|------------|--------------------------------------|------------|
| ** **                                            | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **           | ** ** | ** **                 | ** ** | **Under Prompt**                | ** ** |
| ** **                                            | ** ** | ** ** | ** ** | ** **                 | ** ** | **For Capital** | ** ** | **Corrective Action** | ** ** |
| ** **                                            | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Provisions**       | ** ** |
| ** **                                            | ** ** | **Amount** | ** ** | **Ratio**                  | ** ** | **Amount**           | ** ** | **Ratio**                  | ** ** | **Amount**                           | ** ** | **Ratio** | ** ** |
| **As of September 30, 2006:**                         | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **           | ** ** | ** **                 | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Total Capital  (to Risk-Weighted Assets-the Company)  |       | $          | 887,814    |                       | 21.03      | %                    | $          | 337,804                    |       | 8.00                                 | %          | N/A |   | N/A |   |
| Total Capital  (to Risk-Weighted Assets-the Bank)     |       | $          | 847,234    |                       | 20.07      | %                    | $          | 337,742                    |       | 8.00                                 | %          | $ | 422,177 |   | 10.00 | % |
| Tier 1 Capital  (to Risk-Weighted Assets-the Company) |       | $          | 887,714    |                       | 21.02      | %                    | $          | 168,902                    |       | 4.00                                 | %          | N/A |   | N/A |   |
| Tier 1 Capital  (to Risk-Weighted Assets-the Bank)    |       | $          | 847,134    |                       | 20.07      | %                    | $          | 168,871                    |       | 4.00                                 | %          | $ | 253,306 |   | 6.00 | % |
| Tier 1 Capital  (to Average Assets-the Company)       |       | $          | 887,714    |                       | 7.56       | %                    | $          | 469,431                    |       | 4.00                                 | %          | N/A |   | N/A |   |
| Tier 1 Capital  (to Average Assets-the Bank)          |       | $          | 847,134    |                       | 7.22       | %                    | $          | 469,261                    |       | 4.00                                 | %          | $ | 586,576 |   | 5.00 | % |

 
| **As of December 31, 2005:**                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| Total Capital  (to Risk-Weighted Assets-the Company)  |       | $          | 731,833    |       | 18.50      | %          | $          | 316,553    |       | 8.00       | %          | N/A        |       | N/A |   |
| Total Capital  (to Risk-Weighted Assets-the Bank)     |       | $          | 720,113    |       | 18.21      | %          | $          | 316,349    |       | 8.00       | %          | $          | 395,436    |   | 10.00 | % |
| Tier 1 Capital  (to Risk-Weighted Assets-the Company) |       | $          | 731,733    |       | 18.49      | %          | $          | 158,276    |       | 4.00       | %          | N/A        |       | N/A |   |
| Tier 1 Capital  (to Risk-Weighted Assets-the Bank)    |       | $          | 720,013    |       | 18.21      | %          | $          | 158,174    |       | 4.00       | %          | $          | 237,262    |   | 6.00 | % |
| Tier 1 Capital  (to Average Assets-the Company)       |       | $          | 731,733    |       | 5.95       | %          | $          | 491,685    |       | 4.00       | %          | N/A        |       | N/A |   |
| Tier 1 Capital  (to Average Assets-the Bank)          |       | $          | 720,013    |       | 5.86       | %          | $          | 491,549    |       | 4.00       | %          | $          | 614,437    |   | 5.00 | % |

 

Under Massachusetts law,trust companies such as the Bank, like national banks, may pay dividends nomore often than quarterly, and only out of net profits and to the extent thatsuch payments will not impair the Bank’s capital stock and surplusaccount.  Moreover, prior Commissionerapproval is required if the total dividends for a calendar year would exceednet profits for that year combined with retained net profits for the previoustwo years.  These restrictions on theability of the Bank to pay dividends to the Company may restrict the ability ofthe Company to pay dividends to its stockholders.

The operations of theCompany’s securities broker affiliate, Investors Securities Services, LLC (‘ISS’),are subject to federal and state securities laws, as well as the rules of boththe SEC and the NASD.  Managementbelieves, as of September 30, 2006, that ISS is in material compliance with allof the foregoing requirements to which it is subject.

The operations of theCompany’s captive insurance affiliate, Investors Vermont Insurance Company (‘IVIC’),are subject to the laws and regulations of the BISHCA.  Management believes, as of September 30,2006, that IVIC is in material compliance with all of the foregoingrequirements to which it is subject.

The operations of theCompany’s affiliated international subsidiaries are subject to laws andregulations of various regulators, including the OSFI, the IFSRA, the CIMA, theFSA and the CSSF.  Management believes,as of September 30, 2006, that its affiliated international subsidiaries areall in compliance with all of the foregoing requirements to which each issubject.

21

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

**14.  Geographic Reporting and Service Lines**

The Company does notutilize segment information for internal reporting, as management views theCompany as one segment. The following represents net operating revenue andlong-lived assets (including goodwill) by geographic area (Dollars inthousands):
| ** **                      | ** ** | **Net Operating Revenue** | ** ** | **Net Operating Revenue** | ** ** | **Long-Lived Assets** | ** ** |
|---------------------------------|------------|-------------------------------------|------------|-------------------------------------|------------|----------------------------|------------|
| ** **                      | ** ** | **Nine Months Ended**     | ** ** | **Three Months Ended**    | ** ** | ** **                 | ** ** | ** ** | ** ** |
| ** **                      | ** ** | **September 30,**              | ** ** | **September 30,**              | ** ** | **September 30,**     | ** ** | **December 31,** | ** ** |
| **Geographic Information** | ** ** | **2006**                            | ** ** | **2005**                            | ** ** | **2006**                   | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| United States                   |       | $                                   | 554,170    |                                | $          | 476,283                    |       | $ | 180,267 |   | $ | 158,914 |   | $ | 166,887 |   | $ | 141,810 |   |
| Ireland                         |       | 35,114                              |       | 27,352                              |       | 11,799                     |       | 8,929 |   | 7,967 |   | 6,325 |   |
| Canada                          |       | 4,599                               |       | 4,006                               |       | 1,598                      |       | 1,372 |   | 194 |   | 385 |   |
| United Kingdom                  |       | 266                                 |       | —                              |       | 86                         |       | — |   | 1,570 |   | 850 |   |
| Cayman Islands                  |       | 119                                 |       | 126                                 |       | 37                         |       | 41 |   | — |   | — |   |
| Luxembourg                      |       | 77                                  |       | —                              |       | 77                         |       | — |   | 28 |   | — |   |
|                            |       |                                |       |                                |       |                       |       |   |   |   |   |   |   |
| Total                           |       | $                                   | 594,345    |                                | $          | 507,767                    |       | $ | 193,864 |   | $ | 169,256 |   | $ | 176,646 |   | $ | 149,370 |   |

 

Barclays GlobalInvestors, N.A. (‘BGI’) accounted for approximately 18% of the Company’sconsolidated net operating revenues for both the nine-month periods endedSeptember 30, 2006 and 2005, and 18% and 19% of the Company’s consolidated netoperating revenues for the three-month periods ended September 30, 2006 and2005, respectively.  No client other thanBGI accounted for more than 10% of the Company’s consolidated net operatingrevenues for the nine-month periods ended September 30, 2006 and 2005.

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

|                                        | ** ** | **For the Nine Months Ended** | ** ** | **For the Three Months Ended** | ** ** |
|----------------------------------------|------------|---------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                             | ** ** | **September 30,**                            | ** ** | **September 30,**                             | ** ** |
| ** **                             | ** ** | **2006**                                          | ** ** | **2005**                                           | ** ** | **2006** | ** ** | **2005** | ** ** |
| Core service  fees:                    |       |                                              |       |                                               |       |   |   |   |   |
| Custody, accounting and administration |       | $                                                 | 331,249    |                                               | $          | 274,150 |   | $ | 111,247 |   | $ | 95,447 |   |
|                                   |       |                                              |       |                                               |       |   |   |   |   |
| Value-added  service fees:             |       |                                              |       |                                               |       |   |   |   |   |
| Foreign exchange                       |       | 65,151                                            |       | 41,050                                             |       | 17,052 |   | 15,546 |   |
| Cash management                        |       | 40,866                                            |       | 25,956                                             |       | 16,411 |   | 9,419 |   |
| Securities lending                     |       | 21,779                                            |       | 17,162                                             |       | 5,125 |   | 5,312 |   |
| Investment advisory                    |       | 5,562                                             |       | 6,189                                              |       | 1,801 |   | 2,485 |   |
| Other service fees                     |       | 2,285                                             |       | 2,013                                              |       | 818 |   | 610 |   |
| Total value-added service fees         |       | 135,643                                           |       | 92,370                                             |       | 41,207 |   | 33,372 |   |
|                                   |       |                                              |       |                                               |       |   |   |   |   |
| Total asset servicing  fees            |       | $                                                 | 466,892    |                                               | $          | 366,520 |   | $ | 152,454 |   | $ | 128,819 |   |

 

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**15.  Net Interest Income**

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

|                                                                | ** ** | **For the Nine Months  Ended** | ** ** | **For the Three Months  Ended** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                     | ** ** | **September 30,**                        | ** ** | **September 30,**                         | ** ** |
| ** **                                                     | ** ** | **2006**                                      | ** ** | **2005**                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Interest income:                                               |       |                                          |       |                                           |       |   |   |   |   |
| Federal Funds sold and other short-term  investments           |       | $                                             | 4,651      |                                           | $          | 1,318 |   | $ | 2,782 |   | $ | 565 |   |
| Investment securities held to maturity and available  for sale |       | 392,947                                       |       | 313,304                                        |       | 131,801 |   | 111,711 |   |
| Loans                                                          |       | 15,098                                        |       | 6,048                                          |       | 5,755 |   | 2,236 |   |
| Total interest income                                          |       | 412,696                                       |       | 320,670                                        |       | 140,338 |   | 114,512 |   |
| Interest  expense:                                             |       |                                          |       |                                           |       |   |   |   |   |
| Deposits                                                       |       | 126,843                                       |       | 49,237                                         |       | 52,644 |   | 20,010 |   |
| Securities sold under repurchase agreements                    |       | 122,714                                       |       | 103,031                                        |       | 42,412 |   | 40,344 |   |
| Short-term and other borrowings                                |       | 40,448                                        |       | 38,887                                         |       | 5,687 |   | 15,512 |   |
| Junior subordinated debentures                                 |       | 1,815                                         |       | 1,815                                          |       | 605 |   | 605 |   |
| Total interest expense                                         |       | 291,820                                       |       | 192,970                                        |       | 101,348 |   | 76,471 |   |
|                                                           |       |                                          |       |                                           |       |   |   |   |   |
| Net interest  income                                           |       | $                                             | 120,876    |                                           | $          | 127,700 |   | $ | 38,990 |   | $ | 38,041 |   |

 

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**REPORT OF INDEPENDENT REGISTERED PUBLICACCOUNTING FIRM**

To theBoard of Directors and Stockholdersof Investors Financial Services Corp.

We havereviewed the accompanying consolidated balance sheet of Investors FinancialServices Corp. and subsidiaries (the “Company”) as of September 30, 2006, andthe related consolidated statements of income and comprehensive income for thenine-month and three-month periods ended September 30, 2006 and 2005, andstockholders’ equity and cash flows for the nine-month period ended September30, 2006 and 2005.  These interim financial statements are theresponsibility of the Company’s management.

Weconducted our reviews in accordance with the standards of the Public CompanyAccounting Oversight Board (United States).  A review of interim financialinformation consists principally of applying analytical procedures and makinginquiries of persons responsible for financial and accounting matters.  Itis substantially less in scope than an audit conducted in accordance with thestandards of the Public Company Accounting Oversight Board (United States), theobjective of which is the expression of an opinion regarding the financialstatements taken as a whole.  Accordingly, we do not express such anopinion.

Basedon our reviews, we are not aware of any material modifications that should bemade to such consolidated interim financial statements for them to be inconformity with accounting principles generally accepted in the United Statesof America.

We havepreviously audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the consolidated balance sheet ofthe Company and subsidiaries as of December 31, 2005, and the relatedconsolidated statements of income and comprehensive income, stockholders’equity, and cash flows for the year then ended (not presented herein); and inour report dated March 2, 2006, we expressed an unqualified opinion on thoseconsolidated financial statements.  In our opinion, the information setforth in the accompanying consolidated balance sheet as of December 31, 2005 isfairly stated, in all material respects, in relation to the consolidatedbalance sheet from which it has been derived.

DELOITTE& TOUCHE LLP
| /s/Deloitte & Touche LLP |
|------------------------------|
| Boston, Massachusetts        |
| November 6, 2006             |

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**Item2.**           Management’sDiscussion and Analysis of Financial Condition and Results of Operations

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

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

**Overview**

We provide asset administrationservices for the financial services industry through our wholly-ownedsubsidiary, Investors Bank & Trust Company. We provide core services and value-added services to a variety offinancial asset managers, including mutual fund complexes, investment advisors,family offices, hedge funds, banks and insurance companies.  Core services include middle officeoutsourcing, global custody, multicurrency accounting and fundadministration.  Value-added servicesinclude securities lending, foreign exchange, cash management, performancemeasurement, institutional transfer agency, investment advisory services, linesof credit and brokerage and transition management services.  We have offices located in the United States,Ireland, Canada, the Cayman Islands, the United Kingdom and Luxembourg with avast global subcustodian network established to accommodate the internationalneeds of our clients.  At September 30,2006, we provided services for approximately $2.0 trillion in net assets,including approximately $0.4 trillion in foreign net assets.

We grow our business by sellingour services to new clients and by further penetrating our existingclients.  We believe that we service approximately 10% of the assetsmanaged by our existing clients, and we have traditionally achieved significantsuccess in growing client relationships.  Our ability to service newclients and expand our relationships with existing clients depends on ourprovision of superior client service.  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.

Wederive our asset servicing revenue from providing core and value-addedservices.  We derive our net interest income by investing the cashbalances our clients leave on deposit with us.  Since we price our serviceofferings on a bundled basis, our share of earnings from these investments isviewed as part of the total compensation that our clients pay us for servicingtheir assets.  In establishing a fee structure for a specific client, weanalyze all expected revenue and expenses.  We believe net operatingrevenue (net interest income plus noninterest income) and net income are themost meaningful measures of our financial results.

As an asset administrationservices company, the amount of net operating revenue that we generate isimpacted by overall market conditions, client activity and the prevailinginterest rate environment.  A significant portion of our core servicesrevenue is based upon the amount of assets we process.  As market valuesof underlying assets fluctuate, so will our revenue.  We have managed thisvolatility by offering a tiered pricing structure for our asset-basedfees.  As asset values increase, the basis point fee is reduced for theincremental assets.  When asset values decrease, revenue is only impactedat the then marginal rate.  Many of our value-added services aretransactional based, and we receive a fee for each transaction processed.  The lower net interest margin experienced during thefirst nine months of 2006 as compared to the same period in 2005 is primarily aresult of external market factors and the repricing characteristics of ourbalance sheet.  The yield curve has remained very flat to inverted throughout2006, impacting reinvestment and purchase spreads on investments.  Themajority of our liability base reprices to overnight or short term rates which,given the increase in short-term rates throughout 2006, has also contributed tolower net interest margin results year-to-date. The market implied forward yield curve, which is used as a basis in ournet interest income forecasting, continues to remain inverted for the remainderof 2006.

To position us for futuregrowth, we have accelerated some disciplined investments during the thirdquarter of 2006.  We believe ourinvestments in personnel, technology and space are necessary to support thefuture growth for the Company in areas such as technology, alternative investments,middle office outsourcing, fund services and our European presence.  While these investments have and willcontinue to decrease our short-term operating margins, we believe they arenecessary to build the foundation for future growth.

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**Certain Factors That May Affect Future Results**

From time to time,information provided by us, statements made by our employees, or informationincluded in our filings with the Securities Exchange Commission (‘SEC’)(including this Form 10-Q) may contain statements which are not historicalfacts, so-called “forward-looking statements,” which are made under Section 21Eof the Securities Exchange Act of 1934 and which involve risks anduncertainties.  These statements relate to future events or our future financialperformance and are identified by words such as “may,” “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, capital resources,growth rate, annual dividend payments, interest rate conditions, the shape ofthe yield curve, interest rate sensitivity, compliance with capital adequacyguidelines, loss exposure on lines of credit, foreign exchange revenue, cashmanagement revenue, securities lending revenue, net interest income, operatingmargin, operating expenses, including occupancy expenses and needs, transactionprocessing services expense, professional fee expense, compensation expense,travel and sales expense, investments in technology, pension plan andsupplemental pension expense, depreciation expense, investments in Federal HomeLoan Bank of Boston (‘FHLBB’) capital stock, the effect on earnings of changesin equity values or fixed income values, the effects of increased prepaymentsand reduced investment opportunities for our net interest income, the effect ofany anticipated activity under our stock repurchase plan, contributing to oursupplemental retirement plan, the effect of new accounting pronouncements andthe effect of certain legal claims against us. Our actual future results may differ significantly from those stated inany forward-looking statements.  Factorsthat may cause such differences include, but are not limited to, the factorsdiscussed in Item 1A of this Form 10-Q and our Form 10-K filed on March 2,2006.

**Statements of Income**

***Comparisonof Operating Results for the Nine and Three Months Ended September 30, 2006 and2005***

Net income for the nine monthsended September 30, 2006 decreased 2% to $118.1 million from the same period in2005.  The decrease primarily resultedfrom continued pressure on our net interest margin, as well as increasedoperating expenses.  This decrease wassubstantially offset by increased asset servicing fees, which reflect ourability to sell to new and existing clients combined with market appreciationand strong client fund flows.  Net incomefor the three months ended September 30, 2006 increased 3% to $36.4 millionfrom the same period in 2005, which was primarily due to stronger clientfunding and increased asset levels.

*Fees and Other Revenue*

The components of feesand other revenue are as follows (Dollars in thousands):

|                               | ** ** | **For the Nine Months Ended  September 30,** | ** ** | **For the Three Months Ended  September 30,** | ** ** |
|-------------------------------|------------|-----------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                    | ** ** | **2006**                                                              | ** ** | **2005**                                                               | ** ** | **Change** | ** ** | **2006** | ** ** | **2005** | ** ** | **Change** | ** ** |
|                          |       |                                                                  |       |                                                                   |       |   |   |   |   |   |   |   |   |
| Total asset  servicing fees   |       | $                                                                     | 466,892    |                                                                   | $          | 366,520 |   | 27 | % | $ | 152,454 |   | $ | 128,819 |   | 18 | % |
| Other operating  income       |       | 4,054                                                                 |       | 2,424                                                                  |       | 67 | % | 2,420 |   | 1,013 |   | 139 | % |
| Gain on sale of  investments  |       | 2,523                                                                 |       | 11,123                                                                 |       | (77 | )% | — |   | 1,383 |   | (100 | )% |
|                          |       |                                                                  |       |                                                                   |       |   |   |   |   |   |   |   |   |
| Total fees and other  revenue |       | $                                                                     | 473,469    |                                                                   | $          | 380,067 |   | 25 | % | $ | 154,874 |   | $ | 131,215 |   | 18 | % |

 

The largest components ofasset servicing fees are custody, accounting and administration fees, whichincreased 21% to $331.2 million and 17% to $111.2 million for the nine-monthand three-month periods ended September 30, 2006, respectively, from the sameperiods in 2005.  Custody, multicurrencyaccounting and fund administration fees are based in part on the value ofassets processed.  Assets processed isthe total dollar value of financial assets on the reported date for which weprovide one or more of the followingservices: middle office outsourcing, global custody, multicurrency accounting,fund administration, securities lending, foreign exchange, cash management,performance measurement, institutional transfer agency, investment advisoryservices, lines of credit and brokerage and transition management services.

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

|                                            | ** ** | **For the Nine Months Ended  September 30, 2006** | ** ** | **For the Three Months Ended  September 30, 2006** | ** ** |
|--------------------------------------------|------------|---------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
|                                       |       |                                                                            |       |                                                                             |       |
| Net assets  processed, beginning of period |       |                                                                            | $          | 1,793                                                                            |       |   |   | $ | 1,952 |   |   |
| Change in net  assets processed:           |       |                                                                            |       |                                                                             |       |   |   |   |   |
| Sales to new clients                       |       |                                                                            | 1          |                                                                             |       |   | — |   |   |
| Further penetration of existing clients    |       |                                                                            | 25         |                                                                             |       |   | 7 |   |   |
| Lost clients                               |       |                                                                            | (1         | )                                                                                |       |   | (1 | ) |   |
| Fund flows and market gain                 |       |                                                                            | 217        |                                                                             |       |   | 77 |   |   |
| Total change in net assets processed       |       |                                                                            | 242        |                                                                             |       |   | 83 |   |   |
| Net assets processed,  end of period       |       |                                                                            | $          | 2,035                                                                            |       |   |   | $ | 2,035 |   |   |

 

Themajority of the increase in assets processed for both the nine months and threemonths ended September 30, 2006 was due to client fund flows and marketmovements.  As indicated in the ‘Overview’section, our core services fees are primarily generated by charging a fee basedupon the value of assets processed.  Asmarket values or clients’ asset levels fluctuate, so will our revenue.  Our tiered pricing structure, coupled withminimum and flat fees, allow us to manage this volatility to a certainextent.  As asset values increase, thebasis point fee typically lowers.  Whenasset values decrease, revenue is only impacted by the asset decline at thethen marginal rate.

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

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

·                  Foreign exchange fees were $65.2 million for thenine-month period ended September 30, 2006, up 59% from the same period in2005, and were $17.1 million for the three-month period ended September 30,2006, up 10% from the same period in 2005. The increase in foreign exchange fees is attributable to increasedvolatility in currency markets and increased volume of client activity.  Future foreign exchange income is dependenton the volume of new and existing client activity and overall volatility in thecurrencies traded.

·                  Cash management fees, which consist of sweep fees,were $40.9 million for the nine-month period ended September 30, 2006, up 57%from the same period in 2005, and were $16.4 million for the three-month periodended September 30, 2006, up 74% from the same period in 2005.  The increase is primarily due to higherbalances placed by our clients in the cash management products we offer.  Cash management fees will continue to depend onthe level of client balances maintained in the cash management products we offer.  If our clients’ investment products continueto maintain higher cash balances than they did in comparable periods, we expectour cash management revenue to be positively impacted.

·                  Securities lending fees were $21.8 million for thenine-month period ended September 30, 2006, up 27% from the same period in2005, primarily due to new business, higher volumes in the first half of 2006and improved market conditions. Securities lending fees were $5.1 million for the three-month periodended September 30, 2006, down 4% from the same period in 2005, primarily dueto lower transaction volume.  Securitieslending transaction volume is positively affected by the market value ofsecurities on loan, merger and acquisition activity, increased IPO activity,the seasonality of international dividend arbitrage and a steeper short end ofthe yield curve.  If the capital marketsexperience any of the aforementioned activity, it is likely that our securitieslending revenue will be positively impacted. If we experience any of the following: 1) a reduction in our securitieslending portfolio, 2) lower market values or 3) compression of the spreadsearned on securities lending activity, our securities lending revenue willlikely be negatively impacted.

27

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·                  Investment advisory fees were $5.6 million for thenine-month period ended September 30, 2006, down 10% from the same period in2005, and were $1.8 million for the three-month period ended September 30,2006, down 28% from the same period in 2005. The decrease in investment advisory fees is attributable to lower assetsin our proprietary Merrimac money market funds. Future investment advisory fee income is dependent upon asset levelswithin the Merrimac money market funds, which are driven by overall marketconditions, client activity and transaction volumes.

·                  Other service fees were $2.3 million for thenine-month period ended September 30, 2006, up 14% from the same period in2005, and were $0.8 million for the three-month period ended September 30,2006, up 34% from the same period in 2005. Other service fees include income earned on compliance advisory,brokerage and transition management services. The increase in other service fees is primarily due to an increase incommission fees and transition management service fees.

·                  Other operating income for the nine-month periodended September 30, 2006 was $4.1 million, up 67% from the same period in 2005,primarily due to an increase in interest earned on clearing agencydeposits.  Other operating income for thethree-month period ended September 30, 2006 was $2.4 million, up 139% from thesame period in 2005, primarily due to higher FHLBB stock dividend income causedby a change in the FHLBB dividend declaration policy.

Duringthe first nine months of 2006, we sold municipal securities held in ouravailable for sale portfolio, resulting in the recognition of $2.5 million ingains for the nine-month period ended September 30, 2006.  We did not sell any securities during thethree-month period ended September 30, 2006. During the first nine months of 2005, we sold municipal securities andU.S. Treasury securities held in our available for sale portfolio, resulting inthe recognition of $11.1 million and $1.4 million in gains for the nine-monthand three-month periods ended September 30, 2005, respectively.  These security sales in 2005 and 2006 werethe result of our strategy to improve the after-tax yield of our municipalsecurities portfolio by replacing certain municipal securities sold with thosethat offer a more attractive after-tax yield, as well as to capitalize onstrong market conditions.

*Net Interest Income*

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

|                     | ** ** | **For the Nine Months ended September 30,** | ** ** | **For the Three Months Ended September 30,** | ** ** |
|---------------------|------------|---------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **          | ** ** | **2006**                                                                  | ** ** | **2005**                                                                   | ** ** | **Change** | ** ** | **2006** | ** ** | **2005** | ** ** | **Change** | ** ** |
|                |       |                                                                      |       |                                                                       |       |   |   |   |   |   |   |   |   |
| Interest income     |       | $                                                                         | 412,696    |                                                                       | $          | 320,670 |   | 29 | % | $ | 140,338 |   | $ | 114,512 |   | 23 | % |
| Interest expense    |       | 291,820                                                                   |       | 192,970                                                                    |       | 51 | % | 101,348 |   | 76,471 |   | 33 | % |
| Net interest income |       | $                                                                         | 120,876    |                                                                       | $          | 127,700 |   | (5 | )% | $ | 38,990 |   | $ | 38,041 |   | 2 | % |

 

Net interest income is affectedby the volume and mix of assets and liabilities and the movement and level ofinterest rates.  Thedecrease in our net interest income for the nine-month period ended September30, 2006 was primarily driven by increasing short-term interest rates without aconcurrent increase in longer-term rates, which resulted in a very flat, and attimes inverted, yield curve. Consequently, our interest-bearing liabilities, of which the majority ispriced based on overnight and short-term rates, have repriced at higher ratesfaster than our interest-earning assets have repriced, resulting in a lower netinterest margin as compared to the same period in 2005.  In addition,reinvestment and purchase spreads on fixed and floating-rate assets were lowerthan expected due to many factors, including yield curve shape and level ofrates.  The increase in our net interestincome for the three-month period ended September 30, 2006 was primarily due tostrong client funding.  Average investmentsecurity balances were down $0.1 billion and $0.6 billion for the nine-monthand three-month periods ended September 30, 2006, respectively, compared to thesame periods in 2005, primarily due to slower reinvestment.

28

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Thetable below presents the changes in net interest income resulting from changesin the volume of interest-earning assets or interest-bearing liabilities andchanges in interest rates for the nine months and three months ended September30, 2006 compared to the same periods in 2005. Changes attributed to both volume and rate have been allocated based onthe proportion of change in each category (Dollars in thousands):
| ** **                                    | ** ** | **For the Nine Months Ended  September 30, 2006** | ** ** | **For the Three Months Ended  September 30, 2006** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| ** **                                    | ** ** | **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 short-term investments |       | $                                                                               | 2,200      |                                                                             | $          | 1,133 |   | $ | 3,333 |   | $ | 1,852 |   | $ | 365 |   | $ | 2,217 |   |
| Investment securities                         |       | (4,050                                                                          | )          | 83,693                                                                           |       | 79,643 |   | (6,544 | ) | 26,634 |   | 20,090 |   |
| Loans                                         |       | 3,416                                                                           |       | 5,634                                                                            |       | 9,050 |   | 568 |   | 2,951 |   | 3,519 |   |
|                                          |       |                                                                            |       |                                                                             |       |   |   |   |   |   |   |   |   |
| Total interest-earning assets                 |       | 1,566                                                                           |       | 90,460                                                                           |       | 92,026 |   | (4,124 | ) | 29,950 |   | 25,826 |   |
|                                          |       |                                                                            |       |                                                                             |       |   |   |   |   |   |   |   |   |
| **Interest-bearing  liabilities:**            | ** ** | ** **                                                                      | ** ** | ** **                                                                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Deposits                                      |       | 24,555                                                                          |       | 53,051                                                                           |       | 77,606 |   | 14,634 |   | 18,000 |   | 32,634 |   |
| Borrowings                                    |       | (33,022                                                                         | )          | 54,266                                                                           |       | 21,244 |   | (24,947 | ) | 17,190 |   | (7,757 | ) |
|                                          |       |                                                                            |       |                                                                             |       |   |   |   |   |   |   |   |   |
| Total interest-bearing liabilities            |       | (8,467                                                                          | )          | 107,317                                                                          |       | 98,850 |   | (10,313 | ) | 35,190 |   | 24,877 |   |
|                                          |       |                                                                            |       |                                                                             |       |   |   |   |   |   |   |   |   |
| Change in net interest  income                |       | $                                                                               | 10,033     |                                                                             | $          | (16,857 | ) | $ | (6,824 | ) | $ | 6,189 |   | $ | (5,240 | ) | $ | 949 |   |

 

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

29

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The following tablespresent average balances, interest income and expense, and yields earned orpaid on the major categories of assets and liabilities for the periodsindicated (Dollars in thousands):
| ** **                                                        | ** ** | **Nine Months ended  September 30, 2006** | ** ** | **Nine Months ended  September 30, 2005** | ** ** |
|-------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                        | ** ** | **Average**                                                   | ** ** | ** **                                                    | ** ** | **Average** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                                        | ** ** | **Balance**                                                   | ** ** | **Interest**                                                  | ** ** | **Yield/Cost** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Yield/Cost** | ** ** |
| **Interest-earning  assets:**                                     |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
| Federal Funds sold and other short-term investments               |       | $                                                             | 127,428    |                                                          | $          | 4,651 |   | 4.87 | % | $ | 58,227 |   | $ | 1,318 |   | 3.02 | % |
| Investment securities(1)                                          |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
| Mortgage-backed securities                                        |       | 8,144,745                                                     |       | 297,757                                                       |       | 4.87 | % | 7,998,105 |   | 226,213 |   | 3.77 | % |
| Federal agency securities                                         |       | 2,057,485                                                     |       | 70,985                                                        |       | 4.60 | % | 2,330,004 |   | 64,255 |   | 3.68 | % |
| State and political subdivisions                                  |       | 474,363                                                       |       | 15,254                                                        |       | 4.29 | % | 468,945 |   | 16,106 |   | 4.58 | % |
| Other securities                                                  |       | 208,337                                                       |       | 8,951                                                         |       | 5.73 | % | 237,103 |   | 6,730 |   | 3.78 | % |
| Total investment securities                                       |       | 10,884,930                                                    |       | 392,947                                                       |       | 4.81 | % | 11,034,157 |   | 313,304 |   | 3.79 | % |
| Loans                                                             |       | 302,106                                                       |       | 15,098                                                        |       | 6.66 | % | 209,407 |   | 6,048 |   | 3.85 | % |
| Total interest-earning assets                                     |       | 11,314,464                                                    |       | 412,696                                                       |       | 4.86 | % | 11,301,791 |   | 320,670 |   | 3.78 | % |
| Allowance for loan losses                                         |       | (100                                                          | )          |                                                          |       |   |   | (100 | ) |   |   |   |   |
| Noninterest-earning assets                                        |       | 639,025                                                       |       |                                                          |       |   |   | 673,158 |   |   |   |   |   |
|                                                              |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
| Total assets                                                      |       | $                                                             | 11,953,389 |                                                          |       |   |   |   | $ | 11,974,849 |   |   |   |   |   |
|                                                              |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
| **Interest-bearing  liabilities:**                                |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
| Deposits:                                                         |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
| Demand                                                            |       | $                                                             | 93,242     |                                                          | $          | 2,992 |   | 4.28 | % | $ | 4,250 |   | $ | 103 |   | 3.23 | % |
| Savings                                                           |       | 4,406,215                                                     |       | 118,331                                                       |       | 3.58 | % | 3,277,370 |   | 47,231 |   | 1.92 | % |
| Time                                                              |       | 145,151                                                       |       | 5,520                                                         |       | 5.07 | % | 89,905 |   | 1,903 |   | 2.82 | % |
| Securities sold under repurchase agreements                       |       | 4,537,407                                                     |       | 122,714                                                       |       | 3.61 | % | 5,312,310 |   | 103,031 |   | 2.59 | % |
| Junior subordinated debentures                                    |       | 24,774                                                        |       | 1,815                                                         |       | 9.77 | % | 24,774 |   | 1,815 |   | 9.77 | % |
| Other borrowings                                                  |       | 1,094,145                                                     |       | 40,448                                                        |       | 4.93 | % | 1,684,399 |   | 38,887 |   | 3.08 | % |
| Total interest-bearing liabilities                                |       | 10,300,934                                                    |       | 291,820                                                       |       | 3.78 | % | 10,393,008 |   | 192,970 |   | 2.48 | % |
| Noninterest-bearing liabilities:                                  |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
| Demand deposits                                                   |       | 329,952                                                       |       |                                                          |       |   |   | 287,791 |   |   |   |   |   |
| Savings                                                           |       | 66,994                                                        |       |                                                          |       |   |   | 59,890 |   |   |   |   |   |
| Noninterest-bearing time deposits                                 |       | 223,626                                                       |       |                                                          |       |   |   | 203,205 |   |   |   |   |   |
| Other liabilities                                                 |       | 187,892                                                       |       |                                                          |       |   |   | 272,330 |   |   |   |   |   |
| Total liabilities                                                 |       | 11,109,398                                                    |       |                                                          |       |   |   | 11,216,224 |   |   |   |   |   |
| Equity                                                            |       | 843,991                                                       |       |                                                          |       |   |   | 758,625 |   |   |   |   |   |
| Total liabilities and equity                                      |       | $                                                             | 11,953,389 |                                                          |       |   |   |   | $ | 11,974,849 |   |   |   |   |   |
| Net interest income                                               |       |                                                          |       | $                                                             | 120,876    |   |   |   |   |   | $ | 127,700 |   |   |   |
| Net interest margin (2)                                           |       |                                                          |       |                                                          |       | 1.42 | % |   |   |   |   | 1.51 | % |
| Average interest rate spread (3)                                  |       |                                                          |       |                                                          |       | 1.08 | % |   |   |   |   | 1.30 | % |
|                                                              |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
| Ratio of  interest-earning assets to interest-bearing liabilities |       |                                                          |       |                                                          |       | 109.84 | % |   |   |   |   | 108.74 | % |

 

----

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

(2)           Annualized net interestincome divided by total interest-earning assets.

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

30

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*Operating Expenses*

Total operating expenseswere $423.8 million for the nine months ended September 30, 2006, up 27% fromthe same period in 2005.  Total operatingexpenses were $139.2 million for the three months ended September 30, 2006, up20% from the same period in 2005.  Theincreases in total operating expenses for both the nine-month and three-monthperiods ended September 30, 2006 were primarily due to increased compensationand benefits, technology and telecommunications, transaction processingservices, occupancy and other operating expenses, as detailed below.  Weexpect that incremental expense for the remainder of 2006 will primarily bedriven by continued investments in personnel, office space and in ourintegrated global technology platform. The components of operating expenses were as follows (Dollars inthousands):
| ** **                         | ** ** | **For the Nine Months ended September 30,** | ** ** | **For the Three Months Ended September 30,** | ** ** |
|------------------------------------|------------|---------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                         | ** ** | **2006**                                                                  | ** ** | **2005**                                                                   | ** ** | **Change** | ** ** | **2006** | ** ** | **2005** | ** ** | **Change** | ** ** |
|                               |       |                                                                      |       |                                                                       |       |   |   |   |   |   |   |   |   |
| Compensation and  benefits         |       | $                                                                         | 238,846    |                                                                       | $          | 185,779 |   | 29 | % | $ | 74,639 |   | $ | 65,428 |   | 14 | % |
| Technology and  telecommunications |       | 54,750                                                                    |       | 39,901                                                                     |       | 37 | % | 19,625 |   | 13,988 |   | 40 | % |
| Transaction  processing services   |       | 45,487                                                                    |       | 35,252                                                                     |       | 29 | % | 16,018 |   | 12,476 |   | 28 | % |
| Occupancy                          |       | 24,163                                                                    |       | 19,409                                                                     |       | 24 | % | 8,600 |   | 6,569 |   | 31 | % |
| Depreciation and  amortization     |       | 23,513                                                                    |       | 23,724                                                                     |       | (1 | )% | 7,971 |   | 7,740 |   | 3 | % |
| Professional  fees                 |       | 9,881                                                                     |       | 9,253                                                                      |       | 7 | % | 4,477 |   | 2,874 |   | 56 | % |
| Travel and sales  promotion        |       | 6,451                                                                     |       | 4,823                                                                      |       | 34 | % | 2,374 |   | 1,649 |   | 44 | % |
| Recruitment                        |       | 3,388                                                                     |       | 1,928                                                                      |       | 76 | % | 1,568 |   | 873 |   | 80 | % |
| Insurance                          |       | 2,944                                                                     |       | 3,284                                                                      |       | (10 | )% | 977 |   | 1,009 |   | (3 | )% |
| Other operating  expenses          |       | 14,340                                                                    |       | 10,806                                                                     |       | 33 | % | 2,905 |   | 3,524 |   | (18 | )% |
|                               |       |                                                                      |       |                                                                       |       |   |   |   |   |   |   |   |   |
| Total operating  expenses          |       | $                                                                         | 423,763    |                                                                       | $          | 334,159 |   | 27 | % | $ | 139,154 |   | $ | 116,130 |   | 20 | % |

 

Compensation and benefitsexpense was $238.8 million for the nine months ended September 30, 2006 and was$74.6 million for the three months ended September 30, 2006, up 29% and 14%,respectively, from the same periods last year due to higher headcount in ourBoston and European offices.  Annualsalary increases and option expense also contributed to the growth in thecompensation and benefits expense. Further increases in compensation expense in 2006 will be primarilydependent upon hiring needs driven by sales to new and existing clients.

Technology andtelecommunications expense was $54.8 million for the nine months endedSeptember 30, 2006 and was $19.6 million for the three months ended September30, 2006, up 37% and 40%, respectively, from the same periods last year.  The increases are primarily due to ourinvestment in enhancing our global integrated technology platform, which weview as a significant competitive advantage and growth in new business andexisting customer volumes.  Generally, weexpect technology reinvestment to equal approximately 18-20% of net operatingrevenue each year, including related compensation costs.

Transaction processing servicesexpense was $45.5 million for the nine months ended September 30, 2006 and was$16.0 million for the three months ended September 30, 2006, up 29% and 28%,respectively, from the same periods last year due to increases in transactionvolumes, higher market values and new business. Future transaction processing services expense will be dependent uponasset levels and the volume of client transaction activity.

Occupancy expense was $24.2million for the nine months ended September 30, 2006 and was $8.6 million forthe three months ended September 30, 2006, up 24% and 31%, respectively, fromthe same periods last year.  Theseincreases are due to our new office space in Boston, California, London andLuxembourg.  Occupancy expense isexpected to increase throughout the remainder of 2006 and into the middle of2007, due to the addition of new space needed to accommodate growth.

Professional fees expense was$9.9 million for the nine months ended September 30, 2006 and was $4.5 millionfor the three months ended September 30, 2006, up 7% and 56%, respectively,from the same periods last year.  Theincreases are primarily attributed to higher consulting fees for technology.

Travel and sales promotionexpense was $6.5 million for the nine months ended September 30, 2006 and was$2.4 million for the three months ended September 30, 2006, up 34% and 44%,respectively, from the same periods last year. Travel and sales promotion expense consists of expenses incurred by thesales force, client management staff and other employees in connection withsales calls on potential clients, as well as traveling to existing client sitesand our foreign offices.  The increasesresulted from a higher level of sales calls to potential clients, a higherlevel of travel to client sites and foreign offices and attendance at industryconferences.

31

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Recruitment expense was $3.4million for the nine months ended September 30, 2006 and was $1.6 million forthe three months ended September 30, 2006, up 76% and 80%, respectively, fromthe same periods last year.  Theincreases are primarily attributable to addition of 700 new employees during2006.  Recruitment expenses areexpected to continue to increase in 2006 due to higher staffing and recruitingcosts as a result of the growth of our business.

Other operating expense was$14.3 million for the nine months ended September 30, 2006, up 33% from thesame period last year as a result of higher temporary staffing expenses and oursettlement of pending litigation.  Otheroperating expense was $2.9 million for the three months ended September 30,2006, down 18% from the same period last year as a result of fewer processingerrors.

*Income Taxes*

Income taxes were $52.5million for the nine-month period ended September 30, 2006, down 2% from thesame period in 2005.  This decrease inincome taxes is primarily related to a decrease in pretax earnings, as well asa 1% decrease in the 2006 effective tax rate resulting from a change in therecognition threshold of a tax position. The decrease in income taxes and the effective tax rate was partiallyoffset by the decrease in one-time tax benefits.  During the second quarter of 2005, we adoptedthe indefinite reversal provisions of Accounting Principles Board Opinion No.23, *Accounting for Income Taxes – Special Areas*(‘APB 23’), which specifies that U.S. income taxes should not be recorded onthe undistributed earnings of a foreign subsidiary if those undistributedearnings have been or will be invested indefinitely in that subsidiary.  We determined that the undistributed earningsof our Irish subsidiaries will be permanently invested in our Irish operationsto support continued growth.  During thesecond quarter of 2006, we reversed previously accrued taxes resulting from atax position that no longer met the probable recognition threshold underStatement of Financial Accounting Standards No. 5, *Accountingfor Contingencies* (‘SFAS 5’).

Income taxes were $18.3million for the three-month period ended September 30, 2006, up 2% from thesame period in 2005.  This increase inincome taxes is primarily related to an increase in pretax earnings, as well asa decrease in the one-time tax benefits, as discussed above.  The increase in income taxes was partiallyoffset by the decrease in the 2006 effective tax rate resulting from a changein the recognition threshold of a tax position, as discussed above.

32

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**Financial Condition**

At September 30, 2006,our total assets were $11.6 billion, down 4% from $12.1 billion at December 31,2005, primarily due to a net decrease in our investment portfolio.  Average interest-earning assets decreased$0.4 billion, or 4%, for the three-month period ended September 30, 2006 ascompared to the same period in 2005, primarily due to paydowns on ourmortgage-backed and Federal agency securities.

*Investment Portfolio*

The income we derive from our investment portfolio isgenerated primarily by investing client cash balances and is a component of ourasset processing business.  In addition,we use the investment portfolio to secure open positions at securities clearinginstitutions in connection with our custody services.  The following table summarizes our investmentportfolio as of the dates indicated (Dollars in thousands):
|                                      | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                           | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| **Securities  held to maturity**     | ** ** | ** **             | ** ** | ** **            | ** ** |
| Mortgage-backed  securities          |       | $                      | 3,889,455  |                  | $          | 4,342,254 |   |
| Federal agency  securities           |       | 1,833,915              |       | 2,305,331             |       |
| State and  political subdivisions    |       | 106,652                |       | 114,345               |       |
|                                 |       |                   |       |                  |       |
| Total securities held to maturity    |       | $                      | 5,830,022  |                  | $          | 6,761,930 |   |
| ** **                           | ** ** | ** **             | ** ** | ** **            | ** ** |
| **Securities  available for sale**   | ** ** | ** **             | ** ** | ** **            | ** ** |
| Mortgage-backed  securities          |       | $                      | 4,083,398  |                  | $          | 3,766,101 |   |
| State and  political subdivisions    |       | 347,860                |       | 392,391               |       |
| Corporate debt                       |       | 181,137                |       | 200,692               |       |
| Foreign  government securities       |       | 10,998                 |       | 10,536                |       |
|                                 |       |                   |       |                  |       |
| Total securities  available for sale |       | $                      | 4,623,393  |                  | $          | 4,369,720 |   |

 

Our held to maturitysecurities portfolio decreased $1.0 billion, or 14%, from December 31, 2005 toSeptember 30, 2006.  The decrease isprimarily due to paydowns and slower reinvestment.  Our held to maturity portfolio securities arepurchased with the intent and ability to hold them to maturity.

Our available for salesecurities portfolio increased $0.3 billion, or 6%, from December 31, 2005 toSeptember 30, 2006.  The increase wasmainly due to purchases of new investment securities, offset by maturities andprepayments.  Our investment securitypurchases included mortgage-backed securities and municipal securities.  We believe that purchasing these securitiesallows us to take advantage of attractive yields and limited extension riskwhich aligns with our asset and liability strategy.  Refer to the gap analysis under the ‘MarketRisk’ section for additional details regarding the matching of ourinterest-earning assets and interest-bearing liabilities.

The average balance ofour investment securities for the nine-month period ended September 30, 2006was $10.9 billion, with an average yield of 4.81%, compared to an averagebalance of $11.0 billion with an average yield of 3.79% during the same periodin 2005.  The increase in yield isprimarily due to our variable-rate securities repricing at higher interestrates.  If long-term interest rates rise,we would expect slower prepayments and our overall yield to increase as ourvariable-rate securities reprice. Conversely, if long-term interest rates decline, we would expect thatprepayments would accelerate, with the cash flows from these prepayments beingreinvested in lower-yielding assets of equal quality and similar risk.

Prepayment cash flowlevels on our Federal agency securities increased in the first nine months of2006, which we believe were attributable to the expiration of borrower prepaymentpenalties, refinancing and loan payoff activity.  Mortgaged-backed security prepayment cashflow levels decreased for the first nine months of 2006, primarily attributableto decreased refinancing opportunities.

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

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We invest in AAA rated,insured municipal securities to generate stable, tax-advantaged income. Municipal securities generally have lower stated yields than Federal agency andU.S. Treasury securities, but their after-tax yields are comparable. Municipal securities are subject to call risk.  Call risk is similar toprepayment risk and results from the possibility that fluctuating interestrates and other factors may result in the exercise of the call option by theissuing municipality prior to the maturity date of the security.

*Loan Portfolio*

The balance in our loanportfolio was $286.4 million, down 29% from December 31, 2005.  The decrease was primarily due to repaymentsof lines of credit, partially offset by new loan originations.

We make loans to individually managed accountcustomers and to mutual funds and other pooled product clients.  We offeroverdraft protection and lines of credit to our clients for the purpose offunding redemptions, covering overnight cash shortfalls, leveraging portfoliosand meeting other client borrowing needs.  The majority of loans toindividually managed account customers are written on a demand basis, bearvariable interest rates tied to the Prime rate or the Federal Funds rate andare fully secured by liquid collateral, primarily freely tradable securitiesheld in custody by us for the borrower.  We monitor the value ofcollateral daily to ensure the amount of collateral held by us exceeds the loanbalance by a certain threshold.  Loans to mutual funds and other pooledproduct clients include unsecured lines of credit that may, in the event ofdefault, be collateralized at our option by securities held in custody by usfor those clients.  Loans to individually managed account customers,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, 2006, our onlylending concentrations that exceeded 10% of total loan balances were the linesof credit to mutual fund clients discussed above.  These loans were made in the ordinary courseof business on substantially similar terms and conditions prevailing at thetime for comparable transactions.

Our loan portfolio credit performancehas been excellent.  There have been noloan charge-offs in the history of our Company. It is our policy to place a loan on nonaccrual status when eitherprincipal or interest becomes 90 days past due and the loan’s collateralis not sufficient to cover both principal and accrued interest.  As of September 30, 2006, there were no loanson nonaccrual status and no troubled debt restructurings.  Although virtually all of our loans are fullycollateralized with freely tradable securities, management recognizes somecredit risk inherent in the loan portfolio, and therefore has recorded anallowance for loan losses of $0.1 million at September 30, 2006, a levelwhich 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 activelymonitors the loan portfolio and the underlying collateral and regularlyassesses the adequacy of the allowance for loan losses.

*Deposits*

Total deposits were $6.2billion at September 30, 2006, up 24% from December 31, 2005.  The increase in our deposit balances is aresult of new business and our clients holding larger cash positions in theirportfolios.

Time deposits withbalances greater than $100,000 totaled $352.1 million and $230.1 million atSeptember 30, 2006 and December 31, 2005, respectively.  All time deposits had a maturity of less thanthree months at September 30, 2006 and December 31, 2005.

*Repurchase Agreements andShort-Term and Other Borrowings*

Repurchase agreementsdecreased $0.7 billion, or 14%, from December 31, 2005 to September 30,2006.  The majority of our repurchaseagreements are with 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, 2006 was $4.5 billion with an average cost of approximately 3.61%, comparedto an average balance of $5.3 billion and an average cost of approximately2.59% for the same period in 2005.  Theincrease in the average cost of repurchase agreements was due to highershort-term interest rates in the first nine months of 2006 compared to the sameperiod in 2005.

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Short-term and otherborrowings decreased $1.3 billion, or 97%, from December 31, 2005 to September30, 2006, primarily due to increased client funding.  We use short-term and other borrowings tooffset the variability of deposit flow. The average balance of short-term and other borrowings for the ninemonths ended September 30, 2006 was $1.1 billion with an average cost ofapproximately 4.93%, compared to an average balance of $1.7 billion and anaverage cost of approximately 3.08% for the same period in 2005.  The increase in the average cost ofshort-term and other borrowings was due to higher short-term interest rates inthe first nine months of 2006 compared to the same period in 2005.

**Market Risk**

Our clients, in the course oftheir financial asset management, maintain cash balances, which they candeposit with us on a short-term basis in interest-bearing accounts or clientrepurchase agreements.  We either directlyinvest these cash balances to earn interest income, or place these deposits inthird-party vehicles and remit a portion of the earnings on these investmentsto our clients after deducting a fee as our compensation for investing clients’funds in these investment vehicles.  Inthe conduct of these activities, we are subject to market risk.

Market risk is the risk of anadverse financial impact from changes in market prices.  The level of risk we assume is a function ofour overall strategic objectives and liquidity needs, client requirements andmarket volatility.  The active managementof market risk is integral to our operations.

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

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

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

The results of the incomesimulation model as of September 30, 2006 and 2005 indicated that an upwardshift of interest rates by 200 basis points over a twelve-month period wouldresult in a reduction in projected net interest income of 7.2% and 8.1%,respectively, which is within our 10% policy limit.  We also simulate a 200 basis point ratereduction over a twelve-month period. This simulation would result in an increase in projected net interestincome of 2.4% and 1.8% as of September 30, 2006 and 2005, respectively, bothwithin our 10% policy limit.

We also use gap analysis as asecondary tool to manage our interest rate sensitivity.  Gap analysis involves measurement of thedifference in asset and liability repricing on a cumulative basis within aspecified time frame.  A positive gapindicates that more interest-earning assets than interest-bearing liabilitiesmature in a time frame, and a negative gap indicates the opposite.  By seeking to minimize the net amount ofassets and liabilities that could reprice in the same time frame, we attempt toreduce the risk of significant adverse effects on net interest income caused byinterest rate changes.  As shown in thecumulative gap position in the table presented on the following page, atSeptember 30, 2006, interest-bearing liabilities repriced faster thaninterest-earning assets in the short term. Generally speaking, during a period of falling interest rates, netinterest income would be higher than it would have been until interest ratesstabilize.  During a period of risinginterest rates, net interest income would be lower than it would have beenuntil interest 

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rates stabilize. Other important determinants of net interest income are the shape of theyield curve, general rate levels, reinvestment spreads, balance sheet growthand mix, and interest rate spreads.  Wecontinue to run a closely matched balance sheet by investing the majority ofour assets in short duration, variable-rate securities and executing interestrate swaps against client liabilities, including client repurchase agreements.

Wemanage the structure of interest-earning assets and interest-bearingliabilities by adjusting their mix, yield, maturity and/or repricing characteristicsbased on market conditions.  Clientdeposits and repurchase agreements, which are predominantly short term, are ourprimary sources of funds.  We also useterm borrowings and interest rate swap agreements to augment our management ofinterest rate exposure.  The effect ofthe swap agreements is to lengthen both a forecasted series of fixed-rateovernight liabilities incurred at different daily fixed rates and short-termvariable-rate liabilities into longer-term fixed-rate liabilities.  The weighted-average fixed-payment rates onour swap agreements were 3.78% and 3.36% at September 30, 2006 and 2005,respectively.  Variable-interest paymentsreceived are currently indexed to the overnight Federal Funds rate.  At September 30, 2006 and 2005, the weighted-averagerates of variable market-indexed interest payment obligations to us were 5.30%and 3.72%, respectively.  The remainingterms of swaps at September 30, 2006 range from 1 to 25 months.  These contracts had net fair values ofapproximately $17.6 million and $22.3 million at September 30, 2006 and 2005,respectively.

The following table presents the repricing schedule ofour interest-earning assets and interest-bearing liabilities at September 30,2006 (Dollars in thousands):
| ** **                                                                         | ** ** | **Within Three** | ** ** | **Three to Six** | ** ** | **Six to Twelve** | ** ** | **One Year to** | ** ** | **Over Five** | ** ** | ** ** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------|------------|----------------------------|------------|-----------------------------|------------|---------------------------|------------|--------------------|------------|------------|------------|
| ** **                                                                         | ** ** | **Months**            | ** ** | **Months**                 | ** ** | **Months**                  | ** ** | **Five Years**       | ** ** | **Years**          | ** ** | **Total**  | ** ** |
| ** **                                                                         | ** ** | ** **            | ** ** | ** **                 | ** ** | ** **                  | ** ** | ** **                | ** ** | ** **         | ** ** | ** ** | ** ** |
| Interest-earning  assets:(1)                                                       |       |                  |       |                       |       |                        |       |                      |       |               |       |       |       |
| Investment  securities (2),(3)                                                     |       | $                     | 6,031,327  |                       | $          | 434,999                     |       | $                         | 872,894    |               | $          | 2,307,619  |       | $ | 763,407 |   | $ | 10,410,246 |   |
| Federal funds sold and other short-term investments                                |       | 273,229               |       | —                     |       | —                      |       | —                    |       | —             |       | 273,229    |       |
| Loans - variable rate                                                              |       | 286,466               |       | —                     |       | —                      |       | —                    |       | —             |       | 286,466    |       |
| Loans - fixed rate                                                                 |       | —                |       | —                     |       | —                      |       | 12                        |       | —             |       | 12         |       |
| Total interest-earning assets                                                      |       | $                     | 6,591,022  |                       | $          | 434,999                     |       | $                         | 872,894    |               | $          | 2,307,631  |       | $ | 763,407 |   | $ | 10,969,953 |   |
| Interest-bearing  liabilities:                                                     |       |                  |       |                       |       |                        |       |                      |       |               |       |       |       |
| Demand deposits                                                                    |       | $                     | 95,019     |                       | $          | —                      |       | $                         | —     |               | $          | —     |       | $ | — |   | $ | 95,019 |   |
| Savings accounts                                                                   |       | 4,942,806             |       | —                     |       | —                      |       | 28,244                    |       | —             |       | 4,971,050  |       |
| Time deposits                                                                      |       | 127,142               |       | —                     |       | —                      |       | —                    |       | —             |       | 127,142    |       |
| Interest rate contracts                                                            |       | (1,550,000            | )          | 220,000                    |       | 510,000                     |       | 820,000                   |       | —             |       | —     |       |
| Securities sold under repurchase agreements                                        |       | 3,578,598             |       | 100,000                    |       | 300,000                     |       | 150,000                   |       | —             |       | 4,128,598  |       |
| Short-term and other borrowings                                                    |       | 44,685                |       | —                     |       | —                      |       | —                    |       | —             |       | 44,685     |       |
| Junior subordinated debentures                                                     |       | —                |       | 24,774                     |       | —                      |       | —                    |       | —             |       | 24,774     |       |
| Total interest-bearing liabilities                                                 |       | $                     | 7,238,250  |                       | $          | 344,774                     |       | $                         | 810,000    |               | $          | 998,244    |       | $ | — |   | $ | 9,391,268 |   |
| Net interest-sensitivity gap during the period                                     |       | $                     | (647,228   | )                          | $          | 90,225                      |       | $                         | 62,894     |               | $          | 1,309,387  |       | $ | 763,407 |   | $ | 1,578,685 |   |
| Cumulative gap                                                                     |       | $                     | (647,228   | )                          | $          | (557,003                    | )          | $                         | (494,109   | )                  | $          | 815,278    |       | $ | 1,578,685 |   |   |   |
| Interest-earning  assets as a percent of interest-bearing liabilities (cumulative) |       | 91.06                 | %          | 92.65                      | %          | 94.11                       | %          | 108.68                    | %          | 116.81             | %          |       |       |
| Interest-earning  assets as a percent of total assets (cumulative)                 |       | 56.95                 | %          | 60.71                      | %          | 68.26                       | %          | 88.20                     | %          | 94.79              | %          |       |       |
| Net  interest-sensitivity gap as a percent of total assets                         |       | (5.59                 | )%         | 0.78                       | %          | 0.54                        | %          | 11.31                     | %          | 6.60               | %          |       |       |
| Cumulative gap as a  percent of total assets                                       |       | (5.59                 | )%         | (4.81                      | )%         | (4.27                       | )%         | 7.04                      | %          | 13.64              | %          |       |       |

 

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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$72.9 million of unsettled securities purchases and $29.8 million of netunrealized losses as of September 30, 2006.

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**Liquidity**

Liquidity represents the abilityof an institution to meet present and future financial obligations througheither runoff due to prepayments, asset sales, maturity of existing assets orthe acquisition of additional funds through liability management.  For a financial institution such as ours,these obligations arise from the withdrawals of deposits, the payment ofoperating expenses, and the inclusion of capital expenditures for fixed assetsand leasehold improvements.

Our primary sources of liquidityinclude cash and cash equivalents, Federal Funds sold, new deposits, short-termborrowings, interest and principal payments on securities held to maturity andavailable for sale, fees collected from asset administration clients, FHLBBborrowings and the Federal Reserve Discount Window.  As a result of our management of liquidassets and our ability to generate liquidity through liability funds,management believes that we maintain overall liquidity sufficient to meet ourdepositors’ needs, to satisfy our operating requirements and to fund thepayment of an anticipated annual cash dividend of $0.09 per share for 2006(approximately $6.0 million based upon 66,149,016 shares outstanding as ofSeptember 30, 2006).

Our ability to pay dividends oncommon stock may depend on the receipt of dividends from the Bank.  Any dividend payments by the Bank are subjectto certain restrictions imposed by the Massachusetts Commissioner of Banks.  During all periods presented in this report,the Company did not require dividends from the Bank in order to fund theCompany’s own dividends.  In addition, wemay not pay dividends on our common stock if we are in default under certainagreements entered into in connection with the sale of our CapitalSecurities.  The Capital Securities wereissued in 1997 by Investors Capital Trust I, a Delaware statutory businesstrust sponsored by us, and qualify as Tier 1 capital under the capitalguidelines of the Federal Reserve Board of Governors (‘FRB’).

In June 2006, we announced that our Board ofDirectors had authorized a new repurchase plan of up to $150.0 million of ourcommon stock over the twelve months following the announcement.  We do not expect our stock repurchase programto have a material impact on our capital resources, such as maintainingrisk-based capital ratios in excess of capital adequacy guidelines and ourability to pay dividends on our common stock. As of September 30, 2006, we have not repurchased any shares under thisplan.

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

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

The Bank’s capital stockinvestment in the FHLBB totaled $33.3 million as of September 30, 2006.  This amount reflects a $16.7 million decreaseduring the three months ended September 30, 2006.  The $33.3 millioncapital stock investment includes both a $25.0 million membership component anda $8.3 million activity-based component. FHLBB capital stock investments require a five-year advancenotice of withdrawal.  The Bank’s$33.3 million capital stock investment in the FHLBB provides an overnightborrowing capacity of up to $273.0 million.  There was no outstanding balance under thisarrangement as of September 30, 2006.  Additional borrowing is availableto the Bank based on prescribed collateral levels and increased investment inFHLBB capital stock.  The Bank currently has the ability to purchase up to$25.0 million of activity-based capital, which would provide a total overnightborrowing capacity of $833.0 million.

In October 2006, the Bankbecame a member of the Federal Reserve Bank of Boston (‘FRBB’).  In connection with its membership, the Bankwas required to subscribe to purchase stock of the FRBB totaling 6% of the Bank’scapital and surplus.  In October 2006,the Bank fulfilled its obligation to purchase 50% of its subscribed amount bypurchasing $7.4 million of FRBB stock. The remaining subscription amount is subject to purchase upon therequest of the FRBB.

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**Capital Resources**

Historically,we have financed our operations principally through internally generated cashflows.  We incur capital expenditures forfurniture, fixtures, capitalized software and miscellaneous equipmentneeds.  We lease office space and computingequipment through operating leases. Capital expenditures have been incurred and leases entered into on anas-required basis, primarily to meet our growing operating needs.  As a result, our capital expenditures were$50.8 million and $20.5 million for the nine months ended September 30, 2006and 2005, respectively.  For the ninemonths ended September 30, 2006, capital expenditures were comprised of $21.6million in capitalized software and projects in process, $16.7 million in fixedassets and $12.5 million in leasehold improvements.  For the nine months ended September 30, 2005,capital expenditures were comprised of a $15.2 million in capitalized softwareand projects in process, $5.2 million in fixed assets and $0.1 million inleasehold improvements.

Stockholders’ equity atSeptember 30, 2006 was $933.8 million, up 21% from December 31, 2005, primarilydue to net income earned and the exercise of stock options.  The ratio of average stockholders’ equity toaverage assets was approximately 7% for September 30, 2006, compared to 6% forDecember 31, 2005.

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

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

We are currently incompliance with both the Total Risk-Based Capital Ratio and the Leverage Ratiorequirements, and management expects these ratios to remain in compliance withthe FRB’s capital adequacy guidelines. At September 30, 2006, our Total Risk-Based Capital Ratio and LeverageRatio were 21.03% and 7.56%, respectively.

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

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

**Item 4.            Controlsand Procedures**

**Evaluationof Disclosure Controls and Procedures**

As required by Rule 13a-15 under the SecuritiesExchange Act of 1934, as of September 30, 2006, the end of the quarter coveredby this report, the Company carried out an evaluation under the supervision andwith the participation of the Company’s management, including the Company’sChief Executive Officer and Chief Financial Officer, of the effectiveness ofthe design and operation of the Company’s disclosure controls andprocedures.  In designing and evaluatingthe Company’s disclosure controls and procedures, the Company and itsmanagement recognize that any controls and procedures, no matter how welldesigned and operated, can provide only reasonable assurance of achieving thedesired control objectives, and the Company’s management necessarily wasrequired to apply its judgment in evaluating and implementing possible controlsand procedures.  Based upon thatevaluation, the Chief Executive Officer and Chief Financial Officer concludedthat the Company’s disclosure controls and procedures were effective at thereasonable assurance level to ensure that information required to be disclosedby the Company in the reports it files or submits under the Exchange Act isaccumulated and communicated to our management, including our Chief ExecutiveOfficer and Chief Financial Officer, as appropriate, to allow timely decisionsregarding required disclosure, and is recorded, processed, summarized andreported, within the time periods specified in the Securities and ExchangeCommission’s rules and forms.  There wasno change in the Company’s internal control over financial reporting thatoccurred during the quarter ended September 30, 2006 that has materially affected,or is reasonably likely to materially affect, the Company’s internal controlover financial reporting.  The Companyreviews, on an ongoing basis, its disclosure controls and procedures, which mayinclude its internal controls over financial reporting, and may from time totime make changes aimed at enhancing their effectiveness and to ensure that theCompany’s systems evolve with its business.

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**PART II.  OTHER INFORMATION**

**Item 1. Legal Proceedings**

On June 27, 2003,we and an individual employee of ours were named in a lawsuit alleging, amongother things, that we breached an implied covenant of good faith and fairdealing in a subadvisory contract with Opus Investment Management, Inc. andthat our individual employee engaged in a breach of fiduciary duties andtortuous interference with a contract.  The lawsuit was filed in theSuperior Court of Worcester, Massachusetts and sought unspecified damages. In October 2006, the parties settled the lawsuit.  Included in otherliabilities in our consolidated balance sheet at September 30, 2006 and inother operating expenses in our consolidated statement of income for the ninemonths ended September 30, 2006 is approximately $1.8 million for settlementcosts, legal fees and administrative costs related to the settlement.

We and certain ofour officers were named as defendants in three purported class actioncomplaints that were filed on or about August 4, 2005, August 15, 2005, andSeptember 30, 2005 in the United States District Court for the District ofMassachusetts, Boston, Massachusetts.  The U.S. District Court hasconsolidated those cases and appointed a lead plaintiff, who filed a consolidatedcomplaint against us and seven of our current and former officers on February3, 2006.  Among other things, the consolidated complaint asserts that thedefendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of1934 during the period April 10, 2001 until July 15, 2005.  Theallegations in the consolidated complaint predominantly relate to: (1) ourOctober 2004 restatement of its financial results, and (2) our July 2005revision of public guidance regarding our future financial performance. The consolidated complaint seeks unspecified damages, interest, fees, andcosts.  On May 14, 2006, we filed a motion to dismiss all claims assertedin the consolidated complaint.  Thatmotion is currently pending before the Court.  We strongly believe thatthe lawsuit lacks merit and we intend to defend against the claimsvigorously.  However, we cannot predict the outcome of the lawsuit at thistime, and we can give no assurance that it will not materially adversely affectour financial condition or results of operations.

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

**Item 1A. Risk Factors**

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

A significant portion of our fees is based on themarket value of the assets we process. Accordingly, our operating results are subject to fluctuations ininterest rates and securities markets as these fluctuations affect the marketvalue of assets processed.  Our netinterest income is earned by investing depositors’ funds in our investmentportfolio and, in small part, by making loans. A rising short-term interest rate environment, such as we are nowexperiencing, generally causes downward pressure on net interest income.  Changes in the relationship betweenshort-term and long-term interest rates, referred to as the yield curve, couldalso adversely affect the market value of, or the earnings produced by, ourinvestment and loan portfolios, and thus could adversely affect our operatingresults.  The current very flat yieldcurve, where short-term rates have increased while long-term rates have failedto increase, has resulted in a decrease in our net interest margin that willcontinue to have a material impact on our net interest income.

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

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

In addition, we are experiencing narrower investmentportfolio reinvestment spreads, which reduces our net interest income.  If reinvestments spreads on the securitytypes we purchase remain narrow, or become narrower, our net interest incomewill continue to be impacted 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’s iShares and MasterInvestment Portfolios, our assumption of the operations of the U.S. asset administrationunit of BGI in 2001 and our servicing assets for Barclays Global InvestorsCanada, Ltd., BGI accounted for approximately 18% of our net operating revenuefor both the nine months and three months ended September 30, 2006.  We recently renewed our U.S. assetadministration outsourcing agreement and our iShares and Master InvestmentPortfolio custody and fund accounting agreements with BGI and we expect thatBGI will continue to account for a significant portion of our net operatingrevenue.  We provide services to BGIunder long-term contracts that may be terminated before the expiration of thecontracts under certain circumstances. Further information regarding the terms of certain BGI contracts,including early termination provisions, was disclosed in Item 8.01 on our Form8-K filed on January 25, 2006.

*We may incur losses due tooperational errors.*

The services that we providerequire complex processes and interaction with numerous third parties.  While we maintain sophisticated computersystems and a comprehensive system of internal controls, and our operationalhistory has been excellent, from time to time we may make operational errorsfor which we are responsible to our clients. In addition, even though we maintain appropriate errors and omissionsand other insurance policies, an operational error could result in asignificant liability to us and may have a material adverse effect on ourresults of operations.

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

We are part of an extremelycompetitive asset servicing industry. Many of our current and potential competitors have longer operatinghistories, greater name recognition and substantially greater financial, marketingand other resources than we do.  Thesegreater resources could, for example, allow our competitors to developtechnology 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 lawsuitsin U.S. District Court in Massachusetts alleging, among other things,violations of securities laws.  While webelieve these claims are without merit, we cannot be sure that we will prevailin the defense of these claims.  We arealso party to other litigation and we may become subject to other legal claimsin the future.  Litigation is costly andcould divert the attention of management. For a more detailed discussion of our ongoing lawsuits, please see Item1, Legal Proceedings, in Part II of this report and Item 3, Legal Proceedings,in Part 1 of our Annual Report on Form 10-K for the year ended December 31,2005.

*Our future results depend, inpart, on successful integration of prior and possible future outsourcingtransactions.*

Integration of outsourcingtransactions is complicated and frequently presents unforeseen difficulties andexpenses which can affect whether and when a particular outsourcing transactionwill be accretive to our earnings per share. Any future outsourcing transactions will present similarchallenges.  These outsourcingtransactions can also consume a significant amount of management’s time.

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

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

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

Qualified personnel, inparticular managers and other senior personnel, are in great demand throughoutthe financial services industry.  As aresult, we could find it increasingly difficult to continue to attract andretain sufficient numbers of these highly skilled employees, which could affectour ability to attract and retain clients.

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

To position us for futuregrowth, we have accelerated some disciplined investments during 2006.  We believe our investments in personnel,technology and space are necessary to support our future growth in areas suchas our European presence, technology, alternative investments, middle officeoutsourcing and fund services.  Whilethese investments have and will continue to decrease our short-term operatingmargins, we believe they are necessary to build the foundation for futuregrowth.  However, we may not reap any orall of the expected benefits of our recent investments.

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

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

*Our quarterly and annualoperating results may fluctuate.*

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

·                  The timing of commencement or termination ofclient engagements;

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

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

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

Most of our expenses, such asemployee compensation and rent, are relatively fixed and are expected toincrease in 2006 to support expected growth. As a result, any shortfall in revenue relative to our expectations couldsignificantly affect our operating results.

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

Federal and state laws andregulations applicable to financial institutions and their parent companiesapply to us.  Our primary regulators arethe Federal Reserve Board of Governors (‘FRB’), the Federal Deposit InsuranceCorporation (‘FDIC’), the office of the Commissioner of Banks of the Commonwealthof Massachusetts, the National Association of Securities Dealers, Inc. (‘NASD’),the State of Vermont Department of Banking, Insurance, Securities, Health CareAdministration (‘BISHCA’), the Office of the Superintendent of FinancialInstitutions in Canada (‘OSFI’), the Irish Financial Services RegulatoryAuthority (‘IFSRA’), the Cayman Islands Monetary Authority (‘CIMA’), theFinancial Services Authority in the United Kingdom (‘FSA’) and the Commissionde Surveillance du Secteur Financier in Luxembourg (‘CSSF’).  Virtuallyall aspects of our operations are subject to specific requirements orrestrictions and general regulatory oversight including the following:

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

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

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

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

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

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

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

**Item2.  Unregistered Sales of EquitySecurities and Use of Proceeds**

**Purchasesof Equity Securities by the Issuer and Affiliated Purchasers**
| Period                                 | ** ** | **Total  Number of**  Shares  Purchased (1) | ** ** | **Average**  Price Paid Per  Share | ** ** |
|----------------------------------------|------------|-------------------------------------------------------|------------|----------------------------------------------|------------|
|                                   |       |                                                  |       |                                         |       |
| September 1 –  September 30, 2006 |       | 318                                                   |       | $                                            | 43.68      |   |
|                                   |       | 318                                                   |       | $                                            | 43.68      |   |

 

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

In June 2006,we announced that our Board of Directors had authorized a new repurchase planof up to $150.0 million of our common stock over the twelve months followingthe announcement.  We do not expect ourstock repurchase program to have a material impact on our capital resources,such as maintaining risk-based capital ratios in excess of capital adequacyguidelines and our ability to pay dividends on our common stock.  As of September 30, 2006, we have notrepurchased any shares under this plan.

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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. |

 

**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
|                         |   | **INVESTORS FINANCIAL SERVICES CORP.**                                                           |
|-------------------------|--------|--------------------------------------------------------------------------------------------------|
|                    |   | ** **                                                                                       |
| Date: November 6,  2006 | By:    | /s/ Kevin J. Sheehan                                                                             |   |
|                    |   | Kevin J. Sheehan                                                                                 |
|                    |   | Chairman and Chief Executive Officer                                                             |
|                    |   |                                                                                             |
|                    |   |                                                                                             |
|                    | By:    | /s/ John N. Spinney, Jr.                                                                         |   |
|                    |   | John N. Spinney, Jr.                                                                             |
|                    |   | Senior Vice President and Chief Financial Officer   (Principal Financial and Accounting Officer) |

 

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