**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

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** **

**FORM 10-Q**

** **

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** **

| **(Mark One)**                                                                                                                                                                                         |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                   |   |   |
| **ý**                                                                                                                                                                                             |   | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                   |   |   |
| **For the Quarterly period ended June 30,  2003**                                                                                                                                                      |
|                                                                                                                                                                                                   |   |   |
| **or**                                                                                                                                                                                                 |
|                                                                                                                                                                                                   |   |   |
| **o**                                                                                                                                                                                                  |   | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                   |   |   |
| **For the Transition period from                 to               ** |
|                                                                                                                                                                                                   |   |   |
| **0-26996**                                                                                                                                                                                            |
| **(Commission File Number)**                                                                                                                                                                           |

** **

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** **

**INVESTORS FINANCIAL SERVICES CORP.**

(Exact name of registrant as specified in itscharter)

** **

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** **

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

 

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

 

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

 

As of July 31,2003 there were 65,144,525 shares of Common Stock outstanding.

 

** **

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**INVESTORS FINANCIAL SERVICES CORP.**

 

**INDEX**

 
| **PART I.**    |   | **FINANCIAL INFORMATION**                                                                                       |
|----------------|--------|-----------------------------------------------------------------------------------------------------------------|
|           |   |                                                                                                            |
| Item 1.        |   | Unaudited Condensed Consolidated Financial Statements                                                           |
|           |   |                                                                                                            |
|           |   | Condensed Consolidated Balance Sheets  June 30, 2003 and December 31, 2002                                      |
|           |   |                                                                                                            |
|           |   | Condensed Consolidated Statements of Income  and Comprehensive Income  Six months ended June 30, 2003 and 2002  |
|           |   |                                                                                                            |
|           |   | Condensed Consolidated Statements of Income and Comprehensive Income  Three months ended June 30, 2003 and 2002 |
|           |   |                                                                                                            |
|           |   | Condensed Consolidated Statements of  Stockholders’ Equity  Six months ended June 30, 2003 and 2002        |
|           |   |                                                                                                            |
|           |   | Condensed Consolidated Statements of Cash  Flows  Six months ended June 30, 2003 and 2002                       |
|           |   |                                                                                                            |
|           |   | Notes to Condensed Consolidated Financial  Statements                                                           |
|           |   |                                                                                                            |
|           |   | Independent Accountants’ Report                                                                            |
|           |   |                                                                                                            |
| Item 2.        |   | Management’s Discussion and Analysis of Financial Condition and  Results of Operations                     |
|           |   |                                                                                                            |
| Item 3.        |   | Quantitative and Qualitative Disclosure about Market Risk                                                       |
|           |   |                                                                                                            |
| Item 4.        |   | Controls and Procedures                                                                                         |
|           |   |                                                                                                            |
| **PART II.**   |   | **OTHER INFORMATION**                                                                                           |
|           |   |                                                                                                            |
| Item 1.        |   | Legal  Proceedings                                                                                              |
| Item  4.       |   | Submission  of Matters to a Vote of Security Holders                                                            |
| Item  6.       |   | Exhibits  and Reports on Form 8-K                                                                               |
|           |   |                                                                                                            |
| **SIGNATURES** |

 

2

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**PARTI****.  FINANCIAL INFORMATION**

** **

**Item 1****.            UnauditedCondensed Consolidated Financial Statements**

** **

**INVESTORS FINANCIAL SERVICES CORP.**

**CONDENSED CONSOLIDATED BALANCE SHEETS June 30, 2003 and December 31, 2002**

**(Dollarsin thousands, except share data)**

 
|                                                                                                                                                                                                              |   | **June 30,  2003** |      | **December 31,  2002** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|-----------|-----------------------------|--------|
|                                                                                                                                                                                                              |   |               |      |                        |   |
| **Assets**                                                                                                                                                                                                        |   |               |      |                        |   |
| Cash and due from banks                                                                                                                                                                                           |   | $                  | 11,245    |                        | $      | 14,568 |   |
| Securities purchased under resale  agreements                                                                                                                                                                     |   | 110,000            |      | —                      |   |
| Securities held to maturity (approximate  fair value of $4,034,621 and $3,460,754   at June 30, 2003 and December 31, 2002, respectively)                                                               |   | 4,020,891          |      | 3,438,689                   |   |
| Securities available for sale                                                                                                                                                                                     |   | 3,693,905          |      | 3,272,465                   |   |
| Non-marketable equity securities                                                                                                                                                                                  |   | 50,000             |      | 50,000                      |   |
| Loans, less allowance for loan losses of  $100 at June 30, 2003 and December 31, 2002                                                                                                                        |   | 126,703            |      | 143,737                     |   |
| Accrued interest and fees receivable                                                                                                                                                                              |   | 67,891             |      | 67,261                      |   |
| Equipment and leasehold improvements, less  accumulated depreciation of $34,405 and $25,402 at June 30, 2003 and  December 31, 2002, respectively                                                            |   | 79,220             |      | 74,869                      |   |
| Goodwill, net                                                                                                                                                                                                     |   | 79,969             |      | 79,969                      |   |
| Other assets                                                                                                                                                                                                      |   | 114,236            |      | 73,219                      |   |
|                                                                                                                                                                                                              |   |               |      |                        |   |
| **Total Assets**                                                                                                                                                                                                  |   | $                  | 8,354,060 |                        | $      | 7,214,777 |   |
|                                                                                                                                                                                                              |   |               |      |                        |   |
| **Liabilities and Stockholders’ Equity**                                                                                                                                                                     |   |               |      |                        |   |
| **Liabilities:**                                                                                                                                                                                                  |   |               |      |                        |   |
| Deposits:                                                                                                                                                                                                         |   |               |      |                        |   |
| Demand                                                                                                                                                                                                            |   | $                  | 534,466   |                        | $      | 384,461 |   |
| Savings                                                                                                                                                                                                           |   | 2,892,990          |      | 2,858,457                   |   |
| Time                                                                                                                                                                                                              |   | 145,000            |      | 90,000                      |   |
| Total deposits                                                                                                                                                                                                    |   | 3,572,456          |      | 3,332,918                   |   |
|                                                                                                                                                                                                              |   |               |      |                        |   |
| Securities sold under repurchase agreements                                                                                                                                                                       |   | 3,086,912          |      | 2,301,974                   |   |
| Short-term and other borrowings                                                                                                                                                                                   |   | 887,924            |      | 741,107                     |   |
| Due to brokers for open trades payable                                                                                                                                                                            |   | 190,305            |      | 286,843                     |   |
| Other liabilities                                                                                                                                                                                                 |   | 103,163            |      | 85,676                      |   |
| Total liabilities                                                                                                                                                                                                 |   | 7,840,760          |      | 6,748,518                   |   |
|                                                                                                                                                                                                              |   |               |      |                        |   |
| Commitments and contingencies                                                                                                                                                                                     |   | —             |      | —                      |   |
|                                                                                                                                                                                                              |   |               |      |                        |   |
| Company-obligated, mandatorily redeemable,  preferred securities of subsidiary trust holding solely junior subordinated  deferrable interest debentures of the Company                                            |   | 23,317             |      | 23,303                      |   |
|                                                                                                                                                                                                              |   |               |      |                        |   |
| **Stockholders’ Equity:**                                                                                                                                                                                    |   |               |      |                        |   |
| Preferred stock, par value $0.01 (shares  authorized: 1,000,000; issued and outstanding: none at June 30, 2003 and  December 31, 2002)                                                                       |   | —             |      | —                      |   |
| Common stock, par value $0.01 (shares  authorized: 100,000,000 at June 30, 2003 and December 31, 2002; issued  and outstanding:  65,138,599 at June  30, 2003 and 64,775,042 at December 31, 2002) |   | 651                |      | 648                         |   |
| Surplus                                                                                                                                                                                                           |   | 237,404            |      | 233,337                     |   |
| Deferred compensation                                                                                                                                                                                             |   | (1,326             | )         | (1,599                      | )      |
| Retained earnings                                                                                                                                                                                                 |   | 229,767            |      | 198,282                     |   |
| Cumulative translation adjustments, net of  tax                                                                                                                                                                   |   | 245                |      | —                      |   |
| Accumulated other comprehensive income, net                                                                                                                                                                       |   | 23,242             |      | 12,288                      |   |
| Treasury stock, par value $0.01 (10,814  shares at June 30, 2003 and December 31, 2002)                                                                                                                      |   | —             |      | —                      |   |
| Total stockholders’ equity                                                                                                                                                                                   |   | 489,983            |      | 442,956                     |   |
|                                                                                                                                                                                                              |   |               |      |                        |   |
| **Total Liabilities and Stockholders’ Equity**                                                                                                                                                               |   | $                  | 8,354,060 |                        | $      | 7,214,777 |   |

 

*See Notes to Unaudited Condensed ConsolidatedFinancial Statements.*

 

3

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**INVESTORS FINANCIAL SERVICES CORP.**

**CONDENSED CONSOLIDATED STATEMENTS OF INCOMEAND COMPREHENSIVE INCOME Six Months Ended June 30, 2003 and 2002**

**(Dollars in thousands, except per share data)**

 
|                                                                                                                         |   | **June 30,  2003** |   | **June 30,  2002** |   |
|------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|--------|--------------------|--------|
| **Operating Revenue:**                                                                                                       |   |               |   |               |   |
| Interest income:                                                                                                             |   |               |   |               |   |
| Federal funds sold and securities purchased  under resale agreements                                                         |   | $                  | 182    |               | $      | 207 |   |
| Investment securities held to maturity and  available for sale                                                               |   | 119,594            |   | 119,016            |   |
| Loans                                                                                                                        |   | 1,778              |   | 1,961              |   |
| Total interest income                                                                                                        |   | 121,554            |   | 121,184            |   |
|                                                                                                                         |   |               |   |               |   |
| Interest expense:                                                                                                            |   |               |   |               |   |
| Deposits                                                                                                                     |   | 18,231             |   | 21,027             |   |
| Short-term and other borrowings                                                                                              |   | 25,786             |   | 30,040             |   |
| Total interest expense                                                                                                       |   | 44,017             |   | 51,067             |   |
|                                                                                                                         |   |               |   |               |   |
| Net interest income                                                                                                          |   | 77,537             |   | 70,117             |   |
|                                                                                                                         |   |               |   |               |   |
| Noninterest income:                                                                                                          |   |               |   |               |   |
| Asset servicing fees                                                                                                         |   | 155,367            |   | 144,121            |   |
| Other operating income                                                                                                       |   | 1,428              |   | 1,130              |   |
|                                                                                                                         |   |               |   |               |   |
| Net operating revenue                                                                                                        |   | 234,332            |   | 215,368            |   |
|                                                                                                                         |   |               |   |               |   |
| **Operating Expenses:**                                                                                                      |   |               |   |               |   |
| Compensation and benefits                                                                                                    |   | 100,735            |   | 98,868             |   |
| Technology and telecommunications                                                                                            |   | 18,850             |   | 20,066             |   |
| Transaction processing services                                                                                              |   | 16,339             |   | 17,314             |   |
| Occupancy                                                                                                                    |   | 14,530             |   | 11,406             |   |
| Depreciation and amortization                                                                                                |   | 12,685             |   | 6,639              |   |
| Professional fees                                                                                                            |   | 3,741              |   | 3,216              |   |
| Travel and sales promotion                                                                                                   |   | 2,068              |   | 2,754              |   |
| Other operating expenses                                                                                                     |   | 5,210              |   | 6,209              |   |
| Total operating expenses                                                                                                     |   | 174,158            |   | 166,472            |   |
|                                                                                                                         |   |               |   |               |   |
| **Income Before Income Taxes and Minority  Interest**                                                                        |   | 60,174             |   | 48,896             |   |
|                                                                                                                         |   |               |   |               |   |
| Provision for income taxes  (Note 10)                                                                                   |   | 25,980             |   | 14,730             |   |
| Minority interest expense, net of income  taxes                                                                              |   | 762                |   | 794                |   |
|                                                                                                                         |   |               |   |               |   |
| **Net Income**                                                                                                               |   | $                  | 33,432 |               | $      | 33,372 |   |
|                                                                                                                         |   |               |   |               |   |
| **Basic Earnings Per Share**                                                                                                 |   | $                  | 0.51   |               | $      | 0.52 |   |
|                                                                                                                         |   |               |   |               |   |
| **Diluted Earnings Per Share**                                                                                               |   | $                  | 0.50   |               | $      | 0.50 |   |
|                                                                                                                         |   |               |   |               |   |
| **Comprehensive Income:**                                                                                                    |   |               |   |               |   |
| Net income                                                                                                                   |   | $                  | 33,432 |               | $      | 33,372 |   |
| Other comprehensive income net of tax of  $7,408 and $11,159 for the six months ended June 30, 2003 and 2002,  respectively: |   |               |   |               |   |
| Net unrealized investment gain                                                                                               |   | 8,538              |   | 23,153             |   |
| Net  unrealized derivative instrument gain (loss)                                                                            |   | 2,416              |   | (2,429             | )      |
| Other comprehensive income                                                                                                   |   | 10,954             |   | 20,724             |   |
| Comprehensive income                                                                                                         |   | $                  | 44,386 |               | $      | 54,096 |   |

 

*See Notes to Unaudited Condensed ConsolidatedFinancial Statements.*

 

4

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**INVESTORS FINANCIAL SERVICES CORP.**

**CONDENSEDCONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME Three Months Ended June 30, 2003 and 2002**

**(Dollars in thousands, except per share data)**

 
|                                                                                                                           |   | **June 30,  2003** |   | **June 30,  2002** |   |
|--------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|--------|--------------------|--------|
| **Operating Revenue:**                                                                                                         |   |               |   |               |   |
| Interest income:                                                                                                               |   |               |   |               |   |
| Federal funds sold and securities purchased  under resale agreements                                                           |   | $                  | 166    |               | $      | 140 |   |
| Investment securities held to maturity and  available for sale                                                                 |   | 60,109             |   | 61,456             |   |
| Loans                                                                                                                          |   | 930                |   | 956                |   |
| Total interest income                                                                                                          |   | 61,205             |   | 62,552             |   |
|                                                                                                                           |   |               |   |               |   |
| Interest expense:                                                                                                              |   |               |   |               |   |
| Deposits                                                                                                                       |   | 9,114              |   | 10,433             |   |
| Short-term and other borrowings                                                                                                |   | 13,923             |   | 17,739             |   |
| Total interest expense                                                                                                         |   | 23,037             |   | 28,172             |   |
|                                                                                                                           |   |               |   |               |   |
| Net interest income                                                                                                            |   | 38,168             |   | 34,380             |   |
|                                                                                                                           |   |               |   |               |   |
| Noninterest income:                                                                                                            |   |               |   |               |   |
| Asset servicing fees                                                                                                           |   | 82,493             |   | 74,788             |   |
| Other operating income                                                                                                         |   | 658                |   | 546                |   |
|                                                                                                                           |   |               |   |               |   |
| Net operating revenue                                                                                                          |   | 121,319            |   | 109,714            |   |
|                                                                                                                           |   |               |   |               |   |
| **Operating Expenses:**                                                                                                        |   |               |   |               |   |
| Compensation and benefits                                                                                                      |   | 50,964             |   | 48,938             |   |
| Technology and telecommunications                                                                                              |   | 9,559              |   | 10,104             |   |
| Transaction processing services                                                                                                |   | 9,531              |   | 9,825              |   |
| Occupancy                                                                                                                      |   | 7,205              |   | 5,643              |   |
| Depreciation and amortization                                                                                                  |   | 6,606              |   | 3,503              |   |
| Professional fees                                                                                                              |   | 2,062              |   | 1,538              |   |
| Travel and sales promotion                                                                                                     |   | 1,083              |   | 1,520              |   |
| Other operating expenses                                                                                                       |   | 2,701              |   | 3,293              |   |
| Total operating expenses                                                                                                       |   | 89,711             |   | 84,364             |   |
|                                                                                                                           |   |               |   |               |   |
| **Income Before Income Taxes and Minority  Interest**                                                                          |   | 31,608             |   | 25,350             |   |
|                                                                                                                           |   |               |   |               |   |
| Provision for income taxes  (Note 10)                                                                                     |   | 3,207              |   | 7,636              |   |
| Minority interest expense, net of income  taxes                                                                                |   | 381                |   | 397                |   |
|                                                                                                                           |   |               |   |               |   |
| **Net Income**                                                                                                                 |   | $                  | 28,020 |               | $      | 17,317 |   |
|                                                                                                                           |   |               |   |               |   |
| **Basic Earnings Per Share**                                                                                                   |   | $                  | 0.43   |               | $      | 0.27 |   |
|                                                                                                                           |   |               |   |               |   |
| **Diluted Earnings Per Share**                                                                                                 |   | $                  | 0.42   |               | $      | 0.26 |   |
|                                                                                                                           |   |               |   |               |   |
| **Comprehensive Income:**                                                                                                      |   |               |   |               |   |
| Net income                                                                                                                     |   | $                  | 28,020 |               | $      | 17,317 |   |
| Other comprehensive income net of tax of  $2,271 and $10,360 for the three months ended June 30, 2003 and 2002,  respectively: |   |               |   |               |   |
| Net unrealized investment gain                                                                                                 |   | 1,817              |   | 26,141             |   |
| Net unrealized derivative instrument gain  (loss)                                                                              |   | 873                |   | (6,901             | )      |
| Other comprehensive income                                                                                                     |   | 2,690              |   | 19,240             |   |
| Comprehensive income                                                                                                           |   | $                  | 30,710 |               | $      | 36,557 |   |

 

*See Notes to Unaudited Condensed ConsolidatedFinancial Statements.*

 

5

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**INVESTORS FINANCIAL SERVICES CORP.**

**CONDENSED CONSOLIDATED STATEMENTS OFSTOCKHOLDERS’ EQUITY Six Months Ended June 30, 2003 and 2002**

**(Dollars in thousands, except share data)**

 
|                                                                                                   |   | **June 30,  2003** |       | **June 30,  2002** | ** ** |
|--------------------------------------------------------------------------------------------------------|--------|--------------------|------------|--------------------|------------|
| **Common shares**                                                                                      |   |               | ** ** |               | ** ** |
| Balance, beginning of period                                                                           |   | 64,775,042         |       | 31,971,404         |       |
| Exercise of stock options                                                                              |   | 292,951            |       | 271,213            |       |
| Common stock issuance                                                                                  |   | 70,606             |       | 61,193             |       |
| Stock dividend, two-for-one split                                                                      |   | —             |       | 32,168,922         |       |
| Balance, end of period                                                                                 |   | 65,138,599         |       | 64,472,732         |       |
|                                                                                                   |   |               |       |               |       |
| **Treasury shares**                                                                                    |   |               | ** ** |               | ** ** |
| Balance, beginning of period                                                                           |   | 10,814             |       | 10,814             |       |
| Balance, end of period                                                                                 |   | 10,814             |       | 10,814             |       |
|                                                                                                   |   |               |       |               |       |
| **Common stock**                                                                                       |   |               | ** ** |               | ** ** |
| Balance, beginning of period                                                                           |   | $                  | 648        |               | $          | 320 |   |
| Exercise of stock options                                                                              |   | 3                  |       | 3                  |       |
| Stock dividend, two-for-one split                                                                      |   | —             |       | 322                |       |
| Balance, end of period                                                                                 |   | 651                |       | 645                |       |
|                                                                                                   |   |               |       |               |       |
| **Surplus**                                                                                            |   |               |       |               |       |
| Balance, beginning of period                                                                           |   | 233,337            |       | 222,440            |       |
| Exercise of stock options                                                                              |   | 1,046              |       | 1,861              |       |
| Tax benefit from exercise of stock options                                                             |   | 1,221              |       | 2,731              |       |
| Common stock issuance                                                                                  |   | 1,800              |       | 1,835              |       |
| Balance, end of period                                                                                 |   | 237,404            |       | 228,867            |       |
|                                                                                                   |   |               |       |               |       |
| **Deferred compensation**                                                                              |   |               |       |               |       |
| Balance, beginning of the period                                                                       |   | (1,599             | )          | (2,563             | )          |
| Amortization of deferred compensation                                                                  |   | 273                |       | 565                |       |
| Balance, end of period                                                                                 |   | (1,326             | )          | (1,998             | )          |
|                                                                                                   |   |               |       |               |       |
| **Retained earnings**                                                                                  |   |               |       |               |       |
| Balance, beginning of period                                                                           |   | 198,282            |       | 132,877            |       |
| Net income                                                                                             |   | 33,432             |       | 33,372             |       |
| Stock dividend, two-for-one split                                                                      |   | —             |       | (322               | )          |
| Cash dividend, $0.030 and $0.025 per share  in the periods ending June 30, 2003 and 2002, respectively |   | (1,947             | )          | (1,605             | )          |
| Balance, end of period                                                                                 |   | 229,767            |       | 164,322            |       |
|                                                                                                   |   |               |       |               |       |
| **Cumulative translation adjustments, net of  tax**                                                    |   |               |       |               |       |
| Balance, beginning of the period                                                                       |   | —             |       | —             |       |
| Effect of foreign currency translation                                                                 |   | 245                |       | —             |       |
| Balance, end of period                                                                                 |   | 245                |       | —             |       |
|                                                                                                   |   |               |       |               |       |
| **Accumulated other comprehensive income  (loss), net**                                                |   |               |       |               |       |
| Balance, beginning of period                                                                           |   | 12,288             |       | (10,296            | )          |
| Net unrealized investment gain                                                                         |   | 8,538              |       | 23,153             |       |
| Net unrealized derivative instrument gain  (loss)                                                      |   | 2,122              |       | (3,954             | )          |
| Amortization of transition-related  adjustment                                                         |   | 294                |       | 1,525              |       |
| Balance, end of period                                                                                 |   | 23,242             |       | 10,428             |       |
|                                                                                                   |   |               |       |               |       |
| **Treasury stock**                                                                                     |   |               |       |               |       |
| Balance, beginning of period                                                                           |   | —             |       | —             |       |
| Balance, end of period                                                                                 |   | —             |       | —             |       |
|                                                                                                   |   |               |       |               |       |
| **Total Stockholders’ Equity**                                                                    |   | $                  | 489,983    |               | $          | 402,264 |   |

 

*See Notes to Unaudited Condensed ConsolidatedFinancial Statements*.

 

6

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**INVESTORS FINANCIAL SERVICES CORP.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASHFLOWS Six Months Ended June 30, 2003 and 2002**

**(Dollars in thousands)**

 
|                                                                                 |   | **June 30,  2003** |   | **June 30,  2002** |   |
|--------------------------------------------------------------------------------------|--------|--------------------|--------|--------------------|--------|
|                                                                                 |   |               |   |               |   |
| **Cash Flows From Operating Activities:**                                            |   |               |   |               |   |
| Net income                                                                           |   | $                  | 33,432 |               | $      | 33,372 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities:   |   |               |   |               |   |
| Depreciation and amortization                                                        |   | 12,685             |   | 6,639              |   |
| Amortization of deferred compensation                                                |   | 273                |   | 565                |   |
| Amortization of premiums on securities, net  of accretion of discounts               |   | 17,217             |   | 2,284              |   |
| Changes in assets and liabilities:                                                   |   |               |   |               |   |
| Accrued interest and fees receivable                                                 |   | (630               | )      | (7,957             | )      |
| Other assets                                                                         |   | (41,017            | )      | 33,430             |   |
| Other liabilities                                                                    |   | 15,378             |   | (18,859            | )      |
| Net cash provided by operating activities                                            |   | 37,338             |   | 49,474             |   |
|                                                                                 |   |               |   |               |   |
| **Cash Flows From Investing Activities:**                                            |   |               |   |               |   |
| Proceeds from maturities and paydowns of  securities available for sale              |   | 731,064            |   | 246,365            |   |
| Proceeds from maturities and paydowns of  securities held to maturity                |   | 1,008,261          |   | 874,839            |   |
| Purchases of securities available for sale                                           |   | (1,145,407         | )      | (846,149           | )      |
| Purchases of securities held to maturity                                             |   | (1,600,492         | )      | (1,125,935         | )      |
| Net decrease in due to brokers for open  trades payable                              |   | (96,538            | )      | —             |   |
| Net increase in federal funds sold and  securities purchased under resale agreements |   | (110,000           | )      | (610,000           | )      |
| Net decrease in loans                                                                |   | 17,034             |   | 106,264            |   |
| Purchases of fixed assets, capitalized  software and leasehold improvements          |   | (17,023            | )      | (23,219            | )      |
| Net cash used for investing activities                                               |   | (1,213,101         | )      | (1,377,835         | )      |
|                                                                                 |   |               |   |               |   |
| **Cash Flows From Financing Activities:**                                            |   |               |   |               |   |
| Net increase in demand deposits                                                      |   | 150,005            |   | 318,440            |   |
| Net increase in time and savings deposits                                            |   | 89,533             |   | 76,207             |   |
| Net increase in securities sold under  repurchase agreements                         |   | 784,938            |   | 788,945            |   |
| Net increase in short-term and other  borrowings                                     |   | 146,817            |   | 144,937            |   |
| Proceeds from exercise of stock options                                              |   | 1,049              |   | 1,864              |   |
| Proceeds from issuance of common stock                                               |   | 1,800              |   | 1,835              |   |
| Cash dividends to shareholders                                                       |   | (1,947             | )      | (1,605             | )      |
| Net cash provided by financing activities                                            |   | 1,172,195          |   | 1,330,623          |   |
|                                                                                 |   |               |   |               |   |
| **Effect of foreign currency translation**                                           |   | 245                |   | —             |   |
|                                                                                 |   |               |   |               |   |
| **Net (Decrease) Increase In Cash And Due  From Banks**                              |   | (3,323             | )      | 2,262              |   |
|                                                                                 |   |               |   |               |   |
| **Cash and Due From Banks, Beginning of  Period**                                    |   | 14,568             |   | 15,605             |   |
|                                                                                 |   |               |   |               |   |
| **Cash and Due From Banks, End of Period**                                           |   | $                  | 11,245 |               | $      | 17,867 |   |
|                                                                                 |   |               |   |               |   |
| **Supplemental Disclosure of Cash Flow  Information:**                               |   |               |   |               |   |
| Cash paid for interest                                                               |   | $                  | 43,805 |               | $      | 51,075 |   |
| Cash paid for income taxes                                                           |   | $                  | 25,368 |               | $      | 14,962 |   |

 

*See Notes to Unaudited Condensed ConsolidatedFinancial Statements.*

 

7

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**INVESTORS FINANCIAL SERVICES CORP.**

**NOTES TO UNAUDITED CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**(Information is as of and for the six monthsand the three months ended June 30, 2003 and 2002)**

 

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

 

Investors Financial Services Corp. (‘IFSC’) provides asset servicingfor the financial services industry through its wholly-owned subsidiary,Investors Bank & Trust Company (the ‘Bank’).  As used herein, the defined term “the Company” shall mean IFSCtogether with the Bank and its domestic and foreign subsidiaries.  The Company provides global custody,multicurrency accounting, mutual fund administration, securities lending,foreign exchange, cash management, performance measurement, institutionaltransfer agency, investment advisory services, lines of credit and brokerageservices to a variety of financial asset managers, including mutual fundcomplexes, investment advisors, banks and insurance companies.  The Company is subject to regulation by theFederal Reserve Board of Governors, the Office of the Commissioner of Banks ofthe Commonwealth of Massachusetts, the Federal Deposit Insurance Corporationand the National Association of Securities Dealers.

 

On April 23, 2002, the Board of Directors approved a two-for-one stocksplit in the form of a 100% stock dividend to stockholders of record as of May24, 2002.  All share numbers in thenotes to the unaudited condensed consolidated financial statements have beenrestated to reflect the two-for-one stock split paid June 14, 2002, whereapplicable.

 

**2.****                                     InterimFinancial****Statements**

 

The unaudited condensed consolidated interim financial statements ofthe Company and subsidiaries as of June 30, 2003 and December 31, 2002, and forthe six-month and three-month periods ended June 30, 2003 and 2002 have beenprepared by the Company pursuant to the rules and regulations of the Securitiesand Exchange Commission.  Certaininformation and footnote disclosures normally included in annual financialstatements prepared in accordance with accounting principles generally acceptedin the United States of America have been condensed or omitted as permitted bysuch rules and regulations.  Alladjustments, consisting of normal recurring adjustments, necessary for theirfair presentation in conformity with accounting principles generally acceptedin the United States of America (‘GAAP’) are included.  Management believes that the disclosures areadequate to present fairly the financial position, results of operations andcash flows at the dates and for the periods presented. It is suggested thatthese interim financial statements be read in conjunction with the financialstatements and the notes thereto included in the Company’s latest annual reporton Form 10-K. Results for interim periods are not necessarily indicative ofthose to be expected for the full fiscal year. Certain amounts in priorfinancial statements have been reclassified to conform to the currentpresentation.

 

8

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

 
|                                                                                                                                          |   | **For the  Six Months  Ended June 30,** |   | **For the  Three Months  Ended June 30,** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------|--------|-------------------------------------------|--------|
|                                                                                                                                          |   | **2003**                                |   | **2002**                                  |   | **2003** |   | **2002** |   |
|                                                                                                                                          |   |                                    |   |                                      |   |   |   |   |   |
| Net income as reported                                                                                                                        |   | $                                       | 33,432 |                                      | $      | 33,372 |   | $ | 28,020 |   | $ | 17,317 |   |
| Deduct: Total stock-based employee  compensation expense determined under fair value based method for all awards,  net of related tax effects |   | (3,504                                  | )      | (5,812                                    | )      | (1,820 | ) | (2,812 | ) |
| Pro forma net income                                                                                                                          |   | $                                       | 29,928 |                                      | $      | 27,560 |   | $ | 26,200 |   | $ | 14,505 |   |
|                                                                                                                                          |   |                                    |   |                                      |   |   |   |   |   |
| Earnings per share:                                                                                                                           |   |                                    |   |                                      |   |   |   |   |   |
| Basic-as reported                                                                                                                             |   | $                                       | 0.51   |                                      | $      | 0.52 |   | $ | 0.43 |   | $ | 0.27 |   |
| Basic-pro forma                                                                                                                               |   | 0.46                                    |   | 0.43                                      |   | 0.40 |   | 0.23 |   |
|                                                                                                                                          |   |                                    |   |                                      |   |   |   |   |   |
| Diluted-as reported                                                                                                                           |   | $                                       | 0.50   |                                      | $      | 0.50 |   | $ | 0.42 |   | $ | 0.26 |   |
| Diluted-pro forma                                                                                                                             |   | 0.45                                    |   | 0.41                                      |   | 0.40 |   | 0.22 |   |

 

The fair value of each option grant under the Amended and Restated 1995Stock Plan was estimated on the date of grant using the Black-Scholes valuationmodel with the following assumptions for the six months ended June 30, 2003 and2002, respectively: an average assumed risk-free interest rate of 2.17% and2.40%, an expected life of four years, an average expected volatility of 56.26%and 56.20%, and an average dividend yield of 0.23% and 0.22%.

 

For the three months ended June 30, 2003 and 2002, respectively, thefollowing assumptions were used in the Black-Scholes valuation model: anassumed risk-free interest rate of 2.04% and 2.40%, an expected life of fouryears, an expected volatility of 56.34% and 56.20%, and a dividend yield of0.21% and 0.22%.

 

***New AccountingPrinciples*** – The Company has adopted FASBInterpretation No. 45, *Guarantor’s Accounting and Disclosure Requirementsfor Guarantees, Including Indirect Guarantees of Indebtedness of Others.*  This interpretation elaborates ondisclosures to be made by a guarantor about its obligations and requiresrecognition of a liability for the fair value of the obligation undertaken inissuing guarantees. On behalf of its clients, the Company lends securities tocreditworthy broker-dealers.  In certaincircumstances, the Company may indemnify its clients for the fair market valueof those securities against a failure of the borrower to return suchsecurities.  The Company requires theborrowers to provide collateral in an amount equal to or in excess of 102% ofthe fair market value of U.S. dollar denominated securities borrowed and 105%of the fair market value of non-U.S. dollar denominated securitiesborrowed.  The borrowed securities arerevalued daily to determine if additional collateral is necessary.  As guarantor, the Company is required torecognize, at the inception of a guarantee, a liability for the fair value ofthe obligation undertaken in issuing the guarantee.  The Company measures the fair value of its indemnificationobligation by marking its securities lending portfolio to market on a dailybasis and compares the value of the portfolio to the collateral holdingsposition.  The fair value to be recordedwould be the deficiency of collateral to the value of the securities lendingportfolio.  At June 30, 2003, thecollateral received by the Company was in excess of the value of the securitiesthat the Company would be required to replace if the borrower defaulted andfailed to return such securities.  Therefore,the fair value of the indemnification obligation was zero.  The Company has recorded no liability forthe indemnification obligation.

 

9

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The Company has adopted SFAS No. 145, *Rescission of FASB Statements No. 4,44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.*  Among its provisions, this Statementrescinds Statement No. 4, *Reporting Gains and Losses from Extinguishment ofDebt*, and an amendment of that Statement, Statement No. 64, *Extinguishmentsof Debt Made to Satisfy Sinking-Fund Requirements*, and eliminatesthe extraordinary item treatment of reporting gains and losses fromextinguishments of debt.  During thethree months ended June 30, 2003, the Company recorded an early extinguishmentof $50 million of its Federal Home Loan Bank debt by replacing it with newdebt.  The Company recognized a $1.1million fee which has been classified in net interest expense.  The adoption of this Statement did not havea material impact on the Company’s financial position or results of operations.

 

The Company has adopted SFAS No. 146, *Accounting for Costs Associated withExit or Disposal Activities*. This Statement addresses financial accounting and reporting for costsassociated with exit or disposal activities by requiring that a liability for acost associated with an exit or disposal activity be recognized and measuredinitially at fair value only when the liability is incurred.  The adoption of this Statement did not havea material impact on the Company’s financial position or results of operations.

 

In April 2003, the FASB issued SFAS No. 149, *Amendment of Statement 133 onDerivative Instruments and Hedging Activities*. SFAS No. 149 amendsand clarifies financial accounting and reporting for derivative instruments,including certain derivative instruments embedded in other contracts and forhedging activities under SFAS No. 133, *Accounting for Derivative Instruments and HedgingActivities*, resulting in more consistent reporting of contracts aseither derivatives or hybrid instruments. SFAS No. 149 is effective for contracts entered into or modified afterJune 30, 2003, and should be applied prospectively.  The Company has evaluated its financial accounting and reportingmethods for all derivative instruments and has found them to be consistent withSFAS No. 149.

 

In May 2003, the FASB issued SFAS No. 150, *Accounting for Certain FinancialInstruments with Characteristics of both Liabilities and Equity*.SFAS No. 150 requires that an issuer classify a financial instrument that iswithin its scope as a liability (or an asset in some circumstances).  As the Statement relates to mandatorilyredeemable financial instruments, these instruments (or Capital Securities)should be classified as liabilities in the statement of financialposition.  Mandatorily redeemableinstruments should be recorded at fair value upon issuance.  Instruments in existence prior to theadoption of this standard that were originally issued at fair value should bereclassified to liabilities upon adoption of this standard.  No further fair value measurements should berequired.  Interest payments on theCapital Securities will need to be reclassified as a component of interestexpense.  This Statement is effectivefor financial instruments entered into or modified after May 31, 2003, andotherwise is effective at the beginning of the first interim period beginningafter June 15, 2003.  As the CapitalSecurities held by the Company were outstanding prior to the effectiveness ofthis Statement, this Statement is effective for the Company beginning July 1,2003, at which time the Company will be required to classify the CapitalSecurities as a liability.

 

10

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**3.****                                    ****Securities**

 

Amortized cost amounts and fair values of securities are summarized asfollows as of June 30, 2003 (Dollars in thousands):

 
| **Held to Maturity**             |   | **Amortized  Cost** |      | **Unrealized  Gains** |   | **Unrealized  (Losses)** |   | **Fair  Value** |    |
|----------------------------------|--------|---------------------|-----------|-----------------------|--------|--------------------------|--------|-----------------|---------|
|                             |   |                |      |                  |   |                     |   |            |    |
| Mortgage-backed securities       |   | $                   | 2,224,789 |                  | $      | 13,565                   |   | $               | (1,484  | ) | $ | 2,236,870 |   |
| Federal agency securities        |   | 1,670,852           |      | 1,623                 |   | (8,821                   | )      | 1,663,654       |    |
| State and political subdivisions |   | 125,250             |      | 8,847                 |   | —                   |   | 134,097         |    |
|                             |   |                |      |                  |   |                     |   |            |    |
| Total                            |   | $                   | 4,020,891 |                  | $      | 24,035                   |   | $               | (10,305 | ) | $ | 4,034,621 |   |

 
| **Available for Sale**           |   | **Amortized  Cost** |      | **Unrealized  Gains** |   | **Unrealized  (Losses)** |   | **Fair  Value** |   |
|----------------------------------|--------|---------------------|-----------|-----------------------|--------|--------------------------|--------|-----------------|--------|
|                             |   |                |      |                  |   |                     |   |            |   |
| Mortgage-backed securities       |   | $                   | 3,110,960 |                  | $      | 42,970                   |   | $               | (641   | ) | $ | 3,153,289 |   |
| State and political subdivisions |   | 310,647             |      | 24,700                |   | (81                      | )      | 335,266         |   |
| Corporate debt                   |   | 179,105             |      | 58                    |   | (4,107                   | )      | 175,056         |   |
| Federal agency securities        |   | 29,601              |      | 693                   |   | —                   |   | 30,294          |   |
|                             |   |                |      |                  |   |                     |   |            |   |
| Total                            |   | $                   | 3,630,313 |                  | $      | 68,421                   |   | $               | (4,829 | ) | $ | 3,693,905 |   |

 

Amortized cost amounts and fair values of securities are summarized asfollows as of December 31, 2002 (Dollars in thousands):

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

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

 

**4.****                                     Loans**

 

Loans consist of demand loans to custody clients of the Company,including individuals, not-for-profit institutions and mutual fund clients. Theloans to mutual funds and other pooled product clients include lines of creditand advances pursuant to the terms of the custody agreements between theCompany and those mutual fund clients to facilitate securities transactions andredemptions. Generally, the loans are, or may be, in the event of default,collateralized with marketable securities held by the Company as custodian.There were no impaired or nonperforming loans at June 30, 2003 and December 31,2002.  In addition, there

 

11

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were no loan charge-offs or recoveries during the six months ended June30, 2003 and the year ended December 31, 2002. Loans are summarized as follows(Dollars in thousands):

 
|                           |   | **June 30,  2003** |    | **December 31,  2002** |   |
|--------------------------------|--------|--------------------|---------|-----------------------------|--------|
| Loans to individuals           |   | $                  | 75,472  |                        | $      | 76,263 |   |
| Loans to mutual funds          |   | 28,911             |    | 49,372                      |   |
| Loans to others                |   | 22,420             |    | 18,202                      |   |
|                           |   | 126,803            |    | 143,837                     |   |
| Less allowance for loan losses |   | (100               | )       | (100                        | )      |
|                           |   |               |    |                        |   |
| Total                          |   | $                  | 126,703 |                        | $      | 143,737 |   |

 

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

 

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

 
|                                    |   | **June 30,  2003** |      | **December  31, 2002** |   |
|-----------------------------------------|--------|--------------------|-----------|------------------------|--------|
|                                    |   |               |      |                   |   |
| Repurchase agreements – short-term |   | $                  | 2,886,912 |                   | $      | 2,101,849 |   |
| Repurchase agreements – long-term  |   | 200,000            |      | 200,125                |   |
|                                    |   |               |      |                   |   |
| Total                                   |   | $                  | 3,086,912 |                   | $      | 2,301,974 |   |

 

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

 

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

 
|                                                  |   | **June 30,  2003** |    | **December  31,  2002** |   |
|-------------------------------------------------------|--------|--------------------|---------|-------------------------|--------|
|                                                  |   |               |    |                    |   |
| Federal Home Loan Bank of Boston overnight  advances  |   | $                  | 300,000 |                    | $      | 360,000 |   |
| Federal funds purchased – overnight              |   | 257,553            |    | 130,648                 |   |
| Federal Home Loan Bank of Boston long-term  advances  |   | 200,000            |    | 250,000                 |   |
| Federal Home Loan Bank of Boston short-term  advances |   | 100,000            |    | —                  |   |
| Federal funds purchased – short-term             |   | 30,000             |    | —                  |   |
| Treasury, Tax and Loan account                        |   | 371                |    | 459                     |   |
|                                                  |   |               |    |                    |   |
| Total                                                 |   | $                  | 887,924 |                    | $      | 741,107 |   |

 

The Company has a borrowing arrangement with the Federal Home Loan Bankof Boston (‘FHLBB’), which has been utilized on an overnight, short-term andlong-term basis to satisfy funding requirements.

 

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

 

The Company has three stock option plans: the Amended and Restated 1995Stock Plan (‘Stock Plan’), the Amended and Restated 1995 Non-Employee DirectorStock Option Plan (‘Director Plan’), and the 1997 Employee Stock PurchasePlan.  There have been no amendments tothese plans during the six months ended June 30, 2003.

 

12

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During the six months ended June 30, 2003, the following activityoccurred under the Director Plan and Stock Plan:

 
|                                      |   | **June 30,  2003** |   |
|-------------------------------------------|--------|--------------------|--------|
|                                      |   | **Shares**         |   | **Weighted-  Average  Exercise  Price** |   |
| Outstanding at December 31, 2002          |   | 6,621,157          |   | $ | 22 |   |
| Granted                                   |   | 67,384             |   | 23 |   |
| Exercised                                 |   | (347,425           | )      | 7 |   |
| Canceled                                  |   | (82,900            | )      | 31 |   |
| Outstanding at June 30, 2003              |   | 6,258,216          |   | $ | 23 |   |
|                                      |   |               |   |   |   |
| Outstanding and exercisable June 30, 2003 |   | 4,139,305          |   |   |   |

 

A summary of the 1997 Employee Stock Purchase Plan is as follows:

 
|                                                        |   | **For the  Six  Months Ended  June 30,  2003** | ** ** | **For the  Year Ended  December 31,  2002** | ** ** |
|-------------------------------------------------------------|--------|------------------------------------------------|------------|---------------------------------------------|------------|
| Total shares available under the Plan,  beginning of period |   | 356,875                                        |       | 500,764                                     |       |
| Issued at June 30                                           |   | (70,606                                        | )          | (61,193                                     | )          |
| Issued at December 31                                       |   | —                                         |       | (82,696                                     | )          |
|                                                        |   |                                           |       |                                        |       |
| Total shares available under the Plan, end  of period       |   | 286,269                                        |       | 356,875                                     |       |

 

For the six-month period ended June 30, 2003, the purchase price of thestock was $25.50, or 90% of the market value of the Common Stock on the firstbusiness day of the payment period ending June 30, 2003.

 

For the year ended December 31, 2002, the purchase price of the stockwas $30.00 and $24.75, or 90% of the market value of the Common Stock on thefirst business day of the payment period ending June 30, 2002 and the lastbusiness day of the period ending December 31, 2002, respectively.

 

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

 
|                                    |   | **For the  Six Months Ended  June 30,** |   | **For the  Three Months Ended  June 30,** |   |
|-----------------------------------------|--------|-----------------------------------------|--------|-------------------------------------------|--------|
|                                    |   | **2003**                                |   | **2002**                                  |   | **2003** |   | **2002** |   |
|                                    |   |                                    |   |                                      |   |   |   |   |   |
| Income available to common stockholders |   | $                                       | 33,432 |                                      | $      | 33,372 |   | $ | 28,020 |   | $ | 17,317 |   |
|                                    |   |                                    |   |                                      |   |   |   |   |   |
| Basic average shares                    |   | 64,958,192                              |   | 64,249,041                                |   | 65,029,738 |   | 64,312,901 |   |
| Dilutive effect of stock options        |   | 1,353,435                               |   | 2,304,103                                 |   | 1,271,681 |   | 2,279,235 |   |
| Diluted average shares                  |   | 66,311,627                              |   | 66,553,144                                |   | 66,301,419 |   | 66,592,136 |   |
|                                    |   |                                    |   |                                      |   |   |   |   |   |
| Earnings per share:                     |   |                                    |   |                                      |   |   |   |   |   |
| Basic                                   |   | $                                       | 0.51   |                                      | $      | 0.52 |   | $ | 0.43 |   | $ | 0.27 |   |
|                                    |   |                                    |   |                                      |   |   |   |   |   |
| Diluted                                 |   | $                                       | 0.50   |                                      | $      | 0.50 |   | $ | 0.42 |   | $ | 0.26 |   |

 

13

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There were 3,587,429 and 3,591,643 option shares which were notconsidered dilutive for purposes of earnings per share calculations for thesix-month and three-month periods ended June 30, 2003, respectively.

 

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

*** ***

***Lines of Credit*****—At June 30, 2003, the Company had commitments to individuals and mutual fundsunder collateralized open lines of credit totaling $859 million, against which$70 million in loans were drawn. The credit risk involved in issuing lines ofcredit is essentially the same as that involved in extending loan facilities.The Company does not anticipate any loss as a result of these lines of credit.

*** ***

***Securities Lending*****—On behalf of its clients, the Company lends securities to creditworthybroker-dealers.  In certaincircumstances, the Company may indemnify its clients for the fair market valueof those securities against a failure of the borrower to return suchsecurities.  The Company requires theborrowers to provide collateral in an amount equal to or in excess of 102% ofthe fair market value of U.S. dollar denominated securities borrowed and 105%of the fair market value of non-U.S. dollar denominated securitiesborrowed.  The borrowed securities arerevalued daily to determine if additional collateral is necessary.  As guarantor, the Company is required torecognize, at the inception of a guarantee, a liability for the fair value ofthe obligation undertaken in issuing the guarantee.  The Company measures the fair value of its indemnificationobligation by marking its securities lending portfolio to market on a dailybasis and compares the value of the portfolio to the collateral holdingsposition.  The fair value to be recordedwould be the deficiency of collateral to the value of the securities lendingportfolio.

 

With respect to the indemnified securities lending portfolio, the cashand U.S. government securities held by the Company as collateral at June 30,2003 totaled $3.5 billion while the fair value of the portfolio totaledapproximately $3.4 billion.  Given thatthe collateral held was in excess of the value of the securities that theCompany would be required to replace if the borrower defaulted and failed toreturn such securities, the Company’s indemnification obligation was zero andno liability was recorded.

 

All securities loans are categorized as overnight loans. The maximumpotential amount of future payments that the Company could be required to makewould be equal to the market value of the securities borrowed.  Since the securities loans areover-collateralized 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 anobligation if the security on loan increased in value between the time theborrower defaulted and the time the security is “bought-in.”  In such instances, the Company would“buy-in” the security using all available collateral and a loss would resultfrom the difference between the value of the security “bought-in” and the valueof the collateral held.  The Company hasnever experienced a broker default.

 

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

 

***Foreign ExchangeContracts*** - Foreign exchange contracts involve anagreement to exchange the currency of one country for the currency of anothercountry at an agreed-upon rate and settlement date.  Foreign exchange contracts consist of spot, forward and swap contracts.  Spot contracts call for the exchange of onecurrency for another and usually settle in two business days.  Forward contracts call for the exchange ofone currency for another at a date beyond spot.  In a currency swap, the holder of a currency transactssimultaneously both a spot and a forward transaction in that currency for anequivalent amount of another currency to get temporary liquidity in thecurrency owned.  Unrealized gains orlosses resulting from purchases and sales of foreign exchange contracts areincluded within the respective other assets and other liabilities categories onthe Company’s consolidated balance sheet. Unrealized gains in other assets were $5.3 million and $4.4 million asof June 30, 2003 and December 31, 2002, respectively.  Unrealized losses in other liabilities were $4.9 million and $4.5million as of June 30, 2003 and December 31, 2002, respectively.  These gains and losses were reduced byoffsetting balances with the same counterparty where a master netting agreementexists.  These contracts have not beendesignated as hedging instruments, therefore, all changes in fair value areincluded in

 

14

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asset servicing fees.  Thenotional values of the Company’s foreign exchange contracts as of June 30, 2003and December 31, 2002 were $0.9 billion and $0.7 billion, respectively.

 

***Interest-RateContracts*** - Interest rate contracts involve anagreement with a counterparty to exchange cash flows based on an underlyinginterest rate index.  A swap agreementinvolves the exchange of a series of interest payments, either at a fixed orvariable rate, based upon the notional amount without the exchange of theunderlying principal amount. The Company’s exposure from these interest rate contractsresults from the possibility that one party may default on its contractualobligation when the contracts are in a gain position. The Company hasexperienced no terminations by counterparties of interest rate swaps. Creditrisk is limited to the positive fair value of the derivative financialinstrument, which is significantly less than the notional value. The effect ofthese agreements was to lengthen short-term variable rate liabilities intolonger-term fixed rate liabilities. The contractual or notional amounts ofinterest rate swap agreements held by the Company were approximately $1.0billion at June 30, 2003 and December 31, 2002.  These contracts had no cost and the fair values wereapproximately $(28.6) million and $(33.1) million at June 30, 2003 and December31, 2002, respectively.  These fairvalues are included in the other liabilities category on the Company’sconsolidated balance sheet.  Theseinstruments have been designated as cash flow hedges.  Changes in fair value of effective portions are included as acomponent of other comprehensive income. Changes in fair value of ineffective portions are included in netinterest income.

 

***Other -***The Company also enters into fixed price purchase contracts that are designedto hedge the variability of the consideration to be paid for the purchase ofinvestment securities.  By entering intothese contracts, the Company is fixing the price to be paid at a future datefor certain investment securities. At June 30, 2003 and December 31, 2002, theCompany had $874.4 million and $432.6 million, respectively, of fixed pricepurchase contracts outstanding to purchase investment securities.  Changes in fair value of these cash flowhedges are included as a component of other comprehensive income.

 

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

 

***Restrictions on CashBalances***—The Company is required to maintaincertain average cash reserve balances. The average required reserve balancewith the Federal Reserve Bank (‘FRB’) for the two-week period including June30, 2003 was approximately $44.3 million. In addition, the Company’s other assets category includes depositstotaling approximately $27.0 million, which were pledged to secure clearingswith depository institutions.

 

***Contingencies***—TheCompany provides a broad range of services to financial asset managers, such asmutual fund complexes, investment advisors, banks and insurance companies.  Core services include global custody,multicurrency accounting and mutual fund administration.  Value-added services include securitieslending, foreign exchange, cash management, performance measurement,institutional transfer agency, investment advisory services, lines of creditand brokerage services.  Assets undercustody and management, held by the Company in a fiduciary capacity, are notincluded in the consolidated balance sheets since such items are not assets ofthe Company.  Management conductsregular reviews of its fiduciary responsibilities and considers the results inpreparing its consolidated financial statements.  In the opinion of management, there are no contingent liabilitiesat June 30, 2003 that are material to the consolidated financial position orresults of operations of the Company.

 

In March 2003, a change in tax law disallowed a dividends receiveddeduction taken by the Bank on dividends it had received since 1999 from awholly-owned real estate investment trust. As previously reported, in the first quarter of 2003 the Company accruedapproximately $13.9 million, net of federal income tax benefit, as a result ofthe change in accordance with GAAP.  Inthe second quarter of 2003, the Company settled this disputed tax issue withthe Massachusetts Department of Revenue, agreeing to pay approximately 50% ofthe liability.  As a result, the Companyreversed the previous tax accrual by approximately $6.7 million, net of federalincome taxes.  The Company’s incomestatements for the three and six month periods ended June 30, 2003 each reflecta reversal in the amount of $6.7 million, net of federal income taxes, of thetax accrual previously recorded.

 

15

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On January 31, 2003, the Company was named in a class action lawsuitalleging, among other things, violations of California wage and hour laws atour Sacramento and Walnut Creek facilities. The lawsuit was filed in the Superior Court of California, County ofSacramento. On July 23, 2003, we reached an agreement in principle withrepresentatives of the plaintiffs to settle the case. As currently agreed, thesettlement will not have a material impact on our business, financial conditionor results of operations.  Inanticipation of this settlement and related costs, the Company accrued aliability of approximately $1.0 million in the second quarter of 2003.

 

**11.****                              RegulatoryMatters**

 

The Company and the Bank are subject to various regulatory capitalrequirements administered by the federal banking agencies.  Failure to meet minimum capital requirementscan initiate certain mandatory and possibly additional discretionary actions byregulators that, if undertaken, could have a direct material adverse effect onthe Company’s and the Bank’s results of operations and financialcondition.  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 measures established by regulation to ensure capitaladequacy require the Company and the Bank to maintain minimum amounts andratios (set forth in the table below) of Total and Tier 1 capital (as definedin the regulations) to risk-weighted assets (as defined), and of Tier 1 capital(as defined) to average assets (as defined). Management believes, as of June30, 2003, that the Company and the Bank meet all capital adequacy requirementsto which they are subject.

 

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

 
|                                                       |   | **Actual** |    | **For  Capital  Adequacy Purposes** |       | **To Be Well  Capitalized  Under Prompt  Corrective Action  Provisions** |       |
|------------------------------------------------------------|--------|------------|---------|-------------------------------------|------------|--------------------------------------------------------------------------|------------|
|                                                       |   | **Amount** |    | **Ratio**                           | ** ** | **Amount**                                                               | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **As of June 30,  2003:**                                  |   |       |    |                                |       |                                                                     |       |   |   |   |   |   |   |
| Total Capital  (to Risk Weighted Assets—the Company)  |   | $          | 409,944 |                                | 18.07      | %                                                                        | $          | 181,511 |   | 8.00 | % | N/A |   | N/A |   |
| Total Capital  (to Risk Weighted Assets—the Bank)     |   | $          | 405,525 |                                | 17.89      | %                                                                        | $          | 181,334 |   | 8.00 | % | $ | 226,667 |   | 10.00 | % |
| Tier 1 Capital  (to Risk Weighted Assets—the Company) |   | $          | 409,844 |                                | 18.06      | %                                                                        | $          | 90,755 |   | 4.00 | % | N/A |   | N/A |   |
| Tier 1 Capital  (to Risk Weighted Assets—the Bank)    |   | $          | 405,425 |                                | 17.89      | %                                                                        | $          | 90,667 |   | 4.00 | % | $ | 136,000 |   | 6.00 | % |
| Tier 1 Capital  (to Average Assets—the Company)       |   | $          | 409,844 |                                | 5.15       | %                                                                        | $          | 318,561 |   | 4.00 | % | N/A |   | N/A |   |
| Tier 1 Capital  (to Average Assets—the Bank)          |   | $          | 405,425 |                                | 5.09       | %                                                                        | $          | 318,357 |   | 4.00 | % | $ | 397,946 |   | 5.00 | % |
|                                                       |   |       |    |                                |       |                                                                     |       |   |   |   |   |   |   |   |   |   |
| **As of December 31,  2002:**                              |   |       |    |                                |       |                                                                     |       |   |   |   |   |   |   |
| Total Capital  (to Risk Weighted Assets—the Company)  |   | $          | 374,102 |                                | 15.51      | %                                                                        | $          | 192,915 |   | 8.00 | % | N/A |   | N/A |   |
| Total Capital  (to Risk Weighted Assets—the Bank)     |   | $          | 369,498 |                                | 15.32      | %                                                                        | $          | 192,915 |   | 8.00 | % | $ | 241,143 |   | 10.00 | % |
| Tier 1 Capital  (to Risk Weighted Assets—the Company) |   | $          | 374,002 |                                | 15.51      | %                                                                        | $          | 96,457 |   | 4.00 | % | N/A |   | N/A |   |
| Tier 1 Capital  (to Risk Weighted Assets—the Bank)    |   | $          | 369,398 |                                | 15.32      | %                                                                        | $          | 96,457 |   | 4.00 | % | $ | 144,686 |   | 6.00 | % |
| Tier 1 Capital  (to Average Assets—the Company)       |   | $          | 374,002 |                                | 5.50       | %                                                                        | $          | 272,132 |   | 4.00 | % | N/A |   | N/A |   |
| Tier 1 Capital  (to Average Assets—the Bank)          |   | $          | 369,398 |                                | 5.43       | %                                                                        | $          | 272,104 |   | 4.00 | % | $ | 340,130 |   | 5.00 | % |

 

Under Massachusetts law, trust companies such as the Bank, likenational banks, may pay dividends no more often than quarterly, and only out of“net profits” and to the extent that such payments will not impair the Bank’scapital stock and surplus account. Moreover, prior approval of the Commissionerof Banks of the Commonwealth of Massachusetts is required if the totaldividends for a calendar year would exceed net profits for that year combinedwith retained net profits for the previous two 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 the Company’s securities broker affiliate, InvestorsSecurities Services, Inc., are subject to federal and state securities laws, aswell as the rules of both the Securities and Exchange Commission and theNational Association of Securities Dealers, Inc.  Management believes, as of June 30, 2003, that InvestorsSecurities Services, Inc. met all regulatory requirements to which it issubject.

 

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**12.****                               GeographicReporting**

 

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

 
|                        |   | **Net  Operating Revenue**              |    | **Long-Lived  Assets**                    |   |
|-----------------------------|--------|-----------------------------------------|---------|-------------------------------------------|--------|
|                        |   | **For the  Six Months Ended  June 30,** |    | **For the  Three Months Ended  June 30,** |   | **June 30,  2003** |   | **December  31,  2002** |   |
| **Geographic Information:** |   | **2003**                                |    | **2002**                                  |   | **2003** |   | **2002** |   |   |   |
|                        |   |                                    |    |                                      |   |   |   |   |   |   |   |   |   |
| United States               |   | $                                       | 225,096 |                                      | $      | 208,838 |   | $ | 116,286 |   | $ | 106,197 |   | $ | 153,173 |   | $ | 154,060 |   |
| Ireland                     |   | 8,391                                   |    | 5,446                                     |   | 4,633 |   | 2,988 |   | 6,012 |   | 773 |   |
| Canada                      |   | 807                                     |    | 1,042                                     |   | 379 |   | 508 |   | 4 |   | 5 |   |
| Cayman Islands              |   | 38                                      |    | 42                                        |   | 21 |   | 21 |   | — |   | — |   |
|                        |   |                                    |    |                                      |   |   |   |   |   |   |   |   |   |
| Total                       |   | $                                       | 234,332 |                                      | $      | 215,368 |   | $ | 121,319 |   | $ | 109,714 |   | $ | 159,189 |   | $ | 154,838 |   |

 

Barclays Global Investors, N.A. (‘BGI’) accounted for approximately 16%of the Company’s consolidated net operating revenues for the six month periodsended June 30, 2003 and 2002.  For thethree month periods ended June 30, 2003 and 2002, BGI accounted forapproximately 16% and 17%, respectively, of consolidated net operatingrevenues.

 

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INDEPENDENTACCOUNTANTS’ REPORT

 

To the Board of Directors and Stockholders of

Investors Financial Services Corp.

Boston, Massachusetts

 

We have reviewed the accompanying condensed consolidated balance sheetof Investors Financial Services Corp. and subsidiaries (the “Company”) as ofJune 30, 2003, and the related condensed consolidated statements of income andcomprehensive income for the three-month and six-month periods ended June 30,2003 and 2002, and the consolidated stockholders’ equity and cash flows for thesix-month periods ended June 30, 2003 and 2002.  These interim financial statements are the responsibility of theCompany’s management.

 

We conducted our review in accordance with standards established by theAmerican Institute of Certified Public Accountants.  A review of interim financial information consists principally ofapplying analytical procedures and making inquiries of persons responsible forfinancial and accounting matters.  It issubstantially less in scope than an audit conducted in accordance with auditingstandards generally accepted in the United States of America, the objective ofwhich is the expression of an opinion regarding the financial statements takenas a whole.  Accordingly, we do notexpress such an opinion.

 

Based on our reviews, we are not aware of any material modificationsthat should be made to such condensed consolidated interim financial statementsfor them to be in conformity with accounting principles generally accepted inthe United States of America.

 

We have previously audited, in accordance with auditing standardsgenerally accepted in the United States of America, the consolidated balancesheet of Investors Financial Services Corp. and subsidiaries as of December 31,2002, and the related consolidated statements of income and comprehensiveincome, stockholders’ equity and cash flows for the year then ended (notpresented herein); and in our report dated February 14, 2003, we expressed anunqualified opinion on those consolidated financial statements.  In our opinion, the information set forth inthe accompanying condensed consolidated balance sheet as of December 31, 2002is fairly stated, in all material respects, in relation to the consolidatedbalance sheet from which it has been derived.

 

DELOITTE & TOUCHE LLP

Boston, Massachusetts

# August 1, 2003

#  

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

 

**Overview**

 

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

 

We provide a broad range of services to a variety of financial assetmanagers.  These include our coreservices of global custody, multicurrency accounting and mutual fundadministration, as well as our value-added services, which are securitieslending, foreign exchange, cash management, performance measurement,institutional transfer agency, investment advisory services, lines of creditand brokerage services.  At June 30,2003, we provided services for approximately $897 billion in net assets,including approximately $104 billion of foreign net assets.

 

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

 

On January 31, 2003, we were named in a class action lawsuit alleging,among other things, violations of California wage and hour laws at ourSacramento and Walnut Creek facilities. The lawsuit was filed in the SuperiorCourt of California, County of Sacramento. On July 23, 2003, we reachedagreement in principle with representatives of the plaintiffs to settle thecase.  As currently agreed, thesettlement will not have a material impact on our financial condition orresults of operations.  The settlementis subject to preliminary approval by the court, proper administration ofpayments to the class members and final approval by the court. In anticipationof this settlement and related costs, we accrued a liability of approximately$1.0 million in the second quarter of 2003.

 

In March 2003,a change in tax law disallowed a dividends received deduction taken by the Bankon dividends it had received since 1999 from a wholly-owned real estateinvestment trust (‘REIT’).  Aspreviously reported, in the first quarter of 2003 we accrued approximately$13.9 million, net of federal income tax benefit, as a result of the change inaccordance with GAAP.  In the secondquarter of 2003, we settled this disputed tax issue with the MassachusettsDepartment of Revenue (‘DOR’), agreeing to pay approximately 50% of theliability.  As a result, we reversed theprevious tax accrual by approximately $6.7 million, net of federal incometaxes.  Our income statements for thethree and six month periods ended June 30, 2003 each reflect a reversal in theamount of $6.7 million, net of federal income taxes, of the tax accrual previouslyrecorded.

 

On June 27,2003, we and an individual employee of ours were named in a lawsuit alleging,among other things, that we breached an implied covenant of good faith and fairdealing in a sub-advisory contract with Opus Investment Management, Inc.(‘Opus’) and that our individual employee engaged in a breach of fiduciaryduties and tortious interference with a contract.  Opus had been a sub-adviser to the Merrimac Funds, for which weact as investment adviser.  Upon theexpiration of Opus’ contract on June 1, 2003, the Merrimac Funds elected not tore-appoint Opus as sub-adviser.  Thelawsuit was filed in Superior Court in Worcester, Massachusetts and seeksunspecified damages.  We believe thatthe claims are without merit and intend to defend our rights vigorously.

 

On July 31,2003, we finalized the outsourcing of fund accounting, custody and relatedservices for Barclays Global Investors Canada, Ltd. Giving effect to thetransaction as of June 30, 2003 would have increased our assets processed to$919 billion.

 

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**Revenueand Expense Overview**

 

We derive our revenue from financial asset servicing.  Although interest income and noninterestincome are reported separately for financial statement presentation purposes,our service offerings are priced on a bundled basis.  In establishing a fee structure for a specific client, managementanalyzes all expected revenue and related expenses.  Accordingly, we believe net operating revenue (net interest incomeplus noninterest income) and net income are the most meaningful measures of ourfinancial results. Net operating revenue increased 9% and 11% to$234.3 million and $121.3 million from $215.4 million and $109.7 millionfor the six months and three months ended June 30, 2003 and 2002,respectively.  Net income remainedsteady at $33.4 million for the six months ended June 30, 2003 and 2002.  For the three months ended June 30, 2003,net income was $28.0 million, up 62% from $17.3 million for the same period in2002.

 

Net operating income for the six months ended June 30, 2003 was $40.6million, up 22% from $33.4 million for the same period in 2002.  Net operating income for the three monthsended June 30, 2003 was $21.3 million, up 23% from $17.3 million for the sameperiod in 2002.  Net operating incomefor the six months ended June 30, 2003 excludes the net effect of the firstquarter 2003 tax accrual and its later partial reversal resulting from oursettlement with the DOR, as discussed above. Net operating income for the three months ended June 30, 2003 excludesthe partial reversal of a previously recorded tax accrual arising from aretroactive change in Massachusetts tax law enacted during the first quarter of2003, as discussed above.  During 2003,the Company ceased taking the deduction for dividends paid by the REIT and theeffect of this action will increase the effective tax rate to approximately31.5% for the year.  Managementconsiders net operating income to be a more useful depiction of our actualresults of operations.

 

The following table represents a reconciliation between earningspresented on the face of our Statement of Income and earnings on a netoperating income basis:

 

**GAAP Earnings**

** **
|                                          |   | **For the  Six Months Ended  June 30,** |   | **For the  Three Months Ended  June 30,** |   |
|-----------------------------------------------|--------|-----------------------------------------|--------|-------------------------------------------|--------|
|                                          |   | **2003**                                |   | **2002**                                  |   | **2003** |   | **2002** |   |
|                                          |   |                                    |   |                                      |   |   |   |   |   |
| Income before taxes and minority interest     |   | $                                       | 60,174 |                                      | $      | 48,896 |   | $ | 31,608 |   | $ | 25,350 |   |
| Provision for income taxes                    |   | 25,980                                  |   | 14,730                                    |   | 3,207 |   | 7,636 |   |
| Minority interest expense, net of income  tax |   | 762                                     |   | 794                                       |   | 381 |   | 397 |   |
| Net Income                                    |   | $                                       | 33,432 |                                      | $      | 33,372 |   | $ | 28,020 |   | $ | 17,317 |   |
| Earnings per share:                           |   |                                    |   |                                      |   |   |   |   |   |
| Basic                                         |   | $                                       | 0.51   |                                      | $      | 0.52 |   | $ | 0.43 |   | $ | 0.27 |   |
|                                          |   |                                    |   |                                      |   |   |   |   |   |
| Diluted                                       |   | $                                       | 0.50   |                                      | $      | 0.50 |   | $ | 0.42 |   | $ | 0.26 |   |

 

**Operating Earnings**

** **
|                                          |   | **For the  Six Months Ended  June 30,** |   | **For the  Three Months Ended  June 30,** |   |
|-----------------------------------------------|--------|-----------------------------------------|--------|-------------------------------------------|--------|
|                                          |   | **2003**                                |   | **2002**                                  |   | **2003** |   | **2002** |   |
|                                          |   |                                    |   |                                      |   |   |   |   |   |
| Income before taxes and minority interest     |   | $                                       | 60,174 |                                      | $      | 48,896 |   | $ | 31,608 |   | $ | 25,350 |   |
| Provision for income taxes                    |   | 18,780                                  | (1)    | 14,730                                    |   | 9,907 | (2) | 7,636 |   |
| Minority interest expense, net of income  tax |   | 762                                     |   | 794                                       |   | 381 |   | 397 |   |
| Net Income                                    |   | $                                       | 40,632 |                                      | $      | 33,372 |   | $ | 21,320 |   | $ | 17,317 |   |
| Earnings per share:                           |   |                                    |   |                                      |   |   |   |   |   |
| Basic                                         |   | $                                       | 0.63   |                                      | $      | 0.52 |   | $ | 0.33 |   | $ | 0.27 |   |
|                                          |   |                                    |   |                                      |   |   |   |   |   |
| Diluted                                       |   | $                                       | 0.61   |                                      | $      | 0.50 |   | $ | 0.32 |   | $ | 0.26 |   |

 

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(1)          Provision for the sixmonths ended June 30, 2003 excludes a tax accrual of $13.9 million related to aretroactive tax law change by the Commonwealth of Massachusetts disallowing a95% dividends received deduction on dividends that the Bank received from itswholly-owned REIT and excludes the subsequent reversal of $6.7 million of theprovision, net of federal taxes, due to the settlement of our REIT tax disputewith the DOR.  The effect of theexclusions is an increase in net income of $0.11 per diluted share and $0.12per basic share.

 

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(2)          Provision for the threemonths ended June 30, 2003 excludes the reversal of $6.7 million of income taxbenefit, net of federal taxes, due to the settlement of our REIT tax disputewith the DOR. The effect of the exclusion is a decrease in net income of $0.10per diluted and basic share.

 

Noninterest income consists primarily of fees for financial assetservicing and is principally derived from global custody, multicurrencyaccounting, mutual fund administration and institutional transfer agencyservices for financial asset managers and the assets they control. Our clientspay fees based on the volume of assets processed, portfolio transactions, incomecollected and whether other value-added services such as foreign exchange,securities lending and cash management are needed.  Asset-based fees are usually charged on a sliding scale and aresubject to minimum fees.  As such, whenthe assets in a portfolio under custody grow as a result of changes in marketvalues or cash inflows, our fees may be a smaller percentage of thoseassets.  Conversely, as asset valuesfall, our revenue decreases by the marginal rate charged on our sliding scalepricing model.  As a result, as assetvalues decrease, fees will decrease, but at a smaller percentage than the assetvalue decrease.

 

Net interest income represents the difference between income frominterest-earning assets and expense on interest-bearing liabilities. Ourclients, in the course of their financial asset management, maintain cashbalances, which they can deposit with us on a short-term basis ininterest-bearing accounts.  We eitherdirectly invest these cash balances to earn interest income, or place thesedeposits in third-party vehicles and remit a portion of the earnings on theseinvestments to our clients.  Our shareof earnings from these investments is viewed as part of the total compensationthat our clients pay us for servicing their assets.

 

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

 

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

 

# **Critical Accounting Policies**

 

Accounting policies involving significant judgments and assumptions bymanagement, which have, or could have, a material impact on both the carryingvalue of certain assets and net income, are considered critical accountingpolicies.  We consider the following tobe our critical accounting policies: derivatives, valuation of goodwill,capitalized costs of software developed for internal use, other than temporaryimpairment of securities, accounting for stock options, and revenuerecognition.  There have been nosignificant changes in the methods or assumptions used in the accountingpolicies that required material estimates and assumptions during the six monthsended June 30, 2003.  Senior managementhas discussed these critical accounting policies with the audit committee andthe auditors.

 

# *Derivatives*

 

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

 

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rate liabilities.  By entering into apay-fixed/receive-floating interest rate swap, a portion of our floating rateliabilities are effectively converted to a fixed rate liability for the term ofthe interest rate swap agreement.  Thisassists us in matching our fixed rate assets with funding sources with similarmaturities, which is an integral component of our asset liability strategy.  We also enter into fixed price purchasecontracts that are designed to hedge the variability of the consideration to bepaid for the purchase of investment securities.  By entering into these contracts, we are fixing the price to bepaid at a future date for certain investment securities.

 

All derivatives, whether designated in hedging relationships or not,are required to be recorded on the balance sheet at fair value.  If the derivative is designated as a fairvalue hedge, the change in the fair value of the derivative and the item beinghedged will be recognized in earnings. If the derivative is designated as a cash flow hedge, the effectiveportions of changes in the fair value of the derivative are recorded as acomponent of other comprehensive income. Ineffective portions of changes in the fair value of the derivatives arerecognized in earnings.  For derivativesthat do not qualify as hedges changes in fair value are recognized in earnings.

 

We measure the changes in fair value of our hedge-designatedderivatives against the changes in expected cash flows of the underlying hedgedtransactions for each reporting period. This process involves the estimation of the expected future cash flowsof hedged transactions.  Interest rateswaps are valued using a nationally recognized swap valuation model.  The LIBOR (London Interbank Offered Rate)curve in this model serves as the basis for computing the market value of theswap portfolio.  If interest ratesincrease, the swaps would gain in value. Conversely, if interest rates decrease there would be a correspondingdecline in the market value of the swaps portfolio.  Changes in conditions or the occurrence of unforeseen eventscould affect the timing of the recognition of changes in fair value of certainhedging derivatives.  The measurement offair value is based upon market values; however, in the absence of quotedmarket values, measurement involves valuation estimates.  These estimates are based on methodologiesdeemed appropriate in the circumstances. However, the use of alternative assumptions could have a significanteffect on estimated fair values.

 

Hedge ineffectiveness had an insignificant impact on earnings for thesix months ended June 30, 2003.   AtJune 30, 2003, the contractual or notional amounts of our interest rate swapagreements were approximately $1.0 billion. These derivatives have a fair value of approximately $(28.6) million andare included in the other liabilities category of our consolidated balancesheet.  These swaps have been designatedas cash flow hedges and changes in fair value are recognized in othercomprehensive income.

 

At June 30, 2003, we had $874.4 million of fixed price purchasecontracts outstanding to purchase investments. There was no associated unrealized gain or loss for these purchasecontracts.   These contracts have beendesignated as cash flow hedges and changes in fair value are recognized inother comprehensive income.

 

We also enterinto foreign exchange contracts with clients and seek to enter into matchedpositions with another bank.  These contractsare subject to market valuations in foreign currencies.  Gains and losses from such fluctuations arenetted and recorded as an adjustment to asset servicing fees.  Unrealized gains or losses resulting frompurchases and sales of foreign exchange contracts are included within therespective other assets and other liabilities categories on our consolidatedbalance sheet.  Unrealized gains inother assets were $5.3 million and unrealized losses in other liabilities were$4.9 million at June 30, 2003.  Theforeign exchange contracts have been reduced by balances with the samecounterparty where a master netting agreement exists.  These contracts have not been designated as hedginginstruments.  Therefore, all changes infair value are included in asset servicing fees.

 

# *Valuation ofgoodwill*

 

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

 

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*Capitalized costs of software developed forinternal use*

 

Costs of internally developed software, such as those related tosoftware licenses, programming, testing, configuration and integration, arecapitalized and included in equipment and leasehold improvements.  Assets are placed in service and depreciationand/or amortization commences when successful testing has been achieved.  Capitalized software costs are amortizedover the estimated useful life of a given project, which approximate threeyears.  These assets are reviewed on anongoing basis for compliance with accounting standards.  In addition, management periodically reviewscapitalized costs for impairment. Significant judgment is exercised in these impairment reviews includingthe periodic evaluation of the cost/benefit analyses of software projects underdevelopment and in the determination of the remaining useful life of thecompleted projects.

 

# *Other than temporaryimpairment*

 

On a quarterly basis, we evaluate our investment portfolio to determinewhether there are any other than temporary impairment valuation issues.  This analysis is performed by comparingquoted market prices to amortized cost and evaluating each identified securitywhose market value is less than amortized cost for a sustained period of time.Our accounting policy requires recognition of an other than temporaryimpairment charge on a security if it is determined that we are unable torecover all amounts due under the contractual obligations of the security.  Management uses its best estimate regardingthe estimated future payments on the contractual obligation by reviewingchanges in security ratings and evaluating the financial performance of theunderlying issuer.

 

# *Accounting for stockoptions*

 

We measure compensation cost for stock-based plans using the intrinsicvalue method. The intrinsic value method measures compensation cost as thedifference between the exercise price of options granted and the fair marketvalue of our stock at the measurement date, which is generally the date ofgrant. Generally, options granted have an exercise price equivalent to the fairmarket value at the measurement date. Accordingly, no compensation cost has been recorded.  Alternatively, we could choose to recordcompensation expense using the fair value method.  The fair value method utilizes significant assumptions such as volatility,expected life of the option, risk-free interest rates as well as a dividendyield in a Black-Scholes valuation model to calculate the amount ofcompensation expense.  Under the fairvalue method, the compensation expense calculated is recognized over thevesting period of the options.  Theexpected life of an option and the volatility of the underlying stock determinea majority of the value of an option and its ultimate compensation cost.  As such, the longer the option life or thehigher the volatility of the underlying stock, the higher the value of theoption and the higher the related compensation cost to us.   If we had recognized compensation expenseunder the fair value method, compensation expense relating to stock optionswould have been $3.5 million and $1.8 million for the six months and threemonths ended June 30, 2003.

 

# *Revenue recognition*

 

We recognize revenue from asset servicing and investment advisoryservices based on contractual terms signed by our clients.  Generally, revenue is accrued by multiplyingaverage or month-end net assets by contracted rates.  Revenue is considered earned daily as transactions are processedor services are provided and is accrued monthly.   We recognize revenue from our value-added services, such as foreignexchange, securities lending and cash management services based on the specifictype of transaction volume.  Value-addedservice revenue is earned daily as transactions are processed or services areprovided and is accrued monthly. Revenue on interest earning assets is recognized based on the effectiveyield of the financial instrument.

 

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

 

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**CertainFactors That May Affect Future Results**

 

From time to time, information provided by us, statements made by ouremployees, or information included in our filings with the SEC (including thisForm 10-Q) may contain statements which are not historical facts, so-called“forward-looking statements,” and which involve risks and uncertainties.  These statements relate to future events orour future financial performance and are identified by words such as “may,”“will,” “could,” “should,” “expect,” “plan,” “intend,” “seek,” “anticipate,”“believe,” “estimate,” “potential,” or “continue” or other comparable terms orthe negative of those terms. Forward-looking statements in this Form 10-Q include certain statementsregarding liquidity, interest rate conditions, interest rate sensitivity, lossexposure on lines of credit, the timing and effect on earnings of derivativegains and losses, the effect on earnings of changes in equity values, and theeffect 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 below.  Each of these factors,and others, are discussed from time to time in our filings with the SEC.

 

*Our operating results are subject to fluctuations in interest rates andthe securities markets.*

 

We base some of our fees on the market value of the assets weprocess.  Accordingly, our operatingresults are subject to fluctuations in interest rates and securities markets asthese fluctuations affect the market value of assets processed.  Current market conditions, including therecent volatility in equity markets, can have a material effect on ourasset-based fees.  While reductions inasset servicing fees may be offset by increases in other sources of revenue, asustained downward movement of the broad equity markets will have an adverseimpact on our earnings.  Fluctuations ininterest rates or the securities markets can also lead to investors seekingalternatives to the investment offerings of our clients, which could result ina lesser amount of assets processed and correspondingly lower fees.  Also, our net interest income is earned byinvesting depositors’ funds and making loans. Rapid changes in interest rates and flattening of the yield curve couldadversely affect the market value of, or the earnings produced by, ourinvestment and loan portfolios, and could adversely affect our operatingresults.

 

*A material portion of our revenues is derived from our relationshipwith Barclays Global Investors, N.A. (‘BGI’).*

 

As a result of our assumption of the operations of the U.S. assetadministration unit of BGI in 2001 and our ongoing relationship with BGI’siShares and Master Investment Portfolios, BGI accounted for approximately 16%of our net operating revenue during the six months and three months ended June30, 2003.  We expect that BGI willcontinue to account for a significant portion of our net operatingrevenue.  While we provide services toBGI under long-term contracts, those contracts may be terminated for certainregulatory and fiduciary reasons.  Theloss of BGI’s business would cause our net operating revenue to decline andwould have a material adverse effect on our quarterly and annual results.  We were recently selected by Barclays GlobalInvestors Canada to service approximately $22 billion in assets.

 

*We face significant competition from other financial servicescompanies, which could negatively affect our operating results.*

 

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

 

*We may incur significant costs defending legal claims.*

 

We have been named in a lawsuit in Massachusetts state court alleging,among other things, violations of a covenant of good faith and fair dealing ina contract. While we believe this claim is without merit, we cannot be surethat we will prevail in the defense of this claim.  Litigation is costly and could divert the attention ofmanagement.  We may become subject toother legal claims in the future.

 

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*Our future results depend, in part, on successful integration ofpending and possible future acquisitions and outsourcing transactions.*

 

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

 

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

 

We have been experiencing a period of rapid growth that has requiredthe dedication of significant management and other resources. Continued rapidgrowth could place a strain on our management and other resources.  To manage future growth effectively, we mustcontinue to invest in our operational, financial and other internal systems,and our human resources.

 

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

 

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

 

*We may not be able to protect our proprietary technology.*

 

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

 

*Our quarterly and annual operating results may fluctuate.*

 

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

 

•                                          Thetiming of commencement or termination of client engagements;

 

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

 

•                                          Rapidchanges in interest rates and equity values.

 

Most of our expenses, like employee compensation and rent, arerelatively fixed.  As a result, anyshortfall in revenue relative to our expectations could significantly affectour operating results.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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**Results of Operations**

 

*Comparison of Operating Results for the SixMonths and the Three Months Ended June 30, 2003 and 2002*

 

*NetOperating Revenue*

 

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

 
|                        |   | **For the  Six Months Ended June 30,** |    | **For the  Three Months Ended June 30,** |   |
|-----------------------------|--------|----------------------------------------|---------|------------------------------------------|--------|
|                        |   | **2003**                               |    | **2002**                                 |   | **Change** |   | **2003** |   | **2002** |   | **Change** |   |
|                        |   |                                   |    |                                     |   |   |   |   |   |   |   |   |   |
| Net interest income         |   | $                                      | 77,537  |                                     | $      | 70,117 |   | 11 | % | $ | 38,168 |   | $ | 34,380 |   | 11 | % |
| Noninterest income          |   | 156,795                                |    | 145,251                                  |   | 8 | % | 83,151 |   | 75,334 |   | 10 | % |
|                        |   |                                   |    |                                     |   |   |   |   |   |   |   |   |   |
| Total net operating revenue |   | $                                      | 234,332 |                                     | $      | 215,368 |   | 9 | % | $ | 121,319 |   | $ | 109,714 |   | 11 | % |

 

*Net Interest Income*

 

Net interest income is affected by the volume and mix of assets andliabilities, and the movement and level of interest rates. The table belowpresents the change in net interest income resulting from change in the volumeof interest-earning assets or interest-bearing liabilities and change ininterest rates for the six months and three months ended June 30, 2003 comparedto the same periods in 2002. Changes attributed to both volume and rate havebeen allocated based on the proportion of change in each category (Dollars inthousands):

 
|                                                                 |   | **For the  Six Months Ended June 30, 2003** |   | **For the  Three Months Ended June 30, 2003** |   |
|----------------------------------------------------------------------|--------|---------------------------------------------|--------|-----------------------------------------------|--------|
|                                                                 |   | **Change  Due to  Volume**                  |   | **Change  Due to  Rate**                      |   | **Net** |   | **Change  Due to  Volume** |   | **Change  Due to  Rate** |   | **Net** |   |
|                                                                 |   |                                        |   |                                          |   |   |   |   |   |   |   |   |   |
| **Interest-earning assets:**                                         |   |                                        |   |                                          |   |   |   |   |   |   |   |   |   |
| Federal funds sold and securities purchased  under resale agreements |   | $                                           | 44     |                                          | $      | (69 | ) | $ | (25 | ) | $ | 77 |   | $ | (51 | ) | $ | 26 |   |
| Investment securities                                                |   | 32,730                                      |   | (32,152                                       | )      | 578 |   | 16,379 |   | (17,726 | ) | (1,347 | ) |
| Loans                                                                |   | 190                                         |   | (373                                          | )      | (183 | ) | 148 |   | (174 | ) | (26 | ) |
|                                                                 |   |                                        |   |                                          |   |   |   |   |   |   |   |   |   |
| Total interest-earning assets                                        |   | $                                           | 32,964 |                                          | $      | (32,594 | ) | $ | 370 |   | $ | 16,604 |   | $ | (17,951 | ) | $ | (1,347 | ) |
|                                                                 |   |                                        |   |                                          |   |   |   |   |   |   |   |   |   |
| **Interest-bearing  liabilities:**                                   |   |                                        |   |                                          |   |   |   |   |   |   |   |   |   |
| Deposits                                                             |   | $                                           | 6,127  |                                          | $      | (8,923 | ) | $ | (2,796 | ) | $ | 3,819 |   | $ | (5,138 | ) | $ | (1,319 | ) |
| Borrowings                                                           |   | 6,297                                       |   | (10,551                                       | )      | (4,254 | ) | 2,561 |   | (6,377 | ) | (3,816 | ) |
|                                                                 |   |                                        |   |                                          |   |   |   |   |   |   |   |   |   |
| Total interest-bearing liabilities                                   |   | $                                           | 12,424 |                                          | $      | (19,474 | ) | $ | (7,050 | ) | $ | 6,380 |   | $ | (11,515 | ) | $ | (5,135 | ) |
|                                                                 |   |                                        |   |                                          |   |   |   |   |   |   |   |   |   |
| Change in net interest income                                        |   | $                                           | 20,540 |                                          | $      | (13,120 | ) | $ | 7,420 |   | $ | 10,224 |   | $ | (6,436 | ) | $ | 3,788 |   |

 

Net interest income was $77.5 million for the six months endedJune 30, 2003, up 11% from the same period in 2002, primarily due to a decreasein interest expense, as funding costs are down.  Net interest income was $38.2 million for the three monthsended June 30, 2003, also up 11% from the same period in 2002. This improvementin net interest income reflects the same lower funding costs.  The effect of changes in volume ofinterest-earning assets and interest-bearing liabilities was an increase in netinterest income of approximately $20.5 million and $10.2 million for thesix months and three months ended June 30, 2003, respectively.

 

As indicated in the net interest margin table below, the average yieldon interest-earning assets was 3.45% for the six months ended June 30, 2003,down 107 basis points from the same period in 2002. The average rate paid oninterest-bearing liabilities was 1.36% for the six months ended June 30, 2003, down74 basis points from the same period in 2002. These decreases reflect the lowerinterest rate environment for the six months ended June 30, 2003 compared to 

 

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the same period in 2002. The average yield on interest-earning assetswas 3.33% for the three months ended June 30, 2003, down 113 basis points fromthe same period in 2002.  The averagerate paid on interest-bearing liabilities was 1.36% for the three months endedJune 30, 2003, down 84 basis points from the same period in 2002. Again, thesedecreases reflect the lower rate environment for the three months ended June30, 2003. The effect on net interest income due to changes in rates for the sixmonths and three months ended June 30, 2003 was a decrease of $13.1 million and$6.4 million, respectively.

 

The net interest margin decreased 42 basis points to 2.20% anddecreased 37 basis points to 2.08% for the six months and three months endedJune 30, 2003, respectively, compared to the same periods last year.  As the yield curve flattened during thequarter, our net interest margin continued to compress.  During the quarter, mortgage rates hithistoric lows and refinancings rose, resulting in prepayments of the existingmortgage-backed securities that we hold. Since the quarter ended, the yield curve has steepened, however, weexpect high pre-payments to continue into the third quarter.  These proceeds are reinvested at currentmarket rates which remain at a lower yield than those for the same period oneyear ago.  Overall, our asset yieldshave declined more rapidly than liability costs due to already low competitiveinterest rates paid on our deposits.

 

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

 
|                                                                 |   | **Six Months  Ended June 30, 2003** |      | **Six Months  Ended June 30, 2002** |   |
|----------------------------------------------------------------------|--------|-------------------------------------|-----------|-------------------------------------|--------|
|                                                                 |   | **Average  Balance**                |      | **Interest**                        |   | **Average  Yield/Cost** |   | **Average  Balance** |   | **Interest** |   | **Average  Yield/Cost** |   |
| **Interest earning  assets:**                                        |   |                                |      |                                |   |   |   |   |   |   |   |   |   |
| Federal funds sold and securities purchased  under resale agreements |   | $                                   | 30,790    |                                | $      | 182 |   | 1.18 | % | $ | 24,652 |   | $ | 207 |   | 1.68 | % |
| Investment securities (1)                                            |   | 6,893,885                           |      | 119,594                             |   | 3.47 | % | 5,229,213 |   | 119,016 |   | 4.55 | % |
| Loans                                                                |   | 118,775                             |      | 1,778                               |   | 2.99 | % | 107,614 |   | 1,961 |   | 3.64 | % |
| Total interest-earning assets                                        |   | 7,043,450                           |      | 121,554                             |   | 3.45 | % | 5,361,479 |   | 121,184 |   | 4.52 | % |
| Allowance for loan losses                                            |   | (100                                | )         |                                |   |   |   | (100 | ) |   |   |   |   |
| Noninterest-earning assets                                           |   | 611,129                             |      |                                |   |   |   | 333,483 |   |   |   |   |   |
|                                                                 |   |                                |      |                                |   |   |   |   |   |   |   |   |   |
| Total assets                                                         |   | $                                   | 7,654,479 |                                |   |   |   |   | $ | 5,694,862 |   |   |   |   |   |
| **Interest bearing  liabilities:**                                   |   |                                |      |                                |   |   |   |   |   |   |   |   |   |
| Deposits:                                                            |   |                                |      |                                |   |   |   |   |   |   |   |   |   |
| Demand                                                               |   | $                                   | —    |                                | $      | — |   | — |   | $ | 1,660 |   | $ | 4 |   | 0.48 | % |
| Savings                                                              |   | 2,314,517                           |      | 18,231                              |   | 1.58 | % | 1,707,024 |   | 20,999 |   | 2.46 | % |
| Time                                                                 |   | —                              |      | —                              |   | — |   | 2,809 |   | 24 |   | 1.71 | % |
| Securities sold under repurchase agreements                          |   | 3,261,185                           |      | 15,415                              |   | 0.95 | % | 2,313,610 |   | 15,257 |   | 1.32 | % |
| Other borrowings (2)                                                 |   | 887,063                             |      | 10,371                              |   | 2.34 | % | 832,958 |   | 14,783 |   | 3.55 | % |
| Total interest-bearing liabilities                                   |   | 6,462,765                           |      | 44,017                              |   | 1.36 | % | 4,858,061 |   | 51,067 |   | 2.10 | % |
| Noninterest-bearing liabilities:                                     |   |                                |      |                                |   |   |   |   |   |   |   |   |   |
| Demand deposits                                                      |   | 247,829                             |      |                                |   |   |   | 201,633 |   |   |   |   |   |
| Savings                                                              |   | 129,590                             |      |                                |   |   |   | 83,032 |   |   |   |   |   |
| Noninterest-bearing time deposits                                    |   | 93,950                              |      |                                |   |   |   | 90,000 |   |   |   |   |   |
| Other liabilities                                                    |   | 229,250                             |      |                                |   |   |   | 65,092 |   |   |   |   |   |
| Total liabilities                                                    |   | 7,163,384                           |      |                                |   |   |   | 5,297,818 |   |   |   |   |   |
| Trust preferred stock                                                |   | 23,309                              |      |                                |   |   |   | 24,281 |   |   |   |   |   |
| Equity                                                               |   | 467,786                             |      |                                |   |   |   | 372,763 |   |   |   |   |   |
|                                                                 |   |                                |      |                                |   |   |   |   |   |   |   |   |   |
| Total liabilities and equity                                         |   | $                                   | 7,654,479 |                                |   |   |   |   | $ | 5,694,862 |   |   |   |   |   |
| Net interest income                                                  |   |                                |      | $                                   | 77,537 |   |   |   |   |   | $ | 70,117 |   |   |   |
| Net interest margin (3)                                              |   |                                |      |                                |   | 2.20 | % |   |   |   |   | 2.62 | % |
| Average interest rate spread (4)                                     |   |                                |      |                                |   | 2.09 | % |   |   |   |   | 2.42 | % |
|                                                                 |   |                                |      |                                |   |   |   |   |   |   |   |   |   |
| Ratio of interest-earning assets to  interest-bearing liabilities    |   |                                |      |                                |   | 108.99 | % |   |   |   |   | 110.36 | % |

 

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

(2)                                  Interestexpense includes prepayment fees of $1.1 million and $2.8 million for 2003 and2002, respectively.

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

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

 

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*Noninterest Income*

 

Noninterestincome was $156.8 million for the six months ended June 30, 2003, up 8% fromthe same period in 2002, and was $83.2 million for the three months ended June30, 2003, up 10% from the same period in 2002. Noninterest income consists of the following items (Dollars inthousands):

 
|                                   |   | **For the Six Months Ended  June 30, 2002** |    | **For the Three Months Ended  June 30, 2002** |   |
|----------------------------------------|--------|---------------------------------------------|---------|-----------------------------------------------|--------|
|                                   |   | **2003**                                    |    | **2002**                                      |   | **Change** |   | **2003** |   | **2002** |   | **Change** |   |
| Asset servicing fees:                  |   |                                        |    |                                          |   |   |   |   |   |   |   |   |   |
| Custody, accounting and administration |   | $                                           | 118,838 |                                          | $      | 115,192 |   | 3 | % | $ | 62,078 |   | $ | 59,317 |   | 5 | % |
| Foreign exchange                       |   | 16,823                                      |    | 11,037                                        |   | 52 | % | 10,090 |   | 6,181 |   | 63 | % |
| Cash management                        |   | 10,667                                      |    | 7,946                                         |   | 34 | % | 5,632 |   | 3,752 |   | 50 | % |
| Securities lending                     |   | 4,842                                       |    | 6,243                                         |   | (22 | )% | 2,654 |   | 3,605 |   | (26 | )% |
| Investment advisory                    |   | 3,578                                       |    | 3,596                                         |   | (1 | )% | 1,635 |   | 1,878 |   | (13 | )% |
| Other service fees                     |   | 619                                         |    | 107                                           |   | 479 | % | 404 |   | 55 |   | 635 | % |
| Total asset servicing fees             |   | 155,367                                     |    | 144,121                                       |   | 8 | % | 82,493 |   | 74,788 |   | 10 | % |
|                                   |   |                                        |    |                                          |   |   |   |   |   |   |   |   |   |
| Other operating income                 |   | 1,428                                       |    | 1,130                                         |   | 26 | % | 658 |   | 546 |   | 21 | % |
|                                   |   |                                        |    |                                          |   |   |   |   |   |   |   |   |   |
| Total noninterest income               |   | $                                           | 156,795 |                                          | $      | 145,251 |   | 8 | % | $ | 83,151 |   | $ | 75,334 |   | 10 | % |

 

Assetservicing fees for the six months ended June 30, 2003 increased 8% to $155.4million and increased 10% to $82.5 million for the three months ended June 30,2003 from the same periods in 2002.  Thelargest components of asset servicing fees are custody, accounting andadministration, which are based in part on assets processed.  Assets processed is the total dollar valueof financial assets on the reported date for which we provide global custody ormulticurrency accounting.  Total netassets processed at June 30, 2003 increased $112 billion to $897 billion comparedto $785 billion at December 31, 2002, and increased $113 billion from $784billion at March 31, 2003.  The changein net assets processed includes the following components (Dollars inbillions):

 
|                                    |   | **For the  Six Months Ended  June 30, 2003** |   | **For the  Three Months Ended  June 30, 2003** |   |
|-----------------------------------------|--------|----------------------------------------------|--------|------------------------------------------------|--------|
| Further penetration of existing clients |   | $                                            | 9      |                                           | $      | 5 |   |
| Lost clients                            |   | (2                                           | )      | (2                                             | )      |
| Fund flows and market appreciation      |   | 105                                          |   | 110                                            |   |
| Net change in assets processed          |   | $                                            | 112    |                                           | $      | 113 |   |

 

Our ability to win business and the ability of our clients to selladditional product, thus generating fund flows, along with a more positivecapital market environment during the second quarter of 2003 has allowed us togrow asset servicing fees by 8% and 10%, respectively.

 

Transaction-driven income includes our ancillary services, such asforeign exchange, cash management and securities lending. Foreign exchange feeswere $16.8 million for the six months ended June 30, 2003, up 52% from the sameperiod in 2002, and were $10.1 million for the three months ended June 30,2003, up 63% from the same period in 2002. The increases in foreign exchange fees are attributable to furtherpenetration of existing clients, the addition of new clients, highertransaction volumes and increased volatility within the currencies traded byour clients.  Cash management fees were$10.7 million for the six months ended June 30, 2003, up 34% from the sameperiod in 2002. Cash management fees were $5.6 million for the three monthsended June 30, 2003, up 50% from the same period in 2002. These increases areprimarily due to increased client balances. Securities lending fees were $4.8 million for the six months ended June30, 2003, down 22% from the same period in 2002, and were $2.7 million for thethree months ended June 30, 2003, down 26% from the same period in 2002 due todecreases in volume in 2003 and lower rates earned on cash collateral.  Investment advisory service fees were $3.6million for the six months ended June 30, 2003, flat compared to the sameperiod in 2002, and were $1.6 million for the three months ended June 30, 2003,down 13% compared to the same period in 2002 due to lower average assetbalances in the Merrimac Master Portfolio, an investment company for which weact as advisor.  Other services fees were$0.6 million for the six months ended June 30, 2003, up 479% from the sameperiod in 2002, and were $0.4 million for the three months ended June 30, 2003,up 635% from the same period in 2002. The increases were primarily attributed to commission income earned fromthe Company’s broker-dealer subsidiary, which began operations in late 2002.

 

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Other operating income consists of dividends received relating to theFederal Home Loan Bank of Boston (‘FHLBB’) stock investment and miscellaneousfees for systems consulting services. The increases in other operating income for the six and three monthperiods ended June 30, 2003 were largely the result of a client systemsdevelopment project.

 

*Operating Expenses*

 

Total operating expenses were $174.2 million for the six months endedJune 30, 2003, up 5% from the same period in 2002. For the three months endedJune 30, 2003, total operating expenses were $89.7 million, up 6% from the sameperiod in 2002.  The components ofoperating expenses were as follows (Dollars in thousands):

 
|                              |   | **For the Six Months Ended June 30,** |    | **For the Three Months Ended June 30,** |   |
|-----------------------------------|--------|---------------------------------------|---------|-----------------------------------------|--------|
|                              |   | **2003**                              |    | **2002**                                |   | **Change** |   | **2003** |   | **2002** |   | **Change** |   |
|                              |   |                                  |    |                                    |   |   |   |   |   |   |   |   |   |
| Compensation and benefits         |   | $                                     | 100,735 |                                    | $      | 98,868 |   | 2 | % | $ | 50,964 |   | $ | 48,938 |   | 4 | % |
| Technology and telecommunications |   | 18,850                                |    | 20,066                                  |   | (6 | )% | 9,559 |   | 10,104 |   | (5 | )% |
| Transaction processing services   |   | 16,339                                |    | 17,314                                  |   | (6 | )% | 9,531 |   | 9,825 |   | (3 | )% |
| Occupancy                         |   | 14,530                                |    | 11,406                                  |   | 27 | % | 7,205 |   | 5,643 |   | 28 | % |
| Depreciation and amortization     |   | 12,685                                |    | 6,639                                   |   | 91 | % | 6,606 |   | 3,503 |   | 89 | % |
| Professional fees                 |   | 3,741                                 |    | 3,216                                   |   | 16 | % | 2,062 |   | 1,538 |   | 34 | % |
| Travel and sales promotion        |   | 2,068                                 |    | 2,754                                   |   | (25 | )% | 1,083 |   | 1,520 |   | (29 | )% |
| Other operating expenses          |   | 5,210                                 |    | 6,209                                   |   | (16 | )% | 2,701 |   | 3,293 |   | (18 | )% |
|                              |   |                                  |    |                                    |   |   |   |   |   |   |   |   |   |
| Total operating expenses          |   | $                                     | 174,158 |                                    | $      | 166,472 |   | 5 | % | $ | 89,711 |   | $ | 84,364 |   | 6 | % |
|                                   |        |                                       |         |                                         |        |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Compensation and benefits expense was $100.7 million for the sixmonths ended June 30, 2003, relatively flat compared to the same period lastyear due to controlled headcount and lower capitalized software developmentcosts in 2003. Compensation and benefits expense was $51.0 million for thethree months ended June 30, 2003, also relatively flat compared to the sameperiod in 2002 due to controlled headcount offset by higher managementincentive accruals due to the continued strong performance of the Company.  Technology and telecommunications expensewas $18.9 million for the six months ended June 30, 2003, down 6% from the sameperiod in 2002, and was $10.0 million for the three months ended June 30, 2003,down 5% from the same period in 2002. These decreases were the result of BGI integration costs experienced in2002 but not in 2003.  Transactionprocessing services expense was $16.3 million for the six months ended June 30,2003, down 6% from the same period in 2002, and was $9.5 million for the threemonths ended June 30, 2003, down 3% from the same period in 2002.  These decreases were primarily the result ofthe conversion of BGI to our subcustodian system in late 2002.  Occupancy expense was $14.5 million forthe six months ended June 30, 2003, up 27% from the same period in 2002, andwas $7.2 million for the three months ended June 30, 2003, up 28% from thesame period in 2002.  These increaseswere primarily due to increased space in our Boston and Dublin offices tosupport the growth of our business. Depreciation and amortization expense was$12.7 million for the six months ended June 30, 2003, up 91% from the sameperiod in 2002, and was $6.6 million for the three months ended June 30,2003, up 89% from the same period in 2002. These increases resulted fromcompletion of capitalized software projects in late 2002 and 2003 and theirplacement into service.  Other operatingexpenses, including travel and sales promotion, decreased significantly due tostrict management of discretionary expenses.

 

*Income Taxes*

 

Taxes for the six months ended June 30, 2003 were $26.0 million, upfrom $14.7 million for the same period in 2002.  For the three months ended June 30, 2003, taxes were $3.2million, down from $7.6 million for the same period in 2002.  During the first quarter of 2003, theCompany recorded a $13.9 million tax liability, net of federal benefit, due toa retroactive tax law change disallowing a dividends received deduction on thedistributions paid to the Bank from Investors Funding Corp., a REIT 99.9% ownedby the Bank.  During the second quarterof 2003, the Company settled the tax matter with the DOR and agreed to pay approximately50% of the recorded liability, reversing $6.7 million, net of federal taxes, ofthe tax liability.  The net effect ofthe tax law change for the six months ended June 30, 2003 is an increase intaxes of $7.2 million or $0.10 per diluted share.

 

Our effective tax rate for the six months ended June 30, 2003 was31.2%, exclusive of the accrual and partial reversal for the tax settlementagreement relating to the REIT matter, compared to an effective rate of 30.1%for the

 

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same period in 2002. Oureffective tax rate for the three months ended June 30, 2003 was 31.3%,exclusive of the partial reversal for the tax settlement agreement, compared toan effective rate of 30.1% for the same period in 2002. During 2003, theCompany ceased taking the deduction for dividends paid by the REIT and theeffect of this action will increase the effective tax rate to approximately31.5% for the year.

 

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**Financial Condition**

 

Total assetsincreased $1.1 billion, or 16%, to $8.4 billion at June 30, 2003 from $7.2billion at December 31, 2002.  Assetgrowth is primarily attributable to increases in the held to maturity andavailable for sale investment portfolios, specifically mortgage-backed andfederal agency securities, and to an outstanding balance of securitiespurchased under resale agreements at June 30, 2003. Average interest-earningassets for both the six months and three months ended June 30, 2003 increased$1.7 billion, or 31%, compared to the same periods last year.  Funding for our asset growth was provided bya combination of an increase in client balances of approximately $1.2 billionand external borrowings of approximately $0.6 billion for both the six monthsand three months ended June 30, 2003.

 

*Investment Portfolio*

 

Our investment portfolio is comprised of securities of state andpolitical subdivisions (‘municipal securities’), mortgage-backed securitiesissued by the Federal National Mortgage Association (‘FNMA’ or ‘Fannie Mae’),the Federal Home Loan Mortgage Corporation (‘FHLMC’ or ‘Freddie Mac’) and theGovernment National Mortgage Association (‘GNMA’ or ‘Ginnie Mae’), Federalagency bonds, securities issued by the Small Business Administration (‘SBA’),corporate debt securities and securities issued by the Federal Home Loan Bankof Boston.  Our investment portfolio isused to invest depositors’ funds and is a component of our asset processingbusiness.  In addition, we use theinvestment portfolio to secure open positions at securities clearinginstitutions in connection with our custody services.

 

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

 
|                                                  |   | **June 30,  2003** |      | **December  31,  2002** |   |
|-------------------------------------------------------|--------|--------------------|-----------|-------------------------|--------|
| **Securities held to  maturity (at amortized cost):** |   |               |      |                    |   |
| Mortgage-backed securities                            |   | $                  | 2,224,789 |                    | $      | 2,034,430 |   |
| Federal agency securities                             |   | 1,670,852          |      | 1,287,238               |   |
| State and political subdivisions                      |   | 125,250            |      | 117,021                 |   |
|                                                  |   |               |      |                    |   |
| Total securities held to maturity                     |   | $                  | 4,020,891 |                    | $      | 3,438,689 |   |
|                                                  |   |               |      |                    |   |
| **Securities  available for sale (at fair value):**   |   |               |      |                    |   |
| Mortgage-backed securities                            |   | $                  | 3,153,289 |                    | $      | 2,759,793 |   |
| State and political subdivisions                      |   | 335,266            |      | 307,292                 |   |
| Corporate debt                                        |   | 175,056            |      | 174,499                 |   |
| Federal agency securities                             |   | 30,294             |      | 30,881                  |   |
|                                                  |   |               |      |                    |   |
| Total securities available for sale                   |   | $                  | 3,693,905 |                    | $      | 3,272,465 |   |

 

The overall increases in the held to maturity and available for saleportfolios are attributable to investing excess cash and borrowed funds toeffectively utilize the Bank’s capital. Our held to maturity portfolio increased $582 million or 17% to $4.0billion at June 30, 2003 from $3.4 billion at December 31, 2002.  As we continue to grow our balance sheet, wepurchase investment securities that will protect our net interest margin whilemaintaining an acceptable risk profile. The increase in the held to maturity portfolio stems primarily frompurchases of Federal agency securities, particularly those issued by theSBA.  SBA securities provide anattractive yield with limited credit risk and prepayment risk in a rapidlychanging interest rate environment.  Theweighted average life of the SBA securities match with our overall assetliability strategy.  SBA securities arevariable rate securities indexed to the Prime rate and are purchased with anintent and ability to hold to maturity.

 

Our availablefor sale portfolio increased $421 million or 13% to $3.7 billion at June 30,2003 from $3.3 billion at December 31, 2002. The increase in the available for sale portfolio is primarily due to anincrease in mortgage-backed securities, which increased $393 million or14%.  In an effort to maintain the netinterest margin, we have increased our position in mortgage-backed securities.  Mortgage-backed securities provide a higheryield than U.S. Treasury securities due to credit and prepayment risk and alsooffer a match to our short-term liabilities

 

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when combined with our interestrate contracts.  Refer to the gapanalysis under “Market Risk” below for additional details regarding thematching of our interest-earning assets and interest-bearing liabilities.

 

We also invest in municipal securities to generate stable, taxadvantaged income.  Municipal securitiesgenerally have lower stated yields than Federal agency and U.S. Treasurysecurities, but the after-tax yields at current tax rates are morefavorable.  Municipal securities aresubject to credit risk.  However, allmunicipal securities that we invest in are insured and are rated AAA.

 

The average balanceof our combined investment portfolio for the six months ended June 30, 2003 was$6.9 billion, with an average yield of approximately 3.47%, compared to anaverage balance of $5.2 billion and an average approximate yield of 4.55% forthe same period last year.  The averagebalance of our combined investment portfolio for the three months ended June30, 2003 was $7.2 billion, with an average yield of approximately 3.35%,compared to an average balance of $5.5 billion and an average approximate yieldof 4.49% for the same period last year.

 

*Loan Portfolio*

 

Our loan portfolio decreased $17 million, or 12%, to $127 million atJune 30, 2003 from $144 million at December 31, 2002. The overall decrease inthe loan portfolio is primarily attributable to the decrease in the volume ofclient overdrafts from December 31, 2002 to June 30, 2003. The balance ofclient overdraft loans at June 30, 2003 was $53 million compared to $73 millionat December 31, 2002.  These extensionsof credit are secured by freely tradable securities held in custody by us forthe borrower.

 

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

 

At June 30, 2003, our only lending concentrations that exceeded 10% oftotal loan balances were the lines of credit to mutual fund clients discussedabove.  These loans were made in theordinary course of business on the same terms and conditions prevailing at thetime for comparable transactions.

 

Our credit loss experience has been excellent.  There have been no loan charge-offs in ourhistory.  It is our policy to place aloan on nonaccrual status when either principal or interest becomes60 days past due and the loan’s collateral is not sufficient to cover bothprincipal and accrued interest.  As ofJune 30, 2003, there were no loans on nonaccrual status, no loans greater than90 days past due, and no troubled debt restructurings.  Although virtually all of our loans arefully collateralized with freely tradable securities, management recognizessome credit risk inherent in the loan portfolio, and has recorded an allowancefor loan losses of $0.1 million at June 30, 2003.  This amount is not allocated to anyparticular loan, but is intended to absorb any risk of loss inherent in the loanportfolio. Management actively monitors the loan portfolio and the underlyingcollateral and regularly assesses the adequacy of the allowance for loanlosses.

 

*Repurchase Agreements and Short-Term andOther Borrowings*

 

Asset growthwas primarily funded by increased securities sold under repurchase agreementsand other borrowings.  Repurchaseagreements increased $785 million, or 34%, to $3.1 billion at June 30, 2003from $2.3 billion at December 31, 2002. We use repurchase agreements, including client repurchase agreements,because they provide a more favorable source of funding than other short-termborrowings in terms of the cost of these borrowings.  The average balance of securities sold under repurchaseagreements for the six months ended June 30, 2003 was $3.3 billion with anaverage cost of approximately 0.95%, compared to an average balance of $2.3billion and an average cost of approximately 1.32% for the same period lastyear. The average balance of securities sold

 

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under repurchase agreements forthe three months ended June 30, 2003 was $3.4 billion with an average cost ofapproximately 0.94%, compared to an average balance of $2.5 billion and anaverage cost of approximately 1.34% for the same period last year.

 

Short-term and other borrowings increased $147 million, or 20%, to $0.9billion at June 30, 2003 from $0.7 billion at December 31, 2002.  We use advances to offset variability ofdeposit flow.  The average balance ofshort-term and other borrowings for the six months ended June 30, 2003 was $0.9billion with an average cost of approximately 2.34%, compared to an averagebalance of $0.8 billion and an average cost of approximately 3.55% for the sameperiod last year. The average balance of short-term and other borrowings forthe three months ended June 30, 2003 and 2002 was $0.9 billion with an averagecost of approximately 2.55% and 3.97%, respectively.

 

The average cost of borrowing for the three and six months ended June30, 2003 included a $1.1 million prepayment fee due to an asset-liabilitystrategy in which we prepaid a high yielding borrowing with a new borrowing ata lower rate and purchased assets with a similar maturity to lock inspread.  We employed the same strategyin the second quarter of 2002, in which the average cost for the three monthsended June 30, 2002 included a $2.8 million prepayment fee.

 

**Market Risk**

 

We engage in investment activities to accommodate clients’ cashmanagement needs and to contribute to overall corporate earnings.  Our clients, in the course of theirfinancial asset management, maintain cash balances, which they can deposit withus on a short-term basis in interest-bearing accounts.  We either directly invest these cashbalances to earn interest income, or place these deposits in third-party vehiclesand remit a portion of the earnings on these investments to our clients. In theconduct of these activities, we are subject to market risk.  Market risk is the risk of an adversefinancial impact from changes in market prices and interest rates.  The level of risk we assume is a function ofour overall strategic objectives and liquidity needs, client requirements andmarket volatility.

 

The active management of market risk is integral to ouroperations.  The objective of interestrate sensitivity management is to provide sustainable net interest revenueunder various economic conditions.  Wemanage the structure of interest-earning assets and interest-bearingliabilities by adjusting their mix, yield, maturity and/or repricingcharacteristics, based on market conditions. Since client deposits and repurchase agreements, our primary sources offunds, are predominantly short-term, we maintain a generally short-termstructure for our interest-earning assets. We also use term borrowings and interest rate swap agreements to augmentour management of interest rate exposure. The effect of the swap agreements is to lengthen short-termvariable-rate liabilities into longer-term fixed-rate liabilities.

 

Our Board of Directors has set asset and liability management policiesthat define the overall framework for managing interest rate sensitivity,including accountabilities and controls over investment activities.  These policies delineate investment limitsand strategies that are appropriate, given our liquidity and regulatoryrequirements.  For example, we haveestablished a policy limit stating that projected net interest income over thenext 12 months will not be reduced by more than 10% given a change in interestrates of up to 200 basis points (+ or -) over 12 months.  Each quarter, our Board of Directors reviewsour asset and liability positions, including simulations of the effect ofvarious interest rate scenarios on our capital.  Due to current interest rate levels, the Company’s Board ofDirectors has approved a temporary exception to the 10% limit for decreases ininterest rates.  The Board of Directorsapproved the policy exception because, with the Federal Funds target ratecurrently at 1.00%, a 200 basis point further reduction would move rates into anegative position and is therefore not likely to occur.

 

Our Board of Directors has delegated day-to-day responsibility foroversight of the Asset and Liability Management function to our Asset andLiability Committee (‘ALCO’).  ALCO is asenior management committee consisting of the Chief Executive Officer, thePresident, the Chief Financial Officer, the Chief Risk Officer and members ofthe Treasury function. ALCO meets twice monthly.  Our primary tool in managing interest rate sensitivity is anincome simulation model. Key assumptions in the simulation model include thetiming of cash flows, maturities and repricing of financial instruments,changes in market conditions, capital planning and deposit sensitivity.  The model assumes that the composition ofour interest-sensitive assets and liabilities existing at the beginning of aperiod will change periodically over the period being measured.  The model also assumes that a particularchange in interest rates is reflected uniformly across the yield curve regardlessof the duration to maturity or repricing of specific assets andliabilities.  These assumptions areinherently uncertain, and as a result, the model cannot precisely predict theeffect of

 

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changes in interest rates onour net interest income.  Actual resultsmay differ from simulated results due to the timing, magnitude and frequency ofinterest rate changes and changes in market conditions and managementstrategies.

 

The results of the income simulation model as of June 30, 2003 and 2002indicated that an upward shift of interest rates by 200 basis points wouldresult in a reduction in projected net interest income of 6.61% and 4.56%,respectively.  A downward shift of 200basis points would result in a decrease in projected net interest income of17.50% and 14.34% at June 30, 2003 and 2002, respectively.  As discussed above, a 200 basis pointreduction would move some rates into a negative position, which is not likelyto occur, therefore, those interest rates were lowered to zero for purposes ofthe income simulation model.

 

We also use gap analysis as a secondary tool to manage our interestrate sensitivity.  Gap analysis involvesmeasurement of the difference in asset and liability repricing on a cumulativebasis within a specified time frame.  Apositive gap indicates that more interest-earning assets than interest-bearingliabilities mature in a time frame, and a negative gap indicates the opposite.  By seeking to minimize the amount of assetsand liabilities that could reprice in the same time frame, we attempt to reducethe risk of significant adverse effects on net interest income caused byinterest rate changes.  As shown in thetable below, at June 30, 2003, interest-bearing liabilities repriced fasterthan interest-earning assets in the short term, as has been typical forus.  Generally speaking, fallinginterest rates would lead to net interest income that is higher than it wouldhave been; rising rates would lead to lower net interest income.  However, at the current absolute level ofinterest rates, lower interest rates may also lead to lower net interest incomedue to a diminished ability to lower the rates paid on interest-bearingliabilities, including certain client funds, as rates approach zero.  Other important determinants of net interestincome are rate levels, balance sheet growth and mix, and interest ratespreads.

 

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The followingtable presents the repricing schedule of our interest-earning assets andinterest-bearing liabilities at June 30, 2003 (Dollars in thousands):

 
|                                                                                   |   | **Within  Three  Months** |       | **Three to  Six  Months** |   | **Six to  Twelve  Months** |   | **One Year  to  Five Years** |    | **Over Five  Years** |   | **Total** |   |
|----------------------------------------------------------------------------------------|--------|---------------------------|------------|---------------------------|--------|----------------------------|--------|------------------------------|---------|----------------------|--------|-----------|--------|
|                                                                                   |   |                      |       |                      |   |                       |   |                         |    |                 |   |      |   |
| Interest-earning assets(1):                                                            |   |                      |       |                      |   |                       |   |                         |    |                 |   |      |   |
| Investment securities (2,3)                                                            |   | $                         | 4,036,420  |                      | $      | 560,298                    |   | $                            | 886,432 |                 | $      | 1,693,846 |   | $ | 347,495 |   | $ | 7,524,491 |   |
| Federal funds sold and securities purchased  under resale agreements                   |   | 110,000                   |       | —                    |   | —                     |   | —                       |    | —               |   | 110,000   |   |
| Loans—variable rate                                                               |   | 126,791                   |       | —                    |   | —                     |   | —                       |    | —               |   | 126,791   |   |
| Loans—fixed rate                                                                  |   | 12                        |       | —                    |   | —                     |   | —                       |    | —               |   | 12        |   |
| Total interest-earning assets                                                          |   | $                         | 4,273,223  |                      | $      | 560,298                    |   | $                            | 886,432 |                 | $      | 1,693,846 |   | $ | 347,495 |   | $ | 7,761,294 |   |
| Interest-bearing liabilities:                                                          |   |                      |       |                      |   |                       |   |                         |    |                 |   |      |   |
| Savings accounts                                                                       |   | $                         | 2,687,251  |                      | $      | —                     |   | $                            | —  |                 | $      | 25,334    |   | $ | — |   | $ | 2,712,585 |   |
| Interest rate contracts                                                                |   | (970,000                  | )          | 90,000                    |   | 180,000                    |   | 700,000                      |    | —               |   | —    |   |
| Securities sold under repurchase agreements                                            |   | 2,886,912                 |       | —                    |   | —                     |   | 200,000                      |    | —               |   | 3,086,912 |   |
| Short-term and other borrowings                                                        |   | 687,924                   |       | —                    |   | —                     |   | 200,000                      |    | —               |   | 887,924   |   |
| Total interest-bearing liabilities                                                     |   | $                         | 5,292,087  |                      | $      | 90,000                     |   | $                            | 180,000 |                 | $      | 1,125,334 |   | $ | — |   | $ | 6,687,421 |   |
| Net interest-sensitivity gap during the  period                                        |   | $                         | (1,018,864 | )                         | $      | 470,298                    |   | $                            | 706,432 |                 | $      | 568,512   |   | $ | 347,495 |   | $ | 1,073,873 |   |
| Cumulative gap                                                                         |   | $                         | (1,018,864 | )                         | $      | (548,566                   | )      | $                            | 157,866 |                 | $      | 726,378   |   | $ | 1,073,873 |   |   |   |
| Interest-sensitive assets as a percent of  interest sensitive liabilities (cumulative) |   | 80.75                     | %          | 89.81                     | %      | 102.84                     | %      | 110.86                       | %       | 116.06               | %      |      |   |
| Interest-sensitive assets as a percent of  total assets (cumulative)                   |   | 51.15                     | %          | 57.86                     | %      | 68.47                      | %      | 88.74                        | %       | 92.90                | %      |      |   |
|                                                                                   |   |                      |       |                      |   |                       |   |                         |    |                 |   |      |   |
| Net interest-sensitivity gap as a percent  of total assets                             |   | (12.20                    | )%         | 5.63                      | %      | 8.46                       | %      | 6.81                         | %       | 4.16                 | %      |      |   |
| Cumulative gap as a percent of total assets                                            |   | (12.20                    | )%         | (6.57                     | )%     | 1.89                       | %      | 8.69                         | %       | 12.85                | %      |      |   |

 

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(1)                                  Adjustable rateassets are included in the period in which interest rates are next scheduled toadjust 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 theireffective maturity.

(3)                                  Excludes $190 millionof unsettled securities purchases as of June 30, 2003.

 

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**Liquidity**

 

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

 

Our primary sources of liquidity include cash and cash equivalents,Federal Funds sold, new deposits, securities sold under repurchase agreements,short-term borrowings, interest payments on securities held to maturity andavailable for sale, and fees collected from asset administration clients.  As a result of our management of liquid assetsand the ability to generate liquidity through funding, management believes thatwe maintain overall liquidity sufficient to meet our depositors’ needs, tosatisfy our operating requirements and to fund the payment of an anticipatedannual cash dividend of $0.06 per share for 2003 (approximately$3.9 million based upon 65,138,599 shares outstanding as of June 30,2003).

 

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

 

We have informal borrowing arrangements with variouscounterparties.  Each counterparty hasagreed to make funds available to us at the Federal funds overnight rate.  The aggregate amount of these borrowingarrangements as of June 30, 2003 was $1.9 billion.  Each bank may terminate its arrangement atany time and is under no contractual obligation to provide us with requestedfunding.  Our borrowings under thesearrangements are typically on an overnight basis.  We cannot be certain, however, that such funding will beavailable.  Lack of availability of liquidfunds could have a material adverse impact on our operations.

 

We also have Master Repurchase Agreements in place with variouscounterparties.  Each broker has agreedto make funds available to us at various rates in exchange for collateralconsisting of marketable securities. The aggregate amount of these borrowingarrangements at June 30, 2003 was $3.1 billion.

 

We also have a borrowing arrangement with the FHLBB.  We may borrow amounts determined byprescribed collateral levels and the amount of FHLBB stock we hold.  We are required to hold FHLBB stock equal tono less than (i) 1% of our outstanding residential mortgage loan principal(including mortgage pool securities), (ii) 0.3% of total assets, or(iii) total advances from the FHLBB, divided by a leverage factor of20.  The aggregate amount of borrowingavailable to us under this arrangement at June 30, 2003 was $2.2 billion.  The amount outstanding under this arrangementat June 30, 2003 was $0.6 billion.

 

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**Capital Resources**

 

Historically, we have financed our operations principally throughinternally generated cash flows.  Weincur capital expenditures for furniture, fixtures, capitalized software andmiscellaneous equipment needs.  We leasemicrocomputers and servers through operating leases.  Capital expenditures have been incurred and leases entered intoon an as-required basis, primarily to meet our growing operating needs.  As a result, our capital expenditures were$17.0 million and $23.2 million for the six months ended June 30, 2003 and2002, respectively.  For the six monthsended June 30, 2003, capital expenditures were comprised of approximately $7.8million in capitalized software and projects in process, $4.9 million inleasehold improvements and $4.3 million in fixed assets.  For the six months ended June 30, 2002,capital expenditures were comprised of approximately $16.3 million incapitalized software and projects in process and $6.6 million in fixed assetsand $0.3 million in leasehold improvements.

 

Stockholders’ equity at June 30, 2003 was $490 million, up 11%from December 31, 2002, due to net income and unrealized gains in ourinvestment portfolio, which are reflected in other comprehensive income.  The ratio of stockholders’ equity to assetsdecreased to 5.9% at June 30, 2003 from 6.1% at December 31, 2002, primarilydue to balance sheet growth in investment securities and securities purchasedunder resale agreements.

 

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

 

Quantitative measures established by regulation to ensure capitaladequacy require us to maintain minimum amounts and ratios (set forth in thetable below) of Total and Tier 1 capital (as defined in the regulations) torisk-weighted assets (as defined), and of Tier 1 capital (as defined) toaverage assets (as defined). Management believes, as of June 30, 2003, that wemeet all capital adequacy requirements to which we are subject.

 

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The most recent notification from the FDIC categorized us as “wellcapitalized” under the regulatory framework for prompt corrective action. To becategorized as well capitalized, we must maintain minimum Total risk-based,Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the followingtable. There are no conditions or events since that notification thatmanagement believes have changed our category. The following table presents the capital ratios for Investors Financialand Investors Bank (Dollars in thousands):

 
|                                                       |   | **Actual** |    | **For  Capital  Adequacy Purposes** |       | **To Be Well  Capitalized  Under Prompt  Corrective Action  Provisions** |       |
|------------------------------------------------------------|--------|------------|---------|-------------------------------------|------------|--------------------------------------------------------------------------|------------|
|                                                       |   | **Amount** |    | **Ratio**                           | ** ** | **Amount**                                                               | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **As of June 30,  2003:**                                  |   |       |    |                                |       |                                                                     |       |   |   |   |   |   |   |
| Total Capital  (to Risk Weighted Assets—the Company)  |   | $          | 409,944 |                                | 18.07      | %                                                                        | $          | 181,511 |   | 8.00 | % | N/A |   | N/A |   |
| Total Capital  (to Risk Weighted Assets—the Bank)     |   | $          | 405,525 |                                | 17.89      | %                                                                        | $          | 181,334 |   | 8.00 | % | $ | 226,667 |   | 10.00 | % |
| Tier 1 Capital  (to Risk Weighted Assets—the Company) |   | $          | 409,844 |                                | 18.06      | %                                                                        | $          | 90,755 |   | 4.00 | % | N/A |   | N/A |   |
| Tier 1 Capital  (to Risk Weighted Assets—the Bank)    |   | $          | 405,425 |                                | 17.89      | %                                                                        | $          | 90,667 |   | 4.00 | % | $ | 136,000 |   | 6.00 | % |
| Tier 1 Capital  (to Average Assets—the Company)       |   | $          | 409,844 |                                | 5.15       | %                                                                        | $          | 318,561 |   | 4.00 | % | N/A |   | N/A |   |
| Tier 1 Capital  (to Average Assets—the Bank)          |   | $          | 405,425 |                                | 5.09       | %                                                                        | $          | 318,357 |   | 4.00 | % | $ | 397,946 |   | 5.00 | % |
|                                                       |   |       |    |                                |       |                                                                     |       |   |   |   |   |   |   |   |   |   |
| **As of December 31, 2002:**                               |   |       |    |                                |       |                                                                     |       |   |   |   |   |   |   |
| Total Capital  (to Risk Weighted Assets—the Company)  |   | $          | 374,102 |                                | 15.51      | %                                                                        | $          | 192,915 |   | 8.00 | % | N/A |   | N/A |   |
| Total Capital  (to Risk Weighted Assets—the Bank)     |   | $          | 369,498 |                                | 15.32      | %                                                                        | $          | 192,915 |   | 8.00 | % | $ | 241,143 |   | 10.00 | % |
| Tier 1 Capital  (to Risk Weighted Assets—the Company) |   | $          | 374,002 |                                | 15.51      | %                                                                        | $          | 96,457 |   | 4.00 | % | N/A |   | N/A |   |
| Tier 1 Capital  (to Risk Weighted Assets—the Bank)    |   | $          | 369,398 |                                | 15.32      | %                                                                        | $          | 96,457 |   | 4.00 | % | $ | 144,686 |   | 6.00 | % |
| Tier 1 Capital  (to Average Assets—the Company)       |   | $          | 374,002 |                                | 5.50       | %                                                                        | $          | 272,132 |   | 4.00 | % | N/A |   | N/A |   |
| Tier 1 Capital  (to Average Assets—the Bank)          |   | $          | 369,398 |                                | 5.43       | %                                                                        | $          | 272,104 |   | 4.00 | % | $ | 340,130 |   | 5.00 | % |

 

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

 

The operationsof our securities broker affiliate, Investors Securities Services, Inc., aresubject to federal and state securities laws, as well as the rules of both theSecurities and Exchange Commission and the National Association of SecuritiesDealers, Inc.  Management believes, asof June 30, 2003, that Investors Securities Services, Inc. met all regulatoryrequirements to which it is subject.

 

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**Item3.****                                   Quantitativeand Qualitative Disclosure about Market Risk**

 

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

 

**Item4.****                                   Controlsand Procedures**

 

We evaluatedthe effectiveness of the design and operation of our disclosure controls andprocedures as of June 30, 2003.  Ourdisclosure controls and procedures are the controls and other procedures thatwe designed to ensure that we record, process, summarize and report in a timelymanner the information we must disclose in reports that we file or submit tothe SEC.  Kevin J. Sheehan, our Chairmanand Chief Executive Officer, and John N. Spinney, Jr., our Senior VicePresident and Chief Financial Officer, reviewed and participated in thisevaluation.  Based on this evaluation,Messrs. Sheehan and Spinney concluded that, as of the date of the evaluation,our disclosure controls were effective.

 

As a result ofthe evaluation completed by us, and in which Messrs. Sheehan and Spinneyparticipated, we have concluded that no changes occurred during our fiscalquarter ended June 30, 2003 in our internal controls over financial reporting,which changes have materially affected, or are reasonably likely to affect, ourinternal controls over financial reporting.

 

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**PART II.****  OTHERINFORMATION**

 

**Item 1.****Legal Proceedings**

 

In January 2001, as previously reported, we were named as a defendantin an action entitled Mopex, Inc. v. Chicago Stock Exchange, Inc., et al.,Civil Action No. 01 C 0302 (the ‘Complaint’), in the United States DistrictCourt for the Northern District of Illinois. In the Complaint, Mopex alleged that the Bank and numerous otherentities, including Barclays Global Investors, State Street Bank and TrustCompany, and Merrill Lynch, Pierce, Fenner & Smith, Inc., infringed U.S.Patent No. 6,088,685, entitled, “Open End Mutual Fund Securitization Process,”assigned to Mopex.  On or about May 9,2003, the parties to the action executed a settlement agreement and filed ajoint stipulated order of dismissal.  OnMay 13, 2003, the court entered the order of dismissal, terminating thecase.  The order of dismissal entered bythe court provided for the dismissal of Mopex’s claims with prejudice.  We did not pay or promise to pay any moneyto Mopex to obtain the dismissal. Moreover, our counterclaims against Mopex were dismissed without prejudice,keeping alive our defenses in the event of any further litigation involvingthis patent.

 

In 2002, the Bank received from the Commonwealth of MassachusettsDepartment of Revenue (‘DOR’) an assessment for additional state excise taxesof approximately $10.9 million plus interest and penalties with respect to theBank’s tax years ended December 31, 1999, December 31, 2000 and December 31,2001. The DOR contended that dividend distributions to the Bank by InvestorsFunding Corp. (‘IFC’), a real estate investment trust 99.9% owned by the Bank,were fully taxable in Massachusetts. We believed, after consultation with ouradvisors, that the Massachusetts statute then in effect provided for a dividendreceived deduction equal to 95% of certain dividend distributions applies tothe distributions made by IFC to the Bank. Accordingly, no provision was made at that time in our financialstatements for the amounts assessed or additional amounts that might beassessed in the future.

 

In March 2003, a change in tax law disallowed this dividends receiveddeduction taken by the Bank on dividends it had received since 1999 fromIFC.  As previously reported, in thefirst quarter of 2003 we accrued approximately $13.9 million, net of federalincome tax benefit, as a result of the change in accordance with GAAP.

 

In the second quarter of 2003, we settled this disputed tax issue withthe DOR, agreeing to pay approximately 50% of the liability.  As a result, we reversed the previous taxaccrual by approximately $6.7 million, net of federal income taxes.  Our income statements for the three and sixmonth periods ended June 30, 2003 each reflect a reversal in the amount of $6.7million, net of federal income taxes, of the tax accrual previously recorded.

 

On January 31, 2003, we were named in a class action lawsuit alleging,among other things, violations of California wage and hour laws at ourSacramento and Walnut Creek facilities. The lawsuit was filed in the SuperiorCourt of California, County of Sacramento. On July 23, 2003, we reachedagreement in principle with representatives of the plaintiffs to settle thecase.  As currently agreed, thesettlement will not have a material impact on our financial condition orresults of operations.  The settlementis subject to preliminary approval by the court, proper administration ofpayments to the class members and final approval by the court.  In anticipation of this settlement andrelated costs, we accrued a liability of approximately $1.0 million in thesecond quarter of 2003.

 

On June 27, 2003, we and an individual employee of ours were named in alawsuit alleging, among other things, that we breached an implied covenant ofgood faith and fair dealing in a sub-advisory contract with Opus InvestmentManagement, Inc. (‘Opus’) and that our individual employee engaged in a breachof fiduciary duties and tortious interference with a contract.  Opus had been a sub-adviser to the MerrimacFunds, for which we act as investment adviser. Upon the expiration of Opus’ contract on June 1, 2003, the MerrimacFunds elected not to re-appoint Opus as sub-adviser.  The lawsuit was filed in Superior Court in Worcester,Massachusetts and seeks unspecified damages. We believe that the claims are without merit and intend to defend ourrights vigorously.

 

 

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**Item 4.** Submission of Mattersto a Vote of Security Holders.

 

Our annual meeting of stockholders was held on Tuesday, April 15,2003.  A vote was proposed to:

 

•                  Electeach of Frank B. Condon, Jr., and Robert B. Fraser as a Class II director ofthe Company, to serve for a three-year term and until their successor iselected and qualified.

•                  Approvean amendment of the Company’s Certificate of Incorporation limiting theindemnification of officers and directors.

•                  Ratifythe selection of Deloitte & Touche LLP as our independent auditors for ourfiscal year ending December 31, 2003.

 

All proposals were approved. The voting results were as follows:

 
|   |   |                         |       | **Votes  For** |       | **Votes  Against** | ** ** | **Votes  Withheld** | ** ** | **Abstained** | ** ** |
|--------|--------|------------------------------|------------|----------------|------------|--------------------|------------|---------------------|------------|---------------|------------|
|   |   |                         | ** ** |           | ** ** |               | ** ** |                | ** ** |          | ** ** |
| (1)    |   | Frank B. Condon, Jr.         |       | 55,829,884     |       | N/A                |       | 2,228,260           |       | N/A           |       |
|   |   | Robert B. Fraser             |       | 56,390,525     |       | N/A                |       | 1,667,619           |       | N/A           |       |
| (2)    |   | Amendment to Company’s  |       |           |       |               |       |                |       |          |       |
|   |   | Certificate of Incorporation |       | 57,314,182     |       | 680,819            |       | N/A                 |       | 63,142        |       |
| (3)    |   | Deloitte & Touche LLP    |       | 57,073,046     |       | 898,720            |       | N/A                 |       | 86,377        |       |

 

The terms of the following directors continued after the meeting:  Donald G. Friedl, Thomas P. McDermott, JamesM. Oates, Kevin J. Sheehan and Phyllis S. Swersky.

 

The Amendment to the Company’s Certificate of Incorporation approvedunder Proposal 2 is attached as an exhibit to this report.

 

**Item 6.**Exhibits and Reports on Form 8-K.

 

(a)           Exhibits

 
| **Exhibit No.** |   | **Description**                                                                                                                                                                                                             |
|-----------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |   |                                                                                                                                                                                                                        |
|   3.1      |   | Certificate of Amendment of the Certificate of Incorporation of the  Company.                                                                                                                                               |
|            |   |                                                                                                                                                                                                                        |
| 31.1            |   | Certification of Kevin J. Sheehan, Chief Executive Officer                                                                                                                                                                  |
|            |   |                                                                                                                                                                                                                        |
| 31.2            |   | Certification of John N. Spinney, Jr., Chief Financial Officer                                                                                                                                                              |
|            |   |                                                                                                                                                                                                                        |
| 32.1            |   | Certification of Kevin J. Sheehan, Chief Executive Officer, and John  N. Spinney, Jr., Chief Financial Officer, pursuant to 18 U.S.C. Section 1350,  as adopted, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

(b)          On June 24, 2003 the Company filed a currentreport on Form 8-K providing information under Item 5.  On April 10, 2003, June 12, 2003 and June25, 2003, the Company filed a current report on Form 8-K furnishing financialinformation pursuant to Regulation FD.

 

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**SIGNATURES**

 

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

 

 
|                        |   |   | **INVESTORS FINANCIAL SERVICES CORP.**                                                          |
|-----------------------------|--------|--------|-------------------------------------------------------------------------------------------------|
|                        |   |   |                                                                                            |
| Date:  August 11, 2003 |   | By:    | /s/ Kevin J. Sheehan                                                                            |
|                        |   |   | Kevin J. Sheehan   Chairman and Chief Executive Officer                                         |
|                        |   |   |                                                                                            |
|                        |   |   |                                                                                            |
|                        |   | By:    | /s/ John N. Spinney, Jr.                                                                        |
|                        |   |   | John N. Spinney, Jr.                                                                            |
|                        |   |   | Senior Vice President and Chief Financial Officer  (Principal Financial and Accounting Officer) |

 

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