** **

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

----

** **

**FORM 10-Q**

** **

----

**(MarkOne)**

 

**ý**                                 QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934

** **

**Forthe Quarterly period ended June 30, 2005**

** **

**or**

 

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

** **

**Forthe Transition period from            to            **

 

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

** **

----

** **

**INVESTORSFINANCIAL SERVICES CORP.**

(Exactname of registrant as specified in its charter)

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

 

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

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 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 registrantis an accelerated filer (as defined in Exchange Act Rule 12b-2).  Yes ý   No o

 

As of July 31, 2005 there were 66,256,763shares of Common Stock outstanding.

 

 

----

 

**INVESTORS FINANCIAL SERVICES CORP.**

** **

**INDEX**

 
| **PART I.**  | **FINANCIAL INFORMATION**                                                                                                       |   |
|-------------------|---------------------------------------------------------------------------------------------------------------------------------|--------|
| ** **        | ** **                                                                                                                      |   |
| Item  1.          | Unaudited  Condensed Consolidated Financial Statements                                                                          |   |
|              |                                                                                                                            |   |
|              | Unaudited  Condensed Consolidated Balance Sheets June 30, 2005 and December 31,  2004                                 | 3      |
|              |                                                                                                                            |   |
|              | Unaudited Condensed  Consolidated Statements of Income and Comprehensive Income  Six months ended June 30, 2005 and 2004   | 4      |
|              |                                                                                                                            |   |
|              | Unaudited Condensed  Consolidated Statements of Income and Comprehensive Income  Three months ended June 30, 2005 and 2004 | 5      |
|              |                                                                                                                            |   |
|              | Unaudited Condensed  Consolidated Statements of Stockholders’ Equity  Six months ended June 30, 2005 and 2004         | 6      |
|              |                                                                                                                            |   |
|              | Unaudited Condensed  Consolidated Statements of Cash Flows  Six months ended June 30, 2005 and 2004                        | 7      |
|              |                                                                                                                            |   |
|              | Notes  to Unaudited Condensed Consolidated Financial Statements                                                                 | 8      |
|              |                                                                                                                            |   |
|              | Report  of Independent Registered Public Accounting Firm                                                                        | 20     |
|              |                                                                                                                            |   |
| Item 2.           | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                     | 21     |
|              |                                                                                                                            |   |
| Item 3.           | Quantitative  and Qualitative Disclosures about Market Risk                                                                     | 37     |
|              |                                                                                                                            |   |
| Item 4.           | Controls and  Procedures                                                                                                        | 37     |
|              |                                                                                                                            |   |
| **PART II.** | **OTHER INFORMATION**                                                                                                           |   |
| ** **        | ** **                                                                                                                      |   |
| Item 1.           | Legal Proceedings                                                                                                               | 38     |
| ** **        | ** **                                                                                                                      |   |
| Item 4.           | Submission  of Matters to a Vote of Security Holders                                                                            | 38     |
|              |                                                                                                                            |   |
| Item  6.          | Exhibits                                                                                                                        | 38     |
|              |                                                                                                                            |   |
| **SIGNATURES**    | 39                                                                                                                              |

 

2

----

** **

**PART I.  FINANCIAL INFORMATION**

**Item 1.**           Unaudited Condensed Consolidated FinancialStatements

** **

**INVESTORS FINANCIAL SERVICES CORP.**

**UNAUDITED CONDENSED CONSOLIDATED BALANCESHEETS**

**June 30, 2005 and December 31, 2004(Dollars in thousands, except share data)**

** **
| ** **                                                                                                                                                                          | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                          | ** ** | **2005**          | ** ** | **2004**              | ** ** |
| ** **                                                                                                                                                                          | ** ** | ** **        | ** ** | ** **            | ** ** |
| **Assets**                                                                                                                                                                          |       |              |       |                  |       |
| Cash and due  from banks                                                                                                                                                            |       | $                 | 30,434     |                  | $          | 49,059 |   |
| Federal  Funds sold                                                                                                                                                                 |       | 11,000            |       | —                |       |
| Securities  held to maturity (approximate fair value of $6,956,891 and $5,937,462 at June 30,  2005 and December 31, 2004, respectively)                                  |       | 6,964,528         |       | 5,942,717             |       |
| Securities  available for sale                                                                                                                                                      |       | 4,511,673         |       | 4,565,505             |       |
| Nonmarketable  equity securities                                                                                                                                                    |       | 50,000            |       | 50,000                |       |
| Loans, less  allowance for loan losses of $100 at June 30, 2005 and December 31,  2004                                                                                    |       | 209,820           |       | 134,530               |       |
| Accrued  interest and fees receivable                                                                                                                                               |       | 103,777           |       | 89,292                |       |
| Equipment  and leasehold improvements, less accumulated depreciation of $63,263 and  $61,017 at June 30, 2005 and December 31, 2004, respectively                         |       | 65,417            |       | 67,883                |       |
| Goodwill,  net                                                                                                                                                                      |       | 79,969            |       | 79,969                |       |
| Deposits  pledged to secure clearings                                                                                                                                               |       | 166,092           |       | 27,242                |       |
| Other assets                                                                                                                                                                        |       | 213,065           |       | 161,628               |       |
|                                                                                                                                                                                |       |              |       |                  |       |
| **Total  Assets**                                                                                                                                                                   |       | $                 | 12,405,775 |                  | $          | 11,167,825 |   |
|                                                                                                                                                                                |       |              |       |                  |       |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                      |       |              |       |                  |       |
|                                                                                                                                                                                |       |              |       |                  |       |
| **Liabilities:**                                                                                                                                                                    |       |              |       |                  |       |
| Deposits:                                                                                                                                                                           |       |              |       |                  |       |
| Demand                                                                                                                                                                              |       | $                 | 579,807    |                  | $          | 690,308 |   |
| Savings                                                                                                                                                                             |       | 4,107,204         |       | 4,448,405             |       |
| Time                                                                                                                                                                                |       | 412,520           |       | 257,669               |       |
| Total  deposits                                                                                                                                                                     |       | 5,099,531         |       | 5,396,382             |       |
|                                                                                                                                                                                |       |              |       |                  |       |
| Securities  sold under repurchase agreements                                                                                                                                        |       | 4,851,699         |       | 4,255,497             |       |
| Short-term and  other borrowings                                                                                                                                                    |       | 1,353,440         |       | 594,681               |       |
| Due to  brokers for open trades payable                                                                                                                                             |       | 49,371            |       | 5,475                 |       |
| Junior  subordinated deferrable interest debentures                                                                                                                                 |       | 24,774            |       | 24,774                |       |
| Accrued  taxes and other expenses                                                                                                                                                   |       | 58,629            |       | 54,967                |       |
| Other  liabilities                                                                                                                                                                  |       | 174,343           |       | 123,787               |       |
| Total  liabilities                                                                                                                                                                  |       | 11,611,787        |       | 10,455,563            |       |
|                                                                                                                                                                                |       |              |       |                  |       |
| Commitments  and contingencies                                                                                                                                                      |       | —            |       | —                |       |
|                                                                                                                                                                                |       |              |       |                  |       |
| **Stockholders’  Equity:**                                                                                                                                                     |       |              |       |                  |       |
| Preferred  stock, par value $0.01 (shares authorized: 1,000,000; issued and outstanding:  none at June 30, 2005 and December 31, 2004)                                    |       | —            |       | —                |       |
| Common  stock, par value $0.01 (shares authorized: 175,000,000; issued and  outstanding: 66,875,627 and 66,595,349 at June 30, 2005 and December 31,  2004, respectively) |       | 669               |       | 667                   |       |
| Surplus                                                                                                                                                                             |       | 281,868           |       | 272,536               |       |
| Deferred  compensation                                                                                                                                                              |       | (360              | )          | (572                  | )          |
| Retained  earnings                                                                                                                                                                  |       | 500,440           |       | 418,034               |       |
| Accumulated  other comprehensive income, net                                                                                                                                        |       | 13,662            |       | 23,888                |       |
| Treasury  stock, at cost (73,235 shares at June 30, 2005 and December 31,  2004)                                                                                          |       | (2,291            | )          | (2,291                | )          |
| Total  stockholders’ equity                                                                                                                                                    |       | 793,988           |       | 712,262               |       |
|                                                                                                                                                                                |       |              |       |                  |       |
| **Total  Liabilities and Stockholders’ Equity**                                                                                                                                |       | $                 | 12,405,775 |                  | $          | 11,167,825 |   |

* *

*See Notes to Unaudited Condensed ConsolidatedFinancial Statements.*

 

3

----

 

**INVESTORS FINANCIAL SERVICES CORP.**

**UNAUDITED CONDENSED CONSOLIDATED STATEMENTSOF INCOME AND COMPREHENSIVE INCOME**

**Six Months Ended June 30, 2005 and 2004(Dollars in thousands, except per share data)**

 
| ** **                                 | ** ** | **June 30,** | ** ** | **June 30,** | ** ** |
|--------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                 | ** ** | **2005**          | ** ** | **2004**          | ** ** |
| **Fees and  Other Revenue:**               | ** ** | ** **        | ** ** | ** **        | ** ** |
| Asset  servicing fees:                     |       |              |       |              |       |
| Core service  fees                         |       | $                 | 178,703    |              | $          | 154,849 |   |
| Ancillary  service fees                    |       | 58,998            |       | 60,331            |       |
| Total asset  servicing fees                |       | 237,701           |       | 215,180           |       |
| Other  operating income                    |       | 1,411             |       | 1,097             |       |
| Gain on sale  of investments               |       | 9,740             |       | 234               |       |
| Total fees  and other revenue              |       | 248,852           |       | 216,511           |       |
|                                       |       |              |       |              |       |
| Interest  income                           |       | 206,158           |       | 142,776           |       |
| Interest  expense                          |       | 116,499           |       | 52,280            |       |
| Net interest  income                       |       | 89,659            |       | 90,496            |       |
| Net  operating revenue                     |       | 338,511           |       | 307,007           |       |
|                                       |       |              |       |              |       |
| **Operating  Expenses:**                   |       |              |       |              |       |
| Compensation  and benefits                 |       | 120,351           |       | 109,094           |       |
| Technology  and telecommunications         |       | 25,913            |       | 20,722            |       |
| Transaction  processing services           |       | 22,776            |       | 21,138            |       |
| Depreciation  and amortization             |       | 15,984            |       | 16,721            |       |
| Occupancy                                  |       | 12,840            |       | 14,260            |       |
| Professional  fees                         |       | 6,379             |       | 7,256             |       |
| Travel and  sales promotion                |       | 3,174             |       | 2,579             |       |
| Insurance                                  |       | 2,275             |       | 2,360             |       |
| Other  operating expenses                  |       | 8,337             |       | 6,704             |       |
| Total  operating expenses                  |       | 218,029           |       | 200,834           |       |
|                                       |       |              |       |              |       |
| **Income  Before Income Taxes**            |       | 120,482           |       | 106,173           |       |
|                                       |       |              |       |              |       |
| Provision  for income taxes                |       | 35,407            |       | 35,624            |       |
|                                       |       |              |       |              |       |
| **Net  Income**                            |       | $                 | 85,075     |              | $          | 70,549 |   |
| ** **                                 |       |              |       |              |       |   |   |
| **Basic  Earnings Per Share**              |       | $                 | 1.27       |              | $          | 1.07 |   |
| ** **                                 |       |              |       |              |       |   |   |
| **Diluted  Earnings Per Share**            |       | $                 | 1.24       |              | $          | 1.04 |   |
|                                       |       |              |       |              |       |
| **Comprehensive  Income:**                 |       |              |       |              |       |
| Net income                                 |       | $                 | 85,075     |              | $          | 70,549 |   |
| Other  comprehensive loss:                 |       |              |       |              |       |
| Net  unrealized investment loss            |       | (12,694           | )          | (37,076           | )          |
| Net  unrealized derivative instrument gain |       | 2,692             |       | 11,854            |       |
| Cumulative  translation adjustment         |       | (224              | )          | (400              | )          |
| Other  comprehensive loss                  |       | (10,226           | )          | (25,622           | )          |
| Comprehensive  income                      |       | $                 | 74,849     |              | $          | 44,927 |   |

* *

*See Notes to Unaudited Condensed ConsolidatedFinancial Statements.*

 

4

----

 

**INVESTORS FINANCIAL SERVICES CORP.**

**UNAUDITED CONDENSED CONSOLIDATED STATEMENTSOF INCOME AND COMPREHENSIVE INCOME**

**Three Months Ended June 30, 2005 and2004 (Dollars in thousands, except per share data)**

 
| ** **                                        | ** ** | **June 30,** | ** ** | **June 30,** | ** ** |
|---------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                        | ** ** | **2005**          | ** ** | **2004**          | ** ** |
| **Fees and  Other Revenue:**                      | ** ** | ** **        | ** ** | ** **        | ** ** |
| Asset  servicing fees:                            |       |              |       |              |       |
| Core service  fees                                |       | $                 | 90,159     |              | $          | 78,755 |   |
| Ancillary  service fees                           |       | 32,339            |       | 30,238            |       |
| Total asset  servicing fees                       |       | 122,498           |       | 108,993           |       |
| Other  operating income                           |       | 626               |       | 748               |       |
| Gain on sale  of investments                      |       | 5,552             |       | —            |       |
| Total fees  and other revenue                     |       | 128,676           |       | 109,741           |       |
|                                              |       |              |       |              |       |
| Interest  income                                  |       | 108,103           |       | 69,140            |       |
| Interest  expense                                 |       | 66,057            |       | 27,065            |       |
| Net interest  income                              |       | 42,046            |       | 42,075            |       |
| Net  operating revenue                            |       | 170,722           |       | 151,816           |       |
|                                              |       |              |       |              |       |
| **Operating  Expenses:**                          |       |              |       |              |       |
| Compensation  and benefits                        |       | 63,432            |       | 53,771            |       |
| Technology  and telecommunications                |       | 13,077            |       | 10,456            |       |
| Transaction  processing services                  |       | 11,656            |       | 10,198            |       |
| Depreciation  and amortization                    |       | 8,093             |       | 8,767             |       |
| Occupancy                                         |       | 6,227             |       | 6,869             |       |
| Professional  fees                                |       | 3,406             |       | 4,018             |       |
| Travel and  sales promotion                       |       | 1,825             |       | 1,497             |       |
| Insurance                                         |       | 1,146             |       | 1,164             |       |
| Other  operating expenses                         |       | 4,375             |       | 3,960             |       |
| Total  operating expenses                         |       | 113,237           |       | 100,700           |       |
|                                              |       |              |       |              |       |
| **Income  Before Income Taxes**                   |       | 57,485            |       | 51,116            |       |
|                                              |       |              |       |              |       |
| Provision  for income taxes                       |       | 13,358            |       | 17,120            |       |
|                                              |       |              |       |              |       |
| **Net  Income**                                   |       | $                 | 44,127     |              | $          | 33,996 |   |
| ** **                                        |       |              |       |              |       |   |   |
| **Basic  Earnings Per Share**                     |       | $                 | 0.66       |              | $          | 0.51 |   |
| ** **                                        |       |              |       |              |       |   |   |
| **Diluted  Earnings Per Share**                   |       | $                 | 0.64       |              | $          | 0.50 |   |
|                                              |       |              |       |              |       |
| **Comprehensive  Income:**                        |       |              |       |              |       |
| Net income                                        |       | $                 | 44,127     |              | $          | 33,996 |   |
| Other  comprehensive income (loss):               |       |              |       |              |       |
| Net  unrealized investment gain (loss)            |       | 13,545            |       | (58,989           | )          |
| Net  unrealized derivative instrument (loss) gain |       | (5,991            | )          | 13,016            |       |
| Cumulative  translation adjustment                |       | (104              | )          | (317              | )          |
| Other  comprehensive income (loss)                |       | 7,450             |       | (46,290           | )          |
| Comprehensive  income                             |       | $                 | 51,577     |              | $          | (12,294 | ) |

 

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

 

5

----

 

**INVESTORS FINANCIAL SERVICES CORP.**

**UNAUDITED CONDENSED CONSOLIDATED STATEMENTSOF STOCKHOLDERS’ EQUITY**

**Six Months Ended June 30, 2005 and 2004(Dollars in thousands, except share data)**

 
| ** **                                                                                                   | ** ** | **June 30,** | ** ** | **June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                                                                                   | ** ** | **2005**          | ** ** | **2004**          | ** ** |
| **Common  shares**                                                                                           |       |              |       |              |       |
| Balance,  beginning of period                                                                                |       | 66,595,349        |       | 65,436,788        |       |
| Exercise of  stock options                                                                                   |       | 225,416           |       | 740,529           |       |
| Common stock  issuance                                                                                       |       | 54,862            |       | 47,681            |       |
| Balance, end  of period                                                                                      |       | 66,875,627        |       | 66,224,998        |       |
|                                                                                                         |       |              |       |              |       |
| **Treasury  shares**                                                                                         |       |              |       |              |       |
| Balance,  beginning of period                                                                                |       | 73,235            |       | 26,508            |       |
| Balance, end  of period                                                                                      |       | 73,235            |       | 26,508            |       |
|                                                                                                         |       |              |       |              |       |
| **Common  stock**                                                                                            |       |              |       |              |       |
| Balance,  beginning of period                                                                                |       | $                 | 667        |              | $          | 655 |   |
| Exercise of  stock options                                                                                   |       | 2                 |       | 7                 |       |
| Balance, end  of period                                                                                      |       | 669               |       | 662               |       |
|                                                                                                         |       |              |       |              |       |
| **Surplus**                                                                                                  |       |              |       |              |       |
| Balance,  beginning of period                                                                                |       | 272,536           |       | 242,662           |       |
| Exercise of  stock options                                                                                   |       | 6,208             |       | 10,005            |       |
| Tax benefit  from exercise of stock options                                                                  |       | 1,246             |       | 6,539             |       |
| Common stock  issuance                                                                                       |       | 1,878             |       | 1,668             |       |
| Stock option  forfeiture                                                                                     |       | —            |       | (188              | )          |
| Balance, end  of period                                                                                      |       | 281,868           |       | 260,686           |       |
|                                                                                                         |       |              |       |              |       |
| **Deferred  compensation**                                                                                   |       |              |       |              |       |
| Balance,  beginning of period                                                                                |       | (572              | )          | (1,076            | )          |
| Stock option  forfeiture                                                                                     |       | —            |       | 188               |       |
| Amortization  of deferred compensation                                                                       |       | 212               |       | 108               |       |
| Balance, end  of period                                                                                      |       | (360              | )          | (780              | )          |
|                                                                                                         |       |              |       |              |       |
| **Retained  earnings**                                                                                       |       |              |       |              |       |
| Balance,  beginning of period                                                                                |       | 418,034           |       | 280,701           |       |
| Net income                                                                                                   |       | 85,075            |       | 70,549            |       |
| Cash  dividend, $0.040 and $0.035 per share in the periods ending June 30,  2005 and 2004, respectively |       | (2,669            | )          | (2,309            | )          |
| Balance, end  of period                                                                                      |       | 500,440           |       | 348,941           |       |
|                                                                                                         |       |              |       |              |       |
| **Accumulated  other comprehensive income, net**                                                             |       |              |       |              |       |
| Balance,  beginning of period                                                                                |       | 23,888            |       | 17,865            |       |
| Net  unrealized investment loss                                                                              |       | (12,694           | )          | (37,076           | )          |
| Net  unrealized derivative instrument gain                                                                   |       | 2,712             |       | 11,844            |       |
| Amortization  of terminated interest rate swap agreements                                                    |       | (20               | )          | 10                |       |
| Effect of  foreign currency translation                                                                      |       | (224              | )          | (400              | )          |
| Balance, end  of period                                                                                      |       | 13,662            |       | (7,757            | )          |
|                                                                                                         |       |              |       |              |       |
| **Treasury  stock**                                                                                          |       |              |       |              |       |
| Balance,  beginning of period                                                                                |       | (2,291            | )          | (550              | )          |
| Balance, end  of period                                                                                      |       | (2,291            | )          | (550              | )          |
|                                                                                                         |       |              |       |              |       |
| **Total  Stockholders’ Equity**                                                                         |       | $                 | 793,988    |              | $          | 601,202 |   |

** **

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

 

6

----

 

**INVESTORS FINANCIAL SERVICES CORP.**

**UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASHFLOWS**

**Six Months Ended June 30, 2005 and 2004(Dollars in thousands)**

 
| ** **                                                                           | ** ** | **June 30,** | ** ** | **June 30,** | ** ** |
|--------------------------------------------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                                                           | ** ** | **2005**          | ** ** | **2004**          | ** ** |
| ** **                                                                           | ** ** | ** **        | ** ** | ** **        | ** ** |
| **Cash  Flows From Operating Activities:**                                           |       |              |       |              |       |
| Net income                                                                           |       | $                 | 85,075     |              | $          | 70,549 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities:   |       |              |       |              |       |
| Equity in  undistributed loss of unconsolidated subsidiary                           |       | 14                |       | 14                |       |
| Depreciation  and amortization                                                       |       | 15,984            |       | 16,721            |       |
| Amortization  of deferred compensation                                               |       | 212               |       | 108               |       |
| Amortization  of premiums on securities, net of accretion of discounts               |       | 24,440            |       | 21,923            |       |
| Gain on sale  of investments                                                         |       | (9,740            | )          | (234              | )          |
| Changes in  assets and liabilities:                                                  |       |              |       |              |       |
| Accrued  interest and fees receivable                                                |       | (14,485           | )          | (10,888           | )          |
| Other assets                                                                         |       | (51,478           | )          | (13,552           | )          |
| Accrued  taxes and other expenses                                                    |       | 3,662             |       | (2,670            | )          |
| Other  liabilities                                                                   |       | 61,356            |       | 24,907            |       |
| Net cash  used/provided by operating activities                                      |       | 115,040           |       | 106,878           |       |
|                                                                                 |       |              |       |              |       |
| **Cash  Flows From Investing Activities:**                                           |       |              |       |              |       |
| Proceeds  from maturities and paydowns of securities available for sale              |       | 633,126           |       | 717,922           |       |
| Proceeds  from maturities and paydowns of securities held to maturity                |       | 752,969           |       | 758,965           |       |
| Proceeds  from sale of securities available for sale                                 |       | 248,441           |       | 25,041            |       |
| Purchases of  securities available for sale                                          |       | (841,836          | )          | (1,115,949        | )          |
| Purchases of  securities held to maturity                                            |       | (1,795,148        | )          | (1,563,748        | )          |
| Net increase  in deposits pledged to secure clearings                                |       | (138,850          | )          | (158,580          | )          |
| Net increase  in due to brokers for open trades payable                              |       | 43,896            |       | 135,866           |       |
| Net increase  in Federal Funds sold and securities purchased under resale agreements |       | (11,000           | )          | (425,000          | )          |
| Net  (increase) decrease in loans                                                    |       | (75,290           | )          | 7,347             |       |
| Purchases of  fixed assets, capitalized software and leasehold improvements          |       | (13,503           | )          | (11,779           | )          |
| Net cash  used for investing activities                                              |       | (1,197,195        | )          | (1,629,915        | )          |
|                                                                                 |       |              |       |              |       |
| **Cash  Flows From Financing Activities:**                                           |       |              |       |              |       |
| Net  (decrease) increase in demand deposits                                          |       | (110,501          | )          | 718,025           |       |
| Net  (decrease) increase in time and savings deposits                                |       | (186,350          | )          | 78,030            |       |
| Net increase  in securities sold under repurchase agreements                         |       | 596,202           |       | 1,029,674         |       |
| Net increase  (decrease) in short-term and other borrowings                          |       | 758,759           |       | (308,968          | )          |
| Proceeds  from exercise of stock options                                             |       | 6,210             |       | 10,012            |       |
| Proceeds  from issuance of common stock                                              |       | 1,878             |       | 1,668             |       |
| Dividends  paid to stockholders                                                      |       | (2,669            | )          | (2,309            | )          |
| Net cash  provided by financing activities                                           |       | 1,063,529         |       | 1,526,132         |       |
|                                                                                 |       |              |       |              |       |
| **Effect  of exchange rates on cash**                                                |       | 1                 |       | (5                | )          |
|                                                                                 |       |              |       |              |       |
| **Net  (Decrease) Increase in Cash and Due From Banks**                              |       | (18,625           | )          | 3,090             |       |
| ** **                                                                           |       |              |       |              |       |
| **Cash and  Due From Banks, Beginning of Period**                                    |       | 49,059            |       | 39,689            |       |
| ** **                                                                           |       |              |       |              |       |
| **Cash and  Due From Banks, End of Period**                                          |       | $                 | 30,434     |              | $          | 42,779 |   |

* *

*See Notes to Unaudited Condensed ConsolidatedFinancial Statements.*

 

7

----

 

**INVESTORSFINANCIAL SERVICES CORP.**

**NOTES TO UNAUDITED CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**(Information is as of and for the six monthsand the three months ended June 30, 2005 and 2004)**

 

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

 

Investors Financial Services Corp. (‘IFSC’) provides assetadministration services for the financial services industry through itswholly-owned subsidiary, Investors Bank & Trust Company (‘the Bank’).  As used herein, the defined term “the Company”shall mean IFSC together with the Bank and its domestic and foreignsubsidiaries.  The Company provides coreservices and value-added services to a variety of financial asset managers,including mutual fund complexes, investment advisors, family offices, banks andinsurance companies.  Core servicesinclude middle office outsourcing, global custody, multicurrency accounting andfund administration.  Value-added servicesinclude securities lending, foreign exchange, cash management, performancemeasurement, institutional transfer agency, investment advisory services, linesof credit and brokerage and transition management services.  The Company and/or its affiliates are subjectto regulation by the Federal Deposit Insurance Corporation, the Federal ReserveBoard of Governors, the Office of the Commissioner of Banks of the Commonwealthof Massachusetts, the Securities and Exchange Commission (‘SEC’), the NationalAssociation of Securities Dealers, Inc. (‘NASD’), the Office of theSuperintendent of Financial Institutions in Canada, the Irish FinancialServices Regulatory Authority, the Cayman Islands Monetary Authority and theState of Vermont Department of Banking, Insurance, Securities & HealthCare Administration.

 

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

 

The unaudited condensed consolidated interim financial statements ofthe Company and its subsidiaries as of June 30, 2005 and December 31,2004, and for the six-month and the three-month periods ended June 30,2005 and 2004 have been prepared by the Company pursuant to the rules andregulations of the SEC.  Certaininformation and footnote disclosures normally included in annual financialstatements prepared in accordance with accounting principles generally acceptedin the United States of America (‘GAAP’) have been condensed or omitted aspermitted by such rules and regulations. All adjustments, consisting of normal recurring adjustments, necessaryfor their fair presentation in conformity with GAAP are included.  The Company’s management believes that thedisclosures are adequate to present fairly the financial position, results ofoperations and cash flows at the dates and for the periods presented. It issuggested that these interim financial statements be read in conjunction withthe financial statements and the notes thereto included in the Company’s latestannual report on Form 10-K. Results for interim periods are notnecessarily indicative of those to be expected for the full fiscal year.Certain amounts in prior financial statements have been reclassified to conformto the current presentation.

 

***Securities******–***Thespecific identification method is used to determine gains and losses on salesof securities.  Amortization and accretion of debtsecurities purchased at a premium or discount are amortized or accreted intoincome using a method which approximates the constant effective yield. TheCompany applies Financial Accounting Standard No. 91, Accounting forNonrefundable Fees and Costs Associated with Originating or Acquiring Loans andInitial Direct Costs of Leases (‘FAS 91’) for the amortization of premiums andaccretion of discounts. Prepayments are anticipated using three-month actualprepayment experience for securities that represent holdings of large numbersof similar loans for which prepayments are probable and the timing and amountof prepayments can be reasonably estimated.  Premiums and discounts onsecurities not meeting these criteria are amortized or accreted over theircontractual term using the constant effective yield.  Actual prepaymentexperience for all investment securities is reviewed monthly and the timing ofthe amortization and accretion is adjusted accordingly.

 

***Income Taxes******–***Income tax expense is based onestimated taxes payable or refundable on a tax return basis for the currentyear and the changes in deferred tax assets and liabilities during theyear.  Deferred tax assets andliabilities are established for temporary differences between the accountingbasis and the tax basis of the Company’s assets and liabilities at enacted taxrates expected to be in effect when the amounts related to such temporarydifferences are realized or settled.  Ifit is determined that a deferred tax asset will “more likely than not” berealized, the Company records a valuation allowance in accordance with theprovisions of SFAS No. 109, *Accounting for IncomeTaxes*.

 

The Company recorded a one-time benefit of approximately $7 million inthe second quarter of 2005 related to the recognition of the indefinitereversal provision of Accounting Principles Board Opinion No. 23, *Accounting for Income Taxes – Special Areas (*‘APB 23’). Theindefinite reversal provision of APB 23 specifies that U.S. income taxes shouldnot be accrued on the undistributed earnings of a foreign subsidiary if thoseearnings have been or will be invested indefinitely in that subsidiary’soperations. The Company had previously accrued U.S. income taxes on theundistributed earnings of its Irish subsidiaries. In the second quarter of 2005,the Company recognized the indefinite reversal provision of APB 23 due to theprojected capital needs of its Irish subsidiaries necessary to support continuedgrowth. As such, the Company will no longer record U.S. income taxes on theundistributed earnings of its Irish subsidiaries.

 

8

----

 

**2.****                   InterimFinancial Statements (continued)**

 

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

 
| ** **                                                                                                                                  | ** ** | **For the Six Months   Ended June 30,** | ** ** | **For the Three Months   Ended June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                                                                                  | ** ** | **2005**                                     | ** ** | **2004**                                       | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                                                                        |       |                                         |       |                                           |       |   |   |   |   |
| Net income  as reported                                                                                                                     |       | $                                            | 85,075     |                                           | $          | 70,549 |   | $ | 44,127 |   | $ | 33,996 |   |
| Deduct:  Total share-based employee compensation expense determined under the fair  value method for all awards, net of related tax effects |       | (2,196                                       | )          | (5,176                                         | )          | (1,388 | ) | (3,691 | ) |
| Pro forma  net income                                                                                                                       |       | $                                            | 82,879     |                                           | $          | 65,373 |   | $ | 42,739 |   | $ | 30,305 |   |
|                                                                                                                                        |       |                                         |       |                                           |       |   |   |   |   |
| Earnings per  share:                                                                                                                        |       |                                         |       |                                           |       |   |   |   |   |
| Basic-as  reported                                                                                                                          |       | $                                            | 1.27       |                                           | $          | 1.07 |   | $ | 0.66 |   | $ | 0.51 |   |
| Basic-pro  forma                                                                                                                            |       | $                                            | 1.24       |                                           | $          | 0.99 |   | $ | 0.64 |   | $ | 0.46 |   |
|                                                                                                                                        |       |                                         |       |                                           |       |   |   |   |   |
| Diluted-as  reported                                                                                                                        |       | $                                            | 1.24       |                                           | $          | 1.04 |   | $ | 0.64 |   | $ | 0.50 |   |
| Diluted-pro  forma                                                                                                                          |       | $                                            | 1.21       |                                           | $          | 0.97 |   | $ | 0.63 |   | $ | 0.45 |   |

 

The fair value of each option grant was estimated on the date of grantusing the Black-Scholes valuation model with the following assumptions for the sixmonths ended June 30, 2005 and 2004, respectively: an average assumedrisk-free interest rate of 3.93% and 2.89%, an expected life of four years, anaverage expected volatility of 42.87% and 52.84%, and an average dividend yieldof 0.19% and 0.17%.

 

For the three months ended June 30, 2005 and 2004, respectively,the following assumptions were used in the Black-Scholes valuation model: anassumed risk-free interest rate of 3.73% and 3.40%, an expected life of fouryears, an average expected volatility of 41.58% and 51.73%, and a dividendyield of 0.21% and 0.16%.

 

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

 
| ** **                                   | ** ** | **For the Six Months   Ended June 30,** | ** ** | **For the Three Months   Ended June 30,** | ** ** |
|----------------------------------------------|------------|----------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                   | ** ** | **2005**                                     | ** ** | **2004**                                       | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                         |       |                                         |       |                                           |       |   |   |   |   |
| Income  available to common stockholders     |       | $                                            | 85,075     |                                           | $          | 70,549 |   | $ | 44,127 |   | $ | 33,996 |   |
|                                         |       |                                         |       |                                           |       |   |   |   |   |
| Basic  weighted-average shares outstanding   |       | 66,761,409                                   |       | 65,976,331                                     |       | 66,803,946 |   | 66,115,552 |   |
| Dilutive  effect of stock options            |       | 1,682,240                                    |       | 1,731,942                                      |       | 1,443,415 |   | 1,583,639 |   |
| Diluted  weighted-average shares outstanding |       | 68,443,649                                   |       | 67,708,273                                     |       | 68,247,361 |   | 67,699,191 |   |
|                                         |       |                                         |       |                                           |       |   |   |   |   |
| Earnings per  share:                         |       |                                         |       |                                           |       |   |   |   |   |
| Basic                                        |       | $                                            | 1.27       |                                           | $          | 1.07 |   | $ | 0.66 |   | $ | 0.51 |   |
|                                         |       |                                         |       |                                           |       |   |   |   |   |
| Diluted                                      |       | $                                            | 1.24       |                                           | $          | 1.04 |   | $ | 0.64 |   | $ | 0.50 |   |

 

9

----

 

**2.****                   InterimFinancial Statements (continued)**

 

There were 13,917 and 42,109 options which were not considered dilutivefor purposes of EPS calculations for the six-month periods ended June 30,2005 and 2004, respectively.  For thethree-month periods ended June 30, 2005 and 2004 there were 92,274 and 193,514options, respectively, which were not considered dilutive for purposes of EPScalculations.

 

***Recently Issued Accounting Pronouncements***

 

InDecember 2004, the Financial Accounting Standards Board (‘FASB’) issuedSFAS No. 123 (revised 2004), *Share-BasedPayment*.  SFAS No. 123R requires that compensation costrelating to share-based payment transactions be recognized in the financialstatements with measurement based upon the fair value of the equity orliability instruments issued. The Company currently uses the intrinsic valuemethod to measure compensation cost related to its share-based transactions. SFASNo. 123R replaces SFAS No. 123, *Accountingfor Stock-Based Compensation*, and supersedes APB Opinion No. 25,*Accounting for Stock Issued to Employees.*

 

InMarch 2005, the SEC issued Staff Accounting Bulletin (‘SAB’) No. 107,which expresses the views of the SEC regarding the interaction of SFAS No. 123Rand certain SEC regulations and provides the SEC’s views regarding thevaluation of share-based payment arrangements for public companies.

 

InApril 2005, the SEC issued Release 2005-57, which delays the effectivedate for SFAS No. 123R to reporting periods in the first fiscal yearbeginning after June 15, 2005.

 

Accordingly,the Company expects to adopt SFAS No. 123R and follow the guidance of SAB107 beginning on January 1, 2006.  The Company is in the process ofdetermining the valuation methodology it will use under the fair value methodand is assessing the impact the adoption of SFAS No. 123R will have on itsresults of operations and financial condition. The Company does not anticipate any material impact to its financialcondition or results of operations as a result of the adoption of SFAS No. 123R.

 

InMay 2005, the FASB issued SFAS No. 154, *Accounting Changes and Error Corrections- a replacement of APB Opinion No. 20and FASB Statement No. 3*.  SFAS No. 154 replaces APBOpinion No. 20, *Accounting Changes,*andFASB Statement No. 3, *ReportingAccounting Changes in Interim Financial Statements,*and changes the accountingand reporting requirements for a change in accounting principle.  SFAS No. 154applies to all voluntary changes in an accounting principle, as well as tochanges required by a new accounting pronouncement in the unusual instance thatthe pronouncement does not include specific transition provisions.  SFAS No. 154is effective for accounting changes and error corrections made in fiscal yearsbeginning after December 15, 2005 and requires retrospective applicationto prior periods’ financial statements for most voluntary changes in an accountingprinciple, unless it is impracticable to do so.  The Company does notanticipate any material impact to its financial condition or results ofoperations as a result of the adoption of SFAS No. 154.

 

10

----

 

**3.****                   Securities**

 

Amortized cost amounts and fair values of securities are summarized asfollows as of June 30, 2005 (Dollars in thousands):

 
| ** **                        | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair**  | ** ** |
|-----------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|-----------|------------|
| **Held to Maturity**              | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **(Losses)**   | ** ** | **Value** | ** ** |
|                              |       |          |       |           |       |           |       |      |       |
| Mortgage-backed  securities       |       | $             | 4,495,423  |           | $          | 15,005         |       | $         | (9,678     | ) | $ | 4,500,750 |   |
| Federal  agency securities        |       | 2,349,721     |       | 1,575          |       | (20,723        | )          | 2,330,573 |       |
| State and  political subdivisions |       | 119,384       |       | 6,246          |       | (62            | )          | 125,568   |       |
|                              |       |          |       |           |       |           |       |      |       |
| Total                             |       | $             | 6,964,528  |           | $          | 22,826         |       | $         | (30,463    | ) | $ | 6,956,891 |   |

 
| ** **                        | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair**  | ** ** |
|-----------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|-----------|------------|
| **Available for Sale**            | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **(Losses)**   | ** ** | **Value** | ** ** |
|                              |       |          |       |           |       |           |       |      |       |
| Mortgage-backed  securities       |       | $             | 3,954,308  |           | $          | 15,580         |       | $         | (18,916    | ) | $ | 3,950,972 |   |
| State and  political subdivisions |       | 358,979       |       | 15,316         |       | (48            | )          | 374,247   |       |
| Corporate  debt                   |       | 177,038       |       | 1,048          |       | (1,896         | )          | 176,190   |       |
| Foreign  government securities    |       | 10,072        |       | 192            |       | —         |       | 10,264    |       |
|                              |       |          |       |           |       |           |       |      |       |
| Total                             |       | $             | 4,500,397  |           | $          | 32,136         |       | $         | (20,860    | ) | $ | 4,511,673 |   |

 

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

 
| ** **                        | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | ** **     | ** ** |
|-----------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|----------------|------------|
| **Held to Maturity**              | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **(Losses)**   | ** ** | **Fair Value** | ** ** |
|                              |       |          |       |           |       |           |       |           |       |
| Mortgage-backed  securities       |       | $             | 3,543,961  |           | $          | 13,269         |       | $              | (7,802     | ) | $ | 3,549,428 |   |
| Federal  agency securities        |       | 2,274,665     |       | 1,658          |       | (18,443        | )          | 2,257,880      |       |
| State and  political subdivisions |       | 124,091       |       | 6,090          |       | (27            | )          | 130,154        |       |
|                              |       |          |       |           |       |           |       |           |       |
| Total                             |       | $             | 5,942,717  |           | $          | 21,017         |       | $              | (26,272    | ) | $ | 5,937,462 |   |

 
| ** **                        | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | ** **     | ** ** |
|-----------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|----------------|------------|
| **Available for Sale**            | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **(Losses)**   | ** ** | **Fair Value** | ** ** |
|                              |       |          |       |           |       |           |       |           |       |
| Mortgage-backed  securities       |       | $             | 3,848,255  |           | $          | 21,596         |       | $              | (14,951    | ) | $ | 3,854,900 |   |
| State and  political subdivisions |       | 384,859       |       | 20,110         |       | (60            | )          | 404,909        |       |
| Corporate  debt                   |       | 177,201       |       | 911            |       | (1,566         | )          | 176,546        |       |
| U.S.  Treasury securities         |       | 113,843       |       | 4,845          |       | —         |       | 118,688        |       |
| Foreign  government securities    |       | 10,302        |       | 160            |       | —         |       | 10,462         |       |
|                              |       |          |       |           |       |           |       |           |       |
| Total                             |       | $             | 4,534,460  |           | $          | 47,622         |       | $              | (16,577    | ) | $ | 4,565,505 |   |

 

The carrying value of securities pledged amounted to approximately $6.9billion and $6.3 billion at June 30, 2005 and December 31, 2004,respectively.  Securities are pledgedprimarily to secure clearings with other depository institutions, to secure repurchaseagreements and to secure outstanding Federal Home Loan Bank of Boston (‘FHLBB’)borrowings.

 

On a quarterly basis the Company reviews its investment portfolio on asecurity-by-security basis for any investment that may be other-than-temporarilyimpaired.  In its evaluation, the Companyconsiders the length of time the security has been impaired, the severity ofthe impairment, the financial condition and future prospects of the issuer, andthe Company’s ability and intent to hold the security to maturity or until itrecovers in value.  At June 30,2005, no securities were considered to be other-than-temporarily impaired.

 

11

----

 

**4.****                   Loans**

 

Loans consist of demand loans to custody clients of the Company, includingindividuals, not-for-profit institutions and mutual fund clients. The loans tomutual funds and other pooled product clients include lines of credit andadvances pursuant to the terms of the custody agreements between the Companyand those clients to facilitate securities transactions and redemptions.Generally, the loans are, or may be, in the event of default, collateralizedwith marketable securities held by the Company as custodian. There were noimpaired or nonperforming loans at June 30, 2005 and December 31,2004.  In addition, there were no loancharge-offs or recoveries during the six months ended June 30, 2005 northe year ended December 31, 2004. Loans are summarized as follows (Dollarsin thousands):

 

| ** **                      | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **2005**          | ** ** | **2004**              | ** ** |
|                            |       |              |       |                  |       |
| Loans to  mutual funds          |       | $                 | 55,886     |                  | $          | 22,520 |   |
| Loans to  individuals           |       | 110,477           |       | 69,402                |       |
| Loans to  others                |       | 43,557            |       | 42,708                |       |
| Gross loans                     |       | 209,920           |       | 134,630               |       |
| Less  allowance for loan losses |       | (100              | )          | (100                  | )          |
|                            |       |              |       |                  |       |
| Total                           |       | $                 | 209,820    |                  | $          | 134,530 |   |

 

**5.****                   Deposits**

 

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

 

| ** **                                      | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **2005**          | ** ** | **2004**              | ** ** |
| Interest-bearing  deposits:                     |       |              |       |                  |       |
| Savings                                         |       | $                 | 4,084,503  |                  | $          | 4,362,895 |   |
| Time                                            |       | 112,520           |       | 97,669                |       |
| Total  interest-bearing deposits                |       | 4,197,023         |       | 4,460,564             |       |
|                                            |       |              |       |                  |       |
| Noninterest-bearing  deposits:                  |       |              |       |                  |       |
| Demand                                          |       | 579,807           |       | 690,308               |       |
| Savings                                         |       | 22,701            |       | 85,510                |       |
| Time                                            |       | 300,000           |       | 160,000               |       |
|   Total  noninterest-bearing deposits |       | 902,508           |       | 935,818               |       |
|                                            |       |              |       |                  |       |
| Total                                           |       | $                 | 5,099,531  |                  | $          | 5,396,382 |   |

 

Time deposits with balances greater than $100,000 totaled $412.5million and $257.6 million at June 30, 2005 and December 31, 2004,respectively.  All time deposits had amaturity of less than three months at June 30, 2005 and December 31, 2004.

 

**6.****                   Securities SoldUnder Repurchase Agreements**

 

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

 

| ** **                          | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                          | ** ** | **2005**          | ** ** | **2004**              | ** ** |
|                                |       |              |       |                  |       |
| Repurchase  agreements - short term |       | $                 | 4,251,699  |                  | $          | 3,655,497 |   |
| Repurchase  agreements - long term  |       | 600,000           |       | 600,000               |       |
| Total                               |       | $                 | 4,851,699  |                  | $          | 4,255,497 |   |

 

Approximately $5.0 billion and $4.3 billion of securities were pledgedto collateralize repurchase agreements as of June 30, 2005 and December 31,2004, respectively.

 

12

----

 

**7.****                   Short-term andOther Borrowings**

 

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

 

| ** **                                            | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                            | ** ** | **2005**          | ** ** | **2004**              | ** ** |
|                                                  |       |              |       |                  |       |
| Federal  Funds purchased                              |       | $                 | 1,303,326  |                  | $          | 344,491 |   |
| Federal Home  Loan Bank of Boston short-term advances |       | —            |       | 200,000               |       |
| Federal Home  Loan Bank of Boston long-term advances  |       | 50,000            |       | 50,000                |       |
| Treasury,  Tax and Loan account                       |       | 114               |       | 190                   |       |
| Total                                                 |       | $                 | 1,353,440  |                  | $          | 594,681 |   |

 

The Company has borrowing arrangements with the FHLBB and the FederalReserve Discount Window, which have been utilized on an overnight, short-termand long-term basis to satisfy funding requirements.  Approximately $1.8 billion and $1.6 billionof securities were pledged to collateralize these advances as of June 30,2005 and December 31, 2004, respectively.

 

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

 

As of June 30, 2005, the Company’s authorized capital stockconsisted of 1,000,000 shares of Preferred Stock and 175,000,000 shares ofCommon Stock, all with a par value of $0.01 per share.

 

The Company has four equity incentive plans: the Amended and Restated1995 Stock Plan (‘Stock Plan’), the Amended and Restated 1995 Non-EmployeeDirector Stock Option Plan (‘Director Plan’), the 1997 Employee Stock PurchasePlan (‘ESPP’) and the 2005 Equity Incentive Plan, which was approved by thestockholders on April 14, 2005 (the ‘2005 Plan’).  The 2005 Plan supersedes both the Stock Planand the Director Plan, both of which expire in November 2005. There wereno amendments to any plans during the six months ended June 30, 2005.

 

During the six months ended June 30, 2005, the following activityoccurred under the Director Plan, the Stock Plan and the 2005 Plan:

 

| ** **                                         | ** ** | **June 30, 2005** | ** ** |
|----------------------------------------------------|------------|------------------------|------------|
| ** **                                         | ** ** | ** **             | ** ** | **Weighted-Average** | ** ** |
| ** **                                         | ** ** | **Shares**             | ** ** | **Exercise Price** | ** ** |
|                                               |       |                   |       |   |   |
| Outstanding  at December 31, 2004             |       | 5,929,352              |       | $ | 28 |   |
| Granted                                            |       | 52,366                 |       | 47 |   |
| Exercised                                          |       | (250,624               | )          | 30 |   |
| Canceled                                           |       | (38,265                | )          | 33 |   |
| Outstanding  at June 30, 2005                 |       | 5,692,829              |       | $ | 28 |   |
|                                               |       |                   |       |   |   |
| Outstanding  and Exercisable at June 30, 2005 |       | 4,884,575              |       |   |   |

 

13

----

 

**8.****                   Stockholders’Equity (continued)**

 

A summary of activity under the ESPP is as follows:

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

 

Purchases under the ESPP are made two times a year on the last businessday of each payment period.  The purchaseprice is equal to the lesser of (i) 90% of the market value of the CommonStock on the first business day of the payment period, or (ii) 90% of themarket value of the Common Stock on the last business day of the paymentperiod.  The payment periods consist oftwo six-month periods, January 1 through June 30 and July 1through December 31.

 

For the six-month period ended June 30, 2005, the purchase priceof the stock was $34.25, or 90% of the market value of the Common Stock on thelast business day of the payment period ending June 30, 2005.

 

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

 

InJuly 2005, the Company announced that its Board of Directors authorized arepurchase plan of up to $150 million of the Company’s common stock over thenext twelve months.

 

**9.****                   EmployeeBenefit Plans**

 

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

 
| ** **                                          | ** ** | **For the Six Months Ended** | ** ** | **For the Three Months Ended** | ** ** |
|-----------------------------------------------------|------------|------------------------------|------------|--------------------------------|------------|
| ** **                                          | ** ** | **June 30,  2005**      | ** ** | **June 30,  2004**        | ** ** | **June 30,  2005** | ** ** | **June 30,  2004** | ** ** |
|                                                |       |                         |       |                           |       |   |   |   |   |
| Service  cost-benefits earned / benefit obligations |       | $                            | 372        |                           | $          | 463 |   | $ | 186 |   | $ | 177 |   |
| Interest  cost on projected benefit obligations     |       | 572                          |       | 555                            |       | 286 |   | 204 |   |
| Expected  return on plan assets                     |       | (718                         | )          | (725                           | )          | (359 | ) | (358 | ) |
| Net  amortization and deferral                      |       | 156                          |       | 120                            |       | 78 |   | 58 |   |
| Net periodic  pension cost                          |       | $                            | 382        |                           | $          | 413 |   | $ | 191 |   | $ | 81 |   |

 

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

 

14

----

 

**9.****                   EmployeeBenefit Plans (continued)**

 

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

 
| ** **                                          | ** ** | **For the Six Months Ended** | ** ** | **For the Three Months Ended** | ** ** |
|-----------------------------------------------------|------------|------------------------------|------------|--------------------------------|------------|
| ** **                                          | ** ** | **June 30,  2005**      | ** ** | **June 30,  2004**        | ** ** | **June 30,  2005** | ** ** | **June 30,  2004** | ** ** |
|                                                |       |                         |       |                           |       |   |   |   |   |
| Service  cost-benefits earned / benefit obligations |       | $                            | 888        |                           | $          | 476 |   | $ | 444 |   | $ | 238 |   |
| Interest  cost on projected benefit obligations     |       | 736                          |       | 484                            |       | 368 |   | 242 |   |
| Net  amortization and deferral                      |       | 544                          |       | 296                            |       | 272 |   | 148 |   |
| Net periodic  pension cost                          |       | $                            | 2,168      |                           | $          | 1,256 |   | $ | 1,084 |   | $ | 628 |   |

 

During 2005, the Company expects to contribute up to $4 million, but nomore than the maximum deductible contribution the Company can make for thefiscal year to its pension plan.  Duringthe six-month period ended June 30, 2005, the Company did not make anycontributions to the plan.

 

At June 30, 2005, the SERP remained an unfunded plan.  Consistent with the Company’s expectations atDecember 31, 2004, no contributions to the SERP are anticipated during 2005.

 

**10.****            Off-Balance SheetFinancial Instruments**

 

***Lines of Credit****-* At June 30, 2005, the Company had commitments tomutual funds under collateralized open lines of credit totaling $850.0 million,against which $21.2 million in loans were drawn. The credit risk involved inissuing lines of credit is essentially the same as that involved in extendingdemand loans. The Company does not anticipate any loss as a result of theselines of credit.

 

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

 

With respect to the indemnified securities lending portfolio, the cashand U.S. government securities held by the Company as collateral at June 30,2005 totaled $6.0 billion while the fair value of the portfolio totaledapproximately $5.8 billion. Given that the collateral held was in excessof the value of the securities that the Company would be required to replace ifthe borrower defaulted and failed to return such securities, the Company’sindemnification obligation was zero and no liability was recorded.

 

All securities loans are categorized as overnight loans. The maximumpotential amount of future payments that the Company could be required to makewould be equal to the market value of the securities borrowed. Since thesecurities loans are overcollateralized by 2% (for U.S. dollar-denominatedsecurities) to 5% (for non-U.S. dollar-denominated securities) of the fairmarket value of the loan made, the collateral held by the Company would be usedto satisfy the obligation. In addition, each borrowing agreement includes “set-off”language that allows the Company to use any excess collateral on other loans tothat borrower to cover any collateral shortfall of that borrower. However,there is a potential risk that the collateral would not be sufficient to coversuch an obligation if the security on loan increased in value between the timethe borrower defaulted and the time the security is “bought-in.” In thoseinstances, the Company would “buy-in” the security using all availablecollateral and a loss would result from the difference between the value of thesecurity “bought-in” and the value of the collateral held. The Company hasnever experienced a broker default.

 

15

----

 

**11.**            Derivative FinancialInstruments

** **

***Interest Rate Contracts***- Interest rate contracts involve an agreement with a counterparty to exchangecash flows based on an underlying interest rate index.  A swap agreement involves the exchange of aseries of interest payments, either at a fixed or variable rate, based upon thenotional amount without the exchange of the underlying principal amount. TheCompany’s exposure from these interest rate contracts results from thepossibility that one party may default on its contractual obligation when thecontracts are in a gain position.  TheCompany has experienced no terminations or defaults by counterparties ofinterest rate swaps.  Credit risk islimited to the positive fair value of the derivative financial instrument,which is significantly less than the notional value.  As of June 30, 2005, the credit riskrelated to the Company’s interest rate contracts was approximately $10.8 million.

 

The Company enters into pay-fixed/receive-floating interest rate swapagreements.  These instruments have beendesignated as cash flow hedges of variable-rate liabilities.  The contractual or notional amounts of theinterest rate swap agreements held by the Company were approximately $1.8billion and $1.6 billion at June 30, 2005 and December 31, 2004,respectively.  These contracts had netfair values of approximately $10.5 million and $1.5 million at June 30,2005 and December 31, 2004, respectively. These fair values are includedin the respective other assets and other liabilities categories on the Company’sconsolidated balance sheet.

 

For the six months and the three months ended June 30, 2005, theCompany recognized net pre-tax gains of $3.0 million and $0.6 million,respectively, which represented the total ineffectiveness for all cash flowhedges. For both the six months and the three months ended June 30, 2004,total ineffectiveness related to cash flow hedges was $0.9 million.

 

As of June 30, 2005, the Company expects that approximately $5.2million of deferred net after-tax gains on derivative contracts included inother comprehensive income will be reclassified to net interest income withinthe next twelve months. This expectation is based on the net discounted cashflows from derivative instruments hedging short-term variable-rate liabilities,as well as the amortization of gains from the termination of cash flow hedgingderivatives.

 

***Foreign Exchange Contracts***- Foreign exchange contracts involve an agreement to exchange the currency ofone country for the currency of another country at an agreed-upon rate and settlementdate.  Foreign exchange contracts consistof spot, forward and swap contracts. Spot contracts call for the exchange of one currency for another andusually settle in two business days. Forward contracts call for the exchange of one currency for another at adate beyond spot.  In a currency swap,the holder of a currency transacts simultaneously both a spot and a forwardtransaction in that currency for an equivalent amount of another currency toget temporary liquidity in the currency owned. The Company’s risk from foreign exchange contracts results from thepossibility that one party may default on its contractual obligation or frommovements in exchange rates.  Credit riskis limited to the positive market value of the derivative financial instrument,which is significantly less than the notional value. The notional value of theCompany’s foreign exchange contracts as of June 30, 2005 and December 31,2004 was $8.2 billion and $6.9 billion, respectively.  Unrealized gains or losses resulting frompurchases and sales of foreign exchange contracts are included within therespective other assets and other liabilities categories on the Company’sconsolidated balance sheet.  Unrealizedgains in other assets were $125.9 million and $99.6 million as of June 30,2005 and December 31, 2004, respectively. Unrealized losses in other liabilities were $125.2 million and $98.5million as of June 30, 2005 and December 31, 2004, respectively.  Foreign exchange contracts with the samecounterparty are netted in the Company’s consolidated balance sheet when amaster netting agreement exists.  Thesecontracts have not been designated as hedging instruments; therefore, allchanges in fair value are included in asset servicing fees.

 

***Other*** - TheCompany also enters into fixed price purchase contracts that are designed tohedge the variability of the consideration to be paid for the purchase ofinvestment securities.  By entering intothese contracts, the Company is fixing the price to be paid at a future datefor certain investment securities. At June 30, 2005 and December 31,2004, the Company had $114.9 million and $672.2 million, respectively, of fixedprice purchase contracts outstanding to purchase investment securities. The netfair value of the contracts at June 30, 2005 and December 31, 2004was not significant.  Changes in fairvalue of these cash flow hedges are included as a component of othercomprehensive income.

 

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

 

***Restrictions on Cash Balances***- The Company is required to maintain certain average cash reservebalances.  The average required reservebalance with the Federal Reserve Bank (‘FRB’) for the two-week period includingJune 30, 2005 was approximately $16.3 million.  In addition, the Company’s balance sheet includesdeposits totaling $166.0 million, which were pledged to secure clearings withdepository institutions as of June 30, 2005.

 

16

----

 

**12.****            Commitments andContingencies (continued)**

 

***Contingencies*** -Assets held by the Company in a fiduciary capacity are not included in theconsolidated balance sheets since these items are not assets of theCompany.  Management conducts regularreviews of its fiduciary responsibilities and considers the results inpreparing its consolidated financial statements.  In the opinion of management, there were no contingentliabilities at June 30, 2005 that were material to the consolidatedfinancial position or results of operations of the Company.

 

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

 

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

 

Quantitative measures established by regulation to ensure capitaladequacy require the Company and the Bank to maintain minimum amounts andratios (set forth in the table below) of Total and Tier 1 capital (as definedin the regulations) to risk-weighted assets (as defined), and of Tier 1 capital(as defined) to average assets (as defined). Management believes, as of June 30, 2005, that the Company and theBank meet all capital adequacy requirements to which they are subject.

 

As of June 30, 2005, the most recent notification from the FederalDeposit Insurance Corporation categorized the Company and the Bank aswell-capitalized under the regulatory framework for prompt correctiveaction.  To be categorized aswell-capitalized, the Company and the Bank must maintain minimum Totalrisk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in thetable.  There are no conditions or eventssince that notification that management believes have changed the Company’s orthe Bank’s category.  The following tablepresents the capital ratios for the Company and the Bank (Dollars inthousands):

 
| ** **                                              | ** ** | ** ** | ** ** | ** **            | ** ** | ** **      | ** ** | ** **            | ** ** | **To Be Well Capitalized** | ** ** |
|---------------------------------------------------------|------------|------------|------------|-----------------------|------------|-----------------|------------|-----------------------|------------|----------------------------|------------|
| ** **                                              | ** ** | ** ** | ** ** | ** **            | ** ** | ** **      | ** ** | ** **            | ** ** | **Under Prompt**           | ** ** |
| ** **                                              | ** ** | ** ** | ** ** | ** **            | ** ** | **For Capital** | ** ** | **Corrective Action** | ** ** |
| ** **                                              | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Provisions**  | ** ** |
| ** **                                              | ** ** | **Amount** | ** ** | **Ratio**             | ** ** | **Amount**      | ** ** | **Ratio**             | ** ** | **Amount**                 | ** ** | **Ratio** | ** ** |
| **As of June 30,  2005:**                          | ** ** | ** ** | ** ** | ** **            | ** ** | ** **      | ** ** | ** **            | ** ** | ** **                 | ** ** | ** ** | ** ** |
| Total  Capital   (to Risk-Weighted Assets-the Company)  |       | $          | 727,948    |                  | 19.63%     |            | $          | 296,655               |       | 8.00%                      |       | N/A |   | N/A |   |
| Total  Capital   (to Risk-Weighted Assets-the Bank)     |       | $          | 705,812    |                  | 19.05%     |            | $          | 296,455               |       | 8.00%                      |       | $ | 370,569 |   | 10.00% |   |
| Tier 1  Capital   (to Risk-Weighted Assets-the Company) |       | $          | 727,848    |                  | 19.63%     |            | $          | 148,327               |       | 4.00%                      |       | N/A |   | N/A |   |
| Tier 1  Capital   (to Risk-Weighted Assets-the Bank)    |       | $          | 705,711    |                  | 19.04%     |            | $          | 148,228               |       | 4.00%                      |       | $ | 222,342 |   | 6.00% |   |
| Tier 1  Capital   (to Average Assets-the Company)       |       | $          | 727,848    |                  | 6.05%      |            | $          | 481,336               |       | 4.00%                      |       | N/A |   | N/A |   |
| Tier 1  Capital   (to Average Assets-the Bank)          |       | $          | 705,711    |                  | 5.87%      |            | $          | 481,256               |       | 4.00%                      |       | $ | 601,570 |   | 5.00% |   |
| ** **                                              | ** ** | ** ** | ** ** | ** **            | ** ** | ** **      | ** ** | ** **            | ** ** | ** **                 | ** ** | ** ** | ** ** |
|  **As of December 31,  2004:**                | ** ** | ** ** | ** ** | ** **            | ** ** | ** **      | ** ** | ** **            | ** ** | ** **                 | ** ** | ** ** | ** ** |
| Total  Capital   (to Risk-Weighted Assets-the Company)  |       | $          | 636,219    |                  | 20.54%     |            | $          | 247,782               |       | 8.00%                      |       | N/A |   | N/A |   |
| Total  Capital   (to Risk-Weighted Assets-the Bank)     |       | $          | 618,166    |                  | 19.98%     |            | $          | 247,572               |       | 8.00%                      |       | $ | 309,465 |   | 10.00% |   |
| Tier 1  Capital   (to Risk-Weighted Assets-the Company) |       | $          | 636,119    |                  | 20.54%     |            | $          | 123,891               |       | 4.00%                      |       | N/A |   | N/A |   |
| Tier 1  Capital   (to Risk-Weighted Assets-the Bank)    |       | $          | 618,066    |                  | 19.97%     |            | $          | 123,786               |       | 4.00%                      |       | $ | 185,679 |   | 6.00% |   |
| Tier 1  Capital   (to Average Assets-the Company)       |       | $          | 636,119    |                  | 5.85%      |            | $          | 435,080               |       | 4.00%                      |       | N/A |   | N/A |   |
| Tier 1  Capital   (to Average Assets-the Bank)          |       | $          | 618,066    |                  | 5.68%      |            | $          | 435,017               |       | 4.00%                      |       | $ | 543,772 |   | 5.00% |   |
|                                                         |            |            |            |                       |            |                 |            |                       |            |                            |            |  |  |  |  |  |  |

 

17

----

 

**13.****            Regulatory Matters(continued)**

 

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

 

The operations of the Company’s securities broker affiliate, InvestorsSecurities Services, LLC, are subject to federal and state securities laws, aswell as the rules of both the SEC and the NASD.  Management believes, as of June 30, 2005,that Investors Securities Services, LLC is in material compliance with all ofthe foregoing requirements to which it is subject.

 

The operations of the Company’s insurance captive affiliate, InvestorsVermont Insurance Company (IVIC), are subject to the laws of the State ofVermont Department of Banking, Insurance, Securities and Health CareAdministration.  Management believes, asof June 30, 2005, that IVIC is in material compliance with all of therequirements to which it is subject.

 

**14.****            Geographic Reportingand Service Lines**

 

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

 
| ** **       | ** ** | **Net Operating Revenue**                    | ** ** | **Long-Lived Assets**                         | ** ** |
|------------------|------------|----------------------------------------------|------------|-----------------------------------------------|------------|
| **Geographic**   | ** ** | **For the Six Months Ended   June 30,** | ** ** | **For the Three Months Ended  June 30,** | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
| **Information:** | ** ** | **2005**                                     | ** ** | **2004**                                      | ** ** | **2005** | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
|             |       |                                         |       |                                          |       |   |   |   |   |   |   |   |   |
| United  States   |       | $                                            | 317,369    |                                          | $          | 291,240 |   | $ | 159,631 |   | $ | 143,197 |   | $ | 139,613 |   | $ | 141,801 |   |
| Ireland          |       | 18,423                                       |       | 13,440                                        |       | 9,782 |   | 7,343 |   | 5,618 |   | 5,930 |   |
| Canada           |       | 2,634                                        |       | 2,237                                         |       | 1,267 |   | 1,231 |   | 155 |   | 121 |   |
| Cayman  Islands  |       | 85                                           |       | 90                                            |       | 42 |   | 45 |   | — |   | — |   |
|             |       |                                         |       |                                          |       |   |   |   |   |   |   |   |   |
| Total            |       | $                                            | 338,511    |                                          | $          | 307,007 |   | $ | 170,722 |   | $ | 151,816 |   | $ | 145,386 |   | $ | 147,852 |   |

 

Barclays Global Investors, N.A. (‘BGI’) accounted for approximately 18%of the Company’s consolidated net operating revenues for both the six-month andthe three-month periods ended June 30, 2005, and 17% of the Company’sconsolidated net operating revenues for both the six-month and the three-monthperiods ended June 30, 2004.  Noclient other than BGI accounted for more than 10% of the Company’s consolidatednet operating revenues for the six-month and the three-month periods ended June 30,2005 and 2004.

 

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

 

| ** **                              | ** ** | **For the Six Months Ended   June 30,** | ** ** | **For the Three Months Ended   June 30,** | ** ** |
|-----------------------------------------|------------|----------------------------------------------|------------|------------------------------------------------|------------|
| ** **                              | ** ** | **2005**                                     | ** ** | **2004**                                       | ** ** | **2005** | ** ** | **2004** | ** ** |
| Core service  fees:                     |       |                                         |       |                                           |       |   |   |   |   |
| Custody,  accounting and administration |       | $                                            | 178,703    |                                           | $          | 154,849 |   | $ | 90,159 |   | $ | 78,755 |   |
|                                    |       |                                         |       |                                           |       |   |   |   |   |
| Ancillary  service fees:                |       |                                         |       |                                           |       |   |   |   |   |
| Foreign  exchange                       |       | 25,504                                       |       | 33,008                                         |       | 12,255 |   | 14,513 |   |
| Cash  management                        |       | 16,537                                       |       | 12,338                                         |       | 9,173 |   | 6,738 |   |
| Securities  lending                     |       | 11,850                                       |       | 5,724                                          |       | 8,170 |   | 3,581 |   |
| Investment  advisory                    |       | 3,704                                        |       | 8,033                                          |       | 1,989 |   | 4,563 |   |
| Other  service fees                     |       | 1,403                                        |       | 1,228                                          |       | 752 |   | 843 |   |
| Total  ancillary service fees           |       | 58,998                                       |       | 60,331                                         |       | 32,339 |   | 30,238 |   |
|                                    |       |                                         |       |                                           |       |   |   |   |   |
| Total asset  servicing fees             |       | $                                            | 237,701    |                                           | $          | 215,180 |   | $ | 122,498 |   | $ | 108,993 |   |

 

18

----

 

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

 

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

 

| ** **                                                          | ** ** | **For the Six Months Ended   June 30,** | ** ** | **For the Three Months Ended   June 30,** | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                          | ** ** | **2005**                                     | ** ** | **2004**                                       | ** ** | **2005** | ** ** | **2004** | ** ** |
| Interest income:                                                    |       |                                         |       |                                           |       |   |   |   |   |
| Federal  funds sold and securities sold under repurchase agreements |       | $                                            | 753        |                                           | $          | 314 |   | $ | 390 |   | $ | 152 |   |
| Investment  securities held to maturity and available for sale      |       | 201,594                                      |       | 140,310                                        |       | 105,461 |   | 67,961 |   |
| Loans                                                               |       | 3,811                                        |       | 2,152                                          |       | 2,252 |   | 1,027 |   |
| Total  interest income                                              |       | 206,158                                      |       | 142,776                                        |       | 108,103 |   | 69,140 |   |
| Interest  expense:                                                  |       |                                         |       |                                           |       |   |   |   |   |
| Deposits                                                            |       | 31,363                                       |       | 22,274                                         |       | 16,118 |   | 10,904 |   |
| Securities  sold under repurchase agreements                        |       | 60,551                                       |       | 19,086                                         |       | 34,197 |   | 11,439 |   |
| Short-term  and other borrowings                                    |       | 24,585                                       |       | 10,920                                         |       | 15,742 |   | 4,722 |   |
| Total  interest expense                                             |       | 116,499                                      |       | 52,280                                         |       | 66,057 |   | 27,065 |   |
|                                                                |       |                                         |       |                                           |       |   |   |   |   |
| Net interest  income                                                |       | $                                            | 89,659     |                                           | $          | 90,496 |   | $ | 42,046 |   | $ | 42,075 |   |

 

19

----

 

REPORT OF INDEPENDENTREGISTERED PUBLIC ACCOUNTING FIRM

 

To theBoard of Directors and Stockholders of Investors Financial Services Corp.

 

Wehave reviewed the accompanying condensed consolidated balance sheet ofInvestors Financial Services Corp. and subsidiaries (the “Company”) as of June 30,2005, and the related condensed consolidated statements of income andcomprehensive income for the three-month and six-month periods ended June 30,2005 and 2004, and the condensed consolidated statements of stockholders’equity and cash flows for the six-month periods ended June 30, 2005 and2004. These interim financial statements are the responsibility of the Company’smanagement.

 

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

 

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

 

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

 

*DELOITTE & TOUCHE LLP*

 

Boston, Massachusetts August 9, 2005

 

20

----

 

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

 

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

 

**Overview**

 

Weprovide asset administration services for the financial services industrythrough our wholly-owned subsidiary, Investors Bank & Trust Company.  We provide core services and value-addedservices to a variety of financial asset managers, including mutual fundcomplexes, investment advisors, family offices, banks and insurancecompanies.  Core services include middleoffice outsourcing, global custody, multicurrency accounting and fundadministration.  Value-added servicesinclude securities lending, foreign exchange, cash management, performancemeasurement, institutional transfer agency, investment advisory services, linesof credit and brokerage and transition management services.  We have offices located in the United States,Ireland, Canada, and the Cayman Islands with a vast global subcustodian networkestablished to accommodate the international needs of our clients.  At June 30, 2005, we provided services forapproximately $1.5 trillion in net assets, including approximately $250 billionin foreign net assets.

 

Wegrow our business by selling our services to new clients and by furtherpenetrating our existing clients.  Webelieve that we service less than 10% of the assets managed by our existingclients, and we have traditionally achieved significant success in growingclient relationships.  Our ability toservice new clients and expand our relationships with existing clients dependson our provision of superior client service. Our growth is also affected by overall market conditions, the regulatoryenvironment for us and our clients and the success of our clients in marketingtheir products.

 

Wederive our asset servicing revenue from providing core and value-addedservices.  We derive our net interestincome by investing the cash balances our clients leave on deposit withus.  Since we price our service offeringson a bundled basis, our share of earnings from these investments is viewed aspart of the total compensation that our clients pay us for servicing theirassets.  In establishing a fee structurefor a specific client, we analyze all expected revenue and expenses.  We believe net operating revenue (netinterest income plus noninterest income) and net income are the most meaningfulmeasures of our financial results.

 

Asan asset administration services company, the amount of net operating revenuethat we generate is impacted by overall market conditions, client activity andthe prevailing interest rate environment. A significant portion of our core services revenue is based upon theamount of assets under administration. As market values of underlying assets fluctuate, so will our revenue.  We have managed this volatility by offering atiered pricing structure for our asset-based fees.  As asset values increase, the basis point feeis reduced for the incremental assets.  Whenasset values decrease, revenue is only impacted at the then marginal rate.  Many of our value-added services aretransactional based, and we receive a fee for each transaction processed.  We have continued to experience net interestmargin compression during the first half of 2005 versus 2004 due to a flatteryield curve and lower reinvestment spreads and the liability sensitive natureof our balance sheet.  Because we are aliability sensitive institution, as overnight interest rates rise, most of ourliabilities reprice but our assets take longer to reprice due to the nature oftheir reset provisions (i.e., monthly, quarterly and annually).  The lower interest rate spreads were also dueto the narrowing of market spreads on reinvestment and purchase opportunitiesof fixed and floating-rate investment assets.

 

Weremain focused on our sales efforts, prudent expense management and increasingour operating efficiency.  These goalsare complicated by the need to build infrastructure to support our rapidgrowth, the need to maintain state-of-the-art systems and the need to retainand motivate our workforce.

 

21

----

 

**Certain Factors That MayAffect Future Results**

 

From time to time,information provided by us, statements made by our employees, or informationincluded in our filings with the Securities and Exchange Commission (includingthis Form 10-Q) may contain statements which are not historical facts,so-called “forward-looking statements,” which are made under Section 21E of theSecurities Exchange Act of 1934 and which involve risks and uncertainties.  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 or thenegative of those terms.  Forward-lookingstatements in this Form 10-Q include certain statements regarding liquidity, growthrate, annual dividend payments, interest rate conditions, interest ratesensitivity, compliance with capital adequacy guidelines, loss exposure on linesof credit, the timing and effect on earnings of derivative gains and losses andthe reclassification of net after-tax gains on derivative contracts, securitieslending revenue, net interest income, operating expenses, including occupancyneeds, professional fee expense, travel and sales expense, investments intechnology and compensation expense, pension plan and supplemental pensionexpense, depreciation expense, effective tax rate, investments in FHLBB capitalstock, the effect on earnings of changes in equity values or fixed income, ourability to execute our stock repurchase plan, and the effect of certain legalclaims against us.  Our actual futureresults may differ significantly from those stated in any forward-lookingstatements.  Factors that may cause suchdifferences include, but are not limited to, the factors discussed below.  Each of these factors, and others, arediscussed from time to time in our filings with the SEC.

 

*Our operating results aresubject to fluctuations in interest rates and the securities markets.*

 

Asignificant portion of our fees is based on the market value of the assets weprocess.  Accordingly, our operatingresults are subject to fluctuations in interest rates and securities markets asthese fluctuations affect the market value of assets processed.  Current market conditions, including therecent volatility in the equity markets, can have a material effect on ourasset-based fees.  While reductions inasset servicing fees may be offset by increases in other sources of revenue, asustained downward movement of the broad equity markets will likely have anadverse impact on our earnings.

 

Ourgrowth depends in part on the ability of our clients to generate fund flows byselling their investment products to new and existing investors.  Fluctuations in interest rates or thesecurities markets can lead to investors seeking alternatives to the investmentofferings of our clients, which could result in a lesser amount of assetsprocessed and correspondingly lower fees. For example, if the value of equity assets held by our clients were toincrease or decrease by 10%, we estimate currently that this, by itself, wouldcause a corresponding change of approximately 3% in our earnings pershare.  If the value of fixed-incomeassets held by our clients were to increase or decrease by 10%, we estimatecurrently that this, by itself, would cause a corresponding change ofapproximately 2% in our earnings per share.

 

Ournet interest income is earned by investing depositors’ funds in our investmentportfolio and, in small part, by making loans. A rising interest rate environment, such as we are now experiencing,generally causes downward pressure on net interest income.  Changes in the relationship betweenshort-term and long-term interest rates, referred to as the yield curve, could alsoadversely affect the market value of, or the earnings produced by, ourinvestment and loan portfolios, and thus could adversely affect our operatingresults.  The current flattening yieldcurve, where short-term rates have increased while long-term rates have failedto increase, has resulted in a decrease in our net interest margin that maycontinue to have a material impact on our net interest income.

 

Inaddition, we are experiencing narrower investment portfolio reinvestmentspreads.  If reinvestments spreads on thesecurity types we purchase remain narrow, or become narrower, our net interest incomecould be impacted negatively.

 

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

 

Asa result of our selection to service assets for Barclays Global InvestorsCanada, Ltd., our assumption of the operations of the U.S. asset administrationunit of BGI in 2001 and our ongoing relationship with BGI’s iShares and MasterInvestment Portfolios, BGI accounted for approximately 18% of our net operatingrevenue during both the six months and the three months ended June 30,2005.  We expect that BGI will continueto account for a significant portion of our net operating revenue.  While we provide services to BGI underlong-term contracts (that expire in 2006), those contracts may be terminatedfor certain regulatory and fiduciary reasons. The loss of BGI’s business would cause our net operating revenue todecline significantly and would likely have an adverse effect on our quarterlyand annual results.

 

22

----

 

*We may incur losses dueto operational errors.*

 

Theservices that we provide require complex processes and interaction withnumerous third parties.  While wemaintain sophisticated computer systems and a comprehensive system of internalcontrols, and our operational history has been excellent, from time to time wemay make operational errors for which we are responsible to our clients.  In addition, even though we maintainappropriate errors and omissions and other insurance policies, an operationalerror could result in a significant liability to us and may have a materialadverse effect on our results of operations.

 

*We face significantcompetition from other financial services companies, which could negativelyaffect our operating results.*

 

Weare part of an extremely competitive asset servicing industry.  Many of our current and potential competitorshave longer operating histories, greater name recognition and substantiallygreater financial, marketing and other resources than we do.  These greater resources could, for example,allow our competitors to develop technology superior to our own. In addition,we face the risk that 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 significantcosts defending legal claims.*

 

Wehave been named in a lawsuit in U.S. District Court in Massachusetts alleging,among other things, violations of securities laws.  In addition, we have been named in a lawsuitin Massachusetts state court alleging, among other things, violations of acovenant of good faith and fair dealing in a contract. While we believe theseclaims are without merit, we cannot be sure that we will prevail in the defenseof these claims. We are also party to other litigation and we may becomesubject to other legal claims in the future. Litigation is costly and coulddivert the attention of management.

 

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

 

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

 

*The failure to properlymanage our growth could adversely affect the quality of our services and resultin the loss of clients.*

 

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

 

*We must hire and retainskilled personnel in order to succeed.*

 

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

 

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

 

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

 

23

----

 

*Our quarterly and annualoperating results may fluctuate.*

 

Ourquarterly and annual operating results are difficult to predict and mayfluctuate from quarter to quarter and annually for several reasons, including:

 

•                                          The timing of commencement or termination ofclient engagements;

 

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

 

•                                          The rate of net inflows and outflows ofinvestor funds in the investment vehicles offered by our clients; and

 

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

 

Mostof our expenses, such as employee compensation and rent, are relativelyfixed.  As a result, any shortfall inrevenue relative to our expectations could significantly affect our operatingresults.

 

*We are subject toextensive federal and state regulations that impose complex restraints on ourbusiness.*

 

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

 

•                                          The FRB and the FDIC maintain capitalrequirements that we must meet. Failure to meet those requirements could leadto severe regulatory action or even receivership. We are currently consideredto be “well capitalized”;

 

•                                          Under Massachusetts law, the Bank may berestricted in its ability to pay dividends to Investors Financial ServicesCorp., which may in turn restrict our ability to pay dividends to ourstockholders;

 

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

 

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

 

•                                          BISHCA maintains certain regulatoryrequirements that our insurance captive affiliate, Investors Vermont InsuranceCompany, must meet.  Failure to meetthose requirements could lead to regulatory action; and

 

•                                          Our international operations are subject toregulatory oversight by regulators in the jurisdictions in which we operate,including the Office of the Superintendent of Financial Institutions in Canada,the Irish Financial Services Regulatory Authority and the Cayman IslandsMonetary Authority.  Failure to complywith applicable international regulatory requirements could result inregulatory action and impact our ability to provide services in thosejurisdictions.

 

Bankinglaw restricts our ability to own the stock of certain companies and also makesit more difficult for us to be acquired. Also, we have not elected financial holding company status under thefederal Gramm-Leach-Bliley Act of 1999. This may place us at a competitive disadvantage with respect to otherorganizations.

 

24

----

 

**Statements of Income**

 

***Comparison of Operating Resultsfor the Six and Three Months Ended June 30, 2005 and 2004***

 

Net income for the six-monthand three-month periods ended June 30, 2005 increased 21% to $85.1 million, andincreased 30% to $44.1 million, respectively, from the same periods in 2004. Theoverall increase in net income for both the six-month and three-month periodcomparisons resulted from higher asset servicing fees, reflecting strong clientfund flows combined with our continued ability to sell to new and existingclients. The increases in net income for both periods were also due to gainsfrom sales of investment securities in the first half of 2005, as well as aone-time tax benefit related to our recognition of the indefinite reversalprovisions of Accounting Principles Board Opinion No. 23, *Accountingfor Income Taxes – Special Area*s (‘APB 23’), in the second quarterof 2005. See Note 2 in ‘Notes to Unaudited Condensed Consolidated FinancialStatements’ for further discussion of the one-time tax benefit. The increasesin net income for the six-month and three-month periods ended June 30, 2005 werepartially offset by increases in operating expenses, reflecting continuedgrowth in headcount and technology to support new and existing clients.

 

Fees and Other Revenue

 

The components of fees andother revenue are as follows (Dollars in thousands):

 
| ** **                   | ** ** | **For the Six Months Ended June 30,** | ** ** | **For the Three Months Ended June 30,** | ** ** |
|------------------------------|------------|---------------------------------------|------------|-----------------------------------------|------------|
| ** **                   | ** ** | **2005**                              | ** ** | **2004**                                | ** ** | **Change** | ** ** | **2005** | ** ** | **2004** | ** ** | **Change** | ** ** |
|                         |       |                                  |       |                                    |       |   |   |   |   |   |   |   |   |
| Total asset servicing fees   |       | $                                     | 237,701    |                                    | $          | 215,180 |   | 10% |   | $ | 122,498 |   | $ | 108,993 |   | 12% |   |
| Other operating income       |       | 1,411                                 |       | 1,097                                   |       | 29% |   | 626 |   | 748 |   | (16)% |   |
| Gain on sale of investment   |       | 9,740                                 |       | 234                                     |       | 4,062% |   | 5,552 |   | — |   | 100% |   |
|                         |       |                                  |       |                                    |       |   |   |   |   |   |   |   |   |
| Total fees and other revenue |       | $                                     | 248,852    |                                    | $          | 216,511 |   | 15% |   | $ | 128,676 |   | $ | 109,741 |   | 17% |   |

 

The largest components ofasset servicing fees are custody, accounting and administration, whichincreased 15% to $178.7 million, and increased 14% to $90.2 million, for thesix month and three month periods ended June 30, 2005, respectively, from thesame periods in 2004.  The increase in custody,accounting and administration fees in both the six month and three month periodsis primarily due to growth in assets processed resulting from fund flows andmarket value gains and further penetration of existing clients. Assetsprocessed is the total dollar value of financial assets on the reported datefor which we provide one or more of the following services: middle officeoutsourcing, global custody, multicurrency accounting, fund administration,securities lending, foreign exchange, cash management, performance measurement,institutional transfer agency, investment advisory services, lines of creditand brokerage and transition management services.  The change in net assets processed includesthe following components (Dollars in billions):

 
| ** **                                | ** ** | **For the Six Months**  | ** ** | **For the Three Months** | ** ** |
|-------------------------------------------|------------|-------------------------|------------|--------------------------|------------|
| ** **                                | ** ** | **Ended June 30, 2005** | ** ** | **Ended June 30, 2005**  | ** ** |
|                                      |       |                    |       |                     |       |
| Net assets processed, beginning of period |       | $                       | 1,430      |                     | $          | 1,469 |   |
| Change in net assets processed:           |       |                    |       |                     |       |
| Sales to new clients                      |       | 2                       |       | 1                        |       |
| Further penetration of existing clients   |       | 21                      |       | 14                       |       |
| Lost clients                              |       | (11                     | )          | (2                       | )          |
| Fund flows and market gain                |       | 54                      |       | 14                       |       |
| Total change in net assets processed      |       | 66                      |       | 27                       |       |
| Net assets processed, end of period       |       | $                       | 1,496      |                     | $          | 1,496 |   |

 

The majority of the increasein assets processed for the six months ended June 30, 2005 was due to the abilityof our clients to develop and sell product, which generates fund flows thathave a direct, positive impact on our business. The increase in assets processed for the three months ended June 30,2005 was due to client fund flows and sales to new and existing clients.  As indicated in the ‘Overview’ section, ourcore services fees are generated by charging a fee based upon the value ofassets processed.  As market values orclients’ asset levels fluctuate, so will our revenue.  Our tiered pricing structure, coupled withminimum and flat fees, allow us to manage this volatility to a certainextent.  As asset values increase, thebasis point fee typically lowers.  Whenasset values decrease, revenue is only impacted by the asset decline at thethen marginal rate.

 

Ifthe value of equity assets held by our clients were to increase or decrease by10%, we estimate currently that this, by itself, would cause a correspondingchange of approximately 3% in our earnings per share.  If the value of fixed-income assets held byour

 

25

----

 

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

 

Transaction-driven income, acomponent of asset servicing fees, includes our ancillary services, such asforeign exchange, cash management, securities lending and investment advisoryservices.

 

• Foreign exchange fees were $25.5 million forthe six-month period ended June 30, 2005, down 23% from the same period in2004, and were $12.3 million for the three-month period ended June 30, 2005,down 16% from the same period in 2004. The decrease in foreign exchange fees is primarily attributable to lowervolatility in currency markets.  Futureforeign exchange income is dependent on the volume of client activity and theoverall volatility in the currencies traded.

 

• Cash management fees, which consist of sweepfees, were $16.5 million for the six months ended June 30, 2005, up 34% fromthe same period in 2004, and were $9.2 million for the three months ended June30, 2005, up 36% from the same period in 2004. The increase is primarily due tohigher balances placed by our clients in the cash management products we offer.  Cash management revenue will continue todepend on the level of client balances maintained in the cash managementproducts we offer.  If our clients’investment products continue to maintain increasing cash balances, we expect ourcash management revenue to be positively impacted.

 

• Securities lending fees were $11.9 millionfor the six months ended June 30, 2005, up 107% from the same period in 2004,and were $8.2 million for the three-month period ended June 30, 2005, up 128%from the same period in 2004. The increase in securities lending fees in bothperiods was due to higher volumes and improved market conditions.  Securities lending transaction volume ispositively affected by the market value of the securities on loan, merger andacquisition activity, increased IPO activity and a steeper short end of theyield curve.  If the capital marketsexperience any of the aforementioned activity, it is likely that our securitieslending revenue will be positively impacted. If we experience a reduction in our securities lending portfolio, lowermarket values and compression of the spreads earned on securities lendingactivity, our securities lending revenue will likely be negatively impacted.  In addition, second quarter securitieslending fees are typically seasonably higher due to the dividend arbitrageopportunity on foreign securities.

 

• Investment advisory fees were $3.7 million forthe six months ended June 30, 2005, down 54% from the same period in 2004, and were$2.0 million for the three-month period ended June 30, 2005, down 56% from thesame period in 2004.  The decrease ininvestment advisory fees is attributable to lower asset levels in ourproprietary Merrimac money market funds combined with advisory fee waivers oncertain of the funds.  Future investmentadvisory fee income is dependent upon asset levels within the Merrimac moneymarket funds, which are driven by overall market conditions, client activityand transaction volumes. The Company discontinued advisory fee waivers in thesecond quarter of 2005.

 

• Other service fees for the six months endedJune 30, 2005 were $1.4 million, up 14% from the same period last year, andwere $0.8 million for the three months ended June 30, 2005, down 11% from thesame period in 2004. Other service fees primarily include income earned onbrokerage and transition management services, which were provided in greatervolume in the first half of 2005 compared to the same period in 2004. Thedecrease in other service fees from the three-month period ended June 30, 2004to the same period in 2005 was due to a one-time transition for a large clientin the second quarter of 2004.

 

Other operating income forthe six months ended June 30, 2005 was $1.4 million, up 29% from the sameperiod in 2004, and was $0.6 million for the three months ended June 30, 2005,down 16% from the same period in 2004. The increase in the six-month period wasprimarily due to an increase in stock dividend income from Federal Home LoanBank of Boston (‘FHLBB’) from 2004. The decrease in the three-month period wasdue to a one-time client system enhancement project that was completed in thesecond quarter of 2004.

 

During the first half of2005, we sold municipal securities and U.S. Treasury securities held in our availablefor sale portfolio, resulting in the recognition of $9.7 million and $5.6million in gains for the six-month and three-month periods ended June 30, 2005,respectively.  These security sales werethe result of our strategy to improve the after-tax yield of our municipal securitiesportfolio by replacing certain municipal securities sold with those that offera more attractive after-tax yield, as well as to capitalize on strong marketconditions.

 

26

----

 

*Net Interest Income*

 

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

 
| ** **                | ** ** | **For the Six Months Ended June 30,** | ** ** | **For the Three Months Ended June 30,** | ** ** |
|---------------------------|------------|---------------------------------------|------------|-----------------------------------------|------------|
| ** **                | ** ** | **2005**                              | ** ** | **2004**                                | ** ** | **Change** | ** ** | **2005** | ** ** | **2004** | ** ** | **Change** | ** ** |
|                      |       |                                  |       |                                    |       |   |   |   |   |   |   |   |   |
| Interest income           |       | $                                     | 206,158    |                                    | $          | 142,776 |   | 44% |   | $ | 108,103 |   | $ | 69,140 |   | 56% |   |
| Interest expense          |       | 116,499                               |       | 52,280                                  |       | 123% |   | 66,057 |   | 27,065 |   | 144% |   |
| Total net interest income |       | $                                     | 89,659     |                                    | $          | 90,496 |   | (1)% |   | $ | 42,046 |   | $ | 42,075 |   | — |   |

 

Net interest income isaffected by the volume and mix of assets and liabilities and the movement andlevel of interest rates.  The slight decreasein our net interest income for both the six-month and three-month periods endedJune 30, 2005, was primarily driven by lower interest rate spreads, which was partiallyoffset by growth in our investment portfolio. Lower interest rate spreads were due to increasing short-term interestrates without a concurrent increase in longer-term rates, which resulted in aflattening yield curve. Consequently, our interest-bearing liabilities, ofwhich the majority is priced based on overnight floating rates, have repricedfaster than our interest-earning assets, resulting in a lower net interestmargin.  In addition, reinvestment andpurchase spreads on fixed and floating-rate assets were lower than expected dueto higher market demand, especially for shorter-term and floating-rate fixedincome investments. Average investment security balances were higher in 2005 byapproximately $1.8 billion in both the six-month and three-month periods endedJune 30, 2005 compared to the same periods in 2004.

 

The table below presents thechanges in net interest income resulting from changes in the volume ofinterest-earning assets or interest-bearing liabilities and changes in interestrates for the six months and the three months ended June 30, 2005 compared tothe same periods in 2004.  Changesattributed to both volume and rate have been allocated based on the proportionof change in each category (Dollars in thousands):

 
| ** **                                                           | ** ** | **For the Six Months Ended June 30, 2005** | ** ** | **For the Three Months Ended June 30, 2005** | ** ** |
|----------------------------------------------------------------------|------------|--------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                           | ** ** | **Change**                                 | ** ** | **Change**                                   | ** ** | ** ** | ** ** | **Change** | ** ** | **Change** | ** ** | ** ** | ** ** |
| ** **                                                           | ** ** | **Due to**                                 | ** ** | **Due to**                                   | ** ** | ** ** | ** ** | **Due to** | ** ** | **Due to** | ** ** | ** ** | ** ** |
| ** **                                                           | ** ** | **Volume**                                 | ** ** | **Rate**                                     | ** ** | **Net** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Net** | ** ** |
| Interest-earning assets:                                             |       |                                       |       |                                         |       |   |   |   |   |   |   |   |   |
| Federal Funds sold and securities purchased  under resale agreements |       | $                                          | (45        | )                                            | $          | 484 |   | $ | 439 |   | $ | (26 | ) | $ | 264 |   | $ | 238 |   |
| Investment securities                                                |       | 31,083                                     |       | 30,201                                       |       | 61,284 |   | 15,099 |   | 22,401 |   | 37,500 |   |
| Loans                                                                |       | 152                                        |       | 1,507                                        |       | 1,659 |   | 460 |   | 765 |   | 1,225 |   |
|                                                                 |       |                                       |       |                                         |       |   |   |   |   |   |   |   |   |
| Total interest-earning assets                                        |       | $                                          | 31,190     |                                         | $          | 32,192 |   | $ | 63,382 |   | $ | 15,533 |   | $ | 23,430 |   | $ | 38,963 |   |
|                                                                 |       |                                       |       |                                         |       |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                                        |       |                                       |       |                                         |       |   |   |   |   |   |   |   |   |
| Deposits                                                             |       | $                                          | (4,272     | )                                            | $          | 13,361 |   | $ | 9,089 |   | $ | (3,270 | ) | $ | 8,484 |   | $ | 5,214 |   |
| Borrowings                                                           |       | 22,983                                     |       | 32,147                                       |       | 55,130 |   | 14,155 |   | 19,623 |   | 33,778 |   |
|                                                                 |       |                                       |       |                                         |       |   |   |   |   |   |   |   |   |
| Total interest-bearing liabilities                                   |       | $                                          | 18,711     |                                         | $          | 45,508 |   | $ | 64,219 |   | $ | 10,885 |   | $ | 28,107 |   | $ | 38,992 |   |
|                                                                 |       |                                       |       |                                         |       |   |   |   |   |   |   |   |   |
| Change in net interest income                                        |       | $                                          | 12,479     |                                         | $          | (13,316 | ) | $ | (837 | ) | $ | 4,648 |   | $ | (4,677 | ) | $ | (29 | ) |

 

Inaddition to investing in both variable and fixed-rate securities, we usederivative instruments to manage our exposure to interest rate risk. See the ‘MarketRisk’ section for more detailed information.

 

27

----

 

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

 
| ** **                                                           | ** ** | **Six Months Ended June 30, 2005** | ** ** | **Six Months Ended June 30, 2004** | ** ** |
|----------------------------------------------------------------------|------------|------------------------------------|------------|------------------------------------|------------|
| ** **                                                           | ** ** | **Average**                        | ** ** | ** **                         | ** ** | **Average** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                                           | ** ** | **Balance**                        | ** ** | **Interest**                       | ** ** | **Yield/Cost** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Yield/Cost** | ** ** |
| **Interest-earning assets:**                                         |       |                               |       |                               |       |   |   |   |   |   |   |   |   |
| Federal Funds sold and securities purchased  under resale agreements |       | $                                  | 55,967     |                               | $          | 753 |   | 2.69% |   | $ | 64,110 |   | $ | 314 |   | 0.98% |   |
| Investment securities(1)                                             |       |                               |       |                               |       |   |   |   |   |   |   |   |   |
| Mortgage-backed securities                                           |       | 7,867,841                          |       | 145,277                            |       | 3.69% |   | 6,311,071 |   | 100,426 |   | 3.18% |   |
| Federal agency securities                                            |       | 2,318,705                          |       | 40,860                             |       | 3.52% |   | 2,003,017 |   | 24,253 |   | 2.42% |   |
| State and political subdivisions                                     |       | 470,210                            |       | 10,885                             |       | 4.63% |   | 472,435 |   | 10,701 |   | 4.53% |   |
| Other securities                                                     |       | 259,273                            |       | 4,572                              |       | 3.53% |   | 298,676 |   | 4,930 |   | 3.30% |   |
| Total investment securities                                          |       | 10,916,029                         |       | 201,594                            |       | 3.69% |   | 9,085,199 |   | 140,310 |   | 3.09% |   |
| Loans                                                                |       | 192,997                            |       | 3,811                              |       | 3.95% |   | 180,998 |   | 2,152 |   | 2.38% |   |
| Total interest-earning assets                                        |       | 11,164,993                         |       | 206,158                            |       | 3.69% |   | 9,330,307 |   | 142,776 |   | 3.06% |   |
| Allowance for loan losses                                            |       | (100                               | )          |                               |       |   |   | (100 | ) |   |   |   |   |
| Noninterest-earning assets                                           |       | 637,264                            |       |                               |       |   |   | 527,817 |   |   |   |   |   |
| Total assets                                                         |       | $                                  | 11,802,157 |                               |       |   |   |   | $ | 9,858,024 |   |   |   |   |   |
|                                                                 |       |                               |       |                               |       |   |   |   |   |   |   |   |   |
| **Interest-bearing liabilities:**                                    |       |                               |       |                               |       |   |   |   |   |   |   |   |   |
| Deposits:                                                            |       |                               |       |                               |       |   |   |   |   |   |   |   |   |
| Savings                                                              |       | $                                  | 3,252,860  |                               | $          | 29,753 |   | 1.83% |   | $ | 4,050,597 |   | $ | 22,198 |   | 1.10% |   |
| Time                                                                 |       | 118,270                            |       | 1,610                              |       | 2.72% |   | 15,151 |   | 76 |   | 1.00% |   |
| Securities sold under repurchase agreements(2)                       |       | 5,210,157                          |       | 60,551                             |       | 2.32% |   | 3,726,235 |   | 19,086 |   | 1.02% |   |
| Junior subordinated debentures                                       |       | 24,774                             |       | 1,210                              |       | 9.77% |   | 24,774 |   | 1,210 |   | 9.77% |   |
| Other borrowings (3)                                                 |       | 1,647,953                          |       | 23,375                             |       | 2.84% |   | 783,422 |   | 9,710 |   | 2.48% |   |
| Total interest-bearing liabilities                                   |       | 10,254,014                         |       | 116,499                            |       | 2.27% |   | 8,600,179 |   | 52,280 |   | 1.22% |   |
| Noninterest-bearing liabilities:                                     |       |                               |       |                               |       |   |   |   |   |   |   |   |   |
| Demand deposits                                                      |       | 304,401                            |       |                               |       |   |   | 289,415 |   |   |   |   |   |
| Savings                                                              |       | 57,415                             |       |                               |       |   |   | 77,897 |   |   |   |   |   |
| Noninterest-bearing time deposits                                    |       | 203,425                            |       |                               |       |   |   | 165,852 |   |   |   |   |   |
| Other liabilities                                                    |       | 231,710                            |       |                               |       |   |   | 136,181 |   |   |   |   |   |
| Total liabilities                                                    |       | 11,050,965                         |       |                               |       |   |   | 9,269,524 |   |   |   |   |   |
| Equity                                                               |       | 751,192                            |       |                               |       |   |   | 588,500 |   |   |   |   |   |
| Total liabilities and equity                                         |       | $                                  | 11,802,157 |                               |       |   |   |   | $ | 9,858,024 |   |   |   |   |   |
| Net interest income                                                  |       |                               |       | $                                  | 89,659     |   |   |   |   |   | $ | 90,496 |   |   |   |
| Net interest margin (4)                                              |       |                               |       |                               |       | 1.61% |   |   |   |   |   | 1.94% |   |
| Average interest rate spread (5)                                     |       |                               |       |                               |       | 1.42% |   |   |   |   |   | 1.84% |   |
| Ratio of interest-earning assets to interest-bearing  liabilities    |       |                               |       |                               |       | 108.88% |   |   |   |   |   | 108.49% |   |

 

----

|   | (1) |   | Average  yield/cost on available for sale securities is based on amortized cost.                                                                                    |
|--------|-----|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | (2) |   | Interest expense  includes penalties of $2.9 million for the six months ended June 30, 2004 for  prepayment of two term repurchase agreements.                      |
|   | (3) |   | Interest expense  includes contractual prepayment penalties of $3.9 million for the six months  ended June 30, 2004 for the prepayment of certain FHLBB borrowings. |
|   | (4) |   | Annualized net  interest income divided by total interest-earning assets.                                                                                           |
|   | (5) |   | Yield on  interest-earning assets less rate paid on interest-bearing liabilities.                                                                                   |

 

28

----

 

*Operating Expenses*

 

Total operating expenseswere $218.0 million for the six months ended June 30, 2005, up 9% from the sameperiod in 2004. Total operating expenses were $113.2 million for the threemonths ended June 30, 2005, up 12% from the same period in 2004. The increasesin operating expenses were primarily due to increased compensation andbenefits, technology and telecommunications, travel and sales and otheroperating expenses, as detailed below.  Itis expected that incremental expense for the remainder of 2005 will primarilybe driven by continued investments in headcount and technology to support newand existing clients.  The components ofoperating expenses were as follows (Dollars in thousands):

 
| ** **                        | ** ** | **For the Six Months Ended June 30,** | ** ** | **For the Three Months Ended June 30,** | ** ** |
|-----------------------------------|------------|---------------------------------------|------------|-----------------------------------------|------------|
| ** **                        | ** ** | **2005**                              | ** ** | **2004**                                | ** ** | **Change** | ** ** | **2005** | ** ** | **2004** | ** ** | **Change** | ** ** |
| Compensation and benefits         |       | $                                     | 120,351    |                                    | $          | 109,094 |   | 10% |   | $ | 63,432 |   | $ | 53,771 |   | 18% |   |
| Technology and telecommunications |       | 25,913                                |       | 20,722                                  |       | 25% |   | 13,077 |   | 10,456 |   | 25% |   |
| Transaction processing services   |       | 22,776                                |       | 21,138                                  |       | 8% |   | 11,656 |   | 10,198 |   | 14% |   |
| Depreciation and amortization     |       | 15,984                                |       | 16,721                                  |       | (4)% |   | 8,093 |   | 8,767 |   | (8)% |   |
| Occupancy                         |       | 12,840                                |       | 14,260                                  |       | (10)% |   | 6,227 |   | 6,869 |   | (9)% |   |
| Professional fees                 |       | 6,379                                 |       | 7,256                                   |       | (12)% |   | 3,406 |   | 4,018 |   | (15)% |   |
| Travel and sales promotion        |       | 3,174                                 |       | 2,579                                   |       | 23% |   | 1,825 |   | 1,497 |   | 22% |   |
| Insurance                         |       | 2,275                                 |       | 2,360                                   |       | (4)% |   | 1,146 |   | 1,164 |   | (2)% |   |
| Other operating expenses          |       | 8,337                                 |       | 6,704                                   |       | 24% |   | 4,375 |   | 3,960 |   | 10% |   |
|                              |       |                                  |       |                                    |       |   |   |   |   |   |   |   |   |
| Total operating expenses          |       | $                                     | 218,029    |                                    | $          | 200,834 |   | 9% |   | $ | 113,237 |   | $ | 100,700 |   | 12% |   |

 

Compensationand benefits expense was $120.4 million for the six months ended June 30, 2005and was $63.4 million for the three months ended June 30, 2005, up 10% and 18%,respectively, from the same periods last year due to higher headcount andannual salary increases partially offset by lower bonus accruals consistentwith our current EPS projections for 2005. Further increases in compensation expense in 2005 will be primarilydependent upon sales to new and existing clients.

 

Technologyand telecommunications expense was $25.9 million for the six months ended June30, 2005 and was $13.1 million for the three months ended June 30, 2005, both up25% from the same periods last year.  Theseincreases were due to our outsourcing agreement with IBM, which we entered intoin July of 2004.  The costs of thisagreement were partially offset by decreases in other technology andtelecommunications expenses, as the services were previously performed by theBank or other service providers.  Futuretechnology and telecommunications expense will be dependent on clientintegrations associated with new business and ongoing improvement to ourinfrastructure.  Generally, we expecttechnology reinvestment to equal approximately 18-20% of net operating revenueeach year, including the related compensation costs.

 

Occupancyexpense was $12.8 million for the six months ended June 30, 2005 and was $6.2million for the three months ended June 30, 2005, down 10% and 9%,respectively, from the same periods last year. These decreases were due to favorable new ten-year lease agreements forour 505,000 square feet of office space in Boston.  Occupancy expense should remain relativelystable until the fourth quarter of 2005 when we expect to add additional spaceto support our growth.

 

Professionalfees expense was $6.4 million for the six months ended June 30, 2005 and was$3.4 million for the three months ended June 30, 2005, down 12% and 15%,respectively, from the same periods last year. These decreases are attributed primarily to lower subadvisory expenseassociated with our Merrimac Master Portfolios, resulting from lower average fundbalances and advisory fee waivers.  Thesefee waivers were discontinued during the second quarter of 2005.  We expect professional fees expense to remainconsistent for the remainder of the year.

 

Traveland sales promotion expense was $3.2 million for the six months ended June 30,2005 and was $1.8 million for the three months ended June 30, 2005, up 23% and 22%,respectively, compared to the same periods last year.  Travel and sales promotion expense consistsof expenses incurred by the sales force, client management staff and otheremployees in connection with sales calls on potential clients and traveling toexisting client sites and our foreign offices.  The increases in 2005 resulted from a higherlevel of travel to client sites, a higher level of sales calls to potentialclients and industry conferences.  Weexpect travel and sales expense to remain consistent for the remainder of 2005.

 

Otheroperating expense was $8.3 million for the six months ended June 30, 2005 andwas $4.4 million for the three months ended June 30, 2005, up 24% and 10%,respectively, compared to the same periods last year primarily as a result of higherrecruiting expense and higher miscellaneous expenses.  We expect that incremental expense for theremainder of 2005 will be primarily associated with new business.

 

29

----

 

*Income Taxes*

 

Income taxes were $35.4million for the six-month period ended June 30, 2005, down 1% from the sameperiod in 2004, and were $13.4 million for the three-month period ended June 30,2005, down 22% from the same period in 2004. The decrease in income taxes and the effective tax rate in both periods isprimarily attributable to the reversal of deferred income tax accruals ofapproximately $7.0 million in the second quarter of 2005 related to the undistributedearnings of our Irish subsidiaries. During the second quarter of 2005, we recognizedthe indefinite reversal provision of Accounting Principles Board Opinion No.23, *Accounting for Income Taxes – Special Area*s(‘APB 23’), which specifies that U.S. income taxes should not be recorded on theundistributed earnings of a foreign subsidiary if those undistributed earningshave been or will be invested indefinitely in that subsidiary. We havedetermined that the undistributed earnings of our Irish subsidiaries will bepermanently invested in our Irish operations to support continued growth. Thedecrease in income taxes and the effective tax rate for both periods in 2005 waspartially offset by increased pretax earnings, as well as a decreased percentageof tax-exempt income, resulting from the income generated by our municipalsecurities portfolio, in pretax earnings. We expect our effective tax rate for the remainder of 2005 to beapproximately 34.25%.

 

**Financial Condition**

 

At June 30, 2005, our totalassets were $12.4 billion, up 11% from $11.2 billion at December 31, 2004, dueto increased investment securities. Average interest-earning assets increased $1.8 billion, or 20% for thesix-month period ended June 30, 2005 from the same period in 2004, andincreased $1.9 billion, or 20% for the three-month period ended June 30, 2005from the same period in 2004.  Our assetgrowth was primarily funded by increases in average external borrowings ofapproximately $2.1 billion and $2.5 billion for the six-month and three-monthperiods ended June 30, 2005, respectively.

 

*Investment Portfolio*

 

The income we derive from ourinvestment portfolio is generated primarily by investing client cash balances andis a component of our asset processing business.  In addition, we use the investment portfolioto secure open positions at securities clearing institutions in connection withour custody services.  The followingtable summarizes our investment portfolio as of the dates indicated (Dollars inthousands):

 

 
| ** **                          | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|--------------|------------|------------------|------------|
| ** **                          | ** ** | **2005**     | ** ** | **2004**         | ** ** |
| **Securities held to maturity**     |       |         |       |             |       |
| Mortgage-backed securities          |       | $            | 4,495,423  |             | $          | 3,543,961 |   |
| Federal agency securities           |       | 2,349,721    |       | 2,274,665        |       |
| State and political subdivisions    |       | 119,384      |       | 124,091          |       |
| Total securities held to maturity   |       | $            | 6,964,528  |             | $          | 5,942,717 |   |
| ** **                          | ** ** | ** **   | ** ** | ** **       | ** ** |
| **Securities available for sale**   | ** ** | ** **   | ** ** | ** **       | ** ** |
| Mortgage-backed securities          |       | $            | 3,950,972  |             | $          | 3,854,900 |   |
| State and political subdivisions    |       | 374,247      |       | 404,909          |       |
| Corporate debt                      |       | 176,190      |       | 176,546          |       |
| U.S. Treasury securities            |       | —       |       | 118,688          |       |
| Foreign government securities       |       | 10,264       |       | 10,462           |       |
| Total securities available for sale |       | $            | 4,511,673  |             | $          | 4,565,505 |   |

 

The $1.0 billion, or 17%,increase in our held to maturity securities portfolio from December 31, 2004 toJune 30, 2005 is primarily due to investment security purchases that allow usto continue to grow our balance sheet, while maintaining an acceptable riskprofile. Our investment security purchases primarily included floating interestrate mortgage-backed securities which offer an attractive yield and reprice asinterest rates increase.  Our held tomaturity portfolio securities are purchased with the intent and ability to holdto maturity and are not viewed as our primary source of funds to satisfyliquidity needs.

 

Our available for sale securities portfolio decreased$0.1 billion, or 1% from December 31, 2004 to June 30, 2005.  The decrease was mainly due to sales of U.S.Treasuries and municipal securities during 2005 and investment security maturitiesand prepayments, partially offset by purchases of investment securities. Ourinvestment security purchases included mortgage-backed securities, as well as municipalsecurities that offer a more attractive after-tax yield than those that we sold.

 

30

----

 

We believe that purchasing these securities allows us to take advantageof attractive yields and limited extension risk which aligns with our asset andliability strategy.  Refer to the gapanalysis under the ‘Market Risk’ section for additional details regarding thematching of our interest-earning assets and interest-bearing liabilities.

 

The average balance of ourinvestment securities for the six-month period ended June 30, 2005 was $10.9billion, with an average yield of 3.69%, compared to an average balance of $9.1billion with an average yield of 3.09% during the same period in 2004. Theincrease in yield is primarily due to our variable rate securities repricing athigher interest rates. If long-term interest rates rise during 2005, we wouldexpect slower prepayments and our overall yield to increase as our variablerate securities reprice. Conversely, if long-term interest rates decline during2005, we would expect that prepayments would accelerate, with the cash flowsfrom these prepayments being reinvested in lower-yielding assets of equalquality and similar risk.

 

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

 

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

* *

*Loan Portfolio*

 

Our loan portfolio increased$75.3 million, or 56%, from December 31, 2004 to June 30, 2005 primarily due toan increase in overdrafts and demand loans.

 

Wemake loans to individually managed account customers and to mutual funds andother pooled product clients.  We offeroverdraft protection and lines of credit to our clients for the purpose offunding redemptions, covering overnight cash shortfalls, leveraging portfoliosand meeting other client borrowing needs. Virtually all loans to individually managed account customers arewritten on a demand basis, bear variable interest rates tied to the Prime rateor the Federal Funds rate and are fully secured by liquid collateral, primarilyfreely tradable securities held in custody by us for the borrower.  We monitor the value of collateral daily toensure the amount of collateral held by us exceeds the loan balance by a certainthreshold.  Loans to mutual funds andother pooled product clients include unsecured lines of credit that may, in theevent of default, be collateralized at our option by securities held in custodyby us for those clients.  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.

 

AtJune 30, 2005, our only lending concentrations that exceeded 10% of total loanbalances were the lines of credit to mutual fund clients discussed above.  These loans were made in the ordinary courseof business on the same terms and conditions prevailing at the time forcomparable transactions.

 

Ourcredit loss experience has been excellent. There have been no loan charge-offs in the history of our Company.  It is our policy to place a loan onnonaccrual status when either principal or interest becomes 60 days pastdue and the loan’s collateral is

 

31

----

 

not sufficient to cover bothprincipal and accrued interest.  As of June30, 2005, there were no loans on nonaccrual status, no loans greater than90 days past due, and no troubled debt restructurings.  Although virtually all of our loans are fullycollateralized with freely tradable securities, management recognizes somecredit risk inherent in the loan portfolio, and has an allowance for loanlosses of $0.1 million at June 30, 2005, a level which has remainedconsistent for the past five years.  Thisamount is not allocated to any particular loan, but is intended to absorb anyrisk of loss inherent in the loan portfolio. Management actively monitors theloan portfolio and the underlying collateral and regularly assesses theadequacy of the allowance for loan losses.

 

*Repurchase Agreements andShort-Term and Other Borrowings*

 

Asset growth was funded inpart by increased securities sold under repurchase agreements.  Repurchase agreements increased $0.6 billion,or 14%, from December 31, 2004 to June 30, 2005.  The majority of our repurchase agreements arewith clients who prefer a more collateralized form of deposit.  Repurchase agreements provide for the sale ofsecurities for cash coupled with the obligation to repurchase those securitieson a set date or on demand.  We userepurchase agreements, including client repurchase agreements, because theyprovide a lower cost source of funding than other short-term borrowings andallow our clients the extra benefit of collateralization of theirdeposits.  The average balance ofsecurities sold under repurchase agreements for the six months ended June 30,2005 was $5.2 billion with an average cost of approximately 2.32%, compared toan average balance of $3.7 billion and an average cost of approximately 1.02%for the same period last year.  Theincrease in the average cost of repurchase agreements from 2004 is due tohigher short-term interest rates in the first half of 2005 versus the firsthalf of 2004. The average cost of securities sold under repurchase agreementsfor the six months ended June 30, 2004 included prepayment fees of $2.9million.  These fees were incurred toemploy an asset and liability strategy in which we replaced high rateborrowings with lower cost term funding.

 

Short-termand other borrowings increased $0.8 billion, or 128%, from December 31, 2004 toJune 30, 2005.  We use short-term andother borrowings to offset the variability of deposit flow.  The average balance of short-term and otherborrowings for the six months ended June 30, 2005 was $1.6 billion with an averagecost of approximately 2.84%, compared to an average balance of $0.8 billion andan average cost of approximately 2.48% for the same period last year.  The increase in the average cost ofshort-term and other borrowings was due to an increase in short-term ratesduring the first half of 2005 compared to the same period in 2004.  The average cost of borrowings for the sixmonths ended June 30, 2004 included prepayment fees of $3.9 million.  Again, these fees were incurred to employ anasset and liability strategy in which we replaced high rate borrowings with lowercost term funding.

 

**Market Risk**

 

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 or client repurchase agreements.  We either directly invest these cash balancesto earn interest income, or place these deposits in third-party vehicles andremit a portion of the earnings on these investments to our clients afterdeducting a fee as our compensation for investing clients’ funds in theseinvestment vehicles. In the conduct of these activities, we are subject tomarket risk.

 

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

 

Ourbalance sheet is primarily subject to interest rate risk, which is the risk ofloss due to movements in interest rates. Prepayment risk, which is the riskthat changes in interest rates and other economic factors will result ininvestment securities being paid off earlier than the scheduled maturity date, isinherent in our investment securities, mainly our mortgage-backed securitiesand Federal agency bond portfolios. Prepayment levels for mortgage-backed securities are primarily driven bychanges in interest rates.  Prepaymentlevels for Federal agency securities are driven by a number of factors,including expiration of prepayment penalty provisions, economic condition ofthe borrower, borrower refinancing alternatives, and, to a lesser extent,interest rates.

 

Prepayment speeds formortgage-backed securities increased during the second quarter of 2005 dueto increased refinancing activity driven by declining mortgage rates.  Weexpect recent prepayment experience to continue subject to future interest ratemovements.  Prepayment experience for Federal agency securities (primarilySBA guaranteed loan pools) also increased over this period as the weightedaverage life of the securities shortened. We expect the combination of heightened prepayment experience and, moresignificantly, reduced reinvestment opportunities to continue to pressure ournet interest income for the remainder of 2005.

 

32

----

 

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 regulatory requirements.  For example, we have established a policylimit stating that projected net interest income over the next twelve monthswill not change by more than 10% given a change in interest rates of up to 200basis points (+ or -) over twelve months. Each quarter, our Board of Directors reviews our asset and liabilitypositions, including simulations of the effect of various interest ratescenarios on our capital.

 

The day-to-day responsibility for oversight of the Asset and LiabilityManagement function has been delegated by our Board of Directors to our Assetand Liability Committee (‘ALCO’).  ALCOis a senior management committee consisting of the Chief Executive Officer, thePresident, the Chief Financial Officer, the Chief Risk Officer and members of theTreasury function. ALCO meets twice monthly. Our primary tool in managing interest rate sensitivity is an incomesimulation model. Key assumptions in the simulation model include the timing ofcash flows, which include forecasted prepayment speeds that are based on marketand industry data, maturities and repricing of financial instruments, changesin market conditions, capital planning and deposit sensitivity.  The model assumes that the composition of ourinterest-sensitive assets and liabilities existing at the beginning of a periodwill change periodically over the period being measured.  The model also assumes that a particularchange in interest rates is reflected uniformly across the yield curveregardless of the duration to maturity or repricing of specific assets andliabilities.  These assumptions areinherently uncertain, and as a result, the model cannot precisely predict theeffect of changes in interest rates on our net interest income.  Actual results may differ from simulatedresults due to the timing, magnitude and frequency of interest rate changes andchanges in market conditions and management strategies.

 

The results of the income simulation model as of June 30, 2005 and 2004indicated that an upward shift of interest rates by 200 basis points over atwelve-month period would result in a reduction in projected net interestincome of 6.5% and 7.1%, respectively, which is within our 10% policylimit.  We also simulate a 200 basispoint rate reduction over a twelve-month period, however, in the simulation wedo not reduce rates below 0% because of the low likelihood that rates will moveinto a negative position.  This modifiedsimulation would result in an increase in projected net interest income of 0.2%and a reduction of 13.8% as of June 30, 2005 and 2004, respectively.  In 2004, our Board of Directors approved atemporary exception to the 10% limit for decreases in interest rates, as a 200basis point reduction would have moved interest rates into a negative position.

 

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 theopposite.  By seeking to minimize the netamount of assets and liabilities that could reprice in the same time frame, weattempt to reduce the risk of significant adverse effects on net interestincome caused by interest rate changes. As shown in the cumulative gap position in the table presented below, atJune 30, 2005, interest-bearing liabilities repriced faster thaninterest-earning assets in the short term, as has been typical for us.  Generally speaking, during a period offalling interest rates, net interest income would be higher than it would havebeen until interest rates stabilize. During a period of rising interest rates, net interest income would belower than it would have been until interest rates stabilize.  Other important determinants of net interestincome are general rate levels, balance sheet growth and mix, and interest ratespreads.  We continue to run a closelymatched balance sheet by investing the majority of our assets in shortduration, variable-rate securities and adding interest rate swaps againstclient liabilities, including client repurchase agreements.

 

Wemanage the structure of interest-earning assets and interest-bearingliabilities by adjusting their mix, yield, maturity and/or repricingcharacteristics based on market conditions. Client deposits and repurchase agreements, which are predominantly shortterm, are our primary sources of funds. We also use term borrowings and interest rate swap agreements to augmentour management of interest rate exposure. The effect of the swap agreements is to lengthen short-termvariable-rate liabilities into longer-term fixed-rate liabilities.  The weighted-average fixed-payment rates were3.25% and 3.00% at June 30, 2005 and 2004, respectively.  Variable-interest payments received arecurrently indexed to the overnight Federal Funds rate.  At June 30, 2005 and 2004, theweighted-average rates of variable market-indexed interest payment obligationsto the Company were 3.19% and 1.02%, respectively.  The remaining terms of swaps at June 30, 2005range from 0 to 36 months. These contracts had net fair values of approximately$10.5 million and $3.6 million at June 30, 2005 and 2004, respectively.

 

33

----

 

The followingtable presents the repricing schedule of our interest-earning assets andinterest-bearing liabilities at June 30, 2005 (Dollars in thousands):

 
| ** **                                                                             | ** ** | **Within Three  Months** | ** ** | **Three to Six  Months** | ** ** | **Six to Twelve  Months** | ** ** | **One Year to  Five Years** | ** ** | **Over Five  Years** | ** ** | **Total**  | ** ** |
|----------------------------------------------------------------------------------------|------------|--------------------------|------------|--------------------------|------------|---------------------------|------------|-----------------------------|------------|----------------------|------------|------------|------------|
| ** **                                                                             | ** ** | ** **               | ** ** | ** **               | ** ** | ** **                | ** ** | ** **                  | ** ** | ** **           | ** ** | ** ** | ** ** |
| Interest-earning assets:  (1)                                                     |       |                     |       |                     |       |                      |       |                        |       |                 |       |       |       |
| Investment securities (2), (3)                                                         |       | $                        | 6,648,006  |                     | $          | 731,929                   |       | $                           | 1,065,444  |                 | $          | 2,524,400  |       | $ | 445,776 |   | $ | 11,415,555 |   |
| Federal funds sold and securities purchased  under repurchase agreements               |       | 11,000                   |       | —                   |       | —                    |       | —                      |       | —               |       | 11,000     |       |
| Loans - variable rate                                                                  |       | 209,908                  |       | —                   |       | —                    |       | —                      |       | —               |       | 209,908    |       |
| Loans - fixed rate                                                                     |       | —                   |       | —                   |       | 12                        |       |                        |       | —               |       | 12         |       |
| Total interest-earning assets                                                          |       | $                        | 6,868,914  |                     | $          | 731,929                   |       | $                           | 1,065,456  |                 | $          | 2,524,400  |       | $ | 445,776 |   | $ | 11,636,475 |   |
| Interest-bearing liabilities:                                                          |       |                     |       |                     |       |                      |       |                        |       |                 |       |       |       |
| Savings accounts                                                                       |       | $                        | 4,051,685  |                     | $          | —                    |       | $                           | —     |                 | $          | 32,818     |       | $ | — |   | $ | 4,084,503 |   |
| Time deposits                                                                          |       | 112,520                  |       | —                   |       | —                    |       | —                      |       | —               |       | 112,520    |       |
| Interest rate contracts                                                                |       | (1,680,000               | )          | 120,000                  |       | 240,000                   |       | 1,320,000                   |       | —               |       | —     |       |
| Securities sold under  repurchase agreements                                      |       | 4,051,699                |       | 50,000                   |       | 150,000                   |       | 600,000                     |       | —               |       | 4,851,699  |       |
| Short-term and other  borrowings                                                  |       | 1,303,440                |       | —                   |       | —                    |       | 50,000                      |       | —               |       | 1,353,440  |       |
| Junior subordinated debentures                                                         |       | —                   |       | —                   |       | —                    |       | 24,774                      |       | —               |       | 24,774     |       |
| Total interest-bearing liabilities                                                     |       | $                        | 7,839,344  |                     | $          | 170,000                   |       | $                           | 390,000    |                 | $          | 2,027,592  |       | $ | — |   | $ | 10,426,936 |   |
| Net interest-sensitivity gap during the  period                                        |       | $                        | (970,430   | )                        | $          | 561,929                   |       | $                           | 675,456    |                 | $          | 496,808    |       | $ | 445,776 |   | $ | 1,209,539 |   |
|                                                                                   |       |                     |       |                     |       |                      |       |                        |       |                 |       |       |       |
| Cumulative gap                                                                         |       | $                        | (970,430   | )                        | $          | (408,501                  | )          | $                           | 266,955    |                 | $          | 763,763    |       | $ | 1,209,539 |   |   |   |
| Interest-sensitive assets as a percent of  interest-sensitive liabilities (cumulative) |       | 87.62%                   |       | 94.90%                   |       | 103.18%                   |       | 107.32%                     |       | 111.60%              |       |       |       |
| Interest-sensitive assets as a percent of  total assets (cumulative)                   |       | 55.37%                   |       | 61.27%                   |       | 69.86%                    |       | 90.21%                      |       | 93.80%               |       |       |       |
| Net interest-sensitivity gap as a percent  of total assets                             |       | (7.82)%                  |       | 4.53%                    |       | 5.44%                     |       | 4.00%                       |       | 3.59%                |       |       |       |
| Cumulative gap as a percent of total assets                                            |       | (7.82)%                  |       | (3.29)%                  |       | 2.15%                     |       | 6.16%                       |       | 9.75%                |       |       |       |

 

----

(1)          Adjustable rate assetsare included in the period in which interest rates are next scheduled to adjustrather than in the period in which they are due.  Fixed-rate loans are included in the periodin which they are scheduled to be repaid.

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

(3)          Excludes $49.4 millionof unsettled securities purchases and $11.3 million of net unrealized losses asof June 30, 2005.

 

34

----

 

**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, Federal Reserve Discount Window, new deposits, short-termborrowings, interest and principal payments on securities held to maturity andavailable for sale, and fees collected from asset administration clients.  As a result of our management of liquidassets and our ability to generate liquidity through liability funds,management believes that we maintain overall liquidity sufficient to meet ourdepositors’ needs, to satisfy our operating requirements and to fund thepayment of an anticipated annual cash dividend of $0.08 per share for 2005(approximately $5.4 million based upon 66,875,627 shares outstanding as ofJune 30, 2005).

 

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

 

InJuly 2005, we announced that our Board of Directors authorized us to repurchaseup to $150 million of our Common Stock in the open market over the next twelvemonths.  We expect the purchase of ourCommon Stock to be funded primarily by a dividend from the Bank to the Company.  We do not expect the stock purchase programto have a material impact on our liquidity position, our risk-based capitalratios, including our leverage capital ratio, or our ability to pay dividendson our Common Stock.

 

We 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 borrowing arrangementsas of June 30, 2005 was $4.6 billion. Each bank may terminate its arrangement at any time and is under nocontractual obligation to provide us with requested funding.  Our borrowings under these arrangements aretypically on an overnight basis.  Wecannot be certain, however, that such funding will be available.  Lack of availability of liquid funds couldhave a material adverse impact on our operations.

 

We also have Master Repurchase Agreements in place with variouscounterparties.  Each counterparty hasagreed to make funds available to us at various rates in exchange forcollateral consisting of marketable securities. The aggregate amount of theseborrowing arrangements at June 30, 2005 was $6.3 billion.

 

On April 19, 2004, the Federal Home Loan Bank of Boston (‘FHLBB’)implemented a new capital structure mandated for all Federal Home Loan Banks bythe Gramm-Leach-Bliley Act of 1999 and regulations that were subsequentlypromulgated in 2001 by the FHLBB’s regulator, the Federal Housing FinanceBoard.  The Bank’s capital stock investmentin the FHLBB totaled $50 million as of June 30, 2005.  The $50 million capital stock investmentincludes both a $25 million membership component and a $25 millionactivity-based component.  The Bank’s $50million capital stock investment in the FHLBB provides a borrowing capacity ofapproximately $555 million. Under the new capital plan, FHLBB capital stockinvestments require a five-year advance notice of withdrawal.  The amount outstanding under this arrangementat June 30, 2005 was $50 million. Additional borrowing is available to the Bank based on prescribedcollateral levels and increased investment in FHLBB capital stock.  The Bank currently has no plans to increaseits investment in FHLBB capital stock.

 

35

----

 

**Capital Resources**

 

Historically,we have financed our operations principally through internally generated cashflows.  We incur capital expenditures forfurniture, fixtures, capitalized software and miscellaneous equipment needs.  We lease office space and computing equipmentthrough operating leases.  Capitalexpenditures have been incurred and leases entered into on an as-requiredbasis, primarily to meet our growing operating needs.  As a result, our capital expenditures were$13.5 million and $11.8 million for the six months ended June 30, 2005 and2004, respectively.  For the six monthsended June 30, 2005, capital expenditures were comprised of approximately $10.8million in capitalized software and projects in process, $2.6 million in fixedassets, and $0.1 million in leasehold improvements.  For the six months ended June 30, 2004,capital expenditures were comprised of approximately $3.8 million incapitalized software and projects in process, $7.9 million in fixed assets and$0.1 million in leasehold improvements.

 

Stockholders’ equity at June 30, 2005 was $794 million, up 11% fromDecember 31, 2004, primarily due to net income earned in the first half of2005.  The ratio of average stockholders’equity to average assets remained constant at approximately 6% for June 30,2005 and December 31, 2004.

 

InJuly 2005, we announced that our Board of Directors has authorized us torepurchase up to $150 million of our Common Stock in the open market over thenext twelve months.  We do not expect ourstock purchase program to have a material impact on our capital resources, suchas maintaining risk-based capital ratios in excess of capital adequacyguidelines and our ability to pay dividends on our Common Stock.

 

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

 

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

 

Weare currently in compliance with both the Total Risk-Based Capital Ratio andthe Leverage Ratio requirements, and management expects these ratios to remainin compliance with the FRB’s capital adequacy guidelines.  At June 30, 2005, our Total Risk-BasedCapital Ratio and Leverage Ratio were 19.63% and 6.05%, respectively.

 

36

----

 

**Item3.            Quantitative and QualitativeDisclosures about Market Risk**

 

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

 

**Item 4.            Controlsand Procedures**

** **

**Evaluationof Disclosure Controls and Procedures**

 

As required byRule 13a-15 under the Securities Exchange Act of 1934, as of June 30, 2005, theend of the quarter covered by this report, the Company carried out an evaluationunder the supervision and with the participation of the Company’s management,including the Company’s Chief Executive Officer and Chief Financial Officer, ofthe effectiveness of the design and operation of the Company’s disclosurecontrols and procedures.  In designingand evaluating the Company’s disclosure controls and procedures, the Companyand its management recognize that any controls and procedures, no matter howwell designed and operated, can provide only reasonable assurance of achieving thedesired control objectives, and the Company’s management necessarily wasrequired to apply its judgment in evaluating and implementing possible controlsand procedures.  Based upon thatevaluation, the Chief Executive Officer and Chief Financial Officer concludedthat the Company’s disclosure controls and procedures were effective at thereasonable assurance level to ensure that information required to be disclosedby the Company in the reports it files or submits under the Exchange Act isaccumulated and communicated to our management, including our Chief ExecutiveOfficer and Chief Financial Officer, as appropriate, to allow timely decisionsregarding required disclosure, and is recorded, processed, summarized andreported, within the time periods specified in the Securities and ExchangeCommission’s rules and forms.  There wasno change in the Company’s internal control over financial reporting thatoccurred during the quarter ended June 30, 2005 that has materially affected,or is reasonably likely to materially affect, the Company’s internal controlover financial reporting.  The Companyreviews, on an ongoing basis, its disclosure controls and procedures, which mayinclude its internal controls over financial reporting on an ongoing basis, andmay from time to time make changes aimed at enhancing their effectiveness andto ensure that the Company’s systems evolve with its business.

 

37

----

 

**PART II.  OTHER INFORMATION**

 

**Item 1.Legal Proceedings**

 

Investors FinancialServices Corp. and five of its officers are named as defendants in a purportedclass action complaint that was filed on or about August 4, 2005 in the UnitedStates District Court for the District of Massachusetts, Boston, Massachusetts.  Among other things, the complaint assertsthat the defendants violated Sections 10(b) and 20(a) of the SecuritiesExchange Act of 1934 during the period October 15, 2003 until July 15,2005.  The allegations in the Complaint predominantlyrelate to: (1) the Company’s October 2004 restatement of its financial results,and (2) the Company’s July 2005 revision of public guidance regarding itsfuture financial performance.  Thecomplaint seeks unspecified damages, interest and costs.  We strongly believe that the lawsuit lacksmerit and we intend to defend against the claims vigorously.  However, we cannot predict the outcome of thelawsuit at this time, and we can give no assurance that it will not materiallyadversely affect our financial condition or results of operations.

 

**Item 4.****Submission of Matters to aVote of Security Holders**

 

Our annual meeting of stockholders was held on Thursday, April 14,2005.  A vote was proposed to:

 

•      Electtwo (2) Class I directors;

•      Approvethe Company’s 2005 Equity Incentive Plan;

•      Ratifythe selection of Deloitte & Touche LLP as independent registered publicaccounting firm for the fiscal year ending December 31, 2005.

 

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

 
| ** ** | ** ** | ** **                                             | ** ** | **Votes**  | ** ** | **Votes**   | ** ** | **Votes**    | ** ** | ** **    | ** ** |
|------------|------------|--------------------------------------------------------|------------|------------|------------|-------------|------------|--------------|------------|---------------|------------|
| ** ** | ** ** | ** **                                             | ** ** | **For**    | ** ** | **Against** | ** ** | **Withheld** | ** ** | **Abstained** | ** ** |
|       |       |                                                   |       |       |       |        |       |         |       |          |       |
| (1)        |       | Election of Phyllis S. Swersky as a Class I Director   |       | 59,630,521 |       | N/A         |       | 1,286,180    |       | N/A           |       |
|       |       |                                                   |       |       |       |        |       |         |       |          |       |
|       |       | Election of Edward F. Hines, Jr. as a Class I Director |       | 57,327,290 |       | N/A         |       | 3,589,411    |       | N/A           |       |
|       |       |                                                   |       |       |       |        |       |         |       |          |       |
| (2)        |       | Approve the Company’s 2005 Equity Incentive Plan  |       | 43,600,713 |       | 9,507,814   |       | N/A          |       | 201,941       |       |
|       |       |                                                   |       |       |       |        |       |         |       |          |       |
| (3)        |       | Ratify the selection of Deloitte & Touche LLP      |       | 60,213,685 |       | 640,670     |       | N/A          |       | 62,346        |       |

 

**Item 6.            Exhibits**

 

**(a)   Exhibits**

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                  |
|-----------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **      | ** ** | ** **                                                                                                                                                                                                                       |
| **15**          | ** ** | **Letter  of awareness from Deloitte & Touche LLP.**                                                                                                                                                                         |
| ** **      | ** ** | ** **                                                                                                                                                                                                                       |
| **31.1**        | ** ** | **Certification  of Kevin J. Sheehan, Chief Executive Officer.**                                                                                                                                                                 |
| ** **      | ** ** | ** **                                                                                                                                                                                                                       |
| **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.** |

** **

**38**

----

** **

**SIGNATURES**

** **

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

 
| ** **           | ** ** | ** ** | **INVESTORS FINANCIAL SERVICES  CORP.**                                                                               |
|----------------------|------------|------------|-----------------------------------------------------------------------------------------------------------------------|
| ** **           | ** ** | ** ** | ** **                                                                                                            |
| Date: August 9, 2005 |       | By:        | /s/ Kevin J. Sheehan                                                                                                  |   |
|                 |       |       | Kevin J. Sheehan  Chairman and Chief Executive Officer                                                                |
| ** **           | ** ** | ** ** | ** **                                                                                                            |
| ** **           | ** ** | ** ** | ** **                                                                                                            |
|                 |       | By:        | /s/ John N. Spinney,  Jr.                                                                                             |   |
|                 |       |       | John N. Spinney, Jr.  Senior Vice President and Chief Financial Officer  (Principal Financial and Accounting Officer) |
|                      |            |            |                                                                                                                       |  |  |

** **

**39**

----