**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

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**(MarkOne)**

 
| **ý** |   | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|--------|----------------------------------------------------------------------------------------------|

 

**For the Quarterly period ended September 30,2002**

** **

**or**

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

 

**For the Transition period from           to           **

** **

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

 

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**INVESTORS FINANCIAL SERVICES CORP.**

(Exact name of registrant as specified in its charter)

 

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

 

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

 

As of October31, 2002 there were 64,593,149 shares of Common Stock outstanding.

 

 

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**INVESTORS FINANCIAL SERVICES CORP.**

** **

**INDEX**

** **
| **PART I.**        | **FINANCIAL INFORMATION**                                                                                                         |
|--------------------|-----------------------------------------------------------------------------------------------------------------------------------|
|               |                                                                                                                              |
| Item 1.            | Condensed Consolidated Financial Statements                                                                                       |
|               |                                                                                                                              |
|               | Condensed Consolidated Balance Sheets  (unaudited)  September 30, 2002 and December 31, 2001                                      |
|               |                                                                                                                              |
|               | Condensed Consolidated Statements of Income  and Comprehensive Income (unaudited)  Nine months ended September 30, 2002 and 2001  |
|               |                                                                                                                              |
|               | Condensed Consolidated Statements of Income  and Comprehensive Income (unaudited)  Three months ended September 30, 2002 and 2001 |
|               |                                                                                                                              |
|               | Condensed Consolidated Statements of  Stockholders’ Equity (unaudited)  Nine months ended September 30, 2002 and 2001        |
|               |                                                                                                                              |
|               | Condensed Consolidated Statements of Cash  Flows (unaudited)  Nine months ended September 30, 2002 and 2001                       |
|               |                                                                                                                              |
|               | Notes to Condensed Consolidated Financial  Statements (unaudited)                                                                 |
|               |                                                                                                                              |
|               | Independent Accountants’ Report                                                                                              |
|               |                                                                                                                              |
| Item 2.            | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                       |
|               |                                                                                                                              |
| Item 3.            | Quantitative and Qualitative Disclosure  about Market Risk                                                                        |
|               |                                                                                                                              |
| Item 4.            | Controls and Procedures                                                                                                           |
|               |                                                                                                                              |
| **PART II.**       | **OTHER INFORMATION**                                                                                                             |
|               |                                                                                                                              |
| Item 6.            | Exhibits and Reports on Form 8-K                                                                                                  |
|               |                                                                                                                              |
| **SIGNATURES**     |
|               |                                                                                                                              |
| **CERTIFICATIONS** |

 

2

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**PARTI.  FINANCIAL INFORMATION**

** **

**Item 1.    CondensedConsolidated Financial Statements**

** **

**INVESTORS FINANCIAL SERVICES CORP.**

**CONDENSED CONSOLIDATED BALANCE SHEETS(unaudited)**

**September 30, 2002 and December 31, 2001**

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

 
|                                                                                                                                                                                                                        |   | **September  30,  2002** |      | **December 31,  2001** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|-----------|-----------------------------|--------|
|                                                                                                                                                                                                                        |   |                     |      |                        |   |
| **Assets**                                                                                                                                                                                                                  |   |                     |      |                        |   |
| Cash and due from banks                                                                                                                                                                                                     |   | $                        | 81,936    |                        | $      | 15,605 |   |
| Federal funds sold and securities purchased  under resale agreements                                                                                                                                                        |   | 120,000                  |      | —                      |   |
| Securities held to maturity (approximate  fair value of $3,444,558 and $3,157,209 at September 30, 2002 and  December 31, 2001, respectively)                                                                          |   | 3,412,587                |      | 3,135,784                   |   |
| Securities available for sale                                                                                                                                                                                               |   | 2,725,585                |      | 1,621,661                   |   |
| Non-marketable equity securities                                                                                                                                                                                            |   | 50,000                   |      | 50,000                      |   |
| Loans, less allowance for loan losses of  $100 at September 30, 2002 and December 31, 2001                                                                                                                             |   | 138,998                  |      | 232,113                     |   |
| Accrued interest and fees receivable                                                                                                                                                                                        |   | 68,302                   |      | 59,751                      |   |
| Equipment and leasehold improvements, less  accumulated depreciation of $20,386 and $13,023 at September 30, 2002 and  December 31, 2001, respectively                                                                 |   | 70,186                   |      | 42,618                      |   |
| Goodwill, net                                                                                                                                                                                                               |   | 79,969                   |      | 79,969                      |   |
| Other assets                                                                                                                                                                                                                |   | 67,655                   |      | 61,144                      |   |
|                                                                                                                                                                                                                        |   |                     |      |                        |   |
| **Total Assets**                                                                                                                                                                                                            |   | $                        | 6,815,218 |                        | $      | 5,298,645 |   |
|                                                                                                                                                                                                                        |   |                     |      |                        |   |
| **Liabilities and Stockholders’ Equity**                                                                                                                                                                               |   |                     |      |                        |   |
| **Liabilities:**                                                                                                                                                                                                            |   |                     |      |                        |   |
| Deposits:                                                                                                                                                                                                                   |   |                     |      |                        |   |
| Demand                                                                                                                                                                                                                      |   | $                        | 375,784   |                        | $      | 507,067 |   |
| Savings                                                                                                                                                                                                                     |   | 2,311,034                |      | 1,681,810                   |   |
| Time                                                                                                                                                                                                                        |   | 90,000                   |      | 90,000                      |   |
| Total deposits                                                                                                                                                                                                              |   | 2,776,818                |      | 2,278,877                   |   |
|                                                                                                                                                                                                                        |   |                     |      |                        |   |
| Securities sold under repurchase agreements                                                                                                                                                                                 |   | 2,295,375                |      | 1,663,312                   |   |
| Short-term and other borrowings                                                                                                                                                                                             |   | 1,175,529                |      | 910,281                     |   |
| Other liabilities                                                                                                                                                                                                           |   | 124,724                  |      | 79,123                      |   |
| Total liabilities                                                                                                                                                                                                           |   | 6,372,446                |      | 4,931,593                   |   |
|                                                                                                                                                                                                                        |   |                     |      |                        |   |
| Commitments and contingencies (See Note 9)                                                                                                                                                                                  |   | —                   |      | —                      |   |
|                                                                                                                                                                                                                        |   |                     |      |                        |   |
| Company-obligated, mandatorily redeemable,  preferred securities of subsidiary trust holding solely junior subordinated  deferrable interest debentures of the Company                                                      |   | 23,295                   |      | 24,274                      |   |
|                                                                                                                                                                                                                        |   |                     |      |                        |   |
| **Stockholders’ Equity:**                                                                                                                                                                                              |   |                     |      |                        |   |
| Preferred stock, par value $0.01 (shares  authorized: 1,000,000; issued and outstanding: 0 at September 30, 2002 and  December 31, 2001)                                                                               |   | —                   |      | —                      |   |
| Common stock, par value $0.01 (shares  authorized: 100,000,000 at September 30, 2002 and December 31, 2001;  issued and outstanding:  64,583,399 at  September 30, 2002 and 31,971,404 at December 31, 2001) |   | 646                      |      | 320                         |   |
| Surplus                                                                                                                                                                                                                     |   | 230,124                  |      | 222,440                     |   |
| Deferred compensation                                                                                                                                                                                                       |   | (1,812                   | )         | (2,563                      | )      |
| Retained earnings                                                                                                                                                                                                           |   | 180,784                  |      | 132,877                     |   |
| Accumulated other comprehensive  income/(loss), net                                                                                                                                                                         |   | 9,735                    |      | (10,296                     | )      |
| Treasury stock, par value $0.01 (10,814  shares at September 30, 2002 and December 31, 2001)                                                                                                                           |   | —                   |      | —                      |   |
| Total stockholders’ equity                                                                                                                                                                                             |   | 419,477                  |      | 342,778                     |   |
|                                                                                                                                                                                                                        |   |                     |      |                        |   |
| **Total Liabilities and Stockholders’ Equity**                                                                                                                                                                         |   | $                        | 6,815,218 |                        | $      | 5,298,645 |   |

 

*See Notes to Condensed Consolidated FinancialStatements.*

 

3

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**INVESTORS FINANCIAL SERVICES CORP.**

**CONDENSED CONSOLIDATED STATEMENTS OF INCOMEAND COMPREHENSIVE INCOME (unaudited)**

**Nine Months Ended September 30, 2002 and 2001**

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

 
|                                                                                                                            |   | **September  30,  2002** |   | **September  30,  2001** |   |
|---------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|--------|--------------------------|--------|
| **Operating Revenue:**                                                                                                          |   |                     |   |                     |   |
| Interest income:                                                                                                                |   |                     |   |                     |   |
| Federal funds sold and securities purchased  under resale agreements                                                            |   | $                        | 680    |                     | $      | 1,611 |   |
| Investment securities held to maturity and  available for sale                                                                  |   | 181,394                  |   | 184,774                  |   |
| Loans                                                                                                                           |   | 2,891                    |   | 4,279                    |   |
| Total interest income                                                                                                           |   | 184,965                  |   | 190,664                  |   |
|                                                                                                                            |   |                     |   |                     |   |
| Interest expense:                                                                                                               |   |                     |   |                     |   |
| Deposits                                                                                                                        |   | 31,777                   |   | 53,147                   |   |
| Short-term and other borrowings                                                                                                 |   | 47,205                   |   | 60,075                   |   |
| Total interest expense                                                                                                          |   | 78,982                   |   | 113,222                  |   |
|                                                                                                                            |   |                     |   |                     |   |
| Net interest income                                                                                                             |   | 105,983                  |   | 77,442                   |   |
|                                                                                                                            |   |                     |   |                     |   |
| Noninterest income:                                                                                                             |   |                     |   |                     |   |
| Asset servicing fees                                                                                                            |   | 218,103                  |   | 179,308                  |   |
| Other operating income                                                                                                          |   | 1,645                    |   | 2,378                    |   |
|                                                                                                                            |   |                     |   |                     |   |
| Net operating revenue                                                                                                           |   | 325,731                  |   | 259,128                  |   |
|                                                                                                                            |   |                     |   |                     |   |
| **Operating Expenses:**                                                                                                         |   |                     |   |                     |   |
| Compensation and benefits                                                                                                       |   | 146,819                  |   | 120,395                  |   |
| Technology and telecommunications                                                                                               |   | 30,070                   |   | 28,951                   |   |
| Transaction processing services                                                                                                 |   | 26,078                   |   | 17,412                   |   |
| Occupancy                                                                                                                       |   | 18,247                   |   | 12,649                   |   |
| Depreciation and amortization                                                                                                   |   | 11,179                   |   | 5,781                    |   |
| Professional fees                                                                                                               |   | 4,968                    |   | 3,460                    |   |
| Travel and sales promotion                                                                                                      |   | 4,217                    |   | 4,064                    |   |
| Amortization of goodwill                                                                                                        |   | —                   |   | 2,565                    |   |
| Other operating expenses                                                                                                        |   | 9,956                    |   | 10,557                   |   |
| Total operating expenses                                                                                                        |   | 251,534                  |   | 205,834                  |   |
|                                                                                                                            |   |                     |   |                     |   |
| **Income Before Income Taxes and Minority Interest**                                                                            |   | 74,197                   |   | 53,294                   |   |
|                                                                                                                            |   |                     |   |                     |   |
| Provision for income taxes                                                                                                      |   | 22,352                   |   | 16,384                   |   |
| Minority interest expense, net of income  taxes                                                                                 |   | 1,204                    |   | 1,191                    |   |
|                                                                                                                            |   |                     |   |                     |   |
| **Net Income**                                                                                                                  |   | $                        | 50,641 |                     | $      | 35,719 |   |
|                                                                                                                            |   |                     |   |                     |   |
| **Basic Earnings Per Share**                                                                                                    |   | $                        | 0.79   |                     | $      | 0.57 |   |
|                                                                                                                            |   |                     |   |                     |   |
| **Diluted Earnings Per Share**                                                                                                  |   | $                        | 0.76   |                     | $      | 0.54 |   |
|                                                                                                                            |   |                     |   |                     |   |
| **Comprehensive Income:**                                                                                                       |   |                     |   |                     |   |
| Net income                                                                                                                      |   | $                        | 50,641 |                     | $      | 35,719 |   |
| Other comprehensive income net of tax of  $10,786 and $97 for the nine months ended September 30, 2002 and 2001,  respectively: |   |                     |   |                     |   |
| Cumulative effect of a change in accounting  principle                                                                          |   | —                   |   | (3,934                   | )      |
| Net unrealized investment gain                                                                                                  |   | 31,500                   |   | 14,746                   |   |
| Net unrealized derivative instrument loss                                                                                       |   | (11,469                  | )      | (10,631                  | )      |
| Other comprehensive income                                                                                                      |   | 20,031                   |   | 181                      |   |
| Comprehensive income                                                                                                            |   | $                        | 70,672 |                     | $      | 35,900 |   |

 

*See Notes to Condensed Consolidated FinancialStatements.*

 

4

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**INVESTORS FINANCIAL SERVICES CORP.**

**CONDENSEDCONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (unaudited)**

**ThreeMonths Ended September 30, 2002 and 2001**

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

 
|                                                                                                                                      |   | **September  30,  2002** |   | **September  30,  2001** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|--------|--------------------------|--------|
| **Operating Revenue:**                                                                                                                    |   |                     |   |                     |   |
| Interest income:                                                                                                                          |   |                     |   |                     |   |
| Federal funds sold and securities purchased  under resale agreements                                                                      |   | $                        | 473    |                     | $      | 415 |   |
| Investment securities held to maturity and  available for sale                                                                            |   | 62,378                   |   | 64,200                   |   |
| Loans                                                                                                                                     |   | 930                      |   | 1,431                    |   |
| Total interest income                                                                                                                     |   | 63,781                   |   | 66,046                   |   |
|                                                                                                                                      |   |                     |   |                     |   |
| Interest expense:                                                                                                                         |   |                     |   |                     |   |
| Deposits                                                                                                                                  |   | 10,750                   |   | 16,417                   |   |
| Short-term and other borrowings                                                                                                           |   | 17,165                   |   | 20,601                   |   |
| Total interest expense                                                                                                                    |   | 27,915                   |   | 37,018                   |   |
|                                                                                                                                      |   |                     |   |                     |   |
| Net interest income                                                                                                                       |   | 35,866                   |   | 29,028                   |   |
|                                                                                                                                      |   |                     |   |                     |   |
| Noninterest income:                                                                                                                       |   |                     |   |                     |   |
| Asset servicing fees                                                                                                                      |   | 73,982                   |   | 66,677                   |   |
| Other operating income                                                                                                                    |   | 515                      |   | 829                      |   |
|                                                                                                                                      |   |                     |   |                     |   |
| Net operating revenue                                                                                                                     |   | 110,363                  |   | 96,534                   |   |
|                                                                                                                                      |   |                     |   |                     |   |
| **Operating Expenses:**                                                                                                                   |   |                     |   |                     |   |
| Compensation and benefits                                                                                                                 |   | 47,951                   |   | 44,879                   |   |
| Technology and telecommunications                                                                                                         |   | 10,004                   |   | 9,272                    |   |
| Transaction processing services                                                                                                           |   | 8,764                    |   | 7,896                    |   |
| Occupancy                                                                                                                                 |   | 6,841                    |   | 4,847                    |   |
| Depreciation and amortization                                                                                                             |   | 4,540                    |   | 2,558                    |   |
| Professional fees                                                                                                                         |   | 1,752                    |   | 1,127                    |   |
| Travel and sales promotion                                                                                                                |   | 1,463                    |   | 1,670                    |   |
| Amortization of goodwill                                                                                                                  |   | —                   |   | 992                      |   |
| Other operating expenses                                                                                                                  |   | 3,747                    |   | 3,427                    |   |
| Total operating expenses                                                                                                                  |   | 85,062                   |   | 76,668                   |   |
|                                                                                                                                      |   |                     |   |                     |   |
| **Income Before Income Taxes and Minority Interest**                                                                                      |   | 25,301                   |   | 19,866                   |   |
|                                                                                                                                      |   |                     |   |                     |   |
| Provision for income taxes                                                                                                                |   | 7,622                    |   | 5,990                    |   |
| Minority interest expense, net of income  taxes                                                                                           |   | 410                      |   | 397                      |   |
|                                                                                                                                      |   |                     |   |                     |   |
| **Net Income**                                                                                                                            |   | $                        | 17,269 |                     | $      | 13,479 |   |
|                                                                                                                                      |   |                     |   |                     |   |
| **Basic Earnings Per Share**                                                                                                              |   | $                        | 0.27   |                     | $      | 0.22 |   |
|                                                                                                                                      |   |                     |   |                     |   |
| **Diluted Earnings Per Share**                                                                                                            |   | $                        | 0.26   |                     | $      | 0.20 |   |
|                                                                                                                                      |   |                     |   |                     |   |
| **Comprehensive Income:**                                                                                                                 |   |                     |   |                     |   |
| Net income                                                                                                                                |   | $                        | 17,269 |                     | $      | 13,479 |   |
| Other comprehensive (loss)/income net of  tax of ($373) and $1,844 for the three months ended September 30, 2002 and  2001, respectively: |   |                     |   |                     |   |
| Net unrealized investment gain                                                                                                            |   | 8,347                    |   | 12,427                   |   |
| Net unrealized derivative instrument loss                                                                                                 |   | (9,040                   | )      | (9,003                   | )      |
| Other comprehensive (loss)/income                                                                                                         |   | (693                     | )      | 3,424                    |   |
| Comprehensive income                                                                                                                      |   | $                        | 16,576 |                     | $      | 16,903 |   |

 

*See Notes to Condensed Consolidated FinancialStatements.*

 

5

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**INVESTORS FINANCIAL SERVICES CORP.**

**CONDENSED CONSOLIDATED STATEMENTS OFSTOCKHOLDERS’ EQUITY (unaudited)**

**Nine Months Ended September 30, 2002 and 2001**

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

 
|                                                                                                          |   | **September  30,  2002** |       | **September  30,  2001** |       |
|---------------------------------------------------------------------------------------------------------------|--------|--------------------------|------------|--------------------------|------------|
| **Common shares**                                                                                             |   |                     | ** ** |                     | ** ** |
| Balance, beginning of period                                                                                  |   | 31,971,404               |       | 29,912,711               |       |
| Exercise of stock options                                                                                     |   | 381,880                  |       | 325,322                  |       |
| Common stock issuance                                                                                         |   | 61,193                   |       | 1,645,133                |       |
| Restricted stock issuance                                                                                     |   | —                   |       | 4,000                    |       |
| Stock dividend, two-for-one split                                                                             |   | 32,168,922               |       | —                   |       |
| Balance, end of period                                                                                        |   | 64,583,399               |       | 31,887,166               |       |
|                                                                                                          |   |                     |       |                     |       |
| **Treasury shares**                                                                                           |   |                     | ** ** |                     | ** ** |
| Balance, beginning of period                                                                                  |   | 10,814                   |       | 10,814                   |       |
| Balance, end of period                                                                                        |   | 10,814                   |       | 10,814                   |       |
|                                                                                                          |   |                     |       |                     |       |
| **Common stock**                                                                                              |   |                     | ** ** |                     | ** ** |
| Balance, beginning of period                                                                                  |   | $                        | 320        |                     | $          | 299 |   |
| Exercise of stock options                                                                                     |   | 4                        |       | 4                        |       |
| Common stock issuance                                                                                         |   | —                   |       | 16                       |       |
| Stock dividend, two-for-one split                                                                             |   | 322                      |       | —                   |       |
| Balance, end of period                                                                                        |   | 646                      |       | 319                      |       |
|                                                                                                          |   |                     |       |                     |       |
| **Surplus**                                                                                                   |   |                     |       |                     |       |
| Balance, beginning of period                                                                                  |   | 222,440                  |       | 95,007                   |       |
| Exercise of stock options                                                                                     |   | 2,212                    |       | 1,719                    |       |
| Tax benefit from exercise of stock options                                                                    |   | 3,559                    |       | 3,875                    |       |
| Common stock issuance                                                                                         |   | 1,835                    |       | 117,361                  |       |
| Stock option issuance                                                                                         |   | 78                       |       | —                   |       |
| Balance, end of period                                                                                        |   | 230,124                  |       | 217,962                  |       |
|                                                                                                          |   |                     |       |                     |       |
| **Deferred compensation**                                                                                     |   |                     |       |                     |       |
| Balance, beginning of the period                                                                              |   | (2,563                   | )          | (247                     | )          |
| Common stock issuance                                                                                         |   | —                   |       | (335                     | )          |
| Exercise of stock options                                                                                     |   | —                   |       | (13                      | )          |
| Amortization of deferred compensation                                                                         |   | 829                      |       | 120                      |       |
| Stock option issuance                                                                                         |   | (78                      | )          | —                   |       |
| Balance, end of period                                                                                        |   | (1,812                   | )          | (475                     | )          |
|                                                                                                          |   |                     |       |                     |       |
| **Retained earnings**                                                                                         |   |                     |       |                     |       |
| Balance, beginning of period                                                                                  |   | 132,877                  |       | 85,188                   |       |
| Net income                                                                                                    |   | 50,641                   |       | 35,719                   |       |
| Stock dividend, two-for-one split                                                                             |   | (322                     | )          | —                   |       |
| Cash dividend, $0.0375 and $0.0300 per  share in the periods ending September 30, 2002 and 2001, respectively |   | (2,412                   | )          | (1,873                   | )          |
| Balance, end of period                                                                                        |   | 180,784                  |       | 119,034                  |       |
|                                                                                                          |   |                     |       |                     |       |
| **Accumulated other comprehensive income/(loss), net**                                                        |   |                     |       |                     |       |
| Balance, beginning of period                                                                                  |   | (10,296                  | )          | (1,439                   | )          |
| Cumulative effect of a change in accounting  principle                                                        |   | —                   |       | (3,934                   | )          |
| Net unrealized investment gain                                                                                |   | 31,500                   |       | 14,746                   |       |
| Net unrealized derivative instrument loss                                                                     |   | (11,469                  | )          | (10,631                  | )          |
| Balance, end of period                                                                                        |   | 9,735                    |       | (1,258                   | )          |
|                                                                                                          |   |                     |       |                     |       |
| **Treasury stock**                                                                                            |   |                     |       |                     |       |
| Balance, beginning of period                                                                                  |   | —                   |       | —                   |       |
| Balance, end of period                                                                                        |   | —                   |       | —                   |       |
|                                                                                                          |   |                     |       |                     |       |
| **Total Stockholders’ Equity**                                                                           |   | $                        | 419,477    |                     | $          | 335,582 |   |

 

*See Notes to Condensed Consolidated FinancialStatements.*

 

6

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**INVESTORS FINANCIAL SERVICES CORP.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASHFLOWS (unaudited)**

**Nine Months Ended September 30, 2002 and 2001**

**(Dollars in thousands)**

 
|                                                                                               |   | **September  30,  2002** |   | **September  30,  2001** |   |
|----------------------------------------------------------------------------------------------------|--------|--------------------------|--------|--------------------------|--------|
|                                                                                               |   |                     |   |                     |   |
| **Cash Flows From Operating Activities:**                                                          |   |                     |   |                     |   |
| Net income                                                                                         |   | $                        | 50,641 |                     | $      | 35,719 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities:                 |   |                     |   |                     |   |
| Depreciation and amortization                                                                      |   | 11,179                   |   | 8,346                    |   |
| Amortization of deferred compensation                                                              |   | 829                      |   | 120                      |   |
| Amortization of premiums on securities, net  of accretion of discounts                             |   | 4,921                    |   | (2                       | )      |
| Changes in assets and liabilities:                                                                 |   |                     |   |                     |   |
| Accrued interest and fees receivable                                                               |   | (8,551                   | )      | (26,308                  | )      |
| Other assets                                                                                       |   | (19,913                  | )      | (3,899                   | )      |
| Other liabilities                                                                                  |   | 34,133                   |   | 14,162                   |   |
| Total adjustments                                                                                  |   | 22,598                   |   | (7,581                   | )      |
| Net cash provided by operating activities                                                          |   | 73,239                   |   | 28,138                   |   |
|                                                                                               |   |                     |   |                     |   |
| **Cash Flows From Investing Activities:**                                                          |   |                     |   |                     |   |
| Proceeds from maturities of securities  available for sale                                         |   | 411,825                  |   | 308,465                  |   |
| Proceeds from maturities of securities held  to maturity                                           |   | 1,403,792                |   | 747,100                  |   |
| Purchases of securities available for sale                                                         |   | (1,467,910               | )      | (597,293                 | )      |
| Purchases of securities held to maturity                                                           |   | (1,684,895               | )      | (2,058,154               | )      |
| Purchases of non-marketable equity  securities                                                     |   | —                   |   | (35,000                  | )      |
| Net (increase)/decrease in federal funds  sold and securities purchased under resale agreements    |   | (120,000                 | )      | 360,000                  |   |
| Net decrease/(increase) in loans                                                                   |   | 93,115                   |   | (8,560                   | )      |
| Purchase of businesses                                                                             |   | —                   |   | (49,383                  | )      |
| Purchases of fixed assets, capitalized  software and leasehold improvements                        |   | (38,726                  | )      | (27,840                  | )      |
| Net cash used for investing activities                                                             |   | (1,402,799               | )      | (1,360,665               | )      |
|                                                                                               |   |                     |   |                     |   |
| **Cash Flows From Financing Activities:**                                                          |   |                     |   |                     |   |
| Net decrease in demand deposits                                                                    |   | (131,283                 | )      | (17,991                  | )      |
| Net increase/(decrease) in time and savings  deposits                                              |   | 629,224                  |   | (12,258                  | )      |
| Net increase in short-term and other  borrowings                                                   |   | 897,311                  |   | 1,233,254                |   |
| Proceeds from exercise of stock options                                                            |   | 2,216                    |   | 1,710                    |   |
| Proceeds from issuance of common stock                                                             |   | 1,835                    |   | 117,042                  |   |
| Repurchase of Company-obligated,  mandatorily redeemable, preferred securities of subsidiary trust |   | (1,000                   | )      | —                   |   |
| Cash dividends to shareholders                                                                     |   | (2,412                   | )      | (1,873                   | )      |
| Net cash provided by financing activities                                                          |   | 1,395,891                |   | 1,319,884                |   |
|                                                                                               |   |                     |   |                     |   |
| **Net Increase / (Decrease) In Cash And Due From Banks**                                           |   | 66,331                   |   | (12,643                  | )      |
|                                                                                               |   |                     |   |                     |   |
| **Cash and Due From Banks, Beginning of Period**                                                   |   | 15,605                   |   | 30,489                   |   |
|                                                                                               |   |                     |   |                     |   |
| **Cash and Due From Banks, End of Period**                                                         |   | $                        | 81,936 |                     | $      | 17,846 |   |
|                                                                                               |   |                     |   |                     |   |
| **Supplemental Disclosure of Cash Flow Information:**                                              |   |                     |   |                     |   |
| Cash paid for interest                                                                             |   | $                        | 78,641 |                     | $      | 113,819 |   |
| Cash paid for income taxes                                                                         |   | $                        | 22,789 |                     | $      | 9,823 |   |

 

*See Notes to Condensed Consolidated FinancialStatements.*

 

7

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**INVESTORS FINANCIAL SERVICES CORP.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Information as of and for the nine monthsand the three months**

**ended September 30, 2002 and 2001 isunaudited)**

 

**1.       Description of Business**

 

Investors Financial Services Corp. (‘IFSC’)provides asset servicing for the financial services industry through itswholly-owned subsidiaries, Investors Bank & Trust Company (the ‘Bank’) andInvestors Capital Services, Inc.  Asused herein, the defined term “the Company” shall mean IFSC together with theBank and its domestic and foreign subsidiaries.  The Company provides globalcustody, multicurrency accounting, mutual fund administration,securities lending, foreign exchange, cash management, performance measurement,institutional transfer agency, investment advisory services and lines of creditto a variety of financial asset managers, including mutual fund complexes,investment advisors, banks and insurance companies.  IFSC and the Bank are subject to regulation by the FederalReserve Board of Governors, the Office of the Commissioner of Banks of theCommonwealth of Massachusetts and the Federal Deposit Insurance Corporation.

 

On February 1,2001, the Company completed the issuance and sale of 1,624,145 shares of CommonStock at $71.62 per share in a public offering.  A portion of the proceeds was used to fund the acquisition of theoperations of the advisor custody unit of The Chase Manhattan Bank.  The remaining proceeds were used for theassumption of the U.S. asset administration unit of Barclays Global Investors,N.A. and for working capital.

 

On April 23, 2002, the Board of Directorsapproved a two-for-one stock split in the form of a 100% stock dividend tostockholders of record as of May 24, 2002. All share numbers have been restated to reflect the two-for-one stocksplit paid June 14, 2002, where applicable.

 

**2.       InterimFinancial Statements**

 

The condensed consolidated interim financialstatements of the Company and subsidiaries as of September 30, 2002 and 2001and for the nine-month periods and the three-month periods ended September 30,2002 and 2001 have been prepared by the Company, without audit, pursuant to therules and regulations of the Securities and Exchange Commission.  Certain information and footnote disclosuresnormally included in annual financial statements prepared in accordance with accountingprinciples generally accepted in the United States of America have beencondensed or omitted as permitted by such rules and regulations.  All adjustments, consisting of normalrecurring adjustments, necessary for their fair presentation in conformity withaccounting principles generally accepted in the United States of America areincluded.  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 not necessarilyindicative of those to be expected for the full fiscal year. Certain amounts inthe prior periods’ financial statements have been reclassified to conform tothe current periods’ presentation.

 

On January 1, 2001, the Company adopted SFASNo. 133, “Accounting for Derivative Instruments and Hedging Activities,” asamended and interpreted, which established accounting and reporting standardsfor derivative instruments.  The Companyalso adopted SFAS No. 138, “Accounting for Certain Derivative Instruments andCertain Hedging Activities.”  All derivatives,whether designated in hedging relationships or not, are required to be recordedon the balance sheet at fair value.  Ifthe derivative is designated as a fair value hedge, the change in the fairvalue of the derivative and the item being hedged will be recognized inearnings.  If the derivative isdesignated as a cash flow hedge, the effective portions of changes in the fairvalue of the derivative are recorded in Other Comprehensive Income (‘OCI’).  Ineffective portions of changes, asdetermined in accordance with SFAS No. 133, in the fair value of the cash flowhedges are recognized in earnings.  Forderivatives that do not qualify as hedges, changes in their fair value arerecognized in earnings.  The adoption ofSFAS No. 133 on January 1, 2001, resulted in no cumulative effect-typeadjustment to net income.  However, theCompany recorded a reduction to OCI of $3.9 million, net of tax, and acorresponding liability for the fair value of the interest rate swaps.  The reduction to OCI and the recognition ofthe liability are primarily attributable to net unrealized losses on previouslydesignated cash flow hedges.  Inconjunction

 

8

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with the adoption, the Company elected toreclassify approximately $402 million of securities from held to maturity toavailable for sale, which further reduced OCI, net of tax, by approximately$1.4 million.

 

The Company uses derivative instruments tomanage exposures to interest rate risks. The Company routinely enters into interest rate swap agreements in whichthe Company pays a fixed interest rate and receives a floating interestrate.  These transactions are designedto hedge a portion of the Company’s liabilities.  By entering into a pay-fixed/receive-floating interest rate swap,a portion of these liabilities is effectively converted to a fixed rateliability for the term of the interest rate swap agreement.  Most of these derivatives have beendesignated as cash flow hedges.  Aninsignificant portion of the derivatives used to manage exposures to interestrate risks were not considered highly effective and, therefore, did not qualifyfor hedge accounting.

 

Hedge ineffectiveness, determined in accordance with SFAS No. 133, hadan insignificant impact on earnings for the nine months ended September 30,2002.  No cash flow hedges werededesignated or discontinued for the nine months ended September 30, 2002.

 

Net interest income included net gains of $1.2 million and $0.6million, net of tax, for the nine months and three months ended September 30,2002, respectively, on interest rate swaps relating to SFAS No. 133.  The net gains were $2.7 million and $1.0million, net of tax, for the nine-month and three-month periods ended September30, 2002, respectively, on changes in the fair value of derivative instrumentsdesignated as hedging instruments. There were also $1.5 million and $0.4 million of derivative losses, netof tax, for the nine-month and three-month periods ended September 30, 2002,respectively, that resulted primarily from the reclassification of transitionadjustment-related derivative losses from OCI to net interest income inaccordance with SFAS No. 133.  TheCompany estimates that $0.5 million, net of tax, of the remaining transitionadjustment of net derivative losses included in OCI will be reclassified intoearnings within the next twelve months. The recognition in net interest incomeof the transition adjustment derivative losses from OCI will be offset byderivative gains from changes in the fair value liability of the interest rateswaps as they reach maturity.

 

In June 2001, the FASB issued SFAS No. 142, “Goodwill and OtherIntangible Assets,” which supersedes APB No. 17, “Intangible Assets.”  SFAS No. 142 addresses how intangible assetsthat are acquired individually or with a group of other assets (but not thoseacquired in a business combination) should be accounted for in financialstatements upon their acquisition.  Thisstatement also addresses how goodwill and other intangible assets should be accountedfor after they have been initially recognized in the financial statements.  This statement affects the accounting ofpremiums, includes guidelines for the determination, measurement and testing ofimpairment, and requires disclosure of information about goodwill and otherintangible assets in the years subsequent to their acquisition that was notpreviously required.  On January 1,2002, the Company adopted SFAS No. 142 and ceased amortization of goodwill.  As of September 30, 2002 there was no impairmentof goodwill.

 

In November 2001, the FASB issued Emerging Issues Task Force (‘EITF’)No. 01-14, applicable in financial reporting periods beginning after December15, 2001, “Income Statement Characterization of Reimbursements Received forOut-Of-Pocket Expenses Incurred.”  Thisguidance requires companies to recognize the reimbursement of client-relatedexpenses as revenue and the costs as operating expense.  Client reimbursements for out-of-pocketexpenses are reflected in fee revenue in the accompanying financial statements.Prior periods have been reclassified to reflect this presentation, whichresulted in an increase to fee revenue and operating expense of $6.5 millionand $6.2 million for the nine months ended September 30, 2002 and 2001, respectively,and $2.2 million and $2.1 million for the three months ended September 30, 2002and 2001, respectively.

 

9

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**3.       Loans**

** **

Loans consist of demand loans to custody clients of the Company,including individuals and not-for-profit institutions, and loans to mutual fundclients. The loans to mutual funds and other pooled product clients includelines of credit and advances pursuant to the terms of the custody agreementsbetween the Company and those mutual fund clients to facilitate securitiestransactions and redemptions. Generally, the loans are, or may be, in the eventof default, collateralized with marketable securities held by the Company ascustodian. There were no impaired or nonperforming loans at September 30, 2002and December 31, 2001.  In addition,there were no loan charge-offs or recoveries during the nine months endedSeptember 30, 2002 and the year ended December 31, 2001. Loans are summarizedas follows (Dollars in thousands):

 
|                           |   | **September  30,  2002** |    | **December 31,  2001** |   |
|--------------------------------|--------|--------------------------|---------|-----------------------------|--------|
|                           |   |                     |    |                        |   |
| Loans to individuals           |   | $                        | 73,986  |                        | $      | 164,443 |   |
| Loans to mutual funds          |   | 46,721                   |    | 50,359                      |   |
| Loans to others                |   | 18,391                   |    | 17,411                      |   |
|                           |   | 139,098                  |    | 232,213                     |   |
| Less allowance for loan losses |   | (100                     | )       | (100                        | )      |
|                           |   |                     |    |                        |   |
| Total                          |   | $                        | 138,998 |                        | $      | 232,113 |   |

 

The Company had commitments to lend of approximately $660 million and$390 million at September 30, 2002 and December 31, 2001, respectively. Theterms of these commitments are similar to the terms of the outstanding loans.

 

**4.       Acquisitions**

 

Goodwill related to the Company’s acquisitions is summarized as follows(Dollars in thousands):

 
|                          |   | **For the  Nine  Months Ended  September 30, 2002** |   | **For the  Year Ended  December 31, 2001** |   |
|-------------------------------|--------|-----------------------------------------------------|--------|--------------------------------------------|--------|
|                          |   |                                                |   |                                       |   |
| Goodwill, beginning of period |   | $                                                   | 79,969 |                                       | $      | 34,094 |   |
| Plus purchase of businesses   |   | —                                              |   | 49,434                                     |   |
| Less amortization             |   | —                                              |   | (3,559                                     | )      |
|                          |   |                                                |   |                                       |   |
| Goodwill, end of period       |   | $                                                   | 79,969 |                                       | $      | 79,969 |   |

 

On February 1, 2001, the Company purchasedthe operations of the advisor custody unit of The Chase Manhattan Bank.  This unit provided institutional custodyservices to individual accounts holding approximately $27 billion in assets asof February 1, 2001.  These accountsconsist of individual accounts, trusts, endowments and corporate accounts whoseassets are managed by third-party investment advisors.  Pursuant tothe terms of the asset purchase agreement, the Company paid to Chase as ofclosing approximately $31.5 million of the total purchase price, plus another$39.8 million in exchange for the book value of loans to clients.  Under the terms of the asset purchaseagreement, the Company is not obligated to make any further purchase pricepayments to Chase.  The transaction wasaccounted for as a purchase.

 

On May 1, 2001, the Company assumed the operations of the U.S. assetadministration unit of Barclays Global Investors, N.A. (‘BGI’), a largeinternational institutional investment manager.  The unit, located in Sacramento, California, provides custodyaccounting and other operations functions for BGI’s clients.  The transaction was accounted for as apurchase.

 

No pro forma financial results of Chase or BGI are presented as theywere not material to the Company’s financial condition and operating resultsfor the periods presented.

 

10

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On January 1, 2002, the Company adopted SFAS No. 142 and ceasedamortization of goodwill.  See “InterimFinancial Statements” (Footnote 2) for a further discussion of thispronouncement.

 

**5.       Deposits**

** **

Time deposits at September 30, 2002 and December 31, 2001 includednoninterest-bearing amounts of $90 million. All time deposits had a minimum balance of $100,000 and a maturity ofless than three months at September 30, 2002 and December 31, 2001.

 

**6.       Short-termand other borrowings**

** **

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

 
|                                                  |   | **September  30,  2002** |      | **December  31,  2001** |   |
|-------------------------------------------------------|--------|--------------------------|-----------|-------------------------|--------|
|                                                  |   |                     |      |                    |   |
| Federal funds purchased                               |   | $                        | 375,000   |                    | $      | 130,000 |   |
| Federal Home Loan Bank of Boston overnight  advances  |   | 300,000                  |      | 380,000                 |   |
| Federal Home Loan Bank of Boston long-term  advances  |   | 300,000                  |      | 300,000                 |   |
| Federal Home Loan Bank of Boston short-term  advances |   | 200,000                  |      | 100,000                 |   |
| Treasury, Tax and Loan account                        |   | 529                      |      | 281                     |   |
|                                                  |   |                     |      |                    |   |
| Total                                                 |   | $                        | 1,175,529 |                    | $      | 910,281 |   |

 

The Company has a borrowing arrangement with the Federal Home Loan Bankof Boston (“FHLBB”), which is utilized on an overnight and on a term basis tosatisfy funding requirements.  TheCompany has utilized both short-term and long-term features of the termadvances.

 

As of September 30, 2002 and December 31, 2001, there were $300 millionof long-term term advances outstanding with interest rates ranging from 3.28%to 5.17% as of September 30, 2002 and from 3.59% to 5.17% as of December 31,2001.  Maturities ranged from May 2004to September 2006 as of September 30, 2002 and ranged from June 2003 toFebruary 2005 as of December 31, 2001.

 

There was a $200 million short-term term advance outstanding atSeptember 30, 2002 with an interest rate of 1.76% maturing in October2002.  The interest rate on the $100million short-term term advance outstanding at December 31, 2001 was 1.82% andmatured in January 2002.  Outstandingovernight advances, with interest rates based on the Federal funds rate, were$300 million at September 30, 2002 and $380 million at December 31, 2001.

 

The rates on the outstanding balances of federal funds purchased fromother banks at September 30, 2002 and December 31, 2001 were 1.96% and 1.61%,respectively.

 

The Company receives federal tax deposits from clients as agent for theFederal Reserve Bank and accumulates these deposits in the Treasury, Tax andLoan account.  The Federal Reserve Bankcharges the Company interest based on the Federal Funds rate on such deposits.  The interest rate on the outstanding balancewas 1.56% at September 30, 2002 and 1.51% at December 31, 2001.

 

**7.       Stockholders’Equity**

 

As of September 30, 2002, the Company has authorized 1,000,000 sharesof Preferred Stock and 100,000,000 shares of Common Stock, all with a par valueof $0.01 per share.

 

At the Annual Meeting of Stockholders of the Company held on April 17,2001, stockholders approved an increase in the number of authorized shares ofCommon Stock from 40,000,000 to 100,000,000. On April 25, 2001, the Companyamended its Certificate of Incorporation increasing the number of authorizedshares of

 

11

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Common Stock to 100,000,000.  These shares are available for generalcorporate purposes as determined by the Company’s Board of Directors.

 

On April 23, 2002, the Board of Directors approved a two-for-one stocksplit in the form of a 100% stock dividend to shareholders of record on May 24,2002.  The dividend was paid on June 14,2002.  A total of 32,168,922 shares ofcommon stock were issued in connection with the stock split. The stock splitdid not result in a change in the $0.01 par value per share of the common stockor in total stockholders’ equity.

 

The Company has three stock option plans: the Amended and Restated 1995Stock Plan (‘Stock Plan’), the Amended and Restated 1995 Non-Employee DirectorStock Option Plan (‘Director Plan’), and the 1997 Employee Stock Purchase Plan.

 

At the Annual Meeting of Stockholders of the Company held on April 17,2001, stockholders approved the amendment and restatement of the Company’sStock Plan to increase the number of shares available for grant pursuant to theplan from 4,640,000 to 6,140,000.  Atthe Annual Meeting of Stockholders of the Company held on April 23, 2002, stockholdersapproved the amendment and restatement of the Company’s Stock Plan to increasethe number of shares available for grant pursuant to the plan from 6,140,000 to7,640,000.  Effective with the June 2002stock split, the number of shares available to grant increased to15,280,000.  Of the 15,280,000 shares ofCommon Stock authorized for issuance under the Stock Plan at September 30,2002, 4,728,130 were available for grant as of that date.  Under the Stock Plan, the Company may grantoptions to purchase shares of Common Stock to certain employees, consultants,directors and officers.  The options maybe awarded as incentive stock options (employees only), nonqualified stockoptions, stock awards or opportunities to make direct purchases of stock.  No options were granted to consultants duringthe nine months ended September 30, 2002.

 

The terms of the Director Plan provide for the grant of options tonon-employee directors to purchase up to a maximum of 400,000 shares of CommonStock. Effective with the June 2002 stock split, the number of shares availableto grant increased to 800,000.  Of the800,000 shares of Common Stock authorized for issuance under the plan, 124,658were available for grant at September 30, 2002.

 

Pursuant to the terms of the Director Plan, options to purchase 20,000shares of Common Stock were awarded on November 8, 1995 to eachnon-employee director then in office. Each non-employee director receives anautomatic annual grant of options to purchase the number of shares thenspecified by the Director Plan, as described below.  Additionally, any non-employee director may elect to receiveoptions to acquire shares of the Company’s Common Stock in lieu of suchdirector’s cash retainer.  Any suchelection is subject to certain restrictions under the Director Plan. The numberof shares of stock underlying the option granted in lieu of cash is equal tothe quotient obtained by dividing the cash retainer by the fair market value ofan option on the date of grant, which is based on the Black-Scholesoption-pricing model.

 

At the Annual Meeting of Stockholders of the Company held on April 23,2002, stockholders approved amendments to the Director Plan providing that onthe date of each Annual Meeting, each person who is a member of the Boardimmediately after the Annual Meeting of the Company and who is not an employeeof the Company, shall be automatically granted an option to purchase the numberof shares called for by the Director Plan as of that date.  Formerly, each non-employee directorreceived a grant of options upon their election or appointment and annuallythereafter on their anniversary date. The amendments also provide that the number of shares granted to eachnon-employee director annually be adjusted for stock splits and other capitalchanges. After giving effect to the stock split paid on June 14, 2002,non-employee directors shall receive an annual grant of options to purchase5,000 shares.  In addition, theamendments provide that options granted under the Director Plan will vest in 36equal monthly installments beginning on the date of grant, rather than 48 equalmonthly installments, subject to certain restrictions. Finally, the amendmentsto the Director Plan provide that in the event a non-employee director ceasesto be a member of the Board by reason of his or her retirement, the Board mayvote to accelerate and fully vest all unvested options held by the retiringnon-employee director.

 

The exercise price of options under the Director Plan and the incentiveoptions under the Stock Plan may not be less than the fair market value at thedate of the grant.  The exercise priceof non-qualified options under

 

12

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the Stock Plan is determined by the compensation committee of the Boardof Directors.  All options become exercisableas specified by the compensation committee at the date of the grant.

 

On February 13, 2001, the Company granted8,000 shares of Common Stock under the Stock Plan to former employees of theChase advisor custody unit.  This grantis subject to the Company’s right to repurchase the shares if the employees’employment with the Company terminates. The Company’s right to repurchase the shares lapses in five equal annualinstallments beginning one year from the date of grant.  On September 30, 2002, the Company chose notto exercise its right to repurchase 3,200 shares issued in connection with thisgrant when an employee’s employment with the Company did terminate.

 

On May 1, 2001, the Company granted 58,000nonqualified stock options under the Stock Plan to former employees of the U.S.asset administration unit of BGI in connection with the assumption of theoperations of the unit. The exercise price of the options is 10% of the fair market value of theCommon Stock at the close of market on the date of grant.  The grants are exercisable immediately, butany shares acquired on exercise are subject to the Company’s right torepurchase the shares at the exercise price if the employees’ employment withthe Company terminates.  The Company’s right to repurchase the shareslapses in five equal annual installments beginning one year from the date ofgrant.

 

On October 16, 2001, the Company granted10,000 nonqualified stock options to an officer of the Company under the StockPlan. The exercise price of the options is 10% of the fair marketvalue of the Common Stock at the close of market on the date of grant.  The grants are exercisable immediately, butany shares acquired on exercise are subject to the Company’s right torepurchase the shares at the exercise price if the officer’s employment withthe Company terminates.  The Company’s right to repurchase the shareslapses in five equal annual installments beginning one year from the date ofgrant.

 

The Company has recorded deferredcompensation of $1.8 million and $2.6 million at September 30, 2002and December 31, 2001, respectively, related to the grants described inthe above three paragraphs.

 

Under the terms of the 1997 Employee Stock Purchase Plan, the Companymay issue up to 1,120,000 shares of Common Stock pursuant to the exercise ofnontransferable options granted to participating employees. The 1997 EmployeeStock Purchase Plan permits eligible employees to purchase up to 1,000 sharesof Common Stock per payment period, subject to limitations provided bySection 423(b) of the Internal Revenue Code, through accumulated payrolldeductions. The purchases are made twice a year at a price equal to the lesserof (i) 90% of the market value of the Common Stock on the first businessday of the payment period, or (ii) 90% of the market value of the CommonStock on the last business day of the payment period. The payment periodsconsist of two six-month periods, January 1 through June 30 andJuly 1 through December 31.

 

A summary of option activity under the Director Plan and the Stock Planis as follows:

 
|                                               |   | **Number of  Shares** |   | **Weighted-Average  Exercise Price** |   |
|----------------------------------------------------|--------|-----------------------|--------|--------------------------------------|--------|
| Outstanding at December 31, 2001                   |   | 6,921,610             |   | $                                    | 20     |   |
| Granted                                            |   | 202,498               |   | 35                                   |   |
| Exercised                                          |   | (649,345              | )      | 7                                    |   |
| Canceled                                           |   | (162,499              | )      | 29                                   |   |
| Outstanding at September 30, 2002                  |   | 6,312,264             |   | $                                    | 21     |   |
| Outstanding and exercisable at September  30, 2002 |   | 3,540,427             |   |                                 |   |
|                                               |   |                  |   |                                 |   |
| Outstanding at December 31, 2000                   |   | 5,793,324             |   | $                                    | 14     |   |
| Granted                                            |   | 269,658               |   | 30                                   |   |
| Exercised                                          |   | (711,002              | )      | 5                                    |   |
| Canceled                                           |   | (36,800               | )      | 30                                   |   |
| Outstanding at September 30, 2001                  |   | 5,315,180             |   | $                                    | 16     |   |
| Outstanding and exercisable at September  30, 2001 |   | 2,840,518             |   |                                 |   |

 

13

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A summary of activity under the 1997 Employee Stock Purchase Plan is asfollows (Number of shares):

 
|                                                        |   | **For the  Nine  Months Ended  September 30,  2002** |   | **For the  Year Ended  December 31,  2001** |   |
|-------------------------------------------------------------|--------|------------------------------------------------------|--------|---------------------------------------------|--------|
|                                                        |   |                                                 |   |                                        |   |
| Total shares available under the Plan,  beginning of period |   | 500,764                                              |   | 598,068                                     |   |
| Issued at June 30                                           |   | (61,193                                              | )      | (41,976                                     | )      |
| Issued at December 31                                       |   | —                                               |   | (55,328                                     | )      |
|                                                        |   |                                                 |   |                                        |   |
| Total shares available under the Plan, end  of period       |   | 439,571                                              |   | 500,764                                     |   |

 

For the six-month period ended June 30, 2002, the purchase price of thestock was $30.00, or 90% of the market value of the Common Stock on the firstbusiness day of the payment period ending June 30, 2002.

 

For the year ended December 31, 2001, the purchase price of the stockwas $30.25 and $29.875, or 90% of the market value of the Common Stock on thefirst business day of the payment periods ending June 30, 2001 and December 31,2001, respectively.

 

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

 
|                                    |   | **For the Nine Months Ended  September 30,** |   | **For the Three Months Ended  September 30,** |   |
|-----------------------------------------|--------|----------------------------------------------|--------|-----------------------------------------------|--------|
|                                    |   | **2002**                                     |   | **2001**                                      |   | **2002** |   | **2001** |   |
| Income available to common stockholders |   | $                                            | 50,641 |                                          | $      | 35,719 |   | $ | 17,269 |   | $ | 13,479 |   |
|                                    |   |                                         |   |                                          |   |   |   |   |   |
| Basic average shares                    |   | 64,356,467                                   |   | 63,125,702                                    |   | 64,547,952 |   | 63,763,376 |   |
| Dilutive effect of stock options        |   | 2,065,632                                    |   | 2,485,564                                     |   | 1,729,045 |   | 2,364,474 |   |
| Diluted average shares                  |   | 66,422,099                                   |   | 65,611,266                                    |   | 66,276,997 |   | 66,127,850 |   |
|                                    |   |                                         |   |                                          |   |   |   |   |   |
| Earnings per share:                     |   |                                         |   |                                          |   |   |   |   |   |
| Basic                                   |   | $                                            | 0.79   |                                          | $      | 0.57 |   | $ | 0.27 |   | $ | 0.22 |   |
|                                    |   |                                         |   |                                          |   |   |   |   |   |
| Diluted                                 |   | $                                            | 0.76   |                                          | $      | 0.54 |   | $ | 0.26 |   | $ | 0.20 |   |

 

**8.       Off-BalanceSheet Financial Instruments**

 

*Lines of Credit*—AtSeptember 30, 2002, the Company had commitments to individuals and mutual fundsunder collateralized open lines of credit totaling $660 million, against which$61 million in loans were drawn. The credit risk involved in issuing lines ofcredit is essentially the same as that involved in extending loan facilities.The Company does not anticipate any loss as a result of these lines of credit.

* *

*Securities Lending*—Onbehalf of its clients, the Company lends its securities to creditworthy brokersand other institutions.  In certaincircumstances, the Company may indemnify its clients for the fair market valueof those securities against a failure of the borrower to return suchsecurities.  The Company requires theborrowers to provide collateral in an amount equal to or in excess of 102% ofthe fair market value of U.S. dollar denominated securities borrowed and 105%of the fair market value of non-U.S. dollar denominated securities borrowed.  The borrowed securities are revalued dailyto determine if additional collateral is necessary.  The Company held, as collateral, cash and U.S. governmentsecurities totaling approximately $4.6 billion and $2.1 billion for indemnifiedsecurities on loan at September 30, 2002 and December 31, 2001, respectively.

 

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**9.       Commitmentsand Contingencies**

** **

*Restrictions on CashBalances*—The Company is required to maintain certainaverage cash reserve balances. The average required reserve balance with theFederal Reserve Bank (“FRB”) for the two-week period including September 30,2002 was approximately $11.3 million. In addition, other cash balances in the amount of approximately $12.1million were pledged to secure clearings with a depository institution,Depository Trust Company, as of September 30, 2002.

 

*Lease Commitments*—Minimum future commitments on noncancelable operating leases at September 30,2002 were as follows (Dollars in thousands):

 

| **Fiscal Year Ending** |   | **Premises** |    | **Equipment** |   | **Total** |   |
|----------------------------------|--------|--------------|---------|---------------|--------|-----------|--------|
|                             |   |         |    |          |   |      |   |
| 2002                             |   | $            | 5,742   |          | $      | 1,631     |   | $ | 7,373 |   |
| 2003                             |   | 21,812       |    | 5,329         |   | 27,141    |   |
| 2004                             |   | 21,428       |    | 3,550         |   | 24,978    |   |
| 2005                             |   | 21,548       |    | 986           |   | 22,534    |   |
| 2006 and beyond                  |   | 60,008       |    | 56            |   | 60,064    |   |
| Total                            |   | $            | 130,538 |          | $      | 11,552    |   | $ | 142,090 |   |

 

Total rent expense was $24.7 million and $17.5 million for the ninemonths ended September 30, 2002 and 2001, respectively.  Total rent expense was $9.0 million and $6.4million for the three months ended September 30, 2002 and 2001, respectively.

 

Effective January 1, 2000, the Company renewed its five–yearservice agreement with Electronic Data Systems (“EDS”), which now expires onDecember 31, 2005.  Under the terms ofthe agreement, EDS provides data processing services to the Company, which hasagreed to pay certain monthly service fees based on usage.  Service expense under this contract was $5.3million and $3.5 million for the nine months ended September 30, 2002 and 2001,respectively, and was $1.9 million and $1.3 million for the three months endedSeptember 30, 2002 and 2001, respectively.

 

In 2001, the Company renewed its agreement with SEI InvestmentsCompany, which now expires on December 31, 2005.  Under the terms of the agreement, SEI provides data processingservices to the Company, which has agreed to pay certain monthly service feesbased upon usage.  Service expense underthis contract was $3.9 million and $3.0 million for the nine months endedSeptember 30, 2002 and 2001, respectively, and was $1.2 million and $1.3million for the three months ended September 30, 2002 and 2001, respectively.

* *

*Contingencies*—The Company provides a broadrange of services to financial asset managers, such as mutual fund complexes,investment advisors, banks and insurance companies.  The core services include global custody, multicurrencyaccounting and mutual fund administration. The value-added services include securities lending, foreign exchangeand cash management.  Assets undercustody and management, held by the Company in a fiduciary capacity, are notincluded in the consolidated balance sheets since such items are not assets ofthe Company.  Management conductsregular reviews of its fiduciary responsibilities and considers the results inpreparing its consolidated financial statements.  In the opinion of management, there are no contingent liabilitiesat September 30, 2002 that are material to the consolidated financial positionor results of operations of the Company.

 

In June 2002, the Bank received from the Commonwealth of MassachusettsDepartment of Revenue (‘DOR’) a Notice of Intent to Assess additional stateexcise taxes of approximately $5.5 million plus interest and penalties withrespect to the Bank’s tax years ended December 31, 1999 and December 31, 2000.

 

The DOR contends that dividend distributions to the Bank by InvestorsFunding Corp. (‘IFC’), a real estate investment trust 99.9% owned by the Bank,are fully taxable in Massachusetts.  TheCompany, after consultation with its advisors, believes that the Massachusettsstatute that provides for a dividend received deduction equal to 95% of certaindividend distributions applies to the distributions made by IFC to the Bank.

 

15

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Accordingly, no provision has been made in the Company’s financialstatements for the amounts assessed or additional amounts that might beassessed in the future.

 

The Company has been informed that the DOR has sent similar notices tonumerous other financial institutions in Massachusetts that reported adeduction for dividends received from a real estate investment trust on their1999 and 2000 Massachusetts financial institution excise tax returns.  Because the legal issues raised areidentical for all of the financial institutions involved, the Company is actingtogether with those institutions to appeal the assessments and to pursue allavailable means to defend its position vigorously.  Assessed amounts ultimately paid, if any, would be deductibleexpenses for federal income tax purposes.

 

On January 16, 2001, Mopex, Inc. filed an actionentitled Mopex, Inc. v. Chicago Stock Exchange, Inc., et al., CivilAction No. 01 C 0302 (the “Complaint”), in the United States District Court forthe Northern District of Illinois.  Inthe Complaint, Mopex alleges that the Company and numerous other entities,including Barclays Global Investors, State Street Bank and Trust Company, andMerrill Lynch, Pierce, Fenner & Smith, Inc., infringed U.S. Patent No.6,088,685, entitled, “Open End Mutual Fund Securitization Process,” assigned toMopex.  In particular, Mopex allegesthat the ‘685 patent covers the creation and trading of certain securities,including the Barclays iShares exchange traded funds.  The Complaint seeks injunctive relief, damages, and enhanced remedies(including attorneys’ fees and treble damages).  On April 3, 2001, the Company filed an answer and counterclaim,denying any liability on Mopex’s claim and seeking a declaratory judgment thatthe ‘685 patent is invalid and not infringed by the Company’s activities.  The Company, which is indemnified by theiShares Trust for certain defense costs and damages resulting from Mopex’sclaim, believes the claim is without merit.

 

While the Company does not offer or sell thesecurities discussed in the Complaint, it provides certain custody, accountingor other administrative services for the Barclays iShares family of exchangetraded funds. Barclays is one of the defendants named in the Complaint.  The Company cannot be sure that it willprevail in the defense of this claim. Patent litigation can be costly and could divert the attention ofmanagement. If the Company was found to infringe the patent, it would have topay damages and would be ordered to cease any infringing activity or seek alicense under the patent. The Company cannot be sure that it will be able toobtain a license on a timely basis or on reasonable terms, if at all. As aresult, any determination of infringement could have a material adverse effectupon its business, financial condition and results of operations.

 

In July 2000, two of the Company’sDublin subsidiaries, Investors Trust & Custodial Services(Ireland) Ltd. (ITC) and Investors Fund Services (Ireland) Ltd.(IFS), received a plenary summons in the High Court, Dublin, Ireland. Thesummons named ITC and IFS as defendants in an action brought by the FTFForexConcept Fund Plc (the “Fund”), a former client. The summons also named asdefendants FTF Forex Trading and Finance, S.A., the Fund’s investment manager,Ernst & Young, the Fund’s auditors, and Dresdner Bank-Kleinwort Benson(Suisse) S.A., a trading counterparty to the Fund. The Fund is an investmentvehicle organized in Dublin to invest in foreign exchange contracts. A total ofapproximately $4.7 million had been invested in the Fund. Most of thatmoney was lost prior to the Fund’s closing to subscriptions in June 1999.

 

In January 2001, ITC, IFSand the other defendants named in the plenary summons received a statement ofclaim by the Fund seeking unspecified damages allegedly arising from breach ofcontract, misrepresentation and breach of warranty, negligence and breach ofduty of care, and breach of fiduciary duty, among others. The Company continuesto investigate this matter. The Company has notified its insurers and intendsto defend itself vigorously. Based on its investigation through September 30,2002, the Company’s management does not expect this matter to have a materialadverse effect on its results of operations and financial condition.

 

16

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**10.    RegulatoryMatters**

** **

The Company and the Bank are subject to various regulatory capitalrequirements administered by the federal banking agencies.  Failure to meet minimum capital requirementscan initiate certain mandatory and possibly additional discretionary actions byregulators that, if undertaken, could have a direct material adverse effect onthe Company’s and the Bank’s results of operations and financialcondition.  Under capital adequacyguidelines and the regulatory framework for prompt corrective action, the Bankmust meet specific capital guidelines that involve quantitative measures of theBank’s assets, liabilities, and certain off-balance sheet items as calculatedunder regulatory accounting practices. The Company’s and the Bank’s capital amounts and classification are alsosubject to qualitative judgments by the regulators about components, riskweightings, and other factors.

 

Quantitative measures established byregulation to ensure capital adequacy require the Company and the Bank tomaintain minimum amounts and ratios (set forth in the table below) of Total andTier I capital (as defined in the regulations) to risk-weighted assets (asdefined), and of Tier I capital (as defined) to average assets (as defined).Management believes, as of September 30, 2002, that the Company and the Bankmeet all capital adequacy requirements to which they are subject.

 

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As of September 30, 2002, the most recentnotification from the FDIC categorized the Company and the Bank as wellcapitalized under the regulatory framework for prompt corrective action. To becategorized as well capitalized, the Company and the Bank must maintain minimumTotal risk-based, Tier I risk-based, and Tier I leverage ratios as set forth inthe following table. There are no conditions or events since that notificationthat management believes have changed the Company’s or the Bank’scategory.  The following table presentsthe capital ratios for the Company and the Bank (Dollars in thousands): 

 
|                                                       |   | **Actual** |    | **For  Capital   Adequacy Purposes** |   | **To Be Well  Capitalized  Under Prompt  Corrective Action  Provisions** |   |
|------------------------------------------------------------|--------|------------|---------|--------------------------------------|--------|--------------------------------------------------------------------------|--------|
|                                                       |   | **Amount** |    | **Ratio**                            |   | **Amount**                                                               |   | **Ratio** |   | **Amount** |   | **Ratio** |   |
| **As of September 30, 2002:**                              |   |       |    |                                 |   |                                                                     |   |   |   |   |   |   |   |
| Total Capital  (to Risk Weighted Assets—the Company)  |   | $          | 353,169 |                                 | 15.08  | %                                                                        | $      | 187,364 |   | 8.00 | % | N/A |   | N/A |   |
| Total Capital  (to Risk Weighted Assets—the Bank)     |   | $          | 349,302 |                                 | 14.92  | %                                                                        | $      | 187,339 |   | 8.00 | % | $ | 234,174 |   | 10.00 | % |
| Tier I Capital  (to Risk Weighted Assets—the Company) |   | $          | 353,069 |                                 | 15.08  | %                                                                        | $      | 93,682 |   | 4.00 | % | N/A |   | N/A |   |
| Tier I Capital  (to Risk Weighted Assets—the Bank)    |   | $          | 349,202 |                                 | 14.91  | %                                                                        | $      | 93,669 |   | 4.00 | % | $ | 140,504 |   | 6.00 | % |
| Tier I Capital  (to Average Assets—the Company)       |   | $          | 353,069 |                                 | 5.64   | %                                                                        | $      | 250,363 |   | 4.00 | % | N/A |   | N/A |   |
| Tier I Capital  (to Average Assets—the Bank)          |   | $          | 349,202 |                                 | 5.58   | %                                                                        | $      | 250,278 |   | 4.00 | % | $ | 312,847 |   | 5.00 | % |
|                                                       |   |       |    |                                 |   |                                                                     |   |   |   |   |   |   |   |
| **As of December 31, 2001:**                               |   |       |    |                                 |   |                                                                     |   |   |   |   |   |   |   |
| Total Capital  (to Risk Weighted Assets—the Company)  |   | $          | 297,479 |                                 | 16.77  | %                                                                        | $      | 141,932 |   | 8.00 | % | N/A |   | N/A |   |
| Total Capital  (to Risk Weighted Assets—the Bank)     |   | $          | 293,706 |                                 | 16.56  | %                                                                        | $      | 141,898 |   | 8.00 | % | $ | 177,373 |   | 10.00 | % |
| Tier I Capital  (to Risk Weighted Assets—the Company) |   | $          | 297,379 |                                 | 16.76  | %                                                                        | $      | 70,966 |   | 4.00 | % | N/A |   | N/A |   |
| Tier I Capital  (to Risk Weighted Assets—the Bank)    |   | $          | 293,606 |                                 | 16.55  | %                                                                        | $      | 70,949 |   | 4.00 | % | $ | 106,424 |   | 6.00 | % |
| Tier I Capital  (to Average Assets-the Company)            |   | $          | 297,379 |                                 | 5.88   | %                                                                        | $      | 202,377 |   | 4.00 | % | N/A |   | N/A |   |
| Tier I Capital  (to Average Assets—the Bank)          |   | $          | 293,606 |                                 | 5.80   | %                                                                        | $      | 202,334 |   | 4.00 | % | $ | 252,917 |   | 5.00 | % |

 

Under Massachusetts law, trust companies suchas the Bank, like national banks, may pay dividends no more often thanquarterly, and only out of “net profits” and to the extent that such paymentswill not impair the Bank’s capital stock and surplus account. Moreover, priorapproval of the Commissioner of Banks of the Commonwealth of Massachusetts isrequired if the total dividends for a calendar year would exceed net profitsfor that year combined with retained net profits for the previous two years.These restrictions on the ability of the Bank to pay dividends to the Companymay restrict the ability of the Company to pay dividends to its stockholders.

 

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**11.    SegmentReporting**

 

The Company does not utilize segment informationfor internal reporting as management views the Company as one segment. Thefollowing represents net operating revenue and long-lived assets (includinggoodwill) by geographic area (Dollars in thousands):

 
|                        |   | **Net Operating Revenue**                    |    | **Long-Lived Assets**                         |   |
|-----------------------------|--------|----------------------------------------------|---------|-----------------------------------------------|--------|
|                        |   | **For the Nine Months Ended  September 30,** |    | **For the Three Months Ended  September 30,** |   | **September 30,** |   | **December 31,** |   |
| **Geographic Information:** |   | **2002**                                     |    | **2001**                                      |   | **2002** |   | **2001** |   | **2002** |   | **2001** |   |
|                        |   |                                         |    |                                          |   |   |   |   |   |   |   |   |   |
| United States               |   | $                                            | 315,869 |                                          | $      | 251,577 |   | $ | 106,851 |   | $ | 93,801 |   | $ | 149,667 |   | $ | 122,200 |   |
| Ireland                     |   | 8,322                                        |    | 5,788                                         |   | 3,046 |   | 2,151 |   | 482 |   | 370 |   |
| Canada                      |   | 1,477                                        |    | 1,699                                         |   | 445 |   | 561 |   | 6 |   | 17 |   |
| Cayman Islands              |   | 63                                           |    | 64                                            |   | 21 |   | 21 |   | — |   | — |   |
|                        |   |                                         |    |                                          |   |   |   |   |   |   |   |   |   |
| Total                       |   | $                                            | 325,731 |                                          | $      | 259,128 |   | $ | 110,363 |   | $ | 96,534 |   | $ | 150,155 |   | $ | 122,587 |   |

 

BGI accounted for 16.44% and 16.68% of theCompany’s consolidated net operating revenues for the nine months and threemonths ended September 30, 2002, respectively.

 

The following represents the Company’s assetservicing fees by service line (Dollars in thousands):

 
|                                                      |   | **Asset  Servicing Fees**                     |    |
|-----------------------------------------------------------|--------|-----------------------------------------------|---------|
|                                                      |   | **For the  Nine Months Ended  September 30,** |    | **For the  Three Months Ended  September 30,** |   |
|                                                      |   | **2002**                                      |    | **2001** |   | **2002** |   | **2001** |   |
|                                                      |   |                                          |    |   |   |   |   |   |   |
| **Asset servicing fees by service line:**                 |   |                                          |    |   |   |   |   |   |   |
| Custody, accounting, transfer agency, and  administration |   | $                                             | 173,017 |   | $ | 145,588 |   | $ | 57,718 |   | $ | 54,801 |   |
| Foreign exchange                                          |   | 18,706                                        |    | 12,771 |   | 7,669 |   | 4,713 |   |
| Cash management                                           |   | 12,362                                        |    | 11,328 |   | 4,416 |   | 3,989 |   |
| Securities lending                                        |   | 8,605                                         |    | 6,837 |   | 2,362 |   | 1,985 |   |
| Investment advisory                                       |   | 5,413                                         |    | 2,784 |   | 1,817 |   | 1,189 |   |
|                                                      |   |                                          |    |   |   |   |   |   |   |
| Total                                                     |   | $                                             | 218,103 |   | $ | 179,308 |   | $ | 73,982 |   | $ | 66,677 |   |

 

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INDEPENDENTACCOUNTANTS’ REPORT

 

To the Board of Directors andStockholders of

Investors Financial ServicesCorp.

Boston, Massachusetts

 

We have reviewed theaccompanying condensed consolidated balance sheet of Investors FinancialServices Corp. and subsidiaries (the “Corporation”) as of September 30, 2002,and the related condensed consolidated statements of income and comprehensiveincome for the three-month and nine-month periods then ended, and the condensedconsolidated statements of stockholders’ equity and cash flows for thenine-month period then ended.  Thesefinancial statements are the responsibility of the Corporation’s management.

 

We conducted our review inaccordance with standards established by the American Institute of CertifiedPublic Accountants.  A review of interimfinancial information consists principally of applying analytical procedures tofinancial data and of making inquiries of persons responsible for financial andaccounting matters.  It is substantiallyless in scope than an audit conducted in accordance with auditing standards generallyaccepted in the United States of America, the objective of which is theexpression of an opinion regarding the financial statements taken as awhole.  Accordingly, we do not expresssuch an opinion.

 

Based on our review, we are notaware of any material modifications that should be made to such condensedconsolidated financial statements for them to be in conformity with accountingprinciples generally accepted in the United States of America.

 

We have previously audited, inaccordance with auditing standards generally accepted in the United States ofAmerica, the consolidated balance sheet of Investors Financial Services Corp.and subsidiaries as of December 31, 2001, and the consolidated statements ofincome, stockholders’ equity and cash flows for the year then ended, and in ourreport dated February 8, 2002, we expressed an unqualified opinion on thoseconsolidated financial statements.  Inour opinion, the information set forth in the accompanying condensedconsolidated balance sheet as of December 31, 2001 is fairly stated, in allmaterial respects, in relation to the consolidated balance sheet from which ithas been derived.

 

DELOITTE & TOUCHE LLP

Boston, Massachusetts

# November 14, 2002

#  

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**Item2.    Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

**Overview**

 

*You should read the following discussiontogether with our Condensed Consolidated Financial Statements**andrelated notes, 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.*

 

We provide a broad range of services to a variety of financial assetmanagers.  These services include ourcore services, global custody, multicurrency accounting and mutual fundadministration, as well as our value-added services, such as securitieslending, foreign exchange, cash management, performance measurement,institutional transfer agency, investment advisory services and lines ofcredit.  At September 30, 2002, weprovided services for approximately $742 billion in net assets, includingapproximately $78 billion of foreign net assets.

 

On January 1, 2001, we adopted SFAS No. 133, “Accounting for DerivativeInstruments and Hedging Activities,” and the corresponding amendments and SFASNo. 138, “Accounting for Certain Derivative Instruments and Certain HedgingActivities.”  On adoption of these newaccounting standards, we recorded a transition adjustment recognizing an aftertax reduction in Other Comprehensive Income (‘OCI’) of $3.9 million.  In conjunction with the adoption, we electedto reclassify approximately $402 million of securities from held to maturity toavailable for sale, which further reduced OCI, net of tax, by approximately$1.4 million.

 

On February 1, 2001, we completed the issuance and sale of 1,624,145shares of Common Stock at $71.62 per share in a public offering.  A portion of the proceeds was used to fundthe acquisition of the advisor custody unit of the Chase Manhattan Bank.  The remaining proceeds were used for theassumption of the operations of the U.S. asset administration unit of BarclaysGlobal Investors, N.A. and for working capital.

 

On February 1, 2001, we purchased the operations of theadvisor custody unit of The Chase Manhattan Bank (‘Chase’).  This unit provided institutional custodyservices to individual accounts holding approximately $27 billion in assets asof February 1, 2001.  These accountsconsist of individual accounts, trusts, endowments and corporate accounts whoseassets are managed by third-party investment advisors.  Pursuant to the terms of the asset purchaseagreement, we paid to Chase at the closing of the transaction approximately$31.5 million of the total purchase price, plus another $39.8 million inexchange for the book value of loans to its clients.  Under the terms of the assetpurchase agreement, we are not obligated to make any further purchase pricepayments to Chase.  Thetransaction was accounted for as a purchase.

 

On May 1,2001, we assumed the operations of the U.S. asset administration unit ofBarclays Global Investors, N.A. (‘BGI’), a large international institutionalinvestment manager.  The unit, locatedin Sacramento, California, provides custody, fund accounting and otheroperations functions for BGI’s clients. The transaction was accounted for as a purchase.

 

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

 

In June 2002,we received from the Commonwealth of Massachusetts Department of Revenue aNotice of Intent to Assess additional state excise taxes of approximately $5.5million plus interest and penalties with respect to the Bank’s tax years endedDecember 31, 1999 and December 31, 2000.

 

The Departmentof Revenue contends that dividend distributions to the Bank by InvestorsFunding Corp., a real estate investment trust 99.9% owned by the Bank, arefully taxable in Massachusetts.  Afterconsultation with our advisors, we believe that the Massachusetts statute thatprovides for a dividend received deduction equal to 95% of certain dividenddistributions applies to the distributions made by Investors Funding to theBank.  Accordingly, no provision hasbeen made in our financial statements for the amounts assessed or additionalamounts that might be assessed in the future.

 

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We have beeninformed that the Department of Revenue has sent similar notices to numerousother financial institutions in Massachusetts that reported a deduction fordividends received from a real estate investment trust on their 1999 and 2000Massachusetts excise tax returns. Because the legal issues raised are identical for all of the financialinstitutions involved, we are acting together with those institutions to appealthe assessments and to pursue all available means to defend our positionvigorously.  Assessed amounts ultimatelypaid, if any, would be deductible expenses for federal income tax purposes.

 

**Revenue and Expense Overview**

 

We derive our revenue from financial asset servicing.  Although interest income and noninterestincome are reported separately for financial statement presentation purposes,our clients view the pricing of our service offerings on a bundled basis.  In establishing a fee structure for aspecific client, management analyzes all expected revenue and related expenses,as opposed to separately analyzing fee income and interest income and relatedexpenses for each from the relationship. Accordingly, we believe net operating revenue (net interest income plusnoninterest income) and net income are the most meaningful measures of ourfinancial results. Net operating revenue increased 26% and 14% to$325.7 million and $110.4 million from $259.1 million and $96.5 millionfor the nine months and three months ended September 30, 2002 and 2001,respectively.  Net income increased 42%and 28% to $50.6 million and $17.3 million from $35.7 million and $13.5 millionfor the nine months and three months ended September 30, 2002 and 2001,respectively.

 

Noninterest income consists primarily of fees for financial asset servicingand is principally derived from global custody, multicurrency accounting,mutual fund administration and institutional transfer agency services forfinancial asset managers and the assets they control. Our clients pay feesbased on the volume of assets under custody, portfolio transactions, incomecollected and whether other value-added services such as foreign exchange,securities lending and performance measurement are needed.  Asset-based fees are usually charged on asliding scale and are subject to minimum fees. As such, when the assets in a portfolio under custody grow as a resultof changes in market values or cash inflows, our fees may be a smallerpercentage of those assets.  Conversely,as asset values fall, our revenue decreases by the marginal rate charged on oursliding scale pricing model.  As aresult, as asset values decrease, fees will decrease, but at a smallerpercentage than the asset value decrease.

 

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

 

Net interest income represents the difference between income generatedfrom interest-earning assets and expense on interest-bearing liabilities.  Interest-bearing liabilities are generatedby our clients who, in the course of their financial asset management, generatecash balances which they deposit on a short-term basis with us.  We invest these cash balances and remit aportion of the earnings on these investments to our clients.  Our share of earnings from these investmentsis viewed as part of the total package of compensation paid to us from ourclients for performing asset servicing.

 

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

 

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**SignificantAccounting Policies**

 

Theconsolidated financial statements are prepared in accordance with accountingprinciples generally accepted in the U.S., which require us to make estimatesand assumptions.  We have identified thefollowing accounting policies that, as a result of the complexities of theunderlying accounting standards and operations involved, could result insignificant changes to our consolidated financial condition or results ofoperations under different conditions or using different assumptions.

 

***Derivative FinancialInstruments*** -  We do not purchase derivativefinancial instruments for trading purposes. Interest rate swap agreements are matched with specific financialinstruments reported on the consolidated balance sheet.  We use derivative instruments to manageexposures to interest rate risks.  Weroutinely enter into interest rate swap agreements in which we pay a fixed interest rate and receive afloating interest rate.  Thesetransactions are designed to hedge a portion of our liabilities.  By entering into apay-fixed/receive-floating interest rate swap, a portion of these liabilitiesis effectively converted to a fixed rate liability for the term of the interestrate swap agreements.

 

On January 1,2001, we adopted SFAS No. 133, “Accounting for Derivative Instruments andHedging Activities,” as amended and interpreted, which established accountingand reporting standards for derivative instruments.  We also adopted SFAS No. 138, “Accounting for Certain DerivativeInstruments and Certain Hedging Activities.” All derivatives, whether designated in hedging relationships or not, arerequired to be recorded on the balance sheet at fair value.  If the derivative is designated as a fairvalue hedge, the change in the fair value of the derivative and the item beinghedged will be recognized in earnings. If the derivative is designated as a cash flow hedge, the effectiveportions of changes in the fair value of the derivative are recorded inOCI.  Ineffective portions of changes,as determined in accordance with SFAS No. 133, in the fair value of the cashflow hedges are recognized in earnings. For derivatives that do not qualify as hedges, changes in their fairvalue are recognized in earnings.

 

Hedgeaccounting requires that we measure the changes in fair value of derivativesdesignated as hedges as compared to changes in expected cash flows of theunderlying hedged transactions for each reporting period.  Changes in conditions or the occurrence ofunforeseen events could affect the timing of the recognition of changes in fairvalue of certain hedging derivatives. The measurement of fair value is based upon market values, however, inthe absence of quoted market values, measurement involves valuationestimates.  These estimates are based onmethodologies deemed appropriate in the circumstances.  However, the use of alternative assumptionscould have a significant effect on estimated fair value.

 

Hedgeineffectiveness, determined in accordance with SFAS No. 133, had aninsignificant impact on earnings for the nine months ended September 30,2002.  No cash flow hedges werededesignated or discontinued for the nine months ended September 30, 2002.

 

We enter intoforeign exchange contracts with clients and attempt to enter into a matchedposition with another bank. These contracts are subject to market valuefluctuations in foreign currencies. Gains and losses from such fluctuations are netted and recorded as anadjustment of asset servicing fees. Unrealized gains (losses) resulting from purchases and sales of foreignexchange contracts are included within the respective other assets and otherliabilities categories on our consolidated balance sheet.  The foreign exchange contracts have beenreduced by balances with the same counterparty where a master netting agreementexists.

*** ***

***Stock-BasedCompensation*** – We account for stock-basedcompensation using the intrinsic value-based method of Accounting PrinciplesBoard (‘APB’) No. 25, “Accounting for Stock Issued to Employees,” as allowedunder SFAS No. 123, “Accounting for Stock-Based Compensation.”  Under APB No. 25, no compensation costs arerecognized because the option exercise price is equal to the fair market priceof the common stock on the date of the grant. If SFAS No. 123 were adopted, stock options would be valued at grantdate using the Black-Scholes valuation model and compensation costs would berecognized pro rata over the vesting period. The Black-Scholes option-pricing model uses assumptions including theexpected life of an option, the expected volatility of the underlying stock andan assumed risk-free interest rate.

 

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We reported a37% dilution in earnings per share for the fiscal year ended December 31, 2001using the following assumptions: an expected volatility of 57%, an expectedoption life of 10 years, an assumed risk-free interest rate of 5.16% and adividend yield of 0.12%.  We reexaminedthe actual expected life of our options and the volatility of our stock, anddetermined our historical option life to be less than four years and therelated volatility to be 55%.  SinceSFAS No. 123 requires us to use an option life no less than the vesting period,a four-year life was chosen.  Based uponan expected option life of four years and the related volatility of 55% overthe same period, the dilution in earnings per share for the year ended December31, 2001 would have been 20% versus the 37% that was previously disclosed inour December 31, 2001 annual report on Form 10-K.

 

***Capitalized SoftwareCosts*** – Capitalized software costs are accountedfor under the method prescribed by AICPA Statement of Position 98-1,“Accounting for the Costs of Computer Software Developed or Obtained forInternal Use,” (‘SOP 98-1’) and are included within the furniture, fixtures andequipment component.  Capitalizedsoftware costs are amortized over the estimated useful life, not to exceed 5years.  Our policy is to capitalizecosts relating to system development projects that provide significantfunctionality enhancements.  Assets areplaced in service and depreciation and/or amortization commences whensuccessful testing has been achieved. Please see the “Capital Resources” section of this Report regardingcapitalized software expenditures made during the nine months ended September30, 2002 and 2001.

*** ***

***New AccountingPrinciples*** – On January 1, 2002, we adopted SFASNo. 142, “Goodwill and Other Intangible Assets,” which supersedes APB No. 17,“Intangible Assets.”  SFAS No. 142addresses how intangible assets that are acquired individually or with a groupof other assets (but not those acquired in a business combination) should beaccounted for in financial statements upon their acquisition.  This statement also addresses how goodwilland other intangible assets should be accounted for after they have beeninitially recognized in the financial statements.  This statement affects the accounting of premiums, includesguidelines for the determination, measurement and testing of impairment, andrequires disclosure of information about goodwill and other intangible assets inthe years subsequent to their acquisition that was not previouslyrequired.  This Statement eliminates theamortization of goodwill, and requires that goodwill be reviewed at leastannually for impairment.  This Statementaffects all goodwill recognized on our consolidated balance sheet, regardlessof when the assets were initially recorded. Upon adoption of SFAS No. 142, we ceased amortization of goodwill.  As of September 30, 2002 there was noimpairment of goodwill.

 

In November2001, the FASB issued Emerging Issues Task Force (‘EITF’) No. 01-14, “IncomeStatement Characterization of Reimbursements Received for Out-Of-PocketExpenses Incurred.”  This guidancerequires companies to recognize the reimbursement of client-related expenses asrevenue and the costs as operating expense. Client reimbursements for out-of-pocket expenses are reflected in feerevenue in the accompanying financial statements. Prior periods have beenreclassified to reflect this presentation, which resulted in an increase to feerevenue and operating expense of $6.5 million and $6.2 million for the ninemonths ended September 30, 2002 and 2001, respectively, and $2.2 million and$2.1 million for the three months ended September 30, 2002 and 2001,respectively.

 

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**Certain Factors That May Affect FutureResults**

 

From time totime, information provided by us, statements made by our employees, orinformation included in our filings with the SEC (including this Form 10-Q) maycontain statements which are not historical facts, so-called “forward-lookingstatements,” and which involve risks and uncertainties.  Thesestatements relate to future events or our future financial performance and areidentified by words such as “may,” “will,” “could,” “should,” “expect,” “plan,”“intend,” “seek,” “anticipate,” “believe,” “estimate,” “potential,” or“continue” or other comparable terms or the negative of those terms.  Forward-looking statements in thisForm 10-Q include certain statements regarding liquidity, interest rateconditions, interest rate sensitivity, loss exposure on lines of credit, thetiming and effect on earnings of derivative gains and losses, the effect onearnings of changes in equity values, and the effect of certain tax and legal claimsagainst us.  Our actual future resultsmay differ significantly from those stated in any forward-lookingstatements.  Factors that may cause suchdifferences include, but are not limited to, the factors discussed below.  Each of these factors, and others, arediscussed from time to time in our filings with the SEC.

 

*Our operating results are subject tofluctuations in interest rates and the securities markets.*

 

We base someof our fees on the market value of the assets we process.  Accordingly, our operating results aresubject to fluctuations in interest rates or the securities markets as thesefluctuations affect the market value of assets processed.  Current market conditions, including therecent decline in equity markets, adversely affect our asset-based fees.  While reductions in these fees may be offsetby increases in other sources of revenue, continued downward movement of thebroad equity markets will have an adverse impact on our earnings.  Fluctuations in interest rates or thesecurities markets can also lead to investors seeking alternatives to theinvestment offerings of our clients, which could result in a lesser amount ofassets processed and correspondingly lower fees.  Also, our net interest income is earned by investing depositors’funds and making loans.  Rapid changesin interest rates or changes in the relationship between different index ratescould adversely affect the market value of, or the earnings produced by, ourinvestment and loan portfolios.

 

*The failure to properly manage our growthcould adversely affect the quality of our services and result in the loss ofclients.*

 

We have been experiencing a period of rapid growth that has requiredthe dedication of significant management and other resources, including theassumption of the operations of the U.S. asset administration unit of BarclaysGlobal Investors, N.A. (‘BGI’). Continued rapid growth could place a strain onour management and other resources.  Tomanage future growth effectively, we must continue to invest in our operational,financial and other internal systems, and our human resources.  Also, we must continue to expand our officespace at reasonable rates in a competitive real estate market.

 

*Our future results depend, in part, onsuccessful integration of pending and possible future acquisitions andoutsourcing transactions.*

 

The integration of the BGI asset administration unit presents us withchallenges and demands management attention that has to be diverted from othermatters.  Integration of acquisitionsand outsourcing transactions is complicated and frequently presents unforeseendifficulties and expenses which can affect whether and when a particularacquisition will be accretive to our earnings per share.  Any future acquisitions or outsourcingtransactions will present similar challenges.

 

*A material portion of our revenues is derivedfrom our relationship with Barclays Global Investors, N.A.*

 

As a result of our assumption of the operations of the U.S. assetadministration unit of BGI in 2001 and our ongoing relationship with BGI’siShares and Master Investment Portfolios, BGI accounted for approximately 16%of our net operating revenue during the nine months and three months endedSeptember 30, 2002.  We expect that BGIwill continue to account for a significant portion of our net operatingrevenue.  While we provide services toBGI under long-term contracts, those contracts may be terminated for certainregulatory and fiduciary reasons.  Theloss of BGI’s business would cause our net operating revenue to decline andwould have a material adverse effect on our quarterly and annual results.

 

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*We face significant competition from otherfinancial services companies, which could negatively affect our operating results.*

 

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

 

*We may not win our appeal of theMassachusetts Department of Revenue Notice of Assessment.*

 

We receivedfrom the Commonwealth of Massachusetts Department of Revenue a Notice of Intentto Assess additional state excise taxes with respect to the years 1999 and2000.  After consultation with ouradvisors, we do not believe that we owe the additional excise tax.  The Company intends to appeal the assessmentand to pursue all available means to defend its position vigorously.  Legalproceedings to appeal and defend our position could be expensive and divertmanagement’s attention.  In addition, ifwe do not prevail, payment of the additional excise tax would have a materialadverse impact on our earnings for the period in which we pay the assessment.

 

*We may not be able to protect our proprietarytechnology.*

 

Our proprietary technology is important to our business.  We rely on trade secret, copyright and trademarklaws and confidentiality agreements with employees and third parties to protectour proprietary technology, all of which offer only limited protection.  These intellectual property rights may beinvalidated 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.

 

*We may incur significant costs defendinginfringement claims.*

 

We have been sued in federal court claiming that we and others areinfringing a patent allegedly covering the creation and trading of certainsecurities, including exchange traded funds. While we believe the claim is without merit, we cannot be sure that wewill prevail in the defense of this claim. Any patent litigation would be costly and could divert the attention ofmanagement.  If we were found toinfringe the patent, we would have to pay damages and would be ordered to ceaseany infringing activity or seek a license under the patent.  We cannot be sure that we will be able toobtain a license on a timely basis or on reasonable terms, if at all.  While we are indemnified against somedefense costs and damages related to this claim, we may incur significantexpenses defending the claim.  As aresult, any determination of infringement could have a material adverse effectupon our business, financial condition and results of operations.  We may become subject to other infringementclaims in the future.

 

*We must hire and retain skilled personnel inorder to succeed.*

 

Qualified personnel, in particular managers and other senior personnel,are in great demand throughout the financial services industry.  We could find it increasingly difficult tocontinue to attract and retain sufficient numbers of these highly skilledemployees.

 

*Our quarterly and annual operating resultsmay fluctuate.*

 

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

 

•              Thetiming of commencement or termination of client engagements; and

 

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

 

Most of our expenses, like employee compensation and rent, are relativelyfixed.  As a result, any shortfall inrevenue relative to our expectations could significantly affect our operatingresults.

 

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*We are subject to extensive federal and stateregulations that impose complex restraints on our business.*

 

Federal and state laws and regulations applicable to financialinstitutions and their parent companies apply to us.  Our primary banking regulators are the Federal Reserve Board(‘FRB’), the Federal Deposit Insurance Corporation  (‘FDIC’) and the Massachusetts Commissioner of Banks.  Virtually all aspects of our operations aresubject to specific requirements or restrictions and general regulatoryoversight 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, which may inturn restrict our ability to pay dividends to our stockholders; and

 

•                                          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.

 

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

 

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**Statementof Operations**

 

*Comparison of Operating Results for the Nine Months and the ThreeMonths Ended September 30, 2002 and 2001*

 

*Noninterest Income*

 

Noninterestincome was $219.7 million for the nine months ended September 30, 2002, up 21%from the same period in 2001, and was $74.5 million for the three months endedSeptember 30, 2002, up 10% from the same period in 2001.  Noninterest income consists of the followingitems (Dollars in thousands):

 
|                                                     |   | **For the  Nine Months Ended  September 30, 2002** |    | **For the  Three Months Ended  September 30, 2002** |   |
|----------------------------------------------------------|--------|----------------------------------------------------|---------|-----------------------------------------------------|--------|
|                                                     |   | **2002**                                           |    | **2001**                                            |   | **Change** |   | **2002** |   | **2001** |   | **Change** |   |
| Asset servicing fees:                                    |   |                                               |    |                                                |   |   |   |   |   |   |   |   |   |
| Custody, accounting, transfer agency and  administration |   | $                                                  | 173,017 |                                                | $      | 145,588 |   | 19 | % | $ | 57,718 |   | $ | 54,801 |   | 5 | % |
| Foreign exchange                                         |   | 18,706                                             |    | 12,771                                              |   | 47 | % | 7,669 |   | 4,713 |   | 63 | % |
| Cash management                                          |   | 12,362                                             |    | 11,328                                              |   | 9 | % | 4,416 |   | 3,989 |   | 11 | % |
| Securities lending                                       |   | 8,605                                              |    | 6,837                                               |   | 26 | % | 2,362 |   | 1,985 |   | 19 | % |
| Investment advisory                                      |   | 5,413                                              |    | 2,784                                               |   | 94 | % | 1,817 |   | 1,189 |   | 53 | % |
| Total asset servicing fees                               |   | 218,103                                            |    | 179,308                                             |   | 22 | % | 73,982 |   | 66,677 |   | 11 | % |
|                                                     |   |                                               |    |                                                |   |   |   |   |   |   |   |   |   |
| Other operating income                                   |   | 1,645                                              |    | 2,378                                               |   | (31 | )% | 515 |   | 829 |   | (38 | )% |
|                                                     |   |                                               |    |                                                |   |   |   |   |   |   |   |   |   |
| Total noninterest income                                 |   | $                                                  | 219,748 |                                                | $      | 181,686 |   | 21 | % | $ | 74,497 |   | $ | 67,506 |   | 10 | % |

 

Assetservicing fees for the nine months ended September 30, 2002 increased 22% to$218.1 million from the same period in 2001, and were $74.0 million for thethree months ended September 30, 2002, up 11% from the same period in2001.  The largest component of assetservicing fees is asset-based fees, which are based on assets processed.  Assets processed is the total dollar valueof financial assets on the reported date for which we provide one or more ofthe following services: global custody, multicurrency accounting, mutual fundadministration, securities lending, foreign exchange, cash management,performance measurement, institutional transfer agency, investment advisoryservices and lines of credit.  Total netassets processed decreased $72 billion from $814 billion at December 31, 2001to $742 billion at September 30, 2002, and decreased $93 billion from $835 billionat June 30, 2002.  Changes in net assetsprocessed include the following components(Dollars in billions):

 
|                                     |   | **For the Nine Months Ended  September 30, 2002** |   | **For the Three Months Ended  September 30, 2002** |   |
|------------------------------------------|--------|---------------------------------------------------|--------|----------------------------------------------------|--------|
|                                     |   |                                              |   |                                               |   |
| Sales to new clients                     |   | $                                                 | 24     |                                               | $      | 5 |   |
| Further penetration of  existing clients |   | 23                                                |   | 7                                                  |   |
| Fund flows and market loss               |   | (119                                              | )      | (105                                               | )      |
|                                     |   |                                              |   |                                               |   |
| Net change in assets processed           |   | $                                                 | (72    | )                                                  | $      | (93 | ) |

 

Our ability to win business and the ability of our clients to selladditional product, thus generating fund flows, allowed us to minimize theimpact of the market downturn in 2002. Also contributing to this inverse correlation is our tiered pricingstructure for asset based fees.  Sincewe have decremental pricing schedules for asset based fees, as asset valuesdeteriorate, revenue is only impacted by the asset decline at the then marginalrate.

 

Another significant portion of the increase in asset servicing feesresulted from our success in marketing ancillary services, such as foreignexchange, cash management, securities lending, and mutual fund advisoryservices. Foreign exchange fees increased due to higher transaction volumes andvolatility in the currencies traded by our clients.  Cash management and securities lending fees increased with theaddition of new clients and through cross-selling to existing clients.  Increased investment advisory service feeswere the result of growth in the asset size of the Merrimac Master Portfolio,an investment company for which the Company acts as advisor.

 

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Otheroperating income consists of dividends received relating to the Federal HomeLoan Bank of Boston (‘FHLBB’) stock investment and miscellaneous fees forsystems consulting services. The decrease in other operating income for thenine months ended September 30, 2002 resulted primarily from a decrease in thedividend rate paid on the FHLBB stock and from systems consulting workperformed in 2001, but not in 2002.  Thedecrease in other operating income for the three months ended September 30,2002 was due to the decreased FHLBB stock dividend.

 

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*Operating Expenses*

 

Totaloperating expenses were $251.5 million for the nine months ended September 30,2002, up 22% from the same period in 2001. For the three months ended September 30, 2002, total operating expenseswere $85.1 million, up 11% from the same period in 2001.  The components of operating expenses were asfollows (Dollars in thousands):

 
|                               |   | **For the Nine Months Ended September 30,** |    | **For the Three Months Ended September 30,** |   |
|------------------------------------|--------|---------------------------------------------|---------|----------------------------------------------|--------|
|                               |   | **2002**                                    |    | **2001**                                     |   | **Change** |   | **2002** |   | **2001** |   | **Change** |   |
|                               |   |                                        |    |                                         |   |   |   |   |   |   |   |   |   |
| Compensation  and benefits         |   | $                                           | 146,819 |                                         | $      | 120,395 |   | 22 | % | $ | 47,951 |   | $ | 44,879 |   | 7 | % |
| Technology and  telecommunications |   | 30,070                                      |    | 28,951                                       |   | 4 | % | 10,004 |   | 9,272 |   | 8 | % |
| Transaction  processing services   |   | 26,078                                      |    | 17,412                                       |   | 50 | % | 8,764 |   | 7,896 |   | 11 | % |
| Occupancy                          |   | 18,247                                      |    | 12,649                                       |   | 44 | % | 6,841 |   | 4,847 |   | 41 | % |
| Depreciation  and amortization     |   | 11,179                                      |    | 5,781                                        |   | 93 | % | 4,540 |   | 2,558 |   | 77 | % |
| Professional  fees                 |   | 4,968                                       |    | 3,460                                        |   | 44 | % | 1,752 |   | 1,127 |   | 55 | % |
| Travel and  sales promotion        |   | 4,217                                       |    | 4,064                                        |   | 4 | % | 1,463 |   | 1,670 |   | (12 | )% |
| Amortization  of goodwill          |   | —                                      |    | 2,565                                        |   | (100 | )% | — |   | 992 |   | (100 | )% |
| Other  operating expenses          |   | 9,956                                       |    | 10,557                                       |   | (6 | )% | 3,747 |   | 3,427 |   | 9 | % |
|                               |   |                                        |    |                                         |   |   |   |   |   |   |   |   |   |
| Total  operating expenses          |   | $                                           | 251,534 |                                         | $      | 205,834 |   | 22 | % | $ | 85,062 |   | $ | 76,668 |   | 11 | % |

 

Compensation andbenefits expense was $146.8 million for the nine months ended September30, 2002, up 22% from the same period in 2001, and was $48.0 million for thethree months ended September 30, 2002, up 7% from the same period in 2001.  The average number of employees increased20% to 2,649 during the nine months ended September 30, 2002 from 2,202 for thesame period last year.  The average numberof employees for the three months ended September 30, 2002 was 2,698, up 7%compared to 2,515 during the same period in 2001.  We increased the number of employees to support new business andthe expansion of existing client relationships.  For the nine months ended September 30, 2002, compensationexpense related to our management-incentive plans increased $2.9 million as aresult of higher earnings and additional incentive-eligible managers.  This expense decreased $2.0 million for thethree months ended September 30, 2002 compared to the same period last year, ascertain earnings goals were reached earlier in 2002.  Benefits, including payroll taxes, group insurance plans,retirement plan contributions and tuition reimbursement, increased$5.8 million for the nine months ended September 30, 2002, and $1.3million for the three months ended September 30, 2002, consistent with theincreased headcount.  Increasedcapitalized software development in 2002 offset the increase in compensationand benefits by approximately $8.4 million and $2.5 million for the nine monthsand the three months ended September 30, 2002 compared to the same periods lastyear.

 

Technology and telecommunications expense was $30.1 million forthe nine months ended September 30, 2002, up 4% from the same period in 2001,and was $10.0 million for the three months ended September 30, 2002, up 8% fromthe same period in 2001.  Technology andtelecommunications expense consists primarily of contract programming,outsourced services, hardware rent, telecommunications expense and softwarelicenses.  Increased hardware, software,mainframe and trust processing and telecommunications expenditures needed tosupport new business and increased transaction volumes accounted for $7.4million and $1.7 million of the nine- and three-month increases,respectively.  The nine-month increasewas offset by decreased expenses of $6.3 million related to outsourced networkmonitoring, help desk and other outsourced services required in 2001, and notin 2002, primarily due to the Chase acquisition.  The three-month increase was offset primarily by continued costmanagement in 2002.

 

Transaction processing services expense, which consists primarily ofsubcustodian and pricing fees, was $26.1 million for the nine months endedSeptember 30, 2002, up 50% from the same period in 2001.  For the three months ended September 30,2002, transaction processing services expense was $8.8 million, up 11% from thesame period last year.  The increaserelates primarily to increased subcustodian fees, driven by increased volumesof transactions and changes in assets processed for clients, largely a resultof the BGI U.S. asset administration unit assumption in May 2001 and theaddition of new business in 2002.

 

Occupancy expense was $18.2 million for the nine months endedSeptember 30, 2002, up 44% from the same period in 2001 and was $6.8 millionfor the three months ended September 30, 2002, up 41% compared to the same

 

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period in2001. These increases were primarily due to increased space in our Boston, NewYork, and Dublin offices and the California offices assumed from BGI.

 

Depreciation and amortization expense was $11.2 million for thenine months ended September 30, 2002, up 93% from the same period in 2001,reflecting a full nine months of this expense in 2002 compared to a partialyear in 2001 when the Chase acquisition and BGI business unit assumptionoccurred.  This expense was $4.5 millionfor the three months ended September 30, 2002, up 77% from the same period in2001.  This increase resulted fromcompletion of capitalized software projects in 2002 and their placement intoservice and the addition of leasehold improvements as a result of the new spacewe occupied in Boston, New York, Dublin and California.

 

Professional fees were $5.0 million for the nine months ended September30, 2002, up 44% from the same period in 2001, and $1.8 million for the threemonths ended September 30, 2002, up 55% from the same period in 2001. Includedin professional fees are increased accounting, legal and consulting servicesprovided during the periods, as well as increased fees associated with theMerrimac fund.  These fees areasset-based and the increases result from growth in the size of the fund.

 

Travel and sales promotion expense was $4.2 million for the ninemonths ended September 30, 2002, up 4% from the same period in 2001, and $1.5million for the three months ended September 30, 2002, down 12% from the sameperiod in 2001.  Travel and salespromotion expense consists of expenses incurred by the sales force, clientmanagement staff and other employees in connection with sales calls onpotential clients, traveling to existing client sites, to our offices in NewYork and California and to our foreign subsidiaries.

 

Amortization of goodwill expense ended as of January 1, 2002, as aresult of the adoption of SFAS No. 142. Please refer to the “Significant Accounting Policies” section for afurther discussion of this pronouncement.

 

Other operating expenses remained relatively flat at $10.0 million and$3.7 million for the nine months and three months ended September 30, 2002,respectively, compared to the same periods in 2001.  Other operating expenses include fees for recruiting, officesupplies and postage, storage, temporary help, client accommodations andvarious regulatory fee assessments.

 

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*Net Interest Income*

 

Net interest income is affected by the volume and mix of assets and liabilities,and the movement and level of interest rates. 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 compared to the same periods in 2001. Changes attributed to both volumeand rate have been allocated based on the proportion of change in each category(Dollars in thousands):

 
|                                                                 |   | **For the Nine Months Ended September 30, 2002** |   | **For the Three Months Ended September 30, 2002** |   |
|----------------------------------------------------------------------|--------|--------------------------------------------------|--------|---------------------------------------------------|--------|
|                                                                 |   | **Change  Due to  Volume**                       |   | **Change  Due to  Rate**                          |   | **Net** |   | **Change  Due to  Volume** |   | **Change  Due to  Rate** |   | **Net** |   |
|                                                                 |   |                                             |   |                                              |   |   |   |   |   |   |   |   |   |
| **Interest-earning  assets:**                                        |   |                                             |   |                                              |   |   |   |   |   |   |   |   |   |
| Federal funds  sold and securities purchased under resale agreements |   | $                                                | 220    |                                              | $      | (1,151 | ) | $ | (931 | ) | $ | 309 |   | $ | (251 | ) | $ | 58 |   |
| Investment  securities                                               |   | 52,373                                           |   | (55,753                                           | )      | (3,380 | ) | 14,820 |   | (16,642 | ) | (1,822 | ) |
| Loans                                                                |   | (118                                             | )      | (1,270                                            | )      | (1,388 | ) | (50 | ) | (451 | ) | (501 | ) |
|                                                                 |   |                                             |   |                                              |   |   |   |   |   |   |   |   |   |
| Total  interest-earning assets                                       |   | $                                                | 52,475 |                                              | $      | (58,174 | ) | $ | (5,699 | ) | $ | 15,079 |   | $ | (17,344 | ) | $ | (2,265 | ) |
|                                                                 |   |                                             |   |                                              |   |   |   |   |   |   |   |   |   |
| **Interest-earning  liabilities:**                                   |   |                                             |   |                                              |   |   |   |   |   |   |   |   |   |
| Deposits                                                             |   | $                                                | 1,692  |                                              | $      | (23,062 | ) | $ | (21,370 | ) | $ | 974 |   | $ | (6,641 | ) | $ | (5,667 | ) |
| Borrowings                                                           |   | 25,775                                           |   | (38,645                                           | )      | (12,870 | ) | 5,939 |   | (9,375 | ) | (3,436 | ) |
|                                                                 |   |                                             |   |                                              |   |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities                                  |   | $                                                | 27,467 |                                              | $      | (61,707 | ) | $ | (34,240 | ) | $ | 6,913 |   | $ | (16,016 | ) | $ | (9,103 | ) |
|                                                                 |   |                                             |   |                                              |   |   |   |   |   |   |   |   |   |
| Change in net  interest  income                                      |   | $                                                | 25,008 |                                              | $      | 3,533 |   | $ | 28,541 |   | $ | 8,166 |   | $ | (1,328 | ) | $ | 6,838 |   |

 

Net interest income was$106.0 million for the nine months ended September 30, 2002, up 37% fromthe same period in 2001.  Net interestincome was $35.9 million for the three months ended September 30, 2002, up 24%from the same period in 2001.  Theimprovement in net interest income primarily reflects the positive effect ofbalance sheet growth driven by increased client deposits and borrowings and amore favorable interest rate environment. The net interest margin increased 8 basis points to 2.53% for the ninemonths ended September 30, 2002, compared to the first nine months of2001.  The net interest margin decreased6 basis points to 2.39% for the three months ended September 30, 2002, comparedto the same period last year, due to prepayment costs incurred in the thirdquarter of 2002 associated with replacing borrowed funds at a more favorablerate.

 

Average interest-earningassets, primarily investment securities, increased $1.4 billion or 32% for thenine months ended September 30, 2002 and increased $1.3 billion or 27% for thethree months ended September 30, 2002 compared to the same periods lastyear.  Funding for the asset growth forthe nine-month period was provided by a combination of client balances of $0.5billion and external borrowings of $ 0.8 billion.  Funding for the asset growth for the three-month period wasprovided by a combination of client balances of $0.7 billion and externalborrowings of $0.5 billion.  The effectof changes in volume of interest-earning assets and interest-bearingliabilities was an increase in net interest income of approximately$25.0 million and $8.2 million for the nine months and three months endedSeptember 30, 2002, respectively.

 

Average yield oninterest-earning assets was 4.42% for the nine months ended September 30, 2002,down 160 basis points from the same period in 2001, and was 4.25% for the threemonths ended September 30, 2002, down 132 basis points from the same period in2001.  The average rate paid oninterest-bearing liabilities was 2.09% for the nine months ended September 30,2002, down 189 basis points from the same period in 2001.  The average rate paid on interest-bearingliabilities was 2.06% for the three months ended September 30, 2002, down 138basis points from the same period in 2001. The decreases reflect the lower interest rate environment for both thenine months and three months ended September 30, 2002 compared to the sameperiods in 2001.  The effect on netinterest income due to 

 

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changes in rates was an increase ofapproximately $3.5 million for the nine months ended September 30,2002.  The effect on net interest incomedue to changes in rates for the three months ended September 30, 2002 was adecrease of $1.3 million, as the favorable rate environment was offset byprepayment costs associated with replacing borrowed funds at a lower rate in2002.

 

During the past 24 months, ournet interest margin has been unusually favorable.  While interest rates remain low, the yield curve is flattening,meaning the difference between short-term interest rates and long-term interestrates is decreasing.  In addition, withmortgage rates at historic lows, refinancing activities increase, resulting inprepayments of higher yielding mortgage-backed securities that we hold, theproceeds of which are reinvested at current market rates.  These factors, among others, may decreaseour net interest margin to more traditional levels and reduce the unusuallyhigh growth rates in net interest income that we have experienced during thelast two years.

 

On January 1,2001, we adopted SFAS No. 133, as amended and interpreted, which establishedaccounting and reporting standards for derivative instruments.  All derivatives, whether designated inhedging relationships or not, are required to be recorded on the balance sheetat fair value.  If the derivative isdesignated as a fair value hedge, the change in the fair value of thederivative and the item being hedged will be recognized in earnings.  If the derivative is designated as a cashflow hedge, the effective portions of changes in the fair value of thederivative are recorded in Other Comprehensive Income (‘OCI’).  Ineffective portions of changes, asdetermined in accordance with SFAS No. 133, in the fair value of the cash flowhedges are recognized in earnings.  Forderivatives that do not qualify as hedges, changes in their fair value arerecognized in earnings.  The adoption ofSFAS No. 133 on January 1, 2001, resulted in no cumulative effect-typeadjustment to net income.  However, werecorded a reduction to OCI of $3.9 million, net of tax, and a correspondingliability for the fair value of the interest rate swaps.  The reduction to OCI and the recognition ofthe liability are primarily attributable to net unrealized losses on cash flowhedges as of initial adoption.  Inconjunction with the adoption, we elected to reclassify approximately $402million of securities from held to maturity to available for sale, whichfurther reduced OCI, net of tax, by approximately $1.4 million.

 

We use derivative instruments to manageexposures to interest rate risks.  Weroutinely enter into interest rate swap agreements in which we pay a fixedinterest rate and receive a floating interest rate.  These transactions are designed to hedge a portion of ourliabilities.  By entering into apay-fixed/receive-floating interest rate swap, a portion of these liabilitiesis effectively converted to a fixed rate liability for the term of the interestrate swap agreement.  Most of thesederivatives have been designated as highly effective cash flow hedges, asdetermined in accordance with SFAS No. 133. An insignificant portion of the derivatives used to manage exposures tointerest rate risks were not considered highly effective and, therefore, didnot qualify for hedge accounting.

 

Hedgeineffectiveness, determined in accordance with SFAS No. 133, had aninsignificant impact on earnings for the nine months ended September 30, 2002.No cash flow hedges were dedesignated or discontinued for the nine months endedSeptember 30, 2002.

 

Net interestincome included net gains of $1.2 million and $0.6 million, net of tax, for thenine months and three months ended September 30, 2002, respectively, oninterest rate swaps relating to SFAS No. 133. The net gains were $2.7 million and $1.0 million, net of tax, for thenine-month and three-month periods ended September 30, 2002, respectively, onchanges in the fair value of derivative instruments designated as hedginginstruments.  There were also $1.5million and $0.4 million of derivative losses, net of tax, for the nine-monthand three-month periods ended September 30, 2002, respectively, that resultedprimarily from the reclassification of transition adjustment-related derivativelosses from OCI to net interest income in accordance with SFAS No. 133.  The Company estimates that $0.5 million, netof tax, of the remaining transition adjustment of net derivative lossesincluded in OCI will be reclassified into earnings within the next twelvemonths. The recognition in net interest income of the transition adjustmentderivative losses from OCI will be offset by derivative gains from changes inthe fair value liability of the interest rate swaps as they reach maturity.

 

*Income Taxes*

 

Taxes for the nine months ended September 30,2002 were $22.4 million, up 36% from the same period in 2001.  Taxes for the three months ended September30, 2002 were $7.6 million, up 27% from the same period in 2001.  The increases in tax expense reflect thehigher level of pretax income during both periods.  The effective tax rate for the nine- and three-month periodsended September 30, 2002 was 30%, down from 31% for the nine-month period lastyear, and consistent with 30% for the three-month period last year.  The decrease in the effective tax ratereflects our increased investment in tax-exempt municipal securities in 2002.

 

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**FinancialCondition**

 

*Investment Portfolio*

 

The following table summarizes our investmentportfolio for the dates indicated (Dollars in thousands):

 
|                                |   | **September  30,  2002** |      | **December  31,  2001** |   |
|-------------------------------------|--------|--------------------------|-----------|-------------------------|--------|
| **Securities held to maturity:**    |   |                     |      |                    |   |
| Mortgage-backed securities          |   | $                        | 2,295,478 |                    | $      | 2,585,287 |   |
| Federal agency securities           |   | 1,003,045                |      | 456,108                 |   |
| State and political subdivisions    |   | 114,064                  |      | 91,888                  |   |
| Foreign government securities       |   | —                   |      | 2,501                   |   |
|                                |   |                     |      |                    |   |
| Total securities held to maturity   |   | $                        | 3,412,587 |                    | $      | 3,135,784 |   |
|                                |   |                     |      |                    |   |
| **Securities available for sale:**  |   |                     |      |                    |   |
| Mortgage-backed securities          |   | $                        | 2,240,132 |                    | $      | 1,228,841 |   |
| Federal agency securities           |   | 31,022                   |      | 30,848                  |   |
| Corporate debt                      |   | 174,963                  |      | 120,505                 |   |
| State and political subdivisions    |   | 279,468                  |      | 241,467                 |   |
|                                |   |                     |      |                    |   |
| Total securities available for sale |   | $                        | 2,725,585 |                    | $      | 1,621,661 |   |

 

Our investmentportfolio is used to invest depositors’ funds and provide a secondary source ofearnings for us.  In addition, we usethe investment portfolio to secure open positions at securities clearinginstitutions in connection with our custody services.  The portfolio is comprised of securities of state and politicalsubdivisions (‘municipal securities’), mortgage-backed securities issued by theFederal National Mortgage Association (‘FNMA’ or ‘Fannie Mae’) and the FederalHome Loan Mortgage Corporation (‘FHLMC’ or ‘Freddie Mac’), and Federal agencycallable bonds issued by FHLMC and the Federal Home Loan Bank of Boston,securities issued by the Small Business Administration (‘SBA’) and corporatedebt securities.

 

We invest in mortgage-backed securities,Federal agency callable bonds and corporate debt to increase the total returnof the investment portfolio. Mortgage-backed securities generally have a higher yield than U.S.Treasury securities due to credit and prepayment risk.  Credit risk results from the possibilitythat a loss may occur if a counterparty is unable to meet the terms of thecontract.  Prepayment risk results fromthe possibility that changes in interest rates may cause mortgage securities tobe paid off prior to their maturity dates. Federal agency callable bonds generally have a higher yield than U.S.Treasury securities due to credit and call risk.  Credit risk results from the possibility that the Federal agencyissuing the bonds may be unable to meet the terms of the bond.  Call risk results from the possibility thatfluctuating interest rates and other factors may result in the exercise of thecall option by the Federal agency. Credit risk related to mortgage-backed securities and Federal agencycallable bonds is substantially reduced by payment guarantees and creditenhancements.

 

We invest in municipal securities to generatestable, tax advantaged income. Municipal securities generally have lower stated yields than Federalagency and U.S. Treasury securities, but the after-tax yields are comparable.  Municipal securities are subject to creditrisk, however, all municipal securities that we invest in are AAA rated.

 

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The book value and weighted average yield ofour securities held to maturity at September 30, 2002 are reflected in the followingtable (Dollars in thousands):

 
|                              |   | **Years to  Maturity** |    |
|-----------------------------------|--------|------------------------|---------|
|                              |   | **Under 1**            |    | **1 to 5** |   | **5 to 10** |   | **Over 10** |   |
|                              |   | **Amount**             |    | **Yield** |   | **Amount** |   | **Yield** |   | **Amount** |   | **Yield** |   | **Amount** |   | **Yield** |   |
| Mortgage-backed securities        |   | $                      | 459,372 |   | 4.60 | % | $ | 1,481,432 |   | 4.09 | % | $ | 276,933 |   | 4.14 | % | $ | 77,741 |   | 3.83 | % |
| Federal agency securities         |   | —                 |    | — |   | 13,692 |   | 3.88 | % | 504,525 |   | 3.88 | % | 484,828 |   | 3.88 | % |
| State and political subdivisions  |   | —                 |    | — |   | 2,356 |   | 5.08 | % | 5,917 |   | 5.08 | % | 105,791 |   | 5.08 | % |
| Total securities held to maturity |   | $                      | 459,372 |   | 4.60 | % | $ | 1,497,480 |   | 4.09 | % | $ | 787,375 |   | 3.98 | % | $ | 668,360 |   | 4.06 | % |

 

The carryingvalue and weighted average yield of our securities available for sale atSeptember 30, 2002 are reflected in the following table (Dollars in thousands):

 
|                                |   | **Years to  Maturity** |   |
|-------------------------------------|--------|------------------------|--------|
|                                |   | **Under 1**            |   | **1 to 5** |   | **5 to 10** |   | **Over 10** |   |
|                                |   | **Amount**             |   | **Yield** |   | **Amount** |   | **Yield** |   | **Amount** |   | **Yield** |   | **Amount** |   | **Yield** |   |
| Mortgage-backed securities          |   | $                      | — |   | — |   | $ | 772,881 |   | 5.40 | % | $ | 98,978 |   | 5.56 | % | $ | 1,368,273 |   | 5.38 | % |
| Federal agency securities           |   | —                 |   | — |   | 31,022 |   | 5.63 | % | — |   | — |   | — |   | — |   |
| Corporate debt                      |   | —                 |   | — |   | — |   | — |   | — |   | — |   | 174,963 |   | 2.65 | % |
| State and political subdivisions    |   | 3,209                  |   | 4.68 | % | 40,297 |   | 4.68 | % | 191,108 |   | 4.72 | % | 44,854 |   | 4.68 | % |
| Total securities available for sale |   | $                      | 3,209  |   | 4.68 | % | $ | 844,200 |   | 5.37 | % | $ | 290,086 |   | 5.00 | % | $ | 1,588,090 |   | 5.06 | % |

 

*Loan Portfolio*

* *

The followingtable summarizes our loan portfolio for the dates indicated (Dollars inthousands):

 
|                            |   | **September  30,  2002** |    | **December  31,  2001** |   |
|---------------------------------|--------|--------------------------|---------|-------------------------|--------|
|                            |   |                     |    |                    |   |
| Loans to individuals            |   | $                        | 73,986  |                    | $      | 164,443 |   |
| Loans to mutual funds           |   | 46,721                   |    | 50,359                  |   |
| Loans to others                 |   | 18,391                   |    | 17,411                  |   |
|                            |   | 139,098                  |    | 232,213                 |   |
| Less: allowance for loan losses |   | (100                     | )       | (100                    | )      |
|                            |   |                     |    |                    |   |
| Net loans                       |   | $                        | 138,998 |                    | $      | 232,113 |   |
|                            |   |                     |    |                    |   |
| Floating Rate                   |   | $                        | 139,086 |                    | $      | 232,189 |   |
| Fixed Rate                      |   | 12                       |    | 24                      |   |
|                            |   |                     |    |                    |   |
|                            |   | $                        | 139,098 |                    | $      | 232,213 |   |

 

We make loans to individuallymanaged account customers and to mutual funds and other pooled productclients.  Virtually all loans toindividually managed account customers are written on a demand basis, bearvariable interest rates tied to the prime rate or the Federal Funds rate andare fully secured by liquid collateral, primarily freely tradable securitiesheld in custody by us for the borrower. Loans to mutual funds and other pooled product clients include unsecuredlines of credit that may, in the event of default, be collateralized at ouroption by securities held in custody by us for those mutual funds.  Loans to individually managed accountcustomers, mutual funds and other pooled product clients also include advancesthat we make to certain clients pursuant to the terms of our custody agreementswith those clients to facilitate securities transactions and redemptions.

 

At September 30, 2002, our onlylending concentrations that exceeded 10% of total loan balances were the linesof credit to mutual fund clients discussed above.  These loans were made in the ordinary course of business on thesame terms and conditions prevailing at the time for comparable transactions.

 

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Our credit loss experience hasbeen excellent.  There have been no loancharge-offs in our history.  It is ourpolicy to place a loan on nonaccrual status when either principal or interestbecomes 60 days past due and the loan’s collateral is not sufficient tocover both principal and accrued interest. As of September 30, 2002, there were no loans on nonaccrual status, noloans greater than 90 days past due, and no troubled debtrestructurings.  Although virtually allof our loans are fully collateralized with freely tradable securities,management recognizes some credit risk inherent in the loan portfolio, and hasrecorded an allowance for loan losses of $0.1 million at September 30,2002.  This amount is not allocated toany particular loan, but is intended to absorb any risk of loss inherent in theloan portfolio. Management actively monitors the loan portfolio and theunderlying collateral and regularly assesses the adequacy of the allowance forloan losses.

 

**MarketRisk**

 

We engage in investmentactivities to accommodate clients’ cash management needs and contribute tooverall corporate earnings. Interest-bearing liabilities are generated by our clients who, in thecourse of their financial asset management, maintain cash balances which theydeposit on a short-term basis with us. We invest these cash balances and remit a portion of the earnings onthese investments to our clients. In the conduct of these activities, we aresubject to market risk.  Market risk isthe risk of an adverse financial impact from changes in market prices andinterest rates.  The level of risk weassume is a function of our overall strategic objectives and liquidity needs,client requirements and market volatility.

 

The active management of marketrisk is integral to our operations.  Theobjective of interest rate sensitivity management is to provide sustainable netinterest revenue under various economic conditions.  We manage the structure of interest-earning assets andinterest-bearing liabilities by adjusting their mix, yield, maturity and/orrepricing characteristics, based on market conditions.  Since client deposits and repurchaseagreements, our primary sources of funds, are predominantly short term, wemaintain a generally short-term structure for our interest-earning assets,including money-market assets and investments. We also use term borrowings and interest rate swap agreements to augmentour management of interest rate exposure. The effect of the swap agreements is to lengthen short-termvariable-rate liabilities into longer-term fixed-rate liabilities.

 

Our Board of Directors has setasset and liability management policies that define the overall framework formanaging interest rate sensitivity, including accountabilities and controlsover investment activities.  Thesepolicies delineate investment limits and strategies that are appropriate, givenour liquidity and regulatory requirements. For example, we have established a policy limit stating that projectednet interest income over the next 12 months will not be reduced by more than 10%given a change in interest rates of up to 200 basis points (+ or -) over 12months.  Each quarter, our Board ofDirectors reviews our asset and liability positions, including simulations ofthe effect of various interest rate scenarios on our capital.  Due to current interest rate levels, theCompany’s Board of Directors has approved a temporary exception to the 10%limit for decreases in interest rates. The Board of Directors approved the policy exception because, with theFederal Funds target rate currently at 1.25%, a 200 basis point furtherreduction would move rates into a negative position and is therefore not likelyto occur.

 

Our Board of Directors hasdelegated day-to-day responsibility for oversight of the Asset and LiabilityManagement function to our Asset and Liability Committee (‘ALCO’).  ALCO is a senior management committeeconsisting of the Chief Executive Officer, the President, the Chief FinancialOfficer and members of the Treasury function. ALCO meets twice monthly.  Our primary tool in managing interest ratesensitivity is an income simulation model. Key assumptions in the simulationmodel include the timing of cash flows, maturities and repricing of financialinstruments, changes in market conditions, capital planning and deposit sensitivity.  The model assumes that the composition ofour interest-sensitive assets and liabilities existing at the beginning of aperiod will change periodically over the period being measured.  The model also assumes that a particularchange in interest rates is reflected uniformly across the yield 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 simulationmodel as of September 30, 2002 and 2001 indicated that an upward shift ofinterest rates by 200 basis points would result in a reduction in projected netinterest income of 2.84% and 3.79%, respectively.  A downward shift of 200 basis points would result in a decreasein projected net interest income of 13.97%

 

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and 10.35% at September 30, 2002 and 2001,respectively.  As discussed above, theseexceptions to policy were approved by the Board of Directors.

 

We also use gap analysis as asecondary tool to manage our interest rate sensitivity.  Gap analysis involves measurement of thedifference in asset and liability repricing on a cumulative basis within aspecified time frame.  A positive gapindicates that more interest-earning assets than interest-bearing liabilitiesmature in a time frame, and a negative gap indicates the opposite.  By seeking to minimize the amount of assetsand liabilities that could reprice in the same time frame, we attempt to reducethe risk of significant adverse effects on net interest income caused byinterest rate changes.  As shown in thetable below, at September 30, 2002, interest-bearing liabilities repricedfaster than interest-earning assets in the short term, as has been typical forus.  Generally speaking, fallinginterest rates would lead to net interest income that is higher than it wouldhave been; rising rates would lead to lower net interest income.  However, at the current absolute level ofinterest rates, lower interest rates may also lead to lower net income due to adiminished ability to lower interest-bearing liabilities, including certainclient funds, as rates approach zero. Other important determinants of net interest income are rate levels,balance sheet growth and mix, and interest rate spreads.

 

The following table presents the repricingschedule of our interest-earning assets and interest-bearing liabilities atSeptember 30, 2002 (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)                                                              |   | $                         | 3,104,654 |                      | $      | 500,866                    |   | $                            | 640,482 |                 | $      | 1,539,582 |   | $ | 352,588 |   | $ | 6,138,172 |   |
| Federal funds sold and securities purchased  under repurchase agreements               |   | 120,000                   |      | —                    |   | —                     |   | —                       |    | —               |   | 120,000   |   |
| Loans—variable rate                                                               |   | 138,986                   |      | —                    |   | —                     |   | —                       |    | —               |   | 138,986   |   |
| Loans—fixed rate                                                                  |   | 12                        |      | —                    |   | —                     |   | —                       |    | —               |   | 12        |   |
| Total interest-earning assets                                                          |   | $                         | 3,363,652 |                      | $      | 500,866                    |   | $                            | 640,482 |                 | $      | 1,539,582 |   | $ | 352,588 |   | $ | 6,397,170 |   |
| Interest-bearing liabilities:                                                          |   |                      |      |                      |   |                       |   |                         |    |                 |   |      |   |
| Savings accounts                                                                       |   | $                         | 2,129,614 |                      | $      | —                     |   | $                            | —  |                 | $      | 27,621    |   | $ | — |   | $ | 2,157,235 |   |
| Interest rate contracts                                                                |   | (980,000                  | )         | 60,000                    |   | 130,000                    |   | 790,000                      |    | —               |   | —    |   |
| Short-term and other borrowings                                                        |   | 3,070,904                 |      | —                    |   | —                     |   | 400,000                      |    | —               |   | 3,470,904 |   |
| Total interest-bearing liabilities                                                     |   | $                         | 4,220,518 |                      | $      | 60,000                     |   | $                            | 130,000 |                 | $      | 1,217,621 |   | $ | — |   | $ | 5,628,139 |   |
| Net interest-sensitivity gap during the  period                                        |   | $                         | (856,866  | )                         | $      | 440,866                    |   | $                            | 510,482 |                 | $      | 321,961   |   | $ | 352,588 |   | $ | 769,031 |   |
|                                                                                   |   |                      |      |                      |   |                       |   |                         |    |                 |   |      |   |
| Cumulative gap                                                                         |   | $                         | (856,866  | )                         | $      | (416,000                   | )      | $                            | 94,482  |                 | $      | 416,443   |   | $ | 769,031 |   |   |   |
| Interest-sensitive assets as a percent of  interest sensitive liabilities (cumulative) |   | 79.70                     | %         | 90.28                     | %      | 102.14                     | %      | 107.40                       | %       | 113.66               | %      |      |   |
| Interest-sensitive assets as a percent of  total assets (cumulative)                   |   | 49.36                     | %         | 56.70                     | %      | 66.10                      | %      | 88.69                        | %       | 93.87                | %      |      |   |
|                                                                                   |   |                      |      |                      |   |                       |   |                         |    |                 |   |      |   |
| Net interest-sensitivity gap as a percent  of total assets                             |   | (12.57                    | )%        | 6.47                      | %      | 7.49                       | %      | 4.72                         | %       | 5.17                 | %      |      |   |
| Cumulative gap as a percent of total assets                                            |   | (12.57                    | )%        | (6.10                     | )%     | 1.39                       | %      | 6.11                         | %       | 11.28                | %      |      |   |

 

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(1)                   Adjustable rate assets are includedin the period in which interest rates are next scheduled to adjust rather thanin the period in which they are due.  Fixed-rateloans are included in the period in which they are scheduled to be repaid.

(2)                   Mortgage-backed securities areincluded in the pricing category that corresponds with their effectivematurity.

 

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**Liquidity**

 

Liquidity represents the ability of an institution to meet present andfuture financial obligations through either the sale or maturity of existingassets or the acquisition of additional funds through liability management.  For a financial institution such as ours,these obligations arise from the withdrawals of deposits and the payment ofoperating expenses.

 

Our primary sources of liquidity include cash and cash equivalents,federal funds sold, new deposits, short-term borrowings, interest payments onsecurities held to maturity and available for sale, and fees collected fromasset administration clients.  As aresult of our management of liquid assets and the ability to generate liquiditythrough liability funds, management believes that we maintain overall liquiditysufficient to meet our depositors’ needs, to satisfy our operating requirementsand to fund the payment of an anticipated annual cash dividend of $0.05 pershare for 2002 (approximately $3.2 million based upon 64,583,399 sharesoutstanding as of September 30, 2002).

 

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

 

We have informal borrowing arrangements with variouscounterparties.  Each counterparty hasagreed to make funds available to us at the Federal funds overnight rate.  The aggregate amount of these borrowingarrangements as of September 30, 2002 was $1.4 billion.  Each bank may terminate its arrangement atany time and is under no contractual obligation to provide us with requestedfunding.  Our borrowings under thesearrangements are typically on an overnight basis.  We cannot be certain, however, that such funding will beavailable.  Lack of availability ofliquid funds could have a material adverse impact on our operations.

 

We also have Master Repurchase Agreements in place with variouscounterparties.  Each broker has agreedto make funds available to us at various rates in exchange for collateralconsisting of marketable securities. The aggregate amount of these borrowingarrangements at September 30, 2002 was $2.8 billion.

 

We also have a borrowing arrangement with the FHLBB.  We may borrow amounts determined byprescribed collateral levels and the amount of FHLBB stock we hold.  We are required to hold FHLBB stock equal tono less than (i) 1% of our outstanding residential mortgage loan principal(including mortgage pool securities), (ii) 0.3% of total assets, or(iii) total advances from the FHLBB, divided by a leverage factor of20.  The aggregate amount of borrowingavailable to us under this arrangement at September 30, 2002 was $2.4billion.  The amount outstanding underthis arrangement at September 30, 2002 was $0.8 billion.

 

Our cash flows are comprised of three primary classifications: cashflows from operating activities, investing activities, and financingactivities.  Net cash provided byoperating activities was $73.2 million for the nine months ended September 30,2002.  Net cash used for investingactivities for the nine months ended September 30, 2002 was $1.4 billion, consistingprimarily of the excess of purchases of investment securities over proceedsfrom maturities of investment securities and increased Federal funds sold andsecurities purchased under resale agreements. Net cash provided by financing activities, consisting primarily ofincreased short-term and other borrowings, time deposits and savings deposits,was $1.4 billion for the nine months ended September 30, 2002.

 

**Capital Resources**

 

Historically, we have financed our operations principally throughinternally generated cash flows.  Weincur capital expenditures for furniture, fixtures, capitalized software andmiscellaneous equipment needs.  We leasemicrocomputers through operating leases. Capital expenditures have been incurred and leases entered into on anas-required basis, primarily to meet our growing operating needs.  As a result, our capital expenditures were$38.7 million and $27.8 million for the nine months ended September 30,2002 and 2001, respectively.  For thenine months ended September 30, 2002, capital expenditures were comprised ofapproximately $25.2 million in capitalized software and projects in process,$11.0 million in fixed assets and $2.5 million in leasehold improvements.  For the nine months ended September 30,2001, capital expenditures were comprised of approximately $15.1 million infixed assets, $8.4 million in capitalized software and projects in process and$4.3 million in leasehold improvements.

 

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Stockholders’ equity at September 30, 2002 was $419.5 million, up22% from December 31, 2001.  The ratioof stockholders’ equity to assets decreased to 6.2% at September 30, 2002 from6.5% at December 31, 2001.

 

The FRB has adopted a system using internationally consistent risk-basedcapital adequacy guidelines to evaluate the capital adequacy of banks and bankholding companies.  Under the risk-basedcapital guidelines, different categories of assets are assigned different riskweights, based generally upon the perceived credit risk of the asset.  These risk weights are multiplied bycorresponding asset balances to determine a “risk-weighted” asset base.  Some off-balance sheet items are added tothe risk-weighted asset base by converting them to a balance sheet equivalentand assigning them the appropriate risk weight.

 

FRB and FDIC guidelines require that banking organizations have aminimum ratio of total capital to risk-adjusted assets and off-balance sheetitems of 8.0%.  Total capital is definedas the sum of “Tier I” and “Tier II” capital elements, with at leasthalf of the total capital required to be Tier I.  Tier I capital includes, with certain restrictions, the sum ofcommon stockholders’ equity, noncumulative perpetual preferred stock, a limitedamount of cumulative perpetual preferred stock, and minority interests inconsolidated subsidiaries, less certain intangible assets.  Tier II capital includes, with certainlimitations, subordinated debt meeting certain requirements, intermediate-termpreferred stock, certain hybrid capital instruments, certain forms of perpetualpreferred stock, as well as maturing capital instruments and general allowancesfor loan losses.

 

The followingtable summarizes our Tier I and total capital ratios at September 30, 2002(Dollars in thousands):

 
|                                            |   | **Amount** |      | **Ratio** |   |
|-------------------------------------------------|--------|------------|-----------|-----------|--------|
|                                            |   |       |      |      |   |
| Tier I capital                                  |   | $          | 353,069   |      | 15.08  | % |
| Tier I capital minimum requirement              |   | 93,682     |      | 4.00      | %      |
|                                            |   |       |      |      |   |
| Excess Tier I capital                           |   | $          | 259,387   |      | 11.08  | % |
|                                            |   |       |      |      |   |
| Total capital                                   |   | $          | 353,169   |      | 15.08  | % |
| Total capital minimum requirement               |   | 187,364    |      | 8.00      | %      |
|                                            |   |       |      |      |   |
| Excess total capital                            |   | $          | 165,805   |      | 7.08   | % |
|                                            |   |       |      |      |   |
| Risk adjusted assets, net of intangible  assets |   | $          | 2,342,056 |      |   |   |

 

The followingtable summarizes the Bank’s Tier I and total capital ratios at September 30,2002 (Dollars in thousands):

 
|                                           |   | **Amount** |      | **Ratio** |   |
|------------------------------------------------|--------|------------|-----------|-----------|--------|
|                                           |   |       |      |      |   |
| Tier I capital                                 |   | $          | 349,202   |      | 14.91  | % |
| Tier I capital minimum requirement             |   | 93,669     |      | 4.00      | %      |
|                                           |   |       |      |      |   |
| Excess Tier I capital                          |   | $          | 255,533   |      | 10.91  | % |
|                                           |   |       |      |      |   |
| Total capital                                  |   | $          | 349,302   |      | 14.92  | % |
| Total capital minimum requirement              |   | 187,339    |      | 8.00      | %      |
|                                           |   |       |      |      |   |
| Excess total capital                           |   | $          | 161,963   |      | 6.92   | % |
|                                           |   |       |      |      |   |
| Risk adjusted assets, net of intangible assets |   | $          | 2,341,736 |      |   |   |

 

In addition tothe risk-based capital guidelines, the FRB and the FDIC use a “Leverage Ratio”as an additional tool to evaluate capital adequacy.  The Leverage Ratio is defined to be a company’s Tier I capitaldivided by its adjusted total average assets. The Leverage Ratio adopted by the federal banking agencies requires aratio of 3.0% for top-rated banking institutions not experiencing a period ofrapid growth.  All other bankinginstitutions will be expected to maintain a Leverage Ratio of 4.0% to5.0%.  The computation of the risk–basedcapital ratios and the Leverage Ratio requires that our capital and that of theBank be reduced by most intangible assets. Our Leverage

 

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Ratio at September 30, 2002 was5.64%, which is in excess of regulatory requirements.  The Bank’s Leverage Ratio at September 30, 2002 was 5.58%, whichis in excess of regulatory requirements.

 

The followingtables present average balances, interest incomeand expense, and yields earned or paid on the major categories of assets andliabilities for the periods indicated (Dollars in thousands):

 
|                                                                |   | **Nine Months Ended September 30, 2002** |      | **Nine Months Ended September 30, 2001** |    |
|---------------------------------------------------------------------|--------|------------------------------------------|-----------|------------------------------------------|---------|
|                                                                |   | **Average  Balance**                     |      | **Interest**                             |    | **Average  Yield/Cost** |   | **Average  Balance** |   | **Interest** |   | **Average  Yield/Cost** |   |
| **Interest earning assets:**                                        |   |                                     |      |                                     |    |   |   |   |   |   |   |   |   |
| Federal funds sold and securities purchased under resale agreements |   | $                                        | 54,144    |                                     | $       | 680 |   | 1.67 | % | $ | 46,850 |   | $ | 1,611 |   | 4.58 | % |
| Investment securities (1)                                           |   | 5,411,656                                |      | 181,394                                  |    | 4.47 | % | 4,062,126 |   | 184,774 |   | 6.06 | % |
| Loans (2)                                                           |   | 110,747                                  |      | 2,891                                    |    | 3.48 | % | 113,960 |   | 4,279 |   | 5.01 | % |
| Total interest-earning assets                                       |   | 5,576,547                                |      | 184,965                                  |    | 4.42 | % | 4,222,936 |   | 190,664 |   | 6.02 | % |
| Allowance for loan losses                                           |   | (100                                     | )         |                                     |    |   |   | (100 | ) |   |   |   |   |
| Noninterest-earning assets                                          |   | 346,204                                  |      |                                     |    |   |   | 251,413 |   |   |   |   |   |
| Total assets                                                        |   | $                                        | 5,922,651 |                                     |    |   |   |   | $ | 4,474,249 |   |   |   |   |   |
|                                                                |   |                                     |      |                                     |    |   |   |   |   |   |   |   |   |
| **Interest bearing  liabilities:**                                  |   |                                     |      |                                     |    |   |   |   |   |   |   |   |   |
| Deposits:                                                           |   |                                     |      |                                     |    |   |   |   |   |   |   |   |   |
| Demand                                                              |   | $                                        | 1,100     |                                     | $       | 4 |   | 0.48 | % | $ | 3,845 |   | $ | 56 |   | 1.94 | % |
| Savings                                                             |   | 1,797,890                                |      | 31,749                                   |    | 2.35 | % | 1,741,390 |   | 53,078 |   | 4.06 | % |
| Time                                                                |   | 1,862                                    |      | 24                                       |    | 1.72 | % | 319 |   | 13 |   | 5.43 | % |
| Short-term borrowings                                               |   | 2,846,157                                |      | 28,079                                   |    | 1.32 | % | 1,795,578 |   | 50,731 |   | 3.77 | % |
| Other borrowings                                                    |   | 398,901                                  |      | 19,126                                   |    | 6.39 | % | 248,913 |   | 9,344 |   | 5.01 | % |
| Total interest-bearing liabilities                                  |   | 5,045,910                                |      | 78,982                                   |    | 2.09 | % | 3,790,045 |   | 113,222 |   | 3.98 | % |
| Noninterest-bearing liabilities Demand deposits                     |   | 182,606                                  |      |                                     |    |   |   | 175,658 |   |   |   |   |   |
| Savings                                                             |   | 120,666                                  |      |                                     |    |   |   | 66,715 |   |   |   |   |   |
| Noninterest-bearing time deposits                                   |   | 90,000                                   |      |                                     |    |   |   | 73,333 |   |   |   |   |   |
| Other liabilities                                                   |   | 75,971                                   |      |                                     |    |   |   | 49,104 |   |   |   |   |   |
| Total liabilities                                                   |   | 5,515,153                                |      |                                     |    |   |   | 4,154,855 |   |   |   |   |   |
| Trust preferred stock                                               |   | 24,280                                   |      |                                     |    |   |   | 24,256 |   |   |   |   |   |
| Equity                                                              |   | 383,218                                  |      |                                     |    |   |   | 295,138 |   |   |   |   |   |
| Total liabilities and equity                                        |   | $                                        | 5,922,651 |                                     |    |   |   |   | $ | 4,474,249 |   |   |   |   |   |
| Net interest income                                                 |   |                                     |      | $                                        | 105,983 |   |   |   |   |   | $ | 77,442 |   |   |   |
| Net interest margin (3)                                             |   |                                     |      |                                     |    | 2.53 | % |   |   |   |   | 2.45 | % |
| Average interest rate spread (4)                                    |   |                                     |      |                                     |    | 2.33 | % |   |   |   |   | 2.04 | % |
|                                                                |   |                                     |      |                                     |    |   |   |   |   |   |   |   |   |
| Ratio of interest-earning assets to interest-bearing liabilities    |   |                                     |      |                                     |    | 110.52 | % |   |   |   |   | 111.42 | % |

 

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(1)       Average yield/cost on available for salesecurities is based on amortized cost.

(2)       Average yield on loans includes accrualloan balances.

(3)       Net interest income divided by totalinterest-earning assets.

(4)       Yield on interest-earning assets lessrate paid on interest-bearing liabilities.

 

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

 

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

 

40

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**Item4.    Controls and Procedures**

** **

(a)  Evaluation of disclosure controls and procedures.

 

Within 90 daysbefore filing this report, we evaluated the effectiveness of the design andoperation of our disclosure controls and procedures.  Our disclosure controls and procedures are the controls and otherprocedures that we designed to ensure that we record, process, summarize andreport in a timely manner the information we must disclose in reports that wefile or submit to the SEC.  Kevin J.Sheehan, our Chairman and Chief Executive Officer, and John N. Spinney, Jr.,our Senior Vice President and Chief Financial Officer, reviewed andparticipated in this evaluation.  Basedon this evaluation, Messrs. Sheehan and Spinney concluded that, as of the dateof the evaluation, our disclosure controls were effective.

 

(b)  Internal controls.

 

Since the dateof the evaluation described above, there have not been any significant changesin our internal accounting controls or in other factors that couldsignificantly affect those controls.

 

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**PART II. OTHER INFORMATION**

 

**Item6.**  Exhibits and Reports on Form 8-K.

 

**(a)    **Exhibits

**99.1 Certification of Kevin J. Sheehan, Chief ExecutiveOfficer, and John N. Spinney, Jr., Chief Financial Officer, pursuant to 18U.S.C. Section 1350, as adopted, pursuant to Section 906 of the Sarbanes-OxleyAct of 2002.**

** **

**(b)    **Reportson Form 8-K

**On July 11, 2002, August 14, 2002 and September 20, 2002,the Company filed current reports on Form 8-K providing information thereinunder Item 9 (Regulation FD Disclosure). The current report on Form 8-K filed July 11, 2002 contained thefollowing financial statements: Consolidated Statement of Income for theQuarter Ended June 30, 2002; Consolidated Balance Sheet as of June 30, 2002;Average Balance Sheet as of June 30, 2002; and Asset Servicing Fees for theQuarter Ended June 30, 2002.**

 

 

 

42

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**SIGNATURES**

 

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

 
|                          |   |   | **INVESTORS FINANCIAL SERVICES CORP.**                                                           |
|-------------------------------|--------|--------|--------------------------------------------------------------------------------------------------|
|                          |   |   |                                                                                             |
| Date:  November 14, 2002 |   | 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) |

 

**Certifications**

 

I, Kevin J. Sheehan, Chairmanand Chief Executive Officer, certify that:

 

1.             I have reviewed this Quarterly Report on Form 10-Q ofInvestors Financial Services Corp.;

 

2.             Based on my knowledge, this quarterly report does notcontain any untrue statement of a material fact or omit to state a materialfact necessary to make the statements made, in light of the circumstances underwhich such statements were made, not misleading with respect to the periodcovered by this quarterly report;

 

3.             Based on my knowledge, the financial statements, andother financial information included in this quarterly report, fairly presentin all material respects the financial condition, results of operations andcash flows of the registrant as of, and for, the periods presented in thisquarterly report;

 

4.             The registrant’s other certifying officers and I areresponsible for establishing and maintaining disclosure controls and procedures(as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and wehave:

 

(a)           designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this quarterly reportis being prepared;

 

(b)           evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this quarterly report (the “Evaluation Date”); and

 

(c)           presented in this quarterly reportour conclusions about the effectiveness of the disclosure controls andprocedures based on our evaluation as of the Evaluation Date;

 

5.             The registrant’s other certifying officers and I havedisclosed, based on our most recent evaluation, to the registrant’s auditorsand the audit committee of registrant’s board of directors (or personsperforming the equivalent function):

 

(a)           all significant deficiencies in thedesign or operation of internal controls which could adversely affect theregistrant’s ability to record, process, summarize and report financial dataand have identified for the registrant’s auditors any material weaknesses ininternal controls; and

 

(b)           any fraud, whether or not material,that involves management or other employees who have a significant role in theregistrant’s internal controls; and

 

43

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6.             The registrant’s other certifying officers and I haveindicated in this quarterly report whether or not there were significantchanges in internal controls or in other factors that could significantlyaffect internal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 
| Date:  November 14, 2002 |                                  |
|-------------------------------|---------------------------------------|
|                          | /s/ Kevin J.  Sheehan                 |   |
|                          | Kevin J.  Sheehan                     |
|                          | Chairman and  Chief Executive Officer |

 

I, John N. Spinney, Jr., SeniorVice President and Chief Financial Officer, certify that:

 

1.             I have reviewed this Quarterly Report on Form 10-Q ofInvestors Financial Services Corp.;

 

2.             Based on my knowledge, this quarterly report does notcontain any untrue statement of a material fact or omit to state a materialfact necessary to make the statements made, in light of the circumstances underwhich such statements were made, not misleading with respect to the periodcovered by this quarterly report;

 

3.             Based on my knowledge, the financial statements, andother financial information included in this quarterly report, fairly presentin all material respects the financial condition, results of operations andcash flows of the registrant as of, and for, the periods presented in thisquarterly report;

 

4.             The registrant’s other certifying officers and I areresponsible for establishing and maintaining disclosure controls and procedures(as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and wehave:

 

(a)           designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this quarterly reportis being prepared;

 

(b)           evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 days priorto the filing date of this quarterly report (the “Evaluation Date”); and

 

(c)           presented in this quarterly reportour conclusions about the effectiveness of the disclosure controls andprocedures based on our evaluation as of the Evaluation Date;

 

5.             The registrant’s other certifying officers and I havedisclosed, based on our most recent evaluation, to the registrant’s auditorsand the audit committee of registrant’s board of directors (or personsperforming the equivalent function):

 

(a)           all significant deficiencies in thedesign or operation of internal controls which could adversely affect theregistrant’s ability to record, process, summarize and report financial dataand have identified for the registrant’s auditors any material weaknesses ininternal controls; and

 

(b)           any fraud, whether or not material,that involves management or other employees who have a significant role in theregistrant’s internal controls; and

 

6.             The registrant’s other certifying officers and I haveindicated in this quarterly report whether or not there were significantchanges in internal controls or in other factors that could significantlyaffect internal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 
| Date:  November 14, 2002 |                                                |
|-------------------------------|-----------------------------------------------------|
|                          | /s/ John N.  Spinney, Jr.                           |   |
|                          | John N.  Spinney, Jr.                               |
|                          | Senior Vice  President and  Chief Financial Officer |

 

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