**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,DC 20549**

**FORM 10-K**

**(Mark One)**

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

**Forthe fiscal year ended December 31, 2006**

**OR**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe transition period from _______________to _______________**

**CommissionFile Number 0-26996**

**INVESTORS FINANCIALSERVICES CORP.**

(Exact name of registrantas specified in its charter)

| **Delaware**                                                        |   | **04-3279817**       |
|---------------------------------------------------------------------|--------|----------------------|
| (State or other  jurisdiction of                                    |   | (I.R.S Employer      |
| incorporation or  organization)                                     |   | Identification  No.) |
| **200 Clarendon Street  P.O. Box 9130  Boston, Massachusetts** |   | **02116**            |
| (Address of  principal executive offices)                           |   | (Zip Code)           |

 

**Registrant’stelephone number, including area code: (617) 937-6700**

**Securitiesregistered pursuant to Section 12(b) of the Act:**

**CommonStock, $.01 Par Value Registered with the NASDAQ Global Select Market**

**Securitiesregistered pursuant to Section 12(g) of the Act:**

**None**

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act. Yes x  No o

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Act. Yes* *o No* *x

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes* *x No* *o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, tothe best of registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-K orany amendment to this Form 10-K. o

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

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

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theAct). Yes* *o No* *x

The aggregate market valueof common stock held by non-affiliates of the registrant was $2,863,941,561based on the last reported sale price of $44.90 on The NASDAQ Global SelectMarket on June 30, 2006 as reported by NASDAQ.

As of January 31,2007, there were 65,986,040 shares of common stock outstanding.

**DOCUMENTS INCORPORATED BYREFERENCE**

Theregistrant will file a definitive Proxy Statement pursuant to Regulation 14Awithin 120 days of the end of the fiscal year ended December 31, 2006. Portionsof such Proxy Statement are incorporated by reference in Part III.

 

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**PART I**

**ITEM 1. BUSINESS.**

**General**

*Unless otherwiseindicated or unless the context requires otherwise, all references in thisReport to “Investors Financial,” “we,” “us,” “our,” or similar references meanInvestors Financial Services Corp., together with our subsidiaries. “InvestorsBank” or the “Bank” means our subsidiary, Investors Bank & TrustCompany, alone.*

We provide a broad range of services to financialasset managers, such as mutual fund complexes, investment advisors, hedgefunds, family offices, banks and insurance companies. We define these servicesas core services and value-added services. Our core services include globalcustody, multicurrency accounting, fund administration and middle officeoutsourcing. Our value-added services include foreign exchange, cashmanagement, securities lending, investment advisory, performance measurement,institutional transfer agency, lines of credit and brokerage and transitionmanagement services. At December 31, 2006, we provided services forapproximately $2.2 trillion in net assets, including approximately$0.4 trillion of foreign net assets. 

Investors Financial Services Corp. is a bank holdingcompany. We were organized as a Delaware corporation in 1995. Our primaryoperating subsidiary is Investors Bank & Trust Company®  whichwas founded in 1969 as a banking subsidiary of Eaton Vance Corp., an investmentmanagement firm. In 1995, we reorganized as a bank holding company, werespun-off to the stockholders of Eaton Vance and completed our initial publicoffering. We provide our services from offices in Boston, New York, Sacramento,Toronto, Dublin, London, Luxembourg and the Cayman Islands. 

On February 4, 2007,we entered into an Agreement and Plan of Merger (the ‘Merger Agreement’) withState Street Corporation (‘State Street’). At the closing of the transactioncontemplated by the Merger Agreement, we will merge into State Street and ourshareholders will receive 0.906 shares of State Street common stock for eachshare of our common stock. Each company’s Board of Directors has approved theMerger Agreement. We expect to complete the transaction in the third quarter of2007, subject to customary closing conditions, including regulatory andshareholder approval.

**Overview of theAsset Servicing Industry**

Asset managers invest and manage the financial assetsentrusted to them. They do so using a broad range of financial products,including mutual funds, alternative investment vehicles, unit investmenttrusts, separate accounts, variable annuities and other products that pooltogether money from multiple investors. Asset servicing companies like oursperform various back and middle office services for asset managers and thepooled financial products they sponsor, allowing asset managers to focus oncore competencies such as product development and distribution. In addition,asset servicing companies like ours provide these back office services such asthe third-party safekeeping of assets and administrative services to giveinvestors more confidence in the integrity of their investments. The followingdiscussion sets forth our view of the key drivers in today’s asset servicingindustry.

*Historical Financial AssetGrowth.**  *Despitethe stock market declines of 2000 through 2002, over the past ten years, growthin financial assets under management has remained strong. Factors driving thisgrowth include an aging population, the privatization of retirement systems andthe increased popularity of pooled investment products such as mutual funds. Thetotal amount of U.S. financial assets held in mutual funds, life insurancecompanies, private pension funds and bank personal trust accounts was $17.5trillion at December 31, 2005, up from $7.6 trillion in 1995, a compoundedannual growth rate of approximately 9%. Mutual funds, one of the primarymarkets for our services, hold a large portion of the money invested in pooledinvestment vehicles. The U.S. mutual fund market has grown at a compoundedannual growth 

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rate of approximately 12% since 1995, and heldapproximately $8.1 trillion in assets at December 31, 2005. The followingtable presents U.S. financial assets, including mutual funds (Dollars inbillions): 

| ** **                 | ** ** | **December 31, 2005** | ** ** | **December 31, 1995** | ** ** | **Compounded  Annual  Growth Rate** | ** ** |
|----------------------------|------------|---------------------------------|------------|---------------------------------|------------|------------------------------------------|------------|
| **U.S.  Financial Assets** |       |                            |       |                            |       |                                     |       |   |   |   |   |   |   |
| Mutual Funds               |       |                            | $          | 8,056                           |       |                                     |       | $ | 2,594 |   |   |   | 12 | % |   |
| Life Insurance  Companies  |       |                            | 4,351      |                            |       |                                     | 2,064      |   |   |   | 8 |   |   |
| Private Pension  Funds     |       |                            | 5,120      |                            |       |                                     | 2,899      |   |   |   | 6 |   |   |
| Total                      |       |                            | $          | 17,527                          |       |                                     |       | $ | 7,557 |   |   |   | 9 | % |   |

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*Source: FederalReserve Bank*

*Consolidationand Outsourcing Trends.**  *Anotherimportant factor affecting the asset servicing industry is the consolidation ofasset servicing providers. Since the early 1990s, a number of small and mid-sizeasset servicers have consolidated with larger service providers or divestedtheir asset servicing operations to focus their finite resources on their corebusinesses. Also, numerous service providers have combined their operationswith other companies. This ongoing consolidation has concentrated the industryaround a smaller number of service providers and presents us with opportunitiesfor growth as clients react to consolidation and review their relationshipswith existing providers. In addition, as consolidated financial institutionsdispose of businesses that do not fit with their core services, we may seeopportunities to acquire those business lines at a reasonable price. 

The unique operational philosophy of a particularasset management organization determines its view of asset servicing. Themajority of asset managers hire third parties to provide custody services. Someuse more than one custodian in an attempt to foster cost reduction throughcompetition. Large asset managers may have enough assets to justify the cost ofproviding in-house facilities to handle accounting, administration and transferagency services. Other asset managers generally hire third parties to provideaccounting, administration and transfer agency services in addition to custodyservices. Keeping abreast of developments like regulatory changes, internetdata delivery, compressed settlement cycles, and complex investment strategies,structures and instruments has forced significant increases in technologyspending across the financial services industry. We believe that this increasein spending requirements has accelerated the pace at which asset managersoutsource back and middle office operations to asset servicers. 

*Technology.**  *Information technology is a driving force in thefinancial services industry. Asset managers are able to create innovativeinvestment products using technological tools including: 

·       Accessto data from world markets as a result of more powerful and affordableinformation processing power. 

·       Theability to send and receive large volumes of information almost instantlythrough widely dispersed communication networks. 

·       Timelyon-line access to electronic information on security positions, prices andprice shifts that facilitate activities, including on-line currency trading,indexing of assets, real time arbitrage and hedging through the use ofderivative securities. 

Asset servicers use technology as a competitive toolto deliver precise and functional information to asset managers. Technologyalso allows asset servicers to offer more value-added services, such asperformance measurement. Examples of analytical tools used in performancemeasurement include reports showing time-weighted return, performance by sectorand time-weighted return by sector. 

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*ComplexInvestment Products.**  *Assetmanagers create different investment structures in an effort to captureefficiencies and appeal to investors with diverse means, risk tolerances,diversification requirements and time horizons. One innovative example of thisis exchange traded funds, or ETFs. ETFs are securities that replicate an indexand are traded on a national securities exchange, such as the New YorkStock Exchange or the American Stock Exchange. Unlike investing in aconventional index mutual fund, investing in an ETF allows investors to buy andsell shares throughout the trading day at market prices. ETFs also offerpotential tax efficiencies. According to the Investment Company Institute,domestic ETF assets increased 34% to approximately $397 billion as of November 30,2006 from approximately $296 billion as of December 31, 2005. 

Alternative investments, including hedge funds,private equity funds, venture capital funds and commodity pools, are anotherexample of complex investment products that have recently experienced dramaticgrowth. According to *HFMWeek’s*latest hedge fund administrator survey, hedge fund assets totaled approximately$2.1 trillion as of November 30, 2006, which represents an increase of 53%as compared to November 30, 2005. Hedge fund assets have increased due towidening interest from institutional investors such as pension plans andendowments, as well as high net worth individuals. These asset pools oftenfeature increasingly sophisticated trading strategies, financial instrumentsand product structures such as distressed debt, swaps and asset-backedsecurities that require more specialized operational support than traditionalmutual funds.

In addition, a growing number of mutual funds havebeen structured as multi-class funds or as multi-manager funds in orderto address the differing requirements and preferences of potential investors. Multi-classarrangements allow an investment company to sell interests in a singleinvestment portfolio to separate classes of stockholders. Multi-manager fundshave two or more investment managers, who may have different investing styles,managing the assets of one fund. Multi-manager funds offer investors diverseinvestment styles with a single investment. 

Another product innovation is the master-feederstructure. In the master-feeder structure, one or more investment vehicles (the‘feeder funds’) with identical investment objectives pool their assets in thecommon portfolio of a separate investment vehicle (the ‘master fund’). Thisstructure permits each of the feeder funds to be sold to a separate targetmarket or through a different distribution channel. The feeder fund, if it werea stand-alone fund, might not be large enough to support its operating costs. Thefeeder funds benefit from the economies of scale available to the larger poolof assets invested in the master fund. 

*International Investing.*   Assetmanagers have also expanded their reach in the global marketplace to capitalizeon cross-border and multi-national marketing opportunities. This creates demandfor asset servicing around the world and particularly for value-added serviceslike foreign exchange. At December 31, 2006, we provided services forapproximately $2.2 trillion in net assets, including approximately $0.4trillion of foreign net assets, which represents an increase of 23% and 33%,respectively, from December 31, 2005. 

**Our Strategy**

We believe that asset servicing companies operate mostefficiently when bundling core services such as custody and accounting withvalue-added services such as foreign exchange and securities lending. We alsobelieve that efficient integration of these services is critical to bothservice quality and profitability. The following discussion outlines the keycomponents of our growth strategy:

*MaintainOur Technological Expertise.**  *Oneof our core strategies is to commit the necessary capital and resources tomaintain our technological expertise. The asset servicing industry requires thetechnological capability to support a wide range of global security types,currencies and complex portfolio structures. Asset servicers must also maintainthe telecommunications flexibility to support the diversity of 

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global communicationsstandards. Technological change creates opportunities for productdifferentiation and cost reduction. 

Our Fund Accountingand Custody Tracking System, or FACTSTM, is a single integrated technologyplatform that combines our service offerings into one solution for customersand can accommodate rapid growth in net assets processed. FACTS provides thefollowing functions in a single information system: 

·       Custody

·       Securitiesmovement and control 

·       Portfolioaccounting 

·       Multicurrencygeneral ledger accounting 

·       Pricing

·       Netasset value calculation 

·       Middleoffice outsourcing 

·       Multi-classand multi-manager processing 

·       ETFprocessing 

By consolidating these functions, we have eliminatedredundancy in data capture and reduced the opportunity for clerical error. 

The consolidation of functions available through FACTSallows us to assign a dedicated client team to provide a full suite of servicesto each account. We believe that this approach helps us to provide high qualityservice and to maintain better overall relationships with our clients. 

The FACTS architecture also enables us to modify thesystem quickly. Rapid modifications allow us to constantly improve processingquality and efficiency and to implement service innovations for our clients. Webelieve that the integrated nature of FACTS provides us with a competitiveadvantage by allowing us to respond quickly to the continuously changingtechnological demands of the financial services industry. We believe theseparate systems used for different tasks by many other asset servicingproviders may not provide the same advantages. 

*MaintainOur Expertise in Complex Products.**  *Anotherof our core strategies is to maintain our strength in the rapidly growing areaof complex investment products. We have developed expertise in servicing ETFs,various alternative investment structures, master-feeder funds andmulti-managed funds. We are able to respond rapidly to the systems requirementsof complex structures since the design of FACTS allows us to effectmodifications or enhancements quickly. 

*DeliverSuperior Service.**  *Westrive to deliver superior and innovative client service. We believe servicequality is the key to maintaining and expanding existing client relationshipsand to attracting new clients. The consolidation of functions available throughFACTS allows us to take an integrated approach to client servicing. We believethis approach is different from that employed by many of our competitors. Wededicate a single operations team to handle all tasks for a particular client. Inaddition, each client is assigned a client manager, independent of theoperations team, to anticipate the client’s needs, to coordinate servicedelivery and to provide consulting support. 

*Cross-Sell Our Services.**  *We believe that our strong client relationshipsprovide opportunities to cross-sell value-added services to broaden ourcustomer relationships. Many of our clients manage multiple pools of assets. Oncean investment manager becomes a client, we believe that this client is morelikely to select us to service more products, provide additional services, orboth. If we are engaged to provide services for only certain pools of assetsmanaged by our clients, we strive to expand the 

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relationship toinclude more asset pools by providing superior client service. Also, some ofour clients engage us to provide core services such as global custody andmulticurrency accounting, but do not use us for value-added services such asforeign exchange or cash management. We target expanding these relationshipsthrough increasing the number of services provided for each client. 

**Service Offerings**

Weprovide a broad range of services to financial asset managers, such as mutualfund complexes, investment advisors, hedge funds, family offices, banks andinsurance companies. We think of these services in two groupings, core servicesand value-added services, which are comprised of the following: 

| **Core Services** | ** **                | **Value-Added Services** |
|-------------------|---------------------------|--------------------------|
| ·            | Global Custody            |                     | · | Foreign Exchange |
| ·            | Multicurrency  Accounting |                     | · | Cash Management |
| ·            | Fund Administration       |                     | · | Securities Lending |
| ·            | Middle Office Outsourcing |                     | · | Investment Advisory |
|              |                      |                     | · | Performance Measurement |
|              |                      |                     | · | Institutional Transfer Agency |
|              |                      |                     | · | Lines of Credit |
|              |                      |                     | · | Brokerage and Transition Management Services |

 

Our value-added services help clients develop andexecute their strategies, and evaluate and manage their risks, which we believeprovides them with the opportunity to enhance their returns. We strive tomaximize the use of our value-added services by our client base.

Fees charged for core services vary from client toclient based on the value of assets processed, the number of securities heldand the number of portfolio transactions. Generally, fees are billed to ourclients monthly in arrears and, upon their approval, charged directly to theiraccount. Fees charged for core services reflect the price sensitivity of themarket for such services. Fees charged for value-added services reflect a morefavorable pricing environment for us because we can increase activity in theseareas without a necessarily proportionate increase in personnel or otherresources. We also derive net interest income by investing cash balances thatour clients leave on deposit with us. Our share of earnings from theseinvestments is viewed as part of the total compensation that our clients pay usfor servicing their assets.

The following is adescription of the various services we offer:

***Core Services***

*GlobalCustody.**  *Globalcustody entails the safekeeping of securities for clients and settlement ofportfolio transactions. Our net assets processed have grown from$22 billion at October 31, 1990 to $2.2 trillion at December 31,2006. At December 31, 2006, our foreign net assets processed totaledapproximately $0.4 trillion.

In order to service our clients worldwide, we haveestablished a network of global subcustodians in almost 100 markets. Since wedo not have our own branches in these countries, we are able to operate in theforeign custody arena with minimal fixed costs, while our clients benefit fromthe ability to use a single custodian, Investors Bank, for all of theirinternational investment needs.

*MulticurrencyAccounting.**  *Multicurrencyaccounting entails the daily recordkeeping for each account or investmentvehicle, including the calculation of net asset value per share. In addition toproviding these services to domestic-based accounts and investment vehicles, wealso provide fund accounting services to clients in Europe and Canada, which wecontinue to view as areas of significant business opportunity.

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*FundAdministration.**  *Fundadministration services include management reporting, regulatory reporting,compliance monitoring, tax accounting and return preparation, partnershipadministration and chief compliance officer services and support. In additionto these ongoing services, we also provide fund start-up consulting services,which typically include assistance with product definition, service providerselection and fund structuring and registration. We have worked with a numberof investment advisors to assist them in the development of new funds and otherpooled investment vehicles.

*Middle Office Outsourcing.**  *Middle office outsourcing services represent thetasks that need to be performed for financial asset managers after they haveinitiated a particular trade to ensure accurate and timely trade processing andcommunications to any party affected by the trades. We perform some or all ofthe following functions for our middle office outsourcing clients: tradeoperations management, settlements, portfolio and fund accounting, fundadministration, cash management, reconciliation, corporate actions, taxreclaims and tax filings, performance measurement, broker performance andvendor data management.

***Value-Added Services***

*ForeignExchange.**  *Weprovide foreign exchange services to facilitate settlement of internationalsecurities transactions for funds and other accounts and to convert incomepayments denominated in a non-base currency to base dollars. By using us ratherthan a third-party foreign exchange bank to perform these functions, clientscan reduce the amount of time spent coordinating currency delivery andmonitoring delivery failures and claims.

*CashManagement.**  *Weprovide a number of investment options for cash balances held by our clients. Typically,we have a standing arrangement to sweep client balances into one or moreinvestments, including deposit accounts, short-term funds and repurchaseagreements. This allows our clients to conveniently maximize their earnings onidle cash balances.

*SecuritiesLending.**  *Securitieslending involves the lending of clients’ securities to brokers and otherinstitutions for a fee. Receipt of securities lending fees improves a client’sreturn on the underlying securities. We act as agent for our clients for bothinternational and domestic securities lending services.

*InvestmentAdvisory.**  *The Bankacts as the investment advisor to the Merrimac Master Portfolio, an open-endinvestment management company registered under the Investment Company Act of1940, as amended (the ‘ICA’). The portfolio currently consists of a series ofsix master funds in a master-feeder structure. The Merrimac Cash Portfolio, theMerrimac Prime Portfolio and the Merrimac U.S. Government Portfolio aresubadvised by Lehman Brothers Asset Management LLC. The Merrimac TreasuryPortfolio and the Merrimac Treasury Plus Portfolio are subadvised by M&IInvestment Management Corp. The Merrimac Municipal Portfolio is subadvised byABN AMRO Asset Management Inc. At December 31, 2006, the total net assetsof the portfolio approximated $4.5 billion. The portfolio’s master fundsserve as investment vehicles for seven domestic and two active offshore feederfunds whose shares are sold to institutional investors.

*PerformanceMeasurement.**  *Performancemeasurement services involve the creation of systems and databases that enableasset managers to construct, manage and analyze their portfolios. Servicesinclude portfolio profile analysis, portfolio return analysis and customizedbenchmark construction. Performance measurement uses data already captured byFACTS to calculate statistics and report them to asset managers in a customizedformat.

*InstitutionalTransfer Agency.**  *Transferagency encompasses shareholder recordkeeping and communications. We providethese services only to institutional clients with a small number of shareholderaccounts or omnibus positions of retail shareholders.

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*Linesof Credit.**  *We offercredit lines to our clients for the purpose of leveraging portfolios, coveringovernight cash shortfalls and other borrowing needs. We do not conduct retailbanking operations. At December 31, 2006, we had gross loans outstandingto clients of approximately $271 million, which represented approximately 2% ofour total assets. The interest rates charged on the Bank’s loans are indexed toeither the Prime rate or the Federal Funds rate. We have never had a loan loss.All loans are secured, or may be secured, by marketable securities andvirtually all loans to individually managed account customers are due ondemand.

*Brokerage and TransitionManagement Services.**  *In 2002, we beganoffering “introducing broker-dealer” services to clients by acceptingcustomer orders, which we have elected to clear through a clearing broker-dealer.The clearing broker-dealer processes and settles customer transactions andmaintains detailed customer records. This arrangement allows us to use the backoffice processing infrastructure of the clearing broker-dealer while earning acommission on trades executed on behalf of clients. Transition managementservices are designed to assist the process of moving a portfolio from oneasset manager to another in as seamless a manner as possible. Components ofthese services include planning and customizing a strategy for the transition,conducting performance analysis and executing the transition in an efficient,risk-managed fashion. The brokerage services we offer do not include marginaccounts, short selling or market making activities.

**Sales, Marketingand Client Support**

We employ a direct sales staff that targets potentialmarket opportunities, including investment management companies, insurancecompanies, family offices, banks and investment advisors. Sales personnel areprimarily based at our headquarters in Boston, and are given geographic areasales responsibility. We also have sales personnel located in Dublin, Toronto,Luxembourg and London who are responsible for international markets. Includedin the sales staff are individuals who are dedicated to marketing services toinstitutional accounts. Senior managers from all functional areas are directlyinvolved in obtaining new clients, frequently working as a team with a salesprofessional.

In order to service existing clients, a separate teamof client management professionals based in our Boston, Sacramento, New York,Toronto, Dublin and London offices provides dedicated client support. Eachclient is assigned a client manager responsible for the client’s overallsatisfaction. The client manager is usually a senior professional withextensive industry experience who works with the client on designing newproducts and specific systems requirements, provides consulting support,anticipates the client’s needs and coordinates service delivery.

Financial informationregarding our geographic reporting can be found in Note 21 of our Notes toConsolidated Financial Statements included in this Report.

**Significant Clients**

Barclays Global Investors,N.A. (‘BGI’) accounted for approximately 18% of our consolidated net operatingrevenues for the years ended December 31, 2006 and 2005, and approximately17% for the year ended December 31, 2004. No client other than BGIaccounted for more than 10% of our net operating revenues for the years ended December 31,2006, 2005 and 2004. See Item 1A “Risk Factors—A material portion of ourrevenue is derived from our relationship with Barclays Global Investors, N.A. (‘BGI’)and related entities.”

**Software Systemsand Data Center**

Our business requires that we provide daily andperiodic reports of asset accounting and performance, and provide measurementand analytical data to asset managers on-line on a real-time basis. To help usmeet these requirements, our asset servicing operations are supported bysophisticated information 

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technology. We receivevast amounts of information across a worldwide computer network. Thatinformation covers a wide range of global security types in various currenciesand must be processed before system-wide updating and reporting.

Our proprietary system, FACTS, is multi-tiered. FACTSuses personal computers linked to mainframe processing by means of local andwide area networks. This configuration combines the best features of eachplatform. FACTS uses the power and capacity of the mainframe, the datadistribution capabilities of the network and the independence of personalcomputers. The fully functional microcomputer component of FACTS worksindependently of the mainframe throughout the processing cycle. This minimizesthe amount of system-wide delay inherent in data processing. The FACTSconfiguration also allows for fully distributed processing capabilities withinmultiple geographic locations in an effective and efficient manner.

The integrated nature of the FACTS architecture allowsus to effect modifications and enhancements quickly. Swift modifications andenhancements result in increased processing quality and efficiency for ourclients. These modifications and enhancements also help us quickly implementservice innovations for our clients. This integrated architecture helpsdifferentiate us from our competitors. Technological enhancements and upgradesare an ongoing part of asset servicing that are necessary for assetadministrators to remain competitive and to create information deliverymechanisms that add value to the information available as part of clearing andsettling transactions.

Technology also helps us add value to the custody andfund accounting information we gather by processing client assets. We havedeveloped a comprehensive suite of standardized data extracts and reports andcreated automated interfaces that allow our clients to access the full range ofcustody and fund accounting data. We have also developed interfaces that allowour clients to connect electronically with our host systems and access datacollected from clearance and settlement transactions in multiple currencies.Through these information-sharing tools, we are better equipped to supplementour custody and accounting services with foreign exchange services and assetand transaction reporting and monitoring services. Electronic linkages alsoposition us to respond quickly to client requests.

We use the internet as a means to communicate withclients and external parties. We also provide secure value-added services toour clients over the internet. We utilize a secure extranet environment thatprovides the authentication, access controls, intrusion detection, encryptionand firewalls needed to ensure the protection of client information and assets.Internet-based applications provide our clients with secure electronic accessto their data as well as flexible ad-hoc data query and reporting tools.

Our mainframe processing and mainframe disasterrecovery capability is provided by Electronic Data Systems (‘EDS’), located inPlano, Texas. In addition, International Business Machines (‘IBM’), located inArmonk, New York, provides support for our network and hardware environmentsand our help desk services. By outsourcing these infrastructure supportfunctions, we can focus our resources on systems development and minimize ourcapital investment in large-scale computer equipment. EDS and IBM offer usstate-of-the-art computer products and services, access to which we could nototherwise afford, while removing the risk of product obsolescence. Due to theirlarge and diverse customer bases, EDS and IBM can invest in the latest computertechnology and spread the related costs over multiple users. We also receivethe benefit of the continuing investment by EDS and IBM in their computerhardware. Under both contracts we are billed monthly for services provided byEDS or IBM on an as-used basis in accordance with a predetermined pricingschedule for specific products and services. Our current agreement with EDS isscheduled to expire on December 31, 2008. Our current agreement with IBMis scheduled to expire on June 30, 2011.

Each year we target spending approximately 18-20% ofour consolidated net operating revenue on technology. Because of ourrelationships with EDS and IBM and our system architecture, we are able todevote the majority of our technology investments to development, rather thansupport or infrastructure.

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Our trust processing services are provided by SEIInvestments Company (‘SEI’), located in Oaks, Pennsylvania. SEI is a globalprovider of asset management and investment technology solutions. We pay SEIcertain monthly service fees based upon usage. Our current agreement with SEIis scheduled to expire on December 31, 2009.

Investors Bank maintains acomprehensive Business Continuity Plan (‘BCP’). The program has been developedto comply with guidelines issued by various regulatory and industry bodies suchas the Federal Financial Institutions Examination Council (‘FFIEC’). Theplanning process begins with a business impact analysis which isolates criticalbusiness processes and determines their recoverability under various disruptionscenarios. In addition to maintaining regional backup facilities for alloffices, our locations are geographically diverse in order to allow recovery ofessential functions at another location in the event of a widespread disruption.In 2006, BCP staff conducted 132 different tests to ensure that our technologyinfrastructure, facilities and staff could respond and recover in a disaster.

**Competition**

We operate in a highly competitive environment in allareas of our business. Many of our competitors, including State Street Corporation,JP Morgan Chase, The Bank of New York, Mellon, Citigroup, PNC and NorthernTrust, possess substantially greater financial and marketing resources than wedo and process a greater amount of financial assets. Other competitive factorsinclude technological advancement and flexibility, breadth of services providedand quality of service. We believe that we compete favorably in thesecategories.

Competition in the asset servicing industry,especially over the past decade, has impacted both pricing and margins in coreservices such as global custody. Partially offsetting this more competitivepricing environment is the development of new services that have higher margins.Our continuous investment in technology has permitted us to offer value-addedservices to clients, such as foreign exchange, securities lending andperformance measurement, on a global basis and at competitive prices. Technologicalevolution and service innovation have enabled us to generate additional revenueto offset competitive pricing in maturing service lines.

We believe that our size,commitment to technology development and enhancement and responsiveness toclient needs provide the asset management industry with a very attractive assetservicing alternative to large money center banks and other asset servicers. Asmany of our competitors grow larger through acquisition, we believe that ourcustomized and highly responsive service offerings become even more attractive.While consolidation within the investment management and asset servicingindustries may adversely affect our ability to retain clients that have beenacquired, it also creates opportunity for us as prospective clients reviewtheir relationships with existing service providers that are affected byacquisitions. In addition, consolidation among large financial institutions mayenable us to acquire, at a reasonable price, asset servicing businesses that donot fit within the core focus of these newly consolidated financialinstitutions.

**IntellectualProperty**

Our success is dependentupon our software development methodology and other intellectual propertyrights that we have developed and own, including FACTS. We rely on tradesecret, copyright and trademark laws, and confidentiality agreements withemployees and third parties to protect our proprietary technology, all of whichoffer only limited protection. There can be no assurance that the steps we takein this regard will be adequate to deter misappropriation of our proprietaryinformation or that we will be able to detect unauthorized use. Furthermore,our intellectual property rights may be invalidated or our competitors maydevelop similar technology independently. In addition, effective copyright,trademark, trade secret and other protection may not be available in certaininternational markets that we service.

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**Employees**

On December 31, 2006, we had 4,265 employees. Wemaintain a professional development program for entry level staff. Successfulcompletion of the program is required of most newly hired employees. This trainingprogram is supplemented by ongoing education on systems and technologicaldevelopments and innovations, the financial services industry, the regulatoryenvironment and our client base. This program is administered by experiencedfull-time trainers that continually enhance existing courses and develop newprograms to match an evolving business and regulatory environment.

None of our employees arecovered by collective bargaining agreements, and we believe our relations withour employees are good.

**Regulation andSupervision**

Virtually all aspects ofour business and operations are regulated under state and federal law. Inaddition to the laws governing businesses and employers, we are subject tofederal and state laws and regulations applicable to financial institutions andtheir parent companies. The operations of our securities broker affiliate,Investors Securities Services, LLC, are also subject to federal and statesecurities laws, as well as the rules of both the Securities and ExchangeCommission (‘SEC’) and the National Association of Securities Dealers, Inc.(‘NASD’). The principal objective of state and federal banking laws is themaintenance of the safety and soundness of financial institutions and thefederal deposit insurance system, the protection of consumers or classes ofconsumers and the furtherance of broad public policy goals, rather than thespecific protection of stockholders of a bank or its parent company. Some ofthe significant statutory and regulatory provisions to which we and oursubsidiaries are subject are described below. The description of thesestatutory and regulatory provisions is not complete and is qualified in itsentirety by reference to the particular statutory or regulatory provision. Anychange in applicable law or regulation may have a material effect on ourbusiness, prospects and operations, as well as those of our subsidiaries.

***Investors Financial***

*General.**  *As a registered Bank Holding Company (‘BHC’),Investors Financial is subject to regulation under the Bank Holding Company Actof 1956, as amended (‘BHCA’), and to inspection, examination and supervision bythe Board of Governors of the Federal Reserve System (‘FRB’) and by theMassachusetts Commissioner of Banks (‘Commissioner’). We are required to filereports of our operations with, and are subject to examination by, the FRB andthe Commissioner. The FRB has the authority to issue orders to BHCs to ceaseand desist from unsafe or unsound banking practices and violations ofconditions imposed by, or violations of agreements with, the FRB. The FRB isalso empowered to assess civil money penalties against companies or individualswho violate the BHCA or orders or regulations thereunder, to order terminationof nonbanking activities of nonbanking subsidiaries of BHCs and to ordertermination of ownership and control of a nonbanking subsidiary by a BHC.

*BHCA-Activitiesand Other Limitations.**  *TheBHCA prohibits a BHC from acquiring substantially all the assets of a bank oracquiring direct or indirect ownership or control of more than 5% of any classof the voting shares of any bank, BHC or savings association, or increasingsuch ownership or control of any bank, BHC or savings association, or mergingor consolidating with any BHC without prior approval of the FRB. TheRiegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (‘Riegle-Neal’)permits adequately capitalized and adequately managed BHCs, as determined bythe FRB, to acquire banks located in any state, subject to certainconcentration limits and other conditions. Subject to certain conditions,Riegle-Neal also generally authorizes the interstate mergers of banks and, to alesser extent, interstate branching, as long as the law of the host statespecifically authorizes such action. Massachusetts law imposes certain approvalrequirements with respect to acquisitions by a BHC of certain bankinginstitutions and to mergers of BHCs.

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Unless a BHC becomes a financial holding company (‘FHC’)under the Gramm-Leach-Bliley Act of 1999 (‘GLBA’), the BHCA also prohibits aBHC from acquiring a direct or indirect interest in or control of more than 5%of the voting securities of any company that is not a bank or a BHC and fromengaging directly or indirectly in activities other than those of banking,managing or controlling banks or furnishing services to its subsidiary banks,except that it may engage in and may own shares of companies engaged in certainactivities the FRB determined to be so closely related to banking or managingand controlling banks as to be a proper incident thereto. Before permitting aBHC to engage in such activities that are closely related to banking or makingan investment in a company engaged in such activities, the FRB is required toweigh the expected benefit to the public, such as greater convenience,increased competition or gains in efficiency, against the possible adverseeffects, such as undue concentration of resources, decreased or unfaircompetition, conflicts of interests or unsound banking practices.

The GLBA permits a BHC that qualifies and elects to betreated as a FHC to engage in a significantly broader range of financialactivities than BHCs, such as Investors Financial, that have not elected FHCstatus. “Financial activities” is broadly defined to include not only banking,insurance and securities activities, but also merchant banking and additionalactivities that the FRB, in consultation with the Secretary of the Treasury,determines to be financial in nature or incidental to such financialactivities, or that the FRB determines to be complementary activities that donot pose a substantial risk to the safety and soundness of depositoryinstitutions or the financial system generally. To elect to become a FHC, aBHC, such as Investors Financial, must meet certain tests and file an electionwith the FRB. To qualify, all of a BHC’s subsidiary banks must bewell-capitalized and well-managed, as measured by regulatory guidelines. Inaddition, each of the BHC’s banks must have been rated “satisfactory” or betterin its most recent federal Community Reinvestment Act (‘CRA’) evaluation. A BHCthat elects to be treated as a FHC may face significant consequences if itsbanks fail to maintain the required capital and management ratings, includingentering into an agreement with the FRB which imposes limitations on itsoperations. Investors Financial has not elected to become a FHC.

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

In addition to the risk-based capital requirements,the FRB requires BHCs to maintain a minimum leverage capital ratio of Tier 1capital to its average total consolidated assets (the ‘Leverage Ratio’) of 3%. Totalaverage consolidated assets for this purpose does not include goodwill and anyother intangible assets and investments that the FRB determines should bededucted from Tier 1 capital. The FRB has announced that the 3% Leverage Ratiorequirement is the minimum for the top-rated BHCs. All other BHCs are requiredto maintain a minimum Leverage Ratio of 4%. BHCs with supervisory, financial,operational or managerial weaknesses, as well as BHCs that are anticipating orexperiencing significant growth, are expected to maintain capital ratios wellabove the minimum levels. Because we anticipate significant future growth, wewill be required to maintain a Leverage Ratio of 4% or higher.

We are currently in compliance with both the TotalRisk-Based Capital Ratio and the Leverage Ratio requirements, and managementexpects these ratios to remain in compliance with the FRB’s capital 

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adequacy guidelines. At December 31,2006, our Total Risk-Based Capital Ratio and Leverage Ratio were 19.04% and7.63%, respectively.

In June 2004, the Basel Committee on BankingSupervision (‘Basel Committee’) released the document “InternationalConvergence of Capital Measurement and Capital Standards: A Revised Framework”.The Framework, also referred to as Basel II, is designed to secure internationalconvergence on regulations and standards governing the capital adequacy ofinternationally active banking organizations. In September 2006, the U.S.banking and thrift supervisory agencies issued a Notice of Proposed Rulemakingsetting forth a proposed framework for the timing and qualification process forU.S. banks that are either required (‘core banks’) or choose (‘opt-in banks’)to be subject to Basel II. As currently proposed, the new rules as appliedin the U.S. are expected to become effective on January 1, 2009, subjectto transitional parallel testing beginning on January 1, 2008. AlthoughInvestors Bank is not required to be compliant with the new rules, we are inthe process of developing and implementing a program to achieve Basel II compliance.Ultimately, U.S. implementation of Basel II will depend on, and will be subjectto, final regulations and related policies promulgated by the U.S. supervisoryagencies. We cannot predict the final form of the rules, nor their impact onour risk-based capital.

*ControlAcquisitions.**  *TheChange in Bank Control Act prohibits a person or group of persons fromacquiring “control” of a depository institution or a depository institutionholding company unless the FRB has been notified and has not objected to theproposal. Under a rebuttable presumption established by the FRB, theacquisition of 10% or more of a class of voting securities of a depositoryinstitution or depository institution holding company with a class ofsecurities registered under Section 12 of the Securities Exchange Act of1934, as amended (the ‘Exchange Act’), would, under the circumstances set forthin the presumption, constitute the acquisition of control of the depositoryinstitution or a depository institution holding company. In addition, anycompany, as that term is broadly defined in the statute, would be required toobtain the approval of the FRB under the BHCA before acquiring 25% (5% in thecase of an acquirer that is a BHC) or more of any class of voting securities ofa bank or BHC or a savings association, or otherwise obtaining control or acontrolling influence over such an institution.

*MassachusettsLaw.**  *InvestorsFinancial is also considered a BHC for purposes of Massachusetts law. Accordingly,we have registered with the Commissioner and are obligated to make reports tothe Commissioner. Under Massachusetts law, any person that proposes to acquire,directly or indirectly, 25% or more of any class of voting securities of acompany must give prior notice to the Massachusetts Commissioner of Banks, whomay disapprove the transaction. Additionally, any company that is a BHC underMassachusetts law must obtain the approval of the Massachusetts Board of BankIncorporation before acquiring more than 5% of the voting stock of a company. Asa general matter, however, the Commissioner does not rule upon or regulatethe activities in which a BHC or its nonbank subsidiaries engage.

*CashDividends.*   FRB policy provides that a bank or aBHC generally should not maintain its existing rate of cash dividends on commonstock unless the organization’s net income available to common shareholdersover the past year has been sufficient to fully fund the dividends and theprospective rate of earnings retention appears consistent with the organization’scapital needs, asset quality and overall financial condition. FRB policyfurther provides that a BHC should not maintain a level of cash dividends toits shareholders that places undue pressure on the capital of banksubsidiaries, or that can be funded only through additional borrowings or otherarrangements that may undermine the BHC’s ability to serve as a source ofstrength.

*Source of Strength.**  *FRB policy requires BHCs to serve as sources offinancial and managerial strength to their subsidiary banks and, if necessary,to use available resources to provide adequate capital funds to its subsidiarybanks during periods of financial stress or adversity and to maintain thefinancial flexibility and capital-raising capacity to obtain additionalresources for assisting its subsidiary banks in a 

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manner consistentwith FRB policy. This support may be required at times when the BHC may not havethe resources to provide it. Accordingly, Investors Financial is expected tocommit resources to the Bank in circumstances where it might not do so absentsuch policy.

***Investors Bank***

*General.**  *The Bank is subject to extensive regulation andexamination by the Commissioner and the FRB, its primary federal bankingregulator. The Bank became a member of the Federal Reserve System (‘FRS’) (a ‘statemember bank’) in October 2006. Prior to becoming a state member bank, theBank’s primary federal regulator was the Federal Deposit Insurance Corporation(‘FDIC’). Although the FDIC is no longer its primary federal regulator, theBank, like all insured depository institutions, is nevertheless subject to certainrequirements established by the FDIC, which insures the Bank’s deposits. Thefederal and state laws and regulations that are applicable to banks regulateamong other things, the scope of their business, their investments, theirreserves against deposits, the timing of the availability of certain depositedfunds, the amount of loans to individuals and related borrowers, the nature andamount of and collateral for certain loans, and the amount of interest that maybe charged on loans. Various state consumer laws and regulations also affectthe operations of state banks.

*FDIC Insurance Premiums.**  *The Bank currently pays deposit insurance premiums tothe FDIC based on an assessment rate established by the FDIC for Bank InsuranceFund (‘BIF’)-member institutions. The FDIC has established a risk-based premiumsystem under which the FDIC classifies institutions based on their capitalratios and on other relevant information and generally assesses higher rates onthose institutions that tend to pose greater risks to the federal depositinsurance funds. Prior to the enactment of the Federal Deposit Insurance ReformAct of 2005 (the ‘FDIR Act’) on February 8, 2006, the FDIC was notrequired to charge all banks deposit insurance premiums when the ratio ofdeposit insurance reserves to insured deposits was maintained above specifiedlevels. Under new rules issued by the FDIC pursuant to the FDIR Act,however, the FDIC will impose assessments on all banks at a rate determined bythe institution’s risk classification regardless of the ratio of depositinsurance reserves to insured deposits. The new rules were issued November 2,2006 and became effective on January 1, 2007. An increase in the Bank’sdeposit insurance assessments over previous levels as a result of the new rules wouldhave an adverse effect on net earnings.

*Additionally, as a result of the passage of the FDIR Act:(i) the BIF will be merged with the FDIC’s Savings Association Insurance Fundcreating the Deposit Insurance Fund (the ‘DIF’); (ii) the $100,000 per accountinsurance level will be indexed to reflect inflation; (iii) deposit insurance coveragefor certain retirement accounts will be increased to $250,000; and (iv) a capwill be placed on the level of the DIF and dividends will be paid to banks oncethe level of the DIF exceeds the specified threshold.*

*Capital Requirements.**  *The FRB has promulgated regulations and adopted astatement of policy regarding the capital adequacy of state-chartered banks,which, like the Bank, are not members of the Federal Reserve System. Theserequirements are substantially similar to those adopted by the FRB regardingBHCs.

The Federal DepositInsurance Corporation Improvement Act of 1991 (‘FDICIA’) identifies fivecapital categories for insured depository institutions (well-capitalized,adequately capitalized, undercapitalized, significantly undercapitalized andcritically undercapitalized) and requires the federal bank regulatory agenciesto implement systems for “prompt corrective action” for insured depositoryinstitutions that do not meet minimum capital requirements within suchcategories. FDICIA imposes progressively more restrictive constraints onoperations, management and capital distributions, depending on the category inwhich an institution is classified. Failure to meet the capital guidelinescould also subject a banking institution to capital-raising requirements. An “undercapitalized”bank must develop a capital restoration plan, and its parent holding companymust guarantee that bank’s compliance with the plan. The liability of a parentholding company under any such guarantee is limited to the lesser of 5% of a 

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bank’sassets at the time it became “undercapitalized” or the amount needed to complywith the plan. Furthermore, in the event of the bankruptcy of a parent holdingcompany, such guarantee would take priority over a parent’s general unsecuredcreditors. In addition, FDICIA requires the various regulatory agencies toprescribe certain non-capital standards for safety and soundness relatinggenerally to operations and management, asset quality and executivecompensation, and permits regulatory action against a financial institutionthat does not meet such standards.

The various regulatory agencies have adoptedsubstantially similar regulations that define the five capital categoriesidentified by FDICIA, using the total risk-based capital, Tier 1 risk-basedcapital and leverage capital ratios as the relevant capital measures. Suchregulations establish various degrees of corrective action to be taken when aninstitution is considered undercapitalized. Under the regulations, a “well-capitalized”institution must have a Tier 1 risk-based capital ratio of at least 6%, a totalrisk-based capital ratio of at least 10% and a leverage ratio of at least5% and not be subject to a capital directive order. Regulators also must takeinto consideration (a) concentrations of credit risk; (b) interestrate risk (when the interest rate sensitivity of an institution’s assets doesnot match the sensitivity of its liabilities or its off-balance-sheetposition); and (c) risks from non-traditional activities, as well as aninstitution’s ability to manage those risks, when determining the adequacy ofan institution’s capital. This evaluation will be made as a part of aninstitution’s regular safety and soundness examination. At December 31,2006, the Bank was deemed to be a well-capitalized institution.

*TheCommunity Reinvestment Act.*   The CommunityReinvestment Act (‘CRA’) requires lenders to identify the communities served bythe institution’s offices and other deposit-taking facilities and to make loansand investments and provide services that meet the credit needs of thesecommunities. Regulatory agencies examine each of the banks and rate suchinstitutions’ compliance with CRA as “Outstanding”, “Satisfactory”, “Needs toImprove” or “Substantial Noncompliance”. Failure of an institution to receiveat least a “Satisfactory” rating could inhibit such institution or its holdingcompany from undertaking certain activities, including engaging in activitiesnewly permitted as a financial holding company under the GLBA and acquisitionsof other financial institutions. The FRB and other federal banking agenciesmust take into account the record of performance of banks in meeting the creditneeds of the entire community served, including low- and moderate-incomeneighborhoods, before they approve certain bank acquisitions, mergers, branchestablishments and other transactions proposed by banking organizations. Massachusettshas also enacted a similar statute that requires the Commissioner to evaluatethe Bank’s performance in helping to meet the credit needs of its entirecommunity and to take that record into account in considering certainapplications. Management believes the Bank is currently in compliance with allCRA requirements.

*CustomerInformation Security.**  *TheFRB and other bank regulatory agencies have established standards for safeguardingnonpublic personal information about customers that implement provisions of theGLBA. Specifically, the Information Security Guidelines established by the GLBArequire each financial institution, under the supervision and ongoing oversightof its Board of Directors or an appropriate Board committee, to develop,implement and maintain a comprehensive written information security programdesigned to ensure the security and confidentiality of customer information, toprotect against anticipated threats or hazards to the security or integrity ofsuch information and to protect against unauthorized access to or use of suchinformation that could result in substantial harm or inconvenience to anycustomer.

*Privacy.*   TheGLBA requires financial institutions to implement policies and proceduresregarding the disclosure of nonpublic personal information about consumers tononaffiliated third parties. In general, the statute requires financialinstitutions to explain to consumers their policies and procedures regardingthe disclosure of such nonpublic personal information, and, unless otherwiserequired or permitted by law, financial institutions are prohibited fromdisclosing such information except as provided in their policies andprocedures.

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*USAPatriot Act.**  *The USAPatriot Act of 2001 (the ‘USA Patriot Act’), designed to deny terrorists andothers the ability to obtain anonymous access to the U.S. financial system, hassignificant implications for depository institutions, broker-dealers and otherbusinesses involved in the transfer of money. The USA Patriot Act, togetherwith the implementing regulations of various federal regulatory agencies,require financial institutions, including the Bank, to adopt and implementpolicies and procedures with respect to, among other things, anti-moneylaundering compliance, suspicious activity and currency transaction reporting,customer identity verification and customer risk analysis. The statute and itsunderlying regulations also permit information sharing for counter-terroristpurposes between federal law enforcement agencies and financial institutions,as well as among financial institutions, subject to certain conditions, andrequire federal banking agencies to evaluate the effectiveness of an applicantin combating money laundering activities when considering applications filedunder Section 3 of the BHCA or the Bank Merger Act. Management believesthat we are currently in compliance with all requirements prescribed by the USAPatriot Act and all applicable regulations. 

*Dividends.**  *The FRB has the authority to use its enforcementpowers to prohibit a bank from paying dividends if, in its opinion, the paymentof dividends would constitute an unsafe or unsound practice, and generallyrestricts a state member bank’s ability to pay dividends or other capitaldistributions. For example, a state member bank may not declare or pay adividend if the total of all dividends declared during the calendar year,including the proposed dividend, exceeds the sum of the bank’s net incomeduring the current calendar year and the retained net income of the prior twocalendar years, unless the dividend has been approved by the FRB. Federal lawalso prohibits the payment of dividends by a bank that will result in the bankfailing to meet its applicable capital requirements on a pro forma basis. UnderMassachusetts law, the board of directors of a trust company, such as the Bank,may declare from “net profits” cash dividends no more often than quarterly,provided that there is no impairment to the trust company’s capital stock. Moreover,prior Commissioner approval is required if the total of all dividends declaredby a trust company in any calendar year would exceed the total of its netprofits for that year combined with its retained net profits for the previoustwo years, less any required transfer to surplus or a fund for the retirementof any preferred stock. These restrictions on the Bank’s ability to declare andto pay dividends may limit Investors Financial’s ability to pay dividends toits stockholders. 

*Investments.*   TheFRB imposes quantitative limitations and other conditions, including noticerequirements, on a state member bank’s investments in bank premises, stocks andinvestment securities. The FRB also imposes conditions on a state member bank’sability to invest in foreign corporations. These limitations may prevent theBank from making investments it would otherwise make.

*OtherSecurities Law Issues.**  *TheGLBA requires a bank that acts as investment adviser to a registered investmentcompany to register as an investment adviser or to conduct such advisoryactivities through a separately identifiable department or division of the bankso registered. Accordingly, the Bank furnishes investment advice to registeredinvestment companies through a separately identifiable department or divisionof the Bank that is registered with the SEC as an investment adviser. Federaland state laws impose onerous obligations on registered investment advisers,including fiduciary duties, recordkeeping requirements and disclosure obligations.Currently, management believes that the Bank is in compliance with theserequirements. 

*Regulation of InvestmentCompanies.**  *Certainof our mutual fund and unit investment trust clients are regulated as “investmentcompanies” as that term is defined under the ICA and are subject to examinationand reporting requirements applicable to the services we provide. Theprovisions of the ICA and the regulations promulgated thereunder prescribe thetype of institution which may act as a custodian of investment company assets,as well as the manner in which a custodian administers the assets in itscustody. Because we serve as custodian for a number of our investment companyclients, these regulations require, among other things, that we maintaincertain minimum aggregate capital, surplus, and undivided profits. Additionally,arrangements between us and clearing agencies or other securities depositoriesmust meet 

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ICA requirementsfor segregation of assets, identification of assets and client approval. Currently,management believes we are in compliance with all minimum capital andsecurities depository requirements. Investment companies are also subject toextensive recordkeeping and reporting requirements. These requirements dictatethe type, volume and duration of the recordkeeping we undertake, either in ourrole as custodian for an investment company or as a provider of administrativeservices to an investment company. Further, we must follow specific ICAguidelines when calculating the net asset value of a client mutual fund. Consequently,changes in the statutes or regulations governing recordkeeping and reporting orvaluation calculations will affect the manner in which we conduct ouroperations.

**Availability of Filings**

You may access, free of charge, copies of the following documents andrelated amendments, if any, in the Investor Relations section of our web siteat www.ibtco.com:

1)              OurAnnual Reports on Form 10-K;

2)              OurQuarterly Reports on Form 10-Q; 

3)              OurCurrent Reports on Form 8-K; and

4)              Our ProxyStatement.

You may also access, free of charge, copies of the following corporategovernance documents in the Investor Relations section of our website atwww.ibtco.com:

1)              OurCode of Conduct;

2)              OurCorporate Governance Guidelines;

3)              OurAudit Committee Charter;

4)              OurNominating and Corporate Governance Committee Charter; and

5)              OurCompensation Committee Charter.

Wepost these documents on our web site as soon as reasonably practicable after wefile or furnish them electronically with or to the Securities and ExchangeCommission or, in the case of the corporate governance documents, as soon asreasonably practicable after material amendment. The information contained onour web site is not incorporated by reference into this document and should notbe considered a part of this Report. Our web site address is included in thisdocument as an inactive textual reference only.

**ITEM 1A.**        RISKFACTORS.

*Our operatingresults are subject to fluctuations in interest rates and the securitiesmarkets.*

A significant portion of our fees is based on themarket value of the assets we process. Accordingly, our operating results aresubject to fluctuations in interest rates and securities markets as thesefluctuations affect the market value of assets processed. Our net interestincome is primarily driven by the spread between earnings on our investmentsand loan portfolios relative to our cost of funds. The relationship betweenshort-term and long-term interest rates, referred to as the shape of the yieldcurve, affects the market value of, and the earnings produced by, ourinvestment and loan portfolios, and thus could impact our net interest income. Inaddition, narrower investment portfolio reinvestment and purchase spreads haveimpacted, and could potentially continue to impact, our net interest income.

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Volatility in the equity markets can have a materialeffect on our asset-based fees. While reductions in asset servicing fees may beoffset by increases in other sources of revenue, a sustained downward movementof the broad equity markets will likely have an adverse impact on our earnings.

Our growth depends in parton the ability of our clients to generate fund flows by selling theirinvestment products to new and existing investors. Fluctuations in interest ratesor the securities markets can lead to investors seeking alternatives to theinvestment offerings of our clients, which could result in a lesser amount ofassets processed and correspondingly lower fees. For example, if the value of equity or fixed income assets heldby our clients were to increase or decrease by 10% for a sustained period oftime, we estimate currently that this market movement, by itself, would cause acorresponding change of less than 5% in our earnings per share.

*We may not consummateour merger with State Street Corporation.*

Consummation of thetransaction contemplated by the Agreement and Plan of Merger is subject tocustomary closing conditions, including stockholder and regulatory approval. Failureto complete the merger could have a material adverse impact on our ability tosell our services to new clients.

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

As a result of our ongoing relationship with BGI’siShares and Master Investment Portfolios, our assumption of the operations ofthe U.S. asset administration unit of BGI in 2001 and our servicing assets forBarclays Global Investors Canada, Ltd., BGI accounted for approximately 18%,18% and 17% of our net operating revenue for the years ended December 31,2006, 2005 and 2004, respectively. During 2006, we renewed our U.S. assetadministration outsourcing agreement and our iShares and Master InvestmentPortfolio custody and fund accounting agreements with BGI, and we expect thatBGI will continue to account for a significant portion of our net operatingrevenue. We provide services to BGI under long-term contracts that may beterminated before the expiration of the contracts under certain circumstancesthat we have described in filings with the SEC as described below. While webelieve that our relationship with BGI is excellent, the loss of BGI’s businesswould cause our net operating revenue to decline significantly and would havean adverse effect on our quarterly and annual results. 

The outsourcing agreement was renewed pursuant to anamendment (the ‘Amendment’) to the Custodial, Fund Accounting and ServicesAgreement between the Bank and BGI dated May 1, 2001 (the ‘CustodialAgreement’). Under the terms of the Amendment, the Custodial Agreement isextended through April 30, 2013. As provided in the Amendment, BGI mayterminate the Custodial Agreement upon sixty days prior written notice: (i) asto any underlying account if BGI fails to receive any consent required by lawfor the Bank to act as servicing agent for such account; (ii) as to anyunderlying account if the continued provision of services by the Bank to suchaccount would be inconsistent with BGI’s fiduciary duties under applicable law;or (iii) as to the entire Custodial Agreement in the event a conservatoror receiver is appointed for the Bank under applicable federal law. Inaddition, BGI may terminate the Custodial Agreement prior to April 30, 2013if the Bank fails to meet a certain number of service level commitments forfour consecutive months in any rolling twelve-month period or if the Bankmaterially breaches a material provision of the Custodial Agreement, in bothcases subject to customary notice and opportunity to cure provisions.

Also, under the terms ofthe Amendment, the parties have agreed to assess the fee schedule andstatus of each party and of the industry 90 days prior to November 1, 2009and to negotiate in good faith any appropriate amendments to the feeschedule arising from that assessment. If the parties are unable to agreeon an amended fee schedule by November 1, 2009, BGI may terminate theCustodial Agreement. 

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TheAmendment also provides that the Bank will continue to service BGI for up totwo years, or longer under certain circumstances, after expiration ortermination by BGI of the Custodial Agreement.

*We may incur lossesdue to operational errors.*

The services that weprovide require complex processes and interaction with numerous third parties. Whilewe maintain sophisticated computer systems and a comprehensive system ofinternal controls, and our operational history has been excellent, from time totime we may make operational errors for which we are responsible to our clients.In addition, even though we maintain appropriate errors and omissions and otherinsurance policies, an operational error could result in a significantliability to us and may have a material adverse effect on our results ofoperations.

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

We are part of anextremely competitive asset servicing industry. Many of our current andpotential competitors have longer operating histories, greater name recognitionand substantially greater financial, marketing and other resources than we do. Thesegreater resources could, for example, allow our competitors to developtechnology superior to our own. In addition, we face the risk that large mutualfund complexes may build in-house asset servicing capabilities and no longeroutsource these services to us. As a result, we may not be able to competeeffectively with current or future competitors, which could result in a loss ofexisting clients or difficulty in gaining new clients.

*We may incursignificant costs defending legal claims.*

We have been named inlawsuits in U.S. District Court in Massachusetts alleging, among other things,violations of securities laws. While we believe these claims are without merit,we cannot be sure that we will prevail in the defense of these claims. We arealso party to other litigation and we may become subject to other legal claimsin the future. Litigation is costly and could divert the attention of management.For a more detailed discussion of our ongoing lawsuits, please see Item 3.Legal Proceedings, in Part I of this report. 

*The failure to properly manage our growth couldadversely affect the quality of our services and result in the loss of clients.*

We have experienced aperiod of rapid growth that has required the dedication of significantmanagement and other resources. Continued growth could place a strain on ourmanagement and other resources. To manage future growth effectively, we mustcontinue to invest in our operational, financial and other internal systems,and our human resources, which could affect our profitability. 

*We must hire andretain skilled personnel in order to succeed.*

Qualified personnel, inparticular managers and other senior personnel, are in great demand throughoutthe financial services industry. As a result, we could find it increasinglydifficult to continue to attract and retain sufficient numbers of these highlyskilled employees, which could affect our ability to attract and retain clients.In addition, uncertainty regarding integration in our merger with State StreetCorporation could cause key employees to seek employment elsewhere.

*We may not reap allor any of the expected benefits of our recent increased spending.*

To position us for futuregrowth, we have accelerated some disciplined investments during 2006. Webelieve our investments in personnel, technology and office space are necessaryto support our future growth in areas such as Europe, technology, alternativeinvestments, middle office outsourcing and fund 

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services.While these investments have and will continue to decrease our short-termoperating margins, we believe they are necessary to build the foundation forfuture growth. However, we may not reap any or all of the expected benefits ofour recent investments.

*We may not be ableto protect our proprietary technology.*

Our proprietary technologyis 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. Theseintellectual property rights may be invalidated or our competitors may developsimilar technology independently. Legal proceedings to enforce our intellectualproperty rights may be unsuccessful and could also be expensive and divertmanagement’s attention. 

*Our quarterly andannual operating results may fluctuate.*

Our quarterly andannual operating results are difficult to predict and may fluctuate fromquarter to quarter and annually for several reasons, including: 

·       Thetiming of commencement or termination of client engagements; 

·       Changesin interest rates, the relationship between different interest rates or equityvalues;

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

·       Thetiming and magnitude of share repurchases under our share repurchase plan. 

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

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

Federal and state lawsand regulations applicable to financial institutions and their parent companiesapply to us. Our primary regulators are the Federal Reserve Board of Governors(‘FRB’), the Federal Deposit Insurance Corporation (‘FDIC’), the Office of theCommissioner of Banks of the Commonwealth of Massachusetts, the Securities andExchange Commission, the National Association of Securities Dealers, Inc.(‘NASD’), the State of Vermont Department of Banking, Insurance, Securities andHealth Care Administration (‘BISHCA’), the Office of the Superintendent ofFinancial Institutions in Canada (‘OSFI’), the Irish Financial ServicesRegulatory Authority (‘IFSRA’), the Cayman Islands Monetary Authority (‘CIMA’),the Financial Services Authority in the United Kingdom (‘FSA’) and theCommission de Surveillance du Secteur Financier in Luxembourg (‘CSSF’). Virtuallyall aspects of our operations are subject to specific requirements orrestrictions and general regulatory oversight including the following: 

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

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

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

·       TheNASD maintains certain regulatory requirements that our securities brokeraffiliate, Investors Securities Services, LLC, must meet. Failure to meet thoserequirements could lead to severe regulatory action; 

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·       BISHCAmaintains certain regulatory requirements that our insurance captive affiliate,Investors Vermont Insurance Company, must meet. Failure to meet thoserequirements could lead to regulatory action; and

·       Ourinternational operations are subject to regulatory oversight by regulators inthe jurisdictions in which we operate, including the OSFI, the IFSRA, the CIMA,the FSA and the CSSF. Failure to comply with applicable internationalregulatory requirements could result in regulatory action and impact our abilityto provide services in those jurisdictions.

Banking law restricts ourability to own the stock of certain companies and also makes it more difficultfor us to be acquired. Also, we have not elected financial holding companystatus under the federal Gramm-Leach-Bliley Act of 1999. This may place us at acompetitive disadvantage with respect to other organizations. 

**ITEM 1B.**       UNRESOLVEDSTAFF COMMENTS

None.

**ITEM 2.**                PROPERTIES.

Thefollowing table provides certain summary information with respect to the principalproperties that we leased as of December 31, 2006:

| **Location**                            | ** ** | ** **                                          | ** ** | **Function** | ** ** | **Sq. Ft.** | ** ** | **Expiration Date** | ** ** |
|-----------------------------------------|------------|-----------------------------------------------------|------------|--------------|------------|------------------|------------|--------------------------|------------|
| 200 Clarendon  Street, Boston, MA       |       | Principal  Executive Offices and  Operations Center |       | 387,127      |       |             | 2014       |                     |       |
| 100 Huntington  Avenue, Boston, MA      |       | Operations  Center                                  |       | 350,647      |       |             | 2014       |                     |       |
| 800 Boylston  Street, Boston, MA        |       | Operations  Center                                  |       | 49,430       |       |             | 2014       |                     |       |
| 1 Exeter Plaza,  Boston, MA             |       | Training  Center                                    |       | 14,870       |       |             | 2007       |                     |       |
| 980 Ninth Street,  Sacramento, CA       |       | Operations  Center                                  |       | 79,421       |       |             | 2015       |                     |       |
| 1277 Treat  Boulevard, Walnut Creek, CA |       | Operations  Center                                  |       | 18,921       |       |             | 2008       |                     |       |
| 33 Maiden Lane,  New York, NY           |       | Operations  Center                                  |       | 21,994       |       |             | 2011       |                     |       |
| Iveagh Court,  Dublin                   |       | Offshore  Processing Center                         |       | 67,183       |       |             | 2028       | *                        |       |
| Park Place,  Dublin                     |       | Offshore  Processing Center                         |       | 40,388       |       |             | 2031       | **                       |       |
| 1 First Canadian  Place, Toronto   |       | Offshore  Processing Center                         |       | 17,790       |       |             | 2011       |                     |       |
| 17 Dominion  Street, London             |       | Operations  Center                                  |       | 4,478        |       |             | 2010       |                     |       |
| 26 Boulevard Royal,  Luxembourg         |       | Operations Center                                   |       | 474          |       |             | 2007       |                     |       |

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*                    Pursuant tothe terms of the contract, this lease can be terminated in 2013 by paying sixmonths rent as compensation.

**             Pursuant to the termsof the contract, this lease can be terminated in 2019 by paying twelve monthsrent as compensation.

For more information, seeNote 16 of our Notes to Consolidated Financial Statements included in thisReport.

**ITEM 3.**                LEGALPROCEEDINGS.

On June 27, 2003, we and an individual employeeof ours were named in a lawsuit alleging, among other things, that we breachedan implied covenant of good faith and fair dealing in a subadvisory contractwith Opus Investment Management, Inc. and that our individual employeeengaged in a breach of fiduciary duties and tortious interference with acontract. The lawsuit was filed in the Superior Court of Worcester, Massachusettsand sought unspecified damages. In October 2006, the parties settled the 

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lawsuit. Included in otheroperating expenses in our consolidated statement of income for the year ended December 31,2006 is approximately $1.8 million for settlement costs, legal fees andadministrative costs related to the settlement.

We and certain of our officers were named asdefendants in three purported class action complaints that were filed on orabout August 4, 2005, August 15, 2005, and September 30, 2005 inthe United States District Court for the District of Massachusetts, Boston,Massachusetts. The U.S. District Court has consolidated those cases andappointed lead plaintiffs, who filed a consolidated complaint against us andseven of our current and former officers on February 3, 2006. Among otherthings, the consolidated complaint asserts that the defendants violatedSections 10(b) and 20(a) of the Securities Exchange Act of 1934during the period April 10, 2001 until July 15, 2005. The allegationsin the consolidated complaint predominantly relate to: (1) our October 2004restatement of our financial results, and (2) our July 2005 revisionof public guidance regarding our future financial performance. The consolidatedcomplaint seeks unspecified damages, interest, fees, and costs. On May 14,2006, we filed a motion to dismiss all claims asserted in the consolidatedcomplaint. That motion is currently pending before the Court. We stronglybelieve that the lawsuit lacks merit and we intend to defend against the claimsvigorously. However, we cannot predict the outcome of the lawsuit at this time,and we can give no assurance that it will not materially adversely affect ourfinancial condition or results of operations.

We and nine of our officers and directors are named asdefendants in two shareholder derivative complaints that were filed on or aboutSeptember 22, 2005 and October 17, 2005 in the United States DistrictCourt for the District of Massachusetts, Boston, Massachusetts. Among otherthings, the complaints assert that the defendants are liable for breach offiduciary duty, unjust enrichment, abuse of control, mismanagement,misappropriation of information, insider trading, and violation of Section 14(a) ofthe Securities Exchange Act of 1934. The complaint filed on September 22,2005 also seeks reimbursement under the Sarbanes-Oxley Act of 2002. Theallegations in the complaints predominantly relate to: (1) our October 2004restatement of our financial results, and (2) our July 2005 revisionof public guidance regarding our future financial performance. The complaintsseek unspecified damages, attorneys’ fees, accountant and expert fees, andcosts. We are also named as a nominal defendant in these complaints, althoughthe actions are derivative in nature and purportedly asserted on behalf of us. Weare in the process of evaluating these claims. However, we cannot predict theoutcome of the lawsuits at this time, and we can give no assurance that theywill not materially adversely affect our financial condition or results ofoperations.

In July 2000, two of our Dublin subsidiaries,Investors Trust & Custodial Services (Ireland) Ltd. (‘ITC’) andInvestors Fund Services (Ireland) Ltd. (‘IFS’), received a plenary summonsin the High Court, Dublin, Ireland. The summons named ITC and IFS as defendantsin an action brought by the FTF ForexConcept Fund Plc (the ‘Fund’), a formerclient. The summons also named as defendants FTF Forex Trading and Finance,S.A., the Fund’s investment manager, Ernst & Young, LLP, the Fund’sauditors, and Dresdner Bank-Kleinwort Benson (Suisse) S.A., a tradingcounterparty to the Fund. The Fund is an investment vehicle organized in Dublinto invest in foreign exchange contracts. A total of approximately$4.7 million had been invested in the Fund. Most of that money was lostprior to the Fund’s closing to subscriptions in June 1999. In January 2001,ITC, IFS and the other defendants named in the plenary summons received astatement of claim by the Fund seeking unspecified damages allegedly arisingfrom breach of contract, misrepresentation and breach of warranty, negligenceand breach of duty of care, and breach of fiduciary duty, among others. We havenotified our insurers and intend to defend this claim vigorously. Based on ourinvestigation through December 31, 2006, we do not expect this matter tohave a material adverse effect on our business, financial condition or resultsof operations.

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**PART II**

**ITEM5.**                MARKET FORREGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASE OFEQUITY SECURITIES.

**Price Range of Common Stock and Dividend History andPolicy**

Ourcommon stock is quoted on the NASDAQ Global Select Market under the symbol “IFIN”.The following table sets forth, for the calendar periods indicated, the highand low sale prices for the common stock as reported by NASDAQ and dividendsper share paid on the common stock.

| ** **     | ** ** | **High** | ** ** | **Low** | ** ** | **Dividend** | ** ** |
|----------------|------------|----------|------------|---------|------------|--------------|------------|
| **2006**       |       |     |       |    |       |         |       |
| First quarter  |       | $        | 48.11      |    | $          | 36.36        |       | $ | 0.0225 |   |
| Second quarter |       | 50.98    |       | 41.40   |       | 0.0225       |       |
| Third quarter  |       | 46.82    |       | 41.49   |       | 0.0225       |       |
| Fourth quarter |       | 44.26    |       | 37.00   |       | 0.0225       |       |
| **2005**       |       |     |       |    |       |         |       |
| First quarter  |       | $        | 53.44      |    | $          | 45.33        |       | $ | 0.0200 |   |
| Second quarter |       | 51.05    |       | 36.05   |       | 0.0200       |       |
| Third quarter  |       | 42.80    |       | 31.67   |       | 0.0200       |       |
| Fourth quarter |       | 40.98    |       | 30.64   |       | 0.0200       |       |

 

As of January 31,2007, there were approximately 587 stockholders of record.

We currently intend toretain the majority of future earnings to fund the development and growth ofour business. Our ability to pay dividends on our common stock may depend onthe receipt of dividends from Investors Bank. In addition, we may not paydividends on our common stock if we are in default under certain agreementsthat we entered into in connection with the sale of the 9.77% CapitalSecurities by Investors Capital Trust I. See Note 10 of our Notes toConsolidated Financial Statements included with this Report. Any dividendpayments by Investors Bank are subject to certain restrictions imposed by federallaw and by the Massachusetts Commissioner of Banks. See ‘Business - Regulationand Supervision’ for additional information. Subject to regulatoryrequirements, we expect to pay an annual dividend to our stockholders,currently estimated to be in an amount equal to $0.10 per share of outstandingcommon stock (approximately $6.6 million based upon 65,628,108 sharesoutstanding as of December 31, 2006). We expect to declare and pay suchdividend ratably on a quarterly basis.

The information requiredunder this item regarding securities authorized for issuance under equitycompensation plans is incorporated herein by reference to the section entitled ‘StockPlans’ contained in our definitive proxy statement pursuant to Regulation 14A,which proxy statement will be filed with the Securities and Exchange Commissionnot later than 120 days after the close of our fiscal year ended December 31,2006.

**Purchases of Equity Securities by the Issuer andAffiliated Purchasers**

| **Period**                                | ** ** | ** ** | ** ** | **a**  | ** ** | **b**  | ** ** | **c**  | ** **  | **d**       | ** ** |
|-------------------------------------------|------------|------------|------------|--------|------------|--------|------------|--------|-------------|-------------|------------|
| October 1 -  October 31, 2006   |       | 113,600    |       | $      | 38.40      |   | 113,600    |   | $           | 145,638,023 |       |
| November 1 -  November 30, 2006 |       | 656,434    |       | $      | 38.80      |   | 641,639    |   | $           | 120,735,516 |       |
| December 1 -  December 31, 2006 |       | —     |       | — |       | — |       | $      | 120,735,516 |        |
| Total                                     |       | 770,034    |       | $      | 38.74      |   | 755,239    |   | $           | 120,735,516 |       |

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(a)           Totalnumber of shares purchased

(b)          Average price paid pershare

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

(d)          Approximate dollar valuethat may yet be purchased under the plan

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In June 2006, weannounced that our Board of Directors had authorized a new repurchase plan ofup to $150.0 million of our common stock in the open market over the twelvemonths following the announcement. We do not expect our stock repurchaseprogram to have a material impact on our capital resources, such as maintainingrisk-based capital ratios in excess of capital adequacy guidelines and ourability to pay dividends on our common stock. As of December 31, 2006, wehave repurchased 755,239 shares totaling approximately $29.3 million underthis plan. The plan expires in June 2007.

**Stock Performance**

The following graphcompares the change in the cumulative total stockholder return on the Company’scommon stock for the period from January 1, 2002 through December 31,2006, with the cumulative total return on the Center for Research in SecuritiesPrices Index for the NASDAQ Stock Market (‘NASDAQ Stock Market Index’) and theCenter for Research in Securities Prices Index for NASDAQ financial stocks (‘NASDAQFinancial Stocks Index’). The comparison assumes $100 was invested on December 31,2001 in the Company’s common stock at the $32.77 closing price on that day andin each of the foregoing indices and assumes reinvestment of dividends, if any.

**Comparison of Five Year**Cumulative Total Return Among

**Investors Financial Services Corp., NASDAQ StockMarket Index**

**and NASDAQ Financial Stocks Index**

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The following graphcompares the change in the cumulative total stockholder return on the Company’scommon stock for the period from January 1, 1996 through December 31,2006, with the cumulative total return on the Center for Research in SecuritiesPrices Index for the NASDAQ Stock Market (‘NASDAQ Stock Market Index’) and theCenter for Research in Securities Prices Index for NASDAQ financial stocks (‘NASDAQFinancial Stocks Index’). The comparison assumes $100 was invested on December 29,1995 in the Company’s common stock at the $2.53 closing price on that day andin each of the foregoing indices and assumes reinvestment of dividends, if any.

**Comparison of Ten Year**Cumulative Total Return Among

**Investors Financial Services Corp., NASDAQ StockMarket Index**

**and NASDAQFinancial Stocks Index**

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**ITEM 6.**                SELECTEDFINANCIAL DATA.

The following tablecontains certain of our consolidated financial and statistical information andshould be read in conjunction with ‘Management’s Discussion and Analysis ofFinancial Condition and Results of Operations’, our Consolidated FinancialStatements and Notes to Consolidated Financial Statements, and other financialinformation appearing elsewhere in this Report. (Dollars in thousands, exceptper share and employee data):

| ** **                            | ** ** | **For the Year Ended December 31,** | ** **    |
|---------------------------------------|------------|--------------------------------------------------------------|---------------|
| ** **                            | ** ** | **2006**                                                     | ** **    | **2005** | ** ** | **2004** | ** ** | **2003**(1) | ** ** | **2002** | ** ** |
| **Statement  of Income Data:**        |       |                                                         |          |   |   |   |   |   |   |   |   |
| Noninterest income                    |       | $                                                            | 639,454       |   | $ | 525,537 |   | $ | 425,491 |   | $ | 336,193 |   | $ | 298,844 |   |
| Net interest income                   |       | 164,194                                                      |          | 170,425 |   | 187,680 |   | 153,914 |   | 138,725 |   |
| Net operating revenues                |       | 803,648                                                      |          | 695,962 |   | 613,171 |   | 490,107 |   | 437,569 |   |
| Operating expenses                    |       | 579,354                                                      |          | 460,109 |   | 398,383 |   | 344,921 |   | 341,395 |   |
| Income before income  taxes           |       | 224,294                                                      |          | 235,853 |   | 214,788 |   | 145,186 |   | 96,174 |   |
| Income taxes                          |       | 70,491                                                       |          | 76,035 |   | 72,826 |   | 52,765 |   | 28,737 |   |
| Net income                            |       | $                                                            | 153,803       |   | $ | 159,818 |   | $ | 141,962 |   | $ | 92,421 |   | $ | 67,437 |   |
| **Per  Share Data:**                  |       |                                                         |          |   |   |   |   |   |   |   |   |
| Basic earnings per share              |       | $                                                            | 2.34          |   | $ | 2.42 |   | $ | 2.15 |   | $ | 1.42 |   | $ | 1.05 |   |
| Diluted earnings per  share           |       | $                                                            | 2.28          |   | $ | 2.37 |   | $ | 2.09 |   | $ | 1.39 |   | $ | 1.02 |   |
| Dividends per share                   |       | $                                                            | 0.09          |   | $ | 0.08 |   | $ | 0.07 |   | $ | 0.06 |   | $ | 0.05 |   |
| **Balance  Sheet Data:**              |       |                                                         |          |   |   |   |   |   |   |   |   |
| Total assets at end of  period        |       | $                                                            | 11,558,206    |   | $ | 12,088,734 |   | $ | 11,142,690 |   | $ | 9,223,178 |   | $ | 7,214,740 |   |
| **Average  Balance Sheet Data:**      |       |                                                         |          |   |   |   |   |   |   |   |   |
| Interest-earning assets               |       | $                                                            | 11,288,335    |   | $ | 11,364,656 |   | $ | 9,770,924 |   | $ | 7,556,061 |   | $ | 5,769,971 |   |
| Total assets                          |       | 11,929,813                                                   |          | 12,033,698 |   | 10,276,479 |   | 8,139,985 |   | 6,173,187 |   |
| Total deposits                        |       | 5,453,856                                                    |          | 4,099,305 |   | 4,495,858 |   | 3,153,306 |   | 2,342,247 |   |
| Junior subordinated  debentures(2)    |       | 24,774                                                       |          | 24,774 |   | 24,774 |   | 24,194 |   | — |   |
| Trust preferred  securities(2)        |       | —                                                       |          | — |   | — |   | — |   | 24,667 |   |
| Common stockholders’  equity     |       | 866,514                                                      |          | 758,552 |   | 625,964 |   | 483,923 |   | 395,101 |   |
| **Selected  Financial Ratios:**       |       |                                                         |          |   |   |   |   |   |   |   |   |
| Return on average equity              |       | 17.7                                                         | %             | 21.1 | % | 22.7 | % | 19.1 | % | 17.1 | % |
| Return on average assets              |       | 1.3                                                          | %             | 1.3 | % | 1.4 | % | 1.1 | % | 1.1 | % |
| Average common  equity as a % of      |       |                                                         |          |   |   |   |   |   |   |   |   |
| average assets                        |       | 7.3                                                          | %             | 6.3 | % | 6.1 | % | 5.9 | % | 6.4 | % |
| Dividend payout ratio(3)              |       | 3.9                                                          | %             | 3.4 | % | 3.3 | % | 4.3 | % | 4.9 | % |
| Tier 1 capital ratio(4)               |       | 19.0                                                         | %             | 18.5 | % | 20.5 | % | 17.6 | % | 15.3 | % |
| Leverage ratio(4)                     |       | 7.6                                                          | %             | 6.0 | % | 5.9 | % | 5.4 | % | 5.4 | % |
| Noninterest income  as % of net       |       |                                                         |          |   |   |   |   |   |   |   |   |
| operating income                      |       | 79.6                                                         | %             | 75.5 | % | 69.4 | % | 68.6 | % | 68.3 | % |
| **Other  Statistical Data:**          |       |                                                         |          |   |   |   |   |   |   |   |   |
| Assets processed at end  of period(5) |       | $                                                            | 2,211,740,622 |   | $ | 1,792,571,911 |   | $ | 1,430,471,217 |   | $ | 1,056,871,924 |   | $ | 785,418,321 |   |
| Employees at end of  period           |       | 4,265                                                        |          | 3,252 |   | 2,778 |   | 2,413 |   | 2,591 |   |

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(1)             Effective July 1, 2003, we adopted the provisionsof Statement of Financial Accounting Standards No. 150, *Accounting for Certain Financial Instruments with Characteristics ofboth Liabilities and Equity*, which resulted in a reclassification ofthe trust preferred securities from mezzanine financing to liabilities. Assuch, interest expense associated with the trust preferred securities wasreclassified to net interest income.

(2)             Effective October 1, 2003, we adoptedthe provisions of FASB Interpretation No. 46 (revised December 2003),*Consolidation of Variable Interest Entities*,which resulted in the deconsolidation of Investors Capital Trust I, the trustthat holds the trust preferred securities.

(3)             We intend to retain the majority of futureearnings to fund development and growth of our business. We currently expect topay cash dividends at an annualized rate of $0.10 per share subject toregulatory requirements. Refer to ‘Liquidity’ included in Management’sDiscussion and Analysis of Financial Condition and Results of Operations forfurther information.

(4)             Refer to ‘Capital Resources’ includedwithin Management’s Discussion and Analysis of Financial Condition and Resultsof Operations for further information.

(5)             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, fundadministration, middle office outsourcing, foreign exchange, cash management,securities lending, investment advisory, performance measurement, institutionaltransfer agency, lines of credit and brokerage and transition managementservices.

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**ITEM 7.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

*You should read the following discussion together withour Consolidated Financial Statements and related Notes to ConsolidatedFinancial Statements, which are included elsewhere in this Report. Thefollowing discussion contains forward-looking statements that reflect plans,estimates and beliefs. Our actual results could differ materially from thosediscussed in the forward-looking statements. See “Certain Factors That May AffectFuture Results” herein.*

**Overview**

We provide assetadministration services for the financial services industry through ourwholly-owned subsidiary, Investors Bank & Trust Company. We providecore services and value-added services to a variety of financial assetmanagers, including mutual fund complexes, investment advisors, hedge funds,family offices, banks and insurance companies. Core services include globalcustody, multicurrency accounting, fund administration and middle officeoutsourcing. Value-added services include foreign exchange, cash management,securities lending, investment advisory, performance measurement, institutionaltransfer agency, lines of credit and brokerage and transition managementservices. We have offices located in the United States, Ireland, Canada, theCayman Islands, the United Kingdom and Luxembourg with a vast globalsubcustodian network established to accommodate the international needs of ourclients. At December 31, 2006, we provided services for approximately $2.2trillion in net assets, including approximately $0.4 trillion in foreign netassets.

We grow our business byselling our services to new clients and by further penetrating our existingclients. We believe that we service approximately 12% of the assets managed byour existing clients, and we have traditionally achieved significant success ingrowing client relationships. Our ability to service new clients and expand ourrelationships with existing clients depends on our provision of superior clientservice. Our growth is also affected by conditions in the global securitiesmarkets, the interest rate environment, the regulatory environment for us andour clients and the success of our clients in marketing their products.

We derive our assetservicing revenue from providing core and value-added services. We derive ournet interest income by investing the cash balances our clients leave on depositwith us. Since we price our service offerings on a bundled basis, our share ofearnings from these investments is viewed as part of the total compensationthat our clients pay us for servicing their assets. In establishing a feestructure for a specific client, we analyze all expected revenue and expenses. Webelieve net operating revenue (noninterest income plus net interest income )and net income are the most meaningful measures of our financial results.

As an asset administrationservices company, the amount of net operating revenue that we generate isimpacted by overall market conditions, client activity and the prevailinginterest rate environment. A significant portion of our core services revenueis based upon the amount of assets we process. As market values of underlyingassets fluctuate, so will our revenue. We have managed this volatility byoffering a tiered pricing structure for our asset-based fees. As asset valuesincrease, the basis point fee is reduced for the incremental assets. When assetvalues decrease, revenue is only impacted at the then marginal rate. Many ofour value-added services are transactional based, and we receive a fee for eachtransaction processed. The lower net interest margin experienced during 2006 ascompared to 2005 is primarily a result of external market factors and therepricing characteristics of our balance sheet. The yield curve remainedinverted for the majority of 2006, impacting reinvestment and purchase spreadson investments. The majority of our liability base reprices to overnight orshort-term rates which, given the increase in short-term rates during the firsthalf of 2006, has also contributed to lower net interest margin results year-to-date.

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To position us for futuregrowth, we accelerated some disciplined investments during the third and fourthquarters of 2006. We believe our investments in personnel, technology andoffice space are necessary to support our future growth in areas such astechnology, alternative investments, middle office outsourcing, fund servicesand our European presence. While these investments have and will continue todecrease our short-term operating margins through the first half of 2007, webelieve they are necessary to position us for future growth.

**Critical Accounting Policies**

Our consolidated financialstatements are prepared in accordance with accounting principles generally acceptedin the United States of America, which require us to make estimates andassumptions. We have identified the following accounting policies that, as aresult of the complexities of the underlying accounting standards andoperations involved, could result in significant changes to our consolidatedfinancial condition or consolidated results of operations under differentconditions or using different assumptions. Senior management has discussedthese critical accounting policies with the Audit Committee.

***Derivative Financial Instruments—******Cash*** flowhedge accounting requires that we measure the changes in fair value ofderivatives designated as hedges as compared to changes in expected cash flowsof the underlying hedged transactions for each reporting period. This processinvolves the estimation of the expected future cash flows of hedgedtransactions. Interest rate swaps are valued using a nationally recognized swapvaluation model. The LIBOR (London InterBank Offered Rate) curve in this modelserves as the basis for computing the market value of the swap portfolio. Ifshort-term interest rates increase, as they did during the first half of 2006,we would expect the swaps to gain in value. Conversely, if short-term interestrates decrease, we would expect there to be a corresponding decline in themarket value of the swap portfolio. The measurement of fair value of ourderivatives portfolio is based upon market interest rate curve and spreads.

***Defined Benefit Pension Assumptions—******Each*** fiscalyear, we must assess and select the discount rate, compensation increasepercentage and average return on plan assets assumptions in order to determineour net periodic pension cost and to project our benefit obligations under ourdefined benefit plans. The discount rate is based on the weighted-average yieldon high-quality fixed-income investments that are expected to match the plan’sprojected cash flows. The compensation increase percentage is based uponmanagement’s current and expected salary increases. The average return on planassets is based on the expected return on the plan’s current investmentportfolio, which can reflect the historical returns of the various assetclasses.

For the fiscal year ended December 31,2006, the discount rate used to determine the projected benefit obligations forboth our qualified defined benefit pension plan (‘pension plan’) and ournonqualified, unfunded, supplemental retirement plan (‘SERP’) was 6.00%. Thediscount rate was 0.25% higher than the rate at December 31, 2005primarily due to increased yields in long-term bond indices. The compensationincrease percentage assumption for our SERP ranged from 4.00% to 10.00% at December 31,2006, which was consistent with the prior year.

For the fiscal year ended December 31,2006, the discount rate used to determine net periodic pension benefit/cost forboth our pension plan and our SERP was 5.75%. The rate of compensation increasefor both our pension plan and our SERP of 4.00% at December 31, 2006 wasconsistent with the rate used in the prior year. The average return on planassets for our pension plan of 8.50% for the year ended December 31, 2006has remained consistent with the prior year.

Effective December 31,2005, all pension plan participant’s accounts were frozen, and effective January 1,2006, no further pension plan benefit will accrue on behalf of any pension planparticipant. As a result, we recorded a net periodic pension benefit on ourpension plan for 2006 of $0.2 million, as 

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comparedto a $0.8 million net periodic pension expense, excluding the effect ofcurtailment, for the year ended December 31, 2005. We expect the netperiodic pension benefit on our pension plan to be approximately $0.5 millionin fiscal year 2007.

The net periodic pensionexpense for the SERP was $4.4 million for the year ended December 31,2006, which was consistent with the prior year. We expect the net periodicpension expense on our SERP to be approximately $4.2 million in fiscal year2007.

**New Accounting Pronouncements**

In June 2006, theFinancial Accounting Standards Board (‘FASB’) issued FASB Interpretation No. 48,*Accounting for Uncertainty in Income Taxes—aninterpretation of FASB Statement No. 109* (‘FIN 48’). FIN48 establishes a recognition threshold and measurement attribute for thefinancial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return. Pursuant to FIN 48, the effects of a taxposition are recognized in the financial statements when it is more likely thannot, based on the technical merits, that the position will be sustained uponexamination by the taxing authority. Conversely, previously recognized taxpositions are derecognized when it is no longer more likely than not that thetax position would be sustained upon examination. FIN 48 also requires certaindisclosures regarding unrecognized tax benefits and the amounts andclassification of the related interest and penalties. FIN 48 is effective forfiscal years beginning after December 15, 2006. Accordingly, we adoptedFIN 48 on January 1, 2007, and there was no material impact to ourfinancial condition or results of operations.

In September 2006,the FASB issued Statement of Financial Accounting Standards No. 157, *Fair Value Measurements*(‘SFAS 157’). SFAS 157 defines fair value, establishes a framework formeasuring fair value, and expands upon existing disclosures about fair valuemeasurements. SFAS 157 does not require any new fair value measurements. Rather,the guidance contained in SFAS 157 applies to assets, liabilities, and certainequity instruments that are already measured at fair value under existingaccounting pronouncements. SFAS 157 is effective for fiscal yearsbeginning after November 15, 2007. We do not anticipate any materialimpact to our financial condition or results of operations as a result of theadoption of SFAS 157.

In September 2006,the SEC issued Staff Accounting Bulletin 108, *Consideringthe Effects of Prior Year Misstatements When Quantifying Misstatements inCurrent Year Financial Statements* (‘SAB 108’). SAB 108 provides interpretive guidance on how theeffects of the carryover or reversal of prior year financial statementmisstatements should be considered in quantifying a current year misstatement. SAB108 is effective for financial statements covering the first fiscal yearending after November 15, 2006. Accordingly, we adopted SAB 108 on December 31,2006, and there was no material impact to our financial condition or results ofoperations.

In February 2007, theFASB issued Statement of Financial Accounting Standards No. 159, *The Fair Value Option for Financial Assets and Financial Liabilities*(‘SFAS 159’). SFAS 159 permits entities to elect to measure certain financialinstruments and other items at fair value through earnings. The fair valueoption may be applied on an instrument by instrument basis, is irrevocable andis applied only to entire instruments. SFAS 159 requires additional financialstatement presentation and disclosure requirements for those entities thatelect to adopt the standard and is effective for fiscal years beginning after November 15,2007. We do not anticipate any material impact to our financial condition orresults of operations as a result of the adoption of SFAS 159.

**Certain Factors That May Affect Future Results**

From time to time,information provided by us, statements made by our employees, or informationincluded in our filings with the SEC (including this Form 10-K) maycontain statements which are not historical facts, so-called “forward-lookingstatements,” which are made under Section 21E of the 

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SecuritiesExchange Act of 1934 and which involve risks and uncertainties. These statements relate to future events or ourfuture financial performance and are identified by words such as “may”, “could”,“should”, “expect”, “plan”, “intend”, “seek”, “anticipate”, “believe”, “estimate”,“potential”, or “continue” or other comparable terms or the negative of thoseterms. Forward-looking statements in this Form 10-K includecertain statements regarding closing of our acquisition by State StreetCorporation, liquidity, capital resources, growth rate, annual dividendpayments, interest rate conditions, the shape of the yield curve, interest ratesensitivity, compliance with capital adequacy guidelines, loss exposure onlines of credit, foreign exchange revenue, cash management revenue, securitieslending revenue, net interest income, operating margin, operating expenses,including occupancy expenses and needs, transaction processing servicesexpense, professional fee expense, compensation expense, travel and salesexpense, investments in technology, pension plan and supplemental pensionexpense, depreciation expense, investments in Federal Home Loan Bank of Boston(‘FHLBB’) capital stock, the effect on earnings of changes in equity values orfixed income values, the effects of increased prepayments and reducedinvestment opportunities for our net interest income, the effect of anyanticipated activity under our stock repurchase plan, contributing to oursupplemental retirement plan, the effect of new accounting pronouncements, theeffect of amortization, the effect of an opportunity arising from industryconsolidation, our expected effective tax rate and the effect of certain legalclaims against us. Our actual future results may differ significantly fromthose stated in any forward-looking statements. Factors that may cause suchdifferences include, but are not limited to, the factors discussed in Item 1Aof this Form 10-K. Each of these factors, and others, are discussedfrom time to time in our filings with the SEC.

**Statements of Income**

***Comparison ofOperating Results for the Years Ended December 31, 2006 and 2005.***

Net income for the yearended December 31, 2006 was $153.8 million, down 4% from $159.8 millionfor the same period in 2005. The decrease primarily resulted from continuedpressure on our net interest margin, as well as increased operating expenses. Thisdecrease was offset substantially by increased asset servicing fees, whichreflect our ability to sell to new and existing clients combined with marketappreciation and strong client fund flows.

*Fees and Other Revenue*

Thecomponents of fees and other revenue are as follows (Dollars in thousands):

| ** **                    | ** ** | **For the Year Ended  December 31,** | ** ** |
|-------------------------------|------------|----------------------------------------------------------|------------|
| ** **                    | ** ** | **2006**                                                 | ** ** | **2005** | ** ** | **Change** | ** ** |
| Total asset  servicing fees   |       | $                                                        | 631,240    |   | $ | 509,059 |   |   | 24 | % |   |
| Other operating  income       |       | 5,691                                                    |       | 4,081 |   |   | 39 | % |   |
| Gain on sale of  investments  |       | 2,523                                                    |       | 12,397 |   |   | * |   |   |
| Total fees and  other revenue |       | $                                                        | 639,454    |   | $ | 525,537 |   |   | 22 | % |   |

----

*                    *Percentage is not considered meaningful*.

The largest components of asset servicing fees arecustody, multicurrency accounting and fund administration, which increased 21%to $453.6 million for the year ended December 31, 2006 from $375.6 millionfor the same period in 2005. Custody, multicurrency accounting and fund administrationfees are based in part on the value of assets processed. Assets processed isthe total dollar value of financial assets on the reported date for which weprovide one or more of the followingservices: global custody, multicurrency accounting, fund administration, middleoffice outsourcing, foreign exchange, cash management, securities lending,investment advisory, performance measurement, institutional transfer agency,lines of credit and brokerage and transition management services.

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Thechange in net assets processed includes the following components (Dollars inbillions):

| ** **                                 | ** ** | **For the Year Ended  December 31, 2006** | ** ** | **For the Three Months Ended  December 31, 2006** | ** ** |
|--------------------------------------------|------------|--------------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| Net assets  processed, beginning of period |       |                                                               | $          | 1,793                                                                           |       |   |   | $ | 2,035 |   |   |
| Change in net  assets processed:           |       |                                                               |       |                                                                            |       |   |   |   |   |
| Sales to new clients                       |       |                                                               | 8          |                                                                            |       |   | 7 |   |   |
| Further penetration of existing clients    |       |                                                               | 29         |                                                                            |       |   | 4 |   |   |
| Lost clients                               |       |                                                               | (1         | )                                                                               |       |   | — |   |   |
| Fund flows and market gain                 |       |                                                               | 383        |                                                                            |       |   | 166 |   |   |
| Total change in net assets processed       |       |                                                               | 419        |                                                                            |       |   | 177 |   |   |
| Net assets  processed, end of period       |       |                                                               | $          | 2,212                                                                           |       |   |   | $ | 2,212 |   |   |

 

Themajority of the increase in assets processed was due to sales to new andexisting clients, the ability of our clients to develop and sell product, whichgenerates fund flows that have a direct, positive impact on our business, andhigher asset values compared to a year ago. Asindicated in the ‘Overview’ section, our core services fees are generated bycharging a fee based upon the value of assets processed. As market values orclients’ asset levels fluctuate, so will our revenue. Our tiered pricingstructure, coupled with minimum and flat fees, allow us to manage thisvolatility to a certain extent. As asset values increase, the basis point feetypically lowers. When asset values decrease, revenue is only impacted by theasset decline at the then marginal rate.

If the value of equity orfixed income assets held by our clients were to increase or decrease by 10% fora sustained period of time, we estimate currently that this market movement, byitself, would cause a corresponding change of less than 5% in our earnings pershare. Earnings per share do not track precisely to the value of the equity andfixed-income markets because conditions present in a market increase ordecrease may generate offsetting increases or decreases in other revenue andexpense items that are influenced by the value of the assets we administer. Forexample, increased market volatility often results in higher transaction feerevenue. Also, market value declines may result in increased interest incomeand sweep fee income as clients move larger amounts of assets into the cashmanagement vehicles that we offer. In addition, our tiered pricing structurereduces the impact of volatility in asset values to a certain extent. However,there can be no assurance that any of these offsetting revenue and expensemovements will occur during any future upturn or downturn in the equity orfixed-income markets, or that our tiered pricing structure will reduce theimpact on us of a sustained change in asset values.

Transaction-drivenincome includes our value-added services, such as foreign exchange, cashmanagement, securities lending and investment advisory services.

·       Foreignexchange fees were $81.0 million for the year ended December 31, 2006, up30% from the same period in 2005. The increase in foreign exchange fees isattributable to new business, increased volume of client activity andvolatility in currency markets. Future foreign exchange income is dependent onthe volume of new and existing client activity and overall volatility in thecurrencies traded.

·       Cashmanagement fees, which consist of sweep fees, were $58.8 million for the yearended December 31, 2006, up 56% from the same period in 2005. The increaseis primarily due to higher balances placed by our clients in the cashmanagement products we offer. Cash management revenue will continue to dependon the level of client balances maintained in the cash management products weoffer. If our clients’ investment products continue to maintain higher cashbalances than they did in comparable periods, we expect our cash managementrevenue to be positively impacted.

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·       Securities lending fees were $27.4 million forthe year ended December 31, 2006, up 21% from the same period in 2005,primarily due to new business, higher volumes and improved market conditions. Securitieslending transaction volume is positively affected by merger and acquisitionactivity, increased IPO activity, the seasonality of international dividendarbitrage and a steeper short-end of the yield curve. If the capital marketsexperience any of the aforementioned activity, it is likely that our securitieslending revenue will be positively impacted. If we experience any of thefollowing: 1) a reduction in our securities lending portfolio, 2) lower marketvalues or 3) compression of the spreads earned on our securities lendingactivity, our securities lending revenue will likely be negatively impacted.

·       Investment advisory fees were $7.5 million forthe year ended December 31, 2006, down 12% from the same period in 2005. Thedecrease in investment advisory fees is attributable to lower asset values inour proprietary Merrimac money market funds. Future investment advisory feeincome is dependent upon the asset levels within the Merrimac money marketfunds, which are driven by overall market conditions, client activity andtransaction volumes.

·       Other service fees were $3.1 million for theyear ended December 31, 2006, up 11% from the same period in 2005. Otherservice fees include income earned on compliance advisory, brokerage andtransition management services. The increase in other service fees wasprimarily due to an increase in commission fees and compliance service fees.

·       Otheroperating income for the year ended December 31, 2006 was $5.7 million, up39% from the same period in 2005. The increase is primarily due to an increasein interest earned on clearing agency deposits and an increase in the dividendrate on our FHLBB stock.

During the year ended December 31,2006, we sold municipal securities held in our available for sale portfolio,resulting in the recognition of $2.5 million in gains. During the year ended December 31,2005, we sold municipal securities and U.S. Treasury securities held in ouravailable for sale portfolio, resulting in the recognition of $12.4 million ingains. These security sales in 2005 and 2006 were the result of a strategy toimprove the after-tax yield of our municipal securities portfolio by replacingthe sold municipal securities with those that offer a more attractive after-taxyield, as well as to capitalize on strong market conditions.

*Net Interest Income*

Thefollowing table presents the components of net interest income (Dollars inthousands):

| ** **                 | ** ** | **For the Year Ended December 31,** | ** ** |
|----------------------------|------------|--------------------------------------------------------------|------------|
| ** **                 | ** ** | **2006**                                                     | ** ** | **2005** | ** ** | **Change** | ** ** |
| Interest income            |       | $                                                            | 557,749    |   | $ | 447,705 |   |   | 25 | % |   |
| Interest expense           |       | 393,555                                                      |       | 277,280 |   |   | 42 | % |   |
| Total net interest  income |       | $                                                            | 164,194    |   | $ | 170,425 |   |   | (4 | )% |   |

 

Net interest income is affectedby the volume and mix of assets and liabilities and the movement and level ofinterest rates. The decrease in our net interest income from the yearended December 31, 2006 was primarily driven by increasing short-terminterest rates without a concurrent increase in longer-term rates, whichresulted in an inverted yield curve. Consequently, our interest-bearingliabilities, of which the majority is priced based on overnight and short-termrates, have repriced at higher rates faster than our interest-earning assetshave repriced, resulting in a lower net interest margin as compared to the yearended December 31, 2005. In addition, reinvestment and purchase spreads onfixed and floating-rate assets were lower than expected due to many factors,including yield curve shape and level of rates. Average investment securitybalances were down $0.3 billion for the year ended December 31, 2006,compared to the year ended December 31, 2005, primarily due to slowerreinvestment.

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Thetable below presents the changes in net interest income resulting from changesin the volume of interest-earning assets or interest-bearing liabilities andchanges in interest rates for the year ended December 31, 2006 compared tothe year ended December 31, 2005. Changes attributed to both volume andrate have been allocated based on the proportion of change in each category(Dollars in thousands):

| ** **                                                                                       | ** ** | **For the Year Ended  December 31, 2006 vs. December 31, 2005** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                       | ** ** | **Change Due  to Volume**                                                                          | ** ** | **Change Due  to Rate** | ** ** | **Net** | ** ** |
| **Interest-earning assets**                                                                      | ** ** |                                                                                                         | ** ** | ** ** |   |   | ** ** | ** ** |   | ** ** | ** ** |
| Federal funds sold, interest-bearing deposits with  other banks and other short-term investments |       |                                                                                                         | $     | 5,331 |   |   |   | $  | 1,560 |   |   | $  | 6,891 |   |
| Investment securities                                                                            |       |                                                                                                         | (10,160    | ) |   |   | 101,543 |   |   | 91,383 |   |
| Loans                                                                                            |       |                                                                                                         | 3,374      |   |   |   | 8,396 |   |   | 11,770 |   |
| Total  interest-earning assets                                                                   |       |                                                                                                         | (1,455     | ) |   |   | 111,499 |   |   | 110,044 |   |
| **Interest-bearing  liabilities**                                                                | ** ** |                                                                                                         | ** ** | ** ** |   |   | ** ** | ** ** |   | ** ** | ** ** |
| Deposits                                                                                         |       |                                                                                                         | 36,572     |   |   |   | 66,049 |   |   | 102,621 |   |
| Borrowings                                                                                       |       |                                                                                                         | (51,892    | ) |   |   | 65,546 |   |   | 13,654 |   |
| Total  interest-bearing liabilities                                                              |       |                                                                                                         | (15,320    | ) |   |   | 131,595 |   |   | 116,275 |   |
| Change in net  interest income                                                                   |       |                                                                                                         | $          | 13,865 |   |   |   | $ | (20,096 | ) |   | $ | (6,231 | ) |

 

Amortization and accretionof debt securities purchased at a premium or discount are amortized or accretedinto income using a method which approximates the constant effective yieldmethod. We apply Statement of Financial Accounting Standards No. 91, *Accounting for Nonrefundable Fees and Costs Associated with Originatingor Acquiring Loans and Initial Direct Costs of Leases* (‘SFAS 91’)for the amortization of premiums and accretion of discounts. In calculating theeffective yield for securities that represent holdings of large numbers ofsimilar loans for which prepayments are probable and the timing and amount ofprepayments can be reasonably estimated, prepayments are anticipated using ouractual three-month prepayment experience.

The amount of amortizationor accretion to recognize in income is driven by the calculation of theconstant effective yield. When calculating this yield, we assume thatprepayments will continue from the analysis date to the date of the security’sexpected maturity at our most recent three-month prepayment rate. Theprepayment rate is updated monthly based on our previous three-month actualprepayment experience.

We utilize three-monthprepayment rates to anticipate prepayments because such rates are based on ourown actual prepayment experience and because we believe three-month rates are abetter estimate of future experience than either one-month or six-month orlonger rates. In the opinion of management, a one-month rate does not captureenough experience to predict future prepayment behavior and may create unduevolatility in interest income due to one-time fluctuations in prepaymentactivity. Conversely, in the opinion of management, a six-month or longer ratewould not capture enough volatility to predict future prepayment behavior.

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

For securities that do notrepresent holdings of large numbers of similar loans for which prepayments areprobable and the timing and amount of prepayments can be reasonably estimated,the associated 

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premiumsand discounts are amortized or accreted over their contractual term using theconstant effective yield. Actual prepayment experience for such securities isreviewed monthly and a proportionate amount of premium or discount isrecognized in income at that time such that the effective yield on theremaining portion of the securities continues unchanged.

As of and for the yearsended December 31, 2006, 2005, and 2004, we anticipated prepayments on ourresidential mortgage-backed securities. All other securities do not meet theSFAS 91 criteria for anticipating prepayments. Accordingly, no prepayments wereanticipated for these securities.

In addition to investingin both variable and fixed-rate securities, we use derivative instruments tomanage our exposure to interest rate risks. See the ‘Market Risk’ section formore detailed information.

*Operating Expenses*

Totaloperating expenses were $579.4 million in 2006, up 26% from 2005. The increasein total operating expenses was primarily due to increased compensation andbenefits, technology and telecommunications, transaction processing services,occupancy and other operating expenses, as detailed below. The components ofoperating expenses were as follows (Dollars in thousands):

| ** **                         | ** ** | **For the Year Ended December 31,** | ** ** |
|------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                         | ** ** | **2006**                                                     | ** ** | **2005** | ** ** | **Change** | ** ** |
| Compensation and  benefits         |       | $                                                            | 327,342    |   | $ | 250,459 |   |   | 31 | % |   |
| Technology and  telecommunications |       | 73,909                                                       |       | 54,732 |   |   | 35 | % |   |
| Transaction  processing services   |       | 61,396                                                       |       | 49,873 |   |   | 23 | % |   |
| Occupancy                          |       | 33,653                                                       |       | 26,490 |   |   | 27 | % |   |
| Depreciation and  amortization     |       | 32,819                                                       |       | 31,578 |   |   | 4 | % |   |
| Professional fees                  |       | 13,845                                                       |       | 13,380 |   |   | 3 | % |   |
| Travel and sales  promotion        |       | 8,883                                                        |       | 6,825 |   |   | 30 | % |   |
| Insurance                          |       | 3,929                                                        |       | 4,219 |   |   | (7 | )% |   |
| Loss and loss  adjustment expenses |       | 30                                                           |       | 5,837 |   |   | * |   |   |
| Other operating  expenses          |       | 23,548                                                       |       | 16,716 |   |   | 41 | % |   |
| Total operating  expenses          |       | $                                                            | 579,354    |   | $ | 460,109 |   |   | 26 | % |   |

----

*                    *Percentage is not considered meaningful.*

Compensation and benefits increased 31% from 2005 dueto higher headcount in our North American and European offices. Annual salaryincreases, bonus accruals and options expense also contributed to the growth inthe compensation and benefits expense. Further increases in compensationexpense in 2007 will be primarily dependant upon hiring needs driven by salesto new and existing clients, the full year impact of staff additions made in2006, annual salary increases and share-based compensation.

Technology and telecommunications expense increased35% from 2005 as a result of increased infrastructure investments in 2006. Theincrease is primarily due to our investment in enhancing our global integratedtechnology platform, which we view as a significant competitive advantage andgrowth in new business and customer volumes. Generally, we expect technologyreinvestment to equal approximately 18-20% of net operating revenue eachyear, including related compensation costs.

Transaction processing services expense increased 23%from 2005 due to increases in transaction volumes, higher market values and newbusiness. Future transaction processing servicing expense will be dependent onasset levels and the volume of client transaction activity. 

Occupancy expense increased 27% from 2005 and is alsoexpected to increase into the middle of 2007, due to the addition of new officespace worldwide needed to accommodate growth.

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Professional fees expense increased 3% from 2005,primarily due to higher consulting fees for technology. Future professionalfees are dependent upon changes in the value of the Merrimac portfolios andupon other business needs for outside professional services.

Travel and sales promotion expense increased 30% from2005. Travel and sales promotion expense consists of expenses incurred by oursales force, client management staff and other employees in connection withsales calls on potential clients, as wellas traveling to existing client sites and our foreign offices. The increasesresulted from a higher level of sales calls on potential clients, a higherlevel of travel to client sites and foreign offices and attendance at industryconferences. Travel and sales promotion expense in 2007 will be dependent uponnew business leads and other client and business needs.

The decrease in loss and loss adjustment expenses from2005 to 2006 is primarily due to a processing error that occurred during thefourth quarter of 2005.

Other operating expenseincreased 41% from 2005 primarily due to higher recruitment costs, highertemporary staffing expenses and our settlement of pending litigation.

*Income Taxes*

Income taxes were $70.5million for the year ended December 31, 2006, down 7% from the same periodin 2005. This decrease in income taxes is primarily related to a decrease inpretax earnings, as well as a 1% decrease in the 2006 effective tax rateresulting from a change in the recognition threshold of a tax position. Thedecrease in income taxes and the effective tax rate was partially offset by thedecrease in one-time tax benefits. During the second quarter of 2005, weadopted the indefinite reversal provisions of Accounting Principles BoardOpinion No. 23, *Accounting for IncomeTaxes—Special Areas* (‘APB 23’), which specifies that U.S. incometaxes should not be recorded on the undistributed earnings of a foreignsubsidiary if those undistributed earnings have been or will be investedindefinitely in that subsidiary. We determined that the undistributed earningsof our Irish subsidiaries will be permanently invested in our Irish operationsto support continued growth. During the second quarter of 2006, we reversedpreviously accrued taxes resulting from a tax position that no longer met theprobable recognition threshold under Statement of Financial AccountingStandards No. 5, *Accounting forContingencies* (‘SFAS 5’). 

In 2007, we expect thatour effective tax rate will approximate 33.5% of pretax income.

***Comparison of Operating Results for the Years Ended December 31,2005 and 2004.***

Net income for the yearended December 31, 2005 was $159.8 million, up 13% from $142.0 million forthe same period in 2004. The principal factors contributing to our net incomegrowth were growth in asset servicing fees of 20% and increased gain on sale ofinvestments. Net income growth was partially offset by a 15% increase inoperating expenses (largely due to new business wins, additional headcount andtechnology requirements) and a 9% decrease in net interest income.

*Fees and Other Revenue*

Thecomponents of fees and other revenue are as follows (Dollars in thousands):

| ** **                    | ** ** | **For the Year Ended** | ** ** |
|-------------------------------|------------|---------------------------------------|------------|
| ** **                    | ** ** | **December 31,**                 | ** ** |
| ** **                    | ** ** | **2005**                              | ** ** | **2004** | ** ** | **Change** | ** ** |
| Total asset  servicing fees   |       | $                                     | 509,059    |   | $ | 423,200 |   |   | 20 | % |   |
| Gain on sale of  investments  |       | 12,397                                |       | 234 |   |   | * |   |   |
| Other operating  income       |       | 4,081                                 |       | 2,057 |   |   | 98 | % |   |
| Total fees and  other revenue |       | $                                     | 525,537    |   | $ | 425,491 |   |   | 24 | % |   |

----

*                    *Percentage is not considered meaningful.*

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The largest components ofasset servicing fees are custody, multicurrency accounting and fundadministration, which increased 20% to $375.6 million for the year ended December 31,2005 from $314.3 million for the same period in 2004. 

Thechange in net assets processed includes the following components (Dollars inbillions):

| ** **                                 | ** ** | **For the Year Ended** | ** ** |
|--------------------------------------------|------------|---------------------------------------|------------|
| ** **                                 | ** ** | **December 31, 2005**       | ** ** |
| Net assets  processed, beginning of period |       |                                  | $          | 1,430 |   |   |
| Change in net  assets processed:           |       |                                  |       |   |   |
| Sales to new clients                       |       |                                  | 159        |   |   |
| Further penetration of existing clients    |       |                                  | 42         |   |   |
| Lost clients                               |       |                                  | (11        | ) |   |
| Fund flows and market gain                 |       |                                  | 173        |   |   |
| Total change in net assets processed       |       |                                  | 363        |   |   |
| Net assets  processed, end of period       |       |                                  | $          | 1,793 |   |   |

 

The majority of the increase in assets processed was dueto sales to new and existing clients, the ability of our clients todevelop and sell product, which generates fund flows that have a direct,positive impact on our business, and slightly higher asset values compared to ayear ago. 

·       Foreignexchange fees were $62.1 million for the year ended December 31, 2005, up14% from the same period in 2004. The increase in foreign exchange fees isattributable to new business, increased volume of client activity andvolatility in currency markets. 

·       Cashmanagement fees were $37.6 million for the year ended December 31, 2005,up 42% from the same period in 2004. The increase is primarily due to higherbalances placed by our clients in the cash management products we offer. 

·       Securitieslending fees were $22.5 million for the year ended December 31, 2005, up117% from the same period in 2004, primarily due to new business, highervolumes and improved market conditions.

·       Investment advisory fees were $8.4 million forthe year ended December 31, 2005, down 44% from the same period in 2004. Thedecrease in investment advisory fees is attributable to lower asset values inour proprietary Merrimac money market funds combined with advisory fee waiverson certain of the funds.

·       Other service fees for the year ended December 31,2005 were $2.8 million, up 5% from the same period in 2004. The increase in2005 was due to an increase in compliance and brokerage services.

·       Otheroperating income for the year ended December 31, 2005 was $4.1 million, up98% from the same period in 2004. The increase is primarily due to an increasein the dividend rate on our holding of FHLBB stock.

*Net Interest Income*

Thefollowing table presents the components of net interest income (Dollars inthousands):

| ** **                 | ** ** | **For the Year Ended December 31,** | ** ** |
|----------------------------|------------|--------------------------------------------------------------|------------|
| ** **                 | ** ** | **2005**                                                     | ** ** | **2004** | ** ** | **Change** | ** ** |
| Interest income            |       | $                                                            | 447,705    |   | $ | 313,149 |   |   | 43 | % |   |
| Interest expense           |       | 277,280                                                      |       | 125,469 |   |   | 121 | % |   |
| Total net  interest income |       | $                                                            | 170,425    |   | $ | 187,680 |   |   | (9 | )% |   |

 

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The decrease in our net interest income was primarilydriven by lower interest rate spreads, which was partially offset by growth inour investment portfolio. Average investment security balances were upapproximately $1.5 billion for the year ended December 31, 2005 comparedto the same period in 2004.

Thetable below presents the changes in net interest income resulting from changesin the volume of interest-earning assets or interest-bearing liabilities andchanges in interest rates for the year ended December 31, 2005 compared tothe year ended December 31, 2004. Changes attributed to both volume andrate have been allocated based on the proportion of change in each category(Dollars in thousands): 

| ** **                                     | ** ** | **For the Year Ended**                                     | ** ** |
|------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                     | ** ** | **December 31, 2005 vs. December 31, 2004** | ** ** |
| ** **                                     | ** ** | **Change Due**                                                       | ** ** | **Change Due** | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | **to Volume**                                                        | ** ** | **to Rate** | ** ** | **Net** | ** ** |
| **Interest-earning  assets**                   |       |                                                                      |       |   |   |   |   |   |   |   |   |
| Federal funds  sold and short-term investments |       |                                                                      | $          | 226 |   |   |   | $ | 1,357 |   |   | $ | 1,583 |   |
| Investment  securities                         |       |                                                                      | 53,222     |   |   |   | 75,076 |   |   | 128,298 |   |
| Loans                                          |       |                                                                      | 2,281      |   |   |   | 2,394 |   |   | 4,675 |   |
| Total  interest-earning assets                 |       |                                                                      | 55,729     |   |   |   | 78,827 |   |   | 134,556 |   |
| **Interest-bearing liabilities**               |       |                                                                      |       |   |   |   |   |   |   |   |   |
| Deposits                                       |       |                                                                      | (6,879     | ) |   |   | 33,864 |   |   | 26,985 |   |
| Borrowings                                     |       |                                                                      | 38,994     |   |   |   | 85,832 |   |   | 124,826 |   |
| Total  interest-bearing liabilities            |       |                                                                      | 32,115     |   |   |   | 119,696 |   |   | 151,811 |   |
| Change in net  interest income                 |       |                                                                      | $          | 23,614 |   |   |   | $ | (40,869 | ) |   | $ | (17,255 | ) |

 

*Operating Expenses*

Totaloperating expenses were $460.1 million in 2005, up 15% from 2004. Thecomponents of operating expenses were as follows (Dollars in thousands):

| ** **                         | ** ** | **For the Year Ended December 31,** | ** ** |
|------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                         | ** ** | **2005**                                                     | ** ** | **2004** | ** ** | **Change** | ** ** |
| Compensation and  benefits         |       | $                                                            | 250,459    |   | $ | 205,728 |   |   | 22 | % |   |
| Technology and  telecommunications |       | 54,732                                                       |       | 49,816 |   |   | 10 | % |   |
| Transaction  processing services   |       | 49,873                                                       |       | 42,159 |   |   | 18 | % |   |
| Depreciation and  amortization     |       | 31,578                                                       |       | 32,124 |   |   | (2 | )% |   |
| Occupancy                          |       | 26,490                                                       |       | 29,032 |   |   | (9 | )% |   |
| Professional fees                  |       | 13,380                                                       |       | 15,346 |   |   | (13 | )% |   |
| Travel and sales  promotion        |       | 6,825                                                        |       | 5,470 |   |   | 25 | % |   |
| Loss and loss  adjustment expenses |       | 5,837                                                        |       | 924 |   |   | * |   |   |
| Insurance                          |       | 4,219                                                        |       | 4,625 |   |   | (9 | )% |   |
| Other operating  expenses          |       | 16,716                                                       |       | 13,159 |   |   | 27 | % |   |
| Total operating  expenses          |       | $                                                            | 460,109    |   | $ | 398,383 |   |   | 15 | % |   |

----

*                    *Percentage is not considered meaningful.*

Compensation and benefits increased 22% from 2004 dueto higher headcount and annual salary increases.

Technology and telecommunications expense increased10% from 2004 as a result of increased infrastructure investments in 2005. Theincrease is also due to our outsourcing agreement with IBM, which we enteredinto in July of 2004. A portion of the increase is offset by lowercompensation costs due to 

37

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employees transferring toIBM. Also, increases in our processing volumes drove higher technology andtelecommunications expense.

Transaction processing services expense increased 18%from 2004 as a result of higher global asset values and transactions with oursubcustodians.

Professional fees expense decreased 13% from 2004,primarily due to lower subadvisory expense associated with our Merrimac moneymarket funds, resulting from lower average fund balances.

Travel and sales promotion expense increased 25% from2004. The increase resulted from a higher level of travel to client sites, ahigher level of sales calls to potential clients, attendance at industryconferences, and travel related to the establishment of our new Europeanoffices.

The increase in loss and loss adjustment expenses from2004 to 2005 is due to a processing error identified during the fourth quarterof 2005.

Other operating expenseincreased 27% from 2004 primarily as a result of higher recruiting and staffingexpense.

*Income Taxes*

Income taxes were $76.0 million for the year ended December 31,2005, up 4% from the same period in 2004. The increase in income taxes and theeffective tax rate (excluding the effect of APB 23) is primarily attributableto increased pretax earnings as well as a decrease in the percentage oftax-exempt income to pretax income. The increase in income taxes was partiallyoffset by the reversal of a deferred income tax liability related to theundistributed earnings of our Irish subsidiaries. During the second quarter of2005, we recognized the indefinite reversal provision of APB 23, whichspecifies that U.S. income taxes should not be recorded on the undistributedearnings of a foreign subsidiary if those undistributed earnings have been orwill be invested indefinitely in that subsidiary. We have determined that theundistributed earnings of our Irish subsidiaries will be permanently investedin our Irish operations to support continued growth.

38

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The following tablespresent average balances, interest income and expense, and yields earned orpaid on the major categories of assets and liabilities for the periodsindicated (Dollars in thousands):

| ** **                                                                                         | ** ** | **Year Ended December 31, 2006** | ** ** | **Year Ended December 31, 2005** | ** ** | **Year Ended December 31, 2004** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                         | ** ** | **Average  Balance**                                 | ** ** | **Interest**                                         | ** ** | **Average  Yield/Cost**                              | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Average  Yield/Cost** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Average  Yield/Cost** | ** ** |
| **Interest-earning assets**                                                                        | ** ** | ** **                                           | ** ** | ** **                                           | ** ** |                                                 | ** ** | ** ** |   | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** |   |
| Federal funds  sold, interest- bearing deposits with other banks and other short-term  investments |       | $                                               | 181,272    |                                                 | $     | 9,141                                                |       |   | 5.04 | % |   | $  | 66,926 |   | $  | 2,250 |   |   | 3.36 | % |   | $  | 52,544 |   | $  | 667 |   |   | 1.27 | % |   |
| Investment securities:(1)                                                                          |       |                                                 |       |                                                 |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Mortgage-backed securities                                                                         |       | 8,154,233                                            |       | 403,717                                              |       |                                                 | 4.95       |   |   | 8,034,870 |   | 315,845 |   |   | 3.93 |   |   | 6,677,678 |   | 221,248 |   |   | 3.31 |   |   |
| Federal agency  securities                                                                         |       | 1,976,985                                            |       | 91,861                                               |       |                                                 | 4.65       |   |   | 2,333,005 |   | 89,864 |   |   | 3.85 |   |   | 2,084,988 |   | 53,977 |   |   | 2.59 |   |   |
| State and  political subdivisions                                                                  |       | 467,649                                              |       | 20,071                                               |       |                                                 | 4.29       |   |   | 465,451 |   | 21,217 |   |   | 4.56 |   |   | 490,621 |   | 22,300 |   |   | 4.55 |   |   |
| Other securities                                                                                   |       | 204,551                                              |       | 11,927                                               |       |                                                 | 5.83       |   |   | 230,832 |   | 9,267 |   |   | 4.01 |   |   | 299,529 |   | 10,370 |   |   | 3.46 |   |   |
| Total investment  securities                                                                       |       | 10,803,418                                           |       | 527,576                                              |       |                                                 | 4.88       |   |   | 11,064,158 |   | 436,193 |   |   | 3.94 |   |   | 9,552,816 |   | 307,895 |   |   | 3.22 |   |   |
| Loans(2)                                                                                           |       | 303,645                                              |       | 21,032                                               |       |                                                 | 6.93       |   |   | 233,572 |   | 9,262 |   |   | 3.97 |   |   | 165,564 |   | 4,587 |   |   | 2.77 |   |   |
| Total  interest-earning  assets                                                                    |       | 11,288,335                                           |       | 557,749                                              |       |                                                 | 4.94       |   |   | 11,364,656 |   | 447,705 |   |   | 3.94 |   |   | 9,770,924 |   | 313,149 |   |   | 3.20 |   |   |
| Allowance for loan  losses                                                                         |       | (100                                                 | )          |                                                 |       |                                                 |       |   |   | (100 | ) |   |   |   |   |   |   | (100 | ) |   |   |   |   |   |   |
| Noninterest-earning  assets                                                                        |       | 641,578                                              |       |                                                 |       |                                                 |       |   |   | 669,142 |   |   |   |   |   |   |   | 505,655 |   |   |   |   |   |   |   |
| Total assets                                                                                       |       | $                                                    | 11,929,813 |                                                 |       |                                                 |       |   |   |   | $ | 12,033,698 |   |   |   |   |   |   |   | $ | 10,276,479 |   |   |   |   |   |   |   |
| **Interest-bearing liabilities**                                                                   | ** ** | ** **                                           | ** ** | ** **                                           | ** ** |                                                 | ** ** | ** ** |   | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** |   |
| Deposits:                                                                                          |       |                                                 |       |                                                 |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand                                                                                             |       | $                                                    | 96,292     |                                                 | $          | 4,227                                                |       |   | 4.39 | % |   | $ | 24,470 |   | $ | 866 |   |   | 3.54 | % |   | $ | — |   | $ | — |   |   | 0.00 | % |   |
| Savings                                                                                            |       | 4,576,730                                            |       | 168,247                                              |       |                                                 | 3.68       |   |   | 3,428,223 |   | 74,391 |   |   | 2.17 |   |   | 3,947,865 |   | 49,622 |   |   | 1.26 |   |   |
| Time                                                                                               |       | 152,708                                              |       | 7,853                                                |       |                                                 | 5.14       |   |   | 80,729 |   | 2,449 |   |   | 3.03 |   |   | 68,594 |   | 1,099 |   |   | 1.60 |   |   |
| Securities sold  under repurchase  agreements(3)                                                   |       | 4,490,240                                            |       | 164,970                                              |       |                                                 | 3.67       |   |   | 5,244,614 |   | 142,681 |   |   | 2.72 |   |   | 4,162,132 |   | 54,376 |   |   | 1.31 |   |   |
| Junior  subordinated debentures                                                                    |       | 24,774                                               |       | 2,420                                                |       |                                                 | 9.77       |   |   | 24,774 |   | 2,420 |   |   | 9.77 |   |   | 24,774 |   | 2,420 |   |   | 9.77 |   |   |
| Other  borrowings(4)                                                                               |       | 913,340                                              |       | 45,838                                               |       |                                                 | 5.02       |   |   | 1,643,948 |   | 54,473 |   |   | 3.31 |   |   | 841,708 |   | 17,952 |   |   | 2.13 |   |   |
| Total  interest-bearing liabilities                                                                |       | 10,254,084                                           |       | 393,555                                              |       |                                                 | 3.84       |   |   | 10,446,758 |   | 277,280 |   |   | 2.65 |   |   | 9,045,073 |   | 125,469 |   |   | 1.39 |   |   |
| Noninterest-bearing liabilities:                                                                   |       |                                                 |       |                                                 |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                                                                    |       | 323,228                                              |       |                                                 |       |                                                 |       |   |   | 305,289 |   |   |   |   |   |   |   | 252,246 |   |   |   |   |   |   |   |
| Savings                                                                                            |       | 74,008                                               |       |                                                 |       |                                                 |       |   |   | 61,745 |   |   |   |   |   |   |   | 72,536 |   |   |   |   |   |   |   |
| Time deposits                                                                                      |       | 230,890                                              |       |                                                 |       |                                                 |       |   |   | 198,849 |   |   |   |   |   |   |   | 154,617 |   |   |   |   |   |   |   |
| Other liabilities                                                                                  |       | 181,089                                              |       |                                                 |       |                                                 |       |   |   | 262,505 |   |   |   |   |   |   |   | 126,043 |   |   |   |   |   |   |   |
| Total liabilities                                                                                  |       | 11,063,299                                           |       |                                                 |       |                                                 |       |   |   | 11,275,146 |   |   |   |   |   |   |   | 9,650,515 |   |   |   |   |   |   |   |
| Equity                                                                                             |       | 866,514                                              |       |                                                 |       |                                                 |       |   |   | 758,552 |   |   |   |   |   |   |   | 625,964 |   |   |   |   |   |   |   |
| Total liabilities  and equity                                                                      |       | $                                                    | 11,929,813 |                                                 |       |                                                 |       |   |   |   | $ | 12,033,698 |   |   |   |   |   |   |   | $ | 10,276,479 |   |   |   |   |   |   |   |
| Net interest  income                                                                               |       |                                                 |       | $                                                    | 164,194    |                                                 |       |   |   |   |   |   | $ | 170,425 |   |   |   |   |   |   |   | $ | 187,680 |   |   |   |   |   |
| Net interest  margin(5)                                                                            |       |                                                 |       |                                                 |       |                                                 | 1.45       | % |   |   |   |   |   |   | 1.50 | % |   |   |   |   |   |   | 1.92 | % |   |
| Average interest  rate spread(6)                                                                   |       |                                                 |       |                                                 |       |                                                 | 1.10       | % |   |   |   |   |   |   | 1.29 | % |   |   |   |   |   |   | 1.81 | % |   |
| Ratio of  interest-earning assets to interest-bearing liabilities                                  |       |                                                 |       |                                                 |       |                                                 | 110.09     | % |   |   |   |   |   |   | 108.79 | % |   |   |   |   |   |   | 108.02 | % |   |

----

(1)             Average yield/cost on available for sale securities isbased on amortized cost.

(2)             Average yield/cost on demand loans includes onlyperforming loan balances. During the years ended December 31, 2006, 2005and 2004 there were no non-performing loan balances.

(3)             Interest expense includes penalties of $2.9 million in2004 for prepayment of two term repurchase agreements.

(4)             Interest expense includes contractual prepaymentpenalties of $3.9 million in 2004 for prepayment of certain FHLBB borrowings.

(5)             Net interest income divided by total interest-earningassets.

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

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**Financial Condition**

At December 31, 2006,our total assets were $11.6 billion, down 4% from December 31, 2005,primarily due to a net decrease in our investment portfolio. Averageinterest-earning assets decreased $0.1 billion, or 1%, for the year ended December 31,2006 compared to the same period last year, primarily due to paydowns on ourFederal agency securities.

*InvestmentPortfolio*

Theincome we derive from our investment portfolio is generated primarily byinvesting client cash balances and is a component of our asset processingbusiness. In addition, we use our investment portfolio to secure open positionsat securities clearing institutions in connection with our custody services. Thefollowing table summarizes our investment portfolio as of the dates indicated(Dollars in thousands):

| ** **                           | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|-----------------------|------------|
| ** **                           | ** ** | **2006**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Securities held to maturity:**     | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Mortgage-backed  securities          |       | $                     | 3,753,497  |   | $ | 4,342,254 |   | $ | 3,543,961 |   |
| Federal agency  securities           |       | 1,680,458             |       | 2,305,331 |   | 2,274,665 |   |
| State and political  subdivisions    |       | 98,375                |       | 114,345 |   | 124,091 |   |
| Total securities held to maturity    |       | $                     | 5,532,330  |   | $ | 6,761,930 |   | $ | 5,942,717 |   |
| **Securities  available for sale:**  |       |                  |       |   |   |   |   |
| Mortgage-backed  securities          |       | $                     | 4,275,051  |   | $ | 3,766,101 |   | $ | 3,854,900 |   |
| State and  political subdivisions    |       | 344,304               |       | 392,391 |   | 404,909 |   |
| Corporate debt                       |       | 169,850               |       | 200,692 |   | 176,546 |   |
| US Treasury  securities              |       | —                |       | — |   | 118,688 |   |
| Foreign  government securities       |       | 10,535                |       | 10,536 |   | 10,462 |   |
| Total securities  available for sale |       | $                     | 4,799,740  |   | $ | 4,369,720 |   | $ | 4,565,505 |   |

 

The $1.2 billion, or 18%, decrease in our held tomaturity securities portfolio from December 31, 2005 to December 31,2006 is primarily due to paydowns and slower reinvestment. Our investmentsecurity purchases primarily consisted of floating interest ratemortgage-backed securities which offer an attractive yield and reprice asinterest rates increase. Our held to maturity portfolio securities arepurchased with the intent and ability to hold to maturity and are not viewed asour primary source of funds to satisfy liquidity needs.

Our available for sale securities portfolio increased$0.4 billion, or 10% from December 31, 2005 to December 31, 2006. Theincrease was mainly due to purchases of new investment securities, offset bymaturities and prepayments. Our investment security purchases includedmortgage-backed securities and municipal securities. We believe that purchasingthese securities allows us to take advantage of attractive yields and cashflows which aligns with our asset and liability strategy. Refer to the gapanalysis under the ‘Market Risk’ section for additional details regarding thematching of our interest-earning assets and interest-bearing liabilities.

The average balance of our investment securities forthe year ended December 31, 2006 was $10.8 billion, with an averageyield of 4.88%, compared to an average balance of $11.1 billion with an averageyield of 3.94% during the same period in 2005. The increased portfolio yield isprimarily due to higher rates on our variable-rate securities. Anticipatingprepayments in calculating the constant effective yield for mortgage-backedsecurities may result in more monthly earnings volatility due to the impact ofchanging interest rates and the resulting adjustments to the amount ofamortization. We do not expect 

40

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changes to the amount ofamortization resulting from anticipating prepayments to have a material effecton our future reported financial results or financial condition.

Prepayment cash flow levels on our Federal agencysecurities increased in 2006, which we believe was attributable to theexpiration of borrower prepayment penalties, increased refinancing and loanpayoff activity. Mortgaged-backed security prepayment cash flow levelsdecreased for most of 2006, primarily attributable to decreased refinancingopportunities.

We invest in mortgage-backed securities and Federalagency securities because they provide a risk/return profile consistent withour investment objectives. Mortgage-backed securities and Federal agencysecurities generally have a higher yield than U.S. Treasury securities due tocredit and prepayment risk. Credit risk results from the possibility that aloss may occur if a counterparty, such as the Federal agency issuing thesecurities, is unable to meet the terms of the contract. Credit risk related tomortgage-backed securities and Federal agency securities is substantiallyreduced by payment guarantees and credit enhancements. Prepayment risk resultsfrom the possibility that changes in interest rates and other economic factorswill result in investment securities paying off earlier than the scheduledmaturity date. Refer to the ‘Market Risk’ section for additional detailsregarding our net interest income simulation model, which includes the impactof changes in interest rates, and therefore prepayment risk, on our netinterest income.

We invest in AAA rated, insured municipal securitiesto generate stable, tax advantaged income. Municipal securities generally havelower stated yields than Federal agency and U.S. Treasury securities, but theirafter-tax yields are comparable. Municipal securities are subject to call risk.Call risk is similar to prepayment risk and results from the possibility thatfluctuating interest rates and other factors may result in the exercise of thecall option by the issuing municipality prior to the maturity date of thesecurity.

Thecarrying value, weighted-average yield, and contractual maturity of oursecurities held to maturity at December 31, 2006 are reflected in thefollowing 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         |       |                            | $          | 341 |   |   |   | 5.67 | % |   |   | $ | 2,846 |   |   |   | 5.69 | % |   | $ | 5,108 |   |   | 6.68 | % |   | $ | 3,745,202 |   |   | 5.61 | % |   |
| Federal agency securities          |       |                            | —     |   |   |   | — |   |   |   | 2,520 |   |   |   | 6.67 |   |   | 339,928 |   |   | 5.99 |   |   | 1,338,010 |   |   | 4.47 |   |   |
| State and political subdivisions   |       |                            | —     |   |   |   | — |   |   |   | 8,297 |   |   |   | 4.85 |   |   | 10,764 |   |   | 5.19 |   |   | 79,314 |   |   | 4.97 |   |   |
| Total securities held  to maturity |       |                            | $          | 341 |   |   |   | 5.67 | % |   |   | $ | 13,663 |   |   |   | 5.36 | % |   | $ | 355,800 |   |   | 5.98 | % |   | $ | 5,162,526 |   |   | 5.31 | % |   |

 

Thecarrying value, weighted-average yield, and contractual maturity of oursecurities available for sale at December 31, 2006 are reflected in thefollowing 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           |       |                            | $          | — |   |   |   | 0.00 | % |   |   | $ | 24,676 |   |   |   | 5.60 | % |   | $ | 135,013 |   |   | 5.40 | % |   | $ | 4,115,362 |   |   | 5.01 | % |   |
| State and political subdivisions     |       |                            | 968        |   |   |   | 5.00 |   |   |   | 3,358 |   |   |   | 4.78 |   |   | 96,048 |   |   | 3.94 |   |   | 243,930 |   |   | 4.06 |   |   |
| Corporate debt                       |       |                            | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   | — |   |   | — |   |   | 169,850 |   |   | 6.08 |   |   |
| Foreign government                   |       |                            | 10,535     |   |   |   | 3.82 |   |   |   | — |   |   |   | — |   |   | — |   |   | — |   |   | — |   |   | — |   |   |
| Total securities  available for sale |       |                            | $          | 11,503 |   |   |   | 3.92 | % |   |   | $ | 28,034 |   |   |   | 5.50 | % |   | $ | 231,061 |   |   | 4.79 | % |   | $ | 4,529,142 |   |   | 5.00 | % |   |

 

Actual maturities willdiffer from contractual maturities because borrowers may have the right to callor prepay obligations with or without call or prepayment penalties.

41

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*Loan Portfolio*

Our loan portfolio decreased $131.7 million, or 33%,from 2005 to 2006 primarily due to repayments of lines of credit.

Thefollowing table summarizes our loan portfolio for the dates indicated (Dollarsin thousands):

| ** **                       | ** ** | **December 31,** | ** ** |
|----------------------------------|------------|-----------------------|------------|
| ** **                       | ** ** | **2006**              | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| Loans to mutual  funds           |       | $                     | 152,491    |   | $ | 286,144 |   | $ | 22,520 |   | $ | 104,954 |   | $ | 49,372 |   |
| Loans to  individuals            |       | 64,118                |       | 81,392 |   | 69,402 |   | 67,641 |   | 70,023 |   |
| Commercial and  industrial       |       | 6,634                 |       | 15,697 |   | 12,177 |   | 7,739 |   | 6,240 |   |
| Other                            |       | 47,550                |       | 19,237 |   | 30,531 |   | 19,296 |   | 18,202 |   |
|                             |       | 270,793               |       | 402,470 |   | 134,630 |   | 199,630 |   | 143,837 |   |
| Less: allowance  for loan losses |       | (100                  | )          | (100 | ) | (100 | ) | (100 | ) | (100 | ) |
| Net loans                        |       | $                     | 270,693    |   | $ | 402,370 |   | $ | 134,530 |   | $ | 199,530 |   | $ | 143,737 |   |
| Floating rate                    |       | $                     | 270,781    |   | $ | 402,458 |   | $ | 134,618 |   | $ | 199,618 |   | $ | 143,825 |   |
| Fixed rate                       |       | 12                    |       | 12 |   | 12 |   | 12 |   | 12 |   |
| Gross loans                      |       | $                     | 270,793    |   | $ | 402,470 |   | $ | 134,630 |   | $ | 199,630 |   | $ | 143,837 |   |

 

We make loans to individually managed accountcustomers and to mutual funds and other pooled product clients. We offeroverdraft protection and lines of credit to our clients for the purpose offunding redemptions, covering overnight cash shortfalls, leveraging portfoliosand meeting other client borrowing needs. The majority of loans to individuallymanaged account customers are written on a demand basis, bear variable interestrates tied to the Prime rate or the Federal Funds rate and are fully secured byliquid collateral, primarily freely tradable securities held in custody by usfor the borrower. We monitor the value of collateral daily to ensure the amountof collateral held by us exceeds the loan balance by a certain threshold. Loansto mutual funds and other pooled product clients include unsecured lines ofcredit that may, in the event of default, be collateralized at our option bysecurities held in custody by us for those clients. Loans to individuallymanaged account customers, mutual funds and other pooled product clients alsoinclude advances that we make to certain clients pursuant to the terms of ourcustody agreements with those clients to facilitate securities transactions andredemptions.

At December 31, 2006, our only lendingconcentrations that exceeded 10% of total loan balances were the lines ofcredit to mutual fund clients discussed above. These loans were made in theordinary course of business on substantially similar terms and conditionsprevailing at the time for comparable transactions.

We periodically issue lines of credit and advances toour mutual fund clients to help those clients with security transactions. ThePresident of one of our clients is a related party to James M. Oates, a memberof our Board of Directors. At December 31, 2006, we had total contractualagreements for $150.0 million of committed lines of credit with two mutualfunds within the related party complex (the ‘mutual funds’). The primary sourceof repayment of the loans is the proceeds from the sale of investments in thenormal course of the mutual funds’ business. As part of the agreement, themutual funds are required to segregate and maintain specific collateral for usequal to 200% of the lines of credit. At December 31, 2006, loans due fromthe mutual funds totaled $63.7 million. At December 31, 2005, loans duefrom the mutual funds totaled $125.0 million. The terms and conditions of ourcontractual agreements with the mutual funds, including collateralrequirements, lending limits and fees, are consistent with other lendingclients that have similar composition, size and overall business relationshipswith us. Also, Mr. Oates must abstain from voting on any board matterinvolving any proposed transaction with the mutual funds.

Our loan portfolio creditperformance has been excellent. There have been no loan charge-offs in thehistory of our Company. It is our policy to place a loan on nonaccrual statuswhen either principal or 

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interestbecomes 90 days past due and the loan’s collateral is not sufficient tocover both principal and accrued interest. As of December 31, 2006, therewere no loans on nonaccrual status and no troubled debt restructurings. Althoughvirtually all of our loans are fully collateralized with freely tradablesecurities, management recognizes some credit risk inherent in the loanportfolio, and therefore we have recorded an allowance for loan losses of$0.1 million at December 31, 2006, a level which has remainedconsistent for the past five years. This allowance is not allocated to anyparticular loan, but is intended to absorb any risk of loss inherent in theloan portfolio at the balance sheet date that is not captured in our historicalloss rates. Management actively monitors the loan portfolio and the underlyingcollateral and regularly assesses the adequacy of the allowance for loanlosses.

*Deposits*

Total deposits were $6.1 billion at December 31,2006, up 23% from December 31, 2005. The increase in our deposit balancesis a result of new business and our clients holding larger cash positions intheir portfolios.

Time deposits withbalances greater than $100,000 totaled $524.4 million and $230.1 million at December 31,2006 and 2005, respectively. All time deposits had a maturity of less thanthree months at December 31, 2006 and 2005.

*RepurchaseAgreements and Short-Term and Other Borrowings*

Repurchase agreements decreased $1.1 billion, or 22%,from December 31, 2005 to December 31, 2006. The majority of ourrepurchase agreements are with clients who seek collateralized deposits. Wholesalerepurchase agreements are a stable source of funding and are used to offset thevariability of deposit flow. The average balance of securities sold underrepurchase agreements for the year ended December 31, 2006 was $4.5billion with an average cost of approximately 3.67%, compared to an averagebalance of $5.2 billion and an average cost of approximately 2.72% for the sameperiod in 2005. The increase in the average cost of repurchase agreements wasdue to higher short-term interest rates in 2006 compared to 2005.

Thefollowing table represents information regarding our securities sold underrepurchase agreements (Dollars in thousands):

| ** **                            | ** ** | **December 31,** | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|---------------------------------------|------------|-----------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                            | ** ** | **2006**              | ** ** | **2005**              | ** ** | **2004**              | ** ** |
| Outstanding at  end of year           |       |                  | $          | 3,727,800             |       |                  |       | $ | 4,797,868 |   |   |   | $ | 4,255,497 |   |   |
| Maximum  outstanding at any month end |       |                  | 4,977,489  |                  |       |                  | 5,972,855  |   |   |   | 4,749,456 |   |   |
| Average balance  for the year         |       |                  | 4,490,240  |                  |       |                  | 5,244,614  |   |   |   | 4,162,132 |   |   |
| Weighted-average  rate at end of year |       |                  | 4.15       | %                     |       |                  | 3.55       | % |   |   | 1.98 | % |   |
| Weighted-average rate  for the year   |       |                  | 3.67       | %                     |       |                  | 2.72       | % |   |   | 1.31 | % |   |

 

Short-term and other borrowings decreased $0.8billion, or 62%, from December 31, 2005 to December 31, 2006. Short-termand other borrowings are sources of funding and are used to offset thevariability of deposit flow. The average balance of short-term and otherborrowings for the year ended December 31, 2006 was $0.9 billion with anaverage cost of approximately 5.02%, compared to an average balance of $1.6billion and an average cost of approximately 3.31% for the same period in 2005.The increase in the average cost of short-term and other borrowings was due toan increase in short-term rates during 2006 compared to 2005.

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Thefollowing table represents information regarding our Federal Funds purchased(Dollars in thousands):

| ** **                            | ** ** | **December 31,** | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|---------------------------------------|------------|-----------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                            | ** ** | **2006**              | ** ** | **2005**              | ** ** | **2004**              | ** ** |
| Outstanding at  end of year           |       |                  | $          | 391,967               |       |                  |       | $ | 810,511 |   |   |   | $ | 344,491 |   |   |
| Maximum  outstanding at any month end |       |                  | 1,145,025  |                  |       |                  | 1,603,757  |   |   |   | 739,038 |   |   |
| Average balance  for the year         |       |                  | 743,101    |                  |       |                  | 1,298,684  |   |   |   | 491,170 |   |   |
| Weighted-average  rate at end of year |       |                  | 5.20       | %                     |       |                  | 4.25       | % |   |   | 1.94 | % |   |
| Weighted-average rate  for the year   |       |                  | 4.91       | %                     |       |                  | 3.33       | % |   |   | 1.45 | % |   |

 

**Market Risk**

Our clients, in the course of their financial assetmanagement, maintain cash balances, which they can deposit with us on ashort-term basis in interest-bearing accounts or client repurchase agreements. Weeither directly invest these cash balances to earn interest income, or placethese deposits in third-party vehicles and remit a portion of the earnings onthese investments to our clients after deducting a fee as our compensation forinvesting clients’ funds in these investment vehicles. In the conduct of theseactivities, we are subject to market risk.

Market risk is the risk of an adverse financial impactfrom changes in market prices. The level of risk we assume is a function of ouroverall strategic objectives and liquidity needs, client requirements andmarket volatility. The active management of market risk is integral to ouroperations.

Our balance sheet is primarily subject to interestrate risk, which is the risk of loss due to movements in interest rates. Prepaymentrisk, which is the risk that changes in interest rates and other economicfactors will result in investment securities paying off earlier than thescheduled maturity date, is inherent in our investment securities, mainly ourmortgage-backed securities and Federal agency securities. Prepayment levels formortgage-backed securities are primarily driven by changes in interest rates. Prepaymentlevels for Federal agency securities are driven by a number of factors,including expiration of prepayment penalty provisions, the economic conditionof the borrower, borrower refinancing alternatives, and interest rates. Theobjective of interest rate sensitivity management is to provide sustainable netinterest income under various economic conditions.

Our Board of Directors has set asset and liabilitymanagement policies that define the overall framework for managing interestrate sensitivity, including accountabilities and controls over investmentactivities. These policies delineate investment limits and strategies that areappropriate, given our liquidity and regulatory requirements. For example, wehave established a policy limit stating that projected net interest income willnot be impacted by more than 10% given a change in interest rates of 200 basispoints (+ or -) over a twelve-month period. Each quarter, our Board ofDirectors reviews our asset and liability positions, including simulations ofthe effect of various interest rate scenarios on our net interest income.

The day-to-day responsibility for oversight of theAsset and Liability Management function has been delegated by our Board ofDirectors to our Asset and Liability Committee (‘ALCO’). ALCO is a seniormanagement committee consisting of the Chief Executive Officer, the President,the Chief Financial Officer, the Chief Risk Officer and members of the Treasuryfunction. 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, which include forecasted prepaymentspeeds that are based on market and industry data, maturities and repricing offinancial instruments, changes in market conditions, capital planning anddeposit sensitivity. The model assumes that the composition of ourinterest-sensitive assets and liabilities will change over the period beingmeasured. The model also assumes that the change in interest rates is aparallel shift of the yield curve across all maturities. These assumptions areinherently uncertain, and as a result, the model cannot precisely predict theeffect of changes in 

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interest rates on our netinterest income. Actual results may differ from simulated results due to thetiming, magnitude and frequency of interest rate changes and changes in marketconditions and management strategies.

The results of the income simulation model as of December 31,2006 and 2005 indicated that an upward shift of interest rates by 200 basispoints over a twelve-month period would result in a reduction in projected netinterest income of approximately 6.2% and 7.0%, respectively, which are bothwithin our 10% policy limit. We also simulate a 200 basis point rate reductionover a twelve-month period. This simulation would result in an increase inprojected net interest income of approximately 3.3% and 1.1% at December 31,2006 and 2005, respectively, both within our 10% policy limit.

We also use gap analysis as a secondary tool to manageour interest rate sensitivity. Gap analysis involves measurement of thedifference in asset and liability repricing on a cumulative basis within aspecified time frame. A positive gap indicates that more interest-earningassets than interest-bearing liabilities reprice/mature in a time frame, and anegative gap indicates the opposite. As shown in the cumulative gap position inthe table presented on the following page, at December 31, 2006,interest-bearing liabilities repriced faster than interest-earning assets inthe short term. Generally speaking, net interest income would benefit from lowershort-term interest rates. During a period of rising interest rates, such asthe one we experienced during 2005 and the first half of 2006, net interestincome would be lower than it would have been until interest rates stabilize. Otherimportant determinants of net interest income are the shape of the yield curve,general rate levels, reinvestment spreads, balance sheet growth and mix, andinterest rate spreads. We continue to run a closely matched balance sheet byinvesting the majority of our assets in short duration, variable-ratesecurities and executing interest rate swaps against client liabilities,including client repurchase agreements.

We manage the structure of interest-earning assets andinterest-bearing liabilities by adjusting their mix, yield, maturity and/orrepricing characteristics based on market conditions. Client deposits andrepurchase agreements, which are predominantly short term, are our primarysources of funds. We also use term borrowings and interest rate swap agreementsto augment our management of interest rate exposure. The effect of the swapagreements is to lengthen both a forecasted series of fixed-rate overnightliabilities incurred at different daily fixed rates and short-termvariable-rate liabilities into longer-term fixed-rate liabilities. Theweighted-average fixed-payment rates on our swap agreements were 3.82% and3.51% at December 31, 2006 and 2005, respectively. Variable-interestpayments received are currently indexed to the overnight Federal Funds rate. AtDecember 31, 2006 and 2005, the weighted-average rates of variablemarket-indexed interest payment obligations to us were 5.24% and 4.00%,respectively. The remaining terms of swaps at December 31, 2006 range from1 to 22 months. These contracts had net fair values of approximately $13.8million and $24.2 million at December 31, 2006 and 2005, respectively.

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Thefollowing table presents the repricing schedule for our interest-earning assetsand interest-bearing liabilities at December 31, 2006 (Dollars inthousands):

| ** **                                                                                       | ** ** | **Within** | ** ** | **Three**       | ** ** | **Six**            | ** ** | **One**             | ** ** | ** **         | ** ** | ** ** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|------------|------------|
| ** **                                                                                       | ** ** | **Three**  | ** ** | **To Six** | ** ** | **To Twelve** | ** ** | **Year to**    | ** ** | **Over Five** | ** ** | ** ** | ** ** |
| ** **                                                                                       | ** ** | **Months** | ** ** | **Months**      | ** ** | **Months**         | ** ** | **Five Years** | ** ** | **Years**          | ** ** | **Total**  | ** ** |
| Interest-earning  assets(1):                                                                     |       |       |       |            |       |               |       |                |       |               |       |       |       |   |   |   |   |
| Investment securities(2,3)                                                                       |       | $          | 5,921,097  |            | $          | 488,872            |       |                | $          | 740,712            |       |       |       | $ | 2,412,779 |   |   | $ | 770,003 |   | $ | 10,333,463 |   |
| Federal funds sold, interest-bearing deposits with  other banks and other short-term investments |       | 323,189    |       | —          |       |               | —     |                |       |               | —     |       |       | — |   | 323,189 |   |
| Loans—variable rate                                                                         |       | 269,781    |       | 1,000           |       |               | —     |                |       |               | —     |       |       | — |   | 270,781 |   |
| Loans—fixed rate                                                                            |       | —     |       | —          |       |               | —     |                |       |               | 12         |       |       | — |   | 12 |   |
| Total interest-earning  assets                                                                   |       | 6,514,067  |       | 489,872         |       |               | 740,712    |                |       |               | 2,412,791  |       |       | 770,003 |   | 10,927,445 |   |
| Interest-bearing liabilities:                                                                    |       |       |       |            |       |               |       |                |       |               |       |       |       |   |   |   |   |
| Demand deposit accounts                                                                          |       | 110,647    |       | —          |       |               | —     |                |       |               | —     |       |       | — |   | 110,647 |   |
| Savings accounts                                                                                 |       | 4,854,711  |       | —          |       |               | —     |                |       |               | —     |       |       | — |   | 4,854,711 |   |
| Time deposits                                                                                    |       | 224,386    |       | —          |       |               | —     |                |       |               | —     |       |       | — |   | 224,386 |   |
| Interest rate contracts                                                                          |       | (1,330,000 | )          | 260,000         |       |               | 400,000    |                |       |               | 670,000    |       |       | — |   | — |   |
| Securities sold under repurchase agreements                                                      |       | 3,277,800  |       | 150,000         |       |               | 200,000    |                |       |               | 100,000    |       |       | — |   | 3,727,800 |   |
| Short-term and other borrowings                                                                  |       | 517,051    |       | —          |       |               | —     |                |       |               | —     |       |       | — |   | 517,051 |   |
| Junior subordinated  debentures                                                                  |       | 24,774     |       | —          |       |               | —     |                |       |               | —     |       |       | — |   | 24,774 |   |
| Total interest-bearing liabilities                                                               |       | 7,679,369  |       | 410,000         |       |               | 600,000    |                |       |               | 770,000    |       |       | — |   | 9,459,369 |   |
| Net interest-sensitivity gap during the period                                                   |       | $          | (1,165,302 | )               | $          | 79,872             |       |                | $          | 140,712            |       |       |       | $ | 1,642,791 |   |   | $ | 770,003 |   | $ | 1,468,076 |   |
| Cumulative gap                                                                                   |       | $          | (1,165,302 | )               | $          | (1,085,430         | )          |                | $          | (944,718           | )          |       |       | $ | 698,073 |   |   | $ | 1,468,076 |   |   |   |
| Interest-sensitive assets as a percent of  interest-sensitive liabilities (cumulative)           |       | 84.83      | %          | 86.58           | %          |               | 89.13      | %                   |       |               | 107.38     | %          |       | 115.52 | % |   |   |
| Interest-sensitive assets as a percent of total  assets (cumulative)                             |       | 56.36      | %          | 60.60           | %          |               | 67.01      | %                   |       |               | 87.88      | %          |       | 94.54 | % |   |   |
| Net interest-sensitivity gap as a percent of total  assets                                       |       | (10.08     | )%         | 0.69            | %          |               | 1.22       | %                   |       |               | 14.21      | %          |       | 6.66 | % |   |   |
| Cumulative gap as  a percent of total assets                                                     |       | (10.08     | )%         | (9.39           | )%         |               | (8.17      | )%                  |       |               | 6.04       | %          |       | 12.70 | % |   |   |

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(1)             Adjustable rate assets are included in the period inwhich interest rates are next scheduled to adjust rather than in the period inwhich they are due. Fixed-rate loans are included in the period in which theyare scheduled to be repaid.

(2)             Mortgage-backed securities are included in the pricingcategory that corresponds with the earlier of their first repricing date orprincipal paydown schedule generated from industry sourced prepaymentprojections.

(3)             Excludes $26.4 million of unsettled securitiespurchases and $27.8 million of net unrealized losses as of December 31,2006.

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**Liquidity**

Liquidity represents the ability of an institution tomeet present and future financial obligations through either runoff due toprepayments, asset sales, maturity of existing assets or the acquisition ofadditional funds through liability management. These obligations arise from thewithdrawals of deposits, the payment of operating expenses, and the inclusionof capital expenditures for fixed assets and leasehold improvements.

Our primary sources of liquidity include cash and cashequivalents, Federal Funds sold, new deposits, short-term borrowings, interestand principal payments on securities held to maturity and available for sale,fees collected from asset administration clients, FHLBB borrowings and theFederal Reserve Discount Window. As a result of our management of liquid assetsand our ability to generate liquidity through liability funds, managementbelieves that we maintain overall liquidity sufficient to meet our depositors’needs, to satisfy our operating requirements and to fund the payment of ananticipated annual cash dividend of $0.10 per share for 2007 (approximately$6.6 million based upon 65,628,108 shares outstanding as of December 31,2006).

Our ability to pay dividends on common stock maydepend on the receipt of dividends from the Bank. Any dividend payments by theBank are subject to certain restrictions imposed by the MassachusettsCommissioner of Banks. During all periods presented in this report, the Companydid not require dividends from the Bank in order to fund the Company’s owndividends. In addition, we may not pay dividends on our common stock if we arein default under certain agreements entered into in connection with the sale ofour Capital Securities. The Capital Securities were issued in 1997 by InvestorsCapital Trust I, a Delaware statutory business trust sponsored by us, andqualify as Tier 1 capital under the capital guidelines of the Federal ReserveBoard of Governors (‘FRB’).

In June 2006, we announced that our Board ofDirectors had authorized a new repurchase plan of up to $150.0 million of ourcommon stock over the twelve months following the announcement. We do notexpect the stock repurchase program to have a material impact on our capitalresources, such as maintaining risk-based capital ratios in excess of capitaladequacy guidelines and our ability to pay dividends on our common stock. As ofDecember 31, 2006, we have repurchased $29.3 million of our common stockunder this plan.

We have informal borrowing arrangements with variouscounterparties. Each counterparty has agreed to make funds available to us atthe Federal Funds overnight rate. Each counterparty may terminate itsarrangement at any time and is under no contractual obligation to provide uswith requested funding. Our borrowings under these arrangements are typicallyon a short-term basis. We cannot be certain, however, that such funding will beavailable. Lack of availability of liquid funds could have a material adverseimpact on our operations.

We also have Master Repurchase Agreements in placewith various counterparties. Each counterparty has agreed on an uncommittedbasis to make funds available to us at various rates in exchange for collateralconsisting of marketable securities.

Our capital stock investment in the FHLBB totaled$29.4 million as of December 31, 2006. This amount reflects a $20.6million decrease from December 31, 2005. The $29.4 million capital stockinvestment includes both a $25.0 million membership component and a $4.4million activity-based component. The membership component of the FHLBB capitalstock investment requires a five-year advance notice of withdrawal. Our $29.4million capital stock investment in the FHLBB provides an overnight borrowingcapacity of up to $146.4 million. The amount outstanding under this arrangementas of December 31, 2006 was $125.0 million. Additional borrowing isavailable to us based on prescribed collateral levels and increased investmentin FHLBB capital stock. We currently have the ability to 

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purchase up to $25.0million of activity-based capital, which would provide a total overnightborrowing capacity of $833.3 million.

In October 2006, webecame a member of the Federal Reserve Bank of Boston (‘FRBB’). In connectionwith our membership, we were required to subscribe to purchase stock of theFRBB totaling 6% of the Bank’s capital and surplus. We fulfilled our obligationto purchase 50% of the subscribed amount by purchasing $7.4 million of FRBBstock. The remaining subscription amount is subject to purchase upon therequest of the FRBB.

Thefollowing table details our contractual obligations as of December 31,2006 (Dollars in thousands):

| ** **                        | ** ** | **Payments due by period** | ** ** |
|-----------------------------------|------------|-------------------------------------------|------------|
| ** **                        | ** ** | ** **                                | ** ** | **Less than 1** | ** ** | **1-3** | ** ** | **4-5** | ** ** | **More than** | ** ** |
| ** **                        | ** ** | **Total**                                 | ** ** | **year** | ** ** | **years** | ** ** | **years** | ** ** | **5 years** | ** ** |
| **Contractual obligations**       |       |                                      |       |   |   |   |   |   |   |   |   |
| Debt obligations(1)               |       | $                                         | 517,051    |   | $ | 517,051 |   | $ | — |   | $ | — |   | $ | — |   |
| Repurchase agreements             |       | 3,727,800                                 |       | 3,627,800 |   | 100,000 |   | — |   | — |   |
| Junior subordinated debentures(2) |       | 24,000                                    |       | 24,000 |   | — |   | — |   | — |   |
| Operating lease obligations       |       | 299,416                                   |       | 35,189 |   | 70,328 |   | 72,020 |   | 121,879 |   |
| Total                             |       | $                                         | 4,568,267  |   | $ | 4,204,040 |   | $ | 170,328 |   | $ | 72,020 |   | $ | 121,879 |   |

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(1)          Debt obligationspresented are variable in nature and do not include interest amounts.

(2)          Thesesecurities ultimately mature in 2027; however, we have the right to redeem thesecurities as early as February 2007.

| ** **                 | ** ** | **Payments due by period** | ** ** |
|----------------------------|------------|-------------------------------------------|------------|
| ** **                 | ** ** | ** **                                | ** ** | **Less than 1** | ** ** | **1-3** | ** ** | **4-5** | ** ** | **More than** | ** ** |
| ** **                 | ** ** | **Total**                                 | ** ** | **year** | ** ** | **years** | ** ** | **years** | ** ** | **5 years** | ** ** |
| **Other commitments**      |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Unused commitments to lend |       | $                                         | 1,053,632  |   | $ | 1,044,632 |   | $ | — |   | $ | 9,000 |   |   | $ | — |   |   |
| Other                      |       | 148,156                                   |       | 37,777 |   | 74,844 |   | 35,535 |   |   | — |   |   |
| Total                      |       | $                                         | 1,201,788  |   | $ | 1,082,409 |   | $ | 74,844 |   | $ | 44,535 |   |   | $ | — |   |   |

 

Included in the othercommitments line presented above are contracts in which we are obligated toutilize the data processing services of Electronic Data Systems through December 31,2008, SEI Investments Company through December 31, 2009 and InternationalBusiness Machines Corporation through June 30, 2011. The commitments topay for these services are based upon transaction volumes and includeinflationary price clauses.

**Capital Resources**

Historically, we have financed our operationsprincipally through internally generated cash flows. We incur capitalexpenditures for furniture, fixtures, capitalized software and miscellaneousequipment needs. We lease office space and computing equipment throughoperating leases. Capital expenditures have been incurred and leases enteredinto on an as-required basis, primarily to meet our growing operating needs. Asa result, our capital expenditures were $76.7 million and $33.1 million for theyears ended December 31, 2006 and 2005, respectively. For the year ended December 31,2006, capital expenditures were comprised of approximately $33.2 million incapitalized software and projects in process, $22.8 million in leasehold improvementsand $20.7 million in fixed assets. For the year ended December 31, 2005,capital expenditures were comprised of approximately $19.0 million incapitalized software and projects in process, $13.6 million in fixed assets and$0.5 million in leasehold improvements.

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Stockholders’ equity at December 31, 2006 was$938.7 million, up 21% from 2005, primarily due to net income earned and theexercise of stock options. The ratio of average stockholders’ equity to averageassets was approximately 7% for the year ended December 31, 2006 comparedto 6% for the year ended December 31, 2005.

The FRB has adopted capital adequacy guidelinesapplicable to United States banking organizations. The FRB’s capital adequacyguidelines generally require bank holding companies (‘BHCs’) to maintain totalcapital equal to 8% of total risk-adjusted assets and off-balance sheet items(the ‘Total Risk-Based Capital Ratio’), with at least 50% of that amountconsisting of Tier 1, or core capital, and the remaining amount consisting ofTier 2, or supplementary capital. Tier 1 capital for BHCs generally consists ofthe sum of common stockholders’ equity and perpetual preferred stock (subjectto certain limitations), less goodwill and other nonqualifying intangibleassets. Tier 2 capital generally consists of hybrid capital instruments,perpetual debt and mandatory convertible debt securities; perpetual preferredstock, not included as Tier 1 capital; term subordinated debt andintermediate-term preferred stock; and, subject to limitations, generalallowances for loan and lease losses. Assets are adjusted under the risk-basedguidelines to take into account different risk characteristics.

In addition to the risk-based capital requirements,the FRB requires BHCs to maintain a minimum leverage capital ratio of Tier 1capital to its average total consolidated assets (the ‘Leverage Ratio’) of 3%. Totalaverage consolidated assets for this purpose does not include goodwill and anyother intangible assets and investments that the FRB determines should bededucted from Tier 1 capital. The FRB has announced that the 3% Leverage Ratiorequirement is the minimum for the top-rated BHCs. All other BHCs are requiredto maintain a minimum Leverage Ratio of 4%. BHCs with supervisory, financial,operational or managerial weaknesses, as well as BHCs that are anticipating orexperiencing significant growth, are expected to maintain capital ratios wellabove the minimum levels. Because we anticipate significant future growth, wewill be required to maintain a Leverage Ratio of 4% or higher.

We are currently incompliance with both the Total Risk-Based Capital Ratio and the Leverage Ratiorequirements, and management expects these ratios to remain in compliance withthe FRB’s capital adequacy guidelines. At December 31, 2006, our TotalRisk-Based Capital Ratio and Leverage Ratio were 19.04% and 7.63%,respectively.

**Off Balance SheetArrangements**

***Lines of Credit***—AtDecember 31, 2006, we had commitments to mutual funds, individuals andothers under collateralized open lines of credit totaling $1.2 billion, againstwhich $184.6 million in loans were drawn. The credit risk involved inissuing lines of credit is essentially the same as that involved in extendingdemand loans. We do not anticipate any loss as a result of these lines ofcredit.

***Securities Lending***—Onbehalf of our clients, we lend securities to creditworthy broker-dealers. Incertain circumstances, we may indemnify our clients for the fair market valueof those securities against a failure of the borrower to return such securities.We require the borrowers to provide collateral in an amount equal to, or inexcess of, 102% of the fair market value of U.S. dollar-denominated securitiesborrowed and 105% of the fair market value of non-U.S. dollar-denominatedsecurities borrowed. The borrowed securities are revalued daily to determinewhether additional collateral is necessary. As guarantor, we are required torecognize, at the inception of a guarantee, a liability for the fair value ofthe obligation undertaken in issuing the guarantee. We measure the fair valueof our indemnification obligation by marking our securities lending portfolioto market on a daily basis and comparing the value of the portfolio to thecollateral holdings position. The fair value of the indemnification obligationto be recorded would be the deficiency of collateral as compared to the valueof the securities out on loan.

With respect to the indemnified securities lendingportfolio, the cash and U.S. government securities held by us as collateral at December 31,2006 totaled $11.1 billion, while the fair value of the portfolio 

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totaled approximately$10.7 billion. Given that the value of the collateral held was in excessof the value of the securities that we would be required to replace if theborrower defaulted and failed to return such securities, our indemnificationobligation was zero and no liability was recorded.

All securities loans arecategorized as overnight loans. The maximum potential amount of future paymentsthat we could be required to make would be equal to the market value of thesecurities borrowed. Since the securities loans are overcollateralized by 2%(for U.S. dollar-denominated securities) to 5% (for non-U.S. dollar-denominatedsecurities) of the fair market value of the loan made, the collateral held byus would be used to satisfy the obligation. In addition, each borrowingagreement includes “set-off” language that allows us to use any excesscollateral on other loans to that borrower to cover any collateral shortfall ofthat borrower. However, there is a potential risk that the collateral would notbe sufficient to cover such an obligation if the security on loan increased invalue between the time the borrower defaulted and the time the security is “bought-in”.In those instances, we would “buy-in” the security using all availablecollateral and a loss would result from the difference between the value of thesecurity “bought-in” and the value of the collateral held. We have neverexperienced a broker default.

**ITEM 7A.**        QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

The information requiredby this item is contained in the ‘Market Risk’ section in the ‘Management’sDiscussion and Analysis of Financial Condition and Results of Operations,’ aspart of this Report.

**ITEM 8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA.

The information requiredby this item is contained in the financial statements and schedules set forthin Item 15(a) under the captions ‘Consolidated Financial Statements’ and ‘FinancialStatement Schedules’ as a part of this Report.

**ITEM 9A.**        CONTROLSAND PROCEDURES.

**Evaluation ofDisclosure Controls and Procedures**

As of December 31, 2006, we evaluated theeffectiveness of the design and operation of our disclosure controls andprocedures. 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 Securities and Exchange Commission and that theinformation required to be disclosed is accumulated and communicated to ourprincipal executive and principal financial officers as appropriate to allowtimely decisions regarding required disclosure. Kevin J. Sheehan, our Chairmanand Chief Executive Officer, and John N. Spinney, Jr., our Senior VicePresident and Chief Financial Officer, reviewed and participated in thisevaluation. Based on this evaluation, Messrs. Sheehan and Spinneyconcluded that, as of December 31, 2006, our disclosure controls andprocedures were effective. During the year ended December 31, 2006, therewere no significant changes in our internal control over financial reportingthat materially affected our internal control over financial reporting.

50

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**REPORT OFMANAGEMENT TO THE BOARD OF DIRECTORS AND STOCKHOLDERS**

February 26, 2007To the Board of Directors and Stockholders:

**FinancialStatements**

The management ofInvestors Financial Services Corp. and its subsidiaries (“the Company”) isresponsible for the preparation, integrity, and fair presentation of itspublished financial statements and all other information presented in theconsolidated financial statements of the Company contained in this Report. Theconsolidated financial statements of the Company have been prepared inaccordance with accounting principles generally accepted in the United Statesof America and, as such, include amounts based on informed judgments andestimates made by management.

**Internal Control**

Management is responsible for establishing andmaintaining effective internal control over financial reporting, includingsafeguarding of assets, for financial statements in conformity with accountingprinciples generally accepted in the United States of America. The internalcontrol contains monitoring mechanisms, and actions are taken to correctdeficiencies identified. There are inherent limitations in the effectiveness ofany internal control, including the possibility of human error and thecircumvention or overriding of controls. Accordingly, even effective internalcontrol can provide only reasonable assurance with respect to financialstatement preparation. Further, because of changes in conditions, theeffectiveness of internal control may vary over time.

Management has made a comprehensive review, evaluationand assessment of the Company’s internal control over financial reporting,including safeguarding of assets, for financial presentations in conformitywith accounting principles generally accepted in the United States of Americaas of December 31, 2006, including controls over the preparation byInvestors Bank & Trust Company (a wholly owned banking subsidiary ofthe Company) of the schedules equivalent to the basic financial statements inaccordance with the Federal Financial Institutions Examination CouncilInstructions for Consolidated Reports of Condition and Income for Schedules RC, RI and RI-A (the “Call ReportInstructions”). This assessment was based on criteria for effective internalcontrol over financial reporting, including safeguarding of assets, describedin ‘*Internal Control—Integrated Framework’*issued by the Committee of Sponsoring Organizations of the Treadway Commission.Based on this assessment, management has concluded that the Company maintainedeffective internal control over financial reporting, including safeguarding ofassets, presented in conformity with accounting principles generally acceptedin the United States of America as of December 31, 2006.

The Audit Committee of the Board of Directors iscomprised entirely of outside directors who are independent of the Company’smanagement; it includes members with banking or related management experience,has access to its own outside counsel, and does not include representatives ofany large customers of the institution. The Audit Committee is responsible forrecommending to the Board of Directors the selection of independent auditors. Itmeets periodically with management, the independent auditors and the internalauditors to ensure that they are carrying out their responsibilities. The AuditCommittee is also responsible for performing an oversight role by reviewing andmonitoring the financial, accounting and auditing procedures of the Company inaddition to reviewing the Company’s financial reports. The independent auditorsand the internal auditors have full and free access to the Audit Committee,with or without the presence of management, to discuss the adequacy of internalcontrol over financial reporting and any other matters which they believe shouldbe brought to the attention of the Audit Committee.

51

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Deloitte &Touche, LLP, an Independent Registered Public Accounting Firm, which hasaudited and reported on the consolidated financial statements contained in thisForm 10-K, has issued their report dated February 26, 2007 onmanagement’s assessment with respect to the effectiveness of the Company’sinternal control over financial reporting as of December 31, 2006.

**Compliance WithLaws and Regulations**

Management is also responsible for ensuring compliancewith the federal laws and regulations concerning loans to insiders and thefederal and state laws and regulations concerning dividend restrictions, bothof which are designated by the Federal Deposit Insurance Corporation (‘FDIC’)as safety and soundness laws and regulations.

Managementassessed its compliance with the designated safety and soundness laws andregulations and has maintained records of its determinations and assessments asrequired by the FDIC. Based on this assessment, management believes that theBank has complied, in all material respects, with the designated safety andsoundness laws and regulations for the year ended December 31, 2006.
| /s/ KEVIN J. SHEEHAN                                 |   |
|------------------------------------------------------|--------|
| Kevin J. Sheehan                                     |
| *Chairman  and Chief Executive Officer*              |
| /s/ JOHN N. SPINNEY, JR.                        |   |
| John N.  Spinney, Jr.                           |
| *Senior  Vice President and Chief Financial Officer* |

 

52

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**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

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

We have audited management’s assessment, included inthe accompanying Report of Management to the Board of Directors andStockholders, that Investors Financial Services Corp. and subsidiaries (the “Company”)maintained effective internal control over financial reporting as of December 31,2006, based on criteria established in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission. Because management’s assessment and our audit wereconducted to meet the reporting requirements of Section 112 of the FederalDeposit Insurance Corporation Improvement Act (FDICIA), management’s assessmentand our audit of the Company’s internal control over financial reportingincluded controls over the preparation by Investors Bank & TrustCompany (a wholly-owned banking subsidiary of the Company) of the schedulesequivalent to the basic financial statements in accordance with the FederalFinancial Institutions Examination Council Instructions for ConsolidatedReports of Condition and Income for Schedules RC, RI and RI-A (the “Call ReportInstructions”). The Company’s management is responsible for maintainingeffective internal control over financial reporting and for its assessment ofthe effectiveness of internal control over financial reporting. Ourresponsibility is to express an opinion on management’s assessment and anopinion on the effectiveness of the Company’s internal control over financialreporting based on our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, evaluatingmanagement’s assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinions.

A company’s internal control over financial reportingis a process designed by, or under the supervision of, the company’s principalexecutive and principal financial officers, or persons performing similarfunctions, and effected by the company’s board of directors, management, andother personnel to provide reasonable assurance regarding the reliability offinancial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of the inherent limitations of internalcontrol over financial reporting, including the possibility of collusion orimproper management override of controls, material misstatements due to error orfraud may not be prevented or detected on a timely basis. Also, projections ofany evaluation of the effectiveness of the internal control over financialreporting to future periods are subject to the risk that the controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that theCompany maintained effective internal control over financial reporting as of December 31,2006, is fairly stated, in all material respects, based on the criteriaestablished in *Internal Control—Integrated Framework*issued by the Committee of Sponsoring 

53

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Organizations of theTreadway Commission. Also in our opinion, the Company maintained, in allmaterial respects, effective internal control over financial reporting as of December 31,2006, based on the criteria established in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission.

We have not examined and, accordingly, we do notexpress an opinion or any other form of assurance on management’s statementreferring to compliance with laws and regulations.

We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the consolidated financial statements as of and for the yearended December 31, 2006 of the Company and our report dated February 26,2007 expressed an unqualified opinion on those financial statements.

DELOITTE & TOUCHE LLP

Boston, MassachusettsFebruary 26, 2007

54

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**PART III**

**ITEM 10.**         DIRECTORS,EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.

The information requiredunder this item is incorporated herein by reference to our definitive proxystatement pursuant to Regulation 14A, which proxy statement will be filed withthe Securities and Exchange Commission not later than 120 days after the closeof our fiscal year ended December 31, 2006.

**ITEM 11.**         EXECUTIVECOMPENSATION.

The information requiredunder this item is incorporated herein by reference to our definitive proxy statementpursuant to Regulation 14A, which proxy statement will be filed with theSecurities and Exchange Commission not later than 120 days after the close ofour fiscal year ended December 31, 2006.

**ITEM 12.**         SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS.

The information requiredunder this item is incorporated herein by reference to our definitive proxystatement pursuant to Regulation 14A, which proxy statement will be filed withthe Securities and Exchange Commission not later than 120 days after the closeof our fiscal year ended December 31, 2006.

**ITEM 13.**         CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.

The information requiredunder this item is incorporated herein by reference to our definitive proxystatement pursuant to Regulation 14A, which proxy statement will be filed withthe Securities and Exchange Commission not later than 120 days after the closeof our fiscal year ended December 31, 2006.

**ITEM 14.**         PRINCIPALACCOUNTING FEES AND SERVICES.

The information requiredunder this item is incorporated herein by reference to our definitive proxystatement pursuant to Regulation 14A, which proxy statement will be filed withthe Securities and Exchange Commission not later than 120 days after the closeof our fiscal year ended December 31, 2006.

55

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**PART IV**

**ITEM 15.**         EXHIBITSAND FINANCIAL STATEMENT SCHEDULES.

**(a)****         1.      Consolidated Financial Statements.**

For the following consolidated financial informationincluded herein, see Index to Consolidated Financial Statements on Page F-1:

Report ofIndependent Registered Public Accounting Firm.

ConsolidatedBalance Sheets as of December 31, 2006 and December 31, 2005.

ConsolidatedStatements of Income and Comprehensive Income for the Years Ended December 31,2006, 2005 and 2004.

ConsolidatedStatements of Stockholders’ Equity for the Years Ended December 31, 2006,2005 and 2004.

ConsolidatedStatements of Cash Flows for the Years Ended December 31, 2006, 2005 and2004.

Notes to Consolidated Financial Statements.

**2.****                 FinancialStatement Schedules.**

None.

**3.****                 Listof Exhibits.**
| Exhibit No.    | ** ** | ** **                                                                                                                                                                                            | ** ** | **Description** |
|---------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
|   2.1(13) |       | Agreement and Plan of Merger between the Company and  State Street Corporation, dated February 4, 2007                                                                                           |
|   3.1(6)  |       | Certificate of Incorporation of the Company                                                                                                                                                           |
|   3.2(3)  |       | Certificate of  Amendment of Certificate of Incorporation of the Company                                                                                                                              |
|   3.3(5)  |       | Certificate of  Amendment of Certificate of Incorporation of the Company                                                                                                                              |
|   3.4(8)  |       | Certificate of  Amendment of Certificate of Incorporation of the Company                                                                                                                              |
|   3.5(9)  |       | Certificate of  Amendment of Certificate of Incorporation of the Company                                                                                                                              |
|   3.6(6)  |       | Amended and  Restated Bylaws of the Company                                                                                                                                                           |
|   4.1(6)  |       | Specimen  certificate representing the common stock of the Company                                                                                                                                    |
| 10.1(7)*            |       | Amended and  Restated 1995 Stock Plan                                                                                                                                                                 |
| 10.2(7)*            |       | Amended and  Restated 1995 Non-Employee Director Stock Option Plan                                                                                                                                    |
| 10.3(11)*           |       | 2005 Equity  Compensation Plan                                                                                                                                                                        |
| 10.4(6)             |       | Information  Technology Services Contract between the Company and Electronic Data  Systems, Inc., dated September 20, 1995                                                                  |
| 10.5(1)             |       | Lease Agreement  between the Company and John Hancock Mutual Life Insurance Company, dated  November 13, 1995, for the premises located at 200 Clarendon Street,  Boston, Massachusetts          |
| 10.6(11)**          |       | Amendment to  Lease between Investors Financial Services Corp. and 100 & 200  Clarendon LLC (successors to the John Hancock Mutual Life Insurance Company),  dated January 1, 2005 |
| 10.7(9)*            |       | 1997 Employee  Stock Purchase Plan, as amended                                                                                                                                                        |
| 10.8(2)             |       | Amended and  Restated Declaration of Trust among the Company and the Trustees named  therein, dated January 31, 1997                                                                             |
| 10.9(2)             |       | Indenture between  the Company and The Bank of New York, dated January 31, 1997                                                                                                                  |

56

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| 10.10(2)   |   | Common Securities  Guarantee Agreement by the Company as Guarantor, dated January 31, 1997                                                                                    |
|------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.11(2)   |   | Capital  Securities Guarantee Agreement between the Company as Guarantor and The Bank  of New York as Capital Securities Guarantee Trustee, dated January 31,  1997                |
| 10.12(4)   |   | First Amendment,  effective January 1, 2000 to Information Technology Services Contract  between the Company and Electronic Data Systems, Inc. dated  September 20, 1995 |
| 10.13(4)*  |   | Amended and  Restated Employment Agreement between the Company and Kevin Sheehan                                                                                                        |
| 10.14(4)*  |   | Change of Control  Employment Agreement between the Company and Kevin Sheehan                                                                                                           |
| 10.15(4)*  |   | Amended and  Restated Employment Agreement between the Company and Michael Rogers                                                                                                       |
| 10.16(4)*  |   | Change of Control  Employment Agreement between the Company and Michael Rogers                                                                                                          |
| 10.17(4)*  |   | Amended and  Restated Employment Agreement between the Company and Edmund Maroney                                                                                                       |
| 10.18(4)*  |   | Change of Control  Employment Agreement between the Company and Edmund Maroney                                                                                                          |
| 10.19(4)*  |   | Amended and  Restated Employment Agreement between the Company and Robert Mancuso                                                                                                       |
| 10.20(4)*  |   | Change of Control  Employment Agreement between the Company and Robert Mancuso                                                                                                          |
| 10.21(4)*  |   | Amended and  Restated Employment Agreement between the Company and John Henry                                                                                                           |
| 10.22(4)*  |   | Change of Control  Employment Agreement between the Company and John Henry                                                                                                              |
| 10.23(6)*  |   | Change of Control  Employment Agreement between the Company and John N. Spinney, Jr.                                                                                               |
| 10.24(7)*  |   | Employment  Agreement between the Company and John N. Spinney, Jr.                                                                                                                 |
| 10.25(9)   |   | Information  Technology Services Agreement dated July 1, 2004 between the Company and  International Business Machines Corporation.                                                |
| 10.26(10)  |   | Stock Option  Agreement dated November 15, 2004 between the Company and Kevin J. Sheehan                                                                                 |
| 10.27(10)* |   | Stock Option  Agreement dated November 15, 2004 between the Company and Kevin J. Sheehan                                                                                 |
| 10.28(10)* |   | Stock Option  Agreement dated November 15, 2004 between the Company and Michael F. Rogers                                                                                |
| 10.29(10)* |   | Stock Option  Agreement dated November 15, 2004 between the Company and Michael F. Rogers                                                                                |
| 10.30(10)* |   | Stock Option Agreement  dated November 15, 2004 between the Company and Edmund J. Maroney                                                                                |
| 10.31(10)* |   | Stock Option  Agreement dated November 15, 2004 between the Company and Edmund J. Maroney                                                                                |
| 10.32(10)* |   | Stock Option  Agreement dated November 15, 2004 between the Company and John N. Spinney, Jr.                                                                        |

57

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| 10.33(10)*  |   | Stock Option  Agreement dated November 15, 2004 between the Company and Robert D. Mancuso                                                                                                                                    |
|-------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.34(12)** |   | Amended and  Restated Trust 3000 Service Agreement between the Company and SEI Investments  Company dated July 1, 2004.                                                                                                                |
| 10.35(12)   |   | Lease agreement  between the Company and Copley Place Associates, LLC dated August 2,  1999, as amended.                                                                                                                               |
| 21.1        |   | Subsidiaries of  the Company                                                                                                                                                                                                                |
| 23.1        |   | Consent of  Deloitte & Touche LLP                                                                                                                                                                                                  |
| 24.1        |   | Power of Attorney  (see Power of Attorney and Signature Page of this Report).                                                                                                                                                          |
| 31.1        |   | Certificate of  Kevin J. Sheehan, Chief Executive Officer                                                                                                                                                                                   |
| 31.2        |   | Certificate of  John N. Spinney, Jr., Chief Financial Officer                                                                                                                                                                          |
| 32.1        |   | Certification of Kevin  J. Sheehan, Chief Executive Officer, and John N. Spinney, Jr., Chief Financial  Officer, pursuant to 18 U.S.C. Section 1350, as adopted, pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. |

----

       (1) Previously filed as an exhibit to Form 10-K for thefiscal year ended October 31, 1995.

       (2) Previously filed as an exhibit to Form 10-K for thefiscal year ended December 31, 1996 (File No. 000-26996).

       (3) Previously filed as an exhibit to Form 10-Q for thefiscal quarter ended March 31, 2000.

       (4) Previously filed as an exhibit to Form 10-K for thefiscal year ended December 31, 2000.

       (5) Previously filed as an exhibit to the Company’s RegistrationStatement on Form S-8 filed with the Commission on November 5,2001 (File No. 333-72786).

       (6) Previously filed as an exhibit to Form 10-K for thefiscal year ended December 31, 2001.

       (7) Previously filed as an exhibit to Form 10-K for thefiscal year ended December 31, 2002.

       (8) Previously filed as an exhibit to Form 10-Q for thefiscal quarter ended June 30, 2003.

       (9) Previously filed as an exhibit to Form 10-Q for thefiscal quarter ended June 30, 2004.

(10) Previously filed as an exhibit to Form 10-K for thefiscal year ended December 31, 2004.

(11) Previously filed as an exhibit to Form 10-Q for thefiscal quarter ended March 31, 2005.

(12)    Previously filed as an exhibit to Form 10-K for thefiscal year ended December 31, 2005.

(13)   Previously filed as an exhibitto Form 8-K filed on February 6, 2007.

*                    Indicates amanagement contract or a compensatory plan, contract or arrangement.

**             Confidentialtreatment requested pursuant to rule 24b-2 promulgated under theSecurities Exchange Act of 1934.

**(b)****         Exhibits.**

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TheCompany hereby files as part of this Form 10-K the exhibits listedin Item 15(a)(3) above. Exhibits which are incorporated herein byreference can be inspected and copied at the public reference facilitiesmaintained by the Securities and Exchange Commission, 450 Fifth Street, N.W., Room 1024,Washington, D.C.

**(c)****          FinancialStatement Schedules.**

None.

59

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized, in Boston, Massachusettson the 26th day of February, 2007.

|   |   | INVESTORS FINANCIAL SERVICES CORP. |
|--------|--------|------------------------------------|
|   |   | By:                                | /s/ KEVIN J. SHEEHAN |
|   |   |                               | Kevin J. Sheehan |
|   |   |                               | *Chief Executive Officer and Chairman of the Board* |

 

**POWER OF ATTORNEYAND SIGNATURES**

We, the undersigned officers and directors ofInvestors Financial Services Corp., hereby severally constitute and appointKevin J. Sheehan and Michael F. Rogers, and each of them singly, our true andlawful attorneys, with full power to them and each of them singly, to sign forus in our names in the capacities indicated below, all amendments to thisreport, and generally to do all things in our names and on our behalf in suchcapacities to enable Investors Financial Services Corp. to comply with the provisionsof the Securities Exchange Act of 1934, as amended, and all requirements of theSecurities and Exchange Commission.

Pursuantto the requirements of the Securities Exchange Act of 1934, as amended, thisreport has been signed by the following persons in the capacities indicated onthe 26th day of February, 2007.
|                               | **Signature** | ** **                                                      | ** ** | ** ** | **Title(s)** | ** ** |
|-------------------------------|---------------|-----------------------------------------------------------------|------------|------------|--------------|------------|
| /s/ KEVIN J. SHEEHAN          |          | Chief Executive Officer  and Chairman of the Board              |
| Kevin J. Sheehan              |          | (Principal  Executive Officer); Director                        |
| /s/ MICHAEL F. ROGERS         |          | President                                                       |
| Michael F. Rogers             |          |                                                            |
| /s/ JOHN N. SPINNEY, JR. |          | Senior Vice President and Chief Financial Officer               |
| John N. Spinney, Jr.     |          | (Principal Financial  Officer and Principal Accounting Officer) |
| /s/ RICHARD P. BOYATZI        |          | Director                                                        |
| Richard P. Boyatzi            |          |                                                            |
| /s/ FRANK B. CONDON, JR. |          | Director                                                        |
| Frank B. Condon, Jr.     |          |                                                            |

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| /s/ THOMAS P. MCDERMOTT |   | Director |
|-------------------------|--------|----------|
| Thomas P. McDermott     |   |     |
| /s/ JAMES M. OATES      |   | Director |
| James M. Oates          |   |     |
| /s/ JOHN I. SNOW III    |   | Director |
| John I. Snow III        |   |     |
| /s/ PHYLLIS S. SWERSKY  |   | Director |
| Phyllis S. Swersky      |   |     |

 

61

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**INVESTORS FINANCIAL SERVICES CORP.INDEX TO CONSOLIDATED FINANCIAL STATEMENTS**

|                                                                                                                        | ** ** | ** ** | **Page** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|------------|----------|------------|
| Report of Independent  Registered Public Accounting Firm                                                               |       | F-2        |
| Consolidated Balance Sheets as of  December 31, 2006 and December 31, 2005                                   |       | F-3        |
| Consolidated Statements of  Income and Comprehensive Income for the Years Ended December 31, 2006,  2005 and 2004 |       | F-4        |
| Consolidated Statements of  Stockholders’ Equity for the Years Ended December 31, 2006, 2005 and  2004       |       | F-5        |
| Consolidated Statements of  Cash Flows for the Years Ended December 31, 2006, 2005 and 2004                       |       | F-6        |
| Notes to  Consolidated Financial Statements                                                                            |       | F-7        |

 

F-1

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**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

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

We have audited the accompanying consolidated balancesheets of Investors Financial Services Corp. and subsidiaries (the “Company”)as of December 31, 2006 and 2005, and the related consolidated statementsof income and comprehensive income, stockholders’ equity, and cash flows foreach of the three years in the period ended December 31, 2006. Thesefinancial statements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statementspresent fairly, in all material respects, the financial position of Investors Financial Services Corp. atDecember 31, 2006 and 2005, and the results of its operations and its cashflows for each of the three years in the period ended December 31, 2006,in conformity with accounting principles generally accepted in the UnitedStates of America.

As discussed in Note 2 to the consolidated financialstatements, effective January 1, 2006, the Company adopted the provisionsof Statement of Financial Accounting Standards No. 123 (revised 2004), *Share-Based Payment*. Also as discussed in Note 2 to theconsolidated financial statements, effective December 31, 2006, theCompany adopted the provisions of Statement of Financial Accounting Standards No. 158,*Employers’ Accounting for Defined Benefit Pensionand Other Postretirement Plans*.

We have also audited, in accordance with the standardsof the Public Company Accounting Oversight Board (United States), theeffectiveness of the Company’s internal control over financial reporting as of December 31,2006, based on the criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission and our report dated February 26,2007 expressed an unqualified opinion on management’s assessment of theeffectiveness of the Company’s internal control over financial reporting and anunqualified opinion on the effectiveness of the Company’s internal control overfinancial reporting.

/s/ DELOITTE & TOUCHE LLP

Boston, MassachusettsFebruary 26, 2007

F-2

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**INVESTORS FINANCIAL SERVICES CORP.CONSOLIDATED BALANCE SHEETSDecember 31, 2006 and 2005 (Dollars in thousands, except per share data)**

| ** **                                                                                                                                                                                                                                                       | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                       | ** ** | **2006**              | ** ** | **2005**              | ** ** |
| **Assets**                                                                                                                                                                                                                                                       |       |                  |       |                  |       |   |   |   |   |
| Cash and due from  banks                                                                                                                                                                                                                                         |       |                  | $          | 92,776                |       |   |   | $ | 60,743 |   |   |
| Interest-bearing  deposits with other banks                                                                                                                                                                                                                      |       |                  | 21,218     |                  |       |   | 18,894 |   |   |
| Other short-term  investments                                                                                                                                                                                                                                    |       |                  | 1,971      |                  |       |   | — |   |   |
| Federal funds sold                                                                                                                                                                                                                                               |       |                  | 300,000    |                  |       |   | — |   |   |
| Securities held to  maturity (including securities pledged of $4,096,013 and $4,529,421 at December 31,  2006 and 2005, respectively) (approximate fair value of $5,508,788 and  $6,725,729 at December 31, 2006 and 2005, respectively) (Note 3) |       |                  | 5,532,330  |                  |       |   | 6,761,930 |   |   |
| Securities  available for sale (including securities pledged of $3,071,503 and $2,997,958  at December 31, 2006 and 2005, respectively) (Note 3)                                                                                                       |       |                  | 4,799,740  |                  |       |   | 4,369,720 |   |   |
| Nonmarketable  equity securities (Note 3)                                                                                                                                                                                                                        |       |                  | 40,054     |                  |       |   | 51,251 |   |   |
| Loans, less  allowance for loan losses of $100 at December 31, 2006 and 2005 (Note 4)                                                                                                                                                                       |       |                  | 270,693    |                  |       |   | 402,370 |   |   |
| Accrued interest  and fees receivable                                                                                                                                                                                                                            |       |                  | 134,748    |                  |       |   | 119,583 |   |   |
| Equipment and  leasehold improvements, less accumulated depreciation of $64,290 and $59,156  at December 31, 2006 and 2005, respectively (Note 5)                                                                                                           |       |                  | 113,287    |                  |       |   | 69,401 |   |   |
| Goodwill, net                                                                                                                                                                                                                                                    |       |                  | 79,969     |                  |       |   | 79,969 |   |   |
| Other assets                                                                                                                                                                                                                                                     |       |                  | 171,420    |                  |       |   | 154,873 |   |   |
| **Total  Assets**                                                                                                                                                                                                                                                |       |                  | $          | 11,558,206            |       |   |   | $ | 12,088,734 |   |   |
| **Liabilities and Stockholders’ Equity**                                                                                                                                                                                                                    |       |                  |       |                  |       |   |   |   |   |
| **Liabilities:**                                                                                                                                                                                                                                                 |       |                  |       |                  |       |   |   |   |   |
| Deposits (Note 6):                                                                                                                                                                                                                                               |       |                  |       |                  |       |   |   |   |   |
| Demand                                                                                                                                                                                                                                                           |       |                  | $          | 695,821               |       |   |   | $ | 537,558 |   |   |
| Savings                                                                                                                                                                                                                                                          |       |                  | 4,924,735  |                  |       |   | 4,224,908 |   |   |
| Time                                                                                                                                                                                                                                                             |       |                  | 524,386    |                  |       |   | 230,124 |   |   |
| Total deposits                                                                                                                                                                                                                                                   |       |                  | 6,144,942  |                  |       |   | 4,992,590 |   |   |
| Securities sold  under repurchase agreements (Note 7)                                                                                                                                                                                                            |       |                  | 3,727,800  |                  |       |   | 4,797,868 |   |   |
| Short-term and  other borrowings (Note 8)                                                                                                                                                                                                                        |       |                  | 517,051    |                  |       |   | 1,356,649 |   |   |
| Due to brokers for  open trades payable                                                                                                                                                                                                                          |       |                  | 26,359     |                  |       |   | 21,293 |   |   |
| Junior  subordinated deferrable interest debentures (Note 10)                                                                                                                                                                                                    |       |                  | 24,774     |                  |       |   | 24,774 |   |   |
| Accrued expenses                                                                                                                                                                                                                                                 |       |                  | 77,821     |                  |       |   | 37,418 |   |   |
| Other liabilities                                                                                                                                                                                                                                                |       |                  | 100,721    |                  |       |   | 85,284 |   |   |
| Total liabilities                                                                                                                                                                                                                                                |       |                  | 10,619,468 |                  |       |   | 11,315,876 |   |   |
| Commitments and  contingencies (Note 16)                                                                                                                                                                                                                         |       |                  | —     |                  |       |   | — |   |   |
| **Stockholders’ Equity:**                                                                                                                                                                                                                                   |       |                  |       |                  |       |   |   |   |   |
| Preferred stock,  par value $0.01 (shares authorized: 1,000,000; issued: none at  December 31, 2006 and 2005)                                                                                                                                               |       |                  | —     |                  |       |   | — |   |   |
| Common stock, par  value $0.01 (shares authorized: 175,000,000; issued: 68,523,129 and 67,177,306  at December 31, 2006 and 2005, respectively)                                                                                                        |       |                  | 685        |                  |       |   | 672 |   |   |
| Surplus                                                                                                                                                                                                                                                          |       |                  | 334,929    |                  |       |   | 286,265 |   |   |
| Deferred  compensation                                                                                                                                                                                                                                           |       |                  | —     |                  |       |   | (311 | ) |   |
| Retained earnings                                                                                                                                                                                                                                                |       |                  | 720,433    |                  |       |   | 572,549 |   |   |
| Accumulated other  comprehensive loss, net                                                                                                                                                                                                                       |       |                  | (14,514    | )                     |       |   | (13,369 | ) |   |
| Treasury stock, at  cost (2,895,021 and 2,124,669 shares at December 31, 2006 and 2005, respectively)                                                                                                                                                  |       |                  | (102,795   | )                     |       |   | (72,948 | ) |   |
| Total  stockholders’ equity                                                                                                                                                                                                                                 |       |                  | 938,738    |                  |       |   | 772,858 |   |   |
| **Total  Liabilities and Stockholders’ Equity**                                                                                                                                                                                                             |       |                  | $          | 11,558,206            |       |   |   | $ | 12,088,734 |   |   |

 

See Notes to Consolidated Financial Statements.

F-3

----

**INVESTORS FINANCIAL SERVICES CORP.CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOMEYears Ended December 31, 2006, 2005 and 2004 (Dollars in thousands, exceptper share data)**

| ** **                                       | ** ** | **December 31,** | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **2006**              | ** ** | **2005**              | ** ** | **2004**              | ** ** |
| **Fees and Other Revenue:**                      | ** ** |                  | ** ** | ** **            |       |                  | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Asset  servicing fees:                           |       |                  |       |                  |       |                  |       |   |   |   |   |   |   |
| Core service fees                                |       |                  | $          | 453,573               |       |                  |       | $ | 375,596 |   |   |   | $ | 314,272 |   |   |
| Value-added service fees                         |       |                  | 177,667    |                  |       |                  | 133,463    |   |   |   | 108,928 |   |   |
| Total asset servicing fees                       |       |                  | 631,240    |                  |       |                  | 509,059    |   |   |   | 423,200 |   |   |
| Other operating income                           |       |                  | 5,691      |                  |       |                  | 4,081      |   |   |   | 2,057 |   |   |
| Gain on sale of investments                      |       |                  | 2,523      |                  |       |                  | 12,397     |   |   |   | 234 |   |   |
| Total fees and other revenue                     |       |                  | 639,454    |                  |       |                  | 525,537    |   |   |   | 425,491 |   |   |
| Interest income                                  |       |                  | 557,749    |                  |       |                  | 447,705    |   |   |   | 313,149 |   |   |
| Interest expense                                 |       |                  | 393,555    |                  |       |                  | 277,280    |   |   |   | 125,469 |   |   |
| Net interest income                              |       |                  | 164,194    |                  |       |                  | 170,425    |   |   |   | 187,680 |   |   |
| Net operating revenue                            |       |                  | 803,648    |                  |       |                  | 695,962    |   |   |   | 613,171 |   |   |
| **Operating Expenses:**                          |       |                  |       |                  |       |                  |       |   |   |   |   |   |   |
| Compensation and benefits                        |       |                  | 327,342    |                  |       |                  | 250,459    |   |   |   | 205,728 |   |   |
| Technology and telecommunications                |       |                  | 73,909     |                  |       |                  | 54,732     |   |   |   | 49,816 |   |   |
| Transaction processing services                  |       |                  | 61,396     |                  |       |                  | 49,873     |   |   |   | 42,159 |   |   |
| Occupancy                                        |       |                  | 33,653     |                  |       |                  | 26,490     |   |   |   | 29,032 |   |   |
| Depreciation and amortization                    |       |                  | 32,819     |                  |       |                  | 31,578     |   |   |   | 32,124 |   |   |
| Professional fees                                |       |                  | 13,845     |                  |       |                  | 13,380     |   |   |   | 15,346 |   |   |
| Travel and sales promotion                       |       |                  | 8,883      |                  |       |                  | 6,825      |   |   |   | 5,470 |   |   |
| Insurance                                        |       |                  | 3,929      |                  |       |                  | 4,219      |   |   |   | 4,625 |   |   |
| Losses and loss adjustment expenses              |       |                  | 30         |                  |       |                  | 5,837      |   |   |   | 924 |   |   |
| Other operating expenses                         |       |                  | 23,548     |                  |       |                  | 16,716     |   |   |   | 13,159 |   |   |
| Total operating expenses                         |       |                  | 579,354    |                  |       |                  | 460,109    |   |   |   | 398,383 |   |   |
| **Income Before Income Taxes**                   |       |                  | 224,294    |                  |       |                  | 235,853    |   |   |   | 214,788 |   |   |
| Provision for income taxes (Note 9)              |       |                  | 70,491     |                  |       |                  | 76,035     |   |   |   | 72,826 |   |   |
| **Net Income**                                   |       |                  | $          | 153,803               |       |                  |       | $ | 159,818 |   |   |   | $ | 141,962 |   |   |
| **Basic Earnings Per Share**                     |       |                  | $          | 2.34                  |       |                  |       | $ | 2.42 |   |   |   | $ | 2.15 |   |   |
| **Diluted Earnings Per Share**                   |       |                  | $          | 2.28                  |       |                  |       | $ | 2.37 |   |   |   | $ | 2.09 |   |   |
| **Weighted-Average Basic Shares**                |       |                  | 65,730,456 |                  |       |                  | 66,139,323 |   |   |   | 66,179,286 |   |   |
| **Weighted-Average Diluted Shares**              |       |                  | 67,493,081 |                  |       |                  | 67,473,804 |   |   |   | 67,916,217 |   |   |
| **Comprehensive Income:**                        |       |                  |       |                  |       |                  |       |   |   |   |   |   |   |
| Net income                                       |       |                  | $          | 153,803               |       |                  |       | $ | 159,818 |   |   |   | $ | 141,962 |   |   |
| Other  comprehensive income (loss) (Note 12):    |       |                  |       |                  |       |                  |       |   |   |   |   |   |   |
| Net unrealized investment gain (loss)            |       |                  | 10,695     |                  |       |                  | (46,054    | ) |   |   | (7,854 | ) |   |
| Net unrealized derivative instrument (loss) gain |       |                  | (6,525     | )                     |       |                  | 8,745      |   |   |   | 13,031 |   |   |
| Cumulative translation adjustment                |       |                  | 1,444      |                  |       |                  | 52         |   |   |   | 846 |   |   |
| Other comprehensive income (loss)                |       |                  | 5,614      |                  |       |                  | (37,257    | ) |   |   | 6,023 |   |   |
| Comprehensive income                             |       |                  | $          | 159,417               |       |                  |       | $ | 122,561 |   |   |   | $ | 147,985 |   |   |

 

See Notes to Consolidated Financial Statements.

F-4

----

**INVESTORS FINANCIAL SERVICES CORP.CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITYYears Ended December 31, 2006, 2005, and 2004 (Dollars in thousands,except per share data)**

| ** **                                                                                                                                                                                                                                                | ** ** | **December 31,** | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                | ** ** | **2006**              | ** ** | **2005**              | ** ** | **2004**              | ** ** |
| **Common shares**                                                                                                                                                                                                                                         | ** ** |                  | ** ** | ** **            |       |                  | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Balance, beginning  of year                                                                                                                                                                                                                               |       |                  | 67,177,306 |                  |       |                  | 66,668,584 |   |   |   | 65,463,296 |   |   |
| Exercise of stock  options                                                                                                                                                                                                                                |       |                  | 1,211,518  |                  |       |                  | 394,018    |   |   |   | 1,114,051 |   |   |
| Common stock  issuance                                                                                                                                                                                                                                    |       |                  | 134,305    |                  |       |                  | 114,704    |   |   |   | 91,237 |   |   |
| Balance, end of  year                                                                                                                                                                                                                                     |       |                  | 68,523,129 |                  |       |                  | 67,177,306 |   |   |   | 66,668,584 |   |   |
| **Treasury shares**                                                                                                                                                                                                                                       | ** ** |                  | ** ** | ** **            |       |                  | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Balance, beginning  of year                                                                                                                                                                                                                               |       |                  | 2,124,669  |                  |       |                  | 73,235     |   |   |   | 26,508 |   |   |
| Common stock  repurchased                                                                                                                                                                                                                                 |       |                  | 770,352    |                  |       |                  | 2,051,434  |   |   |   | 46,727 |   |   |
| Balance, end of  year                                                                                                                                                                                                                                     |       |                  | 2,895,021  |                  |       |                  | 2,124,669  |   |   |   | 73,235 |   |   |
| **Common stock**                                                                                                                                                                                                                                          | ** ** |                  | ** ** | ** **            |       |                  | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Balance, beginning  of year                                                                                                                                                                                                                               |       |                  | $          | 672                   |       |                  |       | $ | 667 |   |   |   | $ | 655 |   |   |
| Exercise of stock  options                                                                                                                                                                                                                                |       |                  | 12         |                  |       |                  | 4          |   |   |   | 12 |   |   |
| Common stock  issuance                                                                                                                                                                                                                                    |       |                  | 1          |                  |       |                  | 1          |   |   |   | — |   |   |
| Balance, end of  year                                                                                                                                                                                                                                     |       |                  | $          | 685                   |       |                  |       | $ | 672 |   |   |   | $ | 667 |   |   |
| **Surplus**                                                                                                                                                                                                                                               | ** ** |                  | ** ** | ** **            |       |                  | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Balance, beginning  of year                                                                                                                                                                                                                               |       |                  | $          | 286,265               |       |                  |       | $ | 272,536 |   |   |   | $ | 242,662 |   |   |
| Share-based awards  and exercise of stock options                                                                                                                                                                                                         |       |                  | 37,407     |                  |       |                  | 7,775      |   |   |   | 16,056 |   |   |
| Tax benefit from  exercise of stock options                                                                                                                                                                                                               |       |                  | 6,431      |                  |       |                  | 2,087      |   |   |   | 10,651 |   |   |
| Common stock  issuance                                                                                                                                                                                                                                    |       |                  | 4,826      |                  |       |                  | 3,867      |   |   |   | 3,355 |   |   |
| Transfer of deferred  compensation to surplus                                                                                                                                                                                                             |       |                  | (311       | )                     |       |                  | —     |   |   |   | — |   |   |
| Amortization of  deferred compensation                                                                                                                                                                                                                    |       |                  | 311        |                  |       |                  | —     |   |   |   | — |   |   |
| Stock option  forfeiture                                                                                                                                                                                                                                  |       |                  | —     |                  |       |                  | —     |   |   |   | (188 | ) |   |
| Balance, end of  year                                                                                                                                                                                                                                     |       |                  | $          | 334,929               |       |                  |       | $ | 286,265 |   |   |   | $ | 272,536 |   |   |
| **Deferred compensation**                                                                                                                                                                                                                                 | ** ** |                  | ** ** | ** **            |       |                  | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Balance, beginning  of year                                                                                                                                                                                                                               |       |                  | $          | (311                  | )          |                  |       | $ | (572 | ) |   |   | $ | (1,076 | ) |   |
| Transfer of  deferred compensation to surplus                                                                                                                                                                                                             |       |                  | 311        |                  |       |                  | —     |   |   |   | — |   |   |
| Amortization of  deferred compensation                                                                                                                                                                                                                    |       |                  | —     |                  |       |                  | 261        |   |   |   | 316 |   |   |
| Stock option  forfeiture                                                                                                                                                                                                                                  |       |                  | —     |                  |       |                  | —     |   |   |   | 188 |   |   |
| Balance, end of  year                                                                                                                                                                                                                                     |       |                  | $          | —                |       |                  |       | $ | (311 | ) |   |   | $ | (572 | ) |   |
| **Retained earnings**                                                                                                                                                                                                                                     | ** ** |                  | ** ** | ** **            |       |                  | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Balance, beginning  of year                                                                                                                                                                                                                               |       |                  | $          | 572,549               |       |                  |       | $ | 418,034 |   |   |   | $ | 280,701 |   |   |
| Net income                                                                                                                                                                                                                                                |       |                  | 153,803    |                  |       |                  | 159,818    |   |   |   | 141,962 |   |   |
| Cash dividend,  $0.09, $0.08 and $0.07 per share in the years ended December 31, 2006,  2005 and 2004, respectively                                                                                                                                  |       |                  | (5,919     | )                     |       |                  | (5,303     | ) |   |   | (4,629 | ) |   |
| Balance, end of  year                                                                                                                                                                                                                                     |       |                  | $          | 720,433               |       |                  |       | $ | 572,549 |   |   |   | $ | 418,034 |   |   |
| **Accumulated other comprehensive (loss) income,  net**                                                                                                                                                                                                   | ** ** |                  | ** ** | ** **            |       |                  | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Balance, beginning  of year                                                                                                                                                                                                                               |       |                  | $          | (13,369               | )          |                  |       | $ | 23,888 |   |   |   | $ | 17,865 |   |   |
| Net unrealized  investment gain (loss)                                                                                                                                                                                                                    |       |                  | 11,773     |                  |       |                  | (46,054    | ) |   |   | (7,854 | ) |   |
| Net unrealized  derivative instrument (loss) gain                                                                                                                                                                                                         |       |                  | (5,184     | )                     |       |                  | 10,473     |   |   |   | 12,990 |   |   |
| Amortization of  terminated interest rate swap agreements                                                                                                                                                                                                 |       |                  | (1,341     | )                     |       |                  | (1,728     | ) |   |   | 41 |   |   |
| Adjustment to  initially apply SFAS 158                                                                                                                                                                                                                   |       |                  | (7,837     | )                     |       |                  | —     |   |   |   | — |   |   |
| Cumulative  translation adjustment                                                                                                                                                                                                                        |       |                  | 1,444      |                  |       |                  | 52         |   |   |   | 846 |   |   |
| Balance, end of  year                                                                                                                                                                                                                                     |       |                  | $          | (14,514               | )          |                  |       | $ | (13,369 | ) |   |   | $ | 23,888 |   |   |
| **Treasury stock**                                                                                                                                                                                                                                        | ** ** |                  | ** ** | ** **            |       |                  | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Balance, beginning  of year                                                                                                                                                                                                                               |       |                  | $          | (72,948               | )          |                  |       | $ | (2,291 | ) |   |   | $ | (550 | ) |   |
| Common stock  repurchased (770,352 shares at an average price of $38.74, 2,051,434 shares  at an average price of $34.44, and 46,727 shares at an average price of  $37.24 in the years ended December 31, 2006, 2005, and 2004,  respectively) |       |                  | (29,847    | )                     |       |                  | (70,657    | ) |   |   | (1,741 | ) |   |
| Balance, end of  year                                                                                                                                                                                                                                     |       |                  | $          | (102,795              | )          |                  |       | $ | (72,948 | ) |   |   | $ | (2,291 | ) |   |
| **Total  Stockholders’ Equity**                                                                                                                                                                                                                      |       |                  | $          | 938,738               |       |                  |       | $ | 772,858 |   |   |   | $ | 712,262 |   |   |

 

See Notes to Consolidated Financial Statements.

F-5

----

**INVESTORS FINANCIAL SERVICES CORP.CONSOLIDATED STATEMENTS OF CASH FLOWSYears Ended December 31, 2006, 2005 and 2004 (Dollars in thousands)**

| ** **                                                                         | ** ** | **December 31,** | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                         | ** ** | **2006**              | ** ** | **2005**              | ** ** | **2004**              | ** ** |
| **Cash Flows From Operating Activities:**                                          |       |                  |       |                  |       |                  |       | ** ** |   |   | ** ** | ** ** |   |
| Net income                                                                         |       |                  | $          | 153,803               |       |                  |       | $ | 159,818 |   |   |   | $ | 141,962 |   |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                  |       |                  |       |                  |       |   |   |   |   |   |   |
| Equity in  undistributed loss of unconsolidated subsidiary                         |       |                  | 28         |                  |       |                  | 28         |   |   |   | 28 |   |   |
| Depreciation and  amortization                                                     |       |                  | 32,819     |                  |       |                  | 31,578     |   |   |   | 32,124 |   |   |
| Share-based  compensation                                                          |       |                  | 4,538      |                  |       |                  | —     |   |   |   | — |   |   |
| Amortization of  deferred compensation                                             |       |                  | —     |                  |       |                  | 261        |   |   |   | 316 |   |   |
| Amortization of  premiums on securities, net of accretion of discounts             |       |                  | 55,057     |                  |       |                  | 49,578     |   |   |   | 40,743 |   |   |
| Gain on sale of  investments                                                       |       |                  | (2,523     | )                     |       |                  | (12,397    | ) |   |   | (234 | ) |   |
| Excess tax benefit  related to share-based compensation                            |       |                  | (8,017     | )                     |       |                  | —     |   |   |   | — |   |   |
| Deferred income  taxes                                                             |       |                  | (390       | )                     |       |                  | (6,944     | ) |   |   | 2,997 |   |   |
| Changes in assets and liabilities:                                                 |       |                  |       |                  |       |                  |       |   |   |   |   |   |   |
| Accrued interest and fees  receivable                                              |       |                  | (15,165    | )                     |       |                  | (30,291    | ) |   |   | (16,476 | ) |   |
| Other assets                                                                       |       |                  | (17,182    | )                     |       |                  | 51,657     |   |   |   | (66,625 | ) |   |
| Accrued expenses                                                                   |       |                  | 33,025     |                  |       |                  | 7,586      |   |   |   | 5,672 |   |   |
| Other liabilities                                                                  |       |                  | 15,409     |                  |       |                  | (38,475    | ) |   |   | 81,040 |   |   |
| Net cash provided by  operating activities                                         |       |                  | 251,402    |                  |       |                  | 212,399    |   |   |   | 221,547 |   |   |
| **Cash Flows From Investing Activities:**                                          |       |                  |       |                  |       |                  |       |   |   |   |   |   |   |
| Proceeds from  maturities and paydowns of securities available for sale            |       |                  | 1,111,359  |                  |       |                  | 1,400,359  |   |   |   | 1,392,295 |   |   |
| Proceeds from  maturities and paydowns of securities held to maturity              |       |                  | 1,245,399  |                  |       |                  | 1,628,989  |   |   |   | 1,410,133 |   |   |
| Proceeds from sale  of securities available for sale                               |       |                  | 134,131    |                  |       |                  | 376,143    |   |   |   | 25,041 |   |   |
| Proceeds from the  redemption of non-marketable equity securities                  |       |                  | 41,048     |                  |       |                  | 700        |   |   |   | 328 |   |   |
| Purchases of  securities available for sale                                        |       |                  | (1,662,417 | )                     |       |                  | (1,649,167 | ) |   |   | (1,704,293 | ) |   |
| Purchases of  securities held to maturity                                          |       |                  | (67,274    | )                     |       |                  | (2,489,882 | ) |   |   | (3,078,456 | ) |   |
| Purchases of  non-marketable equity securities                                     |       |                  | (29,851    | )                     |       |                  | (116       | ) |   |   | (542 | ) |   |
| Net increase in  due to brokers for open trades payable                            |       |                  | 5,066      |                  |       |                  | 15,818     |   |   |   | 5,475 |   |   |
| Net increase in  other short-term investments                                      |       |                  | (1,971     | )                     |       |                  | —     |   |   |   | — |   |   |
| Net increase in  Federal funds sold                                                |       |                  | (300,000   | )                     |       |                  | —     |   |   |   | — |   |   |
| Net decrease  (increase) in loans                                                  |       |                  | 131,677    |                  |       |                  | (267,840   | ) |   |   | 65,000 |   |   |
| Purchases of  equipment, leasehold improvements and software                       |       |                  | (76,677    | )                     |       |                  | (33,068    | ) |   |   | (23,559 | ) |   |
| Net cash provided by  (used in) investing activities                               |       |                  | 530,490    |                  |       |                  | (1,018,064 | ) |   |   | (1,908,578 | ) |   |
| **Cash Flows From Financing Activities:**                                          |       |                  |       |                  |       |                  |       |   |   |   |   |   |   |
| Net increase  (decrease) in demand deposits                                        |       |                  | 158,263    |                  |       |                  | (152,750   | ) |   |   | 355,485 |   |   |
| Net increase  (decrease) in time and savings deposits                              |       |                  | 994,089    |                  |       |                  | (251,042   | ) |   |   | 833,779 |   |   |
| Net (decrease)  increase in securities sold under repurchase agreements            |       |                  | (1,070,068 | )                     |       |                  | 542,371    |   |   |   | 997,496 |   |   |
| Net (decrease)  increase in short-term borrowings                                  |       |                  | (839,598   | )                     |       |                  | 761,968    |   |   |   | (503,406 | ) |   |
| Proceeds from  exercise of stock options                                           |       |                  | 33,096     |                  |       |                  | 7,779      |   |   |   | 16,068 |   |   |
| Proceeds from  issuance of common stock                                            |       |                  | 4,827      |                  |       |                  | 3,868      |   |   |   | 3,355 |   |   |
| Common stock  repurchase                                                           |       |                  | (29,847    | )                     |       |                  | (70,657    | ) |   |   | (1,741 | ) |   |
| Excess tax benefit  related to share-based compensation                            |       |                  | 8,017      |                  |       |                  | —     |   |   |   | — |   |   |
| Dividends paid to  stockholders                                                    |       |                  | (5,919     | )                     |       |                  | (5,303     | ) |   |   | (4,629 | ) |   |
| Net cash (used in)  provided by financing activities                               |       |                  | (747,140   | )                     |       |                  | 836,234    |   |   |   | 1,696,407 |   |   |
| **Effect  of exchange rates on changes in cash**                                   |       |                  | (395       | )                     |       |                  | 9          |   |   |   | (6 | ) |   |
| **Net  Increase In Cash and Due From Banks**                                       |       |                  | 34,357     |                  |       |                  | 30,578     |   |   |   | 9,370 |   |   |
| **Cash and  Due From Banks, Beginning of Year**                                    |       |                  | 79,637     |                  |       |                  | 49,059     |   |   |   | 39,689 |   |   |
| **Cash and  Due From Banks, End of Year**                                          |       |                  | $          | 113,994               |       |                  |       | $ | 79,637 |   |   |   | $ | 49,059 |   |   |
| **Supplemental Disclosure of Cash Flow  Information:**                             |       |                  |       |                  |       |                  |       |   |   |   |   |   |   |
| Cash paid for interest                                                             |       |                  | $          | 387,190               |       |                  |       | $ | 270,121 |   |   |   | $ | 121,542 |   |   |
| Cash paid for income taxes                                                         |       |                  | $          | 75,636                |       |                  |       | $ | 68,664 |   |   |   | $ | 77,819 |   |   |

 

See Notes to Consolidated Financial Statements.

F-6

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 2006, 2005 and 2004**

**1. Descriptionof Business**

Investors Financial Services Corp. (‘IFSC’) providesasset administration services for the financial services industry through itswholly-owned subsidiary, Investors Bank & Trust Company (‘the Bank’). Asused herein, the defined term “the Company” shall mean IFSC together with theBank and its domestic and foreign subsidiaries. The Company provides coreservices and value-added services to avariety of financial asset managers, including mutual fund complexes,investment advisors, family offices, hedge funds, banks and insurance companies.Core services include global custody, multicurrency accounting, fundadministration and middle office outsourcing. Value-added services includeforeign exchange, cash management, securities lending, investment advisory,performance measurement, institutional transfer agency, lines of credit andbrokerage and transition management services. The Company is subject toregulation by the Federal Reserve Board of Governors (‘FRB’), the FederalDeposit Insurance Corporation (‘FDIC’), the Office of the Commissioner of Banksof the Commonwealth of Massachusetts (‘Commissioner’), the Securities andExchange Commission (‘SEC’), the National Association of Securities Dealers, Inc.(‘NASD’), the State of Vermont Department of Banking, Insurance, Securities &Health Care Administration (‘BISHCA’), the Office of the Superintendent ofFinancial Institutions in Canada (‘OSFI’), the Irish Financial ServicesRegulatory Authority (‘IFSRA’), the Cayman Islands Monetary Authority (‘CIMA’),the Financial Services Authority in the United Kingdom (‘FSA’) and theCommission de Surveillance du Secteur Financier in Luxembourg (‘CSSF’).

On February 4, 2007,the Company entered into an Agreement and Plan of Merger (the ‘Merger Agreement’)with State Street Corporation (‘State Street’). At the closing of thetransaction contemplated by the Merger Agreement, the Company will merge intoState Street and the Company’s shareholders will receive 0.906 shares of StateStreet common stock for each share of the Company’s common stock. Each company’sBoard of Directors has approved the Merger Agreement. The Company expects tocomplete the transaction in the third quarter of 2007, subject to customaryclosing conditions, including regulatory and shareholder approval.

**2. Summary of SignificantAccounting Policies**

***Basis ofPresentation******—The*********consolidated financial statements include the accounts ofthe Company and its domestic and foreign subsidiaries. All significantintercompany accounts and transactions have been eliminated.

The preparation of the consolidated financialstatements in conformity with accounting principles generally accepted in theUnited States of America requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period. Actualresults could differ from those estimates.

Certain amounts in theprior years’ financial statements have been reclassified to conform to thecurrent year’s presentation.

***Revenue Recognition***

Asset servicing revenue—The Company recognizes revenuefrom asset servicing and investment advisory services based on contractualterms signed by the Company’s clients. Generally, revenue is 

F-7

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**2.Summary of Significant Accounting Policies (Continued)**

accrued by multiplyingaverage or month-end net assets by contracted rates. Asset servicing revenue isconsidered earned daily as transactions are processed or services are providedand when collectibility is reasonably assured.

Value-added services revenue—The Company recognizesrevenue from its value-added services, such as foreign exchange, cashmanagement and securities lending, based on the specific type of transactionprocessed. Value-added services revenue is considered earned daily astransactions are processed or services are provided and when collectibility isreasonably assured.

Interest income—The Company recognizes and accruesincome on its interest-earning assets as earned using a method whichapproximates the constant effective yield method.

***Cash and Cash Equivalents******—For***purposesof reporting cash flows and amounts on the consolidated balance sheets, theCompany defines cash and cash equivalents to include cash, due from banks, andinterest-bearing deposits with other banks that have original maturities of 90days or less.

***Securities—******The*********Company classifies all equitysecurities that have readily determinable fair values and all investments indebt securities into one of three categories. Debt securities that the Companyhas the positive intent and ability to hold to maturity are classified as heldto maturity and carried at amortized cost. Debt and equity securities that arebought and held principally for the purpose of selling them in the near termare classified as trading securities and carried at fair value, with unrealizedgains and losses included in earnings. All other debt and equity securities notclassified as either held to maturity or trading are classified as availablefor sale and carried at fair value, with unrealized gains and losses excludedfrom earnings and reported in other comprehensive income.

Non-marketable securities primarily consist of stockof the Federal Home Loan Bank of Boston (‘FHLBB’) and stock of the FederalReserve Bank of Boston (‘FRBB’). The FHLBB stock is carried at cost andredeemable at par value. The Company is required to hold this stock under its borrowing arrangement with the FHLBB. The Companywas required to purchase stock of the FRBB in connection with its membershipwith the FRBB.

An investment is considered impaired if the fair valueof the investment is less than its cost. The Company recognizes an impairment chargeif, based on the facts and circumstances, management determines the impairmentto be other than temporary. For example, the Company will record an other thantemporary impairment charge on a debt security if it is determined that it isprobable that the Company will be unable to recover all amounts due under thecontractual obligations of the security.

Amortization and accretion of debt securitiespurchased at a premium or discount are amortized or accreted into income usinga method which approximates the constant effective yield method. The Companyapplies Statement of Financial Accounting Standards No. 91, *Accounting for Nonrefundable Fees and Costs Associated with Originatingor Acquiring Loans and Initial Direct Costs of Leases* (‘SFAS 91’)for the amortization of premiums and accretion of discounts. In calculating theeffective yield for securities that represent holdings of large numbers ofsimilar loans for which prepayments are probable and the timing and amount ofprepayments can be reasonably estimated, prepayments are anticipated using theCompany’s actual three-month prepayment experience.

F-8

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**2.Summary of Significant Accounting Policies (Continued)**

The amount of amortization or accretion to recognizein income is driven by the calculation of the constant effective yield. Whencalculating this yield, the Company assumes that prepayments will continue fromthe analysis date to the date of the security’s expected maturity at its mostrecent three-month prepayment rate. The prepayment rate is updated monthlybased on the Company’s previous three-month actual prepayment experience.

The Company utilizes three-month prepayment rates toanticipate prepayments because such rates are based on its own actualprepayment experience and because the Company believes three-month rates are abetter estimate of future experience than either one-month or six-month orlonger rates. In the opinion of management, a one-month rate does not captureenough experience to predict future prepayment behavior and may create unduevolatility in interest income due to one-time fluctuations in prepaymentactivity. Conversely, in the opinion of management, a six-month or longer ratewould not capture enough volatility to predict future prepayment behavior.

If a difference arises between the Company’s estimatedprepayments and its actual prepayments received, the constant effective yieldis recalculated based on the Company’s actual payments to date and anticipatedfuture payments. This monthly recalculation results in the carrying value ofthe security being adjusted to the amount that would have existed had the neweffective yield been applied since the purchase date, and a correspondingcharge or credit is recognized to interest income.

For securities that do not represent holdings of largenumbers of similar loans for which prepayments are probable and the timing andamount of prepayments can be reasonably estimated, the associated premiums anddiscounts are amortized or accreted over their contractual term using theconstant effective yield. Actual prepayment experience for such securities isreviewed monthly and a proportionate amount of premium or discount isrecognized in income at that time such that the effective yield on theremaining portion of the securities continues unchanged.

As of and for the years ended December 31, 2006,2005 and 2004, the Company anticipated prepayments on its residentialmortgage-backed securities. All other securities do not meet the SFAS 91criteria for anticipating prepayments. Accordingly, no prepayments wereanticipated for these securities.

***Loans******—Interest*********on loans is credited to income asearned using a method which approximates the effective yield method, andinterest is only accrued if deemed collectible. Accrual of interest on loans isdiscontinued when management determines that collection of interest is notprobable, or when a loan is both greater than 90 days delinquent and the loan’scollateral is not sufficient to cover both principal and accrued interest. Accrualof interest is restored after all past due principal and interest has been paidand the Company expects repayment of the remaining contractual principal andinterest, or when an improvement in the condition of the loan has occurred thatwould warrant resumption of interest accruals. Other loan fees and charges,including service costs for the prepayment of loans, delinquent charges andother miscellaneous loan services, are recorded as income when collected.

***Equipment, LeaseholdImprovements and Capitalized Software Costs******—Equipment*********and leasehold improvements arestated at cost, less accumulated depreciation and amortization. Depreciationand amortization are recognized using the straight-line method over theestimated useful lives of the assets which range from three to seven years, andfor leasehold improvements over the lesser of the useful life or the life ofthe lease. For costs incurred to develop computer software for internal use,the Company 

F-9

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**2.Summary of Significant Accounting Policies (Continued)**

capitalizes costs incurredduring the application development stage, which includes costs to design thesoftware configuration and interfaces, coding, installation and testing. Costsincurred during the preliminary and post-implementation stages are expensed asincurred. Capitalized software costs are amortized over the estimated usefullife of the project, which can range from three to five years.

***Long-Lived Assets******—Long-lived***assetsto be held and used by the Company are reviewed on a quarterly basis todetermine whether any events or changes in circumstances indicate that thecarrying amount of the asset may not be recoverable. For long-lived assets tobe held and used, the Company bases its evaluation on such impairmentindicators as the nature of the assets, the future economic benefit of theassets, any historical or future profitability measurements, as well as otherexternal market conditions or factors that may be present. During the yearsended December 31, 2006 and 2005, the Company’s analyses indicated therewere no material impairments of its long-lived assets.

***Income Taxes****—*Income tax expense is based on estimated taxes payable orrefundable on a tax return basis for the current year and the changes indeferred tax assets and liabilities during the year. Deferred tax assets andliabilities are established for temporary differences between the accountingbases and the tax bases of the Company’s assets and liabilities at enacted taxrates expected to be in effect when the amounts related to such temporarydifferences are realized or settled. If the Company determines that it is “morelikely than not” that some portion or all of a deferred tax asset will not berealized, the Company records a valuation allowance in accordance with theprovisions of Statement of Financial Accounting Standards No. 109, *Accounting for Income Taxes*(‘SFAS 109’).

In accordance with Accounting Principles Board OpinionNo. 23, *Accounting for Income Taxes—Special Areas*(‘APB 23’), the Company presumes the undistributed earnings of its foreignsubsidiaries will be distributed to its parent company unless the Companyadopts the indefinite reversal provisions of APB 23, which would require theCompany to provide sufficient evidence to support that the subsidiary hasinvested or will invest the undistributed earnings indefinitely. The Companyrecognizes the indefinite reversal provision of APB 23 for its Irish and CaymanIslands subsidiaries due to the projected capital needs necessary to supportthe continued growth of these entities. As such, the Company does not recordU.S. income taxes on the undistributed earnings of its Irish and Cayman Islandsubsidiaries.

***Translation of Foreign Currencies***—Wherethe functional currency is not the U.S. dollar, the Company translates thefinancial statements of its foreign operations into U.S. dollars. Assets andliabilities are translated into U.S. dollars at period-end exchange rates,while income and expenses are translated using average rates for the period. Theresulting translation adjustments are recorded as a component of accumulatedother comprehensive income (‘OCI’) in stockholders’ equity.

For foreign operations where the functional currencyis the U.S. dollar, the local currency financial statements are remeasured intoU.S. dollars using period-end exchange rates for monetary assets andliabilities, exchange rates in effect on the date of acquisition fornon-monetary assets and liabilities (such as premises and equipment and therelated depreciation), and the average exchange rates during the period forincome and expenses. The resulting exchange gains or losses are recorded incurrent period income.

***Derivative Financial Instruments****—*Derivative financial instruments are recorded in theCompany’s consolidated balance sheets at fair value as other assets or other liabilities,depending on the rights and obligations under the contracts. The Companyutilizes derivative financial instruments primarily for 

F-10

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**2.Summary of Significant Accounting Policies (Continued)**

balance sheet asset andliability management purposes. The effective portion of a change in the fairvalue of a derivative that is designated and qualifies as a cash flow hedge isreported in OCI, net of taxes. The ineffective portion, which is the extent towhich the change in the fair value of the derivative exceeds the change in thevariability of the expected future cash flows of the hedged item (on anabsolute basis), is reported in net interest income. The changes in the fairvalue of a derivative that is designated and qualifies as a fair value hedge isreported in net interest income, along with the change in the fair value of thehedged item attributable to the risk being hedged. The change in fair value ofa derivative that is not designated or does not qualify as a hedge isrecognized in earnings.

Hedge accounting is discontinued prospectively if a)the hedging relationship no longer meets the hedging criteria, b) thederivative expires, or is sold, terminated or exercised, or c) the Companyremoves the hedge designation. When hedge accounting is discontinued under cashflow hedge accounting, the component of OCI related to the discontinued hedgeis amortized to net interest income over the remaining term of the derivativefinancial instrument. Under fair value hedge accounting, when a hedge isdiscontinued, the hedged item is no longer adjusted for changes in fair valueand the existing basis adjustment is amortized to net interest income. If cashflow hedge accounting is discontinued due to the probability that theforecasted transaction will not occur within the specified period, gains andlosses accumulated in OCI related to that hedge are recognized immediately tonet interest income.

The Company enters into interest rate derivativecontracts that are designated as cash flow hedges of (a) the variabilityin interest payments related to the planned rollover of short-term liabilitiesat different fixed rates (thereby resulting in a variable interest expensepattern) and (b) the variability in interest payments related tovariable-rate liabilities. The unrealized gains or losses related to thesecontracts are reported in other assets and other liabilities on the Company’sconsolidated balance sheets.

The Company also enters into fixed price purchasecontracts that are designed to hedge the variability of the consideration to bepaid for the purchase of investment securities. By entering into thesecontracts, the Company is fixing the price to be paid at a future date forcertain investment securities. The changes in fair value of these fixed pricecontracts are included as a component of OCI. The unrealized gains and lossesare included in other assets and other liabilities on the Company’sconsolidated balance sheets.

The Company enters into foreign exchange contractswith clients and enters into matched or offsetting positions with eitheranother client or a financial institution. These contracts are subject tomarket value fluctuations in foreign currencies. Gains and losses from suchfluctuations are netted and recorded as an adjustment to asset servicing feesin the Company’s consolidated statements of income. Unrealized gains or lossesresulting from purchases and sales of foreign exchange contracts are includedwithin the respective other assets and other liabilities categories on theCompany’s consolidated balance sheets. Foreign exchange contracts with the samecounterparty are netted in the Company’s consolidated balance sheets when amaster netting agreement exists.

***Securities SoldUnder Repurchase Agreements******—The*********Company enters into sales ofsecurities under agreements to repurchase as a low cost source of funding forits operations. These agreements are treated as secured borrowings, and theobligations to repurchase securities sold are reflected as liabilities in theconsolidated balance sheets. Securities pledged as collateral under agreementsto repurchase are reflected as assets in the accompanying consolidated balancesheets.

F-11

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**2.Summary of Significant Accounting Policies (Continued)**

***Share-BasedCompensation***—On January 1, 2006, the Companyadopted Statement of Financial Accounting Standards No. 123 (revised2004), *Share-Based Payment*(‘SFAS 123R’). SFAS123R requires that compensation cost relating to share-based paymenttransactions be recognized in the financial statements, with measurement basedupon the fair value of the equity or liability instruments issued. The Companyadopted SFAS 123R using the modified prospective application method. Under thatmethod, compensation cost for equity awards granted after January 1, 2006is recognized over the service period based on the grant date fair value. Inaddition, compensation cost for the portion of awards for which the requisiteservice has not been rendered that are outstanding as of January 1, 2006is recognized prospectively as the requisite service is rendered. Thecompensation cost for that portion of awards is based on the grant date fairvalue of those awards as calculated under the pro forma disclosures ofStatement of Financial Accounting Standards No. 123, *Accountingfor Stock-Based Compensation* (‘SFAS 123’). In accordance withthe modified prospective application method, the financial statements ofperiods prior to the adoption of SFAS 123R have not been restated.

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

| ** **                     | ** ** | **For the Year Ended  December 31,** | ** ** |
|--------------------------------|------------|----------------------------------------------------------|------------|
| ** **                     | ** ** | **2006**                                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
| Share-based  compensation cost |       | $                                                        | 4,538      |   | $ | 261 |   | $ | 316 |   |
| Income tax benefit             |       | $                                                        | 580        |   | $ | — |   | $ | — |   |

 

Certain of the Company’s share-based awards containterms that provide for a graded vesting schedule whereby portions of the awardsvest in increments over the requisite service period. As provided for underSFAS 123R, the Company has elected to recognize compensation cost for awardsgranted on or after January 1, 2006 with graded vesting schedules on astraight-line basis over the requisite service period for the entire award.

F-12

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**2.Summary of Significant Accounting Policies (Continued)**

Prior to adopting SFAS123R, the Company measured compensation cost for share-based compensation plansusing the intrinsic value method under Accounting Principles Board Opinion No. 25,*Accounting for Stock Issued to Employees*(‘APB25’),**and made pro forma disclosures of thefair value method under SFAS 123. The intrinsic value method measurescompensation cost as the amount by which the fair market value of the Company’scommon stock exceeds the option exercise price on the measurement date, whichis typically the date of grant. Generally, options granted had an exerciseprice equivalent to the fair market value at the measurement date. Accordingly,no compensation cost was recorded. If share-based compensation cost wererecognized using the fair value method, stock options would be valued at grantdate using the Black-Scholes valuation model and the resulting compensationcost would have decreased net income as indicated below (Dollars in thousands,except per share data):

| ** **                                                                                                                               | ** ** | **For the Year Ended** | ** ** | **For the Year Ended** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                                               | ** ** | **December 31,  2005**           | ** ** | **December 31,  2004**           | ** ** |
| Net income as  reported                                                                                                                  |       |                                  | $          | 159,818                               |       |   |   | $ | 141,962 |   |   |
| Deduct: Total  share-based employee compensation cost determined under the fair value method  for all awards, net of related tax effects |       |                                  | (19,832    | )                                     |       |   | (16,679 | ) |   |
| Pro forma net  income                                                                                                                    |       |                                  | $          | 139,986                               |       |   |   | $ | 125,283 |   |   |
| Earnings per share:                                                                                                                      |       |                                  |       |                                  |       |   |   |   |   |
| Basic-as reported                                                                                                                        |       |                                  | $          | 2.42                                  |       |   |   | $ | 2.15 |   |   |
| Basic-pro forma                                                                                                                          |       |                                  | $          | 2.12                                  |       |   |   | $ | 1.89 |   |   |
| Diluted-as reported                                                                                                                      |       |                                  | $          | 2.37                                  |       |   |   | $ | 2.09 |   |   |
| Diluted-pro forma                                                                                                                        |       |                                  | $          | 2.07                                  |       |   |   | $ | 1.85 |   |   |

 

The fair value of each option grant was estimated onthe date of grant using the Black-Scholes valuation model with the following weighted-averageassumptions for the years ended December 31, 2005 and 2004, respectively: anaverage assumed risk-free interest rate of 4.55% and 3.08%, an expected term offour years, an average expected volatility of 41.04% and 50.49%, and an averagedividend yield of 0.20% and 0.16%.

The amount of share-based compensation cost (net oftax) included in net income as reported was $0.2 million for both the yearsended December 31, 2005 and 2004.

F-13

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**2.Summary of Significant Accounting Policies (Continued)**

The following table presentsthe effect of changing from the intrinsic value method under APB 25 to the fairvalue method under SFAS 123R for the year ended December 31, 2006 (Dollarsin thousands, except per share data):

| ** **                           | ** ** | **For the Year Ended** | ** ** |
|--------------------------------------|------------|---------------------------------------|------------|
| ** **                           | ** ** | **December 31,  2006**           | ** ** |
| Increase/(Decrease) in:              |       |                                  |       |   |   |
| Income from continuing operations    |       |                                  | $          | (4,325 | ) |   |
| Income before  income taxes          |       |                                  | (4,325     | ) |   |
| Net income                           |       |                                  | (2,966     | ) |   |
| Cash flow from  operations           |       |                                  | (8,017     | ) |   |
| Cash flow from  financing activities |       |                                  | 8,017      |   |   |
| Basic EPS                            |       |                                  | $          | (0.05 | ) |   |
| Diluted EPS                          |       |                                  | $          | (0.05 | ) |   |

 

The fair value of each option grant under the DirectorPlan, the Stock Plan, and the 2005 Plan (each as described further in Note 11)was estimated on the grant date using the Black-Scholes valuation model withthe following weighted-average assumptions for the year ended December 31,2006: an average assumed risk-free interest rate of 4.76%, an average expectedterm of five years, an average expected volatility of 41.92%, and an averagedividend yield of 0.20%.

The Company bases its estimate of expected term on thehistorical exercise and post-vesting employment termination behavior forsimilar grants. The Company’s volatility assumption is based on the historicalvolatility of the Company’s stock over a period equating to the expected termof the employee share option, using weekly price observations and lookingbackward from the date of grant.

The fair value of the option feature of grants underthe 1997 Employee Stock Purchase Plan (‘ESPP’) (as described further in Note11) was estimated on the grant date using the Black-Scholes valuation modelwith the following weighted-average assumptions for the year ended December 31,2006: an average assumed risk-free rate of 4.79%, an expected term of 0.5years, an average volatility of 37.55%, and an average dividend yield of 0.23%.

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

SFAS 123R also requires that any deferred compensationrelated to share-based awards granted prior to January 1, 2006 must beeliminated against the appropriate equity accounts. In connection with theCompany’s adoption of SFAS 123R, the presentation in the consolidated statementof stockholders’ equity for the year ended December 31, 2006 was revisedto reflect the transfer of balances previously reported in deferredcompensation to surplus.

F-14

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**2. Summary of SignificantAccounting Policies (Continued)**

***Earnings Per Share—******Basic***earningsper share (‘EPS’) is computed by dividing net income by the weighted-averagenumber of common shares outstanding during the year. Diluted EPS reflects thepotential dilution that could occur if contracts to issue common stock wereexercised into common stock that then shared in the earnings of the Company. Thereconciliation from Basic EPS to Diluted EPS is as follows (Dollars inthousands, except per share data):

| ** **                                                     | ** ** | ** **     | ** ** | **Weighted-Average** | ** ** | **Per Share** | ** ** |
|----------------------------------------------------------------|------------|----------------|------------|----------------------|------------|--------------------|------------|
| ** **                                                     | ** ** | **Income**     | ** ** | **Shares**           | ** ** | **Amount**         | ** ** |
| **December 31, 2006**                                     | ** ** | ** **     | ** ** |                 | ** ** | ** **         |       |   | ** ** | ** ** |   |
| *Basic EPS*                                                    | * *   | * *       | * *   | * *             | * *   | ** **         | * *   | * * | * * | * * | * * |
| Income available  to common stockholders                       |       | $ 153,803 |       |                 | 65,730,456 | ** **         |       |   | $ 2.34 |   |   |
| Dilutive effect  of common equivalent shares  of stock options |       | —         |       |                 | 1,762,625  | ** **         |       |   | (0.06 | ) |   |
| *Diluted  EPS*                                                 |       | $ 153,803 |       |                 | 67,493,081 | ** **         |       |   | $ 2.28 |   |   |
| **December 31, 2005**                                     | ** ** | ** **     | ** ** |                 | ** ** | ** **         |       |   | ** ** | ** ** |   |
| *Basic EPS*                                                    | * *   | * *       | * *   | * *             | * *   | ** **         | * *   | * * | * * | * * | * * |
| Income available  to common stockholders                       |       | $ 159,818 |       |                 | 66,139,323 | ** **         |       |   | $ 2.42 |   |   |
| Dilutive effect  of common equivalent shares  of stock options |       | —         |       |                 | 1,334,481  | ** **         |       |   | (0.05 | ) |   |
| *Diluted  EPS*                                                 |       | $ 159,818 |       |                 | 67,473,804 | ** **         |       |   | $ 2.37 |   |   |
| **December 31, 2004**                                     | ** ** | ** **     | ** ** |                 | ** ** | ** **         |       |   | ** ** | ** ** |   |
| *Basic EPS*                                                    | * *   | * *       | * *   | * *             | * *   | ** **         | * *   | * * | * * | * * | * * |
| Income available  to common stockholders                       |       | $ 141,962 |       |                 | 66,179,286 | ** **         |       |   | $ 2.15 |   |   |
| Dilutive effect  of common equivalent shares  of stock options |       | —         |       |                 | 1,736,931  | ** **         |       |   | (0.06 | ) |   |
| *Diluted EPS*                                                  |       | $ 141,962 |       |                 | 67,916,217 | ** **         |       |   | $ 2.09 |   |   |

 

For the years ended December 31, 2006, 2005 and2004, there were 132,905 options 733,015 options and 29,451 options which werenot considered dilutive for EPS calculations, respectively.

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

F-15

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**2.Summary of Significant Accounting Policies (Continued)**

***Goodwill—******The***Companyreviews goodwill for impairment on an annual basis, or if events or changes incircumstances indicate it would be more likely than not that the fair value ofthe goodwill would be reduced below its carrying value. As of December 31,2006, there was no impairment of goodwill.

***New Accounting Pronouncements***

In June 2006, the Financial Accounting StandardsBoard (‘FASB’) issued FASB Interpretation No. 48, *Accountingfor Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109*(‘FIN 48’). FIN 48 establishes a recognition threshold and measurementattribute for the financial statement recognition and measurement of a taxposition taken or expected to be taken in a tax return. Pursuant to FIN 48, theeffects of a tax position are recognized in the financial statements when it ismore likely than not, based on the technical merits, that the position will besustained upon examination. Conversely, previously recognized tax positions arederecognized when it is no longer more likely than not that the tax positionwould be sustained upon examination. FIN 48 also requires certain disclosuresregarding unrecognized tax benefits and the amounts and classification of therelated interest and penalties. FIN 48 is effective for fiscal years beginning afterDecember 15, 2006. Accordingly, the Company adopted FIN 48 on January 1,2007, and there was no material impact to the financial condition or results ofoperations of the Company.

In September 2006, the FASB issued Statement ofFinancial Accounting Standards No. 157, *Fair ValueMeasurements*(‘SFAS 157’). SFAS 157 defines fair value, establishes a framework formeasuring fair value, and expands upon existing disclosures about fair valuemeasurements. SFAS 157 does not require any new fair value measurements. Rather,the guidance contained in SFAS 157 applies to assets, liabilities, and certainequity instruments that are already measured at fair value under existingaccounting pronouncements. SFAS 157 is effective for fiscal yearsbeginning after November 15, 2007. The Company does not anticipate anymaterial impact to its financial condition or results of operations as a resultof the adoption of SFAS 157.

In September 2006, the SEC issued StaffAccounting Bulletin 108, *Considering the Effects ofPrior Year Misstatements When Quantifying Misstatements in Current YearFinancial Statements* (‘SAB 108’). SAB 108 provides interpretive guidance on how theeffects of the carryover or reversal of prior year financial statementmisstatements should be considered in quantifying a current year misstatement. SAB108 is effective for financial statements covering the first fiscal yearending after November 15, 2006. Accordingly, the Company adopted SAB 108on December 31, 2006, and there was no material impact to the financialcondition or results of operations of the Company.

In February 2007, theFASB issued Statement of Financial Accounting Standards No. 159, *The Fair Value Option for Financial Assets and Financial Liabilities*(‘SFAS 159’). SFAS 159 permits entities to elect to measure certain financialinstruments and other items at fair value through earnings. The fair valueoption may be applied on an instrument by instrument basis, is irrevocable andis applied only to entire instruments. SFAS 159 requires additional financialstatement presentation and disclosure requirements for those entities thatelect to adopt the standard and is effective for fiscal years beginning after November 15,2007. The Company does not anticipate any material impact to its financial conditionor results of operations as a result of the adoption of SFAS 159.

F-16

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**3. Securities**

Amortizedcost amounts and fair values of securities are summarized as follows as of December 31,2006 (Dollars in thousands):

| ** **                        | ** ** | **Amortized**    | ** ** | **Unrealized** | ** **    | **Unrealized** | ** ** | ** **   | ** **     |
|-----------------------------------|------------|------------------|------------|----------------|---------------|----------------|------------|--------------|----------------|
| **Held to Maturity**    | ** ** | ** **       | ** ** | **Cost**       | ** **    | **Gains**      | ** ** | **(Losses)** | ** **     | **Fair Value** | ** ** |
| Mortgage-backed  securities       |       | $ 3,753,497 |       |           | $ 7,271  |           |       |         | $ (25,584 | ) |   | $ 3,735,184 |   |
| Federal agency  securities        |       | 1,680,458        |       |           | 2,956         |           |       |         | (12,328        | ) |   | 1,671,086 |   |
| State and  political subdivisions |       | 98,375           |       |           | 4,206         |           |       |         | (63            | ) |   | 102,518 |   |
| Total                             |       | $ 5,532,330 |       |           | $ 14,433 |           |       |         | $ (37,975 | ) |   | $ 5,508,788 |   |
|                                   |            |                  |            |                |               |                |            |              |                |  |  |  |  |  |  |

 

| ** **                        | ** ** | **Amortized**    | ** ** | **Unrealized** | ** **   | **Unrealized** | ** ** | ** **   | ** **     |
|-----------------------------------|------------|------------------|------------|----------------|--------------|----------------|------------|--------------|----------------|
| **Available for Sale**  | ** ** | ** **       | ** ** | **Cost**       | ** **   | **Gains**      | ** ** | **(Losses)** | ** **     | **Fair Value** | ** ** |
| Mortgage-backed  securities       |       | $ 4,302,932 |       |           | $ 7,400 |           |       |         | $ (35,281 | ) |   | $ 4,275,051 |   |
| State and  political subdivisions |       | 343,204          |       |           | 2,090        |           |       |         | (990           | ) |   | 344,304 |   |
| Corporate debt                    |       | 170,797          |       |           | 226          |           |       |         | (1,173         | ) |   | 169,850 |   |
| Foreign  government securities    |       | 10,559           |       |           | —       |           |       |         | (24            | ) |   | 10,535 |   |
| Total                             |       | $ 4,827,492 |       |           | $ 9,716 |           |       |         | $ (37,468 | ) |   | $ 4,799,740 |   |
|                                   |            |                  |            |                |              |                |            |              |                |  |  |  |  |  |  |

 

Amortizedcost amounts and fair values of securities are summarized as follows as of December 31,2005 (Dollars in thousands):

| ** **                        | ** ** | **Amortized**    | ** ** | **Unrealized** | ** **    | **Unrealized** | ** ** | ** **   | ** **     |
|-----------------------------------|------------|------------------|------------|----------------|---------------|----------------|------------|--------------|----------------|
| **Held to Maturity**    | ** ** | ** **       | ** ** | **Cost**       | ** **    | **Gains**      | ** ** | **(Losses)** | ** **     | **Fair Value** | ** ** |
| Mortgage-backed  securities       |       | $ 4,342,254 |       |           | $ 11,420 |           |       |         | $ (29,818 | ) |   | $ 4,323,856 |   |
| Federal agency  securities        |       | 2,305,331        |       |           | 1,560         |           |       |         | (23,914        | ) |   | 2,282,977 |   |
| State and  political subdivisions |       | 114,345          |       |           | 4,646         |           |       |         | (95            | ) |   | 118,896 |   |
| Total                             |       | $ 6,761,930 |       |           | $ 17,626 |           |       |         | $ (53,827 | ) |   | $ 6,725,729 |   |
|                                   |            |                  |            |                |               |                |            |              |                |  |  |  |  |  |  |

 

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

 

Excluded from the above tables are nonmarketableequity securities, which consisted primarily of stock of the FRBB and FHLBB at December 31,2006 and stock of the FHLBB at December 31, 2005. There was no FRBB stockheld as of December 31, 2005. TheCompany’s capital stock investment in the FHLBB totaled $29.4 million as of December 31,2006. This amount reflects a $20.6 million decrease from December 31, 2005.The $29.4 million capital stock investment includes both a $25.0 millionmembership component and a $4.4 million activity-based component. Themembership component of the FHLBB capital stock investment requires afive-year advance notice of withdrawal. TheCompany’s $29.4 million capital stock investment in the FHLBB provides anovernight borrowing capacity of up to $146.4 million. The amount 

F-17

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**3.Securities (Continued)**

outstanding under thisarrangement as of December 31, 2006 was $125.0 million. The Companycurrently has the ability to purchase up to $25.0 million of activity-basedcapital, which would provide a total overnight borrowing capacity of $833.3million.

In October 2006, theCompany became a member of the FRBB. In connection with its membership, theCompany was required to subscribe to purchase stock of the FRBB totaling 6% ofthe Bank’s capital and surplus. The Company fulfilled its obligation topurchase 50% of the subscribed amount by purchasing $7.4 million of FRBB stock.The remaining subscription amount is subject to purchase upon the request ofthe FRBB.

Theamortized cost amounts and fair values of securities by contractual maturityare as follows (Dollars in thousands):

| ** **                      | ** ** | **December 31, 2006**                                  | ** ** |
|---------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                      | ** ** | **Amortized**                                                    | ** ** | ** ** | ** ** |
| **Held to Maturity**  | ** ** | ** **                                                       | ** ** | **Cost** | ** ** | **Fair Value** | ** ** |
| Due within one  year            |       | $          341 |       | $          342 |   |
| Due from one to  five years     |       | 13,663                                                           |       | 13,804 |   |
| Due five years up  to ten years |       | 355,800                                                          |       | 357,776 |   |
| Due after ten  years            |       | 5,162,526                                                        |       | 5,136,866 |   |
| Total                           |       | $ 5,532,330                                                 |       | $ 5,508,788 |   |
|                                 |            |                                                                  |            |  |  |  |  |

 

| ** **                       | ** ** | **December 31, 2006** | ** ** |
|----------------------------------|------------|---------------------------------|------------|
| ** **                       | ** ** | **Amortized**                   | ** ** | ** ** | ** ** |
| **Available for Sale** | ** ** | ** **                      | ** ** | **Cost** | ** ** | **Fair Value** | ** ** |
| Due within one  year             |       | $    11,514 |       | $    11,503 |   |
| Due from one to  five years      |       | 27,591                          |       | 28,034 |   |
| Due five years up  to ten years  |       | 228,318                         |       | 231,061 |   |
| Due after ten  years             |       | 4,560,069                       |       | 4,529,142 |   |
| Total                            |       | $ 4,827,492                |       | $ 4,799,740 |   |
|                                  |            |                                 |            |  |  |  |  |

 

During the year ended December 31, 2006, theCompany sold forty-two securities classified as available for sale totaling$134.1 million using the specific identification method. The book value of thesecurities was $131.6 million and resulted in a gross realized gain of $2.5million for the year ended December 31, 2006. During the year ended 2005,the Company sold eighty-five securities classified as available for saletotaling $376.1 million using the specific identification method. The bookvalue of the securities was $363.7 million and resulted in a gross realizedgain of $12.4 million for the year ended December 31, 2005. During the yearended December 31, 2004, the Company sold one security classified asavailable for sale totaling $25.0 million using the specific identificationmethod. The book value of the security was $24.8 million and resulted in agross realized gain of $0.2 million for the year ended December 31, 2004.

F-18

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**3. Securities(Continued)**

The carrying value of securities pledged amounted toapproximately $7.2 billion at December 31, 2006 and $7.5 billion at December 31,2005. Securities are pledged primarily to secure clearings with otherdepository institutions, secure repurchase agreements and secure outstandingFHLBB borrowings.

On a quarterly basis the Company reviews itsinvestment portfolio on a security by security basis for any investment thatmay be other than temporarily impaired. In its evaluation, the Companyconsiders the length of time the security has been impaired, the severity ofthe impairment, the financial condition and future prospects of the issuer, andthe Company’s ability and intent to hold the security to maturity or until itrecovers in value.

The unrealized losses related to the Company’sinvestment in mortgage-backed and Federal agency securities are attributable tochanges in market interest rates. The contractual cash flows of thesesecurities are guaranteed by agencies of the U.S. government, includinggovernment sponsored agencies. As a result, the Company’s exposure to thecredit risk of these securities is minimal. At December 31, 2006, therewere 876 mortgage-backed and Federal agency securities that were in unrealizedloss positions. The market value decline as a percentage of amortized cost forthe Company’s mortgage-backed and Federal agency securities portfolio was lessthan 1% at December 31, 2006. The Company has the intent and ability tohold these securities until forecasted recovery, which may in some cases bematurity. The Company does not consider these investments to be other thantemporarily impaired at December 31, 2006. Corporate debt securitiesinclude trust preferred securities (‘trups’) issued by reputable financial institutions.The credit ratings of the underlying issuers range from A1 to Aa3 ratings. TheCompany holds senior tranches of these issuances and believes that it willrecover all contractual payments. The unrealized losses related to the trupsportfolio are due to changes in credit spreads. At December 31, 2006,there were 6 corporate debt securities that were in unrealized loss positions. TheCompany has the intent and ability to hold these securities until forecastedrecovery and does not consider these investments to be other than temporarilyimpaired at December 31, 2006.

Unrealized losses related to the Company’s investmentsin state and political subdivisions securities were due to changes in marketinterest rates. At December 31, 2006, there were 185 state and politicalsubdivisions investment securities in an unrealized loss position. The creditrating on the securities were all Aaa and scheduled payments continue to bemade on a timely basis. Given the minimal amount of unrealized losses and thelimited amount of credit exposure, the Company does not consider theseinvestments to be other than temporarily impaired at December 31, 2006.

F-19

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**3.Securities (Continued)**

The following table presentsthe information about the Company’s temporarily impaired investments at December 31,2006 (Dollars in thousands):

| ** **                             | ** ** | **Less than 12 months** | ** ** | **12 months or longer** | ** ** | **Total**           | ** ** |
|----------------------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|---------------------|------------|
| ** **                             | ** ** | **Fair Value**                    | ** ** | **Unrealized  Losses**                 | ** ** | **Fair Value** | ** ** | **Unrealized  Losses** | ** ** | **Fair Value** | ** ** | **Unrealized  Losses** | ** ** |
| Mortgage-backed  securities            |       | $                                      | 1,816,592  |                                   |       | $                   | 7,677      |   |   | $ | 3,572,895 |   |   | $ | 53,188 |   |   | $ | 5,389,487 |   |   | $ | 60,865 |   |   |
| Federal agency  securities             |       | 167,095                                |       |                                   | 409        |                |       | 1,065,865 |   |   | 11,919 |   |   | 1,232,960 |   |   | 12,328 |   |   |
| Corporate debt                         |       | 10,082                                 |       |                                   | 8          |                |       | 48,317 |   |   | 1,165 |   |   | 58,399 |   |   | 1,173 |   |   |
| State and  political subdivisions      |       | 127,530                                |       |                                   | 907        |                |       | 16,446 |   |   | 146 |   |   | 143,976 |   |   | 1,053 |   |   |
| Foreign                                |       | —                                 |       |                                   | —     |                |       | 10,535 |   |   | 24 |   |   | 10,535 |   |   | 24 |   |   |
| Total temporarily  impaired securities |       | $                                      | 2,121,299  |                                   |       | $                   | 9,001      |   |   | $ | 4,714,058 |   |   | $ | 66,442 |   |   | $ | 6,835,357 |   |   | $ | 75,443 |   |   |

 

The following table presentsthe information about the Company’s temporarily impaired investments at December 31,2005 (Dollars in thousands): 

| ** **                             | ** ** | **Less than 12 months** | ** ** | **12 months or longer** | ** ** | **Total**           | ** ** |
|----------------------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|---------------------|------------|
| ** **                             | ** ** | **Fair Value**                    | ** ** | **Unrealized  Losses**                 | ** ** | **Fair Value** | ** ** | **Unrealized  Losses** | ** ** | **Fair Value** | ** ** | **Unrealized  Losses** | ** ** |
| Mortgage-backed  securities            |       | $                                      | 4,566,743  |                                   |       | $                   | 43,821     |   |   | $ | 1,486,521 |   |   | $ | 34,575 |   |   | $ | 6,053,264 |   |   | $ | 78,396 |   |   |
| Federal agency  securities             |       | 1,443,951                              |       |                                   | 10,809     |                |       | 883,807 |   |   | 13,105 |   |   | 2,327,758 |   |   | 23,914 |   |   |
| Corporate debt                         |       | —                                 |       |                                   | —     |                |       | 47,911 |   |   | 1,543 |   |   | 47,911 |   |   | 1,543 |   |   |
| State and  political subdivisions      |       | 146,147                                |       |                                   | 1,856      |                |       | 8,173 |   |   | 152 |   |   | 154,320 |   |   | 2,008 |   |   |
| Foreign                                |       | 10,536                                 |       |                                   | 3          |                |       | — |   |   | — |   |   | 10,536 |   |   | 3 |   |   |
| Total temporarily  impaired securities |       | $                                      | 6,167,377  |                                   |       | $                   | 56,489     |   |   | $ | 2,426,412 |   |   | $ | 49,375 |   |   | $ | 8,593,789 |   |   | $ | 105,864 |   |   |

 

F-20

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**4. Loans**

Loans consist of demandloans to custody clients of the Company, including individuals, not-for-profitinstitutions and mutual fund clients. The loans to mutual funds and otherpooled product clients include lines of credit and advances pursuant to theterms of the custody agreements between the Company and those clients tofacilitate securities transactions and redemptions. Almost all of the Company’scommitments to fund loans are at variable rates. The credit risk associatedwith these loans is considered low since the loans are, or may be, in the eventof default, collateralized with marketable securities held by the Company ascustodian. However, management recognizessome credit risk inherent in the portfolio, and therefore the Company hasrecorded an allowance for loan losses of $0.1 million at December 31,2006, a level which has remained consistent for the past five years. Thisallowance is not allocated to any particular loan, but is intended to absorbany risk of loss inherent in the loan portfolio at the balance sheet date thatis not captured in the Company’s historical loss rates. Management activelymonitors the loan portfolio and the underlying collateral and regularlyassesses the adequacy of the allowance for loan losses. There were noimpaired loans, non-performing loans, or loans on nonaccrual status at December 31,2006 and 2005. In addition, there were no loan charge-offs or recoveries duringthe years ended December 31, 2006, 2005 and 2004. Loans are summarized asfollows (Dollars in thousands):

| ** **                      | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **2006**              | ** ** | **2005**              | ** ** |
| Loans to mutual funds           |       |                  | $          | 152,491               |       |   |   | $ | 286,144 |   |   |
| Loans to individuals            |       |                  | 64,118     |                  |       |   | 81,392 |   |   |
| Commercial and  industrial      |       |                  | 6,634      |                  |       |   | 15,697 |   |   |
| Other                           |       |                  | 47,550     |                  |       |   | 19,237 |   |   |
|                            |       |                  | 270,793    |                  |       |   | 402,470 |   |   |
| Less allowance for loan  losses |       |                  | (100       | )                     |       |   | (100 | ) |   |
| Total                           |       |                  | $          | 270,693               |       |   |   | $ | 402,370 |   |   |

 

The Company had unused commitments to lendapproximately $1.1 billion and $0.9 billion at December 31, 2006 and 2005,respectively. The terms of these commitments are similar to the terms ofoutstanding loans.

The Company periodicallyissues lines of credit and advances to its mutual fund clients to help thoseclients with security transactions. The President of one of those clients is arelated party to James M. Oates, a member of the Company’s Board ofDirectors. As of December 31, 2006, the Company had total contractualagreements for $150.0 million of committed lines of credit with two mutualfunds within the related party complex (the ‘mutual funds’). The primary sourceof repayment of the loans is the proceeds from the sale of investments in thenormal course of the mutual funds’ business. As part of the agreement, themutual funds are required to segregate and maintain specific collateral for theCompany equal to 200% of the lines of credit. At December 31, 2006, loansdue from the mutual funds totaled $63.7 million. At December 31, 2005,loans due from the mutual funds totaled $125.0 million. Total interest andcommitment fee revenue from the mutual funds for the years ended December 31,2006, 2005 and 2004 was $5.7 million, $2.7 million and $0.4 million,respectively. The terms and conditions of the Company’s contractual agreementswith the mutual funds, including collateral requirements, lending limits andfees, are consistent with other lending clients that have similar composition,size and overall business 

F-21

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**4. Loans(Continued)**

relationshipswith the Company. Also, Mr. Oates abstains from voting on any board matterinvolving any proposed transaction with the mutual funds.

**5. Equipmentand Leasehold Improvements**

Themajor components of equipment and leasehold improvements are as follows(Dollars in thousands):

| ** **                                      | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **2006**              | ** ** | **2005**              | ** ** |
| Furniture,  fixtures and equipment              |       |                  | $          | 138,459               |       |   |   | $ | 112,310 |   |   |
| Leasehold  improvements                         |       |                  | 39,118     |                  |       |   | 16,247 |   |   |
| Total                                           |       |                  | 177,577    |                  |       |   | 128,557 |   |   |
| Less accumulated  depreciation and amortization |       |                  | (64,290    | )                     |       |   | (59,156 | ) |   |
| Equipment and  leasehold improvements, net      |       |                  | $          | 113,287               |       |   |   | $ | 69,401 |   |   |

 

Included in furniture,fixtures and equipment were capitalized internal software costs of $87.6million and $73.3 million at December 31, 2006 and 2005, respectively. Depreciationexpense was $29.0 million, $29.4 million and $30.1 million for the years ended December 31,2006, 2005 and 2004, respectively. Amortization expense was $3.8 million, $2.2million and $2.0 million for the years ended December 31, 2006, 2005 and2004, respectively.

**6. Deposits**

Thefollowing is a summary of deposit balances by type (Dollars in thousands):

| ** **                          | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                          | ** ** | **2006**              | ** ** | **2005**              | ** ** |
| Interest-bearing  deposits:         |       |                  |       |                  |       |   |   |   |   |
| Demand                              |       |                  | $          | 110,647               |       |   |   | $ | 85,157 |   |   |
| Savings                             |       |                  | 4,854,711  |                  |       |   | 4,195,486 |   |   |
| Time                                |       |                  | 224,386    |                  |       |   | 55,124 |   |   |
| Total  interest-bearing deposits    |       |                  | 5,189,744  |                  |       |   | 4,335,767 |   |   |
| Noninterest-bearing  deposits:      |       |                  |       |                  |       |   |   |   |   |
| Demand                              |       |                  | 585,174    |                  |       |   | 452,401 |   |   |
| Savings                             |       |                  | 70,024     |                  |       |   | 29,422 |   |   |
| Time                                |       |                  | 300,000    |                  |       |   | 175,000 |   |   |
| Total  noninterest-bearing deposits |       |                  | 955,198    |                  |       |   | 656,823 |   |   |
| Total                               |       |                  | $          | 6,144,942             |       |   |   | $ | 4,992,590 |   |   |

 

Time deposits withbalances greater than $100,000 totaled $524.4 million and $230.1 million at December 31,2006 and 2005, respectively. All time deposits had a maturity of less thanthree months at December 31, 2006 and 2005. The aggregate amounts ofoverdraft deposits that have been reclassified as loan balances were $86.2million and $162.2 million at December 31, 2006 and 2005, respectively.

F-22

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**7. SecuritiesSold Under Repurchase Agreements**

Informationon the Company’s repurchase agreements and the corresponding securities pledgedas collateral at December 31, 2006 is as follows (Dollars in thousands):

| ** **                          | ** ** | **Securities Pledged as Collateral** | ** ** | ** **              | ** ** | ** **                     | ** ** |
|-------------------------------------|------------|-----------------------------------------------------|------------|-------------------------|------------|--------------------------------|------------|
| ** **                          | ** ** | **Mortgage-backed**                                 | ** ** | **Federal Agency** | ** ** | **Repurchase Agreements** | ** ** |
| ** **                          | ** ** | **Amortized Cost**                             | ** ** | **Fair Value**     | ** ** | **Amortized Cost**        | ** ** | **Fair Value** | ** ** | **Carrying Value** | ** ** | **Rate** | ** ** |
| Maturity of Repurchase  Agreements: |       |                                                |       |                    |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Overnight                           |       |                                                | $          | 2,427,665               |       |                           | $          | 2,417,385 |   |   | $ | 915,827 |   |   | $ | 907,608 |   |   | $ | 3,177,800 |   |   | 4.26 | % |
| 2 to 30 days                        |       |                                                | —     |                    |       | —                         |       |   | — |   |   | — |   |   | — |   |   | — |   |
| 30 to 90 days                       |       |                                                | 77,939     |                    |       | 77,360                         |       |   | — |   |   | — |   |   | 100,000 |   |   | 3.40 | % |
| Over 90 days                        |       |                                                | 498,404    |                    |       | 492,436                        |       |   | — |   |   | — |   |   | 450,000 |   |   | 3.52 | % |
| **Total**                           |       |                                                | $          | 3,004,008               |       |                           | $          | 2,987,181 |   |   | $ | 915,827 |   |   | $ | 907,608 |   |   | $ | 3,727,800 |   |   |   |   |

 

The weighted-averageinterest rate paid on repurchase agreements was 3.67% and 2.72% for the yearsended December 31, 2006 and 2005, respectively.

**8. Short-Termand Other Borrowings**

Thecomponents of short-term and other borrowings are as follows (Dollars inthousands):

| ** **                      | ** ** | **December 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|---------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Federal Funds  purchased        |       |                        | $          | 391,967                     |       |   |   | $ | 810,511 |   |   |
| FHLBB overnight  advances       |       |                        | 125,000    |                        |       |   | 400,000 |   |   |
| FHLBB short-term  advances      |       |                        | —     |                        |       |   | 146,000 |   |   |
| Treasury, Tax and  Loan account |       |                        | 84         |                        |       |   | 138 |   |   |
| Total                           |       |                        | $          | 517,051                     |       |   |   | $ | 1,356,649 |   |   |

 

The Company has borrowing arrangements with theFederal Reserve Discount Window and the FHLBB, which have been utilized on anovernight and short-term basis to satisfy funding requirements.

F-23

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**8. Short-Termand Other Borrowings (Continued)**

A summary of the borrowingarrangements are as follows (Dollars in thousands):

| ** **                         | ** ** | **December 31,** | ** ** |
|------------------------------------|------------|-----------------------|------------|
| ** **                         | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Federal Reserve Discount  Window:  |       |                  |       |   |   |
| Borrowing capacity                 |       | $                     | 1,984,499  |   | $ | 1,372,312 |   |
| Borrowing utilized                 |       | —                |       | — |   |
| Maturity range                     |       | —                |       | — |   |
| Securities pledged                 |       | 2,077,291             |       | 1,447,941 |   |
| Federal Home Loan  Bank of Boston: |       |                  |       |   |   |
| Borrowing capacity                 |       | $                     | 146,430    |   | $ | 833,333 |   |
| Borrowing utilized                 |       | 125,000               |       | 546,000 |   |
| Maturity range                     |       | Overnight             |       | Overnight to  September 2006 |   |
| Securities  pledged                |       | 925,286               |       | 955,743 |   |

 

For the years ended December 31,2006 and 2005, the weighted-average interest rate paid on short-term and otherborrowings was 5.02% and 3.31%, respectively. The Company currently has theability to purchase up to $25.0 million of activity-based capital of the FHLBB,which would provide a total overnight borrowing capacity of $833.3 million.

**9. IncomeTaxes**

Thecomponents of income tax expense are as follows (Dollars in thousands):

| ** **          | ** ** | **December 31,** | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|---------------------|------------|-----------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **          | ** ** | **2006**              | ** ** | **2005**              | ** ** | **2004**              | ** ** |
| Current:            |       |                  |       |                  |       |                  |       |   |   |   |   |   |   |
| Federal             |       |                  | $          | 64,665                |       |                  |       | $ | 76,533 |   |   |   | $ | 62,690 |   |   |
| State               |       |                  | 5,168      |                  |       |                  | 5,420      |   |   |   | 5,892 |   |   |
| Foreign             |       |                  | 1,048      |                  |       |                  | 1,026      |   |   |   | 1,247 |   |   |
| Total current       |       |                  | 70,881     |                  |       |                  | 82,979     |   |   |   | 69,829 |   |   |
| Deferred:           |       |                  |       |                  |       |                  |       |   |   |   |   |   |   |
| Federal             |       |                  | (687       | )                     |       |                  | (9,543     | ) |   |   | 3,413 |   |   |
| State               |       |                  | 318        |                  |       |                  | 1,788      |   |   |   | 94 |   |   |
| Foreign             |       |                  | (21        | )                     |       |                  | 811        |   |   |   | (510 | ) |   |
| Total deferred      |       |                  | (390       | )                     |       |                  | (6,944     | ) |   |   | 2,997 |   |   |
| Total income  taxes |       |                  | $          | 70,491                |       |                  |       | $ | 76,035 |   |   |   | $ | 72,826 |   |   |

 

F-24

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**9. IncomeTaxes (Continued)**

Differences between theeffective income tax rate and the federal statutory rates are as follows:

| ** **                                     | ** ** | **December 31,** | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                     | ** ** | **2006**              | ** ** | **2005**              | ** ** | **2004**              | ** ** |
| Federal statutory  rate                        |       |                  | 35.00      | %                     |       |                  | 35.00      | % |   |   | 35.00 | % |   |
| State income tax  rate, net of federal benefit |       |                  | 1.59       |                  |       |                  | 2.00       |   |   |   | 1.81 |   |   |
| Tax-exempt  income, net of disallowance        |       |                  | (3.04      | )                     |       |                  | (2.89      | ) |   |   | (3.61 | ) |   |
| Foreign taxes                                  |       |                  | 0.53       |                  |       |                  | 0.83       |   |   |   | — |   |   |
| Undistributed  foreign earnings                |       |                  | (1.09      | )                     |       |                  | (4.12      | ) |   |   | — |   |   |
| Other                                          |       |                  | (1.56      | )                     |       |                  | 1.41       |   |   |   | 0.71 |   |   |
| Effective tax  rate                            |       |                  | 31.43      | %                     |       |                  | 32.23      | % |   |   | 33.91 | % |   |

 

The Company reversedpreviously accrued taxes of approximately $5.3 million in the second quarter of2006, resulting from a tax position that no longer met the probable recognitionthreshold under Statement of Financial Accounting Standards No. 5, *Accounting for Contingencies* (‘SFAS 5’).

At December 31, 2006, the Company had a foreignnon-capital loss carryforward of approximately $6.8 million, which begins toexpire in 2009. In accordance with the provisions of SFAS 109, the Companybelieves that it is more likely than not that the related deferred tax asset of$2.2 million will not be realized. As a result, a valuation allowance for theentire deferred tax asset amount has been recorded.

The Company provides U.S. federal income taxes on theunremitted earnings of foreign subsidiaries, except to the extent that suchearnings are permanently reinvested outside the United States. At December 31,2006, there were accumulated unremitted earnings of certain foreignsubsidiaries of $36.5 million. Pursuant to the provisions of APB 23, theCompany has not provided for U.S. federal income taxes or foreign withholdingtaxes on these earnings since it is the Company’s current intention topermanently reinvest those earnings outside of the U.S. If the capital in thesesubsidiaries had been temporarily invested, a U.S. deferred tax liability of$9.0 million would have been recorded.

F-25

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**9. IncomeTaxes (Continued)**

The tax effects oftemporary differences that give rise to significant portions of deferred taxassets and liabilities consist of the following (Dollars in thousands):

| ** **                                   | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                   | ** ** | **2006**              | ** ** | **2005**              | ** ** |
| Deferred tax assets:                         | ** ** |                  | ** ** | ** **            |       |   | ** ** | ** ** |   |
| Securities available for sale                |       |                  | $          | 13,017                |       |   |   | $ | 16,622 |   |   |
| Employee benefit plans                       |       |                  | 14,470     |                  |       |   | 7,094 |   |   |
| Other                                        |       |                  | 3,481      |                  |       |   | 3,691 |   |   |
| Deferred tax  assets                         |       |                  | 30,968     |                  |       |   | 27,407 |   |   |
| Valuation allowance                          |       |                  | (2,239     | )                     |       |   | (565 | ) |   |
| Total deferred  tax assets                   |       |                  | 28,729     |                  |       |   | 26,842 |   |   |
| Deferred tax  liabilities:                   |       |                  |       |                  |       |   |   |   |   |
| Unrealized hedging gain                      |       |                  | (7,998     | )                     |       |   | (13,224 | ) |   |
| Depreciation and amortization                |       |                  | (11,364    | )                     |       |   | (10,698 | ) |   |
| Undistributed income of foreign subsidiaries |       |                  | —     |                  |       |   | (69 | ) |   |
| Pension plan                                 |       |                  | (1,312     | )                     |       |   | (1,196 | ) |   |
| Total deferred  tax liabilities              |       |                  | (20,674    | )                     |       |   | (25,187 | ) |   |
| Net deferred tax asset                       |       |                  | $          | 8,055                 |       |   |   | $ | 1,655 |   |   |

 

**10. SubsidiaryTrust Holding Junior Subordinated Deferrable Interest Debentures of the Company**

On January 31, 1997, Investors Capital Trust I (‘ICTI’),a trust sponsored and wholly-owned by the Company, issued $25 million in 9.77%Trust Preferred Securities (the ‘Capital Securities’), the proceeds of whichwere invested by ICT1 in the same aggregate principal amount of the Company’snewly issued 9.77% Junior Subordinated Deferrable Interest Debentures due February 1,2027 (the ‘Junior Subordinated Debentures’). The Capital Securities werecallable on February 1, 2007; however, the Company did not redeem theCapital Securities at that time. The $25 million aggregate principal amount ofthe Junior Subordinated Debentures represents the sole asset of ICTI. TheCompany has guaranteed, on a subordinated basis, distributions and otherpayments due on the Capital Securities (the ‘Guarantee’). The Guarantee, whentaken together with the Company’s obligations under (i) the JuniorSubordinated Debentures; (ii) the indenture pursuant to which the JuniorSubordinated Debentures were issued; and (iii) the Amended and RestatedDeclaration of Trust governing ICTI, constitutes a full and unconditionalguarantee of ICTI’s obligations under the Capital Securities. No othersubsidiary of the Company guarantees these Capital Securities. Certain of theCompany’s subsidiaries may require prior approval of the Commissioner of Banksof the Commonwealth of Massachusetts if the total dividends for a calendar yearwould exceed net profits for the year combined with retained net profits forthe previous two years. These restrictions on the ability to pay dividends tothe Company may restrict the Company’s ability to pay dividends to itsshareholders. ICTI is an unconsolidated wholly-owned trust and therefore, theCompany presents the junior subordinated debentures as a liability and itsinvestment in ICTI as a component of other assets in its consolidated financialstatements.

F-26

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**11. Stockholders’ Equity**

As of December 31, 2006, the Company’s capitalstock consisted of 1,000,000 authorized shares of preferred stock, of which noshares were issued, and 175,000,000 authorized shares of common stock, of which68,523,129 shares were issued. All shares have par value of $0.01 per share.

The Company has four equity incentive plans:  the Amended and Restated 1995 Stock Plan (‘StockPlan’), the Amended and Restated 1995 Non-Employee Director Stock Option Plan (‘DirectorPlan’), the 1997 Employee Stock Purchase Plan (‘ESPP’) and the 2005 EquityIncentive Plan (the ‘2005 Plan’). The 2005 Plan supersedes both the Stock Planand the Director Plan, both of which continue in effect only with regard tooptions outstanding under those plans. Options awarded under the Stock Plan,the Director Plan and the 2005 Plan generally vest over zero to four years ofcontinuous service and generally have ten-year contractual terms. The exerciseprices of these awards are generally equal to the fair market value of theCompany’s common stock on the date the awards are granted. There were noamendments to any plans during the year ended December 31, 2006.

Cash received from options exercised under allshare-based payment arrangements for the year ended December 31, 2006 was$33.1 million. The actual tax benefit realized for the tax deductions relatedto these exercises amounted to $7.0 million for the year ended December 31,2006.

In June 2006, theCompany announced that its Board of Directors authorized a repurchase of up to$150.0 million of the Company’s common stock over the next twelve monthsfollowing the announcement. As of December 31, 2006, the Company hasrepurchased $29.3 million of its common stock. The plan expires in June 2007.

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

Effective with the start of the 2005 Plan, 45,703shares of the Director Plan and 3,439,197 shares of the Stock Plan weretransferred to the 2005 Plan. On April 14, 2005, the shareholdersauthorized an additional 2,000,000 shares of common stock for issuance underthe 2005 Plan.

Of the shares authorized for issuance under the 2005Plan at December 31, 2006, 4,107,719 were available for grant as of thatdate. No options were granted to consultants during the years ended December 31,2006, 2005 and 2004.

The Company has recorded deferred compensation of $0and $0.3 million at December 31, 2006 and 2005, respectively. Amortizationof deferred compensation was $0, $0.3 million and $0.3 million for the yearsended December 31, 2006, 2005 and 2004, respectively.

F-27

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**11.Stockholders’ Equity (Continued)**

A summary of optionactivity under the Director Plan, Stock Plan and 2005 Plan for the year ended December 31,2006 are as follows:

| ** **                             | ** ** | **Number of  Options** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Weighted-  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value  ($000)** | ** ** |
|----------------------------------------|------------|-----------------------------|------------|-----------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------|------------|
| Outstanding at  January 1, 2006   |       | 6,919,316                   |       |                                    | $          | 31                                                   |       |                                    |       |   |   |   |   |   |   |   |
| Granted                                |       | 81,557                      |       |                                    | 46         |                                                 |       |                                    |       |   |   |   |   |   |   |
| Exercised                              |       | (1,257,593                  | )          |                                    | 28         |                                                 |       |                                    |       |   |   |   |   |   |   |
| Forfeited or  expired                  |       | (36,007                     | )          |                                    | 39         |                                                 |       |                                    |       |   |   |   |   |   |   |
| Outstanding at  December 31, 2006 |       | 5,707,273                   |       |                                    | 31         |                                                 |       |                                    | 5.6 years  |   |   |   | $ | 65,115 |   |   |
| Exercisable at  December 31, 2006 |       | 5,524,039                   |       |                                    | $          | 31                                                   |       |                                    |       | 5.5 years |   |   |   | $ | 64,217 |   |   |

 

The weighted-average grant-date fair values per optionof options granted during the years ended December 31, 2006, 2005 and 2004were $19.68, $14.81, and $16.78, respectively. The total intrinsic value ofoptions exercised during the years ended December 31, 2006, 2005 and 2004were $21.8 million, $8.0 million, and $27.3 million, respectively.

As of December 31, 2006, there was $1.4 millionof total unrecognized compensation cost related to nonvested share-basedcompensation arrangements granted under the Stock Plan, the Director Plan andthe 2005 Plan. That cost is expected to be recognized over a weighted-averageperiod of approximately 1 year.

Asummary of the status of the Company’s nonvested shares for the year ended December 31,2006 is presented below:

| **Nonvested Shares**            | ** ** | ** ** | ** ** | **Number of  Shares** | ** ** | **Weighted-Average  Grant-Date  Fair Value** | ** ** |
|--------------------------------------|------------|------------|------------|----------------------------|------------|---------------------------------------------------|------------|
| Nonvested at January 1,  2006   |       |       | 5,000      |                       |       |                                              | $          | 34 |   |   |
| Granted                              |       |       | —     |                       |       |                                              | —     |   |   |
| Vested                               |       |       | (1,000     | )                          |       |                                              | 34         |   |   |
| Forfeited                            |       |       | —     |                       |       |                                              | —     |   |   |
| Nonvested at  December 31, 2006 |       |       | 4,000      |                       |       |                                              | $          | 34 |   |   |

 

The total fair values ofshares vested during the year ended December 31, 2006, 2005 and 2004 were$0.03 million, $0 and $0, respectively.

*ESPP*

Under the terms of the ESPP, the Company may issue upto 1,620,000 shares of common stock pursuant to the exercise of nontransferableoptions granted to participating employees. The ESPP permits eligible employeesto purchase up to 8,000 shares of common stock per payment period, subject tolimitations provided by Section 423(b) of the Internal Revenue Code,through accumulated payroll 

F-28

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**11.Stockholders’ Equity (Continued)**

deductions. The purchasesare made twice a year at a price equal to the lesser of (i) 90% of themarket value of the Company’s common stock on the first business day of thepayment period or (ii) 90% of the market value of the Company’s commonstock on the last business day of the payment period. The payment periodsconsist of two six-month periods, January 1 through June 30 and July 1through December 31. The NASDAQ Stock Market became a registered nationalsecurities exchange with the SEC in August 2006. In accordance with theterms of the plan, because the Company is now traded on a national securitiesexchange, the Company will calculate the market value on a measurement day tobe the average of the high and low prices of the Company’s common stock on thatday. This calculation method applies to all purchases made during and after thesix-month period ended December 31, 2006.

Asummary of the ESPP shares is as follows:

| ** **                                                | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                | ** ** | **2006**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Total shares  available under the plan, beginning of year |       | 521,563               |       | 636,267 |   | 227,504 |   |
| Approved increase  in shares available                    |       | —                |       | — |   | 500,000 |   |
| Issued at  June 30                                   |       | (68,506               | )          | (54,862 | ) | (47,681 | ) |
| Issued at  December 31                               |       | (65,802               | )          | (59,842 | ) | (43,556 | ) |
| Total shares available  under the plan, end of year       |       | 387,255               |       | 521,563 |   | 636,267 |   |

 

At the Annual Meeting of Stockholders of the Companyheld on April 13, 2004, stockholders approved an amendment to the Company’sESPP to increase the number of shares of common stock that may be issuedthereunder from 1,120,000 to 1,620,000.

For the first payment period in the year ended December 31,2006, the purchase price of the stock was $33.52, or 90% of the market value ofthe Company’s common stock on the first business day of the payment periodending June 30, 2006. For the second payment period in the year ended December 31,2006, the purchase price of the stock was $38.45, or 90% of the market value ofthe average of the high and low price of the Company’s common stock on the lastbusiness day of the payment period ending December 31, 2006.

During the year ended December 31, 2005, thepurchase prices of the stock were $34.25 and $33.25, or 90% of the market valueof the common stock on the last business day of the payment periods ending June 30,2005 and December 31, 2005, respectively.

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

Prior to the adoption ofSFAS 123R, the ESPP was considered a non-compensatory plan and, therefore, nocompensation cost was recognized. However, pursuant to SFAS 123R, the ESPP isconsidered a compensatory plan, effective January 1, 2006. Accordingly,compensation cost is computed as the sum of: (a) 10% of the fair marketvalue of the Company’s common stock on the first day of the purchase period and(b) the fair value of the option features, calculated using theBlack-Scholes valuation model. Compensation cost is recognized ratably over thepayment period based on the components of fair 

F-29

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**11.Stockholders’ Equity (Continued)**

value inthe preceding sentence and the number of shares that could be purchased atgrant date based on the estimated total withholdings and the discounted marketprice of the stock on grant date. The weighted-average grant-date fair value ofawards granted under the ESPP was $7.86 per share for the payment period from January 1,2006 through June 30, 2006 and $9.86 per share for the payment period fromJuly 1, 2006 through December 31, 2006. Compensation cost related tothe ESPP was $1.2 million for the year ended December 31, 2006.

F-30

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**12. Comprehensive Income**

Comprehensiveincome represents the change in equity of the Company during a period fromtransactions and other events and circumstances from non-shareholder sources. Itincludes all changes in equity during a period except those resulting frominvestments by shareholders and distributions to shareholders. The Company’sother comprehensive income and related tax effects for the years ended December 31,2006, 2005 and 2004 are as follows (Dollars in thousands):

| ** **                                                          | ** ** | **Pre-tax  Amount** | ** ** | **Tax (Expense)  Benefit** | ** ** | **After-tax  Amount** | ** ** |
|---------------------------------------------------------------------|------------|---------------------|------------|---------------------------------|------------|-----------------------|------------|
| *2006*                                                              |       |                |       |                            |       |                  |       |   |   |
| Unrealized gains  on securities:                                    |       |                |       |                            |       |                  |       |   |   |
| Unrealized  holding gains arising during the period                 |       | $                   | 16,675     |                            |       | $                     | (4,629     | ) |   | $ | 12,046 |   |
| Less:  reclassification adjustment for gains included in net income |       | 2,523               |       |                            | (1,073     | )                     |       | 1,450 |   |
| Net unrealized holding gains arising during the  period             |       | 14,152              |       |                            | (3,556     | )                     |       | 10,596 |   |
| Other                                                               |       | 156                 |       |                            | (57        | )                     |       | 99 |   |
| Net unrealized gains                                                |       | 14,308              |       |                            | (3,613     | )                     |       | 10,695 |   |
| Net unrealized  derivative instrument loss                          |       | (9,020              | )          |                            | 3,836      |                  |       | (5,184 | ) |
| Amortization of  terminated interest rate swap agreements           |       | (2,360              | )          |                            | 1,019      |                  |       | (1,341 | ) |
| Currency  translation adjustment                                    |       | 1,444               |       |                            | —     |                  |       | 1,444 |   |
| Other comprehensive income                                          |       | $                   | 4,372      |                            |       | $                     | 1,242      |   |   | $ | 5,614 |   |
| *2005*                                                              |       |                |       |                            |       |                  |       |   |   |
| Unrealized losses  on securities:                                   |       |                |       |                            |       |                  |       |   |   |
| Unrealized  holding losses arising during the period                |       | $                   | (60,552    | )                               |       | $                     | 21,481     |   |   | $ | (39,071 | ) |
| Less:  reclassification adjustment for gains included in net income |       | 12,397              |       |                            | (5,185     | )                     |       | 7,212 |   |
| Net unrealized holding losses arising during the  period            |       | (72,949             | )          |                            | 26,666     |                  |       | (46,283 | ) |
| Other                                                               |       | 394                 |       |                            | (165       | )                     |       | 229 |   |
| Net unrealized losses                                               |       | (72,555             | )          |                            | 26,501     |                  |       | (46,054 | ) |
| Net unrealized  derivative instrument gain                          |       | 18,002              |       |                            | (7,529     | )                     |       | 10,473 |   |
| Amortization of  terminated interest rate swap agreements           |       | (2,970              | )          |                            | 1,242      |                  |       | (1,728 | ) |
| Currency  translation adjustment                                    |       | 52                  |       |                            | —     |                  |       | 52 |   |
| Other comprehensive income                                          |       | $                   | (57,471    | )                               |       | $                     | 20,214     |   |   | $ | (37,257 | ) |
| *2004*                                                              |       |                |       |                            |       |                  |       |   |   |
| Unrealized losses  on securities:                                   |       |                |       |                            |       |                  |       |   |   |
| Unrealized  holding losses arising during the period                |       | $                   | (9,168     | )                               |       | $                     | 3,202      |   |   | $ | (5,966 | ) |
| Less:  reclassification adjustment for gains included in net income |       | 234                 |       |                            | (82        | )                     |       | 152 |   |
| Net unrealized holding losses arising during the  period            |       | (9,402              | )          |                            | 3,284      |                  |       | (6,118 | ) |
| Other                                                               |       | (2,671              | )          |                            | 935        |                  |       | (1,736 | ) |
| Net unrealized losses                                               |       | (12,073             | )          |                            | 4,219      |                  |       | (7,854 | ) |
| Net unrealized  derivative instrument gain                          |       | 19,984              |       |                            | (6,994     | )                     |       | 12,990 |   |
| Amortization of  terminated interest rate swap agreements           |       | 63                  |       |                            | (22        | )                     |       | 41 |   |
| Currency  translation adjustment                                    |       | 846                 |       |                            | —     |                  |       | 846 |   |
| Other  comprehensive income                                         |       | $                   | 8,820      |                            |       | $                     | (2,797     | ) |   | $ | 6,023 |   |

 

F-31

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**13. Employee Benefit Plans**

***Pension Plan******—***The Company has a trusteed,noncontributory, qualified defined benefit pension plan (‘Pension Plan’)covering substantially all of its employees who were hired before January 1,1997. The benefits are based on years of service and the employee’scompensation during employment. Generally, the Company’s funding policy is tocontribute annually the maximum amount that can be deducted for federal incometax purposes. Contributions are intended to provide not only for benefitsattributed to service to date but also for benefits expected to be earned inthe future. The plan document was amended in December 2001 and December 2004to freeze benefit accruals for certain highly compensated participants. EffectiveDecember 31, 2005, all Pension Plan participants’ accounts were frozen andeffective January 1, 2006, no further Pension Plan benefit will accrue onbehalf of any Pension Plan participant.

***SupplementalRetirement Plan******—***TheCompany also has a nonqualified, unfunded, supplemental retirement plan (‘SERP’)which was established in 1994 and covers certain employees and pays benefitsthat supplement any benefits paid under the Pension Plan. Benefits under theSERP are generally based on compensation not includable in the calculation ofbenefits to be paid under the Pension Plan. The plan document was amended in April 2000to eliminate the compensation cap and include bonuses and commissions ofcertain employees.

Effective December 31, 2006, the Company adoptedthe provisions of FASB Statement No. 158, *Employers’Accounting for Defined Benefit Pension and Other Postretirement Plans*(‘SFAS158’). SFAS 158 changes current practice by requiring employers torecognize the overfunded or underfunded positions of defined benefit postretirementplans, including pension plans, on the balance sheet. The funded status isdefined as the difference between the projected benefit obligation and the fairvalue of plan assets. SFAS 158 also requires employers to recognize the changein funded status in other comprehensive income (a component of shareholders’equity). Upon adopting SFAS 158, the Company recognized the funded status ofits SERP and pension plans on its consolidated balance sheet. As a result, theCompany recognized an adjustment of $6.8 million to the ending balance ofaccumulated other comprehensive income, net of tax, which represented the netlosses, transition (assets) obligations, and prior service costs that had notbeen included in net periodic benefit cost as of December 31, 2006.

F-32

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**13.Employee Benefit Plans (Continued)**

The incremental effect ofapplying SFAS 158 on individual line items of the Company’s consolidatedbalance sheet consisted of the following:

| ** **                             | ** ** | **Before  Application  of SFAS 158** | ** ** | **Adjustments** | ** ** | **After  Application  of SFAS 158** | ** ** |
|----------------------------------------|------------|------------------------------------------------|------------|-----------------|------------|-----------------------------------------------|------------|
| **Pension Plan**                       | ** ** | ** **                                     | ** ** |            | ** ** | ** **                                    |       | ** ** | ** ** |
| Asset for pension benefits             |       | $                                              | 3,095      |            |       | $                                             | (2,079     | ) |   | $ | 1,016 |   |
| Deferred income tax asset              |       | —                                         |       |            | 884        |                                          |       | 884 |   |
| Accumulated other comprehensive income |       | —                                         |       |            | 1,195      |                                          |       | 1,195 |   |
| **SERP**                               | ** ** | ** **                                     | ** ** |            | ** ** | ** **                                    |       | ** ** | ** ** |
| SERP liability                         |       | $                                              | (19,908    | )               |       | $                                             | (9,408     | ) |   | $ | (29,316 | ) |
| Deferred income tax asset              |       | 648                                            |       |            | 4,916      |                                          |       | 5,564 |   |
| Intangible assets                      |       | 2,150                                          |       |            | (2,150     | )                                             |       | — |   |
| Accumulated other comprehensive income |       | 876                                            |       |            | 6,642      |                                          |       | 7,518 |   |
| **Pension  Plan & SERP**      | ** ** | ** **                                     | ** ** |            | ** ** | ** **                                    |       | ** ** | ** ** |
| Total assets                           |       | $                                              | 11,556,635 |            |       | $                                             | 1,571      |   |   | $ | 11,558,206 |   |
| Total liabilities                      |       | 10,610,060                                     |       |            | 9,408      |                                          |       | 10,619,468 |   |
| Total  stockholders’ equity       |       | 946,575                                        |       |            | (7,837     | )                                             |       | 938,738 |   |

 

F-33

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**13.Employee Benefit Plans (Continued)**

The following table setsforth the status of the Company’s Pension Plan and SERP (Dollars in thousands):

| ** **                                          | ** ** | **December 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|-----------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                                          | ** ** | **Pension Plan**           | ** ** | **SERP**                        | ** ** | **Pension Plan** | ** ** | **SERP** | ** ** |
| Change in benefit  obligation:                      |       |                            |       |                            |       |   |   |   |   |   |   |   |   |
| Benefit obligation at beginning of year             |       |                            | $          | 16,817                          |       |   | $ | 27,576 |   |   | $ | 22,141 |   |   | $ | 23,543 |   |
| Service cost                                        |       |                            | —     |                            |       | 1,846 |   |   | 744 |   |   | 1,788 |   |
| Interest cost                                       |       |                            | 1,015      |                            |       | 1,571 |   |   | 1,143 |   |   | 1,475 |   |
| Actuarial loss                                      |       |                            | 146        |                            |       | (1,170 | ) |   | 249 |   |   | 1,057 |   |
| Benefits paid                                       |       |                            | (1,052     | )                               |       | (507 | ) |   | (1,100 | ) |   | (287 | ) |
| Curtailments                                        |       |                            | —     |                            |       | — |   |   | (6,360 | ) |   | — |   |
| Projected benefit obligation at the end of the year |       |                            | 16,926     |                            |       | 29,316 |   |   | 16,817 |   |   | 27,576 |   |
| Change in plan  assets:                             |       |                            |       |                            |       |   |   |   |   |   |   |   |   |
| Assets at the beginning of the year                 |       |                            | 16,888     |                            |       | — |   |   | 17,185 |   |   | — |   |
| Employer contributions                              |       |                            | —     |                            |       | 507 |   |   | — |   |   | 287 |   |
| Actual return                                       |       |                            | 2,106      |                            |       | — |   |   | 803 |   |   | — |   |
| Benefits paid                                       |       |                            | (1,052     | )                               |       | (507 | ) |   | (1,100 | ) |   | (287 | ) |
| Assets at the end of the year                       |       |                            | 17,942     |                            |       | — |   |   | 16,888 |   |   | — |   |
| Funded status at the end of year                    |       |                            | $          | 1,016                           |       |   | $ | (29,316 | ) |   | 71 |   |   | (27,576 | ) |
| Unrecognized net transition (asset) obligation      |       |                            | NM         |                            |       | NM |   |   | (28 | ) |   | 10 |   |
| Unrecognized prior service cost                     |       |                            | NM         |                            |       | NM |   |   | — |   |   | 2,294 |   |
| Unrecognized net loss                               |       |                            | NM         |                            |       | NM |   |   | 2,817 |   |   | 12,902 |   |
| Net amount  recognized                              |       |                            | NM         |                            |       | NM |   |   | $ | 2,860 |   |   | $ | (12,370 | ) |

----

NM—information isnot meaningful. Due to the adoption of SFAS 158, these amounts are now recordedas a component of accumulated other comprehensive income.

Amountsrecognized in the consolidated balance sheet prior to the adoption of SFAS 158consisted of the following (Dollars in thousands):

| ** **                              | ** ** | **December 31, 2005** | ** ** |
|-----------------------------------------|------------|---------------------------------|------------|
| ** **                              | ** ** | **Pension Plan**           | ** ** | **SERP** | ** ** |
| Prepaid benefit  cost                   |       |                            | $          | 2,860 |   |   | $ | — |   |
| Accrued benefit  cost                   |       |                            | —     |   |   | (18,074 | ) |
| Intangible assets                       |       |                            | —     |   |   | 2,304 |   |
| Accumulated other  comprehensive income |       |                            | —     |   |   | 3,400 |   |
| Net amount recognized                   |       |                            | $          | 2,860 |   |   | $ | (12,370 | ) |

 

F-34

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**13.Employee Benefit Plans (Continued)**

Amounts recognized in theconsolidated balance sheet upon adoption of SFAS 158 on December 31, 2006consisted of the following (Dollars in thousands):

| ** **           | ** ** | **December 31, 2006** | ** ** |
|----------------------|------------|---------------------------------|------------|
| ** **           | ** ** | **Pension Plan**           | ** ** | **SERP** | ** ** |
| Pension assets       |       |                            | $          | 1,016 |   |   | $ | — |   |
| Pension  liabilities |       |                            | —     |   |   | 29,316 |   |
|                 |       |                            | $          | 1,016 |   |   | $ | 29,316 |   |

 

Amountsrecognized in accumulated other comprehensive income upon adoption of SFAS 158consist of (Dollars in thousands):

| ** **                 | ** ** | **December 31, 2006** | ** ** |
|----------------------------|------------|---------------------------------|------------|
| ** **                 | ** ** | **Pension Plan**           | ** ** | **SERP** | ** ** |
| Net loss                   |       |                            | $          | 1,195 |   |   | $ | 6,280 |   |
| Prior service  cost        |       |                            | —     |   |   | 1,235 |   |
| Net transition  obligation |       |                            | —     |   |   | 3 |   |
|                       |       |                            | $          | 1,195 |   |   | $ | 7,518 |   |

 

The accumulated benefit obligation for the PensionPlan was $16.9 million and $16.8 million at December 31, 2006 and 2005,respectively. The accumulated benefit obligation for the SERP was $19.9 millionand $18.1 million at December 31, 2006 and 2005, respectively.

Net periodic pension costfor the Company’s Pension Plan and SERP included the following components(Dollars in thousands):

| ** **                                               | ** ** | **December 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|----------------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                                               | ** ** | **Pension Plan**           | ** ** | **SERP**                        | ** ** | **Pension Plan** | ** ** | **SERP** | ** ** |
| **Net Periodic Benefit Cost**                            | ** ** |                            | ** ** | ** **                      |       | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |
| Service  cost—benefits earned / benefit obligations |       |                            | $          | —                          |       |   | $ | 1,846 |   |   | $ | 744 |   |   | $ | 1,788 |   |
| Interest cost on  projected benefit obligations          |       |                            | 1,015      |                            |       | 1,571 |   |   | 1,143 |   |   | 1,475 |   |
| Expected return  on plan assets                          |       |                            | (1,413     | )                               |       | — |   |   | (1,435 | ) |   | — |   |
| Curtailment gain                                         |       |                            | —     |                            |       | — |   |   | (275 | ) |   | — |   |
| Amortization of  net transition (asset) obligation       |       |                            | (28        | )                               |       | 5 |   |   | (38 | ) |   | 5 |   |
| Amortization of  prior service cost                      |       |                            | —     |                            |       | 145 |   |   | (22 | ) |   | 145 |   |
| Amortization of  net loss                                |       |                            | 191        |                            |       | 805 |   |   | 373 |   |   | 942 |   |
| Net periodic pension  (benefit) cost                     |       |                            | $          | (235                            | )          |   | $ | 4,372 |   |   | $ | 490 |   |   | $ | 4,355 |   |

 

The estimated net loss, prior service cost, andtransition obligation for the defined benefit pension plans that will beamortized from accumulated other comprehensive income into net periodic benefitcost over the next fiscal year are $665, $145 and $5, respectively.

F-35

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**13.Employee Benefit Plans (Continued)**

The weighted-averagediscount rate and the rate of increase in future compensation levels used indetermining the actuarial present value of the projected benefit obligationswere as follows:

| ** **                      | ** ** | **December 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|---------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                      | ** ** | **Pension Plan**           | ** ** | **SERP**                        | ** ** | **Pension Plan** | ** ** | **SERP** | ** ** |
| Discount rate                   |       |                            | 6.00       | %                               |       | 6.00 | % |   | 5.75 | % |   | 5.75 | % |
| Rate of compensation  increases |       |                            | N/A        |                            |       | 4.00-10.00 |   |   | 4.00 |   |   | 4.00-10.00 |   |

 

Theweighted-average discount rate, rate of increase in future compensation levels,and expected rate of return on plan assets used in determining the net periodicpension cost were as follows:

| ** **                              | ** ** | **December 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|-----------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                              | ** ** | **Pension Plan**           | ** ** | **SERP**                        | ** ** | **Pension Plan** | ** ** | **SERP** | ** ** |
| Discount rate                           |       |                            | 5.75       | %                               |       |   | 5.75 | % |   |   | 5.80 | % |   |   | 5.80 | % |   |
| Rate of  compensation increases         |       |                            | 4.00       |                            |       |   | 4.00 |   |   |   | 4.00 |   |   |   | 4.00 |   |   |
| Expected rate of return  on plan assets |       |                            | 8.50       |                            |       |   | — |   |   |   | 8.50 |   |   |   | — |   |   |

 

The Company has utilized an expected rate of return onplan assets of 8.50%, which is consistent with the weighted-average of thehistorical return indices for specific portfolio assets.

TheCompany’s Pension Plan allocation by asset category is as follows:

| **Asset Category**          | ** ** | ** ** | ** ** | **December 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|----------------------------------|------------|------------|------------|---------------------------------|------------|---------------------------------|------------|
| Cash and  short-term investments |       |       | 1.4        | %                               |       |                            | 1.3        | % |   |
| Equity securities                |       |       | 70.5       |                            |       |                            | 68.4       |   |   |
| Debt securities                  |       |       | 28.1       |                            |       |                            | 30.3       |   |   |
| Total                            |       |       | 100.0      | %                               |       |                            | 100.0      | % |   |

 

The Company’s core investment objectives for thePension Plan are long-term capital appreciation and growth of income, whileprotecting the principal value of trust assets from long-term permanent lossand, within reason, from large short-term fluctuations. The approved investmentpolicies of the trust anticipate fixed income investments to compose 25-55%and equity securities to compose 45-75% of the total portfolio. Cashequivalents may be used to provide liquidity, income and stability to theportfolio.

Cash and short-term investments represent money marketfunds at December 31, 2006 and 2005. Equity securities supply currentincome and growth through market appreciation. The Company invests in qualitycompanies with securities that are readily marketable. Debt securities offer asource of current income and reduce the variability of the portfolio’s totalmarket value. Fixed income investments were limited to issues by the U.S.government and its agencies, and investment grade corporate bonds at December 31,2006 and 2005. The Pension Plan was in full compliance with the approved pensionobjectives and policies for the years ended December 31, 2006 and 2005. AtDecember 31, 2006 and 2005, the pension did not hold any securities of theCompany.

The Company does not expect to contribute to itsPension Plan during 2007, and no contributions were made during 2006.

F-36

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**13.Employee Benefit Plans (Continued)**

At December 31, 2006and 2005, the SERP remained an unfunded plan. The Company does not anticipatemaking any contributions to the SERP during 2007.

Thefollowing table shows the expected future benefit payments for the next tenyears (Dollars in thousands):

| ** **  | ** ** | **Pension Plan** | ** ** | **SERP** | ** ** |
|-------------|------------|-----------------------|------------|----------|------------|
| 2007        |       |                  | $          | 270      |       |   | $ | 177 |   |
| 2008        |       |                  | 292        |     |       | 180 |   |
| 2009        |       |                  | 339        |     |       | 185 |   |
| 2010        |       |                  | 363        |     |       | 191 |   |
| 2011        |       |                  | 384        |     |       | 199 |   |
| 2012 - 2016 |       |                  | 2,748      |     |       | 3,214 |   |
|             |            |                       |            |          |            |  |  |  |  |

 

***Employee Savings Plan******—***The Company sponsors a qualifieddefined contribution employee savings plan covering substantially all employees.The Company matches employee contributions to the plan up to specified amounts.The total cost of this plan to the Company was $4.5 million, $3.7 million and$3.2 million for the years ended December 31, 2006, 2005 and 2004,respectively.

**14. OffBalance Sheet Financial Instruments**

***Lines of Credit******—***At December 31,2006, the Company had commitments to mutual funds, individuals and others undercollateralized open lines of credit totaling $1.2 billion, against which$184.6 million in loans were drawn. The credit risk involved in issuinglines of credit is essentially the same as that involved in extending demandloans. The Company does not anticipate any loss as a result of these lines ofcredit.

***Securities Lending******—***On behalf of itsclients, the Company lends securities to creditworthy broker-dealers. Incertain circumstances, the Company may indemnify its clients for the fairmarket value of those securities against a failure of the borrower to returnsuch securities. The Company requires the borrowers to provide collateral in anamount equal to, or in excess of, 102% of the fair market value of U.S.dollar-denominated securities borrowed and 105% of the fair market value ofnon-U.S. dollar-denominated securities borrowed. The borrowed securities arerevalued daily to determine whether additional collateral is necessary. Asguarantor, the Company is required to recognize, at the inception of aguarantee, a liability for the fair value of the obligation undertaken inissuing the guarantee. The Company measures the fair value of its indemnificationobligation by marking its securities lending portfolio to market on a dailybasis and comparing the value of the portfolio to the collateral holdingsposition. The fair value of the indemnification obligation to be recorded wouldbe the deficiency of collateral as compared to the value of the securities outon loan.

With respect to theindemnified securities lending portfolio, the cash and U.S. governmentsecurities held by the Company as collateral at December 31, 2006 totaled$11.1 billion, while the fair value of the securities lending portfolio totaledapproximately $10.7 billion. Given that the collateral held was in excessof the value of the securities that the Company would be required to replace ifthe borrower defaulted and failed to return such securities, the Company’sindemnification obligation was zero and no liability was recorded.

F-37

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**14. OffBalance Sheet Financial Instruments (Continued)**

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

**15. DerivativeFinancial Instruments**

***Interest Rate Contracts******—***Interest ratecontracts involve an agreement with a counterparty to exchange cash flows basedon an underlying interest rate index. A swap agreement involves the exchange ofa series of interest payments, either at a fixed or variable-rate, based uponthe notional amount without the exchange of the underlying principal amount. TheCompany’s exposure from these interest rate contracts results from thepossibility that one party may default on its contractual obligation when thecontracts are in a gain position. The Company has experienced no terminationsby counterparties of interest rate swaps. Credit risk is limited to thepositive fair value of the derivative financial instrument, which issignificantly less than the notional value. The positive fair values related tothe Company’s interest rate contracts were approximately $13.8 million and$24.3 million at December 31, 2006 and 2005, respectively, which areincluded in other assets on the Company’s consolidated balance sheets.

The Company enters into pay-fixed/receive-floatinginterest rate swap agreements. These instruments have been designated as cashflow hedges of variable-rate liabilities and a forecasted series of fixed-rateovernight liabilities incurred at different daily fixed rates (thereby resultingin a variable interest expense pattern). The contractual or notional amounts ofthe interest rate swap agreements held by the Company were approximately $1.6billion and $1.9 billion at December 31, 2006 and 2005, respectively. Thesecontracts had net fair values of approximately $13.8 million and $24.2 millionat December 31, 2006 and 2005, respectively. These fair values areincluded in the respective other assets and other liabilities categories on theCompany’s consolidated balance sheets. See also Note 17 for additionalinformation on the fair value of the interest rate contracts.

For the year ended December 31,2006, the Company recognized a net pre-tax loss of $1.5 million, whichrepresented the total ineffectiveness for all cash flow hedges. For the yearsended December 31, 2005 and 2004, the Company recognized net pre-tax gainsof $3.5 million and $4.1 million, respectively, which represented the totalineffectiveness for all cash flow hedges.

F-38

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**15. Derivative FinancialInstruments (Continued)**

As of December 31,2006, the Company expects that approximately $5.9 million of deferred netafter-tax gains on derivative contracts included in other comprehensive incomewill be reclassified to net interest income within the next twelve months. Thisexpectation is based on the net discounted cash flows from existing cash flowhedging derivatives, as well as the amortization of gains from the terminatedcash flow hedging derivatives.

***Foreign******Exchange Contracts***—Foreign exchangecontracts involve an agreement to exchange the currency of one country for thecurrency of another country at an agreed-upon rate and settlement date. Foreignexchange contracts consist of spot, forward and swap contracts. Spot contractscall for the exchange of one currency for another and usually settle in twobusiness days. Forward contracts call for the exchange of one currency foranother at a date beyond spot. In a currency swap, the holder of a currencytransacts simultaneously both a spot and a forward transaction in that currencyfor an equivalent amount of another currency to get temporary liquidity in thecurrency owned. The Company’s risk from foreign exchange contracts results fromthe possibility that one party may default on its contractual obligation orfrom movements in exchange rates. Credit risk is limited to the positive marketvalue of the derivative financial instrument, which is significantly less thanthe notional value. The notional value of the Company’s foreign exchangecontracts at December 31, 2006 and 2005 was $13.5 billion and $6.3billion, respectively. The Euro foreign exchange contracts representedapproximately 71% and 57% of the notional value outstanding as of December 31,2006 and 2005, respectively. Unrealized gains or losses resulting frompurchases and sales of foreign exchange contracts are included within therespective other assets and other liabilities categories on the Company’sconsolidated balance sheets. Unrealized gains in other assets were $27.5million and $20.8 million at December 31, 2006 and 2005, respectively. Unrealizedlosses in other liabilities were $27.0 million and $19.7 million at December 31,2006 and 2005, respectively. See also Note 17 for additional information on thefair value of the Company’s foreign exchange contracts. Foreign exchangecontracts with the same counterparty are netted in the Company’s consolidatedbalance sheets when a master netting agreement exists. These contracts have notbeen designated as hedging instruments; therefore, all changes in fair valueare included in asset servicing fees.

***Other***—TheCompany also enters into fixed price purchase contracts that are designed tohedge the variability of the consideration to be paid for the purchase ofinvestment securities. By entering into these contracts, the Company is fixingthe price to be paid at a future date for certain investment securities. At December 31,2006 the Company had no fixed price purchase contracts outstanding to purchaseinvestment securities. At December 31, 2005, the Company had $97.5 millionof fixed price purchase contracts outstanding to purchase investment securities.Changes in fair value of these cash flow hedges are included as a component ofother comprehensive income.

**16. Commitments andContingencies**

***Restrictions on Cash Balances***—TheCompany is required to maintain certain average cash reserve balances. Theaverage required reserve balance with the FRB for the two-week period includingDecember 31, 2006 was approximately $35.8 million. In addition, theCompany’s consolidated balance sheet includes deposits totaling $44.4 million,which were pledged to secure clearings with depository institutions as of December 31,2006.

F-39

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**16.Commitments and Contingencies (Continued)**

***Lease Commitments****—*Minimum future commitments on noncancelable operatingleases at December 31, 2006 were as follows (Dollars in thousands):

| **Fiscal Year Ending** | ** ** | ** ** | ** ** | **Bank Premises** | ** ** | **Equipment** | ** ** | **Total** | ** ** |
|----------------------------------|------------|------------|------------|------------------------|------------|---------------|------------|-----------|------------|
| 2007                             |       |       | $          | 32,722                 |       |          |       | $         | 2,467      |   |   | $ | 35,189 |   |
| 2008                             |       |       | 32,813     |                   |       |          | 1,351      |      |       | 34,164 |   |
| 2009                             |       |       | 35,793     |                   |       |          | 371        |      |       | 36,164 |   |
| 2010                             |       |       | 35,581     |                   |       |          | 49         |      |       | 35,630 |   |
| 2011                             |       |       | 36,366     |                   |       |          | 24         |      |       | 36,390 |   |
| 2012 and beyond                  |       |       | 121,879    |                   |       |          | —     |      |       | 121,879 |   |
| Total                            |       |       | $          | 295,154                |       |          |       | $         | 4,262      |   |   | $ | 299,416 |   |

 

Total rent expense was approximately $36.8 million,$29.2 million and $33.4 million for the years ended December 31, 2006,2005 and 2004, respectively.

In 2005, the Company renewed its service agreementwith Electronic Data Systems (‘EDS’), which now expires December 31, 2008.Under the terms of the agreement, EDS provides data processing services to theCompany, which has agreed to pay certain monthly service fees based on usage. Serviceexpense under this contract was $4.7 million, $7.3 million and $8.3 million forthe years ended December 31, 2006, 2005 and 2004, respectively.

In 2004, the Companyrenewed its agreement with SEI Investments Company (‘SEI’), which now expireson December 31, 2009. Under the terms of this agreement, SEI provides dataprocessing services to the Company, which has agreed to pay certain monthly servicefees based upon usage. Service expense under this contract was $6.4 million,$5.3 million and $5.0 million for the years ended December 31, 2006, 2005and 2004, respectively.

In 2004, the Company signed a service agreement withInternational Business Machines Corporation (‘IBM’). Under the terms of thisagreement, IBM provides support for our network and hardware environments andthe Company’s help desk services. The Company has agreed to pay certain monthlyservices fees based upon usage. This agreement expires June 30, 2011. Serviceexpense under this contract was $26.4 million, $13.7 million and $9.5 millionfor the years ended December 31, 2006, 2005 and 2004, respectively.

***Contingencies***—Assetsheld by the Company in a fiduciary capacity are not included in theconsolidated balance sheets since these items are not assets of the Company. Managementconducts regular reviews of its fiduciary responsibilities and considers theresults in preparing its consolidated financial statements. In the opinion of management,there were no contingent liabilities related to its fiduciary capacity at December 31,2006 that were material to the consolidated financial position or consolidatedresults of operations of the Company.

The Company and certain of its officers were named asdefendants in three purported class action complaints that were filed on orabout August 4, 2005, August 15, 2005, and September 30, 2005 inthe United States District Court for the District of Massachusetts, Boston,Massachusetts. The U.S. District 

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**16.Commitments and Contingencies (Continued)**

Court has consolidatedthose cases and appointed lead plaintiffs, who filed a consolidated complaintagainst the Company and seven of its current and former officers on February 3,2006. Among other things, the consolidated complaint asserts that thedefendants violated Sections 10(b) and 20(a) of the SecuritiesExchange Act of 1934 during the period April 10, 2001 until July 15,2005. The allegations in the consolidated complaint predominantly relate to: (1) theCompany’s October 2004 restatement of its financial results, and (2) theCompany’s July 2005 revision of public guidance regarding its futurefinancial performance. The consolidated complaint seeks unspecified damages,interest, fees, and costs. On May 14, 2006, the Company filed a motion todismiss all claims asserted in the consolidated complaint. That motion iscurrently pending before the Court. The Company strongly believes that thelawsuit lacks merit and the Company intends to defend against the claimsvigorously. However, the Company cannot predict the outcome of the lawsuit atthis time, and the Company can give no assurance that it will not materiallyadversely affect the Company’s financial condition or results of operations.

The Company and nine of its officers and directors arenamed as defendants in two shareholder derivative complaints that were filed onor about September 22, 2005 and October 17, 2005 in the United StatesDistrict Court for the District of Massachusetts, Boston, Massachusetts. Amongother things, the complaints assert that the defendants are liable for breachof fiduciary duty, unjust enrichment, abuse of control, mismanagement,misappropriation of information, insider trading, and violation of Section 14(a) ofthe Securities Exchange Act of 1934. The complaint filed on September 22,2005 also seeks reimbursement under the Sarbanes-Oxley Act of 2002. Theallegations in the complaints predominantly relate to: (1) The Company’s October 2004restatement of its financial results, and (2) the Company’s July 2005revision of public guidance regarding its future financial performance. Thecomplaints seek unspecified damages, attorneys’ fees, accountant and expertfees, and costs. The Company is also named as a nominal defendant in thesecomplaints, although the actions are derivative in nature and purportedlyasserted on behalf of the Company. The Company is in the process of evaluatingthese claims. However, the Company cannot predict the outcome of the lawsuitsat this time, and the Company can give no assurance that they will notmaterially adversely affect our financial condition or results of operations.

In July 2000, two ofthe Company’s Dublin subsidiaries, Investors Trust & CustodialServices (Ireland) Ltd. (‘ITC’) and Investors Fund Services(Ireland) Ltd. (‘IFS’), received a plenary summons in the High Court,Dublin, Ireland. The summons named ITC and IFS as defendants in an actionbrought by the FTF ForexConcept Fund Plc (the ‘Fund’), a former client. Thesummons also named as defendants FTF Forex Trading and Finance, S.A., the Fund’sinvestment manager, Ernst & Young, LLP, the Fund’s auditors, andDresdner Bank-Kleinwort Benson (Suisse) S.A., a trading counterparty to theFund. The Fund is an investment vehicle organized in Dublin to invest inforeign exchange contracts. A total of approximately $4.7 million had beeninvested in the Fund. Most of that money was lost prior to the Fund’s closingto subscriptions in June 1999. In January 2001, ITC, IFS and theother defendants named in the plenary summons received a statement of claim bythe Fund seeking unspecified damages allegedly arising from breach of contract,misrepresentation and breach of warranty, negligence and breach of duty ofcare, and breach of fiduciary duty, among others. The Company has notified itsinsurers and intends to defend this claim vigorously. Based on itsinvestigation through December 31, 2006, the Company does not expect thismatter to have a material adverse effect on its business, financial conditionor results of operations.

F-41

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**17. Fair Value ofFinancial Instruments**

Thecarrying amount and estimated fair value of financial instruments are asfollows (Dollars in thousands):

| ** **                                  | ** ** | **December 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|---------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                                  | ** ** | **Carrying**                    | ** ** | **Fair**                        | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| ** **                                  | ** ** | **Amount**                      | ** ** | **Value**                       | ** ** | **Amount** | ** ** | **Value** | ** ** |
| **Financial Assets:**                       |       |                            |       |                            |       |   |   |   |   |
| Cash and due from banks                     |       | $                               | 92,766     |                            | $          | 92,766 |   | $ | 60,743 |   | $ | 60,743 |   |
| Interest-bearing deposits with other banks  |       | 21,218                          |       | 21,218                          |       | 18,894 |   | 18,894 |   |
| Other short-term investments                |       | 1,971                           |       | 1,971                           |       | — |   | — |   |
| Securities held to maturity                 |       | 5,532,330                       |       | 5,508,788                       |       | 6,761,930 |   | 6,725,729 |   |
| Securities available for sale               |       | 4,799,740                       |       | 4,799,740                       |       | 4,369,720 |   | 4,369,720 |   |
| Loans, net of allowance                     |       | 270,693                         |       | 270,693                         |       | 402,370 |   | 402,370 |   |
| Interest rate contracts                     |       | 13,845                          |       | 13,845                          |       | 24,251 |   | 24,251 |   |
| Foreign exchange contracts                  |       | 27,459                          |       | 27,459                          |       | 20,805 |   | 20,805 |   |
| **Financial  Liabilities:**                 |       |                            |       |                            |       |   |   |   |   |
| Deposits                                    |       | $                               | 6,144,942  |                            | $          | 6,144,942 |   | $ | 4,992,590 |   | $ | 4,992,590 |   |
| Securities sold under repurchase agreements |       | 3,727,800                       |       | 3,726,154                       |       | 4,797,868 |   | 4,736,958 |   |
| Short-term and other borrowings             |       | 517,051                         |       | 517,051                         |       | 1,356,649 |   | 1,356,649 |   |
| Interest rate contracts                     |       | 86                              |       | 86                              |       | 101 |   | 101 |   |
| Foreign exchange  contracts                 |       | 26,975                          |       | 26,975                          |       | 19,665 |   | 19,665 |   |

 

The fair value estimates presented herein are based onpertinent information available to management at December 31, 2006 and2005. Although management is not aware of any factors that would significantlyaffect the estimated fair value amounts, such amounts have not beensignificantly revalued for the purposes of these consolidated financialstatements since those dates and, therefore, current estimates of fair valuemay differ significantly from the amounts presented herein.

The Company uses the following methods and assumptionsto determine the fair value of selected financial instruments:

***Short-term financial assets andliabilities***—For financial instruments with a short or nostated maturity, prevailing market rates and limited credit risk, carryingamounts approximate fair value. Those financial instruments include cash anddue from banks, interest bearing deposits with other banks, other short-terminvestments, loans and deposits.

***Securities, available for saleand held to maturity***—Fair values were based on pricesobtained from an independent nationally recognized pricing service, or in theabsence of such, prices were obtained directly from selected broker-dealers.

***Securities sold under repurchaseagreements and short-term and other borrowings***—Fairvalues of the Company’s long-term borrowings and long-term repurchaseagreements were based on quoted market prices, when available, and prevailing marketrates for borrowings of similar terms. Carrying amounts for 

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**17. FairValue of Financial Instruments (Continued)**

short-termborrowings and short-term repurchase agreements approximate fair value due tothe short-term nature of these instruments.

***Interest rate contracts***—Fairvalues were based on the estimated amount that the Company would receive or payto terminate the swap agreements, taking into account the current interestrates and the creditworthiness of the swap counterparties.

***Foreign exchange contracts***—Fairvalues were based on quoted market prices of comparable instruments. Foreignexchange contracts have been reduced by offsetting balances with the same counterpartywhere a master netting agreement exists.

**18. Regulatory Matters**

The Company and the Bank are subject to variousregulatory capital requirements administered by the federal banking agencies. Failureto meet minimum capital requirements can initiate certain mandatory andpossibly additional discretionary actions by regulators that, if undertaken,could have a direct material effect on the Company’s and the Bank’s financialstatements. Under capital adequacy guidelines and the regulatory framework forprompt corrective action, the Bank must meet specific capital guidelines thatinvolve quantitative measures of the Bank’s assets, liabilities, and certainoff-balance sheet items as calculated under regulatory accounting practices. TheCompany’s and the Bank’s capital amounts and classification are also subject toqualitative judgments by the regulators about components, risk weightings, andother factors.

Quantitative measures established by regulation toensure capital adequacy require the Company and the Bank to maintain minimumamounts and ratios (set forth in the table below) of Total and Tier 1 capital(as defined in the regulations) to risk-weighted assets (as defined), and ofTier 1 capital (as defined) to average assets (as defined). Managementbelieves, as of December 31, 2006, that the Company and the Bank meet allcapital adequacy requirements to which they are subject.

As of December 31,2006, the most recent notification from the Federal Deposit InsuranceCorporation categorized the Company and the Bank as well-capitalized under theregulatory framework for prompt corrective action. To be categorized aswell-capitalized, the Company and the Bank must maintain minimum Totalrisk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in thetable. There are no conditions or events since that notification thatmanagement believes have changed the Company’s or the Bank’s category.

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**18.Regulatory Matters (Continued)**

The following tablepresents the capital ratios for the Company and the Bank (Dollars inthousands):

|                                        | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | **To Be Well-**  | ** ** |
|----------------------------------------|------------|------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                             | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | **Capitalized Under** | ** ** |
| ** **                             | ** ** | ** ** | ** ** | ** **                 | ** ** | **For Capital**       | ** ** | **Prompt Corrective** | ** ** |
| ** **                             | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| ** **                             | ** ** | **Amount** | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio** | ** ** |
| **As of December 31, 2006:**      |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |   |   |
| Total Capital                          |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |   |   |
| (to Risk-Weighted Assets-the Company)  |       | $          | 900,299    |                       | 19.04      | %                          | $          | 378,305                    |       |                       | 8.00       | % |   | N/A |   | N/A |   |
| Total Capital                          |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |   |   |
| (to Risk-Weighted Assets-the  Bank)    |       | $          | 863,841    |                       | 18.28      | %                          | $          | 378,048                    |       |                       | 8.00       | % |   | $ | 472,560 |   | 10.00 | % |
| Tier 1 Capital                         |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |   |   |
| (to Risk-Weighted Assets-the Company)  |       | $          | 900,199    |                       | 19.04      | %                          | $          | 189,152                    |       |                       | 4.00       | % |   | N/A |   | N/A |   |
| Tier 1 Capital                         |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |   |   |
| (to Risk-Weighted Assets-the  Bank)    |       | $          | 863,741    |                       | 18.28      | %                          | $          | 189,024                    |       |                       | 4.00       | % |   | $ | 283,536 |   | 6.00 | % |
| Tier 1 Capital                         |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |   |   |
| (to Average Assets-the Company)        |       | $          | 900,199    |                       | 7.63       | %                          | $          | 472,082                    |       |                       | 4.00       | % |   | N/A |   | N/A |   |
| Tier 1 Capital                         |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |   |   |
| (to Average Assets-the Bank)           |       | $          | 863,741    |                       | 7.32       | %                          | $          | 471,715                    |       |                       | 4.00       | % |   | $ | 589,643 |   | 5.00 | % |
| **As of  December 31, 2005:**     |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |   |   |
| Total Capital                          |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |   |   |
| (to Risk-Weighted Assets-the  Company) |       | $          | 731,833    |                       | 18.50      | %                          | $          | 316,553                    |       |                       | 8.00       | % |   | N/A |   | N/A |   |
| Total Capital                          |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |   |   |
| (to Risk-Weighted Assets-the Bank)     |       | $          | 720,113    |                       | 18.21      | %                          | $          | 316,349                    |       |                       | 8.00       | % |   | $ | 395,436 |   | 10.00 | % |
| Tier 1 Capital                         |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |   |   |
| (to Risk-Weighted Assets-the  Company) |       | $          | 731,733    |                       | 18.49      | %                          | $          | 158,276                    |       |                       | 4.00       | % |   | N/A |   | N/A |   |
| Tier 1 Capital                         |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |   |   |
| (to Risk-Weighted Assets-the Bank)     |       | $          | 720,013    |                       | 18.21      | %                          | $          | 158,174                    |       |                       | 4.00       | % |   | $ | 237,262 |   | 6.00 | % |
| Tier 1 Capital                         |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |   |   |
| (to Average Assets-the  Company)       |       | $          | 731,733    |                       | 5.95       | %                          | $          | 491,685                    |       |                       | 4.00       | % |   | N/A |   | N/A |   |
| Tier 1 Capital                         |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |   |   |
| (to Average  Assets-the Bank)          |       | $          | 720,013    |                       | 5.86       | %                          | $          | 491,549                    |       |                       | 4.00       | % |   | $ | 614,437 |   | 5.00 | % |

 

Under Massachusetts law, trust companies such as theBank, like national banks, may pay dividends no more often than quarterly, andonly out of net profits and to the extent that such payments will not impairthe Bank’s capital stock and surplus account. Moreover, prior Commissionerapproval is required if the total dividends for a calendar year would exceednet profits for that year combined with retained net profits for the previoustwo years. These restrictions on the ability of the Bank to pay dividends tothe Company may restrict the ability of the Company to pay dividends to itsstockholders.

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**18.Regulatory Matters (Continued) (Continued)**

The operations of the Company’s securities brokeraffiliate, Investors Securities Services, LLC (‘ISS’), are subject to federaland state securities laws, as well as the rules of both the SEC and theNASD. Management believes, as of December 31, 2006, that ISS is inmaterial compliance with all of the foregoing requirements to which it issubject.

The operations of the Company’s captive insuranceaffiliate, Investors Vermont Insurance Company (‘IVIC’), are subject to thelaws and regulations of the BISHCA. Management believes, as of December 31,2006, that IVIC is in material compliance with all of the foregoingrequirements to which it is subject.

The operations of the Company’s affiliatedinternational subsidiaries are subject to laws and regulations of variousregulators, including the OSFI, the IFSRA, the CIMA, the FSA and the CSSF. Managementbelieves, as of December 31, 2006, that its affiliated internationalsubsidiaries are all in compliance with all of the foregoing requirements towhich each is subject.

In June 2004, theBasel Committee on Banking Supervision (‘Basel Committee’) released thedocument “International Convergence of Capital Measurement and CapitalStandards: A Revised Framework.” The Framework, also referred to as BaselII, is designed to secure international convergence on regulations andstandards governing the capital adequacy of internationally active bankingorganizations. In September 2006, the U.S. banking and thrift supervisoryagencies issued a notice of Proposed Rulemaking setting forth a proposedframework for the timing and qualification process for U.S. banks that areeither required (“core banks”) or choose (“opt-in banks”) to be subject toBasel II. As currently proposed, the new rules as applied in the U.S. areexpected to become effective on January 1, 2009, subject to transitionalparallel testing beginning on January 1, 2008. Although the Bank is not requiredto be compliant with the new rules, the Bank is in the process of developingand implementing a program to achieve Basel II compliance. Ultimately, U.S.implementation of Basel II will depend on, and will be subject to, finalregulations and related policies promulgated by the U.S. supervisory agencies.The Bank cannot predict the final form of the rules, nor their impact on itsrisk-based capital.

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**19. Net Interest Income**

Thecomponents of interest income and interest expense are as follows (Dollars inthousands):

| ** **                                                                                       | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                       | ** ** | **2006**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Interest income:**                                                                             | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Federal funds sold, interest-bearing deposits with  other banks and other short-term investments |       | $                     | 9,141      |   | $ | 2,250 |   | $ | 667 |   |
| Investment  securities:                                                                          |       |                  |       |   |   |   |   |
| Mortgage-backed securities                                                                       |       | 403,717               |       | 315,845 |   | 221,248 |   |
| Federal agency securities                                                                        |       | 91,861                |       | 89,864 |   | 53,977 |   |
| State and political subdivisions (exempt from  federal tax)                                      |       | 20,071                |       | 21,217 |   | 22,300 |   |
| Other securities                                                                                 |       | 11,927                |       | 9,267 |   | 10,370 |   |
| Loans                                                                                            |       | 21,032                |       | 9,262 |   | 4,587 |   |
| Total interest income                                                                            |       | $                     | 557,749    |   | $ | 447,705 |   | $ | 313,149 |   |
| **Interest  expense:**                                                                           |       |                  |       |   |   |   |   |
| Deposits                                                                                         |       | $                     | 180,327    |   | $ | 77,706 |   | $ | 50,721 |   |
| Securities sold under repurchase agreements                                                      |       | 164,970               |       | 142,681 |   | 54,376 |   |
| Short-term and other borrowings                                                                  |       | 45,838                |       | 54,473 |   | 17,952 |   |
| Junior subordinated debentures                                                                   |       | 2,420                 |       | 2,420 |   | 2,420 |   |
| Total interest expense                                                                           |       | $                     | 393,555    |   | $ | 277,280 |   | $ | 125,469 |   |
| Net interest  income                                                                             |       | $                     | 164,194    |   | $ | 170,425 |   | $ | 187,680 |   |

 

**20. SelectedQuarterly Financial Data (unaudited) (Dollars in thousands, except per sharedata):**

| ** **                                           | ** ** | **First**  | ** ** | **Second**  | ** ** | **Third**   | ** ** | **Fourth**  | ** ** |
|------------------------------------------------------|------------|------------|------------|-------------|------------|-------------|------------|-------------|------------|
| **Year Ended December 31, 2006** | ** ** | ** ** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** |
| Noninterest  income                                  |       | $          | 149,467    |        | $          | 169,128     |       | $           | 154,874    |   | $ | 165,985 |   |
| Interest income                                      |       | 134,437    |       | 137,921     |       | 140,338     |       | 145,053     |       |
| Interest expense                                     |       | 91,116     |       | 99,356      |       | 101,348     |       | 101,735     |       |
| Operating  expenses                                  |       | 135,684    |       | 148,925     |       | 139,154     |       | 155,591     |       |
| Income before  income taxes                          |       | 57,104     |       | 58,768      |       | 54,710      |       | 53,712      |       |
| Income taxes                                         |       | 19,701     |       | 14,469      |       | 18,327      |       | 17,994      |       |
| Net income                                           |       | 37,403     |       | 44,299      |       | 36,383      |       | 35,718      |       |
| Basic earnings  per share                            |       | 0.57       |       | 0.68        |       | 0.55        |       | 0.54        |       |
| Diluted earnings  per share                          |       | 0.56       |       | 0.65        |       | 0.54        |       | 0.53        |       |
|                                                      |            |            |            |             |            |             |            |             |            |  |  |  |  |  |  |

 

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**20.Selected Quarterly Financial Data (unaudited) (Dollars in thousands, except pershare data): (Continued)**

| ** **                             | ** ** | **First**  | ** ** | **Second**  | ** ** | **Third**   | ** ** | **Fourth**  | ** ** |
|----------------------------------------|------------|------------|------------|-------------|------------|-------------|------------|-------------|------------|
| **Year Ended  December 31, 2005** | ** ** | ** ** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** |
| Noninterest  income                    |       | $          | 120,176    |        | $          | 128,676     |       | $           | 131,215    |   | $ | 145,470 |   |
| Interest income                        |       | 98,055     |       | 108,103     |       | 114,512     |       | 127,035     |       |
| Interest expense                       |       | 50,442     |       | 66,057      |       | 76,471      |       | 84,310      |       |
| Operating  expenses                    |       | 104,792    |       | 113,237     |       | 116,130     |       | 125,950     |       |
| Income before  income taxes            |       | 62,997     |       | 57,485      |       | 53,126      |       | 62,245      |       |
| Income taxes                           |       | 22,049     |       | 13,358      |       | 17,894      |       | 22,734      |       |
| Net income                             |       | 40,948     |       | 44,127      |       | 35,232      |       | 39,511      |       |
| Basic earnings  per share              |       | 0.61       |       | 0.66        |       | 0.54        |       | 0.61        |       |
| Diluted earnings per  share            |       | 0.60       |       | 0.64        |       | 0.53        |       | 0.60        |       |
|                                        |            |            |            |             |            |             |            |             |            |  |  |  |  |  |  |

 

**21. Geographic Reportingand Service Lines**

TheCompany does not utilize segment information for internal reporting as managementviews the Company as one segment. The following represents net operatingrevenue by geographic area and long-lived assets (including goodwill) bygeographic area (Dollars in thousands):

| ** **                      | ** ** | **Net Operating Revenue**                           | ** ** | **Long-Lived Assets** | ** ** |
|---------------------------------|------------|---------------------------------------------------------------|------------|----------------------------|------------|
| ** **                      | ** ** | **For the Years Ended December 31,** | ** ** | **December 31**       | ** ** | **December 31** | ** ** |
| **Geographic Information** | ** ** | ** **                                                    | ** ** | **2006**                   | ** ** | **2005** | ** ** | **2004** | ** ** | **2006** | ** ** | **2005** | ** ** |
| United States                   |       | $                                                             | 748,133    |                       | $          | 653,305 |   | $ | 579,168 |   |   | $ | 182,276 |   |   |   | $ | 141,810 |   |   |
| Ireland                         |       | 48,567                                                        |       | 37,061                     |       | 28,835 |   |   | 9,269 |   |   |   | 6,325 |   |   |
| Canada                          |       | 6,233                                                         |       | 5,427                      |       | 4,989 |   |   | 116 |   |   |   | 385 |   |   |
| United Kingdom                  |       | 364                                                           |       | 3                          |       | — |   |   | 1,520 |   |   |   | 850 |   |   |
| Luxembourg                      |       | 196                                                           |       | —                     |       | — |   |   | 75 |   |   |   | — |   |   |
| Cayman Islands                  |       | 155                                                           |       | 166                        |       | 179 |   |   | — |   |   |   | — |   |   |
| Total                           |       | $                                                             | 803,648    |                       | $          | 695,962 |   | $ | 613,171 |   |   | $ | 193,256 |   |   |   | $ | 149,370 |   |   |
|                                 |            |                                                               |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Barclays Global Investors, N.A. (‘BGI’) accounted for18%, 18% and 17% of the Company’s consolidated net operating revenues for theyears ended December 31, 2006, 2005 and 2004, respectively. No clientother than BGI accounted for more than 10% of the Company’s consolidated netoperating revenues in the years ended December 31, 2006, 2005 and 2004.

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**21.Geographic Reporting and Service Lines (Continued)**

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

| ** **                                                          | ** ** | **For the Years Ended  December 31,** | ** ** |
|---------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| **Asset servicing fees by service lines:** | ** ** | ** **                                                | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Core service fees:                                                  |       |                                                      |       |   |   |   |   |
| Custody, multicurrency accounting and fund  administration          |       | $                                                         | 453,573    |   | $ | 375,596 |   | $ | 314,272 |   |
| Value-added  service fees:                                          |       |                                                      |       |   |   |   |   |
| Foreign exchange                                                    |       | 80,957                                                    |       | 62,107 |   | 54,466 |   |
| Cash management                                                     |       | 58,777                                                    |       | 37,592 |   | 26,396 |   |
| Securities lending                                                  |       | 27,381                                                    |       | 22,536 |   | 10,385 |   |
| Investment advisory                                                 |       | 7,464                                                     |       | 8,442 |   | 15,020 |   |
| Other service fees                                                  |       | 3,088                                                     |       | 2,786 |   | 2,661 |   |
| Total value-added service fees                                      |       | 177,667                                                   |       | 133,463 |   | 108,928 |   |
| Total                                                               |       | $                                                         | 631,240    |   | $ | 509,059 |   | $ | 423,200 |   |
|                                                                     |            |                                                           |            |  |  |  |  |  |  |  |  |  |

 

**22. Financial Statementsof Investors Financial Services Corp. (Parent Only)**

Thefollowing represents the separate condensed financial statements of IFSC(Dollars in thousands):

| ** **                                                              | ** ** | **Year ended** | ** ** | **Year ended**             | ** ** | **Year ended**             | ** ** |
|-------------------------------------------------------------------------|------------|---------------------|------------|---------------------------------|------------|---------------------------------|------------|
| **Statements of Income**                                      | ** ** | ** **          | ** ** | **December 31, 2006** | ** ** | **December 31, 2005** | ** ** | **December 31, 2004** | ** ** |
| Equity in  undistributed income of bank subsidiary                 |       |                | $          | 156,798                         |       |                            |       | $ | 99,809 |   |   |   | $ | 144,595 |   |   |
| Equity in  undistributed loss of unconsolidated nonbank subsidiary |       |                | (29        | )                               |       |                            | (28        | ) |   |   | (28 | ) |   |
| Dividend income  from bank subsidiary                                   |       |                | —     |                            |       |                            | 63,000     |   |   |   | — |   |   |
| Dividend income  from unconsolidated nonbank subsidiary            |       |                | 76         |                            |       |                            | 76         |   |   |   | 76 |   |   |
| Interest expense  on junior subordinated deferrable interest debentures |       |                | (2,420     | )                               |       |                            | (2,420     | ) |   |   | (2,420 | ) |   |
| Operating  expenses                                                     |       |                | (2,260     | )                               |       |                            | (2,254     | ) |   |   | (1,703 | ) |   |
| Income tax  benefit                                                     |       |                | 1,638      |                            |       |                            | 1,635      |   |   |   | 1,442 |   |   |
| Net Income                                                              |       |                | $          | 153,803                         |       |                            |       | $ | 159,818 |   |   |   | $ | 141,962 |   |   |
|                                                                         |            |                     |            |                                 |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |

 

F-48

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**22. Financial Statements of Investors Financial ServicesCorp. (Parent Only) (Continued)**

| **Balance Sheets**                            | ** ** | **December 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|----------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Assets:                                            |       |                        |       |                        |       |   |   |   |   |
| Cash                                               |       |                        | $          | 34,554                      |       |   |   | $ | 10,303 |   |   |
| Investments in bank subsidiary                     |       |                        | 926,279    |                        |       |   | 785,138 |   |   |
| Investments in nonbank subsidiaries                |       |                        | 681        |                        |       |   | 710 |   |   |
| Receivable due from bank subsidiary                |       |                        | 2,600      |                        |       |   | 1,991 |   |   |
| Other assets                                       |       |                        | 666        |                        |       |   | 709 |   |   |
| Total Assets                                       |       |                        | $          | 964,780                     |       |   |   | $ | 798,851 |   |   |
| Liabilities and Stockholders’ Equity:         |       |                        |       |                        |       |   |   |   |   |
| Liabilities:                                       |       |                        |       |                        |       |   |   |   |   |
| Accrued expenses                                   |       |                        | $          | 98                          |       |   |   | $ | 62 |   |   |
| Payable due to nonbank subsidiary                  |       |                        | 1,157      |                        |       |   | 1,157 |   |   |
| Junior subordinated deferrable interest debentures |       |                        | 24,774     |                        |       |   | 24,774 |   |   |
| Income tax payable                                 |       |                        | 13         |                        |       |   | — |   |   |
| Total liabilities                                  |       |                        | 26,042     |                        |       |   | 25,993 |   |   |
| Stockholders’  Equity:                        |       |                        |       |                        |       |   |   |   |   |
| Common stock                                       |       |                        | 685        |                        |       |   | 672 |   |   |
| Surplus                                            |       |                        | 334,929    |                        |       |   | 286,265 |   |   |
| Deferred compensation                              |       |                        | —     |                        |       |   | (311 | ) |   |
| Retained earnings                                  |       |                        | 720,433    |                        |       |   | 572,549 |   |   |
| Accumulated other comprehensive loss, net          |       |                        | (14,514    | )                           |       |   | (13,369 | ) |   |
| Treasury stock                                     |       |                        | (102,795   | )                           |       |   | (72,948 | ) |   |
| Total stockholders’ equity                    |       |                        | 938,738    |                        |       |   | 772,858 |   |   |
| Total Liabilities and  Stockholders’ Equity   |       |                        | $          | 964,780                     |       |   |   | $ | 798,851 |   |   |

 

F-49

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**INVESTORS FINANCIAL SERVICES CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Years Ended December 31, 2006, 2005 and 2004**

**22. Financial Statements of Investors Financial ServicesCorp. (Parent Only) (Continued)**

| ** **                                                                                   | ** ** | **Year ended**         | ** ** | **Year ended**         | ** ** | **Year ended**         | ** ** |
|----------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| **Statements of Cash Flows**                                                  | ** ** | **December 31,  2006** | ** ** | **December 31,  2005** | ** ** | **December 31,  2004** | ** ** |
| Cash flows from  operating activities:                                                       |       |                        |       |                        |       |                        |       |   |   |   |   |   |   |
| Net income                                                                                   |       |                        | $          | 153,803                     |       |                        |       | $ | 159,818 |   |   |   | $ | 141,962 |   |   |
| Adjustments to  reconcile net income to net cash (used in) provided by operating activities: |       |                        |       |                        |       |                        |       |   |   |   |   |   |   |
| Equity in undistributed income of bank subsidiary                                            |       |                        | (156,798   | )                           |       |                        | (99,809    | ) |   |   | (144,595 | ) |   |
| Equity in  undistributed loss of unconsolidated                                              |       |                        |       |                        |       |                        |       |   |   |   |   |   |   |
| nonbank subsidiary                                                                           |       |                        | 29         |                        |       |                        | 28         |   |   |   | 28 |   |   |
| Share-based awards                                                                           |       |                        | 4,538      |                        |       |                        | —     |   |   |   | — |   |   |
| Amortization of deferred compensation                                                        |       |                        | —     |                        |       |                        | 261        |   |   |   | 316 |   |   |
| Amortization of premium expense                                                              |       |                        | 28         |                        |       |                        | 28         |   |   |   | 28 |   |   |
| Excess tax benefit related to share-based awards                                             |       |                        | (8,017     | )                           |       |                        | —     |   |   |   | — |   |   |
| Change in assets  and liabilities:                                                           |       |                        |       |                        |       |                        |       |   |   |   |   |   |   |
| Receivable due from bank subsidiary                                                          |       |                        | (609       | )                           |       |                        | 44         |   |   |   | (376 | ) |   |
| Income tax receivable/payable                                                                |       |                        | 111        |                        |       |                        | (98        | ) |   |   | 484 |   |   |
| Other assets                                                                                 |       |                        | 9          |                        |       |                        | 13         |   |   |   | (8 | ) |   |
| Accrued expenses                                                                             |       |                        | 36         |                        |       |                        | 19         |   |   |   | (13 | ) |   |
| Net cash (used  in) provided by operating activities                                         |       |                        | (6,870     | )                           |       |                        | 60,304     |   |   |   | (2,174 | ) |   |
| Cash flows from  financing activities:                                                       |       |                        |       |                        |       |                        |       |   |   |   |   |   |   |
| Proceeds from exercise of stock options                                                      |       |                        | 33,096     |                        |       |                        | 7,779      |   |   |   | 16,068 |   |   |
| Proceeds from issuance of common stock                                                       |       |                        | 4,827      |                        |       |                        | 3,868      |   |   |   | 3,355 |   |   |
| Common stock repurchase                                                                      |       |                        | (29,847    | )                           |       |                        | (70,657    | ) |   |   | (1,741 | ) |   |
| Excess tax benefit related to share-based awards                                             |       |                        | 8,017      |                        |       |                        | —     |   |   |   | — |   |   |
| Dividends paid to stockholders                                                               |       |                        | (5,919     | )                           |       |                        | (5,303     | ) |   |   | (4,629 | ) |   |
| Tax benefit related to the issuance of share-based  awards                                   |       |                        | 20,947     |                        |       |                        | —     |   |   |   | — |   |   |
| Net cash provided by (used in) financing activities                                          |       |                        | 31,121     |                        |       |                        | (64,313    | ) |   |   | 13,053 |   |   |
| Net increase (decrease) in cash and due from banks                                           |       |                        | 24,251     |                        |       |                        | (4,009     | ) |   |   | 10,879 |   |   |
| Cash and due from banks, beginning of year                                                   |       |                        | 10,303     |                        |       |                        | 14,312     |   |   |   | 3,433 |   |   |
| Cash and due from  banks, end of year                                                        |       |                        | $          | 34,554                      |       |                        |       | $ | 10,303 |   |   |   | $ | 14,312 |   |   |

 

F-50

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