<PAGE>
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly period ended September 30, 1997
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition period from _____ to _____
Commission File Number 0-26996
INVESTORS FINANCIAL SERVICES CORP.
(Exact name of registrant as specified in its charter)
Delaware 04-3279817
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation or organization)
200 Clarendon Sreet, P.O. Box 9130, Boston, MA 02117-9130
(Address of principal executive offices, including Zip Code)
(617) 330-6700
(Registrant's telephone number, including area code)
----------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [_]
As of October 31, 1997, there were 6,445,862 shares of Common Stock
outstanding.
<PAGE>
INVESTORS FINANCIAL SERVICES CORP.
INDEX
-----
PART I FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page
----
<S> <C>
Item 1. Condensed Consolidated Financial Statements
Consolidated Balance Sheets
December 31, 1996 and
September 30, 1997 (unaudited) 3
Consolidated Income Statements (unaudited)
Nine months ended September 30, 1996 and 1997 4
Consolidated Income Statements (unaudited)
Three months ended September 30, 1996 and 1997 5
Statement of Stockholder's Equity (unaudited)
Nine months ended September 30, 1997 6
Consolidated Statements of Cash Flows (unaudited)
Nine months ended September 30, 1996 and 1997 7
Notes to Condensed Consolidated Financial Statements 9
Item 2. Management's Discussion and Analysis of Financial Condition 19
and Results of Operations
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 34
SIGNATURES 35
</TABLE>
2
<PAGE>
INVESTORS FINANCIAL SERVICES CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND SEPTEMBER 30, 1997
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
December 31, September 30,
1996 1997
(unaudited)
ASSETS
<S> <C> <C>
Cash and due from banks $ 19,226,453 $ 25,029,586
Federal funds sold and securities purchased under resale agreements 120,000,000 -
Securities held to maturity (approximate market values of
$460,182,579 and $757,781,734 at December 31, 1996
and September 30, 1997, respectively) 460,009,923 749,448,367
Securities available for sale 271,120,964 460,281,597
Nonmarketable equity securities 967,400 5,476,600
Loans, less allowance for loan losses of $100,000
at December 31, 1996 and September 30, 1997 66,236,889 47,403,504
Accrued interest and fees receivable 16,366,171 23,432,991
Equipment and leasehold improvements, net 5,243,974 7,722,034
Other assets 5,289,873 13,562,771
--------------- ----------------
TOTAL ASSETS $ 964,461,647 $ 1,332,357,450
=============== ================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits:
Demand $ 264,914,614 $ 291,715,506
Savings 271,602,295 172,179,107
Time 60,000,000 87,800,000
--------------- ----------------
Total deposits 596,516,909 551,694,613
Short-term borrowings 296,820,752 672,444,111
Other liabilities 9,264,676 12,308,082
--------------- ----------------
Total liabilities 902,602,337 1,236,446,806
--------------- ----------------
Company obligated mandatorily redeemable preferred securities of subsidiary trust
holding junior subordinated deferrable interest debentures of the Company - 24,166,257
--------------- ----------------
STOCKHOLDERS' EQUITY:
Class A common stock 3,595 -
Common stock 60,848 64,456
Surplus 54,352,812 54,373,424
Deferred compensation (1,687,675) (1,358,500)
Retained earnings 8,480,431 16,745,644
Net unrealized gain on securities available for sale 649,299 1,919,363
--------------- ----------------
Total stockholders' equity 61,859,310 71,744,387
--------------- ----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 964,461,647 $ 1,332,357,450
=============== ================
</TABLE>
See notes to condensed consolidated financial statements.
3
<PAGE>
INVESTORS FINANCIAL SERVICES CORP.
CONDENSED CONSOLIDATED INCOME STATEMENTS (unaudited)
NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
September 30, September 30,
1996 1997
<S> <C> <C>
OPERATING REVENUE:
Interest income:
Federal funds sold and securities purchased
under resale agreements $ 974,010 $ 946,609
Investment securities held to maturity and available for sale 21,727,649 48,283,937
Loans 1,589,761 1,910,559
------------- -------------
Total interest income 24,291,420 51,141,105
Interest expense:
Deposits 5,565,501 13,868,308
Short-term borrowings 6,024,157 18,129,747
------------- -------------
Total interest expense 11,589,658 31,998,055
------------- -------------
Net interest income 12,701,762 19,143,050
Provision for loan losses 49,114 -
------------- -------------
Net interest income after provision for loan losses 12,652,648 19,143,050
Noninterest income:
Asset administration fees 40,661,709 55,648,699
Computer service fees 365,462 351,000
Other operating income 57,065 249,362
Gain/(loss) on sale of securities available for sale (8,421) 41,760
------------- -------------
Net operating revenue 53,728,463 75,433,871
OPERATING EXPENSES:
Compensation of officers and employees 23,436,228 31,833,284
Pension and other employee benefits 3,904,890 4,711,461
Occupancy 3,242,658 3,044,544
Equipment 3,991,122 5,043,033
Insurance 745,704 550,914
Subcustodian fees 2,929,870 4,309,961
Depreciation and amortization 1,095,115 1,415,873
Professional fees 1,626,804 2,370,808
Travel and sales promotion 698,966 1,139,572
Other operating expenses 3,135,558 5,860,682
------------- -------------
Total operating expenses 44,806,915 60,280,132
------------- -------------
INCOME BEFORE INCOME TAXES AND MINORITY INTEREST 8,921,548 15,153,739
Provision for income taxes 3,432,996 5,455,346
Minority interest expense, net of income taxes - 1,046,476
------------- -------------
NET INCOME $ 5,488,552 $ 8,651,917
============= =============
WEIGHTED AVERAGE SHARES OUTSTANDING 6,467,743 6,603,202
============= =============
EARNINGS PER SHARE $ 0.85 $ 1.31
============= =============
</TABLE>
See notes to condensed consolidated financial statements.
4
<PAGE>
INVESTORS FINANCIAL SERVICES CORP.
CONDENSED CONSOLIDATED INCOME STATEMENTS (unaudited)
THREE MONTHS ENDED SEPTEMBER 30, 1996 AND 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
September 30, September 30,
1996 1997
<S> <C> <C>
OPERATING REVENUE:
Interest income:
Federal funds sold and securities purchased
under resale agreements $ 303,535 $ 103,089
Investment securities held to maturity and available for sale 9,465,012 18,444,231
Loans 591,833 570,264
------------- -------------
Total interest income 10,360,380 19,117,584
Interest expense:
Deposits 2,495,044 4,408,706
Short-term borrowings 3,167,407 8,611,526
------------- -------------
Total interest expense 5,662,451 13,020,232
------------- -------------
Net interest income 4,697,929 6,097,352
Provision for loan losses - -
------------- -------------
Net interest income after provision for loan losses 4,697,929 6,097,352
Noninterest income:
Asset administration fees 13,909,339 19,724,710
Computer service fees 118,852 117,169
Other operating income 20,781 105,393
Gain/(loss) on sale of securities available for sale (14,694) 34,650
------------- -------------
Net operating revenue 18,732,207 26,079,274
OPERATING EXPENSES:
Compensation of officers and employees 8,146,583 11,291,151
Pension and other employee benefits 1,327,020 1,581,993
Occupancy 1,028,716 834,754
Equipment 1,355,353 1,659,376
Insurance 157,682 185,334
Subcustodian fees 1,119,971 1,559,438
Depreciation and amortization 402,594 546,005
Professional fees 597,387 616,052
Travel and sales promotion 205,779 359,827
Other operating expenses 1,036,220 2,239,513
------------- -------------
Total operating expenses 15,377,305 20,873,443
------------- -------------
INCOME BEFORE INCOME TAXES AND MINORITY INTEREST 3,354,902 5,205,831
Provision for income taxes 1,289,904 1,876,046
Minority interest expense, net of income taxes - 395,143
------------- -------------
NET INCOME $ 2,064,998 $ 2,934,642
============= =============
WEIGHTED AVERAGE SHARES OUTSTANDING 6,471,069 6,638,592
============= =============
EARNINGS PER SHARE $ 0.32 $ 0.44
============= =============
</TABLE>
See notes to condensed consolidated financial statements.
5
<PAGE>
INVESTORS FINANCIAL SERVICES CORP.
CONDENSED STATEMENT OF STOCKHOLDERS' EQUITY (unaudited)
NINE MONTHS ENDED SEPTEMBER 30, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Net Unrealized
Gain on
Investment
Class A Securities
Common Common Deferred Retained Available
Stock Stock Surplus Compensation Earnings For Sale Total
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1996 $ 3,595 $60,848 $54,352,812 $(1,687,675) $ 8,480,431 $ 649,299 $61,859,310
Conversion of class A to common stock (3,595) 3,595 -
Amortization of deferred compensation 329,175 329,175
Exercise of stock options 13 20,612 20,625
Net income 8,651,917 8,651,917
Payment of dividend (386,704) (386,704)
Change in net unrealized gain on
securities available for sale 1,270,064 1,270,064
--------- ------- ----------- ----------- ----------- ----------- -----------
BALANCE, SEPTEMBER 30, 1997 $ 0 $64,456 $54,373,424 $(1,358,500) $16,745,644 $1,919,363 $71,744,387
========= ======= =========== =========== =========== ========== ===========
</TABLE>
6
<PAGE>
INVESTORS FINANCIAL SERVICES CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
September 30, September 30,
1996 1997
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 5,488,552 $ 8,651,917
----------------- -----------------
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 1,095,115 1,415,873
Amortization of deferred compensation 320,387 329,175
Provision for loan losses 49,114 -
Amortization of premiums on securities, net of accretion of discounts 1,779,230 2,817,168
Deferred income taxes (161,584) 16,880
(Gain)/loss on sale of securities available for sale 8,421 (41,760)
Loss on disposal of fixed assets 15,211 -
Changes in assets and liabilities:
Accrued interest and fees receivable (5,866,278) (7,066,820)
Other assets (1,508,599) (8,272,898)
Other liabilities 4,919,517 2,425,888
----------------- -----------------
Total adjustments 650,534 (8,376,494)
----------------- -----------------
Net cash provided by operating activities 6,139,086 275,423
----------------- -----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities of securities available for sale 29,825,254 69,408,056
Proceeds from maturities of securities held to maturity 26,069,003 65,406,880
Proceeds from sales of securities available for sale 20,077,388 12,982,134
Purchases of securities available for sale (175,526,949) (271,302,698)
Purchases of securities held to maturity (268,826,637) (355,998,155)
Purchase of nonmarketable equity securities - (4,509,200)
Net decrease in time deposits due from banks 1,000,000 -
Net (increase) decrease in federal funds sold and securities
purchased under resale agreements (79,000,000) 120,000,000
Net (increase) decrease in loans (20,902,267) 18,833,385
Purchases of equipment and leasehold improvements (2,724,992) (3,893,933)
----------------- -----------------
Net cash used for investing activities (470,009,200) (349,073,531)
----------------- -----------------
</TABLE>
See notes to condensed consolidated financial statements.
7
<PAGE>
INVESTORS FINANCIAL SERVICES CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) (CONTINUED)
NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
September 30, September 30,
1996 1997
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in demand deposits $288,156,455 $ 26,800,892
Net increase (decrease) in time and savings deposits 11,512,051 (71,623,188)
Net increase in short-term borrowings 150,225,222 375,623,359
Stock issuance costs 35,193 (833,743)
Proceeds from exercise of stock options 5,148 20,625
Proceeds from issuance of preferred stock - 25,000,000
Dividends paid (128,883) (386,704)
------------ -------------
Net cash provided by financing activities 449,805,186 354,601,241
------------ -------------
NET INCREASE (DECREASE) IN CASH AND DUE FROM BANKS (14,064,928) 5,803,133
CASH AND DUE FROM BANKS, BEGINNING OF PERIOD 21,898,903 19,226,453
------------ -------------
CASH AND DUE FROM BANKS, END OF PERIOD $ 7,833,975 $ 25,029,586
============ =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 11,012,000 $ 32,196,000
============ =============
Cash paid for income taxes $ 3,818,000 $ 5,608,000
============ =============
</TABLE>
See notes to condensed consolidated financial statements.
8
<PAGE>
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION PERTAINING TO THE NINE MONTHS AND THE THREE MONTHS ENDED SEPTEMBER
30, 1996 AND 1997 IS UNAUDITED)
- --------------------------------------------------------------------------------
1. DESCRIPTION OF BUSINESS
Investors Financial Services Corp. ("IFSC") provides asset administration
services for the financial services industry through its wholly owned
subsidiary, Investors Bank & Trust Company (the "Bank"). The Bank provides
global custody, multicurrency accounting, institutional transfer agency,
performance measurement, foreign exchange, securities lending, mutual fund
administration and investment advisory services to a variety of financial
asset managers, including mutual fund complexes, investment advisors,
banks and insurance companies. IFSC and the Bank are subject to regulation
by the Federal Reserve Board of Governors, the Office of the Commissioner
of Banks of the Commonwealth of Massachusetts and the Federal Deposit
Insurance Corporation.
As used herein, the defined term "the Company" shall mean IFSC together
with the Bank from the date of the share exchange discussed below and
shall mean the Bank prior to that date.
On November 8, 1995, the business operations of the Company were separated
from its former parent, Eaton Vance Corp. ("EVC"), by means of a tax-free,
pro rata distribution of EVC's ownership interest in the Company to the
EVC stockholders (the "Spin-off Transaction"). Immediately prior to the
Spin-off Transaction, all of the stockholders of the Bank exchanged their
1,000,000 shares of the Bank's capital stock for a combination of
3,418,573 shares of Common Stock and 611,427 shares of Class A Common
Stock ("Class A Stock") of a newly formed bank holding company formed for
the purpose of facilitating the Spin-off Transaction. For financial
reporting purposes, the exchange has been accounted for as if it occurred
on November 1, 1995. Subsequent to the completion of the Spin-off
Transaction, IFSC sold 2,300,000 additional shares of its Common Stock in
an initial public offering at an offering price of $16.50 per share. The
net effect of this transaction was an increase in the Company's
consolidated capital of approximately $34,000,000.
In December 1995, the Company changed its fiscal year end from October 31
to December 31.
On September 19,1997, pursuant to the terms of the Certificate of
Incorporation of the Company, all shares of the Company's Class A Common
Stock automatically converted into shares of the Company's Common Stock.
The terms of the Class A Common Stock were identical to the terms of the
Common Stock, except that the Common Stock receives only one vote per
share rather than the ten votes per share previously received by Class A
Common stock.
2. INTERIM FINANCIAL STATEMENTS
The consolidated interim financial statements of the Company and
consolidated subsidiaries as of September 30, 1997 and for the nine-month
periods and the three-month periods ended September 30, 1996 and 1997 have
been prepared by the Company, without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission. Certain information
and footnote disclosures normally included in annual financial statements
prepared in accordance with generally accepted accounting principles have
been condensed or omitted as permitted by such rules and regulations. All
adjustments, consisting of normal recurring adjustments, have been
included. Management believes that the disclosures are adequate to present
fairly the financial position, results of operations and cash flows at the
dates and for the periods presented. It is suggested that these interim
financial statements be read in conjunction with the financial statements
and the notes thereto included in the Company's latest annual report on
Form 10-K. Results for interim periods are not necessarily indicative of
those to be expected for the full fiscal year.
9
<PAGE>
2. INTERIM FINANCIAL STATEMENTS (CONTINUED)
During 1997 the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130 "Reporting
Comprehensive Income" and SFAS No. 131 "Disclosure About Segments of an
Enterprise and Related Information", which will be applicable for the
Company in fiscal 1998. Management has not assessed the impact of these
standards.
Certain amounts from the prior year have been reclassified to conform to
current year presentation.
3. SECURITIES
Carrying amounts and approximate market values of securities are
summarized as follows as of December 31, 1996:
<TABLE>
<CAPTION>
Carrying Unrealized Unrealized Approximate
Held to Maturity Value Gains Losses Market Value
<S> <C> <C> <C> <C>
Mortgage-backed securities $ 414,664,590 $ 1,973,263 $ 1,750,168 $ 414,887,685
Federal Agency securities 37,517,495 49,546 224,972 37,342,069
Foreign government securities 7,827,838 124,987 - 7,952,825
------------- ------------- ------------- -------------
Total $ 460,009,923 $ 2,147,796 $ 1,975,140 $ 460,182,579
============= ============= ============= =============
<CAPTION>
Amortized Unrealized Unrealized Carrying
Available for Sale Cost Gains Losses Value
<S> <C> <C> <C> <C>
U.S. Treasury securities $ 40,107,999 $ 151,304 $ 3 $ 40,259,300
Mortgage-backed securities 229,930,801 1,086,092 155,229 230,861,664
------------- ------------- ------------- -------------
Total $ 270,038,800 $ 1,237,396 $ 155,232 $ 271,120,964
============= ============= ============= =============
</TABLE>
Carrying amounts and approximate market values of securities are
summarized as follows as of September 30, 1997:
<TABLE>
<CAPTION>
Carrying Unrealized Unrealized Approximate
Held to Maturity Value Gains Losses Market Value
<S> <C> <C> <C> <C>
State and political subdivisions $ 35,080,916 $ 1,520,552 $ - $ 36,601,468
Mortgage-backed securities 575,332,444 7,644,716 801,620 582,175,540
Federal Agency securities 131,250,616 331,155 512,395 131,069,376
Foreign government securities 7,784,391 150,959 - 7,935,350
------------- ------------- ------------- -------------
Total $ 749,448,367 $ 9,647,382 $ 1,314,015 $ 757,781,734
============= ============= ============= =============
<CAPTION>
Amortized Unrealized Unrealized Carrying
Available for Sale Cost Gains Losses Value
<S> <C> <C> <C> <C>
U.S. Treasury securities $ 35,024,687 $ 121,463 $ - $ 35,146,150
Mortgage-backed securities 422,304,044 2,979,782 148,379 425,135,447
------------- ------------- ------------- -------------
Total $ 457,328,731 $ 3,101,245 $ 148,379 $ 460,281,597
============= ============= ============= =============
</TABLE>
10
<PAGE>
3. SECURITIES (CONTINUED)
Nonmarketable equity securities at September 30, 1997 consisted of
$5,476,600 of stock of the Federal Home Loan Bank of Boston (the "FHLBB").
As a member of the FHLBB, the Company is required to invest in $100 par
value stock of the FHLBB in an amount equal to the greater of (i) 1% of
its outstanding residential mortgage loan principal (including mortgage
pool securities), (ii) 0.3% of total assets, and (iii) total advances from
the FHLBB, divided by a leverage factor of 20. If and when FHLBB stock is
redeemed, the Company will receive an amount equal to the par value of the
stock.
The carrying amounts and approximate market values of securities by
effective maturity are as follows:
<TABLE>
<CAPTION>
December 31, 1996 September 30, 1997
Carrying Approximate Carrying Approximate
Held to Maturity Value Market Value Value Market Value
<S> <C> <C> <C> <C>
Due within one year $ 19,052,213 $ 18,873,837 $ - $ -
Due from one to five years 114,459,070 113,819,081 234,546,376 235,936,056
Due five years up to ten years 240,620,332 241,016,881 298,173,826 299,363,207
Due after ten years 85,878,308 86,472,780 216,728,165 222,482,471
------------- ------------- ------------- -------------
Total $ 460,009,923 $ 460,182,579 $ 749,448,367 $ 757,781,734
============= ============= ============= =============
<CAPTION>
December 31, 1996 September 30, 1997
Amortized Carrying Amortized Carrying
Available for Sale Cost Value Cost Value
<S> <C> <C> <C> <C>
Due within one year $ 19,964,080 $ 20,046,800 $ 25,046,375 $ 25,101,600
Due from one to five years 213,758,992 214,525,641 287,711,520 289,834,350
Due five years up to ten years 36,315,728 36,548,523 144,570,836 145,345,647
------------- ------------- ------------- -------------
Total $ 270,038,800 $ 271,120,964 $ 457,328,731 $ 460,281,597
============= ============= ============= =============
</TABLE>
The maturity distributions of mortgage-backed securities have been
allocated over maturity groupings based upon actual pre-payments to date
and anticipated pre-payments based upon historical experience.
Two securities available for sale were sold during the nine months ended
September 30, 1997, resulting in gains totaling $41,760.
The carrying value of securities pledged amounted to approximately
$362,000,000 and $729,000,000 at December 31, 1996 and September 30, 1997,
respectively. Securities are pledged primarily to secure public funds and
clearings with other depository institutions.
4. LOANS
Loans consist of demand loans with individuals and not-for-profit
institutions located in the greater Boston, Massachusetts metropolitan
area and loans to mutual fund clients. The loans to mutual funds include
lines of credit and advances pursuant to the terms of the custody
agreements between the Company and those mutual fund clients to facilitate
securities transactions and redemptions. Generally, the loans are, or may
be, in the event of default, collateralized with marketable securities
held by the Company as custodian. There were no impaired or nonperforming
loans at December 31, 1996 or September 30, 1997. In addition, there have
been no loan charge-offs or recoveries during the nine months ended
September 30, 1996 and 1997. Loans consisted of the following at December
31, 1996 and September 30, 1997:
11
<PAGE>
4. LOANS (CONTINUED)
<TABLE>
<CAPTION>
December 31, September 30,
1996 1997
<S> <C> <C>
Loans to individuals $ 23,448,999 $ 19,918,608
Loans to not-for-profit institutions 12,500 12,500
Loans to mutual funds 42,875,390 27,572,396
---------------- -----------------
66,336,889 47,503,504
Less allowance for loan losses 100,000 100,000
---------------- -----------------
Total $ 66,236,889 $ 47,403,504
================ =================
</TABLE>
The Company had commitments to lend of approximately $37,128,000 and
$79,050,000 at December 31, 1996 and September 30, 1997, respectively. The
terms of these commitments are similar to the terms of outstanding loans.
5. EQUIPMENT AND LEASEHOLD IMPROVEMENTS
The major components of equipment and leasehold improvements are as
follows at December 31, 1996 and September 30, 1997:
<TABLE>
<CAPTION>
December 31, September 30,
1996 1997
<S> <C> <C>
Furniture, fixtures and equipment $ 8,516,450 $ 10,818,236
Leasehold improvements 744,395 617,897
--------------- ----------------
Total 9,260,845 11,436,133
Less accumulated depreciation and amortization 4,016,871 3,714,099
--------------- ----------------
Equipment and leasehold improvements, net $ 5,243,974 $ 7,722,034
=============== ================
</TABLE>
6. DEPOSITS
Time deposits at December 31, 1996 and September 30, 1997 include
noninterest-bearing amounts of approximately $55,000,000 and $85,000,000,
respectively.
All time deposits had a minimum balance of $100,000 and a maturity of less
than three months at December 31, 1996 and September 30, 1997.
7. SHORT-TERM BORROWINGS
The major components of short-term borrowings are as follows at December
31, 1996 and September 30, 1997:
<TABLE>
<CAPTION>
December 31, September 30,
1996 1997
<S> <C> <C>
Repurchase agreements $ 296,421,201 $ 621,657,318
FHLBB Borrowings - 50,000,000
Treasury, Tax and Loan account 399,551 786,793
------------------ ------------------
Total $ 296,820,752 $ 672,444,111
================== ==================
</TABLE>
12
<PAGE>
7. SHORT-TERM BORROWINGS (CONTINUED)
The Company enters into repurchase agreements whereby securities are sold
by the Company under agreements to repurchase. The Company had liabilities
under these agreements of $296,421,201 and $621,657,318 at December 31,
1996 and September 30, 1997, respectively. The interest rate on the
outstanding agreements at December 31, 1996 was 5.91% and all agreements
matured on January 2, 1997. The interest rates on the outstanding
agreements at September 30, 1997 ranged from 5.53% to 6.55% and all
agreements matured from October 1, 1997 to October 24, 1997. The following
securities were pledged under these agreements at December 31, 1996 and
September 30, 1997:
<TABLE>
<CAPTION>
December 31, 1996 September 30, 1997
Carrying Approximate Carrying Approximate
Value Market Value Value Market Value
<S> <C> <C> <C> <C>
U.S. Treasury securities $ 37,249,940 $ 37,249,940 $ 35,146,150 $ 35,146,150
Federal Agency securities 25,000,000 24,803,950 20,000,000 19,903,900
Mortgage-backed securities 245,689,672 246,777,873 582,459,619 588,511,151
------------------- ------------------ ------------------- -------------------
Total $ 307,939,612 $ 308,831,763 $ 637,605,769 $ 643,561,201
=================== ================== =================== ===================
</TABLE>
The Company has a borrowing arrangement with the FHLBB whereby the Company
may borrow amounts determined by prescribed collateral levels. The Company
had a term advance outstanding under this agreement of $50,000,000 at
September 30, 1997. The interest rate on the outstanding advance at
September 30, 1997 was 5.58%, and the advance matures on September 10,
1999. The Company has the option to put the advance back to the FHLBB on
the 8th day of each month.
The Company receives federal tax deposits from clients as agent for the
Federal Reserve Bank and accumulates these deposits in the Treasury, Tax
and Loan account. The Federal Reserve Bank charges the Company interest at
the Federal Funds rate on such deposits. The Company had liabilities under
this agreement of $399,551 at December 31, 1996 and $786,793 at September
30, 1997. The interest rates on the outstanding balance at December 31,
1996 and September 30, 1997 were 5.10% and 5.41%, respectively.
8. COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF
SUBSIDIARY TRUST HOLDING JUNIOR SUBORDINATED DEFERRABLE INTEREST
DEBENTURES OF THE COMPANY
On January 31, 1997, a trust sponsored and wholly owned by the Company
issued $25,000,000 in 9.77% Trust Preferred Securities (the "Capital
Securities"), the proceeds of which were invested by the trust in the same
aggregate principal amount of the Company's newly issued 9.77% Junior
Subordinated Deferrable Interest Debentures due February 1, 2027 (the
"Junior Subordinated Debentures"). The $25,000,000 aggregate principal
amount of the Junior Subordinated Debentures represents the sole asset of
the Trust. The Company has guaranteed, on a subordinated basis,
distributions and other payments due on the Capital Securities (the
"Guarantee"). The Guarantee, when taken together with the Company's
obligations under (i) the Debentures; (ii) the indenture pursuant to which
the Junior Subordinated Debentures were issued; and (iii) the Amended and
Restated Declaration of Trust governing the Trust constitutes a full and
unconditional guarantee of the Trust's obligations under the Capital
Securities.
9. STOCKHOLDERS' EQUITY
The Company has authorized 1,000,000 shares of Preferred Stock, 650,000
shares of Class A Common Stock and 20,000,000 shares of Common Stock, all
with a par value of $.01 per share. At December 31, 1996 and September 30,
1997, there were no preferred shares issued or outstanding. There were
359,545 shares of Class A Common Stock and 6,084,767 shares of Common
Stock issued and outstanding at December 31, 1996. On September 19, 1997,
pursuant to the terms of the Certificate of
13
<PAGE>
9. STOCKHOLDERS' EQUITY (Continued)
Incorporation of the Company, all shares of the Company's Class A Common
Stock automatically converted into shares of the Company's Common Stock.
The terms of the Class A Common Stock were identical to the terms of the
Common Stock, except that the Common Stock receives only one vote per
share rather than the ten votes per share previously received by Class A
Common stock. As a result, there were 6,445,562 shares of Common Stock
issued and outstanding at September 30, 1997.
The Company has three stock option plans, the 1995 Stock Plan, the 1995
Non-Employee Director Stock Option Plan, and the 1997 Employee Stock
Purchase Plan.
Under the terms of the 1995 Stock Plan, the Company may grant options to
purchase up to a maximum of 560,000 shares of Common Stock to certain
employees, consultants, directors and officers. The options may be awarded
as incentive stock options (employees only), nonqualified stock options,
stock awards or opportunities to make direct purchases of stock.
In November 1995, the Company granted 114,000 shares of Common Stock to
certain officers of the Company under the 1995 Stock Plan. Of these
grants, 105,000 shares vest in sixty equal monthly installments, and the
remainder vest in five equal annual installments. Upon termination of
employment, the Company has the right to repurchase all unvested shares at
a price equal to the fair market value at the date of the grant. The
Company has recorded deferred compensation of $1,687,675 and $1,358,500 at
December 31, 1996 and September 30, 1997, respectively, pursuant to these
grants.
Under the terms of the 1995 Non-Employee Director Stock Option Plan, as
amended at the Company's 1997 Annual Meeting of Stockholders, the Company
may grant options to non-employee directors to purchase up to a maximum of
100,000 shares of Common Stock. Options to purchase 2,500 shares of Common
Stock were awarded at the date of initial public offering to each
director. Subsequently, any director elected or appointed after such date
will receive an automatic initial grant of options to purchase 2,500
shares upon becoming a director. Thereafter, each director will receive an
automatic grant of options to purchase 2,500 shares effective upon each
one-year anniversary of the date of such director's original grant.
Additionally, directors may elect to receive options to acquire shares of
the Company's Common Stock in lieu of such director's cash retainer. Any
election is subject to certain restrictions under the 1995 Non-Employee
Director Stock Option Plan. The number of shares of stock underlying the
option is equal to the quotient obtained by dividing the cash retainer by
the value of an option on the date of grant as determined using the
Black-Scholes model.
The exercise price of options under the 1995 Non-Employee Director Stock
Option Plan and the incentive options under the 1995 Stock Plan may not be
less than fair market value at the date of the grant. The exercise price
of the nonqualified options from the 1995 Stock Plan is determined by the
compensation committee of the Board of Directors. All options become
exercisable as specified at the date of the grant.
The 1997 Employee Stock Purchase Plan was adopted by the Board of
Directors on January 14, 1997 and subsequently approved by the
stockholders at the Company's 1997 Annual Meeting. The Company has
authorized the issuance of 140,000 shares of Common Stock pursuant to the
exercise of nontransferable options granted to participating employees.
The 1997 Purchase Plan permits eligible employees to purchase up to 1,000
shares of Common Stock per payment period, subject to limitations provided
by Section 423(b) of the Internal Revenue Code, through accumulated
payroll deductions. The purchases are made twice a year at a price equal
to the lesser of (i) 90% of the average market value of the Common Stock
on the first business day of the payment period, or (ii) 90% of the
average market value of the Common Stock on the last business day of the
payment period. Annual payment periods consist of two six-month periods,
January 1 through June 30 and July 1 through December 31.
14
<PAGE>
9. STOCKHOLDERS' EQUITY (Continued)
A summary of option activity under all plans is as follows:
<TABLE>
<CAPTION>
Number of Exercise Price
Shares Per Share
<S> <C> <C>
Outstanding at December 31, 1996 345,150 $16.50 - $26.125
Granted 23,324 $27.50 - $47.125
Exercised (1,550) $16.50
Expired/Canceled (375) $16.50
---------------
Outstanding at September 30, 1997 366,549 $16.50 - $47.125
===============
Exercisable at September 30, 1997 112,341
===============
</TABLE>
10. OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
LINES OF CREDIT - At September 30, 1997, the Company had commitments to
individuals under collateralized open lines of credit totaling
$101,355,000, against which $22,305,000 in loans were drawn. The credit
risk involved in issuing lines of credit is essentially the same as that
involved in extending loan facilities. The Company does not anticipate any
loss as a result of these lines of credit.
INTEREST-RATE CONTRACTS - Interest rate contracts involve an agreement
with a counterparty to exchange cash flows based on an underlying interest
rate index. Swap agreements involve the exchange of a series of interest
payments, either at a fixed or variable rate, based upon the notional
amount without the exchange of the underlying principal amount. The
Company's exposure from these interest rate contracts results from the
possibility that the other party may default on its contractual
obligation, so-called counterparty risk. Credit risk is limited to the
positive market value of the derivative financial instrument, which is
significantly less than the notional value. The Company was party to swap
agreements with aggregate notional amounts of $330,000,000 as of September
30, 1997. The effect of these agreements was to lengthen short-term
variable rate liabilities into longer-term fixed-rate liabilities. The
positive market value of the interest rate contracts was $38,000 at
September 30, 1997.
The Company does not purchase derivative financial instruments for trading
purposes. Interest rate swap agreements are matched with specific
financial instruments reported on the balance sheet and periodic cash
payments are accrued on a settlement basis.
The Company also enters into foreign exchange contracts, as discussed in
Note 12., with clients and simultaneously enters into matched positions
with other banks. These contracts are subject to market value fluctuations
in foreign currencies. Gains and losses from such fluctuations are netted
and recorded as an adjustment of asset administration fees.
11. COMMITMENTS AND CONTINGENCIES
Restrictions on Cash Balances - The Company is required to maintain
certain average cash reserve balances with the Federal Reserve Bank. The
reserve balance requirement as of September 30, 1997 was $21,837,000. In
addition, other cash balances in the amount of $1,562,000 were pledged to
secure clearings with a depository institution as of September 30, 1997.
15
<PAGE>
11. COMMITMENTS AND CONTINGENCIES (Continued)
Lease Commitments - Minimum future commitments on noncancelable operating
leases at September 30, 1997 were as follows:
<TABLE>
<CAPTION>
Bank
Fiscal Year Ending Premises Equipment
<S> <C> <C>
1997 $ 1,310,629 $ 477,072
1998 6,067,264 1,879,535
1999 6,096,544 1,543,606
2000 5,824,993 546,200
2001 and beyond 35,704,420 -
</TABLE>
Total rent expense was $4,316,000 and $4,568,000 for the nine months ended
September 30, 1996 and 1997, respectively.
On February 1, 1996, the Company entered into a five year facility
management agreement with a third party provider of duplicating and
delivery services. Under the terms of the agreement, the Company agreed to
pay certain minimum annual charges, subject to increases due to certain
usage thresholds. Service expense under this contract was $167,000 and
$325,000 for the nine months ended September 30, 1996 and 1997,
respectively.
Contingencies - The Company provides global custody, multicurrency
accounting, institutional transfer agency, performance measurement,
foreign exchange, securities lending, mutual fund administration and
investment advisory services to a variety of financial asset managers,
including mutual fund complexes, investment advisors, banks and insurance
companies. Assets under custody and management, held by the Company in a
fiduciary capacity, are not included in the consolidated balance sheets
since such items are not assets of the Company. Management conducts
regular reviews of its fiduciary responsibilities and considers the
results in preparing its consolidated financial statements. In the opinion
of management, there are no contingent liabilities at September 30, 1997
that are material to the consolidated financial position or results of
operations of the Company.
12. FOREIGN EXCHANGE CONTRACTS
The Company enters into foreign exchange contracts with clients and
simultaneously enters into matched positions with another bank. These
contracts are subject to market value fluctuations in foreign currencies.
Gains and losses from such fluctuations are netted and recorded as an
adjustment of asset administration fees. A summary of foreign exchange
contracts outstanding at December 31, 1996 and September 30, 1997 is as
follows (in thousands):
16
<PAGE>
<TABLE>
<CAPTION>
December 31, 1996 September 30, 1997
-------------------------------------------------- ----------------------------------------------
Unrealized Unrealized
Currency Purchases Sales Gain/Loss Purchases Sales Gain/Loss
<S> <C> <C> <C> <C> <C> <C>
Germany (Mark) $ 2,118 $ 2,118 - $ 49,361 $ 49,361 -
Japan (Yen) 40,828 40,828 - 16,550 16,550 -
United Kingdom (Pound) 1,873 1,873 - 13,304 13,304 -
France (Franc) 1,093 1,093 - 3,140 3,140 -
Italy (Lira) 51 51 - 3,064 3,064 -
Switzerland (Franc) - - - 2,511 2,511 -
Singapore (Dollar) 331 331 - 2,202 2,202 -
New Zealand (Dollar) 147 147 - 1,845 1,845 -
Netherlands (Guilder) 918 918 - 1,650 1,650 -
Australia (Dollar) 102 102 - 1,634 1,634 -
Philippines (Peso) 78 78 - 1,297 1,297 -
Hong Kong (Dollar) 1,807 1,807 - 1,251 1,251 -
Malaysia (Ringgit) 6,009 6,009 - 1,109 1,109 -
Other currencies 1,791 1,791 - 4,154 4,154 -
------------- ----------- -------------- ------------- -------------- -----------
$ 57,146 $ 57,146 - $ 103,072 $ 103,072 -
============= =========== ============== ============= ============== ===========
</TABLE>
The maturity of contracts outstanding as of September 30, 1997 is as
follows:
<TABLE>
<CAPTION>
Maturity Purchases Sales
<S> <C> <C>
October 1997 $ 83,305 $ 83,305
November 1997 1,177 1,177
December 1997 13,590 13,590
February 1998 5,000 5,000
</TABLE>
13. REGULATORY MATTERS
The Company and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory - and possibly
additional discretionary - actions by regulators that, if undertaken,
could have a direct material effect on the Company's consolidated
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's
assets, liabilities, and certain off-balance sheet items as calculated
under regulatory accounting practices. The Bank's capital amounts and
classification are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors.
17
<PAGE>
13. REGULATORY MATTERS (CONTINUED)
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the
table below) of total and Tier 1 capital (as defined in the regulations)
to risk-weighted assets (as defined), and of Tier 1 capital (as defined)
to average assets (as defined). Management believes, as of September 30,
1997, that the Bank meets all capital adequacy requirements to which it is
subject.
As of December 21, 1996, the most recent notification from the Federal
Deposit Insurance Corporation categorized the Bank as well capitalized
under the regulatory framework for prompt corrective action. To be
categorized as well capitalized the Bank must maintain minimum total
risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in
the following table. There are no conditions or events since that
notification that management believes have changed the institution's
category. The following table presents the capital ratios for the Bank.
The capital ratios for the Company are substantially similar to those of
the Bank.
<TABLE>
<CAPTION>
To Be Well
Minimum Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
------------------------------- ------------------------------ --------------------------------
Amount Ratio Amount Ratio Amount Ratio
----------------- ---------- ----------------- --------- ----------------- -----------
<S> <C> <C> <C> <C> <C> <C>
As of September 30, 1997:
Total Capital
(to Risk Weighted Assets) $ 92,883,487 29.89% $ 24,858,347 8.00% $ 31,072,934 10.00%
Tier I Capital
(to Risk Weighted Assets) $ 92,783,487 29.86% $ 12,429,173 4.00% $ 18,643,760 6.00%
Tier I Capital
(to Average Assets) $ 92,783,487 7.03% $ 52,757,393 4.00% $ 65,946,741 5.00%
As of December 31, 1996:
Total Capital
(to Risk Weighted Assets) $ 60,818,485 24.71% $ 19,691,528 8.00% $ 24,614,410 10.00%
Tier I Capital
(to Risk Weighted Assets) $ 60,718,485 24.67% $ 9,845,764 4.00% $ 14,768,646 6.00%
Tier I Capital
(to Average Assets) $ 60,718,485 9.65% $ 25,155,710 4.00% $ 31,444,637 5.00%
</TABLE>
Payment of dividends by the Bank is subject to provisions of the
Massachusetts banking laws which provide that dividends may be paid out of
net profits provided (i) capital stock and surplus remain unimpaired, (ii)
dividend and retirement fund requirements of any preferred stock have been
met, (iii) surplus equals or exceeds capital stock, and (iv) there are
deducted from net profits any losses and bad debts, as defined in such
laws, in excess of reserves specifically established therefore.
18
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
The following discussion and analysis of the financial condition and
results of operations of the Company should be read in conjunction with the
Company's Condensed Consolidated Financial Statements and related notes which
are included elsewhere in this Report. The Company, through its wholly owned
subsidiary, Investors Bank & Trust Company, provides global custody,
multicurrency accounting, institutional transfer agency, performance
measurement, foreign exchange, securities lending, mutual fund administration
and investment advisory services to a variety of financial asset managers,
including 50 mutual fund complexes, investment advisors, banks and insurance
companies. Currently, the Company provides financial asset administration
services for assets totaling approximately $148 billion, including approximately
$9.9 billion of foreign assets. The Company also engages in private banking
transactions, including secured lending and deposit accounts.
In November 1996, the Bank executed agreements with the Merrimac Master
Portfolio and the Merrimac Funds, newly formed master-feeder investment
companies (the "Funds"), pursuant to which the Company has agreed to act as
investment advisor to the Funds. At the same time, the Company engaged Aeltus
Investment Management, Inc. to act as sub-advisor to manage the investments of
the Funds. In addition to acting as advisor to the Funds, the Bank has entered
into agreements to provide custody, fund accounting, administration, transfer
agency and certain other related services to the Funds. Currently, the Funds
have two operating master funds, the Merrimac Cash Portfolio and the Merrimac
Treasury Portfolio, and three operating feeder funds, the Merrimac Cash Fund,
the Merrimac Global Cash Fund and the Merrimac Treasury Fund. The Merrimac
feeder funds offer shares only to institutions and other "accredited investors"
(as that term is defined in Rule 501(a) under the Securities Act of 1933) and
invest all of their assets in the Merrimac master funds. The Funds may add
additional feeder funds and master funds in the future.
On January 31, 1997, the Company completed the issuance and sale of
$25,000,000 in 9.77% Capital Securities. The Capital Securities were issued by
Investors Capital Trust I, a Delaware statutory business trust sponsored by the
Company. The capital raised in the offering, along with existing capital and
earnings generated in the future, will be used to support the Company's balance
sheet growth. The Capital Securities qualify as Tier 1 capital under the capital
guidelines of the Federal Reserve. Under current Federal Reserve guidelines, no
more than 25% of the Company's Tier 1 capital may comprise Capital Securities
and other capital securities and cumulative preferred stock of the Company.
The Company derives its revenues from financial asset administration
services and private banking transactions. Although interest income and
noninterest income are reported separately for financial statement presentation
purposes, the Company's clients view the pricing of the Company's asset
administration and banking service offerings on a bundled basis. In establishing
a fee structure for a specific client, management analyzes the expected revenue
and related expenses, as opposed to separately analyzing fee income and interest
income and related expenses for each from such relationship. Accordingly,
management believes net operating revenue (net interest income plus noninterest
income) and net income are meaningful measures of financial results. Revenue
generated from asset administration and other fees and interest income increased
40% from $53,728,000 in the first nine months of 1996 to $75,434,000 in the
first nine months of 1997.
Noninterest income consists primarily of fees for financial asset
administration and is principally derived from custody, multicurrency
accounting, transfer agency and administration services for financial asset
managers and the assets they control. The Company's clients pay fees based on
the volume of assets under custody, the number of securities held and portfolio
transactions, income collected and whether other value-added services such as
foreign exchange, securities lending and performance measurement are needed.
Asset-based fees are usually charged on a sliding scale. As such, when the
assets in a portfolio under custody grow as a result of changes in market values
or cash inflows, the Company's fees may be a smaller percentage of those assets.
Fees for individually managed accounts, such as custodial, trust and portfolio
accounting services for individuals, investment advisors, private trustees,
financial planners, other banks and fiduciaries, and other institutions are also
included in noninterest income.
19
<PAGE>
Net interest income represents the difference between income generated
from interest-earning assets and expense on interest-bearing liabilities.
Interest-bearing liabilities are generated by the Company's clients who, in the
course of their financial asset management, generate cash balances which they
deposit on a short-term basis with the Company. The Company invests these cash
balances and remits a portion of the earnings on these investments to its
clients. The Company's share of earnings from these investments is viewed as
part of the total package of compensation paid to the Company from its clients
for performing asset administration services.
Certain Factors That May Affect Future Results
From time to time, information provided by the Company, statements made
by its employees or information included in its filings with the Securities and
Exchange Commission (including this Form 10-Q) may contain statements which are
not historical facts, so-called "forward-looking statements," and which involve
risks and uncertainties. The Company's actual future results may differ
significantly from those stated in any forward-looking statements. Factors that
may cause such differences include, but are not limited to, the factors
discussed below. Each of these factors, and others, are discussed from time to
time in the Company's filings with the Securities and Exchange Commission.
The Company's future results may be subject to substantial risks and
uncertainties. Because certain fees charged by the Company for its services,
including fees for the provision of investment advisory and other services to
the Merrimac Funds and the Merrimac Master Portfolios, are based on the market
values of assets processed, such fees and the Company's quarterly and annual
operating results are sensitive to changes in interest rates, declines in stock
market values, and investors seeking alternatives to the investment offerings of
the Company's clients. Also, the Company's interest-related services, along with
the market value of the Company's investments, may be adversely affected by
rapid changes in interest rates. In addition, many of the Company's client
engagements are, and in the future are likely to continue to be, terminable upon
60 days notice.
Also, the Company relies on certain intellectual property protections
to preserve its intellectual property rights. Any invalidation of the Company's
intellectual property rights or lengthy and expensive defense of those rights
could have a material adverse affect on the Company. The segment of the
financial services industry in which the Company is engaged is extremely
competitive. Certain current and potential competitors of the Company are more
established and benefit from greater market recognition and have substantially
greater financial, development and marketing resources than the Company.
The Company's quarterly and annual operating results are affected by a
wide variety of factors that could materially adversely affect revenues and
profitability, including: the timing of the commencement or termination of
client engagements, the rate of net inflows and outflows of investor funds in
the debt and equity-based investment vehicles offered by the Company's clients,
the introduction and market acceptance of new services by the Company and
changes or anticipated changes in economic conditions. Because the Company's
operating expenses are relatively fixed, any unanticipated shortfall in revenues
in a quarter may have an adverse impact on the Company's results of operations
for that quarter. As a result of the foregoing and other factors, the Company
may experience material fluctuations in future operating results on a quarterly
or annual basis which could materially and adversely affect its business,
financial condition, operating results and stock price.
20
<PAGE>
Statement of Operations
Comparison of Operating Results for the Nine Months Ended September 30, 1997 and
1996
Noninterest Income
Noninterest income increased $15,215,000 to $56,291,000 for the nine
months ended September 30, 1997 from $41,076,000 for the nine months ended
September 30, 1996. Noninterest income consists of the following items:
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------
1996 1997 CHANGE
------ ------ --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Asset administration fees $40,662 $55,649 37%
Computer service fees 365 351 (4)
Other operating income 57 249 337
Gain (Loss) on sale of security
available for sale (8) 42 625
------- -------
Total Noninterest Income $41,076 $56,291 37%
======= =======
</TABLE>
Asset administration fees increased $14,987,000 to $55,649,000 for the
nine months ended September 30, 1997 compared to $40,662,000 for the nine months
ended September 30, 1996. The Company earns such fees on assets processed by the
Company on behalf of a variety of financial asset managers. Assets processed is
the total dollar value of financial assets on the reported date for which the
Company provides one or more of the following services: custody, multicurrency
accounting, institutional transfer agency, performance measurement, foreign
exchange, securities lending, mutual fund administration and investment advisory
services. Total assets processed increased to $148 billion at September 30, 1997
from $111 billion at September 30, 1996. Of this $37 billion net increase in
assets processed, approximately 23% of the increase reflects assets processed
for new clients, and the remainder of the of the increase reflects growth of
assets processed for existing clients. The largest component of asset
administration fees is asset-based fees, which increased between periods due to
the increase in assets processed. Another significant portion of the increase in
asset administration fees resulted from the Company's success in marketing
ancillary services such as securities lending and foreign exchange.
Computer service fees consist of amounts charged by the Company for
data processing services related to individual accounts. Other operating income
consists of dividends received relating to the FHLBB stock investment and
miscellaneous transaction-oriented private banking fees. The increase in other
operating income was due entirely to the Company's increased investment in FHLBB
stock.
21
<PAGE>
Operating Expenses
Total operating expenses increased by $15,473,000 to $60,280,000 for
the nine months ended September 30, 1997 compared to $44,807,000 for the nine
months ended September 30, 1996. The components of operating expenses were as
follows:
<TABLE>
<CAPTION>
For the Nine Months Ended
September 30,
------------------------------- ----------------
1996 1997 Change
------------- ------------- ----------------
(Dollars in thousands)
<S> <C> <C> <C>
Compensation $ 23,436 $ 31,833 36 %
Pension and other employee benefits 3,905 4,711 21
Occupancy 3,243 3,044 (6)
Equipment 3,991 5,043 26
Insurance 746 551 (26)
Subcustodian fees 2,930 4,310 47
Depreciation and amortization 1,095 1,416 29
Professional fees 1,627 2,371 46
Travel and sales promotion 699 1,140 63
Other operating expenses 3,135 5,861 87
------------- -------------
Total Operating Expenses $ 44,807 $ 60,280 35 %
============= =============
</TABLE>
Compensation of officers and employees increased by $8,397,000 or 36%
from period to period due to several factors. The average number of employees
increased 29% to 914 during the nine months ended September 30, 1997 from 711
during the same period in 1996. This increase relates primarily to the increase
in new client relationships and to the expansion of existing client
relationships during the period. In addition, compensation expense related to
the Company's management incentive plan increased because of the increase in
earnings in the first nine months of 1997 compared to the first nine months of
1996. The remainder of the increase in compensation expense resulted from salary
increases.
Pension and other employee benefits increased to $4,711,000 for the
nine months ended September 30, 1997 from $3,905,000 for the same period in
1996. The 21% increase was due principally to increased payroll taxes
attributable to the increase in compensation expense. In addition, the Company
recognized costs associated with establishing a defined benefit retirement plan
for the Company's Dublin subsidiaries, of which costs approximately $90,000
related to employees' prior years of service.
Equipment expense consists of operating lease payments for
microcomputers and fees charged by Electronic Data Systems for mainframe data
processing and data storage services provided to the Company. These expenses
vary with the level of assets processed by the Company. The $1,052,000 increase
between periods is due principally to the growth in assets processed.
Insurance expense decreased 26% from $746,000 for the nine months ended
September 30, 1996 to $551,000 for the nine months ended September 30, 1997 due
to the renegotiation, in May 1996, of the Company's premiums and coverage for
errors and omissions liability, directors and officers liability and blanket
bond.
Subcustodian expense increased $1,380,000 to $4,310,000 for the nine
months ended September 30, 1997 from $2,930,000 for the nine months ended
September 30, 1996. This increase resulted primarily from the increase in
foreign assets processed, which are typically subject to higher subcustodian
fees than domestic assets processed, from $8.5 billion at September 30, 1996 to
$9.9 billion at September 30, 1997, and from the movement by clients into
emerging markets with higher cost structures.
Depreciation and amortization expense increased $321,000 between
periods due to purchases of furniture, equipment, and capitalized software in
late 1996 and in 1997.
22
<PAGE>
Professional fees increased $744,000 to $2,371,000 for the nine months
ended September 30, 1997 from $1,627,000 for the nine months ended September 30,
1996. This increase results primarily from the Company's increased use of
contract programmers to perform systems development work.
Travel and sales promotion expense increased $441,000 to $1,140,000 for
the nine months ended September 30, 1997 from $699,000 for the nine months ended
September 30, 1996 due to increased travel to the foreign subsidiaries.
Other operating expenses include fees for daily market pricing data,
telephone and office supplies expense, recruiting costs, and temporary help.
These expenses increased $2,726,000 to $5,861,000 for the nine months ended
September 30, 1997 from $3,135,000 for the nine months ended September 30, 1996.
Fees for daily market pricing data, which vary with the level of assets
processed, increased by $159,000 during the period. Other expenses such as
telephone and office supplies vary with staffing levels. Expenses relating to
these items represented $591,000 of the increase. Recruiting costs and costs of
temporary help accounted for $664,000 of the increase; this increase relates to
the tight labor market caused by a period of low unemployment in Massachusetts
during 1997. Additionally, $325,000 of the increase related to the Company's
decision to outsource its mailroom and photocopy facility in February, 1996;
expenses related to these services were included in compensation expense prior
to that time. Approximately $356,000 of the increase relates to annual
maintenance fees on software used to generate automated financial statements for
the Company's clients as part of its expanded mutual fund administration
services.
Net Interest Income
Net interest income is affected by the volume and mix of assets and
liabilities, and the movement and level of interest rates. The table below
presents the changes in net interest income resulting from changes in the volume
of interest-earning assets or interest-bearing liabilities or changes in
interest rates for the nine months ended September 30, 1997 compared to the same
period in 1996.
<TABLE>
<CAPTION>
Change Change
Due to Due to
Volume Rate Net
------------ ------------ -----------
(Dollars in thousands)
<S> <C> <C> <C>
Interest-earning assets
Fed funds sold and
interest-earning deposits $ - $ (27) $ (27)
Investment securities 26,668 (112) 26,556
Loans 527 (207) 320
------------ ------------ -----------
Total interest-earning assets 27,195 (346) 26,849
------------ ------------ -----------
Interest-bearing liabilities
Deposits 7,041 1,258 8,299
Borrowings 11,893 216 12,109
------------ ------------ -----------
Total interest-bearing liabilities 18,934 1,474 20,408
------------ ------------ -----------
Change in net interest income $ 8,261 $ (1,820) $ 6,441
============ ============ ===========
</TABLE>
Net interest income increased $6,441,000 or 51% to $19,143,000 for the
nine months ended September 30, 1997 from $12,702,000 for the same period in
1996. This net increase resulted from an increase in interest income of
$26,849,000 offset in part by an increase in interest expense of $20,408,000.
The net impact of the above changes was a 96 basis point decrease in net
interest margin.
The increase in interest income resulted primarily from a higher level
of interest earning assets. The Company's average assets for the nine months
ended September 30, 1997 increased $582,446,000 or 105% compared to the same
period in 1996. This growth primarily resulted from an increase in average
interest earning assets of $567,322,000.
23
<PAGE>
Interest expense increased due primarily to a $516,668,000 increase in
average deposits and short term borrowings for the nine months ended September
30, 1997 compared to the same period in 1996. Also, to a lesser extent, interest
expense increased due to an increase in the average interest rate paid by the
Company from 4.81% to 5.09% during the period.
Income Taxes
The Company's earnings were taxed on the federal level at 35% for the
1997 and 1996 periods. State taxes on the gross earnings from the Company's
portfolio of investment securities, held by a wholly-owned subsidiary, were
assessed at the tax rate for Massachusetts securities corporations of 1.32%.
State taxes on the remainder of the Company's taxable income were assessed at
the tax rate for Massachusetts banks of 11.76% in 1996 and 11.32% in 1997. The
provision for income taxes for the nine months ended September 30, 1997
increased by $2,022,000 over the same period in 1996. The overall effective tax
rate decreased to 36.0% for the nine months ended September 30, 1997, from 38.5%
for the same period in 1996. The decrease in the effective tax rate is due to
the Company's investment in municipal securities in the first quarter of 1997.
Statement of Operations
Comparison of Operating Results for the Quarters Ended September 30, 1997 and
1996
Noninterest Income
Noninterest income increased $5,948,000 to $19,982,000 for the quarter
ended September 30, 1997 from $14,034,000 for the quarter ended September 30,
1996. Noninterest income consists of the following items:
<TABLE>
<CAPTION>
For the Quarters Ended
September 30,
------------------------------ -------
1996 1997 Change
------------ ------------- -------
(Dollars in thousands)
<S> <C> <C> <C>
Asset administration fees $ 13,909 $ 19,725 42%
Computer service fees 119 117 (2)
Other operating income 21 105 400
Gain on sale of security
available for sale (15) 35 333
------------ -------------
Total Noninterest Income $ 14,034 $ 19,982 42%
============ =============
</TABLE>
Asset administration fees increased $5,816,000 to $19,725,000 for the
three months ended September 30, 1997 compared to $13,909,000 for the three
months ended September 30, 1996. Total assets processed increased to $148
billion at September 30, 1997 from $111 billion at September 30, 1996. Of this
$37 billion net increase in assets processed, approximately 23% of the increase
reflects assets processed for new clients, and the remainder of the of the
increase reflects growth of assets processed for existing clients. The largest
component of asset administration fees is asset-based fees, which increased
between periods due to the increase in assets processed. Another significant
portion of the increase in asset administration fees resulted from the Company's
success in marketing ancillary services such as securities lending and foreign
exchange.
24
<PAGE>
Operating Expenses
Total operating expenses increased by $5,496,000 to $20,873,000 for the
quarter ended September 30, 1997 compared to $15,377,000 for the quarter ended
September 30, 1996. The components of operating expenses were as follows:
<TABLE>
<CAPTION>
For the Quarters Ended
September 30,
------------------------------ ----------
1996 1997 Change
------------- ------------ ----------
(Dollars in thousands)
<S> <C> <C> <C>
Compensation $ 8,146 $ 11,291 39 %
Pension and other employee benefits 1,327 1,582 19
Occupancy 1,029 835 (19)
Equipment 1,355 1,659 22
Insurance 158 185 17
Subcustodian fees 1,120 1,559 39
Depreciation and amortization 403 546 35
Professional fees 597 616 3
Travel and sales promotion 206 360 75
Other operating expenses 1,036 2,240 116
------------- ------------
Total Operating Expenses $ 15,377 $ 20,873 36 %
============= ============
</TABLE>
Compensation of officers and employees increased by $3,145,000 or 39%
from period to period due to several factors. The average number of employees
increased 35% to 994 during the quarter ended September 30, 1997 from 737 during
the same period in 1996. This increase relates primarily to the increase in new
client relationships and to the expansion of existing client relationships
during the period. The remainder of the increase in compensation expense
resulted from salary increases.
Pension and other employee benefits increased to $1,582,000 for the
quarter ended September 30, 1997 from $1,327,000 for the same period in 1996.
The 19% increase was due principally to increased payroll taxes attributable to
the increase in compensation expense.
Occupancy expense decreased by $194,000 to $835,000 for the quarter
ended September 30, 1997 from $1,029,000 during the same period in 1996. The
decrease was non-recurring, and related to the Company's office space
consolidation in the 1997 period.
Equipment expense varies with the level of assets processed by the
Company. The $304,000 increase between periods is due principally to the growth
in assets processed.
Insurance expense increased $27,000 from $158,000 for the quarter ended
September 30, 1996 to $185,000 for the quarter ended September 30, 1997 due to
the addition of certain liability coverage during 1997.
Subcustodian expense increased $439,000 to $1,559,000 for the quarter
ended September 30, 1997 from $1,120,000 for the quarter ended September 30,
1996. This increase resulted from the increase in foreign assets processed,
which are typically subject to higher subcustodian fees than domestic assets
processed, from $8.5 billion at September 30, 1996 to $9.9 billion at September
30, 1997, and from the movement by clients into emerging markets with higher
cost structures.
Depreciation and amortization expense increased $143,000 between
periods due to purchases of furniture, equipment, and capitalized software in
late 1996 and in 1997.
Travel and sales promotion expense increased $154,000 to $360,000 for
the quarter ended September 30, 1997 from $206,000 for the quarter ended
September 30, 1996 due to increased travel to the foreign subsidiaries.
25
<PAGE>
Other operating expenses increased $1,204,000 to $2,240,000 for the
quarter ended September 30, 1997 from $1,036,000 for the quarter ended September
30, 1996. Fees for daily market pricing data, which vary with the level of
assets processed, increased by $41,000 during the period. Other expenses such as
telephone and office supplies vary with staffing levels. Expenses relating to
these items represented $305,000 of the increase. Recruiting costs accounted for
$278,000 of the increase; this increase relates to the tight labor market caused
by a period of low unemployment in Massachusetts during the third quarter of
1997. Additionally, $112,000 of the increase related to the Company's decision
to outsource its mailroom and photocopy facility in February, 1996; expenses
related to these services were included in compensation prior to that time.
Approximately $119,000 of the increase relates to annual maintenance fees on
software used to generate automated financial statements for the Company's
clients as part of its expanded mutual fund administration services.
Net Interest Income
Net interest income is affected by the volume and mix of assets and
liabilities, and the movement and level of interest rates. The table below
presents the changes in net interest income resulting from changes in the volume
of interest-earning assets or interest-bearing liabilities or changes in
interest rates for the quarter ended September 30, 1997 compared to the same
period in 1996.
<TABLE>
<CAPTION>
Change Change
Due to Due to
Volume Rate Net
------------ ------------ -----------
(Dollars in thousands)
<S> <C> <C> <C>
Interest-earning assets
Fed funds sold and
interest-earning deposits $ (179) $ (21) $ (200)
Investment securities 9,147 (168) 8,979
Loans 345 (367) (22)
------------ ------------ -----------
Total interest-earning assets 9,313 (556) 8,757
------------ ------------ -----------
Interest-bearing liabilities
Deposits 964 945 1,909
Borrowings 5,227 222 5,449
------------ ------------ -----------
Total interest-bearing liabilities 6,191 1,167 7,358
------------ ------------ -----------
Change in net interest income $ 3,122 $ (1,723) $ 1,399
============ ============ ===========
</TABLE>
Net interest income increased $1,399,000 or 30% to $6,097,000 for the
quarter ended September 30, 1997 from $4,698,000 for the same period in 1996.
This net increase resulted from an increase in interest income of $8,757,000
offset in part by an increase in interest expense of $7,358,000. The net impact
of the above changes was a 90 basis point decrease in net interest margin.
The increase in interest income resulted primarily from a higher level
of interest earning assets. The Company's average assets for the quarter ended
September 30, 1997 increased $582,943,000 or 83% compared to the same period in
1996. This growth primarily resulted from an increase in average interest
earning assets of $565,140,000.
Interest expense increased due primarily to a $508,236,000 increase in
average deposits and short term borrowings for the quarter ended September 30,
1997 compared to the same period in 1996. Also, to a lesser extent, interest
expense increased due to an increase in the average interest rate paid by the
Company from 4.90% to 5.36% during the period.
26
<PAGE>
Income Taxes
The Company's earnings were taxed on the federal level at 35% for the
1997 and 1996 periods. State taxes on the gross earnings from the Company's
portfolio of investment securities, held by a wholly-owned subsidiary, were
assessed at the tax rate for Massachusetts securities corporations of 1.32%.
State taxes on the remainder of the Company's taxable income were assessed at
the tax rate for Massachusetts banks of 11.76% in 1996 and 11.32% in 1997. The
provision for income taxes for the quarter ended September 30, 1997 increased by
$586,000 over the same period in 1996. The overall effective tax rate decreased
to 36.0% for the quarter ended September 30, 1997, from 38.4% for the same
period in 1996. The decrease in the effective tax rate is due to the Company's
investment in municipal securities in the first quarter of 1997.
FINANCIAL CONDITION
Investment Portfolio
The following table summarizes the Company's investment portfolio for the dates
indicated:
<TABLE>
<CAPTION>
December 31, September 30,
1996 1997
----------------- ------------------
(Dollars in thousands)
<S> <C> <C>
Securities held to maturity:
State and political subdivisions $ - $ 35,081
Mortgage-backed securities 414,665 575,332
Federal Agency securities 37,517 131,251
Foreign government securities 7,828 7,784
----------------- ------------------
Total securities held to maturity $ 460,010 $ 749,448
================= ==================
Securities available for sale:
U.S. Treasury securities $ 40,259 $ 35,146
Mortgage-backed securities 230,862 425,136
----------------- ------------------
Total securities available for sale $ 271,121 $ 460,282
================= ==================
</TABLE>
The investment portfolio is used to invest depositors' funds and
provide a secondary source of earnings for the Company. In addition, the Company
uses the investment portfolio to secure open positions at securities clearing
institutions in connection with its custody services. The portfolio is composed
of U.S. Treasury securities, mortgage-backed securities issued by the Federal
National Mortgage Association ("FNMA" or "Fannie Mae") and the Federal Home Loan
Mortgage Corporation ("FHLMC" or "Freddie Mac"), and Federal Agency callable
bonds issued by FHLMC and the Federal Home Loan Bank of Boston (the "FHLBB"),
municipal securities, and foreign government bonds issued by the Canadian
provinces of Ontario and Manitoba.
The Company invests in mortgage-backed securities and Federal Agency
callable bonds to supplement its portfolio of U.S. Treasury securities and
increase the total return of the investment portfolio. Mortgage-backed
securities generally have a higher yield than U.S. Treasury securities due to
credit risk and prepayment risk. Credit risk results from the possibility that a
loss may occur if a counterparty is unable to meet the terms of a contract.
Prepayment risk results from the possibility that changes in interest rates may
cause mortgage securities to be paid off prior to their maturity dates. Federal
Agency callable bonds generally have a higher yield than U.S. Treasury
securities due to credit risk and call risk. Credit risk results from the
possibility that the Federal Agency issuing the bonds may be unable to meet the
terms of the bond. Call risk results from the possibility that fluctuating
interest rates and other factors may result in the exercise of the call option
by the Federal Agency. Credit risk related to mortgage-backed securities and
Federal Agency callable bonds is substantially reduced by payment guarantees and
credit enhancements.
27
<PAGE>
The Company invests in municipal securities to generate stable, tax
advantaged income. Municipal securities generally have lower stated yields than
Federal Agency and U.S. Treasury securities, but the after-tax yields are
comparable. Municipal securities are subject to credit risk.
The Company invests in foreign government bonds in order to generate
foreign source income to maximize the use of the foreign tax credit. The foreign
government bonds are denominated in U.S. dollars to avoid foreign currency risk.
These bonds are subject to credit risk.
The book value and weighted average yield of the Company's securities
held to maturity at September 30, 1997, by effective maturity, are reflected in
the following table.
<TABLE>
<CAPTION>
Weighted
Book Average
Value Yield
-------------- ------------
<S> <C> <C>
Due within one year $ -
Due from one to five years 234,546 6.64%
Due from five years up to ten years 298,174 6.67%
Due after ten years 216,728 6.28%
--------------
Total securities held to maturity $ 749,448
==============
</TABLE>
The book value and weighted average yield of the Company's securities available
for sale at September 30, 1997, by effective maturity, are reflected in the
following table.
<TABLE>
<CAPTION>
Weighted
Book Average
Value Yield
-------------- ------------
<S> <C> <C>
Due within one year $ 25,102 6.11%
Due from one to five years 289,834 6.60%
Due from five years up to ten years 145,346 6.77%
--------------
Total securities available for sale $ 460,282
==============
</TABLE>
The maturities of mortgage backed securities have been allocated on the above
tables as described in Note 3 of the Notes to Condensed Consolidated Financial
Statements.
Loan Portfolio
The following table summarizes the Company's loan portfolio for the
dates indicated:
<TABLE>
<CAPTION>
December 31, September 30,
1996 1997
--------------- ----------------
(Dollars in thousands)
<S> <C> <C>
Loans to individuals $ 23,449 $ 19,919
Loans to not-for-profit organizations 13 13
Loans to mutual funds 42,875 27,572
--------------- ----------------
66,337 47,504
Less: allowance for loan losses (100) (100)
--------------- ----------------
Net loans $ 66,237 $ 47,404
Floating rate $ 66,324 $ 47,491
Fixed rate 13 13
--------------- ----------------
$ 66,337 $ 47,504
=============== ================
</TABLE>
28
<PAGE>
Virtually all loans to individually managed account customers are
written on a demand basis, bear variable interest rates tied to the prime rate
and are fully secured by liquid collateral, primarily freely tradable securities
held in custody by the Company for the borrower. Since December 1995, the
Company has entered into agreements to provide up to an aggregate of $40 million
under lines of credit to mutual fund clients. These unsecured lines of credit
may, in the event of a default, be collateralized at the Company's option by
securities held in custody by the Company for those mutual funds. Loans to
mutual funds also include advances by the Company to certain mutual fund clients
pursuant to the terms of the custody agreements between the Company and those
clients. The advances facilitate securities transactions and redemptions
involving those mutual funds and are fully collateralized by liquid collateral,
primarily freely tradable securities held in custody by the Company for those
mutual funds.
At September 30, 1997, the Company's only lending concentrations which
exceeded 10% of total loans were revolving lines of credit to mutual fund
clients as discussed above. These loans were made in the ordinary course of
business on the same terms and conditions prevailing at the time for comparable
transactions. The Company also had a lending relationship at September 30, 1997
with Landon T. Clay, former Chairman of the Board of Eaton Vance and a principal
stockholder of the Company, representing two loans aggregating $1,200,000 in
principal amount. These loans to Mr. Clay were made in the ordinary course of
business on the same terms and conditions prevailing at the time for comparable
transactions with unrelated third parties. Each of these loans was secured with
non-voting common stock of Eaton Vance.
The Company's credit loss experience has been excellent. There have
been no loan chargeoffs in the history of the Company. It is the Company's
policy to place a loan on non-accrual status when either principal or interest
becomes 60 days past due and the loan's collateral is not sufficient to cover
both principal and accrued interest. As of September 30, 1997, there were no
past due loans, troubled debt restructurings, or any loans on nonaccrual status.
Although virtually all of the Company's loans are fully collateralized with
freely tradable securities, management recognizes some credit risk inherent in
the loan portfolio, and has recorded an allowance for loan losses of
approximately $100,000 at September 30, 1997. This amount is not allocated to
any particular loan, but is intended to absorb any risk of loss inherent in the
loan portfolio. Management actively monitors the loan portfolio and the
underlying collateral and regularly assesses the adequacy of the allowance for
loan losses.
INTEREST RATE SENSITIVITY
Interest rate risk arises when an earning asset matures or when its
rate of interest changes in a time frame different from that of the supporting
interest-bearing liability. By seeking to minimize the difference between the
amount of earning assets and the amount of interest-bearing liabilities that
could change interest rates in the same time frame, the Company attempts to
reduce the risk of significant adverse effects on net interest income caused by
interest rate changes. The Company does not attempt to match each earning asset
with a specific interest-bearing liability. Instead, as shown in the table
below, it aggregates all of its earning assets and interest-bearing liabilities
to determine the difference between these in specific time frames. This
difference is known as the rate-sensitivity gap. A positive gap indicates that
more earning assets than interest-bearing liabilities mature in a time frame,
and a negative gap indicates the opposite. Maintaining a balanced position will
reduce risk associated with interest rate changes, but it will not guarantee a
stable interest rate spread because the various rates within a time frame may
change by differing amounts and change in different directions.
The Company seeks to manage interest rate risk by investment portfolio
actions designed to address the interest rate sensitivity of asset cash flows in
relation to liability cash flows. Portfolio actions used to manage interest rate
risk include managing the effective duration of the portfolio securities and
utilizing interest rate floors and interest rate swaps. Interest rate swaps
involve elements of credit and market risk which are not reflected in the
Company's consolidated financial statements. Such instruments are entered into
for hedging (as opposed to investment or speculative) purposes. There can be no
assurance that such portfolio actions will adequately limit interest rate risk.
29
<PAGE>
The following table presents the repricing schedule for the Company's interest
earning assets and interest bearing liabilities at September 30, 1997:
<TABLE>
<CAPTION>
Within Over Three Over Six Over One
Three to Six to Twelve Year to Over Five
Months Months Months Five Years Years Total
-------------- ------------ ------------- ------------- ------------- --------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest earning assets (1):
Investment securities (2) $ 516,963 $ 193,280 $ 199,026 $ 194,231 $ 106,230 $ 1,209,730
Loans - fixed rate 13 13
Loans - variable rate 47,491 47,491
-------------- ------------ ------------- ------------- ------------- --------------
Total interest earning
assets 564,454 193,280 199,026 194,244 106,230 1,257,234
-------------- ------------ ------------- ------------- ------------- --------------
Interest bearing liabilities:
Demand deposit accounts 130,293 130,293
Savings accounts 172,179 172,179
Time accounts 2,800 2,800
Interest rate contracts (300,000) 60,000 120,000 120,000 0
Short term borrowings 672,444 672,444
-------------- ------------ ------------- ------------- ------------- --------------
Total interest bearing
liabilities 677,716 60,000 120,000 120,000 0 977,716
-------------- ------------ ------------- ------------- ------------- --------------
Net interest sensitivity gap
during the period $ (113,262) $ 133,280 $ 79,026 $ 74,244 $ 106,230 $ 279,518
============== ============ ============= ============= ============= ==============
Cumulative gap $ (113,262) $ 20,018 $ 99,044 $ 173,288 $ 279,518
============== ============ ============= ============= =============
Interest sensitive assets as a
percent of interest sensitive
liabilities (cumulative) 83.29% 102.71% 111.55% 117.72% 128.59%
Interest sensitive assets as a
percent of total assets
(cumulative) 42.37% 56.87% 71.81% 86.39% 94.36%
Net interest sensitivity gap as a
percent of total assets (8.50%) 10.00% 5.93% 5.57% 7.97%
Cumulative gap as a percent
of total assets (8.50%) 1.50% 7.43% 13.01% 20.98%
</TABLE>
(1)Adjustable rate assets are included in the period in which interest rates
are next scheduled to adjust rather than in the period in which they are
due. Fixed rate loans are included in the period in which they are
scheduled to be repaid.
(2)Mortgage-backed securities are included in the pricing category that
corresponds with their effective maturity.
30
<PAGE>
LIQUIDITY
Liquidity represents the ability of an institution to meet present and
future financial obligations through either the sale or maturity of existing
assets or the acquisition of additional funds through liability management. For
a financial institution such as the Company, these obligations arise from the
withdrawals of deposits and the payment of operating expenses.
The Company's primary sources of liquidity include cash and cash
equivalents, federal funds sold, new deposits, short term borrowings, interest
payments on securities held to maturity and available for sale, fees collected
from asset administration clients, and the capital raised from the sale of the
Capital Securities. Asset liquidity is also provided by managing the duration of
the investment portfolio. As a result of the Company's management of liquid
assets and the ability to generate liquidity through liability funds, management
believes that the Company maintains overall liquidity sufficient to meet its
depositors' needs, to satisfy its operating requirements and to fund the payment
of an anticipated annual cash dividend of approximately $.08 per share.
The Company's ability to pay dividends on the Common Stock depends on
the receipt of dividends from the Bank. Any dividend payments by the Bank are
subject to certain restrictions imposed by the Massachusetts Commissioner of
Banks. Subject to regulatory requirements, the Bank expects to pay an annual
dividend to the Company, which the Company expects to pay to its stockholders,
currently estimated to be in an amount equal to $.08 per share of the Company's
outstanding Common Stock (approximately $515,645 based upon 6,445,562 shares
outstanding as of September 30, 1997).
At September 30, 1997, cash and cash equivalents were 2% of total
assets. At September 30, 1997, approximately $25 million or 2% of total interest
earning assets mature within a one year period.
The Company has informal borrowing arrangements with various
counterparties whereby each counterparty has agreed to make funds available to
the Company at the Federal funds overnight rate. The aggregate amount of these
borrowing arrangements is $116 million. Each bank may terminate its arrangement
at any time and is under no contractual obligation to provide requested funding
to the Company. The Company's borrowings under these arrangements are typically
on an overnight basis. The Company believes that if these banks were unable to
provide funding as described above, a satisfactory alternative source of funding
would be available to the Company.
The Company also has Master Repurchase Agreements in place with various
counterparties whereby each broker has agreed to make funds available to the
Company at various rates in exchange for collateral consisting of marketable
securities. The aggregate amount of these borrowing arrangements is $1,150
million.
The Company also has a borrowing arrangement with the FHLBB whereby the
Company may borrow amounts determined by prescribed collateral levels and the
amount of FHLBB stock held by the Company. The minimum amount of FHLBB stock
held by the Company is required to be the greater (i) 1% of its outstanding
residential mortgage loan principal (including mortgage pool securities), (ii)
0.3% of total assets, (iii) total advances from the FHLBB, divided by a leverage
factor of 20. The aggregate amount of borrowing available to the Company under
this arrangement at September 30, 1997 was $414 million. An additional
investment in FHLBB stock would be required to borrow to the available limit.
CAPITAL RESOURCES
Historically, the Company has financed its operations primarily through
internally generated cash flows. The Company incurs capital expenditures for
furniture, fixtures and miscellaneous equipment needs. The Company leases
microcomputers through operating leases. Such capital expenditures have been
incurred and such leases entered into on an as-required basis, primarily to meet
the growing operating needs of the Company. As a result, the Company's capital
expenditures were $2,725,000 and $3,894,000 for the nine months ended September
30, 1996 and 1997, respectively.
31
<PAGE>
On January 31, 1997, the Company completed the issuance and sale of
$25,000,000 in 9.77% Capital Securities. The capital raised in the offering,
along with existing capital and earnings generated in the future, will be used
to support the Company's balance sheet growth.
Stockholders' equity at September 30, 1997 was $71,744,000, an increase
of $9,885,000 or 16%, from $61,859,000 at December 31, 1996. The ratio of
stockholders' equity to assets decreased to 5.38% at September 30, 1997 from
6.41% at December 31, 1996 due to the significant increase in assets.
The Federal Reserve Board has adopted a system using internationally
consistent risk-based capital adequacy guidelines to evaluate the capital
adequacy of banks and bank holding companies. Under the risk-based capital
guidelines, different categories of assets are assigned different risk weights,
based generally upon the perceived credit risk of the asset. These risk weights
are multiplied by corresponding asset balances to determine a "risk-weighted"
asset base. Certain off-balance sheet items, which previously were not expressly
considered in capital adequacy computations, are added to the risk-weighted
asset base by converting them to a balance sheet equivalent and assigning them
the appropriate risk weight.
Federal Reserve Board and FDIC guidelines require that banking
organizations have a minimum ratio of total capital to risk-adjusted assets and
off balance sheet items of 8.0%. Total capital is defined as the sum of "Tier I"
and "Tier II" capital elements, with at least half of the total capital required
to be Tier I. Tier I capital includes, with certain restrictions, the sum of
common stockholders' equity, noncumulative perpetual preferred stock, a limited
amount of cumulative perpetual preferred stock, and minority interests in
consolidated subsidiaries, less certain intangible assets. Tier II capital
includes, with certain limitations, subordinated debt meeting certain
requirements, intermediate-term preferred stock, certain hybrid capital
instruments, certain forms of perpetual preferred stock, as well as maturing
capital instruments and general allowances for loan losses.
The following table summarizes the Bank's Tier I and total capital
ratios at September 30, 1997:
<TABLE>
<CAPTION>
September 30,1997
----------------------------
Amount Ratio
--------------- ---------
<S> <C> <C>
Tier I capital $ 92,783 29.9%
Tier I capital minimum requirement 12,429 4.0%
--------------- ---------
Excess Tier I capital $ 80,354 25.9%
=============== =========
Total capital $ 92,883 29.9%
Total capital minimum requirement 24,858 8.0%
--------------- ---------
Excess Total capital $ 68,025 21.9%
=============== =========
Risk adjusted assets, net of intangible assets $310,729
===============
</TABLE>
In addition to the risk-based capital guidelines, the Federal Reserve
Board and the FDIC use a "Leverage Capital Ratio" as an additional tool to
evaluate capital adequacy. The Leverage Capital Ratio is defined to be a
company's Tier I capital divided by its adjusted total assets. The Leverage
Capital Ratio adopted by the federal banking agencies requires a ratio of 3.0%
Tier I capital to adjusted average total assets for top rated banking
institutions. All other banking institutions will be expected to maintain a
Leverage Capital Ratio of 4.0% to 5.0%. The computation of the risk-based
capital ratios and the Leverage Capital Ratio requires that the capital of the
Company be reduced by most intangible assets. The Bank's Leverage Capital Ratio
at September 30, 1997 was 7.03%, which is in excess of regulatory requirements.
The capital ratios of the Company are substantially similar to those of the
Bank.
32
<PAGE>
The following tables present average balances, interest income and
expense, and yields earned or paid on the major categories of assets and
liabilities for the periods indicated.
<TABLE>
<CAPTION>
Nine Months Ended September 30, 1996 Nine Months Ended September 30, 1997
----------------------------------------- ------------------------------------------
Average Average Average Average
Balance Interest Yield/Cost Balance Interest Yield/Cost
------------ ------------ ------------ ------------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Interest earning assets
Federal Funds Sold and securities
purchased under resale agreements $ 23,288 $ 968 5.54% $23,429 $ 947 5.39%
Interest earning deposits 168 6 4.76% 0 0
Investment securities 445,023 21,728 6.51% 994,083 48,284 6.48%
Loans 37,944 1,590 5.59% 56,233 1,910 4.53%
------------ ------------ ------------ ------------- ------------ ------------
Total interest earning assets 506,423 24,292 6.40% 1,073,745 51,141 6.35%
------------ ------------ ------------ ------------
Allowance for loan losses (68) (100)
Noninterest-earning assets 49,952 65,108
------------ -------------
Total assets $556,307 $1,138,753
============ =============
Interest bearing liabilities
Deposits:
Demand $143,239 $ 5,236 4.87% $ 124,824 $ 4,835 5.16%
Time 843 32 5.06% 1,424 55 5.15%
Savings 16,992 309 2.42% 245,428 8,986 4.88%
Short term borrowings 160,028 6,013 5.01% 466,094 18,122 5.18%
------------ ------------ ------------ ------------- ------------ ------------
Total interest bearing liabilities 321,102 11,590 4.81% 837,770 31,998 5.09%
------------ ------------ ------------ ------------
Noninterest bearing liabilities
Demand deposits 129,190 144,220
Noninterest bearing time deposits 45,036 55,989
Other liabilities 7,996 12,443
------------ -------------
Total liabilities 503,324 1,050,422
Trust Preferred Stock 0 21,617
Equity 52,983 66,714
------------ -------------
Total liabilities and equity $556,307 $1,138,753
============ =============
Net interest income $ 12,702 $ 19,143
============ ============
Net interest margin (1) 3.34% 2.38%
Average interest rate spread (2) 1.58% 1.26%
Ratio of interest-earning assets to
interest-bearing liabilities 157.71% 128.17%
</TABLE>
(1)Net interest income divided by total interest-earning assets.
(2)Yield on interest-earning assets less rate paid on interest-bearing
liabilities.
33
<PAGE>
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
a. Exhibit 11.1: Statement of Computation of Earnings Per Share:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ ------------------------------
1996 1997 1996 1997
------------- ------------- ------------- -------------
(in thousands, except per share data)
<S> <C> <C> <C> <C>
Net income $ 2,065 $ 2,936 $ 5,489 $ 8,652
Weighted average number of common
shares outstanding 6,444 6,445 6,444 6,445
Dilutive effect of common equivalent
shares of stock options and warrants 27 194 24 158
------------- ------------- ------------- -------------
Weighted average number of common and
common equivalent shares outstanding 6,471 6,639 6,468 6,603
============= ============= ============= =============
Net income per share (1) $ 0.32 $ 0.44 $ 0.85 $ 1.31
============= ============= ============= =============
</TABLE>
(1) Primary and fully diluted income per share are the same for all periods
presented.
b. The Company did not file any Current Reports on Form 8-K during the
three months ended September 30, 1997.
34
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INVESTORS FINANCIAL SERVICES CORP.
Date: November 10, 1997 By: /s/ Kevin J. Sheehan
------------------------------
Kevin J. Sheehan
Chairman, President and Chief
Executive Officer
By: /s/ Karen C. Keenan
------------------------------
Karen C. Keenan
Chief Financial Officer
(Principal Financial and
Accounting Officer)
35
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 25,029,586
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 460,281,597
<INVESTMENTS-CARRYING> 749,448,367
<INVESTMENTS-MARKET> 757,781,734
<LOANS> 47,503,504
<ALLOWANCE> 100,000
<TOTAL-ASSETS> 1,332,357,450
<DEPOSITS> 551,694,613
<SHORT-TERM> 672,444,111
<LIABILITIES-OTHER> 12,308,082
<LONG-TERM> 0
24,166,257
0
<COMMON> 64,456
<OTHER-SE> 71,679,931
<TOTAL-LIABILITIES-AND-EQUITY> 1,332,357,450
<INTEREST-LOAN> 1,910,559
<INTEREST-INVEST> 48,283,937
<INTEREST-OTHER> 946,609
<INTEREST-TOTAL> 51,141,105
<INTEREST-DEPOSIT> 13,868,308
<INTEREST-EXPENSE> 31,998,055
<INTEREST-INCOME-NET> 19,143,050
<LOAN-LOSSES> 0
<SECURITIES-GAINS> 41,760
<EXPENSE-OTHER> 60,280,132
<INCOME-PRETAX> 15,153,739
<INCOME-PRE-EXTRAORDINARY> 15,153,739
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 8,651,917
<EPS-PRIMARY> 1.31
<EPS-DILUTED> 1.31
<YIELD-ACTUAL> 2.38
<LOANS-NON> 0
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 100,000
<CHARGE-OFFS> 0
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 100,000
<ALLOWANCE-DOMESTIC> 0
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 100,000
</TABLE>
