<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 June 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 of (IRS Employer Identification No.)
incorporation or organization)
200 CLARENDON STREET, 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 July 31, 1997, there were 6,131,174 shares of Common Stock
outstanding and 314,388 shares of Class A Common Stock outstanding.
- --------------------------------------------------------------------------------
<PAGE>
INVESTORS FINANCIAL SERVICES CORP.
INDEX
-----
<TABLE>
<CAPTION>
PART I FINANCIAL INFORMATION
Page
----
<S> <C>
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets
December 31, 1996 and
June 30, 1997 (unaudited) 3
Consolidated Income Statements (unaudited)
Six months ended June 30, 1996 and 1997 4
Consolidated Income Statements (unaudited)
Three months ended June 30, 1996 and 1997 5
Statement of Stockholder's Equity (unaudited)
Six months ended June 30, 1997 6
Consolidated Statements of Cash Flows (unaudited)
Six months ended June 30, 1996 and 1997 7
Notes to Condensed Consolidated Financial Statements 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION 17
AND RESULTS OF OPERATIONS
PART II OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 33
SIGNATURES
</TABLE>
2
<PAGE>
INVESTORS FINANCIAL SERVICES CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND JUNE 30, 1997
- -------------------------------------------------------------------------
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
ASSETS 1996 1997
(unaudited)
<S> <C> <C>
Cash and due from banks $ 19,226,453 $ 9,570,008
Federal funds sold and securities
purchased under resale agreements 120,000,000 63,000,000
Securities held to maturity (approximate
market values of $460,182,579 and
$719,500,877 at December 31, 1996
and June 30, 1997, respectively) 460,009,923 716,907,576
Securities available for sale 271,120,964 324,279,511
Nonmarketable equity securities 967,400 5,476,600
Loans, less allowance for loan
losses of $100,000 at December 31,
1996 and June 30, 1997 66,236,889 102,427,199
Accrued interest and fees receivable 16,366,171 20,162,325
Equipment and leasehold improvements,
net 5,243,974 7,065,143
Other assets 5,289,873 7,787,674
------------ --------------
TOTAL ASSETS $964,461,647 $1,256,676,036
============ ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits:
Demand $264,914,614 $ 346,186,667
Savings 276,602,295 344,764,512
Time 55,000,000 50,000,000
------------ --------------
Total deposits 596,516,909 740,951,179
Short-term borrowings 296,820,752 409,123,917
Other liabilities 9,264,676 13,731,989
------------ --------------
Total liabilities 902,602,337 1,163,807,085
------------ --------------
Company obligated mandatorily preferred
securities of subsidiary trust - 24,216,332
------------ --------------
STOCKHOLDERS' EQUITY:
Class A common stock 3,595 3,190
Common stock 60,848 61,265
Surplus 54,352,812 54,371,363
Deferred compensation (1,687,675) (1,468,225)
Retained earnings 8,480,431 13,938,913
Net unrealized gain on securities
available for sale 649,299 1,746,113
------------ --------------
Total stockholders' equity 61,859,310 68,652,619
------------ --------------
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY $964,461,647 $1,256,676,036
============ ==============
</TABLE>
See notes to condensed consolidated financial statements.
3
<PAGE>
INVESTORS FINANCIAL SERVICES CORP.
CONDENSED CONSOLIDATED INCOME STATEMENTS (UNAUDITED)
SIX MONTHS ENDED JUNE 30, 1996 AND 1997
- -------------------------------------------------------------------------
<TABLE>
<CAPTION>
JUNE 30, JUNE 30,
1996 1997
<S> <C> <C>
OPERATING REVENUE:
Interest income:
Federal funds sold and securities
purchased under resale agreements $ 664,027 $ 843,520
Other short-term investments 6,448 -
Investment securities held to maturity 12,262,637 29,839,706
and available for sale
Loans 997,928 1,340,295
--------------- ---------------
Total interest income 13,931,040 32,023,521
--------------- ---------------
Interest expense:
Deposits 3,070,457 9,459,602
Short-term borrowings 2,856,750 9,518,221
--------------- ---------------
Total interest expense 5,927,207 18,977,823
--------------- ---------------
Net interest income 8,003,833 13,045,698
Provision for loan losses 49,114 -
--------------- ---------------
Net interest income after
provision for loan losses 7,954,719 13,045,698
Noninterest income:
Asset administration fees 26,752,370 35,923,989
Computer service fees 246,610 233,831
Other operating income 36,284 143,969
Gain on sale of security
available for sale 6,273 7,110
--------------- ---------------
Net operating revenue 34,996,256 49,354,597
OPERATING EXPENSES:
Compensation of officers and
employees 15,289,645 20,542,133
Pension and other employee benefits 2,577,870 3,129,468
Occupancy 2,213,942 2,209,790
Equipment 2,635,769 3,383,657
Insurance 588,022 365,580
Subcustodian fees 1,809,899 2,750,523
Depreciation and amortization 692,521 869,868
Professional fees 1,029,417 1,754,756
Travel and sales promotion 493,187 779,745
Other operating expenses 2,099,339 3,621,169
--------------- ---------------
Total operating expenses 29,429,611 39,406,689
--------------- ---------------
INCOME BEFORE INCOME TAXES AND MINORITY
INTEREST 5,566,645 9,947,908
Provision for income taxes 2,143,091 3,580,300
Minority interest expense, net of
income taxes - 651,333
--------------- ---------------
NET INCOME $ 3,423,554 $ 5,716,275
=============== ===============
WEIGHTED AVERAGE SHARES OUTSTANDING 6,466,098 6,581,620
=============== ===============
EARNINGS PER SHARE $0.53 $0.87
=============== ===============
</TABLE>
See notes to condensed consolidated financial statements.
4
<PAGE>
INVESTORS FINANCIAL SERVICES CORP.
CONDENSED CONSOLIDATED INCOME STATEMENTS (UNAUDITED)
THREE MONTHS ENDED JUNE 30, 1996 AND 1997
- -------------------------------------------------------------------------
<TABLE>
<CAPTION>
JUNE 30, JUNE 30,
1996 1997
<S> <C> <C>
OPERATING REVENUE:
Interest income:
Federal funds sold and securities
purchased under resale agreements $ 219,483 $ 167,773
Investment securities held to maturity
and available for sale 7,166,947 16,148,260
Loans 579,897 675,886
--------------- --------------
Total interest income 7,966,327 16,991,919
--------------- --------------
Interest expense:
Deposits 2,092,538 5,014,000
Short-term borrowings 1,811,792 5,388,357
--------------- --------------
Total interest expense 3,904,330 10,402,357
--------------- --------------
Net interest income 4,061,997 6,589,562
Provision for loan losses 28,067 -
--------------- --------------
Net interest income after provision
for loan losses 4,033,930 6,589,562
Noninterest income:
Asset administration fees 13,955,006 18,316,614
Computer service fees 122,567 117,371
Other operating income 15,941 107,984
Gain on sale of security
available for sale 3,825 7,110
--------------- --------------
Net operating revenue 18,131,269 25,138,641
OPERATING EXPENSES:
Compensation of officers and employees 7,852,732 10,721,407
Pension and other employee benefits 1,227,109 1,482,059
Occupancy 1,052,711 1,121,310
Equipment 1,329,389 1,765,015
Insurance 282,939 183,821
Subcustodian fees 988,084 1,312,025
Depreciation and amortization 381,651 481,529
Professional fees 475,271 838,028
Travel and sales promotion 293,738 448,242
Other operating expenses 1,028,539 1,739,580
--------------- --------------
Total operating expenses 14,912,163 20,093,016
--------------- --------------
INCOME BEFORE INCOME TAXES AND MINORITY 3,219,106 5,045,625
INTEREST
Provision for income taxes 1,215,814 1,758,081
Minority interest expense, net of - 392,835
income taxes --------------- --------------
NET INCOME $ 2,003,292 $ 2,894,709
=============== ==============
WEIGHTED AVERAGE SHARES OUTSTANDING 6,465,369 6,601,254
=============== ==============
EARNINGS PER SHARE $0.31 $0.44
=============== ==============
</TABLE>
See notes to condensed consolidated financial statements.
5
<PAGE>
INVESTORS FINANCIAL SERVICES CORP.
CONDENSED STATEMENT OF STOCKHOLDERS' EQUITY (UNAUDITED)
SIX MONTHS ENDED JUNE 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 (405) 405 -
Amortization of deferred compensation 219,450 219,450
Exercise of stock options 12 18,551 18,563
Net income 5,716,275 5,716,275
Payment of dividend (257,793) (257,793)
Change in net unrealized gain on
securities available for sale 1,096,814 1,096,814
---------- --------- ----------- ------------ ------------ ----------- -----------
BALANCE, JUNE 30, 1997 $3,190 $61,265 $54,371,363 $(1,468,225) $13,938,913 $1,746,113 $68,652,619
========== ========= =========== ============ ============= ============ ===========
See notes to condensed consolidated financial statements.
</TABLE>
6
<PAGE>
INVESTORS FINANCIAL SERVICES CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
SIX MONTHS ENDED JUNE 30, 1996 AND 1997
- -----------------------------------------------------------------------
<TABLE>
<CAPTION>
JUNE 30, JUNE 30,
1996 1997
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 3,423,554 $ 5,716,275
-------------- -------------
Adjustments to reconcile net income to
net cash provided by
operating activities:
Depreciation and amortization 692,521 869,868
Amortization of deferred compensation 210,662 219,450
Provision for loan losses 49,114 -
Amortization of premiums on securities,
net of accretion of discounts 1,186,515 1,618,885
Deferred income taxes 104,932 16,879
Gain on sale of securities available
for sale (6,273) (7,110)
Loss on disposal of fixed assets 15,211 -
Changes in assets and liabilities:
Accrued interest and fees receivable (3,957,800) (3,796,154)
Other assets (1,885,238) (2,497,800)
Other liabilities 4,868,499 3,943,084
-------------- -------------
Total adjustments 1,278,143 367,102
-------------- ------------
Net cash provided by operating
activities 4,701,697 6,083,377
-------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities of securities
available for sale 11,409,626 42,026,107
Proceeds from maturities of securities
held to maturity 19,612,591 33,985,925
Proceeds from sale of securities
available for sale 15,041,451 5,002,734
Purchases of securities available for
sale (104,767,586) (99,507,745)
Purchases of securities held to maturity (244,401,767) (291,570,831)
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 (60,000,000) 57,000,000
Net increase in loans (63,224,534) (36,190,311)
Purchases of equipment and leasehold
improvements (2,591,750) (2,691,036)
------------- -------------
Net cash used for investing activities (427,921,969) (296,454,357)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in demand deposits 273,957,387 81,272,053
Net increase in time and savings
deposits 11,417,715 63,162,217
Net increase in short-term borrowings 142,600,098 112,303,164
Stock issuance costs 35,192 (783,668)
Proceeds from exercise of stock options 5,148 18,562
Proceeds from issuance of preferred
stock - 25,000,000
Dividends paid (64,440) (257,793)
------------- -------------
Net cash provided by financing
activities 427,951,100 280,714,535
------------- -------------
NET INCREASE (DECREASE) IN CASH AND DUE
FROM BANKS 4,730,828 (9,656,445)
CASH AND DUE FROM BANKS, BEGINNING OF
PERIOD 21,898,903 19,226,453
------------- -------------
CASH AND DUE FROM BANKS, END OF PERIOD $ 26,629,731 $ 9,570,008
============= =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid for interest $ 5,420,000 $ 18,876,000
============= =============
Cash paid for income taxes $ 2,915,000 $ 3,611,000
============= =============
</TABLE>
See notes to condensed consolidated financial statements.
7
<PAGE>
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION PERTAINING TO THE SIX MONTHS AND THE THREE MONTHS ENDED JUNE
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 domestic and 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.
2. INTERIM FINANCIAL STATEMENTS
The consolidated interim financial statements of the Company and
consolidated subsidiaries as of June 30, 1997 and for the six-month
periods and the three-month periods ended June 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.
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.
8
<PAGE>
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
============ ========== ========== ============
AMORTIZED UNREALIZED UNREALIZED CARRYING
AVAILABLE FOR SALE COST GAINS LOSSES VALUE
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 June 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 $ 34,939,268 $ 673,370 $ 12,593 $ 35,600,045
Mortgage-backed securities 572,578,478 3,998,096 2,041,685 574,534,889
Federal Agency securities 101,590,980 324,834 394,646 101,521,168
Foreign government securities 7,798,850 45,925 - 7,844,775
------------ ---------- ---------- ------------
Total $716,907,576 $5,042,225 $2,448,924 $719,500,877
============ ========== ========== ============
AMORTIZED UNREALIZED UNREALIZED CARRYING
AVAILABLE FOR SALE COST GAINS LOSSES VALUE
U.S. Treasury securities $ 40,037,363 $ 95,487 $ - $ 40,132,850
Mortgage-backed securities 281,555,820 2,658,353 67,512 284,146,661
------------ ---------- ---------- ------------
Total $321,593,183 $2,753,840 $ 67,512 $324,279,511
============ ========== ========== ============
</TABLE>
9
<PAGE>
3. SECURITIES (CONTINUED)
Nonmarketable equity securities at June 30, 1997 consisted of $5,477,000 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 JUNE 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 114,459,070 113,819,081 181,601,501 181,403,815
Due five years up to ten years 240,620,332 241,016,881 341,753,541 342,451,798
Due after ten years 85,878,308 86,472,780 193,552,534 195,645,264
------------ ------------ ------------ ------------
Total $460,009,923 $460,182,579 $716,907,576 $719,500,877
============ ============ ============ ============
DECEMBER 31, 1996 JUNE 30, 1997
AMORTIZED CARRYING AMORTIZED CARRYING
AVAILABLE FOR SALE COST VALUE COST VALUE
Due within one year $ 19,964,080 $ 20,046,800 $ 30,062,757 $ 30,130,500
Due from one to five years 213,758,992 214,525,641 249,043,850 251,414,351
Due five years up to ten years 36,315,728 36,548,523 42,486,576 42,734,660
------------ ------------ ------------ ------------
Total $270,038,800 $271,120,964 $321,593,183 $324,279,511
============ ============ ============ ============
</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.
One security available for sale was sold during the six months ended June 30,
1997, resulting in a gain of $7,110.
The carrying value of securities pledged amounted to approximately
$362,000,000 and $481,000,000 at December 31, 1996 and June 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 June 30, 1997. In addition, there have been no loan
charge-offs or recoveries during the six months ended June 30, 1996 and 1997.
Loans consisted of the following at December 31, 1996 and June 30, 1997:
10
<PAGE>
4. LOANS (CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1996 1997
<S> <C> <C>
Loans to individuals $23,448,999 $ 17,462,670
Loans to not-for-profit institutions 12,500 12,500
Loans to mutual funds 42,875,390 85,052,029
----------- ------------
66,336,889 102,527,199
Less allowance for loan losses 100,000 100,000
----------- ------------
Total $66,236,889 $102,427,199
=========== ============
</TABLE>
The Company had commitments to lend of approximately $37,128,000 and
$63,821,000 at December 31, 1996 and June 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 June 30, 1997:
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1996 1997
<S> <C> <C>
Furniture, fixtures and equipment $8,516,450 $ 9,807,614
Leasehold improvements 744,395 921,041
---------- -----------
Total 9,260,845 10,728,655
Less accumulated depreciation and
amortization 4,016,871 3,663,512
---------- -----------
Equipment and leasehold improvements,
net $5,243,974 $ 7,065,143
========== ===========
</TABLE>
6. DEPOSITS
Time deposits at December 31, 1996 and June 30, 1997 include noninterest-
bearing amounts of approximately $55,000,000 and $50,000,000, respectively.
All time deposits had a minimum balance of $100,000 and a maturity of less
than three months at December 31, 1996 and June 30, 1997.
7. SHORT-TERM BORROWINGS
The major components of short-term borrowings are as follows at December 31,
1996 and June 30, 1997:
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1996 1997
<S> <C> <C>
Repurchase agreements $296,421,201 $408,703,232
Treasury, Tax and Loan account 399,551 420,685
------------ ------------
Total $296,820,752 $409,123,917
============ ============
</TABLE>
11
<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 $408,703,232 at December 31, 1996 and
June 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 June 30, 1997 ranged from
5.51% to 6.23% and all agreements matured by July 1, 1997. The following
securities were pledged under these agreements at December 31, 1996 and June
30, 1997:
<TABLE>
<CAPTION>
DECEMBER 31, 1996 JUNE 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 $ 35,124,250 $ 35,124,250
Federal Agency securities 25,000,000 24,803,950 20,000,000 19,770,300
Mortgage-backed securities 245,689,672 246,777,873 363,718,434 366,090,516
------------ ------------ --------------- ------------
Total $307,939,612 $308,831,763 $418,842,684 $420,985,066
============ ============ =============== ============
</TABLE>
The Company has a borrowing arrangement with the FHLBB which is utilized on
an overnight basis to satisfy temporary funding requirements. The Company had
no liabilities outstanding under this agreement at December 31, 1996 or June
30, 1997.
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 $420,685 at June 30, 1997. The
interest rates on the outstanding balance at December 31, 1996 and June 30,
1997 were 5.10% and 5.62%, respectively.
8. COMPANY OBLIGATED MANDATORILY PREFERRED SECURITIES OF SUBSIDIARY TRUST
On January 31, 1997, the Company completed the issuance and sale of
$25,000,000 in 9.77% Capital Securities (the "Capital Securities"). The
Capital Securities were issued by Investors Capital Trust I (the "Trust"), a
Delaware statutory business trust sponsored by the Company. The proceeds of
the Capital Securities were invested in 9.77% Junior Subordinated Debentures
(the "Debentures") issued by the Company. The Debentures will mature on
February 1, 2027 except that such maturity may under certain circumstances be
advanced. The Company has guaranteed all of the Trust's obligations under the
Capital Securities to the extent that the Trust has funds available to meet
such obligations. The guarantee constitutes an unsecured obligation of the
Company and is subordinate and ranks junior in right of payment to all senior
indebtedness of the Company.
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 June 30, 1997,
there were no preferred shares issued or outstanding. There were 359,545 and
318,984 shares of Class A Common Stock and 6,084,767 and 6,126,453 shares of
Common Stock issued and outstanding at December 31, 1996 and June 30, 1997,
respectively. The Common Stock and Class A Common Stock are identical except
that the Class A Common Stock has ten votes per share and automatically
converts into Common Stock upon transfer and under certain other
circumstances.
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.
12
<PAGE>
9. STOCKHOLDERS' EQUITY (CONTINUED)
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 $1,468,225 at December 31, 1996 and
June 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 payments periods consist of two six-month
periods, January 1 through June 30 and July 1 through December 31.
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 15,200 $27.50 - $43.50
Exercised (1,125) $16.50
Expired - -
-------
Outstanding at June 30, 1997 359,225 $16.50 - $43.50
=======
Exercisable at June 30, 1997 96,520
=======
</TABLE>
13
<PAGE>
10. OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
LINES OF CREDIT - At June 30, 1997, the Company had commitments to
individuals under collateralized open lines of credit totaling $96,994,000,
against which $33,173,000 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 - The following table summarizes the contractual or
notional amounts of derivative financial instruments held by the Company at
June 30, 1997:
Interest rate contracts:
Swap agreements $260,000,000
Floor contracts $ 30,000,000
Interest rate contracts involve an agreement with a counterparty to exchange
cash flows based on an underlying interest rate index. An interest rate
floor is a contract purchased from a counterparty which specifies a minimum
interest rate for the specified period of time. A swap agreement involves
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 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 $154,000 at June 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 June 30, 1997 was $20,947,000. In addition, other
cash balances in the amount of $1,488,000 were pledged to secure clearings
with a depository institution as of June 30, 1997.
LEASE COMMITMENTS - Minimum future commitments on noncancelable operating
leases at June 30, 1997 were as follows:
<TABLE>
<CAPTION>
Bank
Fiscal Year Ending Premises Equipment
<S> <C> <C>
1997 $ 2,118,913 $ 795,167
1998 5,503,381 1,416,564
1999 5,503,381 1,080,635
2000 5,503,381 223,055
2001 and beyond 35,407,496 -
</TABLE>
Total rent expense was $2,943,000 and $3,173,000 for the six months
ended June 30, 1996 and 1997, respectively.
14
<PAGE>
11. COMMITMENTS AND CONTINGENCIES (CONTINUED)
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 $96,000 and $213,000 for
the six months ended June 30, 1996 and 1997, respectively.
CONTINGENCIES - The Company provides domestic and 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 June 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 June 30, 1997 is as follows
(in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1996 JUNE 30, 1997
-------------------------------------------- ---------------------------------------------------------
UNREALIZED UNREALIZED
CURRENCY PURCHASES SALES GAIN/LOSS PURCHASES SALES GAIN/LOSS
<S> <C> <C> <C> <C> <C> <C>
Japan (Yen) $40,828 $40,828 - $43,250 $43,250 -
France (Franc) 1,093 1,093 - 4,358 4,358 -
Netherlands (Guilder) 918 918 - 4,225 4,225 -
Hong Kong (Dollar) 1,807 1,807 - 3,202 3,202 -
United Kingdom (Pound) 1,873 1,873 - 2,660 2,660 -
Germany (Mark) 2,118 2,118 - 1,620 1,620 -
Indonesia (Rupiah) 198 198 - 1,320 1,320 -
Malaysia (Ringgit) 6,009 6,009 - 1,183 1,183 -
Sweden (Krona) 139 139 919 919
Other currencies 2,163 2,163 - 3,748 3,748 -
------- ------- --------- -------- --------------- --------------------
$57,146 $57,146 - $66,485 $66,485 -
======= ======= ========= ======== =============== ====================
</TABLE>
The maturity of contracts outstanding as of June 30, 1997 is as follows:
<TABLE>
<CAPTION>
Maturity Purchases Sales
<S> <C> <C>
July 1997 $56,737 $56,737
August 1997 6,128 6,128
December 1997 3,620 3,620
</TABLE>
15
<PAGE>
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.
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 June 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 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 June 30, 1997:
Total Capital
(to Risk Weighted Assets) $90,885,937 26.95% $26,978,106 8.00% $33,722,633 10.00%
Tier I Capital
(to Risk Weighted Assets) $90,785,937 26.92% $13,489,053 4.00% $20,233,580 6.00%
Tier I Capital
(to Average Assets) $90,785,937 7.23% $50,202,352 4.00% $62,752,940 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 law which provides 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 excess of
reserves specifically established therefore.
16
<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 domestic
and 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 55 mutual fund complexes, investment advisors,
banks and insurance companies. Currently, the Company provides financial
asset administration services for assets totaling approximately $146
billion, including approximately $10.5 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 the
Bank of New York 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"). 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 resulting
from deposits expected to be obtained from asset administration clients.
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 41% from $34,996,000 in the
first six months of 1996 to $49,355,000 in the first six 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.
17
<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. During the
quarter ended June 30, 1997, the Company reported that one of its clients
announced plans to consolidate its custody and fund accounting services with
another service provider. As of June 30, 1997, this client represented
approximately $11 billion in assets processed, and less than 1.5% of the
Company's revenues.
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.
18
<PAGE>
STATEMENT OF OPERATIONS
Comparison of Operating Results for the Six Months Ended June 30, 1997 and
1996
Noninterest Income
Noninterest income increased $9,268,000 to $36,309,000 for the six
months ended June 30, 1997 from $27,041,000 for the prior period.
Noninterest income consists of the following items:
<TABLE>
<CAPTION>
For the Six Months
Ended
June 30,
----------------------- ------
1996 1997 Change
------------ --------- ------
<S> <C> <C> <C>
(Dollars in thousands)
Asset administration fees $26,752 $35,924 34%
Computer service fees 247 234 (5)
Other operating income 36 144 300
Gain on sale of security
available for sale 6 7 17
------------ -------
Total Noninterest Income $27,041 $36,309 34%
============ =======
</TABLE>
Asset administration fees increased $9,172,000 to $35,924,000 for the
six months ended June 30, 1997 compared to $26,752,000 for the six months
ended June 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 $146 billion at June 30, 1997 from $108 billion at June 30,
1996. Of this $38 billion net increase in assets processed, approximately
21% 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.
19
<PAGE>
Operating Expenses
Total operating expenses increased by $9,977,000 to $39,407,000 for the
six months ended June 30, 1997 compared to $29,430,000 for the six months
ended June 30, 1996. The components of operating expenses were as follows:
<TABLE>
<CAPTION>
For the Six Months
Ended
June 30,
--------------------
1996 1997 Change
-------- -------- -------
(Dollars in thousands)
<S> <C> <C> <C>
Compensation $15,290 $20,542 34%
Pension and other employee benefits 2,578 3,129 21
Occupancy 2,214 2,210 -
Equipment 2,636 3,384 28
Insurance 588 366 (38)
Subcustodian fees 1,810 2,750 52
Depreciation and amortization 693 870 26
Professional fees 1,029 1,755 71
Travel and sales promotion 493 780 58
Other operating expenses 2,099 3,621 73
------- -------
Total Operating Expenses $29,430 $39,407 34%
======= =======
</TABLE>
Compensation of officers and employees increased by $5,252,000 or 34%
from period to period due to several factors. The average number of employees
increased 23% to 852 during the six months ended June 30, 1997 from 691 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 half of 1997 compared to the first half of 1996. The remainder of the
increase in compensation expense resulted from salary increases.
Pension and other employee benefits increased to $3,129,000 for the six
months ended June 30, 1997 from $2,578,000 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 $748,000 increase
between periods is due principally to the growth in assets processed.
Insurance expense decreased 38% from $588,000 for the six months ended
June 30, 1996 to $366,000 for the six months ended June 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 $940,000 to $2,750,000 for the six
months ended June 30, 1997 from $1,810,000 for the six months ended June 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 $8.0 billion at June 30, 1996 to $10.5 billion at June
30, 1997, and from the movement by clients into emerging markets with higher
cost structures.
Depreciation and amortization expense increased $177,000 between
periods due to purchases of furniture, equipment, and capitalized software in
late 1996 and in 1997.
20
<PAGE>
Professional fees increased $726,000 to $1,755,000 for the six months
ended June 30, 1997 from $1,029,000 for the six months ended June 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 $287,000 to $780,000 for
the six months ended June 30, 1997 from $493,000 for the six months ended June
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 $1,522,000 to $3,621,000 for the six months ended June
30, 1997 from $2,099,000 for the six months ended June 30, 1996. Fees for daily
market pricing data, which vary with the level of assets processed, increased by
$117,000 during the period. Other expenses such as telephone and office
supplies vary with staffing levels. Expenses relating to these items represented
$286,000 of the increase. Recruiting costs and costs of temporary help
accounted for $502,000 of the increase; this increase relates to the tight labor
market caused by a period of low unemployment in Massachusetts during the first
half of 1997. Additionally, $219,000 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 $238,000 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 six months ended June 30, 1997 compared to the same
period in 1996.
<TABLE>
<CAPTION>
Change Change
Due to Due to
Volume Rate Net
-------- ------- -------
<S> <C> <C> <C>
(Dollars in thousands)
INTEREST-EARNING ASSETS
Fed funds sold and
interest-earning deposits $ 178 $ (4) $ 174
Investment securities 17,323 254 17,577
Loans 489 (147) 342
------- ------ ------
Total interest-earning assets 17,990 103 18,093
INTEREST-BEARING LIABILITIES
Deposits 5,922 468 6,390
Borrowings 6,632 29 6,661
------- ------ ------
Total interest-bearing liabilities 12,554 497 13,051
------- ------ ------
Change in net interest income $ 5,436 $(394) $ 5,042
======= ====== =======
</TABLE>
Net interest income increased $5,042,000 or 63% to $13,046,000 for the
six months ended June 30, 1997 from $7,955,000 for the same period in 1996.
This net increase resulted from an increase in interest income of $18,093,000
offset in part by an increase in interest expense of $13,051,000. The net
impact of the above changes was a 102 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 six months
ended June 30, 1997 increased $581,846,000 or 120% compared to the same period
in 1996. This growth primarily resulted from an increase in average interest
earning assets of $561,476,000.
21
<PAGE>
Interest expense increased $13,051,000 due primarily to a $520,557,000
increase in average deposits and short term borrowings for the six months ended
June 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 4.75% to 4.93% 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 six months ended June 30, 1997 increased by
$1,437,000 over the same period in 1996. The overall effective tax rate
decreased to 36.0% for the six months ended June 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 June 30, 1997 and 1996
Noninterest Income
Noninterest income increased $4,452,000 to $18,549,000 for the quarter
ended June 30, 1997 from $14,097,000 for the prior period. Noninterest income
consists of the following items:
<TABLE>
<CAPTION>
For the Quarters
Ended
June 30,
--------------------- ---------
1996 1997 Change
---------- --------- ---------
<S> <C> <C> <C>
(Dollars in
thousands)
Asset administration fees $13,955 $18,317 31%
Computer service fees 122 117 (4)
Other operating income 16 108 575
Gain on sale of security
available for sale 4 7 75
-------- -------
Total Noninterest Income $14,097 $18,549 32%
======== =======
</TABLE>
Asset administration fees increased $4,362,000 to $18,317,000 for the
three months ended June 30, 1997 compared to $13,955,000 for the three months
ended June 30, 1996. Total assets processed increased to $146 billion at June
30, 1997 from $108 billion at June 30, 1996. Of this $38 billion net increase
in assets processed, approximately 21% 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.
22
<PAGE>
Operating Expenses
Total operating expenses increased by $5,181,000 to $20,093,000 for the
quarter ended June 30, 1997 compared to $14,912,000 for the quarter ended June
30, 1996. The components of operating expenses were as follows:
<TABLE>
<CAPTION>
For the Quarters
Ended
June 30,
----------------- ------
1996 1997 Change
------ ------ ------
(Dollars in
thousands)
<S> <C> <C> <C>
Compensation $ 7,853 $10,721 37%
Pension and other employee benefits 1,227 1,482 21
Occupancy 1,053 1,121 6
Equipment 1,329 1,765 33
Insurance 283 184 (35)
Subcustodian fees 988 1,312 33
Depreciation and amortization 382 482 26
Professional fees 475 838 76
Travel and sales promotion 294 448 52
Other operating expenses 1,028 1,740 69
------- -------
Total Operating Expenses $14,912 $20,093 35%
======= =======
</TABLE>
Compensation of officers and employees increased by $2,868,000 or 37%
from period to period due to several factors. The average number of employees
increased 25% to 878 during the quarter ended June 30, 1997 from 701 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 $1,482,000 for the
quarter ended June 30, 1997 from $1,227,000 for the same period in 1996. The
21% increase was due principally to increased payroll taxes attributable to the
increase in compensation expense.
Equipment expense varies with the level of assets processed by the
Company. The $436,000 increase between periods is due principally to the growth
in assets processed.
Insurance expense decreased 35% from $283,000 for the quarter ended
June 30, 1996 to $184,000 for the quarter ended June 30, 1997 due to the
renegotiation, in May 1996, of the Company's coverage for errors and omissions
liability, directors and officers liability and blanket bond.
Subcustodian expense increased $324,000 to $1,312,000 for the quarter
ended June 30, 1997 from $988,000 for the quarter ended June 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 $8.0 billion at June 30, 1996 to $10.5 billion at June 30, 1997, and from
the movement by clients into emerging markets with higher cost structures.
Subcustodian expense was offset in part by the Company's improved cash
management in foreign accounts during the quarter.
Depreciation and amortization expense increased $100,000 between
periods due to purchases of furniture, equipment, and capitalized software in
late 1996 and in 1997.
Professional fees increased $363,000 to $838,000 for the quarter ended
June 30, 1997 from $475,000 for the quarter ended June 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 $154,000 to $448,000 for
the quarter ended June 30, 1997 from $294,000 for the quarter ended June 30,
1996 due to increased travel to the foreign subsidiaries.
23
<PAGE>
Other operating expenses increased $712,000 to $1,740,000 for the
quarter ended June 30, 1997 from $1,028,000 for the quarter ended June 30, 1996.
Fees for daily market pricing data, which vary with the level of assets
processed, increased by $46,000 during the period. Other expenses such as
telephone and office supplies vary with staffing levels. Expenses relating to
these items represented $144,000 of the increase. Recruiting costs and costs of
temporary help accounted for $154,000 of the increase; this increase relates to
the tight labor market caused by a period of low unemployment in Massachusetts
during the second quarter of 1997. Additionally, $105,000 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. Also, $118,000 of the increase resulted from the
adoption of a new regulatory assessment methodology by the Massachusetts
Division of Banks.
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 June 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 $ (69) $ 18 $ (51)
Investment securities 8,679 302 8,981
Loans 94 2 96
-------- ----- -------
Total interest-earning assets 8,704 322 9,026
INTEREST-BEARING LIABILITIES
Deposits 2,616 305 2,921
Borrowings 3,489 88 3,577
-------- ------ ------
Total interest-bearing liabilities 6,105 393 6,498
-------- ------ ------
Change in net interest income $2,599 $(71) $2,528
======== ====== ======
</TABLE>
Net interest income increased $2,528,000 or 62% to $6,590,000 for the
quarter ended June 30, 1997 from $4,062,000 for the same period in 1996. This
net increase resulted from an increase in interest income of $9,026,000 offset
in part by an increase in interest expense of $6,498,000. The net impact of the
above changes was a 63 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
June 30, 1997 increased $552,047,000 or 98% compared to the same period in 1996.
This growth primarily resulted from an increase in average interest earning
assets of $534,859,000.
Interest expense increased $6,498,000 due primarily to a $498,876,000
increase in deposits and short term borrowings for the quarter ended June 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 4.79% to 5.05% during the period.
24
<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 June 30, 1997 increased by
$542,000 over the same period in 1996. The overall effective tax rate decreased
to 34.8% for the quarter ended June 30, 1997, from 37.8% 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.
25
<PAGE>
FINANCIAL CONDITION
Investment Portfolio
The following table summarizes the Company's investment portfolio for the dates
indicated:
<TABLE>
<CAPTION>
December 31, June 30,
1996 1997
-------------- ----------
(Dollars in thousands)
<S> <C> <C>
SECURITIES HELD TO MATURITY:
State and political subdivisions $ - $ 34,939
Mortgage-backed securities 414,665 572,579
Federal Agency securities 37,517 101,591
Foreign government securities 7,828 7,799
---------- ---------
Total securities held to maturity $460,010 $716,908
========== =========
SECURITIES AVAILABLE FOR SALE:
U.S. Treasury securities $ 40,259 $ 40,133
Mortgage-backed securities 230,862 284,147
---------- ---------
Total securities available for sale $271,121 $324,280
========== =========
</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.
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.
26
<PAGE>
The book value and weighted average yield of the Company's securities
held to maturity at June 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 181,602 6.74%
Due after five years up to ten years 341,753 6.75%
Due after ten years 193,553 6.39%
--------
Total securities $716,908
========
</TABLE>
The book value and weighted average yield of the Company's securities
available for sale at June 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 $ 30,131 6.18%
Due from one to five years 251,414 6.81%
Due after five years up to ten years 42,735 6.86%
--------
Total securities $324,280
========
</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, June 30,
1996 1997
-------------- ----------
<S> <C> <C>
(Dollars in thousands)
Loans to individuals $23,449 $ 17,463
Loans to not-for-profit organizations 13 13
Loans to mutual funds 42,875 85,051
-------- --------
66,337 102,527
Less: allowance for loan losses (100) (100)
-------- --------
Net loans $66,237 $102,427
Floating Rate $66,324 $102,514
Fixed Rate 13 13
-------- --------
$66,337 $102,527
======== ========
</TABLE>
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
27
<PAGE>
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 June 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
June 30, 1997 with Landon T. Clay, an officer 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 June 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 June 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 floors and 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.
28
<PAGE>
The following table presents the repricing schedule for the Company's interest
earning assets and interest bearing liabilities at June 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):
Federal Funds Sold $ 63,000 $ 63,000
Investment securities (2) 444,184 175,683 199,861 118,277 103,182 1,041,187
Loans - fixed rate - 13 13
Loans - variable rate 102,514 - - - - 102,514
---------- -------- -------- -------- -------- ----------
Total interest earning assets 609,698 175,683 199,861 118,290 103,182 1,206,714
---------- -------- -------- -------- -------- ----------
Interest bearing liabilities:
Demand deposit accounts 82,471 82,471
Savings accounts 344,765 344,765
Interest rate contracts (200,000) 30,000 120,000 50,000 -
Short term borrowings 409,124 - - - - 409,124
---------- -------- -------- -------- -------- ----------
Total interest bearing
liabilities 636,360 30,000 120,000 50,000 - 836,360
---------- -------- -------- -------- -------- ----------
Net interest sensitivity gap
during the period ($ 26,662) $145,683 $ 79,861 $ 68,290 $103,182 $ 307,354
========== ======== ======== ======== ======== ==========
Cumulative gap ($ 26,662) $119,021 $198,882 $267,172 $307,354
========== ======== ======== ======== ========
Interest sensitive assets as a
percent of interest sensitive
liabilities (cumulative) 95.81% 117.86% 125.29% 131.94% 144.28%
Interest sensitive assets as a
percent of total assets
(cumulative) 48.52% 62.50% 78.40% 87.81% 96.02%
Net interest sensitivity gap as a
percent of total assets (2.12%) 11.59% 6.35% 5.43% 8.21%
Cumulative gap as a percent
of total assets (2.12%) 9.47% 15.83% 21.26% 29.47%
</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.
29
<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 and Class A
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 and Class A
Common Stock (approximately $515,635 based upon 6,445,437 shares outstanding as
of June 30, 1997).
At June 30, 1997, cash and cash equivalents were 1% of total assets.
At June 30, 1997, approximately $30 million or 3% 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 $136 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 $525
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 June 30, 1997 was $483 million. An
additional investment in FHLBB stock would be required to borrow to the
available limit.
30
<PAGE>
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 $2,592,000 and $2,691,000 for the six months ended
June 30, 1996 and 1997, respectively.
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 resulting from deposits expected
to be obtained from asset administration clients.
Stockholders' equity at June 30, 1997 was $68,653,000, an increase of
$6,794,000 or 11%, from $61,859,000 at December 31, 1996. The ratio of
stockholders' equity to assets decreased to 5.22% at June 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 June 30, 1997:
<TABLE>
<CAPTION>
June 30, 1997
-------------
Amount Ratio
-------- -------
(Dollars in
thousands)
<S> <C> <C>
Tier I capital $ 90,786 26.9%
Tier I capital minimum requirement 13,489 4.0%
-------- -------
Excess Tier I capital $ 77,297 22.9%
======== =====
Total capital $ 90,886 27.0%
Total capital minimum requirement 26,978 8.0%
-------- -------
Excess total capital $ 63,908 19.0%
======== =====
Risk adjusted assets, net of intangible
assets $337,226
========
</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
31
<PAGE>
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 June 30, 1997 was 7.23%, which is in
excess of regulatory requirements. The capital ratios of the Company are
substantially similar to those of the Bank.
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>
Six Months Ended June 30, 1996 Six Months Ended June 30, 1997
--------------------------------------- ----------------------------------
Average Average Average Average
Balance Interest Yield/Cost Balance Interest Yield/Cost
------------- ---------- ------------ ---------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS
Fed funds sold and securities
purchased under resale agreements $ 24,929 $ 664 5.33% $ 31,586 $ 844 5.34%
Interest-earning deposits 253 6 4.74% - - -
Investment securities 383,564 12,263 6.39% 914,752 29,840 6.52%
Loans 34,031 998 5.87% 57,915 1,340 4.63%
-------- --------- ---------- --------- ------- ------
Total interest-earning assets 442,777 13,931 6.29% 1,004,253 32,024 6.38%
--------- ---------- ------- ------
Allowance for loan losses (68) (100)
Noninterest-earning assets 41,864 62,266
-------- ----------
Total assets $484,573 $1,066,419
======== ==========
INTEREST-BEARING LIABILITIES
Deposits:
Demand $121,616 2,912 4.79% $ 121,003 2,965 4.90%
Time 762 20 5.25% 472 11 4.66%
Savings 12,365 138 2.23% 269,880 6,484 4.81%
Short Term Borrowings 114,845 2,857 4.98% 378,790 9,518 5.03%
-------- --------- ---------- --------- ------- ------
Total interest-bearing liabilities 249,588 5,927 4.75% 770,145 18,978 4.93%
--------- ---------- ------- ------
Noninterest bearing liabilities
Demand deposits 130,211 147,708
Noninterest bearing time deposits 45,000 51,298
Other liabilities 7,855 11,870
-------- ----------
Total liabilities 432,654 981,021
Trust Preferred Stock - 20,331
Equity 51,919 65,067
-------- ----------
Total liabilities and equity $484,573 $1,066,419
======== ==========
Net interest income $ 8,004 $13,046
======= =======
Net interest margin (1) 3.62% 2.60%
Average interest rate spread (2) 1.54% 1.45%
Ratio of interest-earning assets to 177.40% 130.40%
interest-bearing liabilities
</TABLE>
- ----------------------------------------
(1) Net interest income divided by total interest-earning assets
(2) Yield on interest-earning assets less rate paid on interest-bearing
liabilities
32
<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 June 30, Six Months Ended June 30,
------------------------------ --------------------------
1996 1997 1996 1997
-------------- ---------- ----------- -----------
(in thousands, except per share data)
<S> <C> <C> <C> <C>
Net income $2,003 $2,895 $3,424 $5,716
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 21 156 22 137
---------- -------- -------- ------
Weighted average number of common and
common equivalent shares outstanding 6,465 6,601 6,466 6,582
========== ======== ======== ======
Net income per share (1) $ .31 $ .44 $ .53 $ .87
========== ======== ======== ======
</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 June 30, 1997.
33
<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: August 12, 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)
34
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> JUN-30-1997
<CASH> 9,570,008
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 63,000,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 324,279,511
<INVESTMENTS-CARRYING> 716,907,576
<INVESTMENTS-MARKET> 719,500,877
<LOANS> 102,527,199
<ALLOWANCE> 100,000
<TOTAL-ASSETS> 1,256,676,036
<DEPOSITS> 740,951,179
<SHORT-TERM> 409,123,917
<LIABILITIES-OTHER> 13,731,989
<LONG-TERM> 0
24,216,332
0
<COMMON> 64,455
<OTHER-SE> 68,588,164
<TOTAL-LIABILITIES-AND-EQUITY> 1,256,676,036
<INTEREST-LOAN> 1,340,295
<INTEREST-INVEST> 29,839,706
<INTEREST-OTHER> 843,520
<INTEREST-TOTAL> 32,023,521
<INTEREST-DEPOSIT> 9,459,602
<INTEREST-EXPENSE> 18,977,823
<INTEREST-INCOME-NET> 13,045,698
<LOAN-LOSSES> 0
<SECURITIES-GAINS> 7,110
<EXPENSE-OTHER> 39,406,689
<INCOME-PRETAX> 9,947,908
<INCOME-PRE-EXTRAORDINARY> 9,947,908
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,716,275
<EPS-PRIMARY> 0.87
<EPS-DILUTED> 0.87
<YIELD-ACTUAL> 2.60
<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>
