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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [NO FEE REQUIRED]
For the fiscal year ended December 31, 1997
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
FOR THE TRANSITION PERIOD FROM_________ TO__________
Commission File Number 0-26996
INVESTORS FINANCIAL
SERVICES CORP.
(Exact name of registrant as specified in its charter)
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Delaware 04-3279817
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization
200 Clarendon Street
P.O. Box 9130
Boston, Massachusetts 02116
(Address of principal executive offices) (Zip Code)
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Registrant's telephone number, including area code: (617) 330-6700
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 Par Value
Series A Junior Preferred Stock Purchase Rights
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
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. / /
The aggregate market value of Common Stock held by non-affiliates of the
registrant was $265,287,358 based on the last reported sale price of $44.0625
on The Nasdaq National Market on February 17, 1998 as reported by Nasdaq.
As of February 17, 1998, there were 6,472,188 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The registrant intends to file a definitive Proxy Statement pursuant to
Regulation 14A within 120 days of the end of the fiscal year ended December
31, 1997. Portions of such Proxy Statement are incorporated by reference in
Part III.
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ITEM 1. BUSINESS
GENERAL
Investors Financial Services Corp. (the "Company"), based in Boston,
Massachusetts, provides asset administration services for the financial
services industry through its wholly-owned subsidiary, Investors Bank & Trust
Company-Registered Trademark-. The Company provides global custody,
multicurrency accounting, institutional transfer agency, performance
measurement, foreign exchange, securities lending, mutual fund administration
and investment advisory services to a variety of financial asset managers,
including mutual fund complexes, investment advisors, banks and insurance
companies. The Company provides financial asset administration services for
assets that totaled approximately $139 billion at December 31, 1997,
including assets managed by 53 mutual fund complexes and insurance companies
and approximately $9 billion of foreign assets. The Company also engages in
private banking transactions, including secured lending and deposit accounts.
The Company operated as a subsidiary of Eaton Vance Corp. ("Eaton
Vance"), an investment management firm conducting business through
subsidiaries, from its formation in 1969 through November 1995. In 1995, the
boards of directors of the Company and Eaton Vance determined to separate the
business operations of the Company from those of Eaton Vance by means of a
tax free, pro rata distribution of Eaton Vance's ownership interest in the
Company to the stockholders of Eaton Vance (the "Spin-Off Transaction"). The
principal reasons for the Spin-Off Transaction were to eliminate certain
regulatory restrictions to which the Company was subject under the
Competitive Equality Banking Act of 1987 ("CEBA"), and to enable the Company
to pursue its business goals independent of Eaton Vance. In order to avoid
being regulated as a bank holding company under the Bank Holding Company Act
of 1956, Eaton Vance had operated Investors Bank & Trust Company under
certain growth and activity restrictions. The elimination of the CEBA growth
and activity restrictions enabled the Company to expand its current business
activities and participate in certain additional business activities. The
Spin-Off Transaction was completed on November 10, 1995, prior to the
completion of an initial public offering of 2,300,000 shares of the Company's
Common Stock, $.01 par value, (the "Common Stock") on November 14, 1995 (the
"Offering"). As used herein, the defined term "Company" shall mean Investors
Financial Services Corp. from and after June 29, 1995, the date of
organization of Investors Financial Services Corp., and shall mean Investors
Bank & Trust Company prior to that date, unless the context otherwise
indicates. Investors Bank & Trust Company is sometimes referred to herein as
the "Bank."
Prior to the completion of the Spin-Off Transaction, the Company's fiscal
year end was October 31, the fiscal year end observed by Eaton Vance. The
Company filed an annual report on Form 10-K with the Securities and Exchange
Commission for the year ended October 31, 1995. In December 1995, the Company
elected to change its fiscal year end from October 31 to December 31 in order
to align its fiscal year end with its regulatory, tax and budget reporting
period. The Company filed a Transition Report on Form 10-K for the two-month
period from November 1, 1995 through December 31, 1995 (the "Transition
Period").
OVERVIEW OF THE FINANCIAL SERVICES INDUSTRY
In the financial services industry, asset managers, whether independent
or affiliated with investment management companies, banks or insurance
companies, manage and invest financial assets entrusted to them. Asset
managers utilize a broad range of pooled investment products such as mutual
funds, unit investment trusts, separate accounts and variable annuities to
achieve their clients' investment goals. Asset administration companies, such
as the Company, perform various services for the asset managers and the
pooled products they sponsor, including global custody, multicurrency
accounting, transfer agency, portfolio performance measurement, foreign
exchange, securities lending, administration and investment advisory services.
The Company believes that the rapid pace of financial asset creation
through the flow of assets into pooled products and other investment products
and the related asset administration of those products is the key to revenue
growth for asset administration companies. As shown in the chart on the next
page, total financial assets managed by mutual fund companies, insurance
companies, private pension funds and banks have grown at an average annual
rate of over 13% since 1990. Mutual funds, such as those serviced by the
Company, make up a large part of the financial assets in pooled investment
vehicles. The U.S. mutual fund market has grown at an average annual rate of
more than 20% since 1990, with over $4 trillion in assets at September 30,
1997. According to the International Mutual Funds Survey, worldwide fund
assets were over $7 trillion in September 1997, an increase of $5 trillion in
approximately six years.
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TOTAL U.S. FINANCIAL ASSETS DECEMBER 31, SEPTEMBER 30, GROWTH
(IN BILLIONS) 1990 1997 RATE
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Mutual Funds..................................................................... 1,154.6 4,132.2 20.79%
Life Insurance Companies......................................................... 1,367.4 2,510.4 9.42
Private Pension Funds............................................................ 1,610.9 3,523.5 12.30
Bank Personal Trusts and Estates................................................. 522.1 999.2 10.09
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Total............................................................................ 4,655.0 11,165.3 13.84%
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Source: Federal Reserve Bank
The asset administration environment differs by asset management
organization and operational philosophy. Most asset managers outsource
custody services. In many cases, they use multiple custodians to foster cost
reduction through competition. Large asset managers may have the critical
mass necessary to justify the cost of in-house facilities to handle
accounting, administration and transfer agency services, while smaller asset
managers outsource these services as well. The Company believes that asset
administration companies such as the Company operate most efficiently when
bundling core services such as custody and accounting with value-added
services such as securities lending and foreign exchange. The Fund Accounting
and Custody Tracking System ("FACTS"), the software system developed and
owned by the Company, supports these services with its integrated
functionality, so that information input once is entered into various
administrative subsystems without manual intervention.
Providing asset administration services offshore is a growing activity in
the financial services industry. While the tax laws requiring funds based
outside the U.S. to conduct certain processing from an offshore location were
repealed in 1997, offshore locations are still serving as distribution
channels for offshore funds. In July 1993, the Company opened a subsidiary in
Toronto, Canada to service the offshore mutual fund market. In July 1994, the
Company opened an office in Dublin, Ireland to service investment managers
distributing to European clients. In February 1996, the Company opened an
administration site in the Cayman Islands to service Caribbean-based funds.
Another driving force in the financial services industry is information
technology. Asset managers are able to create innovative investment products
using data from world markets as a result of more powerful and affordable
information processing power, coupled with the ability to send large volumes
of information instantly through widely dispersed communication networks.
Timely on-line access to electronic information on security positions, prices
and price shifts facilitate on-line currency trading, indexation of assets,
real time arbitrage, and hedging through the use of derivative securities.
Asset administration providers use technology as a competitive tool to
deliver precise and functional information to the asset managers, and to
increase value-added services. Value-added services include performance
measurement and analytical tools for asset managers, such as reports showing
time-weighted return, performance by sector, and time-weighted return by
sector. Other factors, such as the reduction in settlement times in world
markets, have created greater demand for asset administration service
providers to have on-line, real-time systems. The Company believes that the
integrated nature of FACTS, compared with the disparate systems used for
different tasks by many other financial service providers, provides the
Company with a competitive advantage and positions the Company well to
respond to the changing technological demands of the financial services
industry.
Competition in the asset administration industry has reduced pricing in
almost all business segments, particularly with respect to custody services
and trustee services. Partially offsetting this trend is the development of
new services that have higher margins. The Company's continuous investment in
technology has permitted it to offer new value-added services to clients,
such as offshore custody and fund accounting, securities lending and foreign
exchange at competitive prices around the globe. Technological evolution and
new service innovation enable the Company to generate additional revenues to
offset price pressure in maturing service lines.
Asset managers create different investment structures in an effort to
capture the efficiencies of larger pools of assets. One example of this
innovation is the master-feeder structure. In the master-feeder structure,
one or more investment vehicles (the "feeder funds") with identical
investment objectives pool their assets in a common portfolio held by a
separate investment vehicle (the "master fund"). This structure permits each
of the feeder funds to be sold to a separate target market and through a
different distribution channel even if the feeder fund, on a stand alone
basis, would not be large enough to support its operating costs. The feeder
funds benefit from economies of scale available to the larger pool of funds
invested in the master fund. A patented variation of the master-feeder
structure, Hub and Spoke-Registered Trademark-, is marketed by Signature
Financial Group, Inc. At December 31, 1997, the Company processed over $40
billion of assets in the master-feeder structures, including $37 billion of
assets processed in the Hub and Spoke structure.
In addition, a growing number of mutual funds have been structured as
multiple class funds in order to address the differing requirements and
preferences of potential investors. In the typical multiple class
environment, investors have the
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option of purchasing fund shares with the sales load structure that best
meets their short-term and long-term investment strategy. Multiple class
arrangements allow an investment company to sell interests in a single
investment portfolio to separate classes of stockholders. Multiple class
funds, due to the increased complexity of their structure, present new
opportunities for asset administration companies.
The financial asset administration service industry continues to
experience a consolidation among service providers. The Company believes that
its size and its responsiveness to client needs provide the financial
services industry with an asset administration alternative to superregional
and money center banks and other administration providers. While
consolidation within the industry may adversely affect the Company's ability
to retain clients that have been acquired, consolidation also creates
opportunity for the Company as prospective clients review their relationships
with existing service providers. The Company's client management, sales and
marketing groups actively monitor these situations as they develop.
COMPANY STRATEGY
Global custody and multicurrency accounting are the principal asset
administration services provided to the Company's clients. The Company's
securities lending, foreign exchange, transfer agency, mutual fund
administration and investment advisory services are value-added services
utilized by clients based on their particular needs. The Company's objective
is to provide a broad range of services to all clients, maximize the use of
its value-added services and increase the size of its client base. To achieve
this objective, the Company has adopted the following strategy:
- Deliver superior service and expand client relationships. Service
quality in asset administration relationships is a key to maintaining
existing business and attracting new clients. The Company takes an
integrated approach to asset administration rather than the
functional approach of some of its competitors. Instead of separate
departments managing components of the custody and accounting task
(e.g., trade settlement, income collection, corporate actions,
general ledger accounting, portfolio accounting and pricing), the
Company has integrated these custody and accounting functions and
dedicates a single operations team to handle all work for a
particular account or fund. In addition, each client is assigned a
Client Manager, independent of the operations team, to anticipate the
client's needs, to coordinate service delivery, and to provide
consulting support. The Company believes that its strong client
relationships create continuing opportunities to provide additional
services to existing customers.
- Maintain technological expertise. The asset administration industry
requires the technological capability to support a wide range of
global security types and complex portfolio structures in both local
and base currencies, as well as the telecommunications flexibility to
support the diversity of global communications standards. FACTS was
developed in the mid-1980s to support the Company's integrated
approach to the provision of services to its clients. From a
technological standpoint, FACTS is an integrated computerized
information system that provides custody, securities movement and
control, portfolio accounting, general ledger accounting, pricing,
net asset value calculation, and Hub and Spoke or master-feeder
processing into a single information system. By consolidating these
functions, the Company has eliminated redundancy in data capture and
reduced the opportunity for clerical error. The FACTS architecture
enables the Company to modify the system quickly, resulting in
increased processing quality and efficiency for its clients. The
Company believes that this integrated architecture helps to
differentiate the Company from its competitors.
Technological enhancements and upgrades are an ongoing part of asset
administration, both to remain competitive and to create information
delivery mechanisms that add value to the information available as
part of clearing and settling transactions. Over the past few years,
the Company developed standardized data extracts and automated
interfaces that allow its clients to connect electronically with the
Company's host computer and access data collected from clearance and
settlement transactions in multiple currencies on a real-time basis.
Through these information-sharing tools, the Company is better
equipped to expand its custody and accounting services with foreign
exchange services and asset and transaction reporting and monitoring
services. This electronic linkage also positions the Company to
respond quickly to client requests.
The Company's technology professionals have developed expertise in
various advanced technologies, including graphical user interfaces,
relational database management systems, distributed processing and
imaging technology. The Company intends to continue to utilize these
technologies to provide the responsiveness necessary to keep pace
with the rapidly changing requirements of the industry and the needs
of its clients.
- Expand offshore processing capabilities. In July 1994, the Company
opened an office in Dublin, Ireland to service the growing European
client base. Assets processed by the Dublin subsidiary increased from
$27
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million at December 31, 1996 to over $1.1 billion at December 31,
1997. The technology requirements of the offshore fund accounting
operations are facilitated by the architecture of FACTS. FACTS allows
microcomputers located at offshore processing centers to use the
FACTS software system to perform the components of processing on-site
in compliance with local jurisdiction requirements for offshore
investment funds, while utilizing the Company's existing U.S.-based
mainframe processing, storage and archive capabilities. In contrast,
other fund accounting providers typically utilize entirely separate
systems for domestic and offshore processing.
SERVICE OFFERINGS
The Company provides a broad range of asset administration services to
the financial services industry, including global custody, multicurrency
accounting, securities lending, foreign exchange, mutual fund administration,
institutional transfer agency, performance measurement, private banking and
investment advisory services. Global custody and multicurrency accounting are
the principal asset administration services provided to the Company's
clients. Fees charged for these services reflect the highly competitive
nature and price-sensitivity of the market for custody and multicurrency
accounting services. Securities lending and foreign exchange services provide
a more favorable pricing environment for the Company and increased activity
by the Company in these areas would not involve a proportionate increase in
personnel or other resources. Mutual fund administration and institutional
transfer agency services provide additional revenue-generating opportunities,
but require a corresponding increase in personnel and processing resources.
Fees charged vary from client to client 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 and performance measurement are needed. Generally, fees are billed
to the client monthly in arrears and, upon their approval, charged directly
to their account.
The Company takes an integrated approach to asset administration rather
than the functional approach of some of its competitors. The Company has
integrated the components of the custody and accounting task (e.g., trade
settlement, income collection, corporate actions, general ledger accounting,
portfolio accounting and pricing) and dedicates a single operations team to
handle all work for a particular account or fund, instead of using separate
departments to manage these custody and accounting functions. In addition,
each client is assigned a Client Manager, independent of the operations team,
to anticipate the client's needs, to coordinate service delivery, and to
provide consulting support. The Company's accounting control group
independently checks and verifies transfer agency, custody and administrative
operations each day.
The following is a description of the various services offered by the
Company.
GLOBAL CUSTODY. Global custody entails overseeing the safekeeping of
domestic and cross border securities for clients and settlement of portfolio
transactions. The Company's domestic assets under custody have grown from $22
billion at October 31, 1990 to $126 billion at December 31, 1997. Examples of
the safekeeping of cross-border securities for clients include the
safekeeping of Hong Kong stocks for a Dutch mutual fund or German bonds held
for a U.S. bank-sponsored mutual fund. At December 31, 1997, the Company's
foreign assets under custody totaled approximately $9 billion.
Custody functions are fully integrated with security movement and
control, portfolio accounting, general ledger accounting, and pricing and
evaluation through FACTS. Custody functions include:
- Settlement of purchases and sales of securities.
- Safekeeping of securities and cash.
- Tracking and collection of income and receivables, such as dividends and
distributions.
- Reconciliation of cash and security positions.
- Disbursement of expenses.
- Calculation and reporting of cash availability to asset managers.
- Reporting and processing of corporate actions, such as stock splits and
bond calls.
- Initiation of settlement inquiries, including reclaims for foreign tax
withholding.
- Periodic reporting of holdings, transactions, income, corporate actions
and cash flow.
The Company entered the foreign custody marketplace in 1988, when the
nature of foreign custody began to change dramatically. In the 1970s, foreign
custody was a series of manual, labor-intensive exchanges; settlement was a
slow process where most securities were re-registered and vaulted in the U.S.
and the volume of assets was relatively small. Major developed countries
throughout the world have evolved to highly automated environments, and the
transition in developing countries is proceeding rapidly.
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Given the evolution of information technology and the industry's
acceptance of computer technology as the preferred vehicle to support foreign
custody, the Company established a worldwide network of global subcustodians.
In countries with centralized clearing houses such as Euroclear, the Company
establishes a subcustodian relationship with the clearing house and is able
to receive information from the subcustodian in electronic format directly
onto FACTS. In nations without automated environments, subcustodians hold
physical securities in their own vaults and provide reporting in hard copy
format to the Company for input onto FACTS. Today, the Company has custody
agreements in 77 countries, typically with regional providers of custody
services. Since the Company does not have its own branches in these
countries, it is able to operate in the foreign custody arena with minimal
fixed costs, while the Company's clients benefit from the ability to use only
one custodian, the Company, for their international investment needs.
MULTICURRENCY ACCOUNTING. Multicurrency accounting entails the daily
recordkeeping for each account or investment vehicle, including calculations
of net asset value per share, dividend rates per share, and the maintenance
of all books, records and financial reports required by the Securities and
Exchange Commission and other regulatory agencies. Due to the growth in
international investments by asset managers, traditional fund accounting
tasks must be reconciled across multiple currencies. The primary approach of
the Company is to bundle the sale of fund accounting and custody services in
order to work within the natural efficiencies and control mechanisms of its
integrated custody/fund accounting system and operational philosophy.
Multicurrency accounting functions include:
- Maintenance of the books and records of a fund in accordance with the
Investment Company Act of 1940.
- Tracking of investment transactions for use in the calculation of tax
gains and losses.
- Calculation and accrual of expenses.
- Booking of purchases, redemptions and transfers of fund shares as
directed by the transfer agent.
- Calculation of gains and losses by security and currency.
- Determination of net income.
- Calculation of daily yield in accordance with Securities and Exchange
Commission formula requirements.
- Preparation of statements of assets and liabilities and statements of
operations.
- Computation of the market value of the account.
- Calculation of the daily Net Asset Value of the account and reporting of
this value to the National Association of Securities Dealers for
publication in newspapers.
In addition to providing the above services to domestic-based accounts
and investment vehicles, the Company also provides offshore fund accounting.
The Company views the offshore market as a significant business opportunity
and will continue to invest in expansion to support client demand. The
Company's Toronto operations, conducted by the Company's wholly-owned
Canadian subsidiary, currently provide offshore services to 47 portfolios. As
of December 31, 1997, the Canadian subsidiary processed over $16 billion in
assets requiring the calculation of 105 daily net asset values. The Company's
Dublin operations provide offshore services to 36 portfolios. As of December
31, 1997, the Dublin subsidiary processed over $1.1 billion in assets
requiring the calculation of 25 daily net asset values and 11 weekly net
asset values. In February 1996, the Company opened an administration site in
the Cayman Islands for Caribbean-based funds.
The technology requirements of the offshore fund accounting operations
are facilitated by the architecture of FACTS. FACTS allows microcomputers
located at offshore processing centers to use the FACTS software system to
perform the components of account processing on-site in compliance with local
jurisdiction requirements for off-shore investment funds, while utilizing the
Company's mainframe processing, storage and archive capabilities. In
contrast, other fund accounting providers typically utilize entirely separate
systems for domestic and offshore processing.
MUTUAL FUND ADMINISTRATION. The Company provides mutual fund
administration services, including management reporting, regulatory
reporting, and tax and accounting reporting. Management reporting consists of
information and reporting which is of primary interest to the fund's asset
managers and its board of trustees and includes:
- Preparation of detailed quarterly financial information for presentation
to fund management and its board of trustees.
- Monitoring the reporting of net asset value, settlement of trades, and
processing of stockholder transactions.
- Monitoring compliance with investment portfolio restrictions.
- Calculation of fund dividends to be declared in accordance with management
guidelines.
- Preparation and monitoring of a fund's expense budget.
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Regulatory reporting is the reporting and accumulation of information
required of the fund by the Securities and Exchange Commission and state
securities regulators and includes:
- Coordination of preparation and filing of Securities and Exchange
Commission reports.
- Maintenance of effective "blue sky" registrations in jurisdictions
selected for fund sales.
- Coordination of the preparation and printing of stockholder reports.
- Preparation of prospectus update and proxy material.
- Coordination of on-going "blue sky" compliance.
Tax and accounting reporting is required either by the fund's auditors or
by Internal Revenue Service rules and regulations and includes:
- Performing portfolio compliance testing to establish qualification as a
regulated investment company.
- Preparation of income and excise tax returns.
- Preparation of audit package for use by independent public accountants.
- Coordination of review of income, capital gains, and distribution
information.
The Company also provides mutual fund start-up services in addition to
ongoing services. The Company has worked with a number of investment advisors
to assist them in the development of new mutual funds and other pooled
investment vehicles. Its services typically include assistance with product
definition, service provider selection, and fund structuring and
registration. The Company's Administration Group is staffed by 81 accounting
and legal professionals who have prior experience in either mutual fund
complexes or mutual fund servicing organizations.
INVESTMENT ADVISORY. The Bank acts as investment advisor to the Merrimac
Master Portfolio and the Merrimac Funds, master-feeder investment companies
(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, with assets totaling over $1.4 billion
at December 31, 1997. The Company has engaged The Bank of New York to act as
sub-advisor to manage the investments of the Merrimac Cash Portfolio and has
engaged Aeltus Investment Management, Inc. to act as sub-advisor to manage
the investments of the Merrimac Treasury Portfolio. 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. 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/or master funds in the future.
FOREIGN EXCHANGE. The Company offers foreign exchange services to
facilitate settlement of international securities transactions for U.S.
dollar denominated mutual funds and other accounts and to convert income
payments denominated in a non-U.S. currency to U.S. dollars. By using the
Company rather than a third party foreign exchange bank to perform these
functions, clients reduce the amount of time spent coordinating currency
delivery and monitoring delivery failures and claims. The Company, as
principal, enters into a foreign exchange contract with a client and
simultaneously enters into a matched trade with another financial
institution. The current volume of trades processed by the Company is
approximately 34,000 trades per year, which vary in size. The Company
initiates foreign exchange transactions only in response to a client's
request and engages in no foreign exchange trading transactions for its own
account. Foreign exchange fee revenue totaled $1,044,000, $237,000,
$2,106,000, and $4,427,000 for the year ended October 31, 1995, for the
Transition Period, and for the years ended December 31, 1996 and 1997,
respectively.
SECURITIES LENDING. Securities lending involves the lending of clients'
securities to brokers and other institutions for a fee, which improves a
client's return on the underlying securities. The Company acts as agent for
its clients for both international and domestic securities lending services.
Currently, lending services are provided to seven clients, and the current
loan portfolio aggregates approximately $1.8 billion. The Company retains as
compensation a portion of the lending fee due to the client as owner of the
borrowed asset. Securities lending fee revenue totaled $1,142,000, $157,000,
$1,947,000, and $2,865,000 for the year ended October 31, 1995, for the
Transition Period, and for the years ended December 31, 1996 and 1997,
respectively.
Through a network of broker/dealers, the Company places the securities
out on loan pursuant to client instruction, delivers the subject securities
and performs the necessary loan accounting. Accounting entails monitoring
each security out on loan by broker, allocating the loans to each fund,
tracking the fixed or variable rebate due the broker, updating the daily
investments, applying the earnings to each security loan and preparing daily
and monthly earnings statements for each fund and all the brokers.
All loans are fully collateralized with cash, government securities or a
letter of credit. This collateral is reinvested according to each client's
instructions. The Company monitors all outstanding loans on a daily basis by
reviewing exposure
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by broker, performing asset reconciliations, and marking each security to
market to ensure that proper collateral levels are maintained.
INSTITUTIONAL TRANSFER AGENCY. Transfer agency encompasses mutual fund
shareholder recordkeeping and communications. Services include tracking
capital shares, fulfilling purchase, transfer, and redemption requests, and
sending account statements, tax reporting information and distributions to
shareholders. The Company provides mutual fund shareholder servicing and
recordkeeping for clients representing approximately 24,000 shareholder
accounts. These services are generally provided only to institutional clients
with smaller numbers of outstanding shareholders or omnibus positions of
retail shareholders.
PERFORMANCE MEASUREMENT. Performance measurement services involve the
creation of systems and databases that enable asset managers to construct,
manage, and analyze their portfolios. Services include portfolio profile
analysis, portfolio return analysis, and customized benchmark construction.
Performance measurement uses data already captured by FACTS to calculate
statistics and report them to asset managers. The Company provides this
service for an aggregate of over $23 billion in assets managed by 46
investment advisors.
PRIVATE BANKING SERVICES. The Company offers private banking services to
individuals, family groups, trusts, endowments and foundations, and
retirement plans. The Company develops this client base by forming
relationships with investment advisors and working with the advisors to
service mutual clients. The Company services individually managed trust and
custody accounts that numbered approximately 5,900 at December 31, 1997. The
Company does not conduct consumer banking operations.
Acting as a fiduciary, the Company provides trust administration and
estate settlement services. These services include on-going fiduciary review
of the trust instrument, collection and safekeeping of assets, distribution
of income, appropriate reporting for court and tax purposes, preparation of
tax returns, and distribution of assets as required. The Company does not
provide investment advice, but works closely with third-party investment
advisors chosen by each client to carry out the investment of assets. Custody
services, such as the safekeeping of securities and the settlement of
securities transactions, are also provided to these clients. Custody service
fees are determined based on assets under custody and number of transactions
in each account.
At December 31, 1997, the Company had gross loans outstanding to
individuals and non-profit institutions of approximately $56 million, which
represented 4% of the Company's total assets. The interest rates charged on
the Bank's loans are indexed to either the prime rate or the rate paid on
90-day Treasury bills. The Company has never had a loan loss, and has no
delinquent loans. Other than a loan made to a non-profit association for
purposes of the Community Reinvestment Act, all loans are secured by
marketable securities and are due on demand.
COMMERCIAL BANKING SERVICES. As a result of the Spin-Off Transaction,
the Company is now able to offer commercial banking services. The Company
offers credit lines to its clients for the purpose of leveraging portfolios
and covering overnight cash shortfalls. Since the Spin-Off Transaction, the
Company has entered into agreements to provide up to an aggregate of $40
million under secured lines of credit to mutual fund clients. Additionally,
the Company's clients, which consist mainly of managers of mutual funds, unit
investment trusts and other pooled asset products, typically generate large
cash balances from securities sales and other transactions which they wish to
invest on a short-term basis. Because the Company was subject to a 7% annual
asset growth cap under CEBA, it was not able to accept those deposits and
directed those deposits to other financial institutions. The Company directed
an average of approximately $1.2 billion of such deposits daily to other
financial institutions in fiscal year 1995. Since the completion of the
Spin-Off Transaction and the Offering, the Company has redirected an average
of approximately $854 million daily of these balances into its own deposit
products and may now offer these deposit services directly to existing and
potential clients.
SALES, MARKETING AND CLIENT SUPPORT
The Company employs a direct sales staff of five employees that targets
potential market areas, including investment management companies, insurance
companies, banks and investment advisors. Sales personnel are primarily based
at the Company's headquarters in Boston and are given geographic area sales
responsibility. Additionally, the Company provides the sales staff with
market data and presentation materials. Senior managers from all functional
areas are directly involved in obtaining new clients, frequently working as a
team with a sales professional.
New client contacts are generated by a variety of methods, including
client referrals, personal sales calls, direct mailing to targeted clients,
attendance at trade shows and seminars, and advertising in trade publications.
In order to service existing clients, a client management staff of
approximately 12 professionals based in the Company's Boston office provides
client support. Each client is assigned a Client Manager responsible for the
overall
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satisfaction of the client. The Client Manager is usually a senior
professional with extensive industry experience and works with the client on
contracts, new products and specific systems requirements.
SIGNIFICANT CLIENTS
The Company presently provides services to approximately 53 mutual fund
complexes and insurance companies. The Company's largest current client,
Eaton Vance, accounted for 14%, 11%, 10% and 10% of the Company's net
operating revenues for the year ended October 31, 1995, for the Transition
Period, and for the years ended December 31, 1996 and 1997, respectively. A
former client of the Company, Merrill Lynch, accounted for 5% of the
Company's net operating revenues for the year end October 31, 1995. Merrill
Lynch paid the Company to assign the Company's servicing rights to The Bank
of New York effective March 1, 1995, and therefore accounted for no net
operating revenue in the Transition Period or in the years ended December 31,
1996 and 1997. The percentages of consolidated revenues attributable to Eaton
Vance and Merrill Lynch for the periods referenced above were substantially
the same as the percentages of net operating revenues described above. Eaton
Vance accounted for 10% of the Company's consolidated revenues for the
Transition Period. No single client represented more than 10% of the
Company's consolidated revenues for the years ended December 31, 1996 and
1997. No other single client of the Company represented more than 10% of net
operating revenues or consolidated revenues for the periods discussed above.
Eaton Vance has been a client of the Company since 1975. The Company's
agreements with mutual funds managed by Eaton Vance, pursuant to which the
Company provides custody and fund accounting services, extend through August
2000 and continue thereafter until terminated by either party upon sixty days
prior notice. If a majority of non-interested trustees of a fund determines
that the performance of the Company under any such agreement has been
unsatisfactory or adverse to the interests of the fund's shareholders, or
that the terms of the agreement are no longer consistent with publicly
available industry standards, the Company has 60 days after receipt of
written notice to such effect to (i) correct its performance or (ii)
renegotiate such terms. If the corrective action or renegotiation is not
satisfactory to the trustees, the agreement may be terminated on sixty days
prior notice. The Company has long-term contracts with 11 other clients with
terms ranging from three to five years. Total assets processed under
long-term contracts at December 31, 1997 were over $42 billion. All other
client engagements are, and in the future may be, terminable upon 60 days
notice.
SOFTWARE SYSTEMS AND DATA CENTER
The Company's asset administration operations are supported by
sophisticated computer technology. The Company receives vast amounts of
information across a world-wide computer network. That information, which
covers a wide range of global security types and complex portfolio structures
in various currencies, must then be processed, resulting in system-wide
updating and reporting. The Company must have the capability to provide not
only daily and periodic reports of asset accounting and performance, but also
to provide measurement and analytical data to asset managers on-line on a
real time basis. These technology requirements call for powerful and
sophisticated computer hardware and software systems operated in a cost
effective manner.
The primary software system used by the Company is FACTS. The system was
developed over a four-year period by the Bank of New England, and was put
into operation in 1986. It was acquired by the Company in 1990 in connection
with the acquisition by the Company of the Financial Products Services
Division of the Bank of New England.
FACTS utilizes microcomputers networked to servers networked to a
mainframe computer system. The microcomputers can be located in any location
with the requisite telecommunications network for the automated interface to
the mainframe, enabling the Company to provide geographically dispersed
processing services effectively and efficiently. This configuration also
provides redundant processing capability; if the mainframe fails, FACTS is
able to process independently on the microcomputers.
FACTS emphasizes efficiency and accuracy because it integrates custody,
securities movement and control, portfolio accounting, general ledger
accounting, pricing, net asset value calculation, and master/ feeder
processing into a single system. The traditional industry approach is to have
separate applications for each of these functions and to interconnect the
component applications with manual intervention at various points in the
process.
The integrated and automated nature of FACTS is best reflected in
following a transaction through the system. For example, a purchase of a
security is entered on a client trading system and the transaction
information is electronically transmitted to FACTS. The receipt of the trade
information by FACTS will trigger the following activities with no manual
intervention by the Company:
- Creation of a Securities Movement and Control transaction to track and
control the trade for the entire settlement cycle (e.g., confirmation,
affirmation, settlement).
- Updating of the portfolio position for the security being purchased.
- Immediate updating of all required general ledger accounts.
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- Creation of a pricing record to enable pricing of the security and
inclusion in the total market value and net asset value determination.
- Affirmation and settlement of the trade upon notification from the
counterparty with associated transaction and general ledger updates
occurring simultaneously.
- Accounting for all income for the holding period of the security.
FACTS also complies with current industry standards such as the
requirement that mandates a three business day settlement cycle for public
securities transactions rather than the traditional five business day cycle.
The enhancements made to FACTS to address this change included enabling FACTS
to interact with the Depository Trust Company via its new Interactive
Institutional Delivery System, which allows institutions to confirm trades
earlier in the trade life cycle.
The integrated nature of the FACTS architecture allows the Company to
affect modifications and enhancements quickly, resulting in increased
processing quality and efficiency for the Company's clients. This integrated
architecture helps differentiate the Company from its competitors. System
enhancements and upgrades are an ongoing part of asset administration, both
to keep ahead of the competition and to create information delivery
mechanisms that add value to the information available as part of clearing
and settling transactions. Over the past few years, the Company has developed
standardized data extracts and automated interfaces that allow its clients to
connect electronically with the Company's host computer and access data
collected from clearance and settlement transactions in multiple currencies
on a real-time basis. This electronic linkage also positions the Company to
respond quickly to client requests.
A substantial portion of the Company's electronic transaction processing
services depends upon mainframe computer hardware, owned and operated by
Electronic Data Systems ("EDS"), contained in the EDS Information Processing
Center ("IPC") in Plano, Texas. Processing and networking functions and
equipment are located at the IPC, and in the Boston, Camp Hill, and Detroit
metropolitan areas. By outsourcing data processing, the Company can focus its
resources on its core line of business and minimize its capital investment in
computer equipment. EDS is able to offer the Company up to date computer
products and services to which it would not otherwise have access, while
removing the risk of product obsolescence. Due to its diverse customer base,
EDS can invest in the latest computer technology and spread the costs over
multiple users. In addition, the defined pricing provided by EDS for products
and services allows the Company to match its data processing cost with the
related revenue stream. The use of EDS as a hardware provider allows the
Company to dedicate its efforts to the ongoing enhancement of its software
systems while receiving the benefit of the continuing investment by EDS in
its computer hardware.
EDS provides mainframe disaster recovery services. EDS maintains
additional processing equipment at the Plano IPC and at a designated
alternate IPC which may be used in the event of equipment failure. The Plano
facility is also supported by an uninterruptable power supply and diesel
generators which can supply power to continue operations for an extended
period of time. Critical software and data files are backed-up daily and
stored off-site. Disaster recovery plans are tested through simulations
conducted by the Company twice a year. Notwithstanding these precautions,
there can be no assurance that a fire or other natural disaster affecting the
data center would not disable the host computer system.
The current agreement between the Company and EDS obligates EDS to
provide the Company with comprehensive data processing services and obligates
the Company to utilize EDS's services for substantially all of its data
processing requirements. The Company is billed for these services monthly on
an as-used basis as determined by a pricing schedule for specific products
and services. EDS began providing services to the Company in December 1990
and the current agreement is scheduled to expire on December 31, 2000.
COMPETITION
The market for asset administration services is highly competitive. The
Company's most significant competitors are State Street Bank & Trust Company,
The Bank of New York, Chase Manhattan Corp., Brown Brothers Harriman & Co.,
and PNC Bank. These competitors possess substantially greater financial,
sales and marketing resources than the Company and process a greater amount
of financial assets than the Company. In addition, the Company also
encounters competition in the sale of fund accounting services from large
in-house accounting departments of mutual fund complexes, insurance companies
and banks offering proprietary mutual funds. Competitive factors include
technological advancement and flexibility, breadth of services provided and
quality of service. The Company believes that it competes favorably in these
categories.
INTELLECTUAL PROPERTY
The Company's success is dependent upon its software development
methodology and other intellectual property rights developed and owned by the
Company, including FACTS. The Company relies on a combination of trade
secret, nondisclosure and other contractual arrangements and technical
measures, and copyright and trademark laws to protect its proprietary rights.
The Company generally enters into confidentiality agreements with its
employees and consultants, and
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limits access to and distribution of its proprietary information. There can
be no assurance that the steps taken by the Company in this regard will be
adequate to deter misappropriation of its proprietary information or that the
Company will be able to detect unauthorized use and take appropriate steps to
enforce its intellectual property rights. Furthermore, such protections may
not preclude competitors from developing products and services with
functionality or features similar to those of the Company. In addition,
effective copyright, trademark and other trade protection may not be
available in certain international markets serviced by the Company. Finally,
there can be no assurance that intellectual property protection will be
available in certain foreign countries. The registration of the service mark
Investors Bank & Trust Company will remain in force until 2006, at which time
it may be renewed.
Although the Company believes that its services do not infringe on the
intellectual property rights of others, there can be no assurance that such a
claim will not be asserted against the Company in the future.
EMPLOYEES AND TRAINING
As of December 31, 1997, the Company had 1,009 full-time employees,
including six in senior management, 18 in marketing and client management,
837 in operations and 148 in general and administration. None of the
Company's employees are represented by a union. The Company believes that its
relations with its employees are good.
The Company has developed a five-week professional development program
for entry level staff. Successful completion of the program is required of
most newly hired employees. Topics covered during the program include an
overview of the financial services industry and pooled asset vehicles,
principles of mutual fund accounting and custody, instruction in control
procedures, manual performance of fund accounting tasks and intensive
training on FACTS. This training program is supplemented by ongoing education
on the industry and client base.
The Company's business is labor-intensive, and its success depends to a
significant extent upon a number of key management employees and skilled
technical, managerial and marketing personnel, few of which are bound by
employment agreements. From October 31, 1990 to December 31, 1997, the
Company's staff increased from 463 to 1,009 employees.
REGULATION AND SUPERVISION
In addition to the generally applicable state and federal laws governing
businesses and employers, the Company and the Bank are further regulated by
federal and state laws and regulations applicable only to financial
institutions and their parent companies. Virtually all aspects of the
Company's and the Bank's operations are subject to specific requirements or
restrictions and general regulatory oversight. State and federal banking laws
have as their principal objective either the maintenance of the safety and
soundness of financial institutions and the federal deposit insurance system
or the protection of consumers or classes of consumers, rather than the
specific protection of stockholders of a bank or its parent company. To the
extent the following material describes statutory or regulatory provisions,
it is qualified in its entirety by reference to the particular statute or
regulation.
THE COMPANY
GENERAL. The Company, as a bank holding company, is subject to regulation
and supervision by the Federal Reserve Board (the "FRB") and by the
Massachusetts Commissioner of Banks (the "Commissioner"). The Company is
required to file annually a report of its operations with, and is subject to
examination by, the FRB and the Commissioner. The FRB has the authority to
issue orders to bank holding companies to cease and desist from unsound
banking practices and violations of conditions imposed by, or violations of
agreements with, the FRB. The FRB is also empowered to assess civil monetary
penalties against companies or individuals who violate the Bank Holding
Company Act of 1956, as amended, (the "BHCA") or orders or regulations
thereunder, to order termination of non-banking activities of non-banking
subsidiaries of bank holding companies, and to order termination of ownership
and control of a non-banking subsidiary by a bank holding company.
BHCA--ACTIVITIES AND OTHER LIMITATIONS. The BHCA prohibits a bank holding
company from acquiring substantially all the assets of a bank or acquiring
direct or indirect ownership or control of more than 5% of the voting shares
of any bank, or increasing such ownership or control of any bank, or merging
or consolidating with any bank holding company without prior approval of the
FRB. No approval under the BHCA is required, however, for a bank holding
company already owning or controlling 50% or more of the voting shares of a
bank to acquire additional shares of such bank. The Riegle-Neal Interstate
Banking and Branching Efficiency Act of 1994 (the "Interstate Act") generally
authorizes bank holding companies to acquire banks located in any state. In
addition, the Interstate Act generally authorizes national and state
chartered banks to merge across state lines (and thereby create interstate
branches) commencing June 1, 1997. Under the provisions of the Interstate
Act, states are permitted to "opt out" of this latter interstate branching
authority by taking action prior to the commencement date. States may also
"opt in" early (i.e., prior to June 1, 1997) to the interstate merger
provisions.
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The BHCA also prohibits a bank holding company from acquiring a direct or
indirect interest in or control of more than 5% of the voting shares of any
company which is not a bank or bank holding company and from engaging
directly or indirectly in activities other than those of banking, managing or
controlling banks or furnishing services to its subsidiary banks, except that
it may engage in and may own shares of companies engaged in certain
activities the FRB has determined to be so closely related to banking or
managing and controlling banks as to be a proper incident thereto. In making
such determinations, the FRB is required to weigh the expected benefit to the
public, such as greater convenience, increased competition or gains in
efficiency, against the possible adverse effects, such as undue concentration
of resources, decreased or unfair competition, conflicts of interests or
unsound banking practices.
The FRB has by regulation determined that certain activities are closely
related to banking within the meaning of the BHCA. Should the Company desire
to expand its activities beyond its current financial services activities, it
would generally be limited to the following activities: operating a mortgage
company, finance company, credit card company, factoring company, trust
company or savings association; performing certain data processing
operations; providing limited securities brokerage services; acting as an
investment or financial advisor; acting as an insurance agent for certain
types of credit-related insurance; leasing personal property on a
full-payout, non-operating basis; providing tax planning and preparation
services; operating a collection agency; and providing certain courier
services. The FRB also has determined that certain other activities,
including real estate brokerage and syndication, land development, property
management and underwriting of life insurance not related to credit
transactions, are not closely related to banking and a proper incident
thereto.
COMMITMENTS TO AFFILIATED INSTITUTIONS. Under FRB policy, the Company is
expected to act as a source of financial strength to the Bank and to commit
resources to support the Bank in circumstances when it might not do so absent
such policy and is expected to maintain the financial flexibility and
capital-raising capacity to obtain additional resources for assisting the
Bank. The legality and precise scope of this policy is unclear, however, in
light of federal judicial precedent. Additionally, the Federal Deposit
Insurance Act (the "FDIA") requires the holding company parent of an
undercapitalized bank to guarantee, up to certain limits, the bank's
compliance with a capital restoration plan approved by the bank's primary
federal supervisory agency. Because Investors Financial Services Corp., as a
holding company for the Bank, has no assets other than its ownership interest
in the Bank, its ability to serve as a source of strength to the Bank through
the contribution of capital is, presently, limited to contributing proceeds
from the sale of securities such as the Capital Securities discussed under
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Capital Resources."
CAPITAL REQUIREMENTS. The FRB has adopted capital adequacy guidelines
pursuant to which it assesses the adequacy of capital in examining and
supervising a bank holding company and in analyzing applications to it under
the BHCA. These capital adequacy guidelines generally require bank holding
companies to maintain total capital equal to 8% of total risk-adjusted assets
and off-balance sheet items, with at least one-half of that amount consisting
of Tier I or core capital and the remaining amount consisting of Tier II or
supplementary capital. Tier I capital for bank holding companies generally
consists of the sum of common stockholders' equity and perpetual preferred
stock (subject in the case of the latter to limitations on the kind and
amount of such stocks which may be included as Tier I capital), less
goodwill. Tier II capital generally consists of hybrid capital instruments;
perpetual preferred stock which is not eligible to be included as Tier I
capital; term subordinated debt and intermediate-term preferred stock; and,
subject to limitations, general allowances for loan losses. Assets are
adjusted under the risk-based guidelines to take into account different risk
characteristics, with the categories ranging from 0% (requiring no additional
capital) for assets such as cash to 100% for such assets as premises, plant
and equipment and traditional consumer loans. Claims on, or guaranteed by,
U.S. government agencies, as well as the portion of claims that are
collateralized by securities issued or guaranteed by the U.S. Treasury are
assigned a 20% level in the risk-weighting system. Off-balance sheet items
also are adjusted to take into account certain risk characteristics.
In addition to the risk-based capital requirements, the FRB requires bank
holding companies to maintain a minimum leverage capital ratio of Tier I
capital (defined by reference to the risk-based capital guidelines) to total
assets of 3.0%. Total assets for this purpose does not include goodwill and
any other intangible assets and investments that the FRB determines should be
deducted from Tier I capital. The FRB has announced that the 3.0% Leverage
Ratio requirement is the minimum for the top-rated bank holding companies
without any supervisory, financial or operational weaknesses or deficiencies
or those which are not experiencing or anticipating significant growth.
Because the Bank, and consequently, the Company, anticipates significant
future growth, the Company will be required to maintain Leverage Ratios of at
least 4.0% to 5.0% or more. Management currently intends to maintain Leverage
Ratios of 6.0%.
The Company currently is in compliance with both the Risk Based Capital
Ratio and the Leverage Ratio requirements. At December 31, 1997, the Company
had a Tier I Risk Based Capital Ratio and a Total Risk Based Capital Ratio
equal to 29.00% and 29.03%, respectively and a Leverage Ratio equal to 6.39%.
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LIMITATIONS ON ACQUISITIONS OF COMMON STOCK. The Federal Change in Bank
Control Act prohibits a person or group of persons from acquiring "control"
of a bank holding company unless the FRB has been given 60 days prior written
notice of such proposed acquisition and within that time period the FRB has
not issued a notice disapproving the proposed acquisition or extending for up
to another 30 days the period during which such a disapproval may be issued.
An acquisition may be made prior to expiration of the disapproval period if
the FRB issues written notice of its intent not to disapprove the action.
Under a rebuttable presumption established by the FRB, the acquisition of 10%
or more of a class of voting stock of a bank holding company with a class of
securities registered under Section 12 of the Securities Exchange Act of
1934, as amended (the "Exchange Act") would, under the circumstances set
forth in the presumption, constitute the acquisition of control.
In addition, any company, as that term is defined in the statute, would
be required to obtain the approval of the FRB under the BHCA before acquiring
25% (5% in the case of an acquirer that is a bank holding company) or more,
or such lesser percentage as the FRB deems to constitute control over the
Company, of the outstanding Common Stock of the Company. Such approval would
be contingent upon, among other things, the acquirer registering as a bank
holding company, divesting all impermissible holdings and ceasing any
activities not permissible for a bank holding company.
MASSACHUSETTS LAW. Massachusetts law generally defines a bank holding
company as a company which owns or controls two or more financial
institutions. Although the Company owns or controls only one financial
institution, it is deemed a bank holding company for purposes of
Massachusetts law due to the manner in which it acquired the Bank.
Accordingly, the Company has registered with the Commissioner and is
obligated to make reports to the Commissioner. Further, as a Massachusetts
bank holding company, the Company may not acquire all or substantially all of
the assets of a banking institution or merge or consolidate with another bank
holding company without the prior consent of the Board of Bank Incorporation
(the "BBI"). As a condition of such consent, the BBI must receive notice from
the Massachusetts Housing Partnership Fund (the "Fund") that arrangements
satisfactory to the Fund have been made by the Company to make 0.9% of its
assets available for financing, down payment assistance, share loans, closing
costs and other costs related to programs promoted by the Fund, including
those related to creating affordable rental housing, limited equity
cooperatives, and tenant management programs.
THE BANK
GENERAL. The Bank is subject to extensive regulation and examination by
the Commissioner and by the FDIC, which insures its deposits to the maximum
extent permitted by law, and to certain requirements established by the FRB.
The federal and state laws and regulations which are applicable to banks
regulate among other things, the scope of their business, their investments,
their reserves against deposits, the timing of the availability of deposited
funds and the nature and amount of and collateral for certain loans.
FDIC INSURANCE PREMIUMS. The Bank pays deposit insurance premiums to the
FDIC based on an assessment rate established by the FDIC for Bank Insurance
Fund-member institutions. The FDIC has established a risk-based assessment
system under which institutions are assigned to one of three capital
groups--"well capitalized," "adequately capitalized" and
"undercapitalized"--which are defined in substantially the same manner as
under the regulations establishing the prompt corrective action system
pursuant to Section 38 of the FDIA, as discussed below. These three capital
groups are then each divided into three subgroups which reflect varying
levels of supervisory concern, from those which are considered to be healthy
to those which are considered to be of substantial supervisory concern. The
matrix so created results in nine assessment risk classifications, with
corresponding assessment rates ranging from .04% for well capitalized,
healthy institutions to .31% for undercapitalized institutions with
substantial supervisory concerns. There is a statutory minimum assessment of
$1,000 per semi-annual period. The Bank is currently subject to the statutory
minimum assessment.
CAPITAL REQUIREMENTS. The FDIC has promulgated regulations and adopted a
statement of policy regarding the capital adequacy of state-chartered banks
which, like the Bank, are not members of the Federal Reserve System. These
requirements are substantially similar to those adopted by the FRB regarding
bank holding companies, as described above.
The FDIC's capital regulation establishes a minimum 3.0% Leverage Ratio
requirement for the most highly-rated state-chartered, non-member banks, with
an additional cushion of at least 100 to 200 basis points for all other
state-chartered, non-member banks, which effectively will increase the
minimum Leverage Ratio for such other banks to 4.0% to 5.0% or more. Under
the FDIC's regulation, highest-rated banks are those that the FDIC determines
are not anticipating or experiencing significant growth and have well
diversified risk, including no undue interest rate risk exposure, excellent
asset quality, high liquidity, good earnings and, in general, which are
considered a strong banking organization, rated composite 1 under the Uniform
Financial Institutions Rating System. A bank having less than the minimum
Leverage Ratio shall, within 45 days of the date as of which it fails to
comply with such requirement, submit to its FDIC regional director for review
and approval a reasonable plan describing the means and timing by which the
bank shall achieve its minimum leverage capital requirement. A bank which
fails to file such plan with the FDIC is deemed to be operating in an unsafe
and unsound manner, and could be subject to a cease-and-desist order from the
FDIC. The FDIC's amended regulation also provides
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that any insured depository institution with a Leverage Ratio less than 2.0%
is deemed to be operating in an unsafe or unsound manner pursuant to Section
8(a) of the FDIA and is subject to potential termination of deposit
insurance. Such an institution, however, will not be subject to an
enforcement proceeding thereunder, solely on account of its capital ratios if
it has entered into and is in compliance with a written agreement with the
FDIC to increase its Leverage Ratio to such level as the FDIC deems
appropriate and to take such other action as may be necessary for the
institution to be operated in a safe and sound manner. The FDIC capital
regulation also provides, among other things, for the issuance by the FDIC or
its designee(s) of a capital directive, which is a final order issued to a
bank that fails to maintain minimum capital to restore its capital to the
minimum leverage capital requirement within a specified time period. Such
directive is enforceable in the same manner as a final cease-and-desist order.
The FDIC has augmented the capital leverage ratios described above with a
risk-based capital framework which is more explicitly and systematically
sensitive to the risk profiles of individual banks. Under the risk-based
capital framework, the assets of the Bank are weighted pursuant to the risk
category in which each asset falls. These risk categories are substantially
the same as those described in the discussion of FRB capital requirements
above. Banks generally will be expected to maintain a minimum Tier I Risk
Based Capital Ratio of 4.0% and a Total Risk Based Capital Ratio of 8.0%. Any
bank that does not meet the minimum requirements, or whose capital is
otherwise considered inadequate, generally will be expected to develop and
implement a capital plan for achieving an adequate level of capital,
consistent with the provisions of the risk-based capital framework.
At December 31, 1997, the Bank was in compliance with all minimum Federal
regulatory capital requirements which are generally applicable to FDIC
insured banks. As of such date, the Bank had a Tier I Risk Based Capital
Ratio and a Total Risk Based Capital Ratio equal to 28.54% and 28.57%,
respectively, and a Leverage Ratio equal to 6.31%.
PROMPT CORRECTIVE ACTION. Under Section 38 of the FDIA, each federal
banking agency is required to implement a system of prompt corrective action
for institutions which it regulates. The federal banking agencies have
promulgated substantially similar regulations to implement the system of
prompt corrective action established by Section 38 of the FDIA. Under the
regulations, a bank shall be deemed to be (i) "well capitalized" if it has
Total Risk Based Capital Ratio of 10.0% or more, has a Tier I Risk Based
Capital Ratio of 6.0% or more, has a Leverage Ratio of 5.0% or more and is
not subject to any written capital order or directive; (ii) "adequately
capitalized" if it has a total Risk Based Capital Ratio of 8.0% or more, a
Tier I Risk Based Capital Ratio of 4.0% or more, and a Leverage Ratio of 4.0%
or more (3.0% under certain circumstances) and does not meet the definition
of "well capitalized," (iii) "undercapitalized" if it has a Total Risk Based
Capital Ratio that is less than 8.0%, a Tier I Risk Based Capital Ratio that
is 4.0% or greater or a Leverage Ratio that is less than 4.0% (3.0% under
certain circumstances), (iv) "significantly undercapitalized" if it has a
Total Risk Based Capital Ratio that is less than 6.0%, a Tier I Risk Based
Capital Ratio that is less than 3.0% or a Leverage Ratio that is less than
3.0%, and (v) "critically undercapitalized" if it has a ratio of tangible
equity to total assets that is equal to or less than 2.0%. Section 38 of the
FDIA and the regulations also specify circumstances under which a federal
banking agency may reclassify a well capitalized institution as adequately
capitalized and may require an adequately capitalized institution or an
undercapitalized institution to comply with supervisory actions as if it were
in the next lower category, except that the FDIC may not reclassify a
significantly undercapitalized institution as critically undercapitalized.
An institution generally must file a written capital restoration plan
which meets specified requirements with an appropriate federal banking agency
within 45 days of the date that the institution receives notice or is deemed
to have notice that it is undercapitalized, significantly undercapitalized or
critically undercapitalized. A federal banking agency must provide the
institution with written notice of approval or disapproval with 60 days after
receiving a capital restoration plan, subject to extensions by the agency.
An institution which is required to submit a capital restoration plan
must concurrently submit a performance guaranty by each company that controls
the institution. Such guaranty shall be limited to the lesser of (i) an
amount equal to 5.0% of the institution's total assets at the time the
institution was notified or deemed to have notice that it was
undercapitalized or (ii) the amount necessary at such time to restore the
relevant capital measure of the institution to the levels required for the
institution to be classified as adequately capitalized. Such a guarantee
shall expire after the federal banking agency notifies the institution that
it has remained adequately capitalized for each of four consecutive calendar
quarters. An institution which fails to submit a written capital restoration
plan within the requisite period, including any required performance
guarantee, or fails in any material respect to implement a capital
restoration plan, shall be subject to the restrictions in Section 38 of the
FDIA which are applicable to significantly undercapitalized institutions.
A critically undercapitalized institution is to be placed in
conservatorship or receivership with 90 days unless the FDIC formally
determines that forbearance from such action would better protect the deposit
insurance fund. Unless the FDIC or other appropriate federal banking
regulatory agency makes specific further findings and certifies that the
institution is viable and is not expected to fail, an institution that
remains critically undercapitalized on average during the fourth calendar
quarter after the date it becomes critically undercapitalized must be placed
in receivership.
14
<PAGE>
Immediately upon becoming undercapitalized, an institution becomes
subject to the provisions of Section 38 of the FDIA (i) restricting payment
of capital distributions and management fees, (ii) requiring that the
appropriate federal banking agency monitor the condition of the institution
and its efforts to restore its capital, (iii) requiring submission of a
capital restoration plan, (iv) restricting the growth of the institution's
assets and (v) requiring prior approval of certain expansion proposals. The
appropriate federal banking agency for an undercapitalized institution also
may take any of a number of discretionary supervisory actions if the agency
determines that any of these actions is necessary to resolve the problems of
the institution at the least possible long-term cost to the deposit insurance
fund, subject in certain cases to specified procedures. These discretionary
supervisory actions include requiring the institution to raise additional
capital; restricting transactions with affiliates; restricting interest rates
paid by the institution on deposits; requiring replacement of senior
executive officers and directors; restricting the activities of the
institution and its affiliates; requiring divestiture of the institution or
the sale of the institution to a willing purchaser; and any other supervisory
action that the agency deems appropriate. These and additional mandatory and
permissive supervisory actions may be taken with respect to significantly
undercapitalized and critically undercapitalized institutions.
At December 31, 1997, the Bank was deemed to be a well capitalized
institution for the above purposes. Bank regulators may raise capital
requirements applicable to banking organizations beyond current levels.
Because the Company is unable to predict whether higher capital requirements
will be imposed and, if so, at what levels and on what schedules, it
therefore cannot predict what effect such higher requirements may have on the
Company and the Bank.
BROKERED DEPOSITS. The FDIA restricts the use of brokered deposits by
certain depository institutions. Under the FDIA and applicable regulations,
(i) a well capitalized institution may solicit and accept, renew or roll over
any brokered deposit without restriction, (ii) an adequately capitalized
institution may not (x) accept, renew or roll over any brokered deposit
unless it has applied for and been granted a waiver of this prohibition by
the FDIC or (y) solicit deposits by offering an effective yield that exceeds
by more than 75 basis points the prevailing effective yields on insured
deposits of comparable maturity in such institution's normal market area or
in the market area in which such deposits are being solicited and (iii) an
undercapitalized institution may not (x) accept, renew or roll over any
brokered deposits or (y) solicit deposits by offering an effective yield that
exceeds by more than 75 basis points the prevailing effective yields on
insured deposits of comparable maturity in such institution's normal market
area or in the market area in which such deposits are being solicited. The
term "undercapitalized insured depository institution" is defined to mean any
insured depository institution that fails to meet the minimum regulatory
capital requirement prescribed by its appropriate federal banking agency. The
FDIC may, on a case-by-case basis and upon application by an adequately
capitalized insured depository institution, waive the restriction on brokered
deposits upon a finding that the acceptance of brokered deposits does not
constitute an unsafe or unsound practice with respect to such institution.
Currently, the Bank is deemed to be a well capitalized insured depository
institution for purposes of the restriction on the use of brokered deposits
by such institutions. The bank historically has not relied upon brokered
deposits as a source of funding and, at December 31, 1997, the Bank did not
have any brokered deposits.
TRANSACTIONS WITH AFFILIATES. The FDIA restricts the range of
permissible transactions between a member bank and an affiliated company. The
Bank is subject to certain restrictions on loans to the Company, on
investment in the stock or securities thereof, on the taking of such stock or
securities as collateral for loans to any borrower, and on the issuance of a
guarantee or letter of credit on behalf of the Company. The Bank also is
subject to certain restrictions on most types of transactions with the
Company, requiring that the terms of such transactions be substantially
equivalent to terms to similar transactions with non-affiliates.
ACTIVITIES AND INVESTMENTS OF INSURED STATE-CHARTERED BANKS. Section 24
of the FDIA generally limits the activities and equity investments of
FDIC-insured, state-chartered banks to those that are permissible for
national banks. Under the FDIC's regulations dealing with equity investments,
an insured state bank generally may not directly or indirectly acquire or
retain any equity investment of a type, or in an amount, that is not
permissible for a national bank. An insured state bank is not prohibited
from, among other things, (i) acquiring or retaining a majority interest in a
subsidiary, (ii) investing as a limited partner in a partnership the sole
purpose of which is direct or indirect investment in the acquisition,
rehabilitation or new construction of a qualified housing project, provided
that such limited partnership investments may not exceed 2% of the Bank's
total assets, (iii) acquiring up to 10% of the voting stock of a company that
solely provides or reinsures directors', trustees', and officers' liability
insurance coverage or bankers' blanket bond group insurance coverage for
insured depository institutions, and (iv) acquiring or retaining the voting
shares of a depository institution if certain requirements are met.
COMMUNITY REINVESTMENT ACT. The Federal Community Reinvestment Act
("CRA") requires the FDIC and the Commissioner to evaluate the Bank's
performance in helping to meet the credit needs of the community. The Bank
has been designated as a "wholesale institution" for CRA purposes by the
Commissioner and the FDIC. This designation reflects the nature of the
Company's business as other than a retail financial institution and
proscribes CRA review criteria applicable to the Bank's particular type of
business. As a part of the CRA program, the Bank is subject to periodic
examinations by the FDIC and the Commissioner, and maintains comprehensive
records of its CRA activities for this
15
<PAGE>
purpose. Management believes the Bank is currently in compliance with all CRA
requirements. The Bank has pending an application with the FDIC to become
designated a "special purpose" institution, which designation would exempt
the Bank from CRA review by the FDIC. The Bank would still be subject to
review by the Commissioner.
MASSACHUSETTS LAW--DIVIDENDS. Under Massachusetts law trust companies
such as the Bank may pay dividends only out of "net profits" and only to the
extent that such payments will not impair the Bank's capital stock and
surplus account. If, prior to declaration of a dividend, the Bank's capital
stock and surplus accounts do not equal at least 10.0% of its deposit
liabilities, then prior to the payment of the dividend the Bank must transfer
from net profits to its surplus account the amount required to make its
surplus account equal to either (i) together with capital stock, 10.0% of
deposit liabilities or, (ii) subject to certain adjustments, 100% of capital
stock. These restrictions on the ability of the Bank to pay dividends to the
Company may restrict the ability of the Company to pay dividends to its
stockholders.
REGULATORY ENFORCEMENT AUTHORITY. The enforcement powers available to
federal banking regulators include, among other things, the ability to assess
civil money penalties, to issue cease-and-desist or removal orders and to
initiate injunctive actions against banking organizations and
institution-affiliated parties, as defined. In general, these enforcement
actions may be initiated for violations of law and regulations and unsafe or
unsound practices. Other actions or inactions may provide the basis for
enforcement action, including misleading or untimely reports filed with
regulatory authorities. Federal law requires, except under certain
circumstances, public disclosure of final enforcement actions by the federal
banking agencies.
TRANSFER AGENCY. In order to serve as transfer agent to its clients that
execute transactions in publicly traded securities, the Company must register
as a transfer agent under the Exchange Act. As a registered transfer agent,
the Company is subject to certain reporting and recordkeeping requirements.
Currently, management believes the Company is in compliance with these
registration, reporting and recordkeeping requirements.
REGULATION OF INVESTMENT COMPANIES. Certain of the Company's mutual fund
and unit investment trust clients are regulated as "investment companies" as
that term is defined under the Investment Company Act of 1940, as amended
(the "ICA"), and are subject to examination and reporting requirements
applicable to the services provided by the Company.
The provisions of the ICA and the regulations promulgated thereunder
prescribe the type of institution which may act as a custodian of investment
company assets, as well as the manner in which a custodian administers the
assets in its custody. Because the Company serves as custodian for a number
of its investment company clients, these regulations require, among other
things, that the Company maintain certain minimum aggregate capital, surplus,
and undivided profits. Additionally, arrangements between the Company and
clearing agencies or other securities depositories must meet ICA requirements
for segregation of assets, identification of assets and client approval.
Future legislative and regulatory changes in the existing laws and
regulations governing custody of investment company assets, particularly with
respect to custodian qualifications, may have a material and adverse impact
on the Company. Currently, management believes the Company is in compliance
with all minimum capital and securities depository requirements. Further, the
Company is not aware of any proposed or pending regulatory developments,
which, if approved, would adversely affect the ability of the Company to act
as custodian to an investment company.
Investment companies are also subject to extensive recordkeeping and
reporting requirements. These requirements dictate the type, volume and
duration of the record-keeping undertaken by the Company, either in its role
as custodian for an investment company or as a provider of administrative
services to an investment company. Further, the Company must follow specific
ICA guidelines when calculating the net asset value of a client mutual fund.
Consequently, changes in the statutes or regulations governing recordkeeping
and reporting or valuation calculations will affect the manner in which the
Company conducts its operations.
New legislation or regulatory requirements could have a significant
impact on the information reporting requirements applicable to the Company's
clients and may in the short term adversely affect the Company's ability to
service those clients at a reasonable cost. Any failure by the Company to
provide such support could cause the loss of customers and have a material
adverse effect on the Company's financial results. Additionally, legislation
or regulations may be proposed or enacted to regulate the Company in a manner
which may adversely affect the Company's financial results.
16
<PAGE>
ITEM 2. PROPERTIES.
As of December 31, 1997, the Company leased three offices located in
Boston, as well as foreign offices in Toronto, Canada and Dublin, Ireland for
its offshore funds processing business.
The following table provides certain summary information with respect to
the principal properties that the Company leases:
<TABLE>
<CAPTION>
EXPIRATION
LOCATION FUNCTION SQ. FT. DATE
- --------------------------------- --------------------------------- --------- ------------------
<S> <C> <C> <C>
200 Clarendon St., Boston, MA Principal Executive Offices and 233,992 2007
Operations Center
1 Exeter Plaza, Boston, MA Training Center 11,375 2001
24 Federal Street, Boston, MA Operations Center 3,658 Tenant at will
1 First Canadian Place, Toronto Offshore Processing Center 13,674 2001
Earlsfort Terrace, Dublin Offshore Processing Center 3,400 2000
</TABLE>
In January 1997, the Company entered into an agreement to lease 4,116
square feet at the 1 First Canadian Place location for a four-year term to
commence in 1998 in order to expand its Toronto operations. In August 1997,
the Company entered into an agreement to lease 3,735 square feet at the
Earlsfort Terrace location for a two-year term to commence in 1998 in order
to expand its Dublin operations. See Note 15 of the Notes to the Consolidated
Financial Statements.
ITEM 3. LEGAL PROCEEDINGS.
The Company is from time to time subject to claims arising in the
ordinary course of business. While the outcome of any claim cannot be
predicted with certainty, management does not expect these matters,
individually or in the aggregate, to have a material adverse effect on the
results of operations and financial condition of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of the Company's security holders
during the quarter ended December 31, 1997.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.
PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY
The Company's Common Stock is currently included in The Nasdaq National
Market under the symbol IFIN. The following table sets forth the range of
quarterly high and low bid quotations for the Company's Common Stock as
reported by NASDAQ. The quotations represent interdealer quotations without
adjustment for retail markups, markdowns or commissions, and may not
necessarily represent actual transactions.
<TABLE>
<CAPTION>
1996 HIGH BID LOW BID
- -------------------------------------- --------- ---------
<S> <C> <C>
First Quarter......................... $ 23.125 $ 20.500
Second Quarter........................ $ 23.500 $ 21.000
Third Quarter......................... $ 26.000 $ 20.875
Fourth Quarter........................ $ 28.000 $ 25.750
</TABLE>
<TABLE>
<CAPTION>
1997 HIGH BID LOW BID
- -------------------------------------- --------- ---------
<S> <C> <C>
First Quarter......................... $ 35.125 $ 27.500
Second Quarter........................ $ 50.000 $ 30.750
Third Quarter......................... $ 48.250 $ 41.250
Fourth Quarter........................ $ 51.250 $ 41.250
</TABLE>
As of February 17, 1998, there were approximately 1,101 stockholders of
record.
17
<PAGE>
DIVIDENDS
The Company currently intends to retain the majority of future earnings
to fund the development and growth of its business. The Company's ability to
pay dividends on the Common Stock depends on the receipt of dividends from
Investors Bank & Trust Company. In addition, the Company may not pay
dividends on its Common Stock if it is in default under certain agreements
which the Company entered into in connection with the sale of the 9.77%
Capital Securities. See "Management Discussion and Analysis of Financial
Condition and Results of Operations--Capital Resources." Any dividend
payments by Investors Bank & Trust Company are subject to certain
restrictions imposed by the Massachusetts Commissioner of Banks. See
"Business--Regulation and Supervision." Subject to regulatory requirements,
Investors Bank & Trust Company 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 $.12 per share of outstanding Common
Stock (approximately $776,438 based upon 6,470,313 shares outstanding as of
December 31, 1997). The Company expects to declare and pay such dividend
ratably on a quarterly basis.
18
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA.
Except as discussed below, the selected financial data presented below
have been derived from the Company's audited financial statements. This data
should be read in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations," the Company's Consolidated
Financial Statements and Notes thereto, and other financial information
appearing elsewhere in this Report.
<TABLE>
<CAPTION>
FOR THE TWO
MONTHS ENDED FOR THE YEAR
FOR THE YEAR ENDED OCTOBER 31, DECEMBER 31, ENDED DECEMBER 31,
------------------------------------------------------------------------------------------
1993 1994 1995(1) 1995 1996 1997
------------- ------------- ------------- ------------- -------------- --------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
Statement of Income Data:
Net interest income......... $ 4,494 $ 4,778 $ 5,870 $ 1,966 $ 17,944 $ 26,173
Noninterest income.......... 32,967 43,049 51,562 8,085 56,634 76,702
Gain/(loss) on sale of
investment securities..... 48 -- -- -- (2) 114
------------- ------------- ------------- ------------- -------------- --------------
Net operating revenues...... 37,509 47,827 57,432 10,051 74,576 102,989
Operating expenses.......... 33,939 42,503 50,224 8,481 61,935 82,649
------------- ------------- ------------- ------------- -------------- --------------
Income before income
taxes..................... 3,570 5,324 7,208 1,570 12,641 20,340
Income taxes................ 1,211 1,863 2,800 670 4,867 7,323
Minority interest expense... -- -- -- -- -- 1,437
------------- ------------- ------------- ------------- -------------- --------------
Net income.................. $ 2,359 $ 3,461 $ 4,408 $ 900 $ 7,774 $ 11,580
------------- ------------- ------------- ------------- -------------- --------------
------------- ------------- ------------- ------------- -------------- --------------
Per Share Data:
Basic earnings per share.... $ 0.14 $ 1.21 $ 1.80
------------- -------------- --------------
------------- -------------- --------------
Diluted earnings per
share..................... $ 0.14 $ 1.20 $ 1.75
------------- -------------- --------------
------------- -------------- --------------
Average Balance Sheet Data:
Interest earning assets..... $ 87,965 $ 94,351 $ 106,130 $ 219,775 $ 575,662 $ 1,167,361
Total assets................ 109,477 116,810 128,174 249,064 628,893 1,236,519
Total deposits.............. 99,523 102,664 106,446 197,013 377,219 594,768
Common stockholders'
equity.................... 9,022 11,779 16,119 34,000 56,137 68,370
Selected Financial Ratios:
Return on equity (2)........ 26.15% 29.38% 27.35% 15.11% 13.85% 16.94%
Return on assets (2)........ 2.15% 2.96% 3.44% 2.12% 1.24% 0.94%
Common equity as % of total
assets.................... 8.24% 10.08% 12.58% 16.57% 6.41% 5.13%
Dividend payout ratio (3)... 2.54% 1.73% 1.36% 0.00% 2.49% 4.45%
Tier 1 capital ratio (4).... 37.08% 42.53% 37.62% 62.10% 24.67% 29.00%
Noninterest income as % of
net operating income...... 87.89% 90.01% 89.78% 80.44% 75.94% 74.48%
Nonperforming assets as % of
total assets.............. 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
Allowance for loan losses as
% of total loans.......... 0.34% 0.26% 0.26% 0.15% 0.15% 0.18%
Other Statistical Data:
Assets processed at end of
period (5)................ $ 61,239,242 $ 72,418,449 $ 91,099,976 $94,208,228 $ 122,563,401 $ 139,418,241
Employees at end of
period.................... 522 678 671 674 792 1,009
</TABLE>
- ------------------------
(1) Noninterest income for the year ended October 31, 1995 includes the
recognition of net proceeds of $2,572,000 from the assignment to a third
party of asset administration rights associated with $5 billion of unit
investment trust assets.
(2) Ratios for the two months ended December 31, 1995 have been annualized. The
ratios for the year ended October 31, 1995 include the effect of the unit
investment trust transaction described in (1) above. Without the earnings
associated with this transaction, return on equity and return on assets for
the year ended October 31, 1995 would have been 18.10% and 2.28%,
respectively.
(3) The Company intends to retain the majority of future earnings to fund
development and growth of its business but the Company currently expects to
pay cash dividends at an annualized rate of $.12 per share, subject to
receipt of a like dividend from the Bank and further subject to regulatory
requirements.
(4) Tier I capital consists of the sum of common stockholders' equity and
non-cumulative perpetual preferred stock minus all intangible assets (other
than certain qualifying goodwill) and excess deferred tax assets.
(5) 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 and mutual
fund administration and investment advisory services.
19
<PAGE>
ITEM 7. 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 Consolidated Financial Statements and related notes, which are
included elsewhere in this Report. The Company, through its wholly owned
subsidiary, Investors Bank & Trust Company, provides global custody,
multicurrency accounting, institutional transfer agency, performance
measurement, foreign exchange, securities lending, mutual fund administration
and investment advisory services to a variety of financial asset managers,
including 53 mutual fund complexes, investment advisors, banks and insurance
companies. The Company provides financial asset administration services for
assets that totaled approximately $139 billion at December 31, 1997,
including approximately $9 billion of assets based outside the United States.
The Company also engages in private banking transactions, including secured
lending and deposit accounts.
The Bank acts as investment advisor to the Merrimac Master Portfolio and
the Merrimac Funds, master-feeder investment companies (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, with assets totaling over $1.4 billion at December
31, 1997. The Company has engaged The Bank of New York to act as sub-advisor
to manage the investments of the Merrimac Cash Portfolio and has engaged
Aeltus Investment Management, Inc. to act as sub-advisor to manage the
investments of the Merrimac Treasury Portfolio. 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. 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/or master funds in the future.
On January 31, 1997, the Company completed the issuance and sale of
$25,000,000 in 9.77% Capital Securities. The Capital Securities were issued
by Investors Capital Trust l, a Delaware statutory business trust sponsored
by the Company. The capital raised in the offering, along with existing
capital and earnings generated in the future, will be used to support the
Company's balance sheet growth. The Capital Securities qualify as Tier I
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. In September 1997 the Company completed an
exchange offer pursuant to which all outstanding capital securities were
exchanged for substantially identical capital securities registered under the
Securities Act of 1933.
The Company's current largest client, Eaton Vance, accounted for 14%,
11%, 10%, and 10% of the Company's net operating revenues for the year ended
October 31, 1995, for the Transition Period, and for the years ended December
31, 1996 and 1997, respectively. The Company believes its relationship with
Eaton Vance is good and expects it to continue. The Company's agreements with
mutual funds managed by Eaton Vance, pursuant to which the Company provides
custody and fund accounting services, extend through August 2000 and continue
thereafter until terminated by either party upon sixty days prior notice. If
a majority of noninterested trustees of a fund determines that the
performance of the Company under any such agreement has been unsatisfactory
or adverse to the interests of the fund's shareholders, or that the terms of
the agreement are no longer consistent with publicly available industry
standards, the Company shall have 60 days after receipt of written notice to
such effect to (i) correct its performance or (ii) renegotiate such terms. If
such corrective action or renegotiation is not satisfactory to such trustees,
such agreement may be terminated on sixty days prior notice. There have been
no requests for corrective action or renegotiation to date pursuant to these
contract clauses.
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 the most
meaningful measures of financial results. Revenue generated from asset
administration and other fees and interest income increased 38% from
$74,576,000 for the year ended December 31, 1996 to $102,989,000 for the year
ended December 31, 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
20
<PAGE>
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.
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-K) may contain statements
which are not historical facts, so-called "forward-looking statements," which
involve risks and uncertainties. Forward looking statements in this 10-K
include certain statements regarding capital ratios and liquidity. 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
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.
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 effect on the Company. In addition the Year
2000 Issue discussed below may affect the Company's operations. 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 specified period may have an adverse impact on the
Company's results of operations for that period. 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.
IMPACT OF THE YEAR 2000 ISSUE
The Year 2000 Issue is the result of computer programs being written
using two digits rather than four to define the applicable year. Any of the
Company's computer programs that have date-sensitive software may recognize a
date using "00" as the year 1900 rather than the year 2000. This could result
in a system failure or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process transactions,
send invoices, or engage in similar normal business activities.
In late 1997 the Company, with the assistance of an outside consultant,
completed a detailed assessment of the Company's Year 2000 compliance status. As
part of the assessment process, the Company also developed project plans for
application renovation and testing. Based on this assessment, the Company
determined that it will be required to modify or upgrade portions of its
software so that its computer systems will properly utilize dates beyond
December 31, 1999. The Company presently believes that with modifications to, or
upgrades of, existing software, the Year 2000 Issue can be
21
<PAGE>
mitigated. However, if such modifications and upgrades are not made, or are
not completed in a timely manner, the Year 2000 Issue could have a material
impact on the operations of the Company.
The Company has initiated formal communications with all of its
significant suppliers and large customers to determine the extent to which
the Company is vulnerable to those third parties' failure to remediate their
own Year 2000 Issue. The Company's total Year 2000 project cost and estimates
to complete include the estimated costs and time associated with the impact
of a third party's Year 2000 Issue, and are based on presently available
information. However, there can be no guarantee that the systems of other
companies on which the Company's systems rely will be timely converted, or
that a failure to convert by another company, or a conversion that is
incompatible with the Company's systems, would not have a material adverse
effect on the Company.
The Company will utilize both internal and external resources to modify
or upgrade existing software and to test such software for Year 2000
compliance. The Company plans to complete the Year 2000 project, including
all testing, by December 31, 1998. The total remaining cost of the Year 2000
project is estimated at $1,600,000, which will be expensed as incurred over
the next twelve months, and is being funded through operating cash flows.
These amounts are not expected to have a material effect on the Company's
results of operations. To date, the Company has incurred and expensed
approximately $165,000 related to the assessment of, and preliminary
remediation efforts in connection with, its Year 2000 project and the
development of a remediation plan.
The costs of the project and the date on which the Company plans to
complete the Year 2000 modifications are based on management's best
estimates, which were derived utilizing numerous assumptions of future events
including the continued availability of certain resources, third party
modification plans and other factors. However, there can be no guarantee that
these estimates will be achieved and actual results could differ materially
from those plans. Specific factors that might cause such material differences
include, but are not limited to, the availability and cost of personnel
trained in this area, the ability to locate and correct all relevant computer
code, the compatibility of third-party interfaces and similar uncertainties.
STATEMENT OF OPERATIONS
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1997 AND
1996
NONINTEREST INCOME
Noninterest income increased $20,184,000 to $76,816,000 for the year
ended December 31, 1997 from $56,632,000 for the year ended December 31,
1996. Noninterest income consists of the following items:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
-----------------------------------
1996 1997 CHANGE
--------- --------- -------------
(DOLLARS IN
THOUSANDS)
<S> <C> <C> <C>
Asset administration fees..................... $ 56,076 $ 75,873 35%
Computer service fees......................... 482 468 (3)
Other operating income........................ 76 361 375
Net gain/(loss) on sale of securities......... (2) 114 --
--------- ---------
Total Noninterest Income...................... $ 56,632 $ 76,816 36%
--------- ---------
--------- ---------
</TABLE>
Asset administration fees increased due principally to higher levels of
assets processed. 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: global custody,
multicurrency accounting, institutional transfer agency, performance
measurement, foreign exchange, securities lending, mutual fund administration
and investment advisory services. Total assets processed increased to $139
billion at December 31, 1997 from $122 billion at December 31, 1996. Of the
$17 billion net increase in assets processed from December 31, 1996 to
December 31, 1997, approximately 24% of the increase reflects assets
processed for new clients, and the remainder of the increase reflects growth
of assets processed for existing clients, offset in part by the assets of
clients no longer serviced by the Company. Also contributing to the growth in
asset administration fees was the expansion of relationships with existing
clients. The largest component of asset administration fees is asset based
fees, which increased between periods due to the previously mentioned
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, foreign exchange and advisory
services.
22
<PAGE>
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 Federal Home Loan Bank of
Boston ("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.
OPERATING EXPENSES
Total operating expenses increased by $20,714,000 to $82,649,000 for the
year ended December 31, 1997 compared to $61,935,000 for the year ended December
31, 1996. The components of operating expenses were as follows:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
-----------------------------------
1996 1997 CHANGE
--------- --------- -------------
(DOLLARS IN
THOUSANDS)
<S> <C> <C> <C>
Compensation and benefits........................ $ 37,502 $ 50,043 33%
Technology and telecommunications................ 7,791 10,484 35
Transaction processing services.................. 5,683 7,999 41
Occupancy........................................ 4,283 4,381 2
Depreciation and amortization.................... 1,502 1,930 28
Travel and sales promotion....................... 1,158 1,586 37
Professional fees................................ 1,115 1,564 40
Insurance........................................ 853 735 (14)
Other operating expenses......................... 2,048 3,927 92
--------- ---------
Total Operating Expenses......................... $ 61,935 $ 82,649 33%
--------- ---------
--------- ---------
</TABLE>
Compensation and benefits expense increased by $12,541,000 or 33% from
period to period due to several factors. The average number of employees
increased 29% to 939 at December 31, 1997 from 729 at December 31, 1996. This
increase relates primarily to the increase in client relationships and to the
expansion of existing client relationships during the period. In addition,
compensation expense related to the Company's management incentive plans
increased $799,000 between periods because of the increase in earnings
subject to incentive payments in 1997 compared to 1996. Benefits, including
payroll taxes, group insurance plans, retirement plan contributions and
tuition reimbursement, increased by $984,000 for the year ended December 31,
1997 from the same period in 1996. The increase was due principally to
increased payroll taxes attributable to the increase in compensation expense.
Technology and telecommunications expense consists of operating lease
payments for microcomputers, fees charged by Electronic Data Systems for
mainframe data processing, telephone expense, software maintenance fees and
licenses, optical imaging and contract programming fees. Increased hardware,
software and telecommunications expenses needed to support the growth in
assets processed accounted for $1,641,000 of the increase between periods.
Also contributing was the Company's increased use of contract programmers to
perform information systems development projects, which accounted for
$644,000 of the increase. License fees on software used to generate automated
financial statements for Company clients as a part of its expanded mutual
fund administration services accounted for $408,000 of the increase.
Transaction processing services expense consists of volume-related
expenses including subcustodian fees and external contract services. The
increase in this expense relates primarily to an increase in subcustodian
fees and pricing services, driven by the growth in assets processed. The
Company's decision to outsource its mailroom and photocopy facility in
February of 1996 contributed to $325,000 of the increase from year to year.
Depreciation and amortization expense increased $428,000 to $1,930,000
for the year ended December 31, 1997 from $1,502,000 for the year ended
December 31, 1996. This increase resulted from the purchase of furniture and
equipment related to the Company's move to new office space in late 1996 and
1997.
Travel and sales promotion expense consists of expenses incurred by the
sales force, client management staff and other employees in connection with
making sales calls on potential clients, traveling to existing client sites
and the Company's foreign subsidiaries, and attending industry conferences.
This expense increased $428,000 to $1,586,000 for the year ended December 31,
1997 from $1,158,000 for the year ended December 31, 1996 due primarily to
increased travel to the foreign subsidiaries.
Professional fees increased $449,000 to $1,564,000 for the year ended
December 31, 1997 from $1,115,000 for the year ended December 31, 1996. This
increase resulted primarily from an increase in consulting fees relating to
23
<PAGE>
performing technical development work along with additional audit fees related
to compliance with the Federal Deposit Insurance Corporation Improvement Act of
1991.
Insurance expense decreased by $118,000 between the periods due to the
renegotiation of the Company's premiums and coverages for errors and omissions
liability, directors and officers liability and blanket bond during 1996.
Other operating expenses increased $1,879,000 to $3,927,000 for the year
ended December 31, 1997 from $2,048,000 for the year ended December 31, 1996.
Other operating expenses include fees for office supplies, recruiting costs,
temporary help and various fees assessed by the Massachusetts Banking
Commission. Recruiting costs and temporary help accounted for $770,000 of the
increase; this increase relates to the tight labor market caused by low
unemployment in Massachusetts in 1997. Fees assessed by the Massachusetts
Banking Commission increased by $278,000 due to the growth in the total assets
of the Bank and a change in the assessment base. The remainder of the increase
relates to growth in assets processed.
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 and changes in
interest rates for the year ended December 31, 1997 compared to the year ended
December 31, 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.................... $ 1,096 $ 20 $ 1,116
Investment securities.......................... 35,563 (564) 34,999
Loans.......................................... 514 (270) 244
--------- --------- ---------
Total interest-earning assets.................. 37,173 (814) 36,359
--------- --------- ---------
INTEREST-BEARING LIABILITIES
Deposits....................................... 8,768 671 9,439
Borrowings..................................... 18,351 405 18,756
--------- --------- ---------
Total interest-bearing liabilities............. 27,119 1,076 28,195
--------- --------- ---------
Change in net interest income.................. $ 10,054 $ (1,890) $ 8,164
--------- --------- ---------
--------- --------- ---------
</TABLE>
Net interest income increased $8,164,000 or 45% to $26,173,000 for the
year ended December 31, 1997 from $18,009,000 for the 1996 period. This net
increase resulted from an increase in interest income of $36,359,000 offset
by an increase in interest expense of $28,195,000. The net impact of the
above changes was an 89 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 year ended
December 31, 1997 increased $607,626,000 or 97% compared to the year ended
December 31, 1996. This growth primarily resulted from an increase in average
interest earning assets of $591,699,000.
Interest expense increased $28,195,000 due primarily to the higher level
of deposits and borrowings and to a lesser extent to an increase in the
interest rate paid by the Company. The average rate paid on deposits and
short-term borrowings increased from 4.83% to 5.03% between periods.
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 11.32%. The provision for income taxes for the year ended
December 31, 1997 increased by $2,456,000 over the 1996 provision. The overall
effective tax
24
<PAGE>
rate decreased to 36% for the year ended December 31, 1997, from 38.5% for
the year ended December 31, 1996. The decrease in the effective tax rate is
due to the Company's investment in municipal securities in the first quarter
of 1997.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1996 AND
1995
NONINTEREST INCOME
Noninterest income increased $4,705,000 to $56,632,000 for the year ended
December 31, 1996 from $51,927,000 for the year ended December 31, 1995.
Noninterest income consists of the following items:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
-----------------------------------
1995 1996 CHANGE
--------- --------- -------------
(DOLLARS IN
THOUSANDS)
<S> <C> <C> <C>
Asset administration fees......................... $ 48,779 $ 56,076 15%
Proceeds from assignment of UIT servicing, net.... 2,572 -- --
Computer service fees............................. 501 482 (4)
Other operating income............................ 75 76 1
Net loss on sale of securities.................... -- (2) --
--------- ---------
Total Noninterest Income.......................... $ 51,927 $ 56,632 9%
--------- ---------
--------- ---------
</TABLE>
Asset administration fees increased due principally to higher levels of
assets processed. Total assets processed increased to $122 billion at
December 31, 1996 from $94 billion at December 31, 1995. Of the $28 billion
net increase in assets processed from December 31, 1995 to December 31, 1996,
approximately 24% of the increase reflects assets processed for new clients,
and the remainder of the increase reflects growth of assets processed for
existing clients and improved methods for tracking the amount of assets
processed, offset in part by the assets of clients no longer serviced by the
Company. The remainder of the growth in asset administration fees was due to
the net expansion of relationships with existing clients and increased use of
the Company's cash management and foreign exchange services. In addition,
because the Company is now able to accept deposits that had been historically
directed to other financial institutions due to CEBA asset growth
restrictions, the Company has experienced a shift in the mix of compensation
received from its clients. See "Overview" in this Item 7. A larger portion of
the Company's compensation from clients is now in the form of interest income
generated from client deposits, resulting in a decrease to asset
administration fees and a related increase in net interest income. The growth
in asset administration fees was also offset by the transfer of unit
investment trust assets discussed below. The administration of these assets
accounted for approximately $1,491,000 in asset administration fees in the
year ended December 31, 1995.
Unit investment trust ("UIT") assets processed by the Company have decreased
over the last five years, a reflection of declining investor demand for this
type of unmanaged investment product. Declining asset levels led one client,
Merrill Lynch, to consolidate its asset administration service providers, and
it agreed, effective March 1, 1995, to pay the Company to assign the Company's
servicing rights to the Bank of New York Company. The Company recognized
proceeds of $2,572,000, net of expenses, resulting from the assignment of the
rights to service approximately $5.0 billion of the client's unit investment
trust assets. The Company has made the strategic decision to focus its marketing
and processing efforts on mutual funds and other pooled investments which
typically experience higher growth in asset levels and can utilize a wider
variety of services provided by the Company, as compared to unit investment
trusts. See Note 11 of Notes to Consolidated Financial Statements.
Other operating income consists of miscellaneous private banking fees for
safe deposit and checking account services.
25
<PAGE>
OPERATING EXPENSES
Total operating expenses increased by $10,672,000 to $61,935,000 for the
year ended December 31, 1996 compared to $51,263,000 for the year ended December
31, 1995. The components of operating expenses were as follows:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
-----------------------------------
<S> <C> <C> <C>
1995 1996 CHANGE
--------- --------- -------------
<CAPTION>
(DOLLARS IN
THOUSANDS)
<S> <C> <C> <C>
Compensation and benefits........................ $ 32,899 $ 37,502 14%
Technology and telecommunications................ 6,476 7,791 20
Transaction processing services.................. 2,765 5,683 106
Occupancy........................................ 4,163 4,283 3
Depreciation and amortization.................... 1,388 1,502 8
Travel and sales promotion....................... 785 1,158 48
Professional fees................................ 774 1,115 44
Insurance........................................ 1,078 853 (21)
Other operating expenses......................... 935 2,048 119
--------- ---------
Total Operating Expenses......................... $ 51,263 $ 61,935 21%
--------- ---------
--------- ---------
</TABLE>
Compensation and benefits increased by $4,603,000 or 14% from period to
period due to several factors. The number of average employees increased 8%
to 729 at December 31, 1996 from 677 at December 31, 1995. In addition,
compensation expense related to the Company's management incentive plan
increased because of the increase in earnings subject to incentive in 1996
compared to 1995. Benefits, including payroll taxes, group insurance plans,
retirement plan contributions and tuition reimbursement, increased $590,000
for the year ended December 31, 1996 from the same period in 1995. The 12%
increase was due to increased payroll taxes attributable to the increase in
compensation expense and a decrease in the discount rate used to calculate
the expense associated with the defined benefit retirement plan.
Technology and telecommunications expense consists of lease payments for
microcomputers, fees charged by Electronic Data Systems for mainframe data
processing, telephone expense, software maintenance fees and licenses, and
contract programming fees. The expense varies with the level of assets
processed by the Company. The growth in assets processed between periods
contributed to $871,000 increase between periods. Also contributing to the
increase was the Company's continued use of contract programmers which
accounted for $444,000 of the increase between periods.
The increase in transaction processing expense relates primarily to an
increase in subcustodian fees and pricing services, driven by the growth in
assets processed. This expense increased $2,918,000 to $5,683,000 for the
year ended December 31, 1996 from $2,765,000 for the year ended December 31,
1995. This increase resulted from the increase in foreign assets processed,
which are subject to higher subcustodian fees, from $6.4 billion at December
31, 1995 to $9.3 billion at December 31, 1996, and from the movement by
clients into emerging markets which have higher costs due to structural
inefficiencies. These costs are passed through to clients and contribute to
the increase in asset administration fees. The outsourcing of the photocopy
service commenced in 1996 and accounted for approximately $240,000 of the
increase between periods. Fees for daily market pricing data which vary with
the level of assets processed, increased by $119,000 during the period.
Travel and sales promotion expense increased $373,000 to $1,158,000 for
the year ended December 31, 1996 from $785,000 for the year ended December
31, 1995 due primarily to increased travel to the foreign subsidiaries.
Professional fees increased $341,000 to $1,115,000 for the year ended
December 31, 1996 from $774,000 for the year ended December 31, 1995. Legal
fees which were incurred in connection with the Company's initial compliance
with year-end related filings with the Securities and Exchange Commission and
the change of the Company's fiscal year contributed to this increase.
Insurance expense decreased by $225,000 or 21% between the periods due to
the renegotiation of the Company's coverage for errors and omissions liability,
directors and officers liability and blanket bond.
26
<PAGE>
Other operating expenses increased $1,113,000 to $2,048,000 for the year
ended December 31, 1996 from $935,000 for the year ended December 31, 1995.
Other operating expenses are comprised of office supplies, recruiting costs,
temporary help, and Delaware excise tax. Expenses such as office supplies vary
with staffing levels. The Delaware excise tax is based on the number of shares
authorized for issuance by the Company. This tax was imposed on the Company
after its formation as a Delaware Company in June 1995 and accounts for $180,000
of the increase between periods. Approximately $797,000 of the increase between
periods related to recruiting costs and temporary help caused by a tight labor
market resulting from a period of low unemployment in Massachusetts. The
remainder of the increase resulted from the increases in assets processed and
staffing levels.
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 and
changes in interest rates for the year ended December 31, 1996 compared to
December 31, 1995.
<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................... $ 1,256 $ (45) $ 1,211
Investment securities....................... 25,876 491 26,367
Loans....................................... 1,341 (250) 1,091
--------- --- ---------
Total interest-earning assets............... 28,473 196 28,669
--------- --- ---------
INTEREST-BEARING LIABILITIES
Deposits.................................... 8,249 180 8,429
Borrowings.................................. 9,236 (41) 9,195
--------- --- ---------
Total interest-bearing liabilities.......... 17,485 139 17,624
--------- --- ---------
Change in net interest income............... $ 10,988 $ 57 $ 11,045
--------- --- ---------
--------- --- ---------
</TABLE>
Net interest income increased $11,045,000 or 159% to $18,009,000 for the
year ended December 31, 1996 from $6,964,000 for the 1995 period. This net
increase resulted from an increase in interest income of $28,669,000 offset by
an increase in interest expense of $17,624,000. The net impact of the above
changes was a 240 basis point decrease in net interest margin.
The increase in interest income resulted primarily from a higher level of
interest earning assets. Prior to the Spin-Off Transaction, the Company was
subject to a 7% annual asset growth cap under CEBA. The elimination of the CEBA
growth restriction has allowed the Company to accept deposits from clients which
it had historically directed to other financial institutions. The Company's
average assets for the year ended December 31, 1996 increased $483,710,000 or
333% compared to the 1995 period. This growth primarily resulted from an
increase in average interest earning assets of $449,720,000.
Interest expense increased $17,624,000 due primarily to the higher level of
deposits and borrowings and to a lesser extent to an increase in the interest
rate paid by the Company. Prior to the Spin-Off Transaction, the Company was not
trying to attract deposits to its balance sheet and therefore did not pay a
competitive interest rate. The average rate paid on deposits and short-term
borrowings increased from 4.12 % to 4.83% between periods.
INCOME TAXES
The Company's earnings were taxed on the federal level at 34% for the 1995
period and 35% for the 1996 period. 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 11.72%. The provision for
income taxes for the year ended December 31, 1996 increased by $1,856,000 over
the 1995 provision. The overall effective tax rate decreased to 38.5% for the
year ended December 31, 1996, from 39.5% for the year ended December 31, 1995.
The decrease in the effective tax rate was due to a decrease in the income of
the Company's Canadian subsidiary, which was
27
<PAGE>
taxed at the Canadian effective rate of 45.37%, and the related increase in
the income of the Company's subsidiaries in Dublin and the Cayman Islands,
which are lower tax jurisdictions. The reduction of the income in the
Company's Canadian subsidiary resulted as the Company transferred certain
offshore processing activities from Toronto to Dublin and the Cayman Islands.
FINANCIAL CONDITION
INVESTMENT PORTFOLIO
The following table summarizes the Company's investment portfolio for the
dates indicated:
<TABLE>
<CAPTION>
OCTOBER 31, DECEMBER 31,
-----------------------------------------------
1995 1995 1996 1997
----------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Securities held to maturity:
U.S. Treasury securities........................................ $ 60,408 $ -- $ -- $ --
State and Political Subdivisions................................ -- -- -- 35,225
Mortgage-backed securities...................................... 49,609 144,124 414,665 590,365
Federal Agency securities....................................... -- 10,000 37,517 168,687
Foreign Government securities................................... -- -- 7,828 7,769
----------- ---------- ---------- ----------
Total securities held to maturity............................... $ 110, 017 $ 154,124 $ 460,010 $ 802,046
----------- ---------- ---------- ----------
----------- ---------- ---------- ----------
Securities available for sale:
U.S. Treasury securities........................................ $ 50,652 $ 40,259 $ 30,092
Municipal Bonds................................................. -- -- 8,382
Mortgage-backed securities...................................... 40,167 230,862 424,376
---------- ---------- ----------
Total securities available for sale............................. $ 90,819 $ 271,121 $ 462,850
---------- ---------- ----------
---------- ---------- ----------
</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 comprised
of U.S. Treasury securities, securities of state and political subdivisions,
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 ("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 and prepayment risk. Credit risk results from the possibility that a loss
may occur if a counterparty is unable to meet the terms of the 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 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.
28
<PAGE>
The book value and weighted average yield of the Company's securities held
to maturity at December 31, 1997, by effective maturity, are reflected in the
following table.
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
BOOK VALUE YIELD
----------- -----------
<S> <C> <C>
Due from one to five years.......................... $ 357,581 6.65%
Due after five years up to ten years................ 183,840 6.57%
Due after ten years................................. 260,625 6.37%
-----------
Total securities held to maturity................... $ 802,046
-----------
-----------
</TABLE>
The book value and weighted average yield of the Company's securities
available for sale at December 31, 1997, by effective maturity, are reflected in
the following table.
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
BOOK VALUE YIELD
----------- -----------
<S> <C> <C>
Due within one year................................ $ 20,039 5.95%
Due from one to five years......................... 309,518 6.57%
Due after five years up to ten years............... 132,756 6.76%
Due after ten years................................ 537 5.57%
-----------
Total securities available for sale................ $ 462,850
-----------
-----------
</TABLE>
LOAN PORTFOLIO
The following table summarizes the Company's loan portfolio for the dates
indicated:
<TABLE>
<CAPTION>
OCTOBER 31, DECEMBER 31,
--------------------------------------------
1995 1995 1996 1997
----------- --------- --------- ---------
<S> <C> <C> <C> <C>
Loans to individuals......................... $ 13,446 $ 12,610 $ 23,449 $ 26,858
Loans to not-for-profit organizations........ 289 289 13 13
Loans to mutual funds........................ 0 10,000 42,875 29,174
----------- --------- --------- ---------
13,735 22,899 66,337 56,045
Less: allowance for loan losses.............. (35) (35) (100) (100)
----------- --------- --------- ---------
Net loans.................................... $ 13,700 $ 22,864 $ 66,237 $ 55,945
----------- --------- --------- ---------
----------- --------- --------- ---------
Floating Rate................................ $ 13,675 $ 22,839 $ 66,224 $ 55,932
Fixed Rate................................... 25 25 13 13
----------- --------- --------- ---------
$ 13,700 $ 22,864 $ 66,237 $ 55,945
----------- --------- --------- ---------
----------- --------- --------- ---------
</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. The 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.
At December 31, 1997, the Company's only lending concentrations which
exceeded 10% of total loans were the revolving lines of credit to mutual fund
clients 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's credit loss experience has been excellent. There have been no
loan chargeoffs or adverse credit actions 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 December 31, 1997, there
were no past due loans, troubled debt restructurings, or any loans on
non-accrual status.
29
<PAGE>
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
$100,000 at December 31, 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
The Company, like all financial intermediaries, is subject to interest rate
risk. Rapid changes in interest rates could adversely affect the profitability
of the Company by causing changes in the market value of the Company's assets
and its net interest income. 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 contracts
are used to hedge against large rate swings and changes in the shape of the
yield curve.
Interest rate contracts 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. See Note 14 to the Consolidated Financial Statements. The
Company periodically monitors the financial stability of its counterparties
according to prudent investment guidelines and established procedures. There can
be no assurance that such portfolio actions will adequately limit interest rate
risk.
30
<PAGE>
The following table presents the repricing schedule for the Company's
interest earning assets and interest bearing liabilities at December 31, 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.............................. $ 75,000 -- -- -- -- $ 75,000
Investment securities (2)....................... 575,410 202,068 180,773 200,640 106,005 1,264,896
Loans--fixed rate............................... -- -- -- 13 -- 13
Loans--variable rate............................ 56,032 -- -- -- -- 56,032
----------- ----------- --------- ---------- ---------- ----------
Total interest earning assets................... 706,442 202,068 180,773 200,653 106,005 1,395,941
Interest bearing liabilities
Demand deposit accounts......................... 201,549 -- -- -- -- 201,549
Savings accounts................................ 427,123 -- -- -- -- 427,123
Interest rate contracts......................... (280,000) 60,000 100,000 110,000 10,000 0
Short-term borrowings........................... 499,933 -- -- -- -- 499,933
----------- ----------- --------- ---------- ---------- ----------
Total interest bearing liabilities.............. 848,605 60,000 100,000 110,000 10,000 1,128,605
----------- ----------- --------- ---------- ---------- ----------
Net interest sensitivity gap during the
period........................................ ($ 142,163) $ 142,068 $ 80,773 $ 90,653 $ 96,005 $ 267,336
----------- ----------- --------- ---------- ---------- ----------
----------- ----------- --------- ---------- ---------- ----------
Cumulative gap.................................. ($ 142,163) ($ 95) $ 80,678 $ 171,331 $ 267,336
----------- ----------- --------- ---------- ----------
----------- ----------- --------- ---------- ----------
Interest sensitive assets as a percent of
interest sensitive liabilities (cumulative)... 83.25% 99.99% 108.00% 115.32% 123.69%
Interest sensitive assets as a percent of total
assets (cumulative)........................... 48.41% 62.25% 74.64% 88.39% 95.66%
Net interest sensitivity gap as a percent of
total asets................................... (9.74%) 9.74% 5.53% 6.21% 6.58%
Cumulative gap as a percent of total asets...... (9.74%) (0.01%) 5.53% 11.74% 18.32%
</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 contractual maturity.
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 $.12 per share.
The Company's ability to pay dividends on the Common Stock depends on the
receipt of dividends from Investors Bank & Trust Company. In addition, the
Company may not pay dividends on its Common Stock if it is in default under
certain agreements entered into in connection with the sale of the Capital
Securities. Any dividend payments by Investors Bank & Trust Company are subject
to certain restrictions imposed by the Massachusetts Commissioner of Banks.
Subject to regulatory requirements, Investors Bank & Trust Company expects to
pay an annual dividend to the Company, which the
31
<PAGE>
Company expects to pay to its stockholders, currently estimated to be in an
amount equal to $.12 per share of outstanding Common Stock (approximately
$776,438 based upon 6,470,313 shares outstanding as of December 31, 1997).
At December 31, 1997, cash and cash equivalents were 1% of total assets,
compared to 2% of total assets at December 31, 1996. At December 31, 1997,
approximately $20 million or 1% of total 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 as of December 31, 1997 was $141 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 at December 31,
1997 was $1.3 billion.
The Company also has a borrowing arrangement with the Federal Home Loan Bank
of Boston (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 (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. If the Company borrows under this
arrangement, the Company is required to hold FHLBB stock equal to 5% of such
outstanding advances. The aggregate amount of borrowing available to the Company
under this arrangement at December 31, 1997 was $573 million.
The Company's cash flows are comprised of three primary classifications:
cash flows from operating activities, investing activities, and financing
activities. Cash flows provided by operating activities were $10,806,000 for the
year ended December 31, 1997. Net cash used in investing activities, consisting
primarily of purchases of investment securities and proceeds from maturities of
investment securities, was $490,696,000 for the year ended December 31, 1997.
Net cash provided by financing activities, consisting primarily of net activity
in deposits, was $477,701,000 for the year ended December 31, 1997.
CAPITAL RESOURCES
Historically, the Company has financed its operations principally 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 $1,564,000 for fiscal 1995, $118,000 for the two-months ended
December 31, 1995, and $3,236,000 and $4,771,000 for the years ended December
31, 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.
Stockholders' equity at December 31, 1997 was $74,901,000, an increase of
$13,042,000 or 21%, from $61,859,000 at December 31, 1996. The ratio of
stockholders' equity to assets decreased to 5.13% at December 31, 1997 from
6.41% at December 31, 1996 due to the significant growth 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, non-cumulative perpetual preferred stock, a limited amount
of cumulative perpetual
32
<PAGE>
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 Company's Tier I and total capital ratios
at December 31, 1997:
<TABLE>
<CAPTION>
AMOUNT RATIO
---------- ---------
<S> <C> <C>
(DOLLARS IN
THOUSANDS)
Tier I capital............................................ $ 97,595 29.00%
Tier I capital minimum requirement........................ 13,460 4.00%
---------- ---------
Excess Tier I capital..................................... $ 84,135 25.00%
---------- ---------
---------- ---------
Total capital............................................. $ 97,695 29.03%
Total capital minimum requirement......................... 26,919 8.00%
---------- ---------
Excess total capital...................................... 70,776 21.03%
---------- ---------
---------- ---------
Risk adjusted assets, net of intangible assets............ $ 336,494
----------
----------
</TABLE>
The following table summarizes the Bank's Tier I and total capital ratios at
December 31, 1997:
<TABLE>
<CAPTION>
AMOUNT RATIO
---------- ---------
<S> <C> <C>
(DOLLARS IN
THOUSANDS)
Tier I capital........................................... $ 96,041 28.54%
Tier I capital minimum requirement....................... 13,460 4.00%
---------- ---------
Excess Tier I capital.................................... $ 82,581 24.54%
---------- ---------
---------- ---------
Total capital............................................ $ 96,141 28.57%
Total capital minimum requirement........................ 26,919 8.00%
---------- ---------
Excess total capital..................................... $ 69,222 20.57%
---------- ---------
---------- ---------
Risk adjusted assets, net of intangible assets........... $ 336,486
----------
----------
</TABLE>
In addition to the risk-based capital guidelines, the Federal Reserve Board
and the FDIC use a "Leverage Ratio" as an additional tool to evaluate capital
adequacy. The Leverage Ratio is defined to be a Company's Tier I capital divided
by its adjusted total assets. The Leverage Ratio adopted by the federal banking
agencies requires a ratio of 3.0% Tier I capital to adjusted average total
assets for top-rated banking institutions. All other banking institutions are
expected to maintain a Leverage Ratio of 4.0% to 5.0%. The computation of the
risk-based capital ratios and the Leverage Ratio requires the capital of the
Company to be reduced by most intangible assets. The Company's Leverage Ratio at
December 31, 1997 was 6.39%, which is in excess of regulatory requirements. The
Bank's Leverage Ratio at December 31, 1997 was 6.31%, which is also in excess of
regulatory requirements. See "Business--Regulation and Supervision."
33
<PAGE>
The following tables present average balances, interest income and expense,
and yields earned or paid on the major categories of assets and liabilities for
the periods indicated.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1995 YEAR ENDED DECEMBER 31, 1996 YEAR ENDED DECEMBER 31, 1997
------------------------------ --------------------------------- ----------------------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST YIELD/COST BALANCE INTEREST YIELD/COST BALANCE INTEREST YIELD/COST
-------- -------- ---------- -------- -------- ----------- ---------- -------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning
assets
Fed funds sold...... $ 10,218 $ 595 5.82% $ 33,989 $ 1,859 5.47% $ 53,758 $ 2,981 5.55%
Interest-earning
deposits.......... 1,000 59 5.90% 126 6 4.76% -- --
Investment
securities........ 100,861 6,123 6.07% 497,965 32,490 6.52% 1,053,009 67,489 6.41%
Demand Loans........ 13,863 1,231 8.88% 43,582 2,322 5.33% 60,594 2,566 4.23%
-------- -------- ------ -------- ------- ---- ---------- ------- ----
Total interest-
earning assets.... 125,942 8,008 6.36% 575,662 36,677 6.37% 1,167,361 73,036 6.26%
-------- ------ ------- ---- ------- ----
Allowance for loan
losses............ (35) (74) (100)
Noninterest-earning
assets............ 19,276 53,305 69,258
-------- -------- ----------
Total assets........ $145,183 628,893 $1,236,519
-------- -------- ----------
-------- -------- ----------
Interest-bearing
liabilities
Deposits:
Demand............. $ 11,995 $ 610 5.09% $142,059 $ 6,944 4.89% $ 140,274 $ 7,179 5.12%
Savings............ 10,742 245 2.28% 56,775 2,302 4.05% 252,408 11,468 4.54%
Time............... -- -- -- 721 38 5.27% 1,472 76 5.16%
Short Term
Borrowings........ 2,575 189 7.34% 186,952 9,384 5.02% 538,315 28,140 5.23%
-------- -------- ------- -------- ------- ---- ---------- -------- ----
Total interest-
bearing
liabilities....... 25,312 1,044 4.12% 386,507 18,668 4.83% 932,469 46,863 5.03%
-------- ------ ------- ---- -------- ----
Noninterest-bearing
liabilities:
Demand deposits.... 46,568 132,063 142,436
Noninterest bearing
time deposits.... 46,368 45,601 58,178
Other liabilities.. 7,442 8,585 12,814
-------- -------- ----------
Total liabilities... 125,690 572,756 1,145,897
Trust Preferred
Securities........ -- -- 22,252
Equity.............. 19,493 56,137 68,370
-------- -------- ----------
Total liabilities
and equity........ $145,183 $628,893 $1,236,519
-------- -------- ----------
-------- -------- ----------
Net interest
income............ $ 6,964 $18,009 $ 26,173
-------- ------- ---------
-------- ------- ---------
Net interest margin
(1)............... 5.53% 3.13% 2.24%
Average interest
rate spread (2)... 2.24% 1.54% 1.23%
Ratio of interest-
earning assets to
interest-bearing
liabilities....... 497.6% 148.9% 125.2%
</TABLE>
- ------------------------
(1) Net interest income divided by total interest-earning assets.
(2) Yield on interest-earning assets less rate paid on interest-bearing
liabilities.
34
<PAGE>
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The information required by this item is contained in the financial
statements and schedules set forth in Item 14(a) under the captions
"Consolidated Financial Statements" and "Financial Statement Schedules"
as a part of this Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.
There have been no changes in or disagreements with accountants on
accounting or financial disclosure matters during the Company's two most
recent fiscal years.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required under this item is incorporated herein by
reference to the information in the sections entitled "Occupations of
Directors and Executive Officers," "Election of Directors" and
"Compensation and other Information Concerning Directors and Officers"
contained in the Company's definitive proxy statement pursuant to
Regulation 14A, which proxy statement will be filed with the Securities and
Exchange Commission not later than 120 days after the close of the Company's
fiscal year ended December 31, 1997.
ITEM 11. EXECUTIVE COMPENSATION.
The information required under this item is incorporated herein by reference
to the information in the section entitled "Compensation and other Information
Concerning Directors and Officers" contained in the Company's definitive proxy
statement pursuant to Regulation 14A, which proxy statement will be filed with
the Securities and Exchange Commission not later than 120 days after the close
of the Company's fiscal year ended December 31, 1997.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required under this item is incorporated herein by
reference to the information in the section entitled "Management and
Principal Holders of Voting Securities" contained in the Company's definitive
proxy statement pursuant to Regulation 14A, which proxy statement will be
filed with the Securities and Exchange Commission not later than 120 days
after the close of the Company's fiscal year ended December 31, 1997.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required under this item is incorporated herein by reference
to the information in the section entitled "Certain Relationships and Related
Transactions" contained in the Company's definitive proxy statement pursuant to
Regulation 14A, which proxy statement will be filed with the Securities and
Exchange Commission not later than 120 days after the close of the Company's
fiscal year ended December 31, 1997.
35
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) 1. Consolidated Financial Statements.
For the following consolidated financial information included herein, see
Index on Page F-1:
Report of Independent Accountants.
Consolidated Balance Sheets as of December 31, 1996 and December 31, 1997.
Consolidated Statements of Income for the Year Ended October 31, 1995,
for the Two-Month Period Ended December 31, 1995, and for the Years
Ended December 31, 1996 and 1997.
Statements of Stockholders' Equity for the Year Ended October 31, 1995, for
the Two-Month Period Ended December 31, 1995, and for the Years Ended
December 31, 1996 and 1997.
Consolidated Statements of Cash Flows for the Year Ended October 31, 1995,
for the Two-Month Period Ended December 31, 1995, and for the Years Ended
December 31, 1996 and 1997.
Notes to Consolidated Financial Statements.
2. Financial Statement Schedules.
None.
3. List of Exhibits.
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ----------- -----------------------------------------------------------------------------------------------------
<C> <S>
2.1(1) Plan of Exchange of Common and Class A Stock of the Company for all outstanding stock of the Bank
3.1(1) Certificate of Incorporation of the Company
3.2(1) By-laws of the Company
4.1(1) Specimen certificate representing the Common Stock
4.2(1) Stockholder Rights Plan
10.1 * Amended and Restated 1995 Stock Plan
10.2(1) Custodian Agreement among and between the Company, Eaton Vance Corp. and each investment company
advised by Eaton Vance Corp. which adopted the Agreement dated December 17, 1990
10.3(1) Transfer and Assumption Agreement between the Company and Bank of New York dated January 27, 1995
regarding the assignment of Merrill Lynch Unit Investment Trust administration service
10.4(1) Information Technology Services Contract between the Company and Electronic Data Systems, Inc. dated
September 24, 1990
10.5(1) Third Party Hub and Spoke Processing License Agreement between the Company and Signature Financial
Group, Inc. dated May 21, 1993
10.6(1) Hub and Spoke Facilities Management Agreement between the Company and Signature Financial Group, Inc.
dated May 21, 1993
10.7(1) Loan Agreements with Landon Clay dated May 10, 1993 and October 6, 1994
10.8(1)* Description of the executive bonus arrangement
10.9(1)* Employment contract between the Company and Kevin Sheehan
10.10(1)* Employment contract between the Company and Michael Rogers
10.11(1)* Employment contract between the Company and Edmund Maroney
10.12(1)* Employment contract between the Company and Robert Mancuso
10.13(1) Sublease Agreement, as amended, between the Company and the Bank of New England, N.A. dated May 25,
1990, for premises located at 89 South Street, Boston, Massachusetts
10.14(3)* 1995 Non-Employee Director Stock Option Plan
10.15(2) Information Technology Services Contract between the Company and Electronic Data Systems, Inc. dated
September 20,1995,
10.16(2) Lease Agreement between the Company and John Hancock Mutual Life Insurance Company, dated November
13, 1995, for the premises located at 200 Clarendon Street, Boston, Massachusetts.
10.17(3)* Employment contract between the Company and Karen C. Keenan
10.18(3)* 1995 Employee Stock Purchase Plan
</TABLE>
36
<PAGE>
<TABLE>
<C> <S>
10.19(3) Amended and Restated Declaration of Trust among the Company and the Trustees named therein, dated
January 31, 1997
10.20(3) Purchase Agreement among the Company, Investors Capital Trust I and Keefe, Bruyette & Woods, Inc.,
dated January 30, 1997 (Included in Exhibit 10.19)
10.21(3) Indenture between the Company and The Bank of New York, dated January 31, 1997
10.22(3) Registration Rights Agreement, among the Company, Investors Capital Trust I and Keefe, Bruyette &
Woods, Inc., dated January 31, 1997
10.23(3) Common Securities Guarantee Agreement by the Company as Guarantor, dated January 31, 1997
10.24(3) Capital Securities Guarantee Agreement between the Company as Guarantor and The Bank of New York as
Capital Securities Guarantee Trustee, dated January 31, 1997
21.1 Subsidiaries of the Company
23.1 Consent of Deloitte & Touche LLP
24.1 Power of Attorney (See Page 38 of this Report)
27 Financial Data Schedule
</TABLE>
(1) Incorporated herein by reference to the exhibits to the Company's
Registration Statement on Form S-1 (File No. 33-95980).
(2) Previously filed as an exhibit to Form 10-K for the fiscal year ended
October 31, 1995.
(3) Previously filed as an exhibit to Form 10-K for the fiscal year ended
December 31, 1996.
* Indicates a management contract or a compensatory plan, contract or
arrangement.
(b) Reports on Form 8-K.
There were no Current Reports on Form 8-K filed by the Company during the
quarter ended December 31, 1997.
(c) Exhibits.
The Company hereby files as part of this Form 10-K the exhibits listed in
Item 14(a)(3) above. Exhibits which are incorporated herein by reference can
be inspected and copied at the public reference facilities maintained by the
Securities and Exchange Commission, 450 Fifth Street, N.W., Room 1024,
Washington, D.C., and at the Securities and Exchange Commission's regional
offices at CitiCorp Center, 500 West Madison Street, Suite 1400, Chicago, IL
60661-2511 and Seven World Trade Center, Suite 1300, New York, NY 10048.
Copies of such material can also be obtained from the Public Reference
Section of the Securities and Exchange Commission, 450 Fifth Street, N.W.,
Washington, D.C. 29549, at prescribed rates.
(d) Financial Statement Schedules
None.
37
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, in Boston,
Massachusetts on the 27th day of February, 1998.
INVESTORS FINANCIAL SERVICES CORP.
BY: /S/ KEVIN J. SHEEHAN
-----------------------------------------
Kevin J. Sheehan
President, Chief Executive Officer and
Chairman of the Board
POWER OF ATTORNEY AND SIGNATURES
We, the undersigned officers and directors of Investors Financial
Services Corp., hereby severally constitute and appoint Kevin J. Sheehan and
Michael F. Rogers, and each of them singly, our true and lawful attorneys,
with full power to them and each of them singly, to sign for us in our names
in the capacities indicated below, all amendments to this report, and
generally to do all things in our names and on our behalf in such capacities
to enable Investors Financial Services Corp. to comply with the provisions of
the Securities Exchange Act of 1934, as amended, and all requirements of the
Securities and Exchange Commission.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons in the capacities and on the
27th day of February, 1998.
<TABLE>
<CAPTION>
SIGNATURE TITLE(s)
- ------------------------------ ------------------------------------------------------
<S> <C>
/s/ KEVIN J. SHEEHAN President, Chief Executive Officer and Chairman of the
- ------------------------------ Board (Principal Executive Officer); Director
Kevin J. Sheehan
/s/ MICHAEL F. ROGERS Executive Vice President
- ------------------------------
Michael F. Rogers
/s/ KAREN C. KEENAN Senior Vice President and Chief Financial Officer (Principal
- ------------------------------ Financial Officer and Principal Accounting Officer)
Karen C. Keenan
/s/ ROBERT B. FRASER Director
- ------------------------------
Robert B. Fraser
/s/ DONALD G. FRIEDL Director
- ------------------------------
Donald G. Friedl
/s/ JAMES M. OATES Director
- ------------------------------
James M. Oates
/s/ PHYLLIS S. SWERSKY Director
- ------------------------------
Phyllis S. Swersky
/s/ THOMAS P. MCDERMOTT Director
- ------------------------------
Thomas P. Mcdermott
/s/ FRANK B. CONDON, JR. Director
- ------------------------------
Frank B. Condon, Jr.
</TABLE>
38
<PAGE>
INVESTORS FINANCIAL SERVICES CORP.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Accountants....................... F-2
Consolidated Balance Sheets as of December 31, 1996 and
December 31, 1997..................................... F-3
Consolidated Statements of Income for the Year Ended
October 31,1995, for the Two-Month Period Ended
December 31, 1995 and for the Years Ended
December 31, 1996 and December 31,1997................ F-4
Statements of Stockholders' Equity for the Year Ended
October 31, 1995, for the Two-Month Period Ended
December 31, 1995 and for the Years Ended
December 31, 1996 and December 31, 1997............... F-5
Consolidated Statements of Cash Flows for the Year Ended
October 31, 1995, for the Two-Month Period Ended
December 31, 1995, and for the Years Ended December
31, 1996 and December 31, 1997........................ F-7
Notes to Consolidated Financial Statements.............. F-9
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Stockholders and the Board of Directors of
Investors Financial Services Corp.:
We have audited the accompanying consolidated balance sheets of Investors
Financial Services Corp., including its predecessor, Investors Bank & Trust
Company and its subsidiaries (collectively, the "Company") as of December 31,
1996 and 1997 and the related consolidated statements of income,
stockholders' equity, and cash flows for the year ended October 31, 1995, for
the two-month period ended December 31, 1995 and for the years ended December
31, 1996 and December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of the Company at December 31,
1996 and 1997, and the results of their operations and their cash flows for
each of the year ended October 31, 1995, for the two-month period ended
December 31, 1995 and for the years ended December 31, 1996 and 1997 in
conformity with generally accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements, in
November 1995 Investors Bank & Trust Company became a wholly owned subsidiary
of Investors Financial Services Corp. as a result of the share exchange
between Investors Financial Services Corp. and shareholders of Investors Bank
& Trust Company.
Deloitte & Touche LLP
Boston, Massachusetts
February 13, 1998
F-2
<PAGE>
INVESTORS FINANCIAL SERVICES CORP.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND 1997
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1997
-------------- ----------------
<S> <C> <C>
ASSETS
Cash and due from banks........................................................ $ 19,226,453 $ 17,037,568
Federal funds sold and securites purchased under resale agreements............. 120,000,000 75,000,000
Securities held to maturity (approximate market values of $460,182,579 and
$809,708,389 at December 31, 1996 and December 31, 1997, respectively)....... 460,009,923 802,046,077
Securities available for sale.................................................. 271,120,964 462,850,089
Nonmarketable equity securities................................................ 967,400 5,476,600
Loans, less allowance for loan losses of $100,000 at December 31, 1996 and
December 31, 1997, respectively.............................................. 66,236,889 55,944,957
Accrued interest and fees receivable........................................... 16,366,171 22,810,182
Equipment and leasehold improvements, net...................................... 5,243,974 7,900,994
Other assets................................................................... 5,289,873 10,277,738
-------------- ----------------
TOTAL ASSETS $ 964,461,647 $ 1,459,344,205
-------------- ----------------
-------------- ----------------
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
DEPOSITS:
DEMAND..................................................................... $ 264,914,614 $ 354,616,945
SAVINGS.................................................................... 276,602,295 427,122,987
TIME....................................................................... 55,000,000 65,000,000
-------------- ----------------
TOTAL DEPOSITS........................................................... 596,516,909 846,739,932
SHORT-TERM BORROWINGS.......................................................... 296,421,201 499,932,628
OTHER LIABILITIES.............................................................. 9,664,227 13,609,660
-------------- ----------------
TOTAL LIABILITIES........................................................ 902,602,337 1,360,282,220
-------------- ----------------
COMPANY OBLIGATED MANDITORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY
TRUST HOLDING JUNIOR SUBORDINATED DEFERRABLE INTEREST DEBENTURES OF THE
COMPANY...................................................................... -- 24,161,104
-------------- ----------------
STOCKHOLDERS' EQUITY:
CLASS A COMMON STOCK......................................................... 3,595 --
COMMON STOCK................................................................. 60,848 64,703
SURPLUS...................................................................... 54,352,812 55,072,990
DEFERRED COMPENSATION........................................................ (1,687,675) (1,248,775)
RETAINED EARNINGS............................................................ 8,480,431 19,545,070
NET UNREALIZED GAIN ON SECURITIES AVAILABLE FOR SALE......................... 649,299 1,466,893
-------------- ----------------
TOTAL STOCKHOLDERS' EQUITY..................................................... 61,859,310 74,900,881
-------------- ----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY..................................... $ 964,461,647 $ 1,459,344,205
-------------- ----------------
-------------- ----------------
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE>
INVESTORS FINANCIAL SERVICES CORP.
CONSOLIDATED STATEMENTS OF INCOME
YEAR ENDED OCTOBER 31, 1995, THE TWO-MONTH PERIOD ENDED DECEMBER 31, 1995
AND THE YEARS ENDED DECEMBER 31, 1996 AND 1997
<TABLE>
<CAPTION>
TWO MONTHS ENDED
OCTOBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1995 1995 1996 1997
------------ ----------------- ------------ -------------
<S> <C> <C> <C> <C>
OPERATING REVENUE:
Interest income:
Federal funds sold and securities purchased
under resale agreements..................... $ 373,384 $ 289,843 $1,864,989 $ 2,980,617
Investment securities held to maturity and
available for sale.......................... 5,116,155 1,844,222 32,490,280 67,488,991
Loans......................................... 1,202,029 229,690 2,322,158 2,566,321
------------ ----------------- ------------ -------------
Total interest income....................... 6,691,568 2,363,755 36,677,427 73,035,929
------------ ----------------- ------------ -------------
Interest expense:
Deposits...................................... 720,395 286,945 9,271,675 18,722,500
Short-term borrowings......................... 101,198 111,154 9,396,359 28,140,731
------------ ----------------- ------------ -------------
Total interest expense...................... 821,593 398,099 18,668,034 46,863,231
------------ ----------------- ------------ -------------
Net interest income........................... 5,869,975 1,965,656 18,009,393 26,172,698
Provision for loan losses..................... -- -- 65,000 --
------------ ----------------- ------------ -------------
Net interest income after provision for loan
losses...................................... 5,869,975 1,965,656 17,944,393 26,172,698
Noninterest income:
Asset administration fees..................... 48,412,551 7,988,056 56,075,625 75,873,093
Proceeds from assignment of UIT servicing,
net......................................... 2,572,298 -- -- --
Computer service fees......................... 505,534 83,424 482,275 468,407
Other operating income........................ 72,029 13,772 76,305 360,742
Gain/(loss) on securities available for
sale........................................ -- -- (2,488) 113,958
------------ ----------------- ------------ -------------
Net operating revenue......................... 57,432,387 10,050,908 74,576,110 102,988,898
OPERATING EXPENSES
Compensation and benefits....................... 31,898,693 5,797,463 37,502,215 50,042,736
Technology and telecommunications............... 6,404,922 1,052,445 7,790,792 10,484,519
Transaction processing services................. 2,885,483 382,528 5,682,979 7,998,604
Occupancy....................................... 4,215,472 624,816 4,283,008 4,380,908
Depreciation and amortization................... 1,220,988 185,791 1,502,196 1,929,920
Travel and sales promotion...................... 837,136 122,682 1,157,718 1,586,167
Professional fees............................... 885,754 100,774 1,115,249 1,563,835
Insurance....................................... 1,060,468 194,016 852,638 735,148
Other operating expenses........................ 815,037 20,301 2,048,782 3,927,160
------------ ----------------- ------------ -------------
Total operating expenses...................... 50,223,953 8,480,816 61,935,577 82,648,997
------------ ----------------- ------------ -------------
NET INCOME BEFORE INCOME TAXES AND MINORITY
INTEREST........................................ 7,208,434 1,570,092 12,640,533 20,339,901
Provision for income taxes........................ 2,800,000 670,298 4,866,571 7,322,364
</TABLE>
<PAGE>
INVESTORS FINANCIAL SERVICES CORP.
CONSOLIDATED STATEMENTS OF INCOME (CONTINUED)
YEAR ENDED OCTOBER 31, 1995, THE TWO-MONTH PERIOD ENDED DECEMBER 31, 1995
AND THE YEARS ENDED DECEMBER 31, 1996 AND 1997
<TABLE>
<CAPTION>
TWO MONTHS ENDED
OCTOBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1995 1995 1996 1997
------------ ----------------- ------------ -------------
<S> <C> <C> <C> <C>
Minority interest expense, net of income taxes.... -- -- -- 1,437,276
------------ ----------------- ------------ -------------
NET INCOME........................................ $ 4,408,434 $ 899,794 $7,773,962 $ 11,580,261
------------ ----------------- ------------ -------------
------------ ----------------- ------------ -------------
BASIC EARNINGS PER SHARE.......................... $ 0.14 $ 1.21 $ 1.80
----------------- ------------ -------------
----------------- ------------ -------------
DILUTED EARNINGS PER SHARE........................ $ 0.14 $ 1.20 $ 1.75
----------------- ------------ -------------
----------------- ------------ -------------
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE>
INVESTORS FINANCIAL SERVICES CORP.
STATEMENTS OF STOCKHOLDERS' EQUITY
YEAR ENDED OCTOBER 31, 1995, THE TWO-MONTH PERIOD ENDED DECEMBER 31, 1995 AND
THE YEARS ENDED DECEMBER 31, 1996 AND 1997
<TABLE>
<CAPTION>
NET
UNREALIZED
GAIN ON
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, NOVEMBER 1,
1994................ $ -- $ 10,000,000 $ -- $ -- $ 3,713,042 $ -- $ 13,713,042
Net income............ -- 4,408,434 4,408,434
Cash dividend, $0.06
per share........... -- (60,000) (60,000)
--------- ------------- ------------- ------------- ------------- ------------ -------------
BALANCE, OCTOBER 31,
1995................ $ -- $ 10,000,000 $ -- $ -- $ 8,061,476 $ -- $ 18,061,476
--------- ------------- ------------- ------------- ------------- ------------ -------------
--------- ------------- ------------- ------------- ------------- ------------ -------------
Effect of share
exchange (Note 1)... $ 6,114 $ 34,186 $ 18,021,176 $ -- $ -- $ -- $ 18,061,476
Common stock issuance,
net of costs of
$3,829,062.......... -- 23,000 34,097,938 -- -- -- 34,120,938
Issuance of restricted
stock............... -- 1,140 2,193,360 (2,194,500) -- -- --
Conversion of Class A
to common stock..... (179) 179 -- -- -- -- --
Amortization of
deferred
compensation........ -- -- -- 76,713 -- -- 76,713
Net income............ -- -- -- -- 899,794 -- 899,794
Net unrealized gain on
securities available
for sale............ -- -- -- -- -- 262,010 262,010
--------- ------------- ------------- ------------- ------------- ------------ -------------
BALANCE, DECEMBER 31,
1995................ 5,935 58,505 54,312,474 (2,117,787) 899,794 262,010 53,420,931
Adjustment to costs of
stock issuance...... -- -- 35,193 -- -- -- 35,193
Conversion of Class A
to common stock..... (2,340) 2,340 -- -- -- -- --
</TABLE>
F-5
<PAGE>
INVESTORS FINANCIAL SERVICES CORP.
STATEMENTS OF STOCKHOLDERS' EQUITY (CONTINUED)
YEAR ENDED OCTOBER 31, 1995, THE TWO-MONTH PERIOD ENDED DECEMBER 31, 1995 AND
THE YEARS ENDED DECEMBER 31, 1996 AND 1997
<TABLE>
<CAPTION>
NET
UNREALIZED
GAIN ON
CLASS A SECURITIES
COMMON COMMON DEFERRED RETAINED AVAILABLE
STOCK STOCK SURPLUS COMPENSATION EARNINGS FOR SALE TOTAL
--------- ------------- ------------- ------------- ------------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Amortization of
deferred
compensation........ -- -- -- 430,112 -- -- 430,112
Exercise of stock
options............. -- 3 5,145 -- -- -- 5,148
Net income............ -- -- -- -- 7,773,962 -- 7,773,962
Cash dividend, $0.03
per share........... -- -- -- -- (193,325) -- (193,325)
Change in net
unrealized gain on
securities available
for sale............ -- -- -- -- -- 387,289 387,289
--------- ------------- ------------- ------------- ------------- ------------ -------------
BALANCE, DECEMBER 31,
1996................ 3,595 60,848 54,352,812 (1,687,675) 8,480,431 649,299 61,859,310
Conversion of Class A
to common stock..... (3,595) 3,595 -- -- -- -- --
Amortization of
deferred
compensation........ -- -- -- 438,900 -- -- 438,900
Exercise of stock
options............. -- 260 720,178 -- -- -- 720,438
Net income............ -- -- -- -- 11,580,261 -- 11,580,261
Cash dividend, $0.08
per share........... -- -- -- -- (515,622) -- (515,622)
Change in net
unrealized gain on
securities available
for sale............ -- -- -- -- -- 817,594 817,594
--------- ------------- ------------- ------------- ------------- ------------ -------------
BALANCE, DECEMBER 31,
1997................ $ -- $ 64,703 $ 55,072,990 $(1,248,775) $ 19,545,070 $ 1,466,893 $ 74,900,881
--------- ------------- ------------- ------------- ------------- ------------ -------------
--------- ------------- ------------- ------------- ------------- ------------ -------------
</TABLE>
F-6
<PAGE>
INVESTORS FINANCIAL SERVICES CORP.
CONSOLIDATED STATEMENTS OF CASHFLOWS
YEAR ENDED OCTOBER 31, 1995, THE TWO-MONTH PERIOD ENDED DECEMBER 31, 1995 AND
THE YEARS ENDED DECEMBER 31, 1996 AND 1997
<TABLE>
<CAPTION>
OCTOBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1995 1995 1996 1997
-------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................... $ 4,408,434 $ 899,794 $ 7,773,962 $ 11,580,261
-------------- --------------- --------------- ---------------
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization.............. 1,220,988 185,791 1,502,196 1,929,920
Amortization of deferred compensation...... -- 76,713 430,112 438,900
Provision for loan losses.................. -- -- 65,000 --
Amortization of premiums on securities, net
of accretion on discounts................ 792,574 205,071 2,521,119 4,455,050
(Gain)/loss on sale of securities available
for sale................................. -- -- 2,488 (113,958)
(Gain)/loss on disposal of fixed assets.... -- -- 15,211 (4,727)
Deferred income taxes...................... (469,000) 78,377 898,513 336,851
Adjustment to carrying value of interest
rate floor contracts..................... 1,057,700 -- -- --
Changes in assets and liabilities:
Accrued interest and fees receivable..... (189,689) (868,478) (5,925,413) (6,444,011)
Other assets............................. (639,592) 814,394 (3,568,354) (4,987,865)
Other liabilities........................ 1,074,563 (667,218) 3,928,728 3,615,871
-------------- --------------- --------------- ---------------
Total adjustments...................... 2,847,544 (175,350) (130,400) (773,969)
-------------- --------------- --------------- ---------------
Net cash provided by operating
activities............................. 7,255,978 724,444 7,643,562 10,806,292
-------------- --------------- --------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities of securities
available for sale......................... -- -- 48,406,151 105,833,935
Proceeds from maturities of securities held
to maturity................................ 18,404,529 12,865,343 39,691,309 107,992,568
Proceeds from sales of securities available
for sale................................... -- -- 26,904,258 24,833,488
Purchases of securities available for sale... -- -- (243,550,740) (323,691,447)
Purchases of securities held to maturity..... (40,936,504) (147,559,658) (359,516,797) (451,865,060)
Purchase of nonmarketable equity
securities................................. -- -- (967,400) (4,509,200)
Net (increase) decrease in time deposits due
from banks................................. (24,345) 24,345 1,000,000 --
Net (increase) decrease in federal funds sold
and securities purchased under resale
agreements................................. (36,000,000) 21,000,000 (105,000,000) 45,000,000
Net (increase) decrease in loans............. (129,487) (9,164,520) (43,437,672) 10,291,932
Proceeds from sales of equipment and
leasehold improvements..................... -- -- -- 189,121
Purchases of equipment and leasehold
improvements............................... (1,563,538) (118,205) (3,235,800) (4,771,333)
-------------- --------------- --------------- ---------------
Net cash used for investing activities... (60,249,345) (122,952,695) (639,706,691) (490,695,996)
-------------- --------------- --------------- ---------------
</TABLE>
F-7
<PAGE>
INVESTORS FINANCIAL SERVICES CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED OCTOBER 31, 1995, THE TWO-MONTH PERIOD ENDED DECEMBER 31, 1995
AND THE YEARS ENDED DECEMBER 31, 1996 AND 1997 (CONTINUED)
<TABLE>
<CAPTION>
OCTOBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1995 1995 1996 1997
------------ ------------- ------------- -------------
<S> <C> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in demand deposits............ 53,411,987 (39,453,616) 142,007,125 89,702,331
Net increase in time and savings deposits............. 332,489 66,023,363 265,516,792 160,520,692
Net increase in short-term borrowings................. -- 74,401,454 222,019,746 203,111,876
Proceeds from issuance of common stock................ -- 37,950,000 -- 720,438
Proceeds from exercise of stock options............... -- -- 5,148 --
Proceeds from issuance of trust preferred stock....... -- -- -- 25,000,000
Costs of stock issuance............................... -- (3,829,062) 35,193 (838,896)
Dividends paid........................................ (60,000) -- (193,325) (515,622)
------------ ------------- ------------- -------------
Net cash provided by financing activities........... 53,684,476 135,092,139 629,390,679 477,700,819
------------ ------------- ------------- -------------
INCREASE (DECREASE) IN CASH AND DUE FROM BANKS........ 691,109 12,863,888 (2,672,450) (2,188,885)
CASH AND DUE FROM BANKS, BEGINNING OF PERIOD.......... 8,343,906 9,035,015 21,898,903 19,226,453
------------ ------------- ------------- -------------
CASH AND DUE FROM BANKS, END OF PERIOD................ $ 9,035,015 $ 21,898,903 $ 19,226,453 $ 17,037,568
------------ ------------- ------------- -------------
------------ ------------- ------------- -------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest................................ $ 898,000 $ 197,750 $ 17,253,000 $ 45,968,000
------------ ------------- ------------- -------------
------------ ------------- ------------- -------------
Cash paid for income taxes............................ $ 2,919,000 $ 885,000 $ 4,220,000 $ 7,049,000
------------ ------------- ------------- -------------
------------ ------------- ------------- -------------
</TABLE>
See notes to consolidated financial statements.
F-8
<PAGE>
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED OCTOBER 31, 1995, THE TWO-MONTH PERIOD ENDED DECEMBER 31, 1995
AND THE YEARS ENDED DECEMBER 31, 1996 AND 1997
- ------------------------------------------------------------------------------
1. DESCRIPTION OF BUSINESS
Investors Financial Services Corp. ("IFSC") provides asset
administration services for the financial services industry
through its wholly owned subsidiary, Investors Bank & Trust
Company (the "Bank"). The Bank provides global custody,
multicurrency accounting, institutional transfer agency,
performance measurement, foreign exchange, securities lending,
mutual fund administration and investment advisory services to a
variety of financial asset managers, including mutual fund
complexes, investment advisors, banks and insurance companies.
IFSC and the Bank are subject to regulation by the Federal Reserve
Board of Governors, the Office of the Commissioner of Banks of the
Commonwealth of Massachusetts and the Federal Deposit Insurance
Corporation.
As used herein, the defined term "the Company" shall mean IFSC
together with the Bank and its domestic and foreign subsidiaries
from the date of the share exchange discussed below and shall mean
the Bank prior to that date.
On November 8, 1995, the business operations of the Company were
separated from its former parent, Eaton Vance Corp. ("EVC"), by
means of a tax-free, pro rata distribution of EVC's ownership
interest in the Company to the EVC stockholders (the "Spin-off
Transaction"). Immediately prior to the Spin-off Transaction, all
of the stockholders of the Bank exchanged their 1,000,000 shares
of the Bank's capital stock for a combination of 3,418,573 shares
of Common Stock and 611,427 shares of Class A Common Stock ("Class
A Stock") of a newly formed bank holding company formed for the
purpose of facilitating the Spin-off Transaction. For financial
reporting purposes, the exchange has been accounted for as if it
occurred on November 1, 1995. Subsequent to the completion of the
Spin-off Transaction, IFSC sold 2,300,000 additional shares of its
Common Stock in an initial public offering at an offering price of
$16.50 per share. The net effect of this transaction was an
increase in the Company's consolidated capital of approximately
$34,000,000.
In December 1995, the Company changed its fiscal year end from
October 31 to December 31.
On September 19, 1997, pursuant to the terms of the Certificate of
Incorporation of the Company, all shares of the Company's Class A
Common Stock automatically converted into shares of the Company's
Common Stock. The terms of the Class A Common Stock were identical
to the terms of the Common Stock, except that the Common Stock
receives only one vote per share rather than the ten votes per
share previously received by Class A Common Stock.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation--The consolidated financial statements
include the accounts of the Company and its domestic and foreign
subsidiaries. All significant intercompany accounts and
transactions have been eliminated.
Custody and Trust Assets--Asset administration fees, including
securities lending and foreign exchange services and computer
services fees, are composed primarily of fee and fee-related
income and are recorded on the accrual basis.
Accounting Estimates--The preparation of the financial statements
in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from
those estimates.
F-9
<PAGE>
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Securities--The Company classifies all equity securities that have
readily determinable fair values and all investments in debt
securities into one of three categories, as follows:
- Debt securities that the Company has the positive intent and
ability to hold to maturity are classified as held to maturity and
reported at amortized cost.
- Debt and equity securities that are bought and held principally
for the purpose of selling them in the near term are classified as
trading securities and reported at fair value, with unrealized
gains and losses included in earnings.
- All other debt and equity securities are classified as available
for sale and reported at fair value, with unrealized gains and
losses excluded from earnings and reported in a separate component
of stockholders' equity.
Fair Value of Financial Instruments--Statement of Financial
Accounting Standards ("SFAS") No. 107 requires the disclosure of
the estimated fair value of financial instruments, whether or not
recognized in the Company's consolidated balance sheets, estimated
using available market information or other appropriate valuation
methodologies.
The carrying amounts of cash and due from banks are a reasonable
estimate of their fair value. The fair value of the Company's
securities is estimated based on quoted market prices. Both loans
(including commitments to lend) and deposits (including time
deposits) bear interest at variable rates and are subject to
periodic repricing. As such, the carrying amount of loans and
deposits is a reasonable estimate of fair value. The fair value of
the Company's interest rate contracts is estimated based on quoted
market prices. The Company does not have any other significant
financial instruments.
Loans--Interest income on loans is recorded on the accrual basis.
Losses on loans are provided for under the allowance method of
accounting. The allowance is increased by provisions charged to
operating expenses based on amounts management considers necessary
to meet reasonably foreseeable losses on loans.
Equipment and Leasehold Improvements--Equipment and leasehold
improvements are stated at cost, less accumulated depreciation and
amortization. Depreciation and amortization are provided on the
straight-line method over the estimated useful lives of the assets
which range from three to seven years.
Income Taxes--Income tax expense is based on estimated taxes
payable or refundable on a tax return basis for the current year
and the changes in deferred tax assets and liabilities during the
year in accordance with SFAS No. 109, "Accounting for Income
Taxes." Deferred tax assets and liabilities are established for
temporary differences between the accounting basis and the tax
basis of the Company's assets and liabilities at enacted tax rates
expected to be in effect when the amounts related to such
temporary differences are realized or settled.
Translation of Foreign Currencies--The functional currency of the
Company's foreign subsidiaries is the U.S. dollar. Accordingly,
gains and losses realized from the settlement of foreign currency
transactions, which were not significant in the year ended October
31, 1995, the two-month period ended December 31, 1995, or the
years ended December 31, 1996 and 1997, are included in other
operating expenses in the consolidated statements of income.
Derivative Financial Instruments--Prior to the assignment of the
unit investment trust servicing more fully described in Note 11,
the Bank used derivative financial instruments in the form of
interest rate floor contracts ("Floors"). These instruments were
matched with fees on trust and custody assets that were based on
current interest rates. Periodic cash payments were accrued on a
settlement basis. The premiums associated with the instruments
were amortized over their term until they were adjusted to market
value in March 1995 in connection with the sale of the hedged
assets as more fully described in Note 11.
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.
F-10
<PAGE>
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The Company also enters into interest rate swap agreements as
discussed in Note 14 and foreign exchange contracts as discussed
in Note 17. The Company implemented SFAS 119, "Disclosure About
Derivative Financial Investments and Fair Value of Financial
Instruments," in fiscal 1996. This standard requires expanded
disclosure about amounts, nature and terms associated with the
derivative financial instruments held. The adoption of SFAS 119
did not have a significant impact on the Company's consolidated
financial statements.
The Company enters into foreign exchange contracts with clients
and simultaneously enters into a matched position 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.
Liabilities--"Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities," SFAS No. 125
establishes consistent accounting standards for transfers and
servicing of financial assets and extinguishments of liabilities.
SFAS No. 125 provides consistent standards for distinguishing
transfers of financial assets that are sales from transfers of
financial assets that are secured borrowings based upon the
existence of control. SFAS No. 125 was effective and adopted
during fiscal 1997. SFAS No. 125 had no material effect upon the
Company's consolidated financial statements.
Stock-Based Compensation--The Company accounts for stock-based
compensation using the intrinsic value-based method of Accounting
Principles Board Opinion No. 25, as allowed under SFAS No. 123,
"Accounting for Stock-Based Compensation."
Earnings Per Share--In 1997, the Company adopted SFAS No. 128,
"Earnings per Share," and SFAS No. 129, "Disclosure of Information
about Capital Structure".
SFAS No. 128 requires that entities with publicly held common
stock or potential common stock compute, present, and disclose
earnings per share based upon the Basic and/or Diluted earnings
per share ("EPS"). Basic EPS were computed by dividing net income
by the weighted average number of common shares outstanding during
the year. Diluted EPS were computed by increasing the weighted
average of common shares outstanding used in Basic EPS by the
number of additional common shares that would have been
outstanding if the dilutive common stock had been issued. Based
upon the Company's capital structure, the Statement requires
presentation of both Basic and Diluted EPS.
SFAS No. 129 establishes standards for disclosure, in summary form
with an entity's financial statements, the pertinent rights and
privileges of the various securities outstanding. Under SFAS No.
129, the Company discloses within its financial statements the
number of shares issued upon conversion, exercise, or satisfaction
of required conditions during the most recent annual fiscal period.
New Accounting Principles--"Reporting Comprehensive Income," SFAS
No. 130 establishes standards for reporting and display of
comprehensive income and its components in a full set of
general-purpose financial statements. SFAS No. 130 requires that
an enterprise classify items of other comprehensive income by
their nature in a financial statement and display the accumulated
balance of other comprehensive income separately from retained
earnings and additional paid-in capital in the equity section of a
statement of financial position. SFAS No. 130 is effective for
financial statements for periods beginning after December 15,
1997.
"Disclosures about Segments of an Enterprise and Related
Information," SFAS No. 131 establishes standards for the way that
public business enterprises report information about operating
segments in annual financial statements and requires that those
enterprises report selected information about operating segments
in the financial reports issued to shareholders. It also
establishes standards for related disclosures about products and
services, geographic areas, and major customers. SFAS No. 131 is
effective for financial statements for periods beginning after
December 15, 1997.
Reclassifications--Certain amounts in the prior periods' financial
statements have been reclassified to conform to the current year's
presentation.
F-11
<PAGE>
3. SECURITIES
Carrying amounts and approximate market values of securities are summarized
as follows as of December 31, 1996:
<TABLE>
<CAPTION>
APPROXIMATE
CARRYING UNREALIZED UNREALIZED MARKET
HELD TO MATURITY VALUE GAINS LOSSES 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
-------------- ------------ ------------ --------------
-------------- ------------ ------------ --------------
</TABLE>
<TABLE>
<CAPTION>
AMORTIZED UNREALIZED UNREALIZED CARRYING
AVAILABLE FOR SALE COST GAINS LOSSES VALUE
- ------------------------------------------------------ -------------- ------------ ---------- --------------
<S> <C> <C> <C> <C>
U.S. Treasury securities.............................. $ 40,107,999 $ 151,304 $ 3 $ 40,259,300
Mortgage-backed securities............................ 229,930,801 1,086,092 155,229 230,861,664
-------------- ------------ ---------- --------------
Total................................................. $ 270,038,800 $ 1,237,396 $ 155,232 $ 271,120,964
-------------- ------------ ---------- --------------
-------------- ------------ ---------- --------------
</TABLE>
Carrying amounts and approximate market values of securities are summarized
as follows as of December 31, 1997:
<TABLE>
<CAPTION>
APPROXIMATE
CARRYING UNREALIZED UNREALIZED MARKET
HELD TO MATURITY VALUE GAINS LOSSES VALUE
- ---------------------------------------------------- -------------- ------------ ------------ --------------
<S> <C> <C> <C> <C>
State and political subdivisions.................... $ 35,224,790 $ 2,296,252 $ -- $ 37,521,042
Mortgage-backed securities.......................... 590,364,940 5,649,718 514,023 595,500,635
Federal Agency securities........................... 168,687,478 545,863 491,229 168,742,112
Foreign government securities....................... 7,768,869 175,731 -- 7,944,600
-------------- ------------ ------------ --------------
Total............................................... $ 802,046,077 $ 8,667,564 $ 1,005,252 $ 809,708,389
-------------- ------------ ------------ --------------
-------------- ------------ ------------ --------------
</TABLE>
<TABLE>
<CAPTION>
AMORTIZED UNREALIZED UNREALIZED CARRYING
AVAILABLE FOR SALE COST GAINS LOSSES VALUE
- ------------------------------------------------------ -------------- ------------ ---------- --------------
<S> <C> <C> <C> <C>
U.S. Treasury securities.............................. $ 30,002,114 $ 90,136 $ -- $ 30,092,250
Municipal Bonds....................................... 8,348,265 33,588 -- 8,381,853
Mortgage-backed securities............................ 422,207,689 2,624,065 455,768 424,375,986
-------------- ------------ ---------- --------------
Total................................................. $ 460,558,068 $ 2,747,789 $ 455,768 $ 462,850,089
-------------- ------------ ---------- --------------
-------------- ------------ ---------- --------------
</TABLE>
F-12
<PAGE>
3. SECURITIES (CONTINUED)
Nonmarketable equity securities at December 31, 1996 and 1997
consisted 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 such 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 DECEMBER 31, 1997
------------------------------ ------------------------------
APPROXIMATE APPROXIMATE
CARRYING MARKET CARRYING MARKET
HELD TO MATURITY VALUE VALUE VALUE VALUE
- ----------------------------------------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Due within one year............................ $ 19,052,213 $ 18,873,837 $ -- $ --
Due from one to five years..................... 114,459,070 113,819,081 357,580,590 360,361,877
Due five years up to ten years................. 240,620,332 241,016,881 183,840,479 184,373,997
Due after ten years............................ 85,878,308 86,472,780 260,625,008 264,972,515
-------------- -------------- -------------- --------------
Total.......................................... $ 460,009,923 $ 460,182,579 $ 802,046,077 $ 809,708,389
-------------- -------------- -------------- --------------
-------------- -------------- -------------- --------------
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1996 DECEMBER 31, 1997
------------------------------ ------------------------------
AMORTIZED CARRYING AMORTIZED CARRYING
AVAILABLE FOR SALE COST VALUE COST VALUE
- ----------------------------------------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Due within one year............................ $ 19,964,080 $ 20,046,800 $ 20,020,094 $ 20,039,100
Due from one to five years..................... 213,758,992 214,525,641 307,636,460 309,517,768
Due five years up to ten years................. 36,315,728 36,548,523 132,367,416 132,756,384
Due after ten years............................ -- -- 534,098 536,837
-------------- -------------- -------------- --------------
Total.......................................... $ 270,038,800 $ 271,120,964 $ 460,558,068 $ 462,850,089
-------------- -------------- -------------- --------------
-------------- -------------- -------------- --------------
</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.
Five securities available for sale were sold during the year ended December
31, 1997 resulting in gains totaling $113,958.
The carrying value of securities pledged amounted to approximately
$362,000,000 and $590,000,000 at December 31, 1996 and December 31, 1997,
respectively. Securities are pledged primarily to secure public funds and
clearings with other depository institutions.
F-13
<PAGE>
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 December 31, 1997. In addition,
there have been no loan charge-offs or recoveries during the year
ended October 31, 1995, the two months ended December 31, 1995 or
the years ended December 31, 1996 and 1997. Loans consisted of the
following at December 31, 1996 and December 31, 1997:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1997
--------------- -------------
<S> <C> <C>
Loans to individuals............................ $ 23,448,999 $ 26,857,933
Loans to not-for-profit institutions............ 12,500 12,500
Loans to mutual funds........................... 42,875,390 29,174,524
--------------- -------------
66,336,889 56,044,957
Less allowance for loan losses.................. 100,000 100,000
--------------- -------------
Total........................................... $ 66,236,889 $ 55,944,957
--------------- -------------
--------------- -------------
</TABLE>
The Company had commitments to lend of approximately $37,128,000
and $62,845,000 at December 31, 1996 and December 31, 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 December 31, 1997:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1997
------------ -------------
<S> <C> <C>
Furniture, fixtures and equipment.................................................... $ 8,516,450 $ 11,189,053
Leasehold improvements............................................................... 744,395 492,138
------------ -------------
Total................................................................................ 9,260,845 11,681,191
Less accumulated depreciation and amortization....................................... 4,016,871 3,780,197
------------ -------------
Equipment and leasehold improvements, net............................................ $ 5,243,974 $ 7,900,994
------------ -------------
------------ -------------
</TABLE>
F-14
<PAGE>
6. DEPOSITS
Time deposits at December 31, 1996 and December 31, 1997 include
noninterest-bearing amounts of approximately $55,000,000 and $65,000,000,
respectively.
All time deposits had a minimum balance of $100,000 and a maturity of less
than three months at December 31, 1996 and December 31, 1997.
7. SHORT-TERM BORROWINGS
The major components of short-term borrowings are as follows at December 31,
1996 and December 31, 1997:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1997
-------------- --------------
<S> <C> <C>
Repurchase agreements............................................................ $ 296,421,201 $ 499,188,363
Treasury, Tax and Loan account................................................... 399,551 744,265
-------------- --------------
Total............................................................................ $ 296,820,752 $ 499,932,628
-------------- --------------
-------------- --------------
</TABLE>
The Company enters into repurchase agreements whereby securities
are sold by the Company under agreements to repurchase. The
interest rate on the outstanding agreements at December 31, 1996
was 5.91% and all agreements matured on January 2, 1997. The
interest rate on the outstanding agreements at December 31, 1997
ranged from 4.95% to 5.90% and all agreements mature by March 3,
1998.
The Company receives federal tax deposits from clients as an
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 interest rates on the outstanding balances at
December 31, 1996 and December 31, 1997 were 5.10% and 5.26%
respectively.
The following securities were pledged under the repurchase
agreements at December 31, 1996 and December 31, 1997:
<TABLE>
<CAPTION>
DECEMBER 31, 1996 DECEMBER 31, 1997
------------------------------ ------------------------------
<S> <C> <C> <C> <C>
APPROXIMATE APPROXIMATE
CARRYING MARKET CARRYING MARKET
VALUE VALUE VALUE VALUE
-------------- -------------- -------------- --------------
U.S. Treasury securities....................... $ 37,249,940 $ 37,249,940 $ 20,392,469 $ 20,392,469
Federal Agency securities...................... 25,000,000 24,803,950 -- --
Mortgage-backed securities..................... 245,689,672 246,777,873 501,141,751 503,300,183
-------------- -------------- -------------- --------------
Total.......................................... $ 307,939,612 $ 308,831,763 $ 521,534,220 $ 523,692,652
-------------- -------------- -------------- --------------
-------------- -------------- -------------- --------------
</TABLE>
The amount outstanding at December 31, 1997 was the highest amount
outstanding at any month end during the year ended December 31,
1997. The average balance during the year ended December 31, 1997
was $509,288,000.
F-15
<PAGE>
8. INCOME TAXES
The components of income tax expenses are as follows for the year ended
October 31, 1995, the two-month period ended December 31, 1995, and the years
ended December 31, 1996 and 1997:
<TABLE>
<CAPTION>
OCTOBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1995 1995 1996 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Current:
Federal............................................... $ 2,781,000 $ 445,480 $3,593,391 $5,453,161
State................................................. 484,000 139,429 181,416 714,422
Foreign............................................... 4,000 7,012 193,251 9,462
------------ ------------ ------------ ------------
3,269,000 591,921 3,968,058 6,177,045
------------ ------------ ------------ ------------
Deferred:
Federal............................................... (391,000) 50,538 619,357 246,014
State................................................. (154,000) 17,580 240,861 90,838
Foreign............................................... 76,000 10,259 38,295 --
------------ ------------ ------------ ------------
(469,000) 78,377 898,513 336,852
------------ ------------ ------------ ------------
Minority Interest....................................... -- -- -- 808,467
------------ ------------ ------------ ------------
Total income taxes...................................... $ 2,800,000 $ 670,298 $4,866,571 $7,322,364
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
</TABLE>
Differences between the effective income tax rate and the federal statutory
rates are as follows for the year ended October 31, 1995, the two-month period
ended December 31, 1995, and the years ended December 31, 1996 and 1997:
<TABLE>
<CAPTION>
OCTOBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1995 1995 1996 1997
------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Federal statutory rate................................... 34.00% 34.00% 35.00% 35.00%
State income tax rate, net of federal benefit............ 3.00 6.60 2.20 2.89
Foreign income taxes with different rates................ 0.70 1.10 1.20 0.03
Tax-exempt income, net of disallowance................... -- -- -- (2.79)
Other.................................................... 1.10 1.00 0.10 0.87
----- ----- ----- -----
Effective tax rate....................................... 38.80% 42.70% 38.50% 36.00%
</TABLE>
F-16
<PAGE>
8. INCOME TAXES (CONTINUED)
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets and liabilities consist of the following at
December 31, 1996 and December 31, 1997:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1997
------------ -------------
<S> <C> <C>
Deferred tax assets:
Employee benefit plans............................................................ $ 933,216 $ 829,330
Other............................................................................. 37,562 84,716
------------ -------------
970,778 914,046
Deferred tax liabilities:
Prepaid insurance................................................................. (620,979) (636,948)
Securities available for sale..................................................... (432,866) (825,128)
Unearned compensation............................................................. (183,175) (139,431)
Depreciation and amortization..................................................... (106,514) (414,409)
------------ -------------
Net deferred tax asset (liability).................................................. $ (372,756) $ (1,101,870)
------------ -------------
------------ -------------
</TABLE>
Net deferred tax liabilities are reported as a component of other
liabilities in the 1996 and 1997 consolidated balance sheets.
9. COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY
TRUST HOLDING JUNIOR SUBORDINATED DEFERRABLE INTEREST DEBENTURES OF THE COMPANY
On January 31, 1997, a trust sponsored and wholly owned by the Company
issued $25,000,000 in 9.77% Trust Preferred Securities (the "Capital
Securities"), the proceeds of which were invested by the trust in the same
aggregate principal amount of the Company's newly issued 9.77% Junior
Subordinated Deferrable Interest Debentures due February 1, 2027 (the "Junior
Subordinated Debentures"). The $25,000,000 aggregate principal amount of the
Junior Subordinated Debentures represents the sole asset of the Trust. The
Company has guaranteed, on a subordinated basis, distributions and other
payments due on the Capital Securities (the "Guarantee"). The Guarantee, when
taken together with the Company's obligations under (i) the Debentures; (ii) the
indenture pursuant to which the Junior Subordinated Debentures were issued; and
(iii) the Amended and Restated Declaration of Trust governing the Trust
constitutes a full and unconditional guarantee of the Trust's obligations under
the Capital Securities.
10. 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 December 31, 1997, there
were no preferred shares issued or outstanding. There were 359,545 and 0 shares
of Class A Common Stock and 6,084,767 and 6,470,313 shares of Common Stock
issued and outstanding at December 31, 1996 and December 31, 1997, respectively.
The Company has three stock option plans, the 1995 Stock Plan, the 1995
Non-Employee Director Stock Option Plan, and the 1997 Employee Stock Purchase
Plan. Under the terms of the 1995 Stock Plan, the Company may grant options
to purchase up to a maximum of 560,000 shares of Common Stock to certain
employees, consultants, directors and officers. On November 18, 1997, subject
to approval by a majority of the holders of the Company's Common Stock
eligible to vote thereon, the Board of Directors of the Company authorized
the issuance of up to an additional 600,000 shares of Common Stock under the
1995 Stock Plan. The options may be awarded as incentive stock options
(employees only), nonqualified stock options, stock awards or opportunities
to make direct purchases of stock.
F-17
<PAGE>
10. STOCKHOLDERS' EQUITY (CONTINUED)
Under the terms of the 1995 Non-Employee Director Stock Option Plan, the
Company may grant options to non-employee directors to purchase up to a maximum
of 40,000 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, non-employee 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 the 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.
In November 1995, the Company granted 114,000 shares 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 $1,248,775 at December 31, 1996 and December 31, 1997, respectively,
pursuant to these grants.
The 1997 Employee Stock Purchase Plan was adopted by the Board of Directors
on January 14, 1997 and subsequently approved by the stockholders at the
Company's 1997 Annual Meeting. The Company has authorized the issuance of
140,000 shares of Common Stock pursuant to the exercise of nontransferable
options granted to participating employees. The 1997 Purchase Plan permits
eligible employees to purchase up to 1,000 shares of Common Stock per payment
period, subject to limitations provided by Section 423(b) of the Internal
Revenue Code, through accumulated payroll deductions. The purchases are made
twice a year at a price equal to the lesser of (i) 90% of the average market
value of the Common Stock on the first business day of the payment period, or
(ii) 90% of the average market value of the Common Stock on the last business
day of the payment period. Annual payment periods consist of two six-month
periods, January 1 through June 30 and July 1 through December 31.
A summary of option activity under all plans is as follows:
<TABLE>
<CAPTION>
NUMBER OF WEIGHTED-AVERAGE
SHARES EXERCISE PRICE
----------- -------------------
<S> <C> <C>
Outstanding at December 31, 1996.................................................... 345,150 $ 21
Granted............................................................................. 187,262 43
Exercised........................................................................... (14,753) 17
Canceled............................................................................ (375) 17
-----------
Outstanding at December 31, 1997.................................................... 517,284 30
-----------
Outstanding and exercisable at December 31, 1997.................................... 148,939
-----------
</TABLE>
Under the Employee Stock Purchase Plan, adopted in fiscal year 1997, the
Company sold 11,248 shares of Common Stock to employees at December 31, 1997.
The exercise price of the stock was $41.50, or 90% of the average market value
of the Common Stock on the last business day of the payment period.
F-18
<PAGE>
10. STOCKHOLDERS' EQUITY (CONTINUED)
Employee Stock-Based Compensation--With respect to employee stock-based
compensation, the Company has adopted the disclosure-only requirements of SFAS
No. 123. Accordingly, no compensation cost has been recognized in the
accompanying financial statements for employee stock-based compensation awarded
under the three stock employee stock option plans. If compensation cost had been
determined for awards granted under the employee stock option plans based on the
fair value of the awards at the date of grant in accordance with the provisions
of SFAS No. 123, the Company's net income and earnings per share for the years
ended December 31, 1996 and December 31, 1997 would have decreased to the pro
forma amounts indicated below:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1997
-------------- ------------
<S> <C> <C> <C>
Net income As reported $7,773,942 $ 11,580,261
Pro forma 7,502,714 10,976,162
Basic earnings per share As reported 1.21 1.80
Pro forma 1.17 1.71
Diluted earnings per share As reported 1.20 1.75
Pro forma 1.16 1.66
</TABLE>
The fair value of each option grant under the employee stock option plan was
estimated on the date of grant using the Black-Scholes option-pricing model with
the following assumptions for the years ended December 31, 1997 and 1996,
respectively: an assumed risk-free interest rate of 5.61% and 6.25%, an expected
life of five years for both years, an expected volatility of 27% and 20%, and
nominal dividends paid for both years.
The fair value of each option grant under the employee stock purchase plan
was estimated by computing the option discount which is the difference between
the average market value of the Company's Common Stock during the payment period
and 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.
F-19
<PAGE>
10. STOCKHOLDERS' EQUITY (CONTINUED)
EARNINGS PER SHARE--As a result of the EPS methods required to be disclosed
by the Company under SFAS No. 128, the Statement also requires disclosure of a
reconciliation from Basic EPS to Diluted EPS for the two-month period ended
December 31, 1995, and for the years ended December 31, 1996 and 1997 as
follows:
<TABLE>
<CAPTION>
PER-
SHARE
INCOME SHARES AMOUNT
------------- ---------- -----------
<S> <C> <C> <C>
DECEMBER 31, 1997
BASIC EPS
Income available to common stockholders..................................... $ 11,580,261 6,446,428 $ 1.80
-----
-----
Dilutive effect of common equivalent shares of stock options................ 169,175
----------
DILUTED EPS
Income available to common stockholders..................................... $ 11,580,261 6,615,603 $ 1.75
------------- ---------- -----
------------- ---------- -----
DECEMBER 31, 1996
BASIC EPS
Income available to common stockholders..................................... $ 7,773,942 6,444,195 $ 1.21
-----
-----
Dilutive effect of common equivalent shares of stock options................ 60,187
----------
DILUTED EPS
Income available to common stockholders..................................... $ 7,773,942 6,504,382 $ 1.20
------------- ---------- -----
------------- ---------- -----
DECEMBER 31, 1995
BASIC EPS
Income available to common stockholders..................................... $ 899,794 6,444,000 $ 0.14
-----
-----
Dilutive effect of common equivalent shares of stock options................ 36,561
----------
DILUTED EPS
Income available to common stockholders..................................... $ 899,794 6,480,561 $ 0.14
------------- ---------- -----
------------- ---------- -----
</TABLE>
11. PROCEEDS FROM ASSIGNMENT OF UNIT INVESTMENT TRUST SERVICING, NET
On March 1, 1995, the Company recognized a net gain of $2,572,298 of
noninterest income resulting from the assignment to another company of the
rights to service approximately $5.0 billion of unit investment trust assets. In
connection with the assignment, the Company adjusted to market value interest
rate floors with a notional amount of $80,000,000, and the resulting loss of
$1,057,700 is reported net of the cash proceeds from the assignment of unit
investment trust servicing. These interest rate floors had previously been
designated as hedges of fees from the unit investment trusts (see Note 14).
F-20
<PAGE>
12. EMPLOYEE BENEFIT PLANS
PENSION PLAN--The Company has a trusteed, noncontributory, qualified
defined benefit pension plan covering substantially all of its employees who
were hired before January 1, 1997. The benefits are based on years of service
and the employee's compensation during employment. The Company's funding
policy is to contribute annually the maximum amount which can be deducted for
federal income tax purposes. Contributions are intended to provide not only
for benefits attributed to service to date but also for benefits expected to
be earned in the future.
The Company established a supplemental retirement plan in 1994 that covers
certain employees and pays benefits that supplements any benefits paid under the
qualified plan. Benefits under the supplemental plan are generally based on
compensation not includable in the calculation of benefits to be paid under the
qualified plan. The total cost of this plan to the Company was $86,563, $6,827,
$36,960 and $60,002 in the year ended October 1995, the two-month period ended
December 31, 1995, and the years ended December 31, 1996 and December 31, 1997,
respectively.
The following table sets forth the funded status and accrued pension cost
for the Company's pension plans.
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1997
------------- -------------
<S> <C> <C>
Actuarial present value of benefit obligations:
Accumulated benefit obligations, including vested benefits of $3,746,000 and
$4,316,000 for December 31, 1996 and 1997, respectively......................... $ 4,109,000 $ 4,775,000
------------- -------------
------------- -------------
Projected benefit obligations for services rendered to date......................... $ 6,885,000 $ 6,285,000
Plan assets at fair value, primarily listed stocks and U.S. government
obligations....................................................................... 6,213,000 8,168,000
------------- -------------
Projected benefit obligations in excess of assets................................... (672,000) 1,883,000
Unrecognized net gain from past experience different from that assumed and effects
of changes in assumptions......................................................... (1,075,000) (3,363,000)
Prior service cost not yet recognized in periodic pension cost...................... 238,000 210,000
Unrecognized net (asset) liability.................................................. (378,000) (339,000)
------------- -------------
Accrued pension cost................................................................ $ (1,887,000) $ (1,609,000)
------------- -------------
------------- -------------
</TABLE>
Net pension cost included the following components for the year ended
October 31, 1995, the two-month period ended December 31, 1995 and the years
ended December 31, 1996 and 1997:
<TABLE>
<CAPTION>
OCTOBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1995 1995 1996 1997
----------- ------------ ------------- -------------
<S> <C> <C> <C> <C>
Service cost--benefits earned during the period......... $ 618,000 $ 123,000 $ 848,000 $ 540,000
Interest cost on projected benefit obligations.......... 425,000 86,000 520,000 557,000
Return on plan assets................................... (420,000) (73,000) (1,013,000) (1,279,000)
Net amortization and deferral........................... (5,000) 1,000 508,000 714,000
----------- ------------ ------------- -------------
Net periodic pension cost............................... $ 618,000 $ 137,000 $ 863,000 $ 532,000
----------- ------------ ------------- -------------
----------- ------------ ------------- -------------
</TABLE>
F-21
<PAGE>
12. EMPLOYEE BENEFIT PLANS (CONTINUED)
The weighted average discount rate and the rate of increase in future
compensation levels used in determining the actuarial present value of the
projected benefit obligations were as follows:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1997
----------------- -----------------
<S> <C> <C>
Weighted average discount rate............................. 7.5% 7.5%
Rate of increase in future compensation levels............. 5.0 5.0
Long-term rate of return on plan assets.................... 8.5 8.5
</TABLE>
EMPLOYEE SAVINGS PLAN--The Company sponsors a qualified defined contribution
employee savings plan covering substantially all employees who elect to
participate. The Company matches employee contributions to the plan up to
specified amounts. The total cost of this plan to the Company was $222,000,
$36,000, $208,000 and $436,000 in the year ended October 31, 1995, the two-month
period ended December 31, 1995, and the years ended December 31, 1996 and 1997,
respectively.
13. RELATED-PARTY TRANSACTIONS
As a result of the Spin-off Transaction described in Note 1, transactions
between the Company and EVC are no longer considered related-party transactions.
However, prior to the Spin-off Transaction, the Company entered into various
transactions with EVC and a group of mutual funds sponsored by EVC. The
following is a summary of such related-party transactions for the year ended
October 31, 1995:
<TABLE>
<CAPTION>
OCTOBER 31,
1995
--------------
<S> <C>
Asset administration fee income............................................... $ 8,355,000
Computer service fee income................................................... 506,000
Occupancy expense............................................................. 260,000
</TABLE>
The aggregate of the above fees exceeded 10% of the Company's interest
income and non-interest income.
In addition, EVC and its group of mutual funds had the following amounts
outstanding with the Company at October 31, 1995:
<TABLE>
<S> <C>
Fees receivable............................................... $ 308,000
Deposits...................................................... 102,869,000
</TABLE>
F-22
<PAGE>
14. OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
LINES OF CREDIT--At December 31, 1997, the Company had commitments to
individuals under collateralized open lines of credit totaling $90,726,000,
against which $27,881,000 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 December 31, 1996 and 1997:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1997
-------------- --------------
<S> <C> <C>
Interest rate contracts:
Swap agreements.................................................................. $ 180,000,000 $ 340,000,000
Floor contracts.................................................................. 30,000,000 --
</TABLE>
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 one party may default on its
contractual obligation. Credit risk is limited to the positive market value
of the derivative financial instrument, which is significantly less than the
notional value. During 1997, the Company entered into agreements to assume
fixed-rate interest payments in exchange for variable market-indexed interest
payments. The original terms range from 12 to 24 months. The weighted-average
fixed-payment rates were 5.90 percent at December 31, 1997. Variable-interest
payments received are indexed to 1 month LIBOR. At December 31, 1997, the
weighted-average rate of variable market-indexed interest payment obligations
to the Bank was 5.79 percent. The effect of these agreements was to lengthen
short-term variable rate liabilities into longer-term fixed rate liabilities.
These contracts had no carrying value and the market value was approximately
($358,000) at December 31, 1997.
15. 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 December 31, 1997 was $37,081,000. In
addition, other cash balances in the amount of $1,562,000 were pledged to
secure clearings with a depository institution as of December 31, 1997.
LEASE COMMITMENTS--Minimum future commitments on noncancelable operating
leases at December 31, 1997 were as follows:
<TABLE>
<CAPTION>
BANK
PREMISES EQUIPMENT
------------ ------------
<S> <C> <C>
Fiscal Year Ending
1998.................................................................................. $ 6,051,092 $ 1,997,720
1999.................................................................................. 6,079,504 1,661,790
2000.................................................................................. 5,814,212 525,269
2001.................................................................................. 5,694,734 --
2002 and beyond....................................................................... 29,999,475 --
</TABLE>
Total rent expense was $5,511,000, $843,000, $5,838,000 and $6,426,000
for the year ended October 31, 1995, the two months ended December 31, 1995,
and the years ended December 31, 1996 and 1997, respectively.
On February 1, 1996, the Company entered into a five year facility
management agreement with a third party provider of duplicating and delivery
services. Under the terms of the agreement, the Company agreed to pay minimum
annual charges of $387,214, $406,788, $427,119, and $35,735 in the years
ended December 31, 1998, 1999, 2000, and 2001, respectively. These minimum
charges can increase due to certain usage thresholds. Service expense under
this contract was $452,463 for the year ended December 31, 1997.
F-23
<PAGE>
15. COMMITMENTS AND CONTINGENCIES (CONTINUED)
CONTINGENCIES--The Company provides global custody, multicurrency
accounting, institutional transfer agency, performance measurement, foreign
exchange, securities lending and mutual fund administration 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 December 31, 1997 that are material to the consolidated
financial position or results of operations of the Company.
16. FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value and estimated fair value of financial instruments are as
follows at December 31, 1996 and 1997 (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1996 DECEMBER 31, 1997
----------------------- -----------------------
<S> <C> <C> <C> <C>
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
---------- ----------- ---------- -----------
On-balance sheet amounts:
Cash and due from banks...................................... $ 19,226 $ 19,226 $ 17,038 $ 17,038
Federal funds sold........................................... 120,000 120,000 75,000 75,000
Securities held to maturity.................................. 460,010 460,183 802,046 809,708
Securities available for sale................................ 271,121 271,121 462,850 462,850
Loans........................................................ 66,237 66,237 55,945 55,945
Deposits..................................................... 596,517 596,517 846,740 846,740
Off-balance sheet amounts:
Commitments to lend ($37,127 and $62,845 at December 31, 1996
and 1997).................................................. -- 37,127 -- 62,845
Interest rate floor contracts (notional amounts of $30,000
and $0 at December 31, 1996 and 1997) -- -- -- --
Interest rate swap agreements (notional amounts of $180,000 and
$340,000 at December 31, 1996 and 1997).................... -- (112,160) -- (357,927)
Foreign exchange contracts (notional amounts of $114,302 and
$45,884 at December 31, 1996 and 1997)..................... -- -- -- --
</TABLE>
The fair value estimates presented herein are based on pertinent information
available to management as of December 31, 1996 and 1997. Although management is
not aware of any factors that would significantly affect the estimated fair
value amounts, such amounts have not been significantly revalued for purposes of
these consolidated financial statements since those dates and therefore, current
estimates of fair value may differ significantly from the amounts presented
herein.
F-24
<PAGE>
17. FOREIGN EXCHANGE CONTRACTS
A summary of foreign exchange contracts outstanding at December 31, 1996 and
December 31, 1997 is as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1996
---------------------------------------
UNREALIZED
CURRENCY PURCHASES SALES GAIN/LOSS
- ----------------------------------------------------- ----------- --------- ---------------
<S> <C> <C> <C>
Hong Kong (HKD)...................................... $ 1,807 $ 1,807 --
Japan (JPY).......................................... 40,828 40,828 --
France (FRF)......................................... 1,093 1,093 --
United Kingdom (GBP)................................. 1,873 1,873 --
Malaysia (MYR)....................................... 6,009 6,009 --
Germany (DEM)........................................ 2,118 2,118 --
Switzerland (CHF).................................... -- -- --
Singapore (SGD)...................................... 331 331 --
Sweden (SEK)......................................... 139 139 --
Canada (CAD)......................................... -- -- --
Netherlands (NLG).................................... 918 918 --
Spain (ESP).......................................... 85 85 --
Italy (ITL).......................................... 51 51 --
Other currencies..................................... 1,894 1,894 --
----------- --------- ---------------
$ 57,146 $ 57,146 --
----------- --------- ---------------
----------- --------- ---------------
<CAPTION>
DECEMBER 31, 1997
------------------------------------------
UNREALIZED
CURRENCY PURCHASES SALES GAIN/LOSS
- ----------------------------------------------------- ----------- --------- ---------------
<S> <C> <C> <C>
Hong Kong (HKD)...................................... $ 5,011 $ 5,011 --
Japan (JPY).......................................... 5,000 5,000 --
France (FRF)......................................... 4,292 4,292 --
United Kingdom (GBP)................................. 3,440 3,440 --
Malaysia (MYR)....................................... 1,218 1,218 --
Germany (DEM)........................................ 1,016 1,016 --
Switzerland (CHF).................................... 483 483 --
Singapore (SGD)...................................... 368 368 --
Sweden (SEK)......................................... 317 317 --
Canada (CAD)......................................... 278 278 --
Netherlands (NLG).................................... 271 271 --
Spain (ESP).......................................... 185 185 --
Italy (ITL).......................................... 145 145 --
Other currencies..................................... 918 918 --
----------- --------- ---------------
$ 22,942 $ 22,942 --
----------- --------- ---------------
----------- --------- ---------------
</TABLE>
The maturity of contracts outstanding as of December 31, 1997 is as follows:
<TABLE>
<CAPTION>
MATURITY PURCHASES SALES
- ------------------------------------------------------------------------------------------- ----------- ---------
<S> <C> <C>
January 1998............................................................................... $ 17,279 $ 17,279
February 1998.............................................................................. 5,663 5,663
</TABLE>
18. 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 and the Bank's 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 Company's and 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 Company and 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 December 31, 1997, that the Company and the Bank meet all capital adequacy
requirements to which it is subject.
As of December 31, 1997, the most recent notification from the Federal
Deposit Insurance Corporation categorized the Company and the Bank as well
capitalized under the regulatory framework for prompt corrective action. To
be categorized as well capitalized, the Company and the Bank must maintain
minimum total risk-based, Tier I risk based, and Tier I leverage ratios as
set forth in the table. There are no conditions or events since that
notification that management believes have changed the Company's or the
Bank's category. The following table presents the capital ratios for the Bank
and the Company for the years ended December 31, 1997 and December 31, 1996.
The capital ratios for the Bank were substantially the same as the capital
ratios of the Company for the year ended December 31, 1996.
F-25
<PAGE>
18. REGULATORY MATTERS (CONTINUED)
<TABLE>
<CAPTION>
TO BE WELL
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 DECEMBER 31, 1997:
Total Capital
(to Risk Weighted Assets--the Company)... $ 97,695,092 29.03% $ 26,919,487 8.00% N/A N/A
(to Risk Weighted Assets--the Bank)...... $ 96,140,693 28.57% $ 26,918,947 8.00% $ 33,648,684 10.00%
Tier I Capital
(to Risk Weighted Assets--the Company)... $ 97,595,092 29.00% $ 13,459,744 4.00% N/A N/A
(to Risk Weighted Assets--the Bank)...... $ 96,040,693 28.54% $ 13,459,473 4.00% $ 20,189,210 6.00%
Tier I Capital
(to Average Assets- the Company)......... $ 97,595,092 6.39% $ 61,062,667 4.00% N/A N/A
(to Average Assets--the Bank)............ $ 96,040,693 6.31% $ 60,892,699 4.00% $ 76,115,874 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 1 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>
Under Massachusetts law, trust companies such as the Bank may only pay
dividends out of "net profits" and only to the extent that such payments will
not impair the Bank's capital stock and surplus account. If, prior to
declaration of a dividend, the Bank's capital stock and surplus accounts do
not equal at least 10% of its deposit liabilities, then prior to the payment
of the dividend, the Bank must transfer from net profits to its surplus
account the amount required to make its surplus account equal to either (i)
together with capital stock, 10% of deposit liabilities, or (ii) subject to
certain adjustments, 100% of capital stock.
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
YEAR ENDED DECEMBER 31, 1997 QUARTER QUARTER QUARTER QUARTER
- ---------------------------------------------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Interest income..................................... $ 15,031,602 $ 16,991,919 $ 19,117,584 $ 21,894,824
Interest expense.................................... 8,575,466 10,402,357 13,020,232 14,865,176
Noninterest income.................................. 17,759,820 18,549,079 19,981,922 20,525,379
Operating expenses.................................. 19,313,673 20,093,016 20,873,443 22,368,865
Income before income taxes and Minority Interest.... 4,902,283 5,045,625 5,205,831 5,186,162
Income taxes........................................ 1,822,219 1,758,081 1,875,046 1,867,018
Minority Interest................................... 258,498 392,835 395,143 390,800
Net income.......................................... 2,821,566 2,894,709 2,935,642 2,928,344
Basic earnings per share............................ .44 .45 .46 .45
Diluted earnings per share.......................... .43 .44 .44 .44
</TABLE>
F-26
<PAGE>
20. FINANCIAL STATEMENTS OF INVESTORS FINANCIAL SECURITIES CORP. (PARENT ONLY)
The following represents the separate condensed financial statements of IFSC
as of December 31, 1996 and 1997, and for the two-month period ended December
31, 1995 and the years ended December 31, 1996 and 1997.
<TABLE>
<CAPTION>
TWO MONTHS
ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
STATEMENTS OF INCOME 1995 1996 1997
- --------------------------------------------------------------------- ------------ ------------ -------------
<S> <C> <C> <C>
Equity in undistributed income of bank subsidiary.................... $ 899,794 $7,601,082 $ 11,026,680
Equity in undistributed income of non-bank subsidiaries.............. -- -- 28,475
Dividend income from bank subsidiary................................. -- 478,546 2,142,391
Dividend income from non-bank subsidiaries........................... -- -- 69,528
Interest expense on subordinated debt................................ -- -- (2,315,271)
Income tax benefit................................................... -- -- 908,284
Operating expenses................................................... -- (305,666) (279,826)
------------ ------------ -------------
Net income........................................................... $ 899,794 $7,773,962 $ 11,580,261
------------ ------------ -------------
------------ ------------ -------------
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
BALANCE SHEETS 1996 1997
- ---------------------------------------------------------------------------------- ------------- --------------
<S> <C> <C>
Assets:
Cash.............................................................................. $ -- $ 1,154,645
Investments in bank subsidiary.................................................... 61,367,783 97,507,587
Investments in non-bank subsidiaries.............................................. -- 732,946
Receivable due from bank subsidiary............................................... 493,089 1,455,953
Income tax receivable............................................................. -- 1,584
Other assets...................................................................... 3,438 5,168
------------- --------------
Total Assets...................................................................... $ 61,864,310 $ 100,857,883
------------- --------------
------------- --------------
Liabilities and Stockholders' Equity
Accrued expenses.................................................................. $ -- $ 23,426
Other liabilities................................................................. 5,000 159,576
Subordinated debt................................................................. -- 25,774,000
------------- --------------
Total Liabilities............................................................. 5,000 25,957,002
------------- --------------
------------- --------------
Stockholders' Equity
Common stock.................................................................... 64,443 64,703
Surplus......................................................................... 54,352,812 55,072,990
Deferred compensation........................................................... (1,687,675) (1,248,775)
Retained earnings............................................................... 8,480,431 19,545,070
Net unrealized gains on available for sale securities........................... 649,299 1,466,893
------------- --------------
Total Stockholders' Equity.................................................... 61,859,310 74,900,881
------------- --------------
Total Liabilities and Stockholders' Equity........................................ $ 61,864,310 $ 100,857,883
------------- --------------
------------- --------------
</TABLE>
F-27
<PAGE>
20. FINANCIAL STATEMENTS OF INVESTORS FINANCIAL SECURITIES CORP. (PARENT ONLY)
(CONTINUED)
<TABLE>
<CAPTION>
TWO MONTHS
ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
STATEMENTS OF CASH FLOWS 1995 1996 1997
- --------------------------------------------------------------------- ------------- ------------ -------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income......................................................... $ 899,794 $7,773,962 $ 11,580,261
------------- ------------ -------------
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization of deferred compensation............................ 76,713 430,112 438,900
Change in assets and liabilities:
Receivable due from bank subsidiary............................ -- (416,376) (962,864)
Income tax receivable.......................................... -- -- (1,584)
Accrued expenses............................................... -- -- 23,426
Other assets................................................... -- (3,438) (1,731)
Other liabilities.............................................. -- 5,000 154,576
Equity in undistributed earnings of bank subsidiary.............. (976,507) (7,601,082) (11,055,155)
------------- ------------ -------------
Total adjustments.................................................. (899,794) (7,585,784) (11,404,432)
------------- ------------ -------------
Net cash provided by operating activities............................ -- 188,178 175,829
------------- ------------ -------------
Cash flows from investing activities:
Payments for investments in and advances to subsidiary............. (34,120,938) (35,193) (25,000,000)
------------- ------------ -------------
Net cash used by investing activities................................ (34,120,938) (35,193) (25,000,000)
------------- ------------ -------------
Cash flows from financing activities:
Proceeds from common stock......................................... 37,950,000 -- --
Costs of stock issuance............................................ (3,829,062) 35,193 720,438
Proceeds from issuance of subordinated debt, net of issuance
costs............................................................ -- -- 25,774,000
Proceeds from exercise of stock options............................ -- 5,148 --
Dividends paid..................................................... (193,326) (515,622)
------------- ------------ -------------
Net cash provided (used) by financing activities..................... 34,120,938 (152,985) 25,978,816
------------- ------------ -------------
Net increase in cash and due from banks.............................. -- -- 1,154,645
Cash and Due from Banks, beginning of period......................... -- -- --
------------- ------------ -------------
Cash and Due from Banks, end of period............................... $ -- $ -- $ 1,154,645
------------- ------------ -------------
------------- ------------ -------------
</TABLE>
F-28
<PAGE>
Exhibit 10.1
INVESTORS FINANCIAL SERVICES CORP.
AMENDED AND RESTATED 1995 STOCK PLAN
1. Purpose. The purpose of the Investors Financial Services Corp. 1995 Stock
Plan (the "Plan") is to encourage key employees of Investors Financial Services
Corp. (the "Company") and of any present or future parent or subsidiary of the
Company (collectively, "Related Corporations") and other individuals who render
services to the Company or a Related Corporation, by providing opportunities to
participate in the ownership of the Company and its future growth through (a)
the grant of options which qualify as "incentive stock options" ("ISOs") under
Section 422(b) of the Internal Revenue Code of 1986, as amended (the "Code");
(b) the grant of options which do not qualify as ISOs ("Non-Qualified Options");
(c) awards of stock in the Company ("Awards"); and (d) opportunities to make
direct purchases of stock in the Company ("Purchases"). Both ISOs and
Non-Qualified Options are referred to hereafter individually as an "Option" and
collectively as "Options." Options, Awards and authorizations to make Purchases
are referred to hereafter collectively as "Stock Rights." As used herein, the
terms "parent" and "subsidiary" mean "parent corporation" and "subsidiary
corporation," respectively, as those terms are defined in Section 424 of the
Code.
2. Administration of the Plan.
A. Board or Committee Administration. The Plan shall be administered
by the Board of Directors of the Company (the "Board") or by a committee
appointed by the Board (the "Committee"); provided that the Plan shall be
administered: (i) to the extent required by applicable regulations under
Section 162(m) of the Code, by two or more "outside directors" (as
defined in applicable regulations thereunder) and (ii) to the extent
required by Rule 16b-3 promulgated under the Securities Exchange Act of
1934 or any successor provision ("Rule 16b-3"), by a disinterested
administrator or administrators within the meaning of Rule 16b-3.
Hereinafter, all references in this Plan to the "Committee" shall mean
the Board if no Committee has been appointed. Subject to ratification of
the grant or authorization of each Stock Right by the Board (if so
required by applicable state law), and subject to the terms of the Plan,
the Committee shall have the authority to (i) determine to whom (from
among the class of employees eligible under paragraph 3 to receive ISOs)
ISOs shall be granted, and to whom (from among the class of individuals
and entities eligible under paragraph 3 to receive Non-Qualified Options
and Awards and to make Purchases) Non-Qualified Options, Awards and
authorizations to make Purchases may be granted; (ii) determine the time
or times at which Options or Awards shall be granted or Purchases made;
(iii) determine the purchase price of shares subject to each Option or
Purchase, which prices shall not be less than the minimum price specified
in paragraph 6; (iv) determine whether each Option granted shall be an
ISO or a Non-Qualified Option; (v) determine (subject to paragraph 7) the
time or times when each Option shall become exercisable and the duration
of the exercise period; (vi) extend the period during which outstanding
Options may be exercised; (vii) determine whether restrictions such as
repurchase options are to be imposed on shares subject to Options, Awards
and Purchases and the nature of such restrictions, if any, and (viii)
interpret the Plan and prescribe and rescind rules and regulations
relating to it. If the Committee determines to issue a Non-Qualified
Option, it shall take whatever actions it deems necessary, under Section
422 of the Code and the regulations promulgated thereunder, to ensure
that such Option is not treated as an ISO. The interpretation and
construction by the Committee of any provisions of the Plan or of any
Stock Right granted under it shall be final unless otherwise determined
by the Board. The Committee may from time to time adopt such rules and
regulations for carrying out the Plan as it may deem advisable. No member
of the Board or the Committee shall be liable for any action or
determination made in good faith with respect to the Plan or any Stock
Right granted under it.
B. Committee Actions. The Committee may select one of its members as
its chairman, and shall hold meetings at such time and places as it may
determine. A majority of the Committee shall constitute a quorum and acts
of a majority of the members of the Committee at a meeting at which a
quorum is present,
<PAGE>
or acts reduced to or approved in writing by all the members of the
Committee (if consistent with applicable state law), shall be the valid
acts of the Committee. From time to time the Board may increase the size
of the Committee and appoint additional members thereof, remove members
(with or without cause) and appoint new members in substitution therefor,
fill vacancies however caused, or remove all members of the Committee and
thereafter directly administer the Plan.
C. Grant of Stock Rights to Board Members. Subject to the provisions
of the first sentence of paragraph 2(A) above, if applicable, Stock
Rights may be granted to members of the Board. All grants of Stock Rights
to members of the Board shall in all other respects be made in accordance
with the provisions of this Plan applicable to other eligible persons.
Consistent with the provisions of the first sentence of Paragraph 2(A)
above, members of the Board who either (i) are eligible to receive grants
of Stock Rights pursuant to the Plan or (ii) have been granted Stock
Rights may vote on any matters affecting the administration of the Plan
or the grant of any Stock Rights pursuant to the Plan, except that no
such member shall act upon the granting to himself or herself of Stock
Rights, but any such member may be counted in determining the existence
of a quorum at any meeting of the Board during which action is taken with
respect to the granting to such member of Stock Rights.
3. Eligible Employees and Others. ISOs may be granted only to employees of
the Company or any Related Corporation. Non-Qualified Options, Awards and
authorizations to make Purchases may be granted to any employee, officer or
director (whether or not also an employee) or consultant of the Company or any
Related Corporation. The Committee may take into consideration a recipient's
individual circumstances in determining whether to grant a Stock Right. The
granting of any Stock Right to any individual or entity shall neither entitle
that individual or entity to, nor disqualify such individual or entity from,
participation in any other grant of Stock Rights.
4. Stock. The stock subject to Stock Rights shall be authorized but unissued
shares of Common Stock of the Company, par value $.01 per share (the "Common
Stock"), or shares of Common Stock reacquired by the Company in any manner. The
aggregate number of shares which may be issued pursuant to the Plan is
1,160,000, subject to adjustment as provided in paragraph 13. If any Stock Right
granted under the Plan shall expire or terminate for any reason without having
been exercised in full or shall cease for any reason to be exercisable in whole
or in part or shall be repurchased by the Company, the shares of Common Stock
subject to such Stock Right shall again be available for grants of Stock Rights
under the Plan.
No employee of the Company or any Related Corporation may be granted Options
to acquire, in the aggregate, more than 448,000 of shares of Common Stock under
the Plan. If any Option granted under the Plan shall expire or terminate for any
reason without having been exercised in full or shall cease for any reason to be
exercisable in whole or in part or shall be repurchased by the Company, the
shares subject to such Option shall be included in the determination of the
aggregate number of shares of Common Stock deemed to have been granted to such
employee under the Plan.
5. Granting of Stock Rights. Stock Rights may be granted under the Plan at
any time on or after August 15, 1995 and prior to August 1, 2005. The date of
grant of a Stock Right under the Plan will be the date specified by the
Committee at the time it grants the Stock Right; provided, however, that such
date shall not be prior to the date on which the Committee acts to approve the
grant. Options granted under the Plan are intended to qualify as
performance-based compensation to the extent required under Proposed Treasury
Regulation Section 1.162-27.
6. Minimum Option Price; ISO Limitations.
A. Price for Non-Qualified Options, Awards and Purchases. The exercise
price per share specified in the agreement relating to each Non-Qualified
Option granted, and the purchase price per share of stock granted in any
Award or authorized as a Purchase, under the Plan shall in no event be
less than
2
<PAGE>
the minimum legal consideration required therefor under the laws of any
jurisdiction in which the Company or its successors in interest may be
organized.
B. Price for ISOs. The exercise price per share specified in the
agreement relating to each ISO granted under the Plan shall not be less
than the fair market value per share of Common Stock on the date of such
grant. In the case of an ISO to be granted to an employee owning stock
possessing more than ten percent (10%) of the total combined voting power
of all classes of stock of the Company or any Related Corporation, the
price per share specified in the agreement relating to such ISO shall not
be less than one hundred ten percent (110%) of the fair market value per
share of Common Stock on the date of grant. For purposes of determining
stock ownership under this paragraph, the rules of Section 424(d) of the
Code shall apply.
C. $100,000 Annual Limitation on ISO Vesting. Each eligible employee
may be granted Options treated as ISOs only to the extent that, in the
aggregate under this Plan and all incentive stock option plans of the
Company and any Related Corporation, ISOs do not become exercisable for
the first time by such employee during any calendar year with respect to
stock having a fair market value (determined at the time the ISOs were
granted) in excess of $100,000. The Company intends to designate any
Options granted in excess of such limitation as Non-Qualified Options.
D. Determination of Fair Market Value. If, at the time an Option is
granted under the Plan, the Company's Common Stock is publicly traded,
"fair market value" shall be determined as of the date of grant or, if
the prices or quotes discussed in this sentence are unavailable for such
date, the last business day for which such prices or quotes are available
prior to the date of grant and shall mean (i) the average (on that date)
of the high and low prices of the Common Stock on the principal national
securities exchange on which the Common Stock is traded, if the Common
Stock is then traded on a national securities exchange; or (ii) the last
reported sale price (on that date) of the Common Stock on the Nasdaq
National Market, if the Common Stock is not then traded on a national
securities exchange; or (iii) the closing bid price (or average of bid
prices) last quoted (on that date) by an established quotation service
for over-the-counter securities, if the Common Stock is not reported on
the Nasdaq National Market. If the Common Stock is not publicly traded at
the time an Option is granted under the Plan, "fair market value" shall
mean the fair value of the Common Stock as determined by the Committee
after taking into consideration all factors which it deems appropriate,
including, without limitation, recent sale and offer prices of the Common
Stock in private transactions negotiated at arm's length.
7. Option Duration. Subject to earlier termination as provided in paragraphs
9 and 10 or in the agreement relating to such Option, each Option shall expire
on the date specified by the Committee, but not more than (i) ten years from the
date of grant in the case of Options generally and (ii) five years from the date
of grant in the case of ISOs granted to an employee owning stock possessing more
than ten percent (10%) of the total combined voting power of all classes of
stock of the Company or any Related Corporation, as determined under paragraph
6(B). Subject to earlier termination as provided in paragraphs 9 and 10, the
term of each ISO shall be the term set forth in the original instrument granting
such ISO, except with respect to any part of such ISO that is converted into a
Non-Qualified Option pursuant to paragraph 16.
8. Exercise of Option. Subject to the provisions of paragraphs 9 through 12,
each Option granted under the Plan shall be exercisable as follows:
A. Vesting. The Option shall either be fully exercisable on the date
of grant or shall become exercisable thereafter in such installments as
the Committee may specify.
B. Full Vesting of Installments. Once an installment becomes
exercisable it shall remain exercisable until expiration or termination
of the Option, unless otherwise specified by the Committee.
3
<PAGE>
C. Partial Exercise. Each Option or installment may be exercised at
any time or from time to time, in whole or in part, for up to the total
number of shares with respect to which it is then exercisable.
D. Acceleration of Vesting. The Committee shall have the right to
accelerate the date that any installment of any Option becomes
exercisable; provided that the Committee shall not, without the consent
of an optionee, accelerate the permitted exercise date of any installment
of any Option granted to any employee as an ISO (and not previously
converted into a Non-Qualified Option pursuant to paragraph 16) if such
acceleration would violate the annual vesting limitation contained in
Section 422(d) of the Code, as described in paragraph 6(C).
9. Termination of Employment. Unless otherwise specified in the agreement
relating to such ISO, if an ISO optionee ceases to be employed by the Company
and all Related Corporations other than by reason of death or disability as
defined in paragraph 10, no further installments of his or her ISOs shall become
exercisable, and his or her ISOs shall terminate on the earlier of (a) thirty
(30) days after the date of termination of his or her employment, or (b) their
specified expiration dates, except to the extent that such ISOs (or unexercised
installments thereof) have been converted into Non-Qualified Options pursuant to
paragraph 16. For purposes of this paragraph 9, employment shall be considered
as continuing uninterrupted during any bona fide leave of absence (such as those
attributable to illness, military obligations or governmental service) provided
that the period of such leave does not exceed 90 days or, if longer, any period
during which such optionee's right to reemployment is guaranteed by statute. A
bona fide leave of absence with the written approval of the Committee shall not
be considered an interruption of employment under this paragraph 9, provided
that such written approval contractually obligates the Company or any Related
Corporation to continue the employment of the optionee after the approved period
of absence. ISOs granted under the Plan shall not be affected by any change of
employment within or among the Company and Related Corporations, so long as the
optionee continues to be an employee of the Company or any Related Corporation.
Nothing in the Plan shall be deemed to give any grantee of any Stock Right the
right to be retained in employment or other service by the Company or any
Related Corporation for any period of time.
10. Death; Disability.
A. Death. If an ISO optionee ceases to be employed by the Company and
all Related Corporations by reason of his or her death, any ISO owned by
such optionee may be exercised, to the extent otherwise exercisable on
the date of death, by the estate, personal representative or beneficiary
who has acquired the ISO by will or by the laws of descent and
distribution, until the earlier of (i) the specified expiration date of
the ISO or (ii) one year from the date of the optionee's death.
B. Disability. If an ISO optionee ceases to be employed by the Company
and all Related Corporations by reason of his or her disability, such
optionee shall have the right to exercise any ISO held by him or her on
the date of termination of employment, for the number of shares for which
he or she could have exercised it on that date, until the earlier of (i)
the specified expiration date of the ISO or (ii) one year from the date
of the termination of the optionee's employment. For the purposes of the
plan, the term "disability" shall mean "permanent and total disability"
as defined in Section 22(e)(3) of the Code or any successor statute.
11. Assignability. No Stock Right shall be assignable or transferable by the
grantee except by will, by the laws of descent and distribution or, in the case
of Non-Qualified Options only, pursuant to a valid domestic relations order.
Except as set forth in the previous sentence, during the lifetime of a grantee
each Stock Right shall be exercisable only by such grantee.
12. Terms and Conditions of Options. Options shall be evidenced by
instruments (which need not be identical) in such forms as the Committee may
from time to time approve. Such instruments shall conform to the terms and
conditions set forth in paragraphs 6 through 11 hereof and may contain such
other provisions as the
4
<PAGE>
Committee deems advisable which are not inconsistent with the Plan, including
restrictions applicable to shares of Common Stock issuable upon exercise of
Options. The Committee may specify that any Non-Qualified Option shall be
subject to the restrictions set forth herein with respect to ISOs, or to such
other termination and cancellation provisions as the Committee may determine.
The Committee may from time to time confer authority and responsibility on
one or more of its own members and/or one or more officers of the Company to
execute and deliver such instruments. The proper officers of the Company are
authorized and directed to take any and all action necessary or advisable
from time to time to carry out the terms of such instruments.
13. Adjustments. Upon the occurrence of any of the following events, an
optionee's rights with respect to Options granted to such optionee hereunder
shall be adjusted as hereinafter provided, unless otherwise specifically
provided in the written agreement between the optionee and the Company relating
to such Option:
A. Stock Dividends and Stock Splits. If the shares of Common Stock
shall be subdivided or combined into a greater or smaller number of
shares or if the Company shall issue any shares of Common Stock as a
stock dividend on its outstanding Common Stock, the number of shares of
Common Stock deliverable upon the exercise of Options shall be
appropriately increased or decreased proportionately, and appropriate
adjustments shall be made in the purchase price per share to reflect such
subdivision, combination or stock dividend.
B. Consolidations or Mergers. If the Company is to be consolidated
with or acquired by another entity in a merger, sale of all or
substantially all of the Company's assets or otherwise (an
"Acquisition"), the Committee or the board of directors of any entity
assuming the obligations of the Company hereunder (the "Successor
Board"), shall, as to outstanding Options, either (i) make appropriate
provision for the continuation of such Options by substituting on an
equitable basis for the shares then subject to such Options either (a)
the consideration payable with respect to the outstanding shares of
Common Stock in connection with the Acquisition, (b) shares of stock of
the surviving corporation or (c) such other securities as the Successor
Board deems appropriate, the fair market value of which shall not
materially exceed the fair market value of the shares of Common Stock
subject to such Options immediately preceding the Acquisition; or (ii)
upon written notice to the optionees, provide that all Options must be
exercised, to the extent then exercisable, within a specified number of
days of the date of such notice, at the end of which period the Options
shall terminate; or (iii) terminate all Options in exchange for a cash
payment equal to the excess of the fair market value of the shares
subject to such Options (to the extent then exercisable) over the
exercise price thereof.
C. Recapitalization or Reorganization. In the event of a
recapitalization or reorganization of the Company (other than a
transaction described in subparagraph B above) pursuant to which
securities of the Company or of another corporation are issued with
respect to the outstanding shares of Common Stock, an optionee upon
exercising an Option shall be entitled to receive for the purchase price
paid upon such exercise the securities he or she would have received if
he or she had exercised such Option prior to such recapitalization or
reorganization.
D. Modification of ISOs. Notwithstanding the foregoing, any
adjustments made pursuant to subparagraphs A, B or C with respect to ISOs
shall be made only after the Committee, after consulting with counsel for
the Company, determines whether such adjustments would constitute a
"modification" of such ISOs (as that term is defined in Section 424 of
the Code) or would cause any adverse tax consequences for the holders of
such ISOs. If the Committee determines that such adjustments made with
respect to ISOs would constitute a modification of such ISOs or would
cause adverse tax consequences to the holders, it may refrain from making
such adjustments.
E. Dissolution or Liquidation. In the event of the proposed
dissolution or liquidation of the Company, each Option will terminate
immediately prior to the consummation of such proposed action or at such
other time and subject to such other conditions as shall be determined by
the Committee.
5
<PAGE>
F. Issuances of Securities. Except as expressly provided herein, no
issuance by the Company of shares of stock of any class, or securities
convertible into shares of stock of any class, shall affect, and no
adjustment by reason thereof shall be made with respect to, the number or
price of shares subject to Options. No adjustments shall be made for
dividends paid in cash or in property other than securities of the
Company.
G. Fractional Shares. No fractional shares shall be issued under the
Plan and the optionee shall receive from the Company cash in lieu of such
fractional shares.
H. Adjustments. Upon the happening of any of the events described in
subparagraphs A, B or C above, the class and aggregate number of shares
set forth in paragraph 4 hereof that are subject to Stock Rights which
previously have been or subsequently may be granted under the Plan shall
also be appropriately adjusted to reflect the events described in such
subparagraphs. The Committee or the Successor Board shall determine the
specific adjustments to be made under this paragraph 13 and, subject to
paragraph 2, its determination shall be conclusive.
14. Means of Exercising Options. An Option (or any part or installment
thereof) shall be exercised by giving written notice to the Company at its
principal office address, or to such transfer agent as the Company shall
designate. Such notice shall identify the Option being exercised and specify the
number of shares as to which such Option is being exercised, accompanied by full
payment of the purchase price therefor either (a) in United States dollars in
cash or by check, (b) at the discretion of the Committee, through delivery of
shares of Common Stock having a fair market value equal as of the date of the
exercise to the cash exercise price of the Option, (c) at the discretion of the
Committee, by delivery of the grantee's personal recourse note bearing interest
payable not less than annually at no less than 100% of the lowest applicable
Federal rate, as defined in Section 1274(d) of the Code, (d) at the discretion
of the Committee and consistent with applicable law, through the delivery of an
assignment to the Company of a sufficient amount of the proceeds from the sale
of the Common Stock acquired upon exercise of the Option and an authorization to
the broker or selling agent to pay that amount to the Company, which sale shall
be at the participant's direction at the time of exercise, or (e) at the
discretion of the Committee, by any combination of (a), (b), (c) and (d) above.
If the Committee exercises its discretion to permit payment of the exercise
price of an ISO by means of the methods set forth in clauses (b), (c), (d) or
(e) of the preceding sentence, such discretion shall be exercised in writing at
the time of the grant of the ISO in question. The holder of an Option shall not
have the rights of a shareholder with respect to the shares covered by such
Option until the date of issuance of a stock certificate to such holder for such
shares. Except as expressly provided above in paragraph 13 with respect to
changes in capitalization and stock dividends, no adjustment shall be made for
dividends or similar rights for which the record date is before the date such
stock certificate is issued.
15. Term and Amendment of Plan. This Plan was adopted by the Board on August
15, 1995, subject, with respect to the validation of ISOs granted under the
Plan, to approval of the Plan by the stockholders of the Company at the next
Meeting of Stockholders or, in lieu thereof, by written consent. If the approval
of stockholders is not obtained prior to August 15, 1996, any grants of ISOs
under the Plan made prior to that date will be rescinded. The Plan shall expire
at the end of the day on August 1, 2005 (except as to Options outstanding on
that date). Subject to the provisions of paragraph 5 above, Options may be
granted under the Plan prior to the date of stockholder approval of the Plan.
The Board may terminate or amend the Plan in any respect at any time, except
that, without the approval of the stockholders obtained within 12 months before
or after the Board adopts a resolution authorizing any of the following actions:
(a) the total number of shares that may be issued under the Plan may not be
increased (except by adjustment pursuant to paragraph 13); (b) the benefits
accruing to participants under the Plan may not be materially increased; (c) the
requirements as to eligibility for participation in the Plan may not be
materially modified; (d) the provisions of paragraph 3 regarding eligibility for
grants of ISOs may not be modified; (e) the provisions of paragraph 6(B)
regarding the exercise price at which shares may be offered pursuant to ISOs may
not be modified (except by adjustment pursuant to paragraph 13); (f) the
expiration date of the Plan may not be extended; and (g) the Board may not take
any action which would cause the Plan to fail to comply with Rule 16b-3. Except
as otherwise provided in this paragraph 15, in no event may action of the Board
or stockholders alter or impair the rights of a grantee, without such grantee's
consent, under any Option previously granted to such grantee.
6
<PAGE>
16. Conversion of ISOs into Non-Qualified Options. The Committee, at the
written request or with the written consent of any optionee, may in its
discretion take such actions as may be necessary to convert such optionee's ISOs
(or any installments or portions of installments thereof) that have not been
exercised on the date of conversion into Non-Qualified Options at any time prior
to the expiration of such ISOs, regardless of whether the optionee is an
employee of the Company or a Related Corporation at the time of such conversion.
Such actions may include, but shall not be limited to, extending the exercise
period or reducing the exercise price of the appropriate installments of such
ISOs. At the time of such conversion, the Committee (with the consent of the
optionee) may impose such conditions on the exercise of the resulting
Non-Qualified Options as the Committee in its discretion may determine, provided
that such conditions shall not be inconsistent with this Plan. Nothing in the
Plan shall be deemed to give any optionee the right to have such optionee's ISOs
converted into Non-Qualified Options, and no such conversion shall occur until
and unless the Committee takes appropriate action.
17. Application Of Funds. The proceeds received by the Company from the sale
of shares pursuant to Options granted and Purchases authorized under the Plan
shall be used for general corporate purposes.
18. Notice to Company of Disqualifying Disposition. By accepting an ISO
granted under the Plan, each optionee agrees to notify the Company in writing
immediately after such optionee makes a Disqualifying Disposition (as described
in Sections 421, 422 and 424 of the Code and regulations thereunder) of any
stock acquired pursuant to the exercise of ISOs granted under the Plan. A
Disqualifying Disposition is generally any disposition occurring on or before
the later of (a) the date two years following the date the ISO was granted or
(b) the date one year following the date the ISO was exercised.
19. Withholding of Additional Income Taxes. Upon the exercise of a
Non-Qualified Option, the grant of an Award, the making of a Purchase of Common
Stock for less than its fair market value, the making of a Disqualifying
Disposition (as defined in paragraph 18), the vesting or transfer of restricted
stock or securities acquired on the exercise of an Option hereunder, or the
making of a distribution or other payment with respect to such stock or
securities, the Company may withhold taxes in respect of amounts that constitute
compensation includible in gross income. The Committee in its discretion may
condition (i) the exercise of an Option, (ii) the grant of an Award, (iii) the
making of a Purchase of Common Stock for less than its fair market value, or
(iv) the vesting or transferability of restricted stock or securities acquired
by exercising an Option, on the grantee's making satisfactory arrangement for
such withholding. Such arrangement may include payment by the grantee in cash or
by check of the amount of the withholding taxes or, at the discretion of the
Committee, by the grantee's delivery of previously held shares of Common Stock
or the withholding from the shares of Common Stock otherwise deliverable upon
exercise of a Option shares having an aggregate fair market value equal to the
amount of such withholding taxes.
20. Governmental Regulation. The Company's obligation to sell and deliver
shares of the Common Stock under this Plan is subject to the approval of any
governmental authority required in connection with the authorization, issuance
or sale of such shares.
Government regulations may impose reporting or other obligations on the
Company with respect to the Plan. For example, the Company may be required to
send tax information statements to employees and former employees that exercise
ISOs under the Plan, and the Company may be required to file tax information
returns reporting the income received by grantees of Options in connection with
the Plan.
21. Governing Law. The validity and construction of the Plan and the
instruments evidencing Options shall be governed by the laws of the Commonwealth
of Massachusetts, or the laws of any jurisdiction in which the Company or its
successors in interest may be organized.
7
<PAGE>
Exhibit 21.1
Subsidiaries of the Company
All subsidiaries do business under the respective names listed below.
1. Investors Capital Trust I
Delaware Trust
2. Investors Bank & Trust Company
Massachusetts chartered trust company
3. Investors Safe Deposit Corp.
Massachusetts corporation
4. IBT Trust Company (Cayman) Ltd.
incorporated in the Cayman Islands
5. Investors Securities Corporation
Massachusetts securities corporation
6. IBT Fund Services (Canada) Inc.
incorporated in Canada
7. Investors Trust Holdings Ireland
organized in the Republic of Ireland
8. Investors Financial Services (Ireland) Ltd.
organized in the Republic of Ireland
9. Investors Trust & Custodial Services (Ireland) Ltd.
organized in the Republic of Ireland
10. Investors Fund Services (Ireland) Ltd.
organized in the Republic of Ireland
<PAGE>
Exhibit 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement Nos.
333-3440 and 333-43353 of Investors Financial Services Corp. on Form S-8 of
our report dated February 13, 1998 appearing in this Annual Report on Form
10-K of Investors Financial Services Corp. for the year ended December 31,
1997.
DELOITTE & TOUCHE LLP
February 13, 1998
Boston, Massachusetts
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24,161,104
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