<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly period ended March 31, 1999
or
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition period from _____ to _____
Commission File Number 0-26996
INVESTORS FINANCIAL SERVICES CORP.
(Exact name of registrant as specified in its charter)
DELAWARE 04-3279817
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
200 CLARENDON STREET, P.O. BOX 9130, BOSTON, MA 02117-9130
(Address of principal executive offices, including Zip Code)
(617) 330-6700
(Registrant's telephone number, including area code)
----------------------------
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days.
YES X NO
----- -----
As of April 30, 1999, there were 14,504,617 shares of Common Stock
outstanding.
<PAGE>
INVESTORS FINANCIAL SERVICES CORP.
INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets
March 31, 1999 (unaudited) and December 31, 1998 (audited) 4
Condensed Consolidated Statements of Income and Comprehensive
Income (unaudited)
Three months ended March 31, 1999 and 1998 5
Condensed Consolidated Statement of Stockholder's Equity (unaudited)
Three months ended March 31, 1999 6
Condensed Consolidated Statements of Cash Flows (unaudited)
Three months ended March 31, 1999 and 1998 7
Notes to Condensed Consolidated Financial Statements 9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION 17
AND RESULTS OF OPERATIONS
PART II OTHER INFORMATION 31
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS 31
ITEM 6. EXHIBITS AND REPORTS ON FORM 8K 31
SIGNATURES 31
</TABLE>
2
<PAGE>
PART I: FINANCIAL INFORMATION
ITEM 1: CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
[REMAINDER OF PAGE INTENTIONALLY LEFT BLANK]
3
<PAGE>
INVESTORS FINANCIAL SERVICES CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS
MARCH 31, 1999 AND DECEMBER 31, 1998
<TABLE>
<CAPTION>
ASSETS MARCH 31, DECEMBER 31,
1999 1998
-------------------- ------------------
(unaudited)
<S> <C> <C>
Cash and due from banks $ 26,210,584 $ 18,775,240
Federal funds sold and securities purchased under resale agreements 70,000,000 -
Securities held to maturity (approximate fair value of
$1,072,355,198 and $948,645,106 at March 31, 1999
and December 31, 1998, respectively) 1,070,519,319 942,816,546
Securities available for sale 372,813,416 345,069,507
Non-marketable equity securities 7,626,500 7,626,500
Loans, less allowance for loan losses of $100,000
at March 31, 1999 and December 31, 1998 65,232,102 54,291,985
Accrued interest and fees receivable 32,501,214 28,666,818
Equipment and leasehold improvements, net 10,735,675 10,832,688
Goodwill, net 43,416,309 43,767,163
Other assets 15,709,916 13,661,094
-------------------- ------------------
TOTAL ASSETS $1,714,765,035 $1,465,507,541
-------------------- ------------------
-------------------- ------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits:
Demand $ 213,466,758 $ 173,207,097
Savings 758,354,864 667,097,468
Time 65,000,000 65,000,000
-------------------- ------------------
Total deposits 1,036,821,622 905,304,565
Securities sold under repurchase agreements 516,184,166 434,168,072
Short-term borrowings 137,069 -
Other liabilities 17,649,656 13,562,592
-------------------- ------------------
Total liabilities 1,570,792,513 1,353,035,229
-------------------- ------------------
Commitments and contingencies (Note 8)
Company-obligated, mandatorily redeemable, preferred securities of subsidiary
trust holding solely junior subordinated deferrable interest debentures of the
Company 24,196,485 24,189,409
-------------------- ------------------
STOCKHOLDERS' EQUITY:
Preferred stock, par value $0.01 (shares authorized: 1,000,000; issued and
outstanding: 0 at 3/31/99 and 12/31/98) - -
Common stock, par value $0.01 (shares authorized: 20,000,000; issued and
outstanding 14,495,946 at 3/31/99 and 6,722,050 at 12/31/98) 145,040 67,261
Surplus 83,937,358 57,705,468
Deferred compensation (1,071,098) (1,198,604)
Retained earnings 37,783,460 33,483,703
Accumulated other comprehensive loss, net (1,018,683) (1,774,885)
Treasury stock, par value $0.01 (shares authorized and issued:
4,000 at 3/31/99 and 4,000 at 12/31/98) (40) (40)
-------------------- ------------------
Total stockholders' equity 119,776,037 88,282,903
-------------------- ------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,714,765,035 $ 1,465,507,541
-------------------- ------------------
-------------------- ------------------
</TABLE>
See notes to condensed consolidated financial statements.
4
<PAGE>
INVESTORS FINANCIAL SERVICES CORP.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 1999 AND 1998
<TABLE>
<CAPTION>
MARCH 31, MARCH 31,
1999 1998
<S> <C> <C>
OPERATING REVENUE:
Interest income:
Federal funds sold and securities purchased
under resale agreements $ 673,052 $ 348,559
Investment securities held to maturity and available for sale 18,747,987 19,963,021
Loans 789,029 668,706
------------ ------------
Total interest income 20,210,068 20,980,286
Interest expense:
Deposits 9,337,263 5,651,354
Short-term borrowings 3,722,448 8,204,808
------------ ------------
Total interest expense 13,059,711 13,856,162
------------ ------------
Net interest income 7,150,357 7,124,124
Non-interest income:
Asset administration fees 31,380,218 21,687,594
Computer service fees 123,283 133,985
Other operating income 129,624 190,586
Gain on sale of securities available for sale -- 200,427
------------ ------------
Net operating revenue 38,783,482 29,336,716
OPERATING EXPENSES:
Compensation and benefits 18,897,304 14,667,218
Technology and telecommunications 3,620,042 2,606,339
Transaction processing services 2,180,414 2,030,977
Occupancy 1,960,403 1,686,907
Depreciation and amortization 878,651 600,707
Amortization of goodwill 443,955 --
Travel and sales promotion 506,878 416,784
Professional fees 645,083 266,636
Insurance 189,147 193,418
Other operating expenses 1,604,991 1,208,121
------------ ------------
Total operating expenses 30,926,868 23,677,107
------------ ------------
INCOME BEFORE INCOME TAXES AND MINORITY INTEREST 7,856,614 5,659,609
Provision for income taxes 2,828,381 2,057,148
Minority interest expense, net of income taxes 390,800 390,800
NET INCOME 4,637,433 3,211,661
Other comprehensive income, net of tax:
Unrealized gain/(loss) on securities:
Unrealized holding gains/(losses) arising during the period 756,202 (493,657)
Less: reclassification adjustment for gains/(losses) included in net
income -- 272,581
------------ ------------
Other comprehensive income/(loss) 756,202 (221,076)
COMPREHENSIVE INCOME $ 5,393,635 $ 2,990,585
------------ ------------
------------ ------------
BASIC EARNINGS PER SHARE $ 0.34 $ 0.24
------------ ------------
------------ ------------
DILUTED EARNINGS PER SHARE $ 0.33 $ 0.23
------------ ------------
------------ ------------
</TABLE>
See notes to condensed consolidated financial statements.
5
<PAGE>
INVESTORS FINANCIAL SERVICES CORP.
CONDENSED STATEMENT OF STOCKHOLDERS' EQUITY (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 1999
<TABLE>
<CAPTION>
COMMON DEFERRED RETAINED
STOCK SURPLUS COMPENSATION EARNINGS
---------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1998 $ 67,261 $57,705,468 $(1,198,604) $33,483,703
Amortization of deferred compensation -- -- 127,506 --
Stock dividend, two-for-one split 68,020 -- -- (68,020)
Exercise of stock options 759 140,890 -- --
Common stock issuance 9,000 26,091,000 -- --
Net income -- -- -- 4,637,433
Cash dividend -- -- -- (269,656)
Change in accumulated other comprehensive
income/(loss), net -- -- -- --
---------- ------------- ------------- -------------
BALANCE, MARCH 31, 1999 $145,040 $83,937,358 $(1,071,098) $37,783,460
---------- ------------- ------------- -------------
---------- ------------- ------------- -------------
<CAPTION>
ACCUMULATED
OTHER
COMPREHENSIVE TREASURY
INCOME(LOSS) STOCK TOTAL
------------- --------- --------------
<S> <C> <C> <C>
BALANCE, DECEMBER 31, 1998 $(1,774,885) $(40) $ 88,282,903
Amortization of deferred compensation -- -- 127,506
Stock dividend, two-for-one split -- -- --
Exercise of stock options -- -- 141,649
Common stock issuance -- -- 26,100,000
Net income -- -- 4,637,433
Cash dividend -- -- (269,656)
Change in accumulated other comprehensive
income/(loss), net 756,202 -- 756,202
------------- --------- --------------
BALANCE, MARCH 31, 1999 $(1,018,683) $(40) $119,776,037
------------- --------- --------------
------------- --------- --------------
</TABLE>
See notes to condensed consolidated financial statements.
6
<PAGE>
INVESTORS FINANCIAL SERVICES CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 1999 AND 1998
<TABLE>
<CAPTION>
MARCH 31, MARCH 31,
1999 1998
------------- -------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 4,637,433 $ 3,211,661
------------- -------------
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 1,322,606 600,707
Amortization of deferred compensation 127,506 184,319
Amortization of premiums on securities, net of accretion of discounts 1,782,885 1,745,984
Deferred income taxes 722,927 -
Loss on sale of securities available for sale - (200,427)
Changes in assets and liabilities:
Accrued interest and fees receivable (3,834,396) (781,750)
Other assets (3,290,214) 531,264
Other liabilities 4,087,064 1,319,000
------------- -------------
Total adjustments 918,378 3,399,097
------------- -------------
Net cash provided by operating activities 5,555,811 6,610,758
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities of securities available for sale 30,041,426 45,320,888
Proceeds from maturities of securities held to maturity 103,028,090 63,343,813
Proceeds from sales of securities available for sale - 42,609,303
Purchases of securities available for sale (57,512,187) (88,335,184)
Purchases of securities held to maturity (231,605,331) (152,556,486)
Purchase of non-marketable equity securities - (2,149,900)
Net decrease/(increase) in federal funds sold and securities
purchased under resale agreements (70,000,000) 25,000,000
Net increase in loans (10,940,117) (22,284,580)
Purchases of equipment and leasehold improvements (774,561) (1,350,562)
------------- -------------
Net cash used for investing activities (237,762,680) (90,402,708)
------------- -------------
</TABLE>
7
<PAGE>
INVESTORS FINANCIAL SERVICES CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 1999 AND 1998 (CONTINUED)
<TABLE>
<CAPTION>
MARCH 31, MARCH 31,
1999 1998
--------------- ----------------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in demand deposits $ 40,259,661 $ 7,176,928
Net increase/(decrease) in time and savings deposits 91,257,395 (53,264,168)
Net increase in short-term borrowings 82,153,164 182,472,805
Proceeds from exercise of stock options 141,649 251,096
Proceeds from issuance of common stock 26,100,000 -
Purchase of treasury stock - (77,000)
Cash dividends to shareholders (269,656) (194,124)
--------------- ----------------
Net cash provided by financing activities 239,642,213 136,365,537
--------------- ----------------
NET INCREASE IN CASH AND DUE FROM BANKS 7,435,344 52,573,587
--------------- ----------------
CASH AND DUE FROM BANKS, BEGINNING OF PERIOD 18,775,240 17,298,566
--------------- ----------------
CASH AND DUE FROM BANKS, END OF PERIOD $ 26,210,584 $ 69,872,153
--------------- ----------------
--------------- ----------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 12,603,000 $ 13,735,000
--------------- ----------------
--------------- ----------------
Cash paid for income taxes $ 1,410,000 $ 746,000
--------------- ----------------
--------------- ----------------
</TABLE>
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
On May 29, 1998, the Company purchased all of the outstanding capital stock of
AMT Capital Services, Inc., in exchange for 388,012 shares of the Company's
common stock. During 1998, AMT Capital Services, Inc., distributed a noncash
dividend of $55,366. The acquisition was accounted for using the
pooling-of-interests method of accounting.
See notes to condensed consolidated financial statements.
8
<PAGE>
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION PERTAINING TO THE THREE MONTHS ENDED MARCH 31, 1999 AND 1998 IS
UNAUDITED)
- --------------------------------------------------------------------------------
1. DESCRIPTION OF BUSINESS
Investors Financial Services Corp. (`IFSC') provides asset administration
services for the financial services industry through its wholly owned
subsidiaries, Investors Bank & Trust Company (the `Bank') and Investors
Capital Services, Inc. IFSC 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.
On February 16, 1999, the Board of Directors of the Company declared a
two-for-one stock split in the form of a 100% stock dividend payable March
17, 1999 to stockholders of record on March 1, 1999.
On March 26, 1999, the Company completed the issuance and sale of 900,000
shares of Common Stock at $29 per share in a private placement to one
investor. The net capital raised in the private placement will be used to
support the Company's balance sheet growth.
2. INTERIM FINANCIAL STATEMENTS
The condensed consolidated interim financial statements of the Company and
subsidiaries as of March 31, 1999 and 1998 and for the three-month periods
ended March 31, 1999 and 1998 have been prepared by the Company, without
audit, pursuant to the rules and regulations of the Securities and
Exchange Commission. Certain information and footnote disclosures normally
included in annual financial statements prepared in accordance with
generally accepted accounting principles have been condensed or omitted as
permitted by such rules and regulations. All adjustments, consisting of
normal recurring adjustments, have been included. Management believes that
the disclosures are adequate to present fairly the financial position,
results of operations and cash flows at the dates and for the periods
presented. It is suggested that these interim financial statements be read
in conjunction with the financial statements and the notes thereto
included in the Company's latest annual report on Form 10-K. Results for
interim periods are not necessarily indicative of those to be expected for
the full fiscal year.
Certain amounts from the prior year have been reclassified to conform to
current year presentation.
The AMT Capital Services, Inc., acquisition was accounted for using the
pooling-of-interests method of accounting. All of the prior period
financial statements were restated and filed with the Securities and
Exchange Commission on Form 8-K filed August 19, 1998. Upon completion of
the acquisition, AMT Capital Services became a wholly-owned subsidiary of
the Company and was re-named Investors Capital Services, Inc.
All share numbers in this report have been restated, when applicable, to
reflect the two-for-one stock split paid March 17, 1999.
9
<PAGE>
3. 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 March 31, 1999 or December 31, 1998. In addition, there have been
no loan charge-offs or recoveries during the three months ended March 31,
1999 and 1998. Loans consisted of the following at March 31, 1999 and
December 31, 1998:
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1999 1998
-------------- -------------
<S> <C> <C>
Loans to individuals $ 26,053,189 $ 25,582,978
Loans to not-for-profit institutions 12,500 12,500
Loans to mutual funds 39,266,413 28,796,507
-------------- -------------
65,332,102 54,391,985
Less allowance for loan losses 100,000 100,000
-------------- -------------
Total $ 65,232,102 $ 54,291,985
-------------- -------------
-------------- -------------
</TABLE>
The Company had commitments to lend of approximately $164,245,000 and
$141,399,000 at March 31, 1999 and December 31, 1998, respectively. The
terms of these commitments are similar to the terms of outstanding loans.
4. DEPOSITS
Time deposits at March 31, 1999 and December 31, 1998 include
noninterest-bearing amounts at both dates of approximately $65,000,000.
All time deposits had a minimum balance of $100,000 and a maturity of less
than three months at March 31, 1999 and December 31, 1998.
5. SHORT-TERM BORROWINGS
Short-term borrowings consisted of Treasury, Tax and Loan balances, which
were $137,069 and $0 at March 31, 1999 and December 31, 1998,
respectively. The Company receives federal tax deposits from clients as
agent for the Federal Reserve Bank and accumulates these deposits in the
Treasury, tax and loan account. The Federal Reserve Bank charges the
Company interest at the Federal funds rate on such deposits. The interest
rate on the outstanding balance at March 31, 1999 was 4.63%.
10
<PAGE>
6. STOCKHOLDERS' EQUITY
The Company has authorized 1,000,000 shares of Preferred Stock and
20,000,000 shares of Common Stock, all with a par value of $0.01 per
share.
On February 16, 1999, the Board of Directors approved a two-for-one stock
split in the form of a 100% stock dividend to shareholders of record on
March 1, 1999. The dividend was paid on March 17, 1999. A total of
6,801,973 shares of common stock were issued in connection with the split.
The par value of these additional shares was capitalized by a transfer
from retained earnings to common stock. The stock split did not cause any
change in the $0.01 par value per share of the common stock or in total
stockholders equity. Prior period share and per share amounts have been
restated for the stock split.
The Company has three stock option plans: the Amended and Restated 1995
Stock Plan, the Amended and Restated 1995 Non-Employee Director Stock
Option Plan, and the 1997 Employee Stock Purchase Plan.
Under the terms of the Amended and Restated 1995 Stock Plan, the Company
may grant options to purchase up to a maximum of 2,320,000 shares of
Common Stock to certain employees, consultants, directors and officers.
The options may be awarded as incentive stock options (employees only),
non-qualified stock options, stock awards or opportunities to make direct
purchases of stock. Of the 2,320,000 shares of Common Stock authorized for
issuance under the plan, 717,288 were available for grant at March 31,
1999.
Under the terms of the Amended and Restated 1995 Non-Employee Director
Stock Option Plan, the Company may grant options to non-employee directors
to purchase up to a maximum of 200,000 shares of Common Stock. Options to
purchase 5,000 shares of Common Stock were awarded on November 8, 1995 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
Amended and Restated 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 Amended and Restated 1995
Non-Employee Director Stock Option Plan and the incentive options under
the Amended and Restated 1995 Stock Plan may not be less than the fair
market value at the date of the grant. The exercise price of the
non-qualified options from the Amended and Restated 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 228,000 of shares of Common Stock to
certain officers of the Company under the 1995 Stock Plan. Of these
grants, 210,000 shares vest in sixty equal monthly installments, and the
remainder vests 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. On March
31, 1998, the Company repurchased 4,000 unvested shares for $77,000 under
the terms of the Amended and Restated 1995 Stock Plan. On May 29, 1998,
the Company granted 20,000 shares of Common Stock to an officer of
Investors Capital Services, Inc. The Company has recorded deferred
compensation of $1,071,098 and $1,198,604 at March 31, 1999 and December
31, 1998 respectively, pursuant to these grants.
11
<PAGE>
6. STOCKHOLDERS' EQUITY (CONTINUED)
Under the terms of the 1997 Employee Stock Purchase Plan, the Company may
issue up to 280,000 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. The 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 the Amended and Restated 1995
Non-Employee Director Stock Option Plan and the Amended and Restated
1995 Stock Plans is as follows:
<TABLE>
<CAPTION>
NUMBER OF WEIGHTED-AVERAGE
SHARES EXERCISE PRICE
<S> <C> <C>
Outstanding at December 31, 1998 1,405,622 $21
Granted 98,876 30
Exercised (236,682) 30
Canceled (8,876) 20
--------------
Outstanding at March 31, 1999 1,258,940 $31
--------------
--------------
Outstanding and exercisable at March 31, 1999 415,022
--------------
--------------
<CAPTION>
NUMBER OF WEIGHTED-AVERAGE
SHARES EXERCISE PRICE
<S> <C> <C>
Outstanding at December 31, 1997 1,034,568 $30
Granted 11,200 45
Exercised (29,562) 17
Canceled (14,086) 20
--------------
Outstanding at March 31, 1998 1,002,120 $29
--------------
--------------
Outstanding and exercisable at March 31, 1998 318,276
--------------
--------------
</TABLE>
A summary of the 1997 Employee Stock Purchase Plan is as follows:
<TABLE>
<CAPTION>
1999 1998
--------------- ---------------
SHARES SHARES
--------------- ---------------
<S> <C> <C>
Total shares available under the Plan, beginning of period 216,802 257,504
Issued at June 30 - (20,732)
Issued at December 31 - (19,970)
--------------- ---------------
--------------- ---------------
Total shares available under the Plan, end of period 216,802 216,802
--------------- ---------------
--------------- ---------------
</TABLE>
During the year ended December 31, 1998, the exercise price of the stock
was $21.625, or 90% of the average market value of the Common Stock on the
first business day of the payment period ending June 30, 1998, and
$23.875, or 90% of the average market value of the Common Stock on the
last business day of the payment period ending December 31, 1998.
12
<PAGE>
6. STOCKHOLDERS' EQUITY (CONTINUED)
EARNINGS PER SHARE - Under SFAS No. 128, the Company is required to
disclose a reconciliation of Basic EPS and Diluted EPS for the periods
ended March 31, 1999 and 1998 as follows:
<TABLE>
<CAPTION>
PER-SHARE
INCOME SHARES AMOUNT
----------- ------------ ----------
<S> <C> <C> <C>
MARCH 31, 1999
BASIC EPS
Income available to common stockholders $ 4,637,433 13,582,568 $ 0.34
----------
----------
Dilutive effect of common equivalent shares of stock options 489,248
------------
DILUTED EPS
Income available to common stockholders $ 4,637,433 14,071,816 $ 0.33
----------- ------------ ----------
----------- ------------ ----------
MARCH 31, 1998
BASIC EPS
Income available to common stockholders $ 3,211,661 13,341,096 $ 0.24
----------
----------
Dilutive effect of common equivalent shares of stock options 386,092
------------
DILUTED EPS
Income available to common stockholders $ 3,211,661 13,727,188 $ 0.23
----------- ------------ ----------
----------- ------------ ----------
</TABLE>
7. OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
LINES OF CREDIT - At March 31, 1999, the Company had commitments to
individuals and mutual funds under collateralized open lines of credit
totaling $198,250,000, against which $34,004,000 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 contractual or notional amounts of swap
agreements, which are derivative financial instruments held by the Company
at March 31, 1999 and 1998 were $460,000,000 and $420,000,000,
respectively. Interest rate contracts involve an agreement with a
counterparty to exchange cash flows based on an underlying interest rate
index. 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. The
Company experienced no terminations by counterparties of interest rate
swaps. Credit risk is limited to the positive fair value of the derivative
financial instrument, which is significantly less than the notional value.
During the first quarter of 1999, 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 36
months. The weighted-average fixed-payment rates were 5.59 percent at
March 31, 1999. Variable-interest payments received are indexed to the one
month London Interbank Offering Rate. At March 31, 1999, the
weighted-average rate of variable market-indexed interest payment
obligations to the Company was 4.94 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 fair value was approximately ($1,727,000) at March 31, 1999.
8. COMMITMENTS AND CONTINGENCIES
RESTRICTIONS ON CASH BALANCES - The Company is required to maintain
certain average cash reserve balances. The reserve balance requirement
with the Federal Reserve Bank as of March 31, 1999 was $17,340,000. In
addition, other cash balances in the amounts of $10,000 and $1,607,052
were pledged to secure clearings with depository institutions, National
Securities Clearing Corporation and Depository Trust Company,
respectively, as of March 31, 1999.
13
<PAGE>
8. COMMITMENTS AND CONTINGENCIES (CONTINUED)
LEASE COMMITMENTS - Minimum future commitments on non-cancelable operating
leases at March 31, 1999 were as follows:
<TABLE>
<CAPTION>
Bank
Fiscal Year Ending Premises Equipment
------------------ ------------ ------------
<S> <C> <C>
1999 $ 5,252,279 $ 1,687,327
2000 6,677,928 1,196,091
2001 6,553,012 399,342
2002 6,091,107 18,080
2003 and beyond 28,444,443 3,036
</TABLE>
Total rent expense was $2,675,537 and $2,152,871 for the three months
ended March 31, 1999 and 1998, respectively.
On February 1, 1996, the Company entered into a five year facility
management agreement with a third party provider of duplicating and
delivery services. Under the terms of the agreement, the Company agreed to
pay certain minimum annual charges, subject to increases due to certain
usage thresholds. Service expense under this contract was $152,804 and
$164,057 for the three months ended March 31, 1999 and 1998, respectively.
CONTINGENCIES - The Company provides global custody, multicurrency
accounting, institutional transfer agency, performance measurement,
foreign exchange, securities lending, mutual fund administration and
investment advisory services to a variety of financial asset managers,
including mutual fund complexes, investment advisors, banks and insurance
companies. Assets under custody and management, held by the Company in a
fiduciary capacity, are not included in the consolidated balance sheets
since such items are not assets of the Company. Management conducts
regular reviews of its fiduciary responsibilities and considers the
results in preparing its consolidated financial statements. In the opinion
of management, there are no contingent liabilities at March 31, 1999 that
are material to the consolidated financial position or results of
operations of the Company.
9. 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 adverse 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 I capital (as defined in
the regulations) to risk-weighted assets (as defined), and of Tier I
capital (as defined) to average assets (as defined). Management believes,
as of March 31, 1999, that the Company and the Bank meet all capital
adequacy requirements to which it is subject.
14
<PAGE>
9. REGULATORY MATTERS (CONTINUED)
As of March 31, 1999, 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 following 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 Company and the Bank for the quarter ended March 31, 1999
and the year ended December 31, 1998.
<TABLE>
<CAPTION>
TO BE WELL CAPITALIZED
FOR CAPITAL UNDER PROMPT
ACTUAL ADEQUACY PURPOSES: CORRECTIVE ACTION PROVISIONS:
------------------------------ ---------------------------- -------------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
----------------- ---------- ---------------- --------- --------------- -----------
<S> <C> <C> <C> <C> <C> <C>
AS OF MARCH 31, 1999:
Total Capital
(to Risk Weighted Assets
- the Company) $101,674,896 17.89% $ 45,477,533 8.00% N/A
Total Capital
(to Risk Weighted Assets
-the Bank) $ 99,277,805 17.52% $ 45,333,563 8.00% $56,666,954 10.00%
Tier I Capital
(to Risk Weighted Assets
- the Company) $101,574,896 17.87% $ 22,738,766 4.00% N/A
Tier I Capital
(to Risk Weighted Assets
-the Bank) $ 99,177,805 17.50% $ 22,666,782 4.00% $34,000,172 6.00%
Tier I Capital
(to Average Assets
- the Company) $101,574,896 6.62% $ 61,366,671 4.00% N/A
Tier I Capital
(to Average Assets
-the Bank) $ 99,177,805 6.47% $ 61,292,777 4.00% $76,615,971 5.00%
AS OF DECEMBER 31, 1998:
Total Capital
(to Risk Weighted Assets
- the Company) $70,580,033 15.34% $36,798,822 8.00% N/A
Total Capital
(to Risk Weighted Assets
- the Bank) $67,866,671 14.81% $36,652,540 8.00% $45,815,675 10.00%
Tier I Capital
(to Risk Weighted Assets
- the Company) $70,480,033 15.32% $18,399,411 4.00% N/A
Tier I Capital
(to Risk Weighted Assets
- the Bank) $67,766,671 14.79% $18,326,270 4.00% $27,489,405 6.00%
Tier I Capital
(to Average Assets
- the Company) $71,480,033 4.61% $61,215,675 4.00% N/A
Tier I Capital
(to Average Assets
- the Bank) $67,766,671 4.43% $61,186,835 4.00% $76,483,544 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.
15
<PAGE>
10. SEGMENT REPORTING
The Company does not utilize segment information for internal reporting as
management views the Company as one segment. The following represents net
operating revenue by geographic area for the three months ended March 31,
1999 and 1998, and long-lived assets by geographic area as of March 31,
1999 and 1998:
<TABLE>
<CAPTION>
NET OPERATING NET OPERATING LONG-LIVED LONG-LIVED
GEOGRAPHIC REVENUE REVENUE ASSETS ASSETS
INFORMATION: 1999 1998 1999 1998
-------------------- ---------------- ---------------- --------------- ----------------
<S> <C> <C> <C> <C>
United States $37,016,177 $27,471,831 $53,669,138 $ 8,153,713
Ireland 1,040,326 875,983 247,326 216,105
Canada 680,818 939,459 235,520 307,144
Cayman Islands 46,161 49,443 - -
---------------- ---------------- --------------- ----------------
Total $38,783,482 $29,336,716 $54,151,984 $ 8,676,962
---------------- ---------------- --------------- ----------------
---------------- ---------------- --------------- ----------------
</TABLE>
The following represents the Company's operating revenue by service line
for the three months ended March 31, 1999 and 1998:
<TABLE>
<CAPTION>
OPERATING REVENUE OPERATING REVENUE
1999 1998
SERVICE LINES:
--------------------------------------- ------------------ --------------------
<S> <C> <C>
Custody, accounting, transfer agency,
and administration $ 28,561,103 $ 19,295,221
Investment advisory 361,117 169,775
Securities lending 1,424,127 842,187
Foreign exchange 1,157,154 1,514,396
------------------ --------------------
Total $ 31,503,501 $ 21,821,579
------------------ --------------------
------------------ --------------------
</TABLE>
No one customer accounted for 10% of the Company's consolidated net
operating revenues for the three months ended March 31, 1999 and 1998.
16
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The following discussion and analysis of the financial condition and
results of operations of the Company should be read in conjunction with the
Company's Condensed Consolidated Financial Statements and related notes, which
are included elsewhere in this Report. The Company, through its wholly owned
subsidiaries, Investors Bank & Trust Company and Investors Capital Services,
Inc., 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 64 mutual fund complexes, investment advisors, banks
and insurance companies. The Company provides financial asset administration
services for net assets that totaled approximately $258 billion at March 31,
1999, including approximately $14 billion of foreign net assets. The Company
also engages in private banking transactions, including secured lending and
deposit accounts.
On May 29, 1998, the Company acquired AMT Capital Services, Inc. and an
affiliated company (collectively, `AMT Capital Services'), a New York-based firm
recognized for providing fund administration services to global and domestic
institutional investment management firms. Under the terms of the acquisition
agreement, the Company acquired all of the outstanding capital stock of AMT
Capital in exchange for 388,012 shares of the Company's common stock. The
acquisition was accounted for using the pooling-of-interests method of
accounting. Upon completion of the acquisition, AMT Capital Services became a
wholly owned subsidiary of the Company and was re-named Investors Capital
Services, Inc. On April 12, 1999, 6,814 of these shares were returned to the
Company pursuant to the indemnification and escrow provisions of the acquisition
agreement.
On October 1, 1998, the Bank acquired the domestic institutional trust
and custody business, (`the' Business) of BankBoston, N.A. Under the terms of
the purchase agreement, the Company paid approximately $48 million to BankBoston
as of the closing and will pay up to an additional $6 million in October of 1999
depending upon business performance. The Business provides master trust and
custody services to endowments, pension funds, municipalities, mutual funds and
other financial institutions, primarily in New England. The acquisition was
accounted for using the purchase method of accounting. In connection with the
acquisition, the Bank and BankBoston also entered into an outsourcing agreement.
Pursuant to the outsourcing agreement, the Company will act as custodian for
three BankBoston asset management related businesses: domestic private banking,
institutional asset management and international private banking. The Company
will provide transaction processing and asset safekeeping and servicing to the
clients of those businesses.
On February 16, 1999, the Board of Directors of the Company declared a
two-for-one stock split in the form of a 100% stock dividend payable March 17,
1999 to stockholders of record on March 1, 1999. All share numbers in this
Report have been restated to reflect the two-for-one stock split paid March 17,
1999, where applicable.
On March 26, 1999, the Company completed the issuance and sale of
900,000 shares of Common Stock at $29 per share in a private placement to one
investor. The net capital raised in the private placement will be used to
support the Company's balance sheet growth.
REVENUE AND INCOME OVERVIEW
The Company derives its revenues from financial asset administration
services and private banking transactions. Although interest income and
non-interest 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 all 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 non-interest
income) and net income are the most meaningful measures of financial results.
Revenue generated from asset administration and other fees and interest income
increased 32% to $38,783,000 for the quarter ended March 31, 1999 from
$29,337,000 for the quarter ended March 31, 1998.
Non-interest income consists primarily of fees for financial asset
administration and is principally derived from custody, multicurrency
accounting, transfer agency and administration services for financial asset
managers and the assets they control. The Company's clients pay fees based on
the volume of assets under custody, the number of securities held and portfolio
transactions, income collected and whether other value-added services such as
foreign exchange, securities lending and performance measurement are needed.
Asset-based fees are usually charged on a sliding scale. As such, when the
assets in a portfolio under custody grow as a result of changes in market values
or cash inflows, the Company's fees may be a smaller percentage of those assets.
Fees for individually managed accounts, such as custodial, trust and portfolio
accounting services for individuals, investment advisors, private trustees,
financial planners, other banks and fiduciaries, and other institutions are also
included in non-interest income.
17
<PAGE>
Net interest income represents the difference between income generated
from interest-earning assets and expense on interest-bearing liabilities.
Interest-bearing liabilities are generated by the Company's clients who, in the
course of their financial asset management, generate cash balances, which they
deposit on a short-term basis with the Company. The Company invests these cash
balances and remits a portion of the earnings on these investments to its
clients. The Company's share of earnings from these investments is viewed as
part of the total package of compensation paid to the Company from its clients
for performing asset administration services.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
From time to time, information provided by the Company, statements made
by its employees or information included in its filings with the Securities and
Exchange Commission (including this Form 10-Q) may contain statements, which are
not historical facts, so-called `forward-looking statements,' which involve
risks and uncertainties. Forward looking statements in this 10-Q include certain
statements regarding liquidity and the Company's Year 2000 Project. 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 are subject to substantial risks and
uncertainties. The Company's liquidity is dependent, in part, upon the continued
availability of current borrowing facilities, the loss of which may impair the
Company's access to liquid funds. 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 or changes in the relationship between certain index 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 has been experiencing a period of rapid growth, which
places a strain on all of its resources, including management. In addition, the
Company completed two acquisitions in 1999 and must successfully integrate those
acquisitions and any future acquisitions into the Company's business. Also, the
Company must continue to attract and retain skilled personnel in a tight labor
market. If the Company fails to manage growth effectively, integrate
acquisitions successfully or attract and retain skilled employees, it could
reduce the quality of the Company's services, lead to loss of key employees and
clients, and have a material adverse effect on the Company's operations.
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 Company's
successful completion of its Year 2000 Project is subject to the risks set forth
under `Year 2000 Readiness Disclosure' below. 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 its
competitors 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.
YEAR 2000 READINESS DISCLOSURE
The Year 2000 Issue is the result of the once common programming
standard 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.
The Company's business is heavily dependent on its internal computer
systems to process transactions and conduct services for clients. In addition,
the Company relies on automated data communications with vendors, clients and
other third parties, as well as certain third party hardware and software
providers such as Electronic Data Systems. The Company also relies on other
third party relationships in the conduct of its business. For example, third
party vendors handle the payroll function for the Company, and the Company also
relies on the services of the landlords of its facilities, telecommunication
companies, utilities and commercial airlines, among others.
18
<PAGE>
Any failure of the Company's internal computer systems, third party
data communications, third party hardware and software providers or other third
party vendors due to the Year 2000 Issue could have material adverse impact on
the Company's ability to provide timely and accurate services to its clients. As
a result, any such failure could have a material adverse impact on the Company's
financial condition and results of operations. In addition, because the Company
is regulated by Federal and State banking authorities, failure to be Year 2000
compliant could subject the Company to formal supervisory or enforcement
actions, which could have a material adverse impact on the Company's business.
Commencing in 1997 the Company, with the assistance of an outside
consultant, assessed its Year 2000 compliance status and developed a
comprehensive program to address related issues. As part of the assessment
process, there is a phased approach followed which includes: inventorying
potentially date sensitive items; assigning a risk rating to each item;
assessing the compliance status of each item; taking corrective action to
renovate, replace, modify or upgrade to achieve compliance; validating
compliance; and developing and validating contingency plans for each critical
function as required. Based on this assessment, the Company determined that it
would be required to modify or upgrade portions of its software so that its
computer systems would properly process dates beyond December 31, 1999. The
Company presently believes that with modifications to, or upgrades of, existing
software, the Year 2000 Issue can be 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 clients to obtain information on the compliance status
of the products and services provided to the Company 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 remediated. Any
failure to remediate by another company, or a remediation that is incompatible
with the Company's systems, could have a material adverse effect on the Company.
The Company has utilized both internal and external resources to modify
or upgrade existing software and to test such software for Year 2000 compliance.
The company inventoried date sensitive items, assigned risk ratings and assessed
the compliance status of each item. The Company plans to complete the renovation
and internal testing of all its mission critical applications, by the second
quarter of 1999. The Company has completed compliance testing of its flagship
applications, significantly completed compliance testing on all other
applications and started integration testing of internal applications. The
Company began testing with clients in the fourth quarter of 1998 and will
continue through the second and third quarters of 1999. The Company believes
that testing with business partners and third party vendors will be
substantially completed by the third quarter of 1999.
The Company is participating in industry-wide Year 2000 testing with
such entities as the Securities Industry Association, the Depository Trust
Company and the Federal Reserve Bank. The Company expects to complete
industry-wide testing in the second quarter of 1999. The Company is also
monitoring its network of global subcustodians for Year 2000 readiness. In
addition to its own review of those subcustodians, the Company also participates
in two industry groups reviewing global subcustodians, The Custody 2000 Working
Group and the Association of Global Custodians Year 2000 sub-committee.
The Company is developing contingency plans for its mission critical
applications and services. These contingency plans address the failure of the
Company or a third party to renovate, validate or implement systems and the
failure of critical systems at times before or after January 1, 2000. The goal
of the Company's contingency plans is to provide uninterrupted services and
communications to and between clients and vendors. Contingency plans include the
use of alternative systems, manual processing and other procedures. The Company
is currently integrating individual application contingency plans into a
comprehensive Business Resumption Contingency Plan. The Company plans to
complete the Business Resumption Contingency Plan by the end of the second
quarter of 1999.
Updates on the status of the Company's Year 2000 efforts are provided
regularly to senior management and the Board of Directors. The Company's Year
2000 program is also subject to review by both the Company internal audit
department and by Federal bank regulatory agencies.
The remaining 1999 cost of the year 2000 project is estimated at
$1,632,000, which will be expensed as incurred. These 1999 costs may include,
but are not limited to, completing testing with third parties that are not Year
2000 compliant and software renovation necessitated by internal and/or third
party testing. These amounts are not expected to have a material effect on the
Company's results of operations. As of March 31, 1999, the Company had incurred
and expensed approximately $2,358,000 related to the assessment of, and
remediation efforts in connection with, its Year 2000 project. All amounts
expensed and to be expensed in connection with the Year 2000 issue will be
funded through operating cash flows.
The costs of the project and the date on which the Company plans to
complete the Year 2000 modifications, testing and contingency plans 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
19
<PAGE>
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, availability of and cooperation by clients, vendors and other
third parties, the compatibility of third-party interfaces, and similar
uncertainties.
STATEMENT OF OPERATIONS
COMPARISON OF OPERATING RESULTS FOR THE QUARTERS ENDED MARCH 31, 1999 AND 1998
Noninterest Income
Noninterest income increased $9,421,000 to $31,633,000 for the quarter
ended March 31, 1999 from $22,212,000 for the quarter ended March 31, 1998.
Noninterest income consists of the following items:
<TABLE>
<CAPTION>
For the Quarters Ended
March 31,
-------------------------------------------------------
1999 1998 Change
---------------- -------------- ----------------
(Dollars in thousands)
<S> <C> <C> <C>
Asset administration fees $31,380 $21,688 45 %
Computer service fees 123 134 (8)
Other operating income 130 190 (32)
Gain on sale of securities - 200 (100)
---------------- --------------
Total Noninterest Income $31,633 $22,212 42 %
---------------- --------------
---------------- --------------
</TABLE>
Asset administration fees increased $9,692,000 to $31,380,000 for
the quarter ended March 31, 1999 compared to $21,688,000 for the quarter
ended March 31, 1998. The Company earns such fees on assets processed by the
Company on behalf of a variety of financial asset managers. Assets processed
is the total dollar value of financial assets on the reported date for which
the Company provides one or more of the following services: custody,
multicurrency accounting, institutional transfer agency, performance
measurement, foreign exchange, securities lending, mutual fund administration
and investment advisory services. Total net assets processed increased to
$258 billion at March 31, 1999 from $155 billion at March 31, 1998. Of the
$103 billion net increase, approximately $76 billion relates to the Company's
acquisition of BankBoston's domestic institutional custody business on
October 1, 1998. Of the remaining $27 billion net increase, approximately 29%
reflects assets processed for new clients and the remainder reflects growth
of assets processed for existing clients. The largest component of asset
administration fees is asset-based fees, which increased between periods due
to the increase in assets processed. Another significant portion of the
increase in asset administration fees resulted from the Company's success in
marketing ancillary services such as cash management services.
Computer service fees consist of amounts charged by the Company for
data processing services related to client accounts. Other operating income
consists of dividends received relating to the Federal Home Loan Bank of
Boston stock investment and miscellaneous transaction-oriented private
banking fees. The decrease in other operating income resulted from services
previously provided by Investors Capital Advisors, Inc., a wholly owned
subsidiary of the Company, which could no longer be provided due to
regulatory restrictions imposed on the Company. Investors Capital Advisors,
Inc. was merged into Investors Capital Services, Inc. on December 31, 1998.
20
<PAGE>
Operating Expenses
Total operating expenses increased by $7,250,000 to $30,927,000 for the
quarter ended March 31, 1999 compared to $23,677,000 for the quarter ended March
31, 1998. The components of operating expenses were as follows:
<TABLE>
<CAPTION>
For the Quarters Ended March 31,
------------------------------------- --------------
1999 1998 Change
------------------- --------------- --------------
(Dollars in thousands)
<S> <C> <C> <C>
Compensation and benefits $18,897 $14,667 29%
Technology and telecommunications 3,620 2,606 39%
Transaction processing services 2,180 2,031 7%
Occupancy 1,960 1,687 16%
Depreciation and amortization 879 601 46%
Amortization of goodwill 444 - 100%
Travel and sales promotion 507 417 22%
Professional fees 645 267 142%
Insurance 189 193 (2)%
Other operating expenses 1,606 1,208 33%
------------------- ---------------
Total Operating Expenses $30,927 $23,677 31%
------------------- ---------------
------------------- ---------------
</TABLE>
Compensation and benefits expense increased by $4,230,000 or 29% from
period to period due to several factors. The average number of employees
increased 24% to 1,308 during the quarter ended March 31, 1999 from 1,058 during
the same period in 1998. This increase relates to the increase in client
relationships, the expansion of existing client relationships during the period
and the addition of employees related to the BankBoston acquisition in October
1998. In addition, compensation expense related to the Company's management
incentive plans increased $550,000 between periods because of the increase in
earnings subject to incentive payments. Benefits, including payroll taxes, group
insurance plans, retirement plan contributions and tuition reimbursement,
increased by $523,000 for the quarter ended March 31, 1999 from the same period
in 1998. 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 contracting programming fees. Technology and
telecommunications expense increased $1,014,000 from period to period. Expenses
related to the conversion of the BankBoston business, and on-going support
accounted for $557,000 of the increase. Also, contributing to the increase was
the Company's use of contract programmers to perform information systems
development projects, which accounted for $335,000 of the increase. Increased
hardware and software expenses needed to support the growth in assets processed
comprised the remainder of the increase.
Occupancy expense increased $273,000 to $1,960,000 for the quarter
ended March 31, 1999 from $1,687,000 for the quarter ended March 31, 1998. The
increase resulted from expansion of office space in the Company's Boston and
Dublin locations.
Depreciation and amortization expense increased $278,000 to $879,000
for the quarter ended March 31, 1999 from $601,000 for the quarter ended March
31, 1998. The increase of $102,000 related to software costs capitalized under
SOP 98-1 throughout 1998 and had been placed in service in 1999. Also
contributing to the increase was $61,000 related to depreciation of fixed assets
acquired from BankBoston.
The acquisition of BankBoston's institutional trust and custody
business was accounted for using the purchase method of accounting and as a
result, the purchase price was allocated first to all identifiable tangible and
intangible assets acquired and liabilities assumed. The remainder of the
purchase price was then allocated to goodwill. Goodwill expense relates to the
amortization of the resulting goodwill from the acquisition, which is being
amortized over its estimated useful life.
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. Travel
and sales promotion expense increased $90,000 to $507,000 for the quarter ended
March 31, 1999 from $417,000 for the quarter ended March 31, 1998 due primarily
to increased travel of the sales and client management staff.
21
<PAGE>
Professional fees increased $378,000 to $645,000 for the quarter ended
March 31, 1999 from $267,000 for the quarter ended March 31, 1998. The increase
in professional fees was mainly attributable to consulting services related to
the integration of the BankBoston business, along with an overall increase in
audit fees.
Other operating expenses include fees for office supplies, recruiting
costs, temporary help and various fees assessed by the Massachusetts Banking
Commission. These expenses increased $398,000 to $1,606,000 for the quarter
ended March 31, 1999 from $1,208,000 for the quarter ended March 31, 1998.
Recruiting costs accounted for $113,000 of the increase, resulting from the
growth in the Company's staffing needs. The growth in assets processed has
resulted in an overall increase in operating expenses.
Net Interest Income
Net interest income is affected by the volume and mix of assets and
liabilities, and the movement and level of interest rates. The table below
presents the changes in net interest income resulting from changes in the volume
of interest-earning assets or interest-bearing liabilities or changes in
interest rates for the quarter ended March 31, 1999 compared to the same period
in 1998.
<TABLE>
<CAPTION>
Change Change
Due to Due to
Volume Rate Net
------------ ------------ --------------
(Dollars in thousands)
<S> <C> <C> <C>
INTEREST-EARNING ASSETS
Fed funds sold and
interest-earning deposits $ 377 $ (52) $ 325
Investment securities 454 (1,669) (1,215)
Loans 62 58 120
------------ ------------ --------------
Total interest-earning assets $ 893 $ (1,663) $ (770)
------------ ------------ --------------
INTEREST-BEARING LIABILITIES
Deposits $ 4,246 $ (559) $ 3,687
Borrowings (3,027) (1,456) (4,483)
------------ ------------ --------------
Total interest-bearing liabilities $ 1,219 $ (2,015) $ (796)
------------ ------------ --------------
Change in net interest income $ (326) $ 352 $ 26
------------ ------------ --------------
------------ ------------ --------------
</TABLE>
Net interest income increased $26,000 or 4% to $7,150,000 for the
quarter ended March 31, 1999 from $7,124,000 for the same period in 1998. This
net increase resulted from a decrease in interest expense of $796,000 offset by
a decrease in interest income of $770,000. The net impact of the above changes
was a nine basis point decrease in net interest margin.
The decrease in interest income resulted primarily from a decrease in
the average yield from 6.11% to 5.61%. The decrease in average yield was
partially offset by an increase in interest-earning assets. The Company's
average assets increased 8% compared to the same period in 1998. This growth
resulted primarily from a 5% increase in average interest-earning assets.
Interest expense decreased due primarily to a decrease in the average
interest rate paid by the Company from 4.97% to 4.08% during the period. The
decrease in the average interest rate was offset by an increase in
interest-bearing liabilities of 15%.
Income Taxes
The Company's earnings were taxed on the federal level at 35% for the
1999 and 1998 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 10.91% in 1998 and 10.50% in 1999. The
provision for income taxes for the quarter ended March 31, 1999 increased by
$771,000 over the same period in 1998. The overall effective tax rate increased
to 36% for the quarter ended March 31, 1999, from 35% for the same period in
1998. The increase in the overall effective tax rate is due to the change in tax
status of Investors Capital Services from an S Corporation to a C Corporation.
22
<PAGE>
FINANCIAL CONDITION
INVESTMENT PORTFOLIO
The following table summarizes the Company's investment portfolio for the dates
indicated:
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
--------------- ---------------
(Dollars in thousands)
<S> <C> <C>
SECURITIES HELD TO MATURITY:
State and political subdivisions $ 53,823 $ 35,821
Mortgage-backed securities 847,784 733,109
Federal agency securities 161,222 166,181
Foreign government securities 7,690 7,706
--------------- ---------------
Total securities held to maturity $ 1,070,519 $ 942,817
--------------- ---------------
--------------- ---------------
SECURITIES AVAILABLE FOR SALE:
State and political subdivisions $ 37,448 $ 37,577
Corporate debt 48,620 48,070
Federal agency securities 54,119 -
Mortgage-backed securities 232,626 259,422
--------------- ---------------
Total securities available for sale $ 372,813 $ 345,069
--------------- ---------------
--------------- ---------------
</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 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, corporate debt securities, and foreign
government bonds issued by the Canadian provinces of Ontario and Manitoba.
The Company invests in mortgage-backed securities, Federal Agency
callable bonds and corporate debt to 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.
23
<PAGE>
The amortized cost and weighted average yield of the Company's
securities held to maturity at March 31, 1999, by effective maturity, are
reflected in the following table:
<TABLE>
<CAPTION>
Weighted
Average
Book Value Yield
-------------- ------------
(Dollars in thousands)
<S> <C> <C>
Due within one year $ 11 7.47%
Due from one to five years 262,483 6.22%
Due after five years up to ten years 170,584 5.96%
Due after ten years 637,441 6.13%
--------------
Total securities held to maturity $1,070,519
--------------
--------------
</TABLE>
The approximate fair value and weighted average yield of the Company's
securities available for sale at March 31, 1999, by effective maturity, are
reflected in the following table:
<TABLE>
<CAPTION>
Weighted
Average
Book Value Yield
-------------- ------------
(Dollars in thousands)
<S> <C> <C>
Due from one to five years $ 281,185 5.85%
Due after five years up to ten years 36,277 5.40%
Due after ten years 55,351 5.41%
--------------
Total securities available for sale $ 372,813
--------------
--------------
</TABLE>
LOAN PORTFOLIO
The following table summarizes the Company's loan portfolio for the
dates indicated:
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
------------------------------
(Dollars in thousands)
<S> <C> <C>
Loans to individuals $26,053 $25,583
Loans to not-for-profit organizations 13 13
Loans to mutual funds 39,266 28,796
----------- --------------
65,332 54,392
Less: allowance for loan losses (100) (100)
----------- --------------
Net loans $65,232 $54,292
----------- --------------
----------- --------------
Floating Rate $65,219 $54,279
Fixed Rate 13 13
----------- --------------
$65,232 $54,292
----------- --------------
----------- --------------
</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. 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 March 31, 1999, 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
24
<PAGE>
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 March 31, 1999,
there were no past due loans, troubled debt restructurings, or any loans on
non-accrual status. Although virtually all of the Company's loans are fully
collateralized with freely tradable securities, management recognizes some
credit risk inherent in the loan portfolio, and has recorded an allowance for
loan losses of $100,000 at March 31, 1999. 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. 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.
25
<PAGE>
The following table presents the repricing schedule for the Company's interest
earning assets and interest bearing liabilities at March 31, 1999:
<TABLE>
<CAPTION>
Within Three Six 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 $ 70,000 $ - $ - $ - $ - $ 70,000
Investment securities (2) 606,630 178,533 153,377 330,822 173,971 1,443,333
Loans - fixed rate - - - 13 - 13
Loans - variable rate 65,220 - - - - 65,220
------------- ------------ ------------- ------------- ------------- --------------
Total interest-earning 741,850 178,533 153,377 330,835 173,971 1,578,566
assets
Interest-bearing liabilities:
Demand deposit accounts 5,719 - - - - 5,719
Savings accounts 758,354 - - - - 758,354
Interest rate contracts (410,000) 60,000 70,000 280,000 - -
Short term borrowings 516,184 - - - - 516,184
------------- ------------ ------------- ------------- ------------- --------------
Total interest-bearing 870,257 60,000 70,000 280,000 - 1,280,257
liabilities
------------- ------------ ------------- ------------- ------------- --------------
Net interest sensitivity
gap during the period ($ 128,407) $ 118,533 $ 83,377 $ 50,835 $ 173,971 $ 298,309
------------- ------------ ------------- ------------- ------------- --------------
------------- ------------ ------------- ------------- ------------- --------------
Cumulative gap ($ 128,407) ($ 9,874) $ 73,503 $ 124,338 $ 298,309
------------- ------------ ------------- ------------- -------------
------------- ------------ ------------- ------------- -------------
Interest sensitive assets as a
percent of interest sensitive
liabilities (cumulative) 85.24% 98.94% 107.35% 109.71% 123.30%
------------- ------------ ------------- ------------- -------------
------------- ------------ ------------- ------------- -------------
Interest sensitive assets as a
percent of total assets
(cumulative) 43.26% 53.67% 62.62% 81.91% 92.06%
------------- ------------ ------------- ------------- -------------
------------- ------------ ------------- ------------- -------------
Net interest sensitivity gap as a
percent of total assets (7.49%) 6.91% 4.86% 2.96% 10.15%
------------- ------------ ------------- ------------- -------------
------------- ------------ ------------- ------------- -------------
Cumulative gap as a percent
of total assets (7.49%) (0.58%) 4.29% 7.25% 17.40%
------------- ------------ ------------- ------------- -------------
------------- ------------ ------------- ------------- -------------
</TABLE>
(1) Adjustable rate assets are included in the period in which interest
rates are next scheduled to adjust rather than in the period in which
they are due. Fixed rate loans are included in the period in which they
are scheduled to be repaid.
(2) Mortgage-backed securities are included in the pricing category that
corresponds with their effective maturity.
26
<PAGE>
MARKET RISK
The principal objective of the Company's interest rate risk management
function is to evaluate the interest rate risk included in certain balance sheet
accounts, determine the level of appropriate risk given the Company's business
focus, operating environment, capital and liquidity requirements and performance
objectives and manage the risk consistent with guidelines approved by the
Company's Board of Directors. The Board reviews, on a quarterly basis, the
Company's asset/liability position, including simulations of the effect on the
Company's capital of various interest rate scenarios. The extent of the movement
of interest rates, higher or lower, is an uncertainty that could have a negative
impact on the earnings of the Company.
In the normal course of business, the financial position of the Company
is routinely subject to a variety of risks, including market risks associated
with interest rate movements. The Company regularly assesses these risks and has
established policies and business practices to protect against the adverse
effects of these and other potential exposures. The Company recognizes that
effective management of interest rate risk includes an understanding of when
adverse changes in interest rates will flow through the statement of income and
comprehensive income. Accordingly, the Company will manage its position so that
it monitors its exposure to net interest income over both a one year planning
horizon and a longer term strategic horizon. In order to manage this interest
rate risk, the Company will follow a policy limit stating that projected net
interest income over the next 12 months will not be reduced by more than 10%
given a change in interest rates of up to 200 basis points (+ or -) over 12
months.
The Bank's primary tool in managing interest rate risk in this manner
is an income simulation model wherein the Company projects the future net
interest income derived from the most current projected balance sheet using a
variety of interest rates scenarios. The model seeks to adjust for cash flow
changes arising from the changing interest rates for mortgage prepayments,
callable securities and adjustable rate securities. The Company also utilizes
interest rate swap agreements to manage interest risk. Interest rate contracts
involve an agreement with a counterparty to exchange cash flows based on an
underlying interest rate index. The effect of these agreements was to lengthen
short-term variable rate liabilities into longer-term fixed rate liabilities.
The results of the sensitivity analysis as of March 31, 1999 and March
31, 1998, indicated that an upward shift of interest rates by 200 basis points
would result in a reduction in projected net interest income of 8.6% and 7.8%,
respectively, versus the policy limit of 10%. Conversely, a downward shift of
200 basis points would result in an increase in projected net interest income of
4.5% and 9.6%, respectively.
Certain shortcomings are inherent in the methodology used in the
above-described interest rate risk measurement. Modeling changes requires the
making of certain assumptions that may tend to oversimplify the manner in which
actual yield and costs respond to changes in market interest rates. Assumptions
are the underlying factors that drive the interest rate risk measurement system
which include interest rate forecasts, client liability funding, mortgage
prepayment assumptions and portfolio yields. The model assumes that the
composition of the Company's interest sensitive assets and liabilities existing
at the beginning of a period will change periodically over the period being
measured. The model also assumes that a particular change in interest rates is
reflected uniformly across the yield curve regardless of the duration to
maturity or repricing of specific assets and liabilities. Accordingly, although
the model provides an indication of the Company's interest rate risk exposure at
a particular point in time, this measurement is not intended to and does not
provide a precise forecast of the effect of changes in market interest rates on
the Company's net interest income and actual results will differ. The results of
this modeling are monitored by management and presented to the Board of
Directors quarterly.
LIQUIDITY
Liquidity represents the ability of an institution to meet present and
future financial obligations through either the sale or maturity of existing
assets or the acquisition of additional funds through liability management. For
a financial institution such as the Company, these obligations arise from the
withdrawals of deposits and the payment of operating expenses.
The Company's primary sources of liquidity include cash and cash
equivalents, federal funds sold, new deposits, short-term borrowings, interest
payments on securities held to maturity and available for sale, fees collected
from asset administration clients, and the capital raised from the sale of the
Capital Securities. Asset liquidity is also provided by managing the duration of
the investment portfolio. As a result of the Company's management of liquid
assets and the ability to generate liquidity through liability funds, management
believes that the Company maintains overall liquidity sufficient to meet its
depositors' needs, to satisfy its operating requirements and to fund the payment
of an anticipated annual cash dividend of approximately $.08 per share.
The Company's ability to pay dividends on the Common Stock may depend
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, the Company expects to pay to an annual
dividend to its stockholders, currently estimated to be in an amount equal to
$.08 per share of outstanding Common Stock (approximately $1,159,676 based upon
14,495,946 shares outstanding as of March 31, 1999).
27
<PAGE>
At March 31, 1999 and 1998, cash and cash equivalents were 2% of total
assets. At March 31, 1999, approximately $17 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 March 31, 1999 was $216 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. There can be no
assurance, however, that such funding will be available on a timely basis, if at
all. Lack of availability of liquid funds could have a material adverse impact
on the operations of 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 March 31,
1999 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 March 31, 1999 was $678 million.
The Company's cash flows are comprised of three primary
classifications: cash flows from operating activities, investing activities, and
financing activities. Net cash provided by operating activities was $5,555,811
for the quarter ended March 31, 1999. Net cash used for investing activities,
consisting primarily of purchases of investment securities, proceeds from
maturities of investment securities, and purchases of acquisitions was
$237,762,680 for the quarter ended March 31, 1999. Net cash provided by
financing activities, consisting primarily of net activity in deposits, was
$239,642,213 for the quarter ended March 31, 1999.
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 $774,000 and $1,319,000 for the quarters ended March 31, 1999
and 1998, respectively.
Stockholders' equity at March 31, 1999 was $119,776,000, an increase of
$31,493,000 or 36%, from $88,283,000 at December 31, 1998. The ratio of
stockholders' equity to assets increased to 6.98% at March 31, 1999 from 6.02%
at December 31, 1998.
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 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.
28
<PAGE>
The following table summarizes the Company's Tier I and total capital
ratios at March 31, 1999:
<TABLE>
<CAPTION>
Amount Ratio
-------------- ---------------
(Dollars in thousands)
<S> <C> <C>
Tier I capital $ 101,575 17.87%
Tier I capital minimum requirement 22,739 4.00%
-------------- ---------------
Excess Tier I capital $ 78,836 13.87%
-------------- ---------------
-------------- ---------------
Total capital $ 101,675 17.89%
Total capital minimum requirement 45,478 8.00%
-------------- ---------------
Excess Total capital $ 56,197 9.89%
-------------- ---------------
-------------- ---------------
Risk adjusted assets, net of intangible assets $ 568,469
--------------
--------------
</TABLE>
[OBJECT OMITTED]
The following table summarizes the Bank's Tier I and total capital
ratios at March 31, 1999:
<TABLE>
<CAPTION>
Amount Ratio
-------------- ---------------
(Dollars in thousands)
<S> <C> <C>
Tier I capital $ 99,178 17.50%
Tier I capital minimum requirement 22,667 4.00%
-------------- ---------------
Excess Tier I capital $ 76,511 13.50%
-------------- ---------------
-------------- ---------------
Total capital $ 99,278 17.52%
Total capital minimum requirement 45,334 8.00%
-------------- ---------------
Excess Total capital $ 53,944 9.52%
-------------- ---------------
-------------- ---------------
Risk adjusted assets, net of intangible assets $ 566,670
--------------
--------------
</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
will be 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 that the
capital of the Company and the Bank be reduced by most intangible assets. The
Company's Leverage Ratio at March 31, 1999 was 6.62%, which is in excess of
regulatory requirements. The Bank's Leverage Ratio at March 31, 1999 was 6.47%,
which is in excess of regulatory requirements.
<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>
Three Months Ended March 31, 1999 Three Months Ended March 31, 1998
------------------------------------------- -----------------------------------------
Average Average Average Average
Balance Interest Yield/Cost Balance Interest Yield/Cost
--------------- ------------ ------------- ------------- ----------- -------------
(Dollars in thousands) (Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
INTEREST EARNING ASSETS
Federal funds sold and securities
purchased under resale
agreements $ 57,033 $ 673 4.72% $ 23,778 $ 348 5.85%
Investment securities (3) 1,320,355 18,748 5.68% 1,291,859 19,963 6.18%
Loans (4) 62,340 789 5.06% 57,271 669 4.67%
--------------- ------------ ------------- ------------- ----------- -------------
Total interest earning assets 1,439,728 $ 20,210 5.61% 1,372,908 20,980 6.11%
------------ ------------- ----------- -------------
Allowance for loan losses (100) (100)
Non-interest-earning assets 136,428 82,833
--------------- -------------
Total assets $ 1,576,056 $ 1,455,641
--------------- -------------
--------------- -------------
INTEREST BEARING LIABILITIES
Deposits:
Demand $ 114,025 $ 1,253 4.40% $ 193,151 $ 2,452 5.08%
Savings 806,896 8,085 4.01% 290,730 3,199 4.40%
Short term borrowings 360,169 3,722 4.13% 630,343 8,205 5.21%
--------------- ------------ ------------- ------------- ----------- -------------
Total interest bearing liabilities 1,281,090 $ 13,060 4.08% 1,114,224 $ 13,856 4.97%
------------ ------------- ----------- -------------
Non-interest bearing liabilities
Demand deposits 99,911 161,098
Non-interest bearing time
deposits 65,000 65,000
Other liabilities 13,699 14,485
--------------- -------------
Total liabilities 1,459,700 1,354,807
Trust preferred stock 24,192 24,164
Equity 92,164 76,670
--------------- -------------
Total liabilities and equity $ 1,576,056 $ 1,455,641
--------------- -------------
--------------- -------------
Net interest income $ 7,150 $ 7,124
------------ -----------
------------ -----------
Net interest margin (1) 1.99% 2.08%
------------- -------------
------------- -------------
Average interest rate spread (2) 1.53% 1.14%
------------- -------------
------------- -------------
Ratio of interest-earning assets to
interest-bearing liabilities 112.38% 123.22%
------------- -------------
------------- -------------
</TABLE>
1) Net interest income divided by total interest-earning assets.
2) Yield on interest-earning assets less rate paid on interest-bearing
liabilities.
3) Average yield/cost on available for sale securities is based on
amortized cost.
4) Average yield/cost on demand loans includes accrual and non accrual
interest balances.
30
<PAGE>
PART II: OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On February 16, 1999, the Board of Directors of Investors Financial
Services Corp. (the `Company') declared a two-for-one stock split in the form of
a 100 percent stock dividend (the `Stock Split') which was paid on March 17,
1999 to stockholders of record on March 1, 1999. As a result of the Stock Split,
on March 17, 1999 the total number of outstanding shares of the Company's common
stock increased by 100 percent.
On March 19, 1999, the Company entered into a stock purchase agreement
(the `Purchase Agreement') with Oakmont Corporation (`Oakmont') pursuant to
which the Company agreed to sell to Oakmont or an assignee of Oakmont 900,000
shares of the Company's Common Stock (the `Shares'), at a price of $29 per
share, for an aggregate purchase price of $26,100,000. On March 26, 1999,
Oakmont assigned its rights and liabilities under the Purchase Agreement to
Hazlenut Partners, L.P. (the `Investor'). On March 26, 1999, the transactions
contemplated by the Purchase Agreement were consummated, the Shares were issued
to the Investor and the Investor paid the Company $26,100,000.
The offer and sale of the Shares was exempt from registration under the
Securities Act of 1933, as amended (the `Securities Act'), pursuant to Section
4(2) and Rule 506 of Regulation D under the Securities Act in reliance upon
certain information available to the Corporation as of March 19, 1999 and March
26, 1999, including certain representations and warranties of Oakmont and the
Investor, each an "accredited investor" as such term is defined pursuant to Rule
501 of Regulation D under the Securities Act.
The Company expects to use the proceeds of the sale of the Shares to
fund further expansion of the Company's balance sheet.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS. None.
(B) REPORTS ON FORM 8-K. On March 31, 1999, the Company filed, under
Item 5, a current report on Form 8-K with regard to the Stock
Split and private placement described under Item 2 above.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INVESTORS FINANCIAL SERVICES CORP.
Date: May 12, 1999 By: /S/ KEVIN J. SHEEHAN
-------------------------------
Kevin J. Sheehan
Chairman, President and Chief
Executive Officer
By: /S/ KAREN C. KEENAN
-------------------------------
Karen C. Keenan
Chief Financial Officer
(Principal Financial and Accounting Officer)
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<FISCAL-YEAR-END> MAR-31-1999
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