INVESTORS FINANCIAL SERVICES CORP.

INDEX

2

PART I. FINANCIAL INFORMATION

Item 1.   Condensed Consolidated Financial Statements

INVESTORS FINANCIAL SERVICES CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, 2000 (unaudited) and December 31, 1999
(Dollars in thousands)

See Notes to Condensed Consolidated Financial Statements.

INVESTORS FINANCIAL SERVICES CORP.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (unaudited)
Nine Months Ended September 30, 2000 and 1999
(Dollars in thousands, except per share data)

See Notes to Condensed Consolidated Financial Statements.

INVESTORS FINANCIAL SERVICES CORP.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (unaudited)
Quarter Ended September 30, 2000 and 1999
(Dollars in thousands, except per share data)

See Notes to Condensed Consolidated Financial Statements.

INVESTORS FINANCIAL SERVICES CORP.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (unaudited)
Nine Months Ended September 30, 2000
(Dollars in thousands)

INVESTORS FINANCIAL SERVICES CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
Nine Months Ended September 30, 2000 and 1999
(Dollars in thousands)

See Notes To Condensed Consolidated Financial Statements.

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Information Pertaining to the Nine Months and the Quarter Ended
September 30, 2000 and 1999 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 (‘FRB’), the Office of the Commissioner of Banks of the Commonwealth of Massachusetts and the Federal Deposit Insurance Corporation (‘FDIC’).

             As used herein, the defined term ‘the Company’ shall mean IFSC together with Investors Capital Services, Inc, and the Bank and its domestic and foreign subsidiaries.

             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 Bank paid approximately $48 million to BankBoston as of the closing and subsequently paid an additional $4.9 million based upon client retention and 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 Bank acted as custodian and provided certain other services for three BankBoston asset management related businesses: domestic private banking, institutional asset management and international private banking. In September 1999, the Bank received notification of BankBoston’s intent to terminate the outsourcing agreement. The termination, effective February 2000, had no impact on the remaining business purchased from BankBoston. Pursuant to the terms of the outsourcing agreement, the Bank received a termination fee of $7 million. In addition, in May 2000, the Bank received notification from the BankBoston sponsored 1784 Funds that the 1784 Funds intended to terminate their custody agreement with the Bank. Pursuant to the terms of the purchase agreement with BankBoston, the Bank received a termination fee of $4.3 million in connection with termination of the 1784 Funds custody agreement. Therefore, a net adjustment was made to decrease the purchase price by $6.4 million resulting from the above mentioned items. The Bank does not anticipate a material impact on net income due to the termination of the outsourcing agreement or the termination of the 1784 funds custody agreement. The Bank was informed by BankBoston that its decision to terminate both the outsourcing and the 1784 Funds custody agreement was not related in any way to the Company’s quality of service but was made as part of the integration process undertaken in connection with the BankBoston/Fleet merger.

             On March 26, 1999, the Company completed the issuance and sale of 1,800,000 shares of Common Stock at $14.50 per share in a private placement to one investor. The net capital raised in the private placement was used to support the Company’s balance sheet growth.

             On October 29, 1999, the Bank entered into an agreement with Sanwa Bank California, pursuant to which the Bank agreed to purchase the right to provide institutional custody and related services to accounts managed by the Trust Company of the West. The Bank completed the purchase on March 10, 2000. The accounts subject to the agreement totaled approximately $4.6 billion in assets at March 10, 2000.

             On May 15, 2000, the Board of Directors of the Company declared a two-for-one stock split in the form of a 100% stock dividend payable June 15, 2000 to stockholders of record on May 31, 2000.

             In June 1998, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities”. In June 2000, the FASB issued SFAS No. 138, which amends certain provisions of SFAS 133 to clarify four areas causing difficulties in implementation. The amendment included expanding the normal purchase and sale exemption for supply contracts, permitting the offsetting of certain intercompany foreign currency derivatives and thus reducing the number of third party derivatives, permitting hedge accounting for foreign-currency denominated assets and

liabilities, and redefining interest rate risk to reduce sources of ineffectiveness. The Company has appointed a team to implement SFAS 133 on a global basis. This team has been implementing a SFAS 133 compliant risk management information system, globally educating both financial and non-financial personnel, inventorying derivatives and addressing various other SFAS 133 related issues. The Company will adopt SFAS 133 and the corresponding amendments under SFAS 138 on January 1, 2001. The Company’s SFAS 133 team is currently determining the impact of SFAS 133 on the consolidated results of operations and financial position. This statement should have no impact on consolidated cash flows.

2.      Interim Financial Statements

             The condensed consolidated interim financial statements of the Company and subsidiaries as of September 30, 2000 and 1999 and for the nine-month periods and three-month periods ended September 30, 2000 and 1999 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 w ith 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.

             All share numbers in this report have been restated, where applicable, to reflect the two-for-one stock split paid June 15, 2000.

             Certain amounts in the prior periods’ financial statements have been reclassified to conform to the current periods’ presentation.

3.      Loans

             Loans consist of demand loans to custody clients of the Company, including 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. In addition, there have been no loan charge-offs or recoveries during the nine months ended September 30, 2000 and the year ended December 31, 1999. Loans are summarized as follows (Dollars in thousands):

             The Company had commitments to lend of approximately $208 million and $160 million at September 30, 2000 and December 31, 1999, respectively. The terms of these commitments are similar to the terms of outstanding loans.

4.      Goodwill

             Goodwill related to the Company’s acquisition of the BankBoston Business pursuant to a purchase and sale agreement dated July 17, 1998 is summarized as follows (Dollars in thousands):

             Under the terms of the purchase agreement with BankBoston, N.A., the Bank paid approximately $44 million, attributable to goodwill, to BankBoston as of the closing of the transaction on October 1, 1998 and paid an additional amount of approximately $4.9 million in February 2000 based upon client retention and business performance. In September 1999, the Bank received notification from BankBoston of its intent to terminate an outsourcing agreement, under which the Bank provided custody services to certain BankBoston asset management related businesses. In May 2000, the Bank received notification from the 1784 Funds that they intended to terminate the custody agreement between the Bank and the 1784 Funds. In connection with the termination of these agreements, the Bank received termination fees of $11.3 million. Therefore, the net effect of the additional payment and the termination fees was a decrease in t he purchase price of $6.4 million.

5.      Deposits

             Time deposits at September 30, 2000 and December 31, 1999 include non-interest bearing amounts of approximately $65 million at both dates.

             All time deposits had a minimum balance of $100,000 and a maturity of less than three months at September 30, 2000 and December 31, 1999.

6.      Short-Term Borrowings

             The components of short-term borrowings are as follows (Dollars in thousands):

             The Company has a borrowing arrangement with the Federal Home Loan Bank of Boston (‘FHLBB’), which is utilized on an overnight basis to satisfy temporary funding requirements. There were no outstanding advances under this agreement at September 30, 2000 or December 31, 1999.

             The rate on the outstanding balance of federal funds purchased from other banks at September 30, 2000 was 6.69%.

             The Company receives federal tax deposits from clients as agent for the FRB and accumulates these deposits in the Treasury, tax and loan account. The FRB charges the Company interest at the Federal funds rate on such deposits. The interest rate on the outstanding balance was 6.40% at September 30, 2000 and 5.46% at December 31, 1999.

7.      Stockholders’ Equity

             As of September 30, 2000, the Company has authorized 1,000,000 shares of Preferred Stock and 40,000,000 shares of Common Stock, all with a par value of $0.01 per share.

             At the Annual Meeting of Shareholders of the Company held on April 18, 2000, Shareholders approved an increase in the number of authorized shares of Common Stock from 20,000,000 to 40,000,000. On May 2, 2000, the Company filed an amendment to its Certificate of Incorporation increasing the number of authorized shares of Common Stock to 40,000,000. Such shares are available for general corporate purposes as determined by the Company’s Board of Directors.

             On May 15, 2000, the Board of Directors approved a two-for-one stock split in the form of a 100% stock dividend to shareholders of record on May 31, 2000. The dividend was paid on June 15, 2000. A total of 14,858,146 shares of common stock were issued in connection with the split. 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 6,797,973 shares of common stock were issued in connection with the stock split. The par value of these additional shares was capitalized by a transfer from retained earnings to common stock. The stock splits did not cause any change in the $0.01 par value per share of the common stock or in total stockholders’ equity.

             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 4,640,000 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 4,640,000 shares of Common Stock authorized for issuance under the plan, 875,726 were available for grant at September 30, 2000.

             The terms of the Amended and Restated 1995 Non-Employee Director Stock Option Plan provide for the grant of options to non-employee directors to purchase up to a maximum of 400,000 shares of Common Stock. Pursuant to the terms of the Plan, options to purchase 10,000 shares of Common Stock were awarded on November 8, 1995 to each director. 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 a nd 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 stock 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 under the Amended and Restated 1995 Stock Plan is determined by the compensation committee of the Board of Directors. All options become exercisable as specified by the Compensation Committee at the date of the grant.

             In November 1995, the Company granted 456,000 shares of Common Stock to certain officers of the Company under the 1995 Stock Plan. These grants were subject to the Company’s right to repurchase the shares if the officers’ employment with the Company terminated. The Company’s right to repurchase the shares lapsed over a five-year period. On March 31, 1998, the Company repurchased 8,000 unvested shares for $0.08 million under the terms of the Amended and Restated 1995 Stock Plan. By November 2000, all remaining shares outstanding under these grants were vested.

             On May 29, 1998, the Company granted 40,000 shares of Common Stock to an officer of Investors Capital Services, Inc. This grant is subject to the Company’s right to repurchase the shares if the officer’s employment with the Company terminates. The Company’s right to repurchase the shares lapses in five equal annual installments beginning one year from the date of grant.

             The Company has recorded deferred compensation of $0.3 million and $0.7 million at September 30, 2000 and December 31, 1999 respectively, related to the grants described in the previous two paragraphs.

             Under the terms of the 1997 Employee Stock Purchase Plan, the Company may issue up to 560,000 shares of Common Stock pursuant to the exercise of nontransferable options granted to participating employees. The 1997 Employee Stock 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:

             A summary of activity under the 1997 Employee Stock Purchase Plan is as follows (Number of shares):

             During the six months ended June 30, 2000, the purchase price of the stock was $21.00 or 90% of the average market value of the Common Stock on the first business day of the payment period ending June 30, 2000.

             During the year ended December 31, 1999, the purchase price of the stock was $13.75 and $17.50, or 90% of the average market value of the Common Stock on the first business day of the payment period ending June 30, 1999 and December 31, 1999, respectively.

             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 September 30, 2000 and 1999 as follows (Dollars in thousands, except share data):

8.      Off-Balance Sheet Financial Instruments

             Lines of Credit—At September 30, 2000, the Company had commitments to individuals and mutual funds under collateralized open lines of credit totaling $277 million, against which $69 million 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 September 30, 2000 and 1999 were $630 million and $500 million, 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 has never experienced 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 nine months of 2000, 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 rate was 6.12% at September 30, 2000. Variable-interest payments received are indexed to the one month London Interbank Offering Rate and the overnight Federal Funds rate. At September 30, 2000, the weighted-average rate of variable market-indexed interest payment obligations to the Company was 6.58%. 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 $0.3 million at September 30, 2000.

9.      Commitments and Contingencies

             Restrictions on Cash Balances—The Company is required to maintain certain average cash reserve balances. The reserve balance requirement with the FRB as of September 30, 2000 was $19.2 million. In addition, another cash balance in the amount of $2.7 million was pledged to secure clearings with a depository institution, Depository Trust Company, as of September 30, 2000.

             Lease Commitments— Minimum future commitments on non-cancelable operating leases at September 30, 2000 were as follows (Dollars in thousands):

             Total rent expense was $10.8 million and $8.2 million for the nine months ended September 30, 2000 and 1999, respectively.

             On September 20, 1995, the Company entered into a five-year service agreement with Electronic Data Systems (‘EDS’) expiring on December 31, 2005. Under the terms of the agreement, the Company agreed to pay certain monthly service fees based on usage. Service expense under this contract was $3.2 million for the nine months ended September 30, 2000 and $2.7 million for the nine months ended September 30, 1999.

             Contingencies—The Company provides global custody, multicurrency accounting, institutional transfer agency, performance measurement, foreign exchange, securities lending, mutual fund administration and investment advisory services to a variety of financial asset managers, including mutual fund complexes, investment advisors, banks and insurance companies. Assets under custody and management, held by the Company in a fiduciary capacity, are not included in the consolidated balance sheets since such items are not assets of the Company. Management conducts regular reviews of its fiduciary responsibilities and considers the results in preparing its consolidated financial statements. In the opinion of management, there are no contingent liabilities at September 30, 2000 that are material to the consolidated financial position or results of operations of the Company.

10.      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 results of operations and financial condition. 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 September 30, 2000, that the Company and the Bank meet all capital adequacy requirements to which they are subject.

             As of September 30, 2000, the most recent notification from the FDIC 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 as of September 30, 2000 and December 31, 1999 (Dollars in thousands):

             Under Massachusetts law, trust companies such as the Bank, like national banks, may pay dividends no more often than quarterly, and only out of ‘ net profits’ and to the extent that such payments will not impair the Bank’s capital stock and surplus account. Moreover, prior approval of the Commissioner of Banks of the Commonwealth of Massachusetts is required if the total dividends for a calendar year would exceed net profits for that year combined with retained net profits for the previous two years. These restrictions on the ability of the Bank to pay dividends to the Company may restrict the ability of the Company to pay dividends to its stockholders.

11.      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 nine months and the quarter ended September 30, 2000 and 1999, and long-lived assets by geographic area as of September 30, 2000 and December 31, 1999 (Dollars in thousands):

             No one customer accounted for 10% of the Company’s consolidated net operating revenues for the nine months or the quarter ended September 30, 2000 and 1999.

             The following represents the Company’s asset administration fees component of operating revenue by service line for the nine months and the quarter ended September 30, 2000 and 1999 (Dollars in thousands):

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 mutual fund complexes, investment advisors, banks and insurance companies. The Company provides financial asset administration services for net assets that totaled approximately $289 billion as of September 30, 2000, including approximately $18 billion of foreign assets.

             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 Bank paid approximately $48 million to BankBoston as of the closing and subsequently paid an additional $4.9 million based upon client retention and 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 Bank acted as custodian and provided certain other services for three BankBoston asset management related businesses: domestic private banking, institutional asset management and international private banking. In September 1999, the Bank received notification of BankBoston’s intent to terminate the outsourcing agreement. The termination, effective February 2000, had no impact on the remaining business purchased from BankBoston. Pursuant to the terms of the outsourcing agreement, the Bank received a termination fee of $7 million. In addition, in May 2000, the Bank received notification from the BankBoston sponsored 1784 Funds that the 1784 Funds intended to terminate their custody agreement with the Bank. Pursuant to the terms of the purchase agreement with BankBoston, the Bank received a termination fee of $4.3 million in connection with termination of the 1784 Funds custody agreement. Therefore, a net adjustment was made to decrease the purchase price by $6.4 million, resulting from the above-mentioned items. The Bank does not anticipate a material impact on net income due to the termination of the outsourcing agreement or the termination of the 1784 Funds custod y agreement. The Bank was informed by BankBoston that its decision to terminate both the outsourcing and the 1784 Funds custody agreement was not related in any way to the Company’s quality of service but was made as part of the integration process undertaken in connection with the BankBoston/Fleet merger.

             On March 26, 1999, the Company completed the issuance and sale of 1,800,000 shares of Common Stock at $14.50 per share in a private placement to one investor. The net capital raised in the private placement was used to support the Company’s balance sheet growth.

             On October 29, 1999, the Bank entered into an agreement with Sanwa Bank California, pursuant to which the Bank agreed to purchase the right to provide institutional custody and related services to accounts managed by the Trust Company of the West. The Bank completed the purchase on March 10, 2000. The accounts subject to the agreement totaled approximately $4.6 billion in assets at March 10, 2000.

             On May 15, 2000, the Board of Directors of the Company declared a two-for-one stock split in the form of a 100% stock dividend payable on or about June 15, 2000 to stockholders of record on May 31, 2000. All share numbers in this report have been restated to reflect the two-for-one stock split paid June 15, 2000, where applicable.

             In June 1998, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities”. In June 2000, the FASB issued SFAS No. 138, which amends certain provisions of SFAS 133 to clarify four areas causing difficulties in implementation. The amendment included expanding the normal purchase and sale exemption for supply contracts, permitting the offsetting of certain intercompany foreign currency derivatives and thus reducing the number of third party derivatives, permitting hedge accounting for foreign-currency denominated assets and liabilities, and redefining interest rate risk to reduce sources of ineffectiveness. The Company has appointed a team to implement SFAS 133 on a global basis. This team has been implementing a SFAS 133 compliant risk management informatio n system, globally educating both financial and non-financial personnel, inventorying

derivatives and addressing various other SFAS 133 related issues. The Company will adopt SFAS 133 and the corresponding amendments under SFAS 138 on January 1, 2001. The Company’s SFAS 133 team is currently determining the impact of SFAS 133 on the consolidated results of operations and financial position. This statement should have no impact on consolidated cash flows.

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 the Company’s financial results. Net operating revenue increased 32% to $162 million in the first nine months of 2000 from $123  million in the first nine months of 1999.

             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, 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 and are subject to minimum fees. 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 tr ustees, financial planners, other banks and fiduciaries, and other institutions are also included in non-interest income.

             Net interest income represents the difference between income generated from interest-earning assets and expense on interest-bearing liabilities. Interest-bearing liabilities are generated by the Company’s clients who, in the course of their financial asset management, generate cash balances, which they deposit on a short-term basis with the Company. The Company invests these cash balances and remits a portion of the earnings on these investments to its clients. The Company’s share of earnings from these investments is viewed as part of the total package of compensation paid to the Company from its clients for performing asset administration services.

Certain Factors That May Affect Future Results

             From time to time, information provided by the Company, statements made by its employees or information included in its filings with the SEC (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, the effect of the termination of the BankBoston outsourcing agreement and the 1784 funds custody agreement, and the effect of certain interest rate movements on the Company’s net interest income. 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 and the factors discussed under “Market Risk: Overview”. Each of these factors, and o thers, are discussed from time to time in the Company’s filings with the SEC.

             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 enga gements are, and in the future are likely to continue to be, terminable upon 60 days’ notice. Also, the outcome of any legal claims against the Company cannot be predicted with certainty and even if the Company is successful in defending or settling any claims, the existence of the claims may harm the Company’s reputation or ability to add new clients.

             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 must successfully integrate future acquisitions, if any, into the Company’s business. Also, the Company must continue to attract and retain skilled personnel in a tight labor market and expand office space commitments on favorable terms. If the Company fails to manage growth effectively, integrate acquisitions successfully, attract and retain skilled employees or expand office space commitments on favorable terms, 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. 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. Conversions of new client assets to the Company’s processing control may be impacted by the timing of client decisions and the willingness and ability of existing service providers to assist with the conversion. Because the Company’s operating expenses are relatively fixed, any unanticipated shortfall in revenues in a specified period may have an adverse impact on th e 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.

Statement of Operations   

Comparison of Operating Results for the Nine Months and the Quarter Ended September 30, 2000 and 1999

Non-interest Income

             Non-interest income increased $22.5 million to $120.8 million for the nine months ended September 30, 2000 from $98.3 million for the nine months ended September 30, 1999 and increased $6.5 million to $40.8 million for the quarter ended September 30, 2000 from $34.3 million for the quarter ended September 30, 1999. Non-interest income consists of the following items (Dollars in thousands):

             Asset administration fees increased $21.8 million to $119.2 million for the nine months ended September 30, 2000 compared to $97.4 million for the same period in 1999. For the quarter ended September 30, 2000 asset administration fees increased $6.2 million to $40.1 million from $33.9 million for the quarter ended September 30, 1999. The largest component of asset administration fees is asset-based fees, which increased in both periods due to an increase in assets processed. 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, multi-currency accounting, institutional transfer agency, performance measurement, foreign exchange, securities lending, mutual fund administration and investment advisory services. Total assets processed increased to $289 billion at September 30, 2000 from $262 billion at S eptember 30, 1999. This increase represents net growth in assets processed of $67 billion between those dates, offset in part by the loss of $40 billion in assets processed due to the termination of the BankBoston outsourcing arrangement and BankBoston 1784 Funds custodian agreement discussed under

“Overview” above. Of the net increase in assets processed, approximately 71% reflect assets processed for new clients and the remainder reflects growth of assets processed for existing clients. Another significant portion of the increase in asset administration fees resulted from the Company’s success in marketing ancillary services, such as foreign exchange and securities lending services.

             Computer service fees consist of amounts charged by the Company for data processing services related to client accounts. Other operating income consists primarily of dividends received relating to the FHLBB stock investment. The increase in other operating income resulted from an increase in FHLBB stock dividend income due to an increase in the Company’s investment in FHLBB stock at September 30, 2000, compared to September 30, 1999. Also included in other operating income was $0.3 million of income from consulting services performed for a client during the quarter ended September 30, 2000.

Operating Expenses

             Total operating expenses increased by $26.3 million to $124.8 million for the nine months ended September 30, 2000 compared to $98.5 million for the same period in 1999. For the quarter ended September 30, 2000, operating expenses increased by $8.0 million to $42.7 million compared to $34.7 million for the same period in 1999. The components of operating expenses were as follows (Dollars in thousands):

             Compensation and benefits expense increased $16.0 million or 26% to $76.4 million for the nine months ended September 30, 2000 from $60.4 million for 1999, and increased $4.4 million or 21% to $25.9 million for the quarter ended September 30, 2000 from $21.5 million for the same period in 1999. The average number of employees increased 15% to 1,602 during the nine months ended September 30, 2000 from 1,391 during the same period in 1999. The average number of employees for the quarter ended September 30, 2000 increased 15% to 1,717 from 1,490 for the quarter ended September 30, 1999. The increases in employees accommodated the expansion of new and existing client relationships during both periods. In addition, compensation expense related to the Company’s management incentive plans increased $3.3 million for the nine-month period because of the increase in earnings subject to incentive payments. Bene fits, including payroll taxes, group insurance plans, retirement plan contributions and tuition reimbursement, increased by $1.1 million for the nine months ended September 30, 2000 from the same period in 1999 and increased by $0.3 million for the quarter ended September 30, 2000 from the third quarter in 1999. These increases were 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 (‘ EDS’) for mainframe data processing, telephone expense, software maintenance fees and licenses, optical imaging and contract programming fees. Technology and telecommunication fees increased $5.4 million to $16.5 million for the nine months ended September 30, 2000 from $11.1 million for the same period in 1999. For the quarter ended September 30, 2000, these expenses increased $2.7 million to $6.4 million from $3.7 million for the same quarter last year. The Company’s use of contract programmers to perform information systems development projects accounted for $2.4 million of the nine month period to period increase and $1.1 million of the quarter to quarter increase. Increased hardware leasing and software maintenance

and licensing fees needed to support the growth in assets processed accounted for $1.5 million of the nine month period to period increase and $0.8 million of the quarter to quarter increase. Expenses related to network monitoring and help desk services, which commenced in 2000, along with mainframe data processing accounted for $0.5 million of both the year to date and quarter to quarter increase.

             Occupancy expense increased $1.9 million to $8.0 million for the nine months ended September 30, 2000 from $6.1 million for the nine months ended September 30, 1999 and increased $0.9 million to $2.9 million for the quarter ended September 30, 2000 from $2.0 million for the quarter ended September 30, 1999. These increases were primarily due to increased rent resulting from the expansion of office space in the Company’s Boston location at the higher current market rental rates.

             Transaction processing services expense consists of volume related expenses including subcustodian fees and external contract services. Transaction processing services expense increased $0.6 million to $7.4 million for the nine months ended September 30, 2000 from $6.8 million for the nine months ended September 30, 1999. This increase was due primarily to an increase in pricing services and subcustodian fees driven by the growth in assets processed.

             Depreciation and amortization expense increased $0.6 million to $3.4 million for the nine months ended September 30, 2000 from $2.8 million for 1999 and increased $0.2 million to $1.2 million for the quarter ended September 30, 2000 from $1.0 million in 1999. Increases in both periods resulted from capitalized software and capitalized expenditures associated with the expansion into additional office space.

             Travel and sales promotion expense consists of expenses incurred by the sales force, client management staff and other employees in connection with sales calls on potential clients, traveling to existing client sites and the Company’s foreign subsidiaries. Travel and sales promotion expense increased $0.9 million to $2.6 million for the nine months ended September 30, 2000 from $1.7 million for the nine months ended September 30, 1999 and increased $0.4 million to $1.1 million for the quarter ended September 30, 2000 from $0.7 million for the same quarter last year. Both increases are consistent with the increased level of business activity this year.

             Professional fees decreased by $0.5 million to $2.1 million for the nine months ended September 30, 2000 from $2.6 million for the nine months ended September 30, 1999 and decreased $0.4 million to $0.5 million for the quarter ended September 30, 2000 from $0.9 million for the same period in 1999. The decrease in professional fees relates primarily to nonrecurring consulting services during 1999 related to the integration of the BankBoston acquisition and tax planning.

             Other operating expenses include fees for recruiting costs, office supplies, temporary help and various fees assessed by the Massachusetts Commissioner of Banks. These expenses increased $1.5 million to $6.6 million for the nine months ended September 30, 2000 from $5.1 million for the nine months ended September 30, 1999. These expenses decreased $0.2 million to $1.7 million for the quarter ended September 30, 2000 from $1.9 million for the quarter ended September 30, 1999. The growth in assets processed contributed to the overall increase in other operating expenses for both periods. Recruiting costs decreased $0.3 million for the quarter to quarter comparison due to more efficient recruiting methods, offsetting the overall increases in other 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 compared to the same periods in 1999 (Dollars in thousands).

             Net interest income increased $16.6 million or 67% to $41.4 million for the nine months ended September 30, 2000 from $24.8 million for the same period in 1999. This increase resulted from an increase in interest income of $53.7 million net of an increase in interest expense of $37.1 million. Net interest income increased $6.4 million or 71% to $15.4 million for the quarter ended September 30, 2000 from $9.0 million for the same period in 1999. This increase resulted from an increase in interest income of $19.2 million net of an increase in interest expense of $12.8 million. The improvement in net interest income in both comparisons primarily reflects the positive effect of balance sheet growth driven by increased client deposits and borrowings. The net interest margin increased 20 basis points and 33 basis points to 2.12% and 1.92% for the nine-month and quarterly periods ended September 30, 2000, respectively, compared to last year.

             Average interest-earning assets, primarily investment securities, increased $889.5 million or 52% to $2.6 billion for the nine months ended September 30, 2000 from $1.7 billion for the nine months ended September 30, 1999 and increased $872.9 million or 45% to $2.8 billion for the quarter ended September 30, 2000 from $1.9 million for the quarter ended September 30, 1999. Funding for the asset growth for the nine months ended September 30, 2000 was provided by an increase in average short-term borrowings, primarily client repurchase agreements, of $493.7 million and an increase in average client deposits of $286.2 million. Funding for the asset growth for the quarter ended September 30, 2000 was provided by an increase in short-term borrowings, primarily client repurchase agreements, of $381.8 million and an increase in average client deposits of $287.1 million. The effect on net interest income from cha n ges in volume of interest-earning assets and interest-bearing liabilities was an increase of approximately $13.2 million for the nine months ended September 30, 2000 compared to the same period in 1999 and an increase of approximately $5.5 million for the quarter ended September 30, 2000 compared to the quarter ended September 30, 1999.

             Average yield on interest earning assets increased 80 basis points to 6.50% for the nine months ended September 30, 2000 from 5.70% for the same period in 1999 and increased 92 basis points to 6.73% for the quarter ended September 30, 2000 from 5.81% during the same period in 1999. The average rate paid by the Company on interest-bearing liabilities increased 75 basis points to 5.12% for the nine months ended September 30, 2000 from 4.37% for the year to date period ended September 30, 1999. The average rate paid increased 88 basis points to 5.41% for the quarter ended September 30, 2000 from 4.53% for the same period in 1999. The increase in rates over both periods reflects the current higher interest rate environment compared with 1999. The effect on net interest income due to changes in rates was an increase of approximately $3.4 million for the nine months ended September 30, 2000 and an increase of a pproximately $0.9 million for the quarter ended September 30, 2000.

Income Taxes

             Taxes for the nine months ended September 30, 2000 were $12.0 million, up from $7.9 million for the same period in 1999. The effective tax rate remained at 32% for both nine-month periods. Taxes for the quarter ended September 30, 2000 were $4.3 million, up from $2.6 million for the quarter ended September 30, 1999. The effective tax rate for the quarter ended September 30, 2000 was 32%, which compares to 30% for the quarter ended September 30, 1999. The quarter to quarter increase reflects a year to date adjustment recorded in the third quarter of 1999 related to the restructuring of corporate entities for state tax planning purposes.

Financial Condition

Investment Portfolio

             The following table summarizes the Company’s investment portfolio for the dates indicated (Dollars in thousands):

             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 exerci se 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.

             The book value and weighted average yield of the Company’s securities held to maturity at September 30, 2000, by effective maturity, are reflected in the following table (Dollars in thousands):

             The book value and weighted average yield of the Company’s securities available for sale at September 30, 2000 by effective maturity, are reflected in the following table: