United States

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, 2007

or

o                                 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition period from           to             

0-26996
(Commission File Number)

INVESTORS FINANCIAL SERVICES CORP.

(Exact name of registrant as specified in its charter)

 

 

(617) 937-6700

(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 o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes o  No x

As of April 30, 2007 there were 67,032,629 shares of common stock outstanding.

 

INVESTORS FINANCIAL SERVICES CORP.

INDEX

				Page
PART I.		FINANCIAL INFORMATION
Item 1.		Unaudited Consolidated Financial Statements
		Unaudited Consolidated Balance Sheets March 31, 2007 and December 31, 2006		3
		Unaudited Consolidated Statements of Income and Comprehensive Income Three months ended March 31, 2007 and 2006		4
		Unaudited Consolidated Statements of Stockholders’ Equity Three months ended March 31, 2007 and 2006		5
		Unaudited Consolidated Statements of Cash Flows Three months ended March 31, 2007 and 2006		6
		Notes to Unaudited Consolidated Financial Statements		7
		Report of Independent Registered Public Accounting Firm		22
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		23
Item 3.		Quantitative and Qualitative Disclosures about Market Risk		35
Item 4.		Controls and Procedures		35
PART II.		OTHER INFORMATION
Item 1.		Legal Proceedings		36
Item 1A.		Risk Factors		36
Item 6.		Exhibits		40
SIGNATURES				40

 

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PART I.  FINANCIAL INFORMATION

Item 1.    Unaudited Consolidated Financial Statements

Investors Financial Services Corp.
Unaudited Consolidated Balance Sheets
March 31, 2007 and December 31, 2006 (Dollars in thousands, except share data)

		March 31,			December 31,
		2007			2006
Assets
Cash and due from banks		$	142,448		$	92,776
Interest-bearing deposits with other banks		20,868			21,218
Other short-term investments		1,134			1,971
Federal funds sold and securities purchased under resale agreements		2,950,000			300,000
Securities held to maturity (including securities pledged of $4,169,418 and $4,096,013 at March 31, 2007 and December 31, 2006, respectively) (approximate fair value of $5,222,865 and $5,508,788 at March 31, 2007 and December 31, 2006, respectively) (Note 3)		5,248,480			5,532,330
Securities available for sale (including securities pledged of $3,730,234 and $3,071,503 at March 31, 2007 and December 31, 2006, respectively) (Note 3)		5,050,836			4,799,740
Nonmarketable equity securities		38,962			40,054
Loans, less allowance for loan losses of $100 at March 31, 2007 and December 31, 2006 (Note 4)		258,955			270,693
Accrued interest and fees receivable		142,106			134,748
Equipment and leasehold improvements, less accumulated depreciation of $66,477 and $64,290 at March 31, 2007 and December 31, 2006, respectively		131,768			113,287
Goodwill, net		79,969			79,969
Other assets		139,822			171,420
Total Assets		$	14,205,348		$	11,558,206
Liabilities and Stockholders’ Equity
Liabilities:
Deposits (Note 5):
Demand		$	1,353,144		$	695,821
Savings		6,499,626			4,924,735
Time		630,260			524,386
Total deposits		8,483,030			6,144,942
Securities sold under repurchase agreements (Note 6)		4,424,073			3,727,800
Short-term and other borrowings (Note 7)		62,497			517,051
Due to brokers for open trades payable		—			26,359
Junior subordinated deferrable interest debentures		24,774			24,774
Accrued taxes and other expenses		76,067			77,821
Other liabilities		110,648			100,721
Total liabilities		13,181,089			10,619,468
Commitments and contingencies (Note 12)		—			—
Stockholders’ Equity:
Preferred stock, par value $0.01 (shares authorized: 1,000,000; issued: none at March 31, 2007 and December 31, 2006)		—			—
Common stock, par value $0.01 (shares authorized: 175,000,000; issued: 69,660,108 and 68,523,129 at March 31, 2007 and December 31, 2006, respectively)		697			685
Surplus		372,773			334,929
Retained earnings		759,284			720,433
Accumulated other comprehensive loss, net		(5,700		)	(14,514		)
Treasury stock, at cost (2,895,021 shares at March 31, 2007 and December 31, 2006)		(102,795		)	(102,795		)
Total stockholders’ equity		1,024,259			938,738
Total Liabilities and Stockholders’ Equity		$	14,205,348		$	11,558,206

See Notes to Unaudited Consolidated Financial Statements.

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Investors Financial Services Corp.
Unaudited Consolidated Statements of Income and Comprehensive Income
Three Months Ended March 31, 2007 and 2006 (Dollars in thousands, except per share data)

		March 31,			March 31,
		2007			2006
Fees and Other Revenue:
Asset servicing fees:
Core service fees		$	129,026		$	107,759
Value-added service fees		40,627			40,544
Total asset servicing fees		169,653			148,303
Other operating income		1,479			1,164
Total fees and other revenue		171,132			149,467
Interest income		157,985			134,437
Interest expense		108,819			91,116
Net interest income		49,166			43,321
Net operating revenue		220,298			192,788
Operating Expenses:
Compensation and benefits		97,420			76,998
Technology and telecommunications		18,535			17,338
Transaction processing services		15,341			13,672
Occupancy		10,018			7,551
Depreciation and amortization		9,691			7,806
Professional fees		2,273			3,461
Travel and sales promotion		2,126			1,931
Insurance		980			973
Other operating expenses		3,010			5,954
Total operating expenses		159,394			135,684
Income Before Income Taxes		60,904			57,104
Provision for income taxes		20,403			19,701
Net Income		$	40,501		$	37,403
Basic Earnings Per Share		$	0.61		$	0.57
Diluted Earnings Per Share		$	0.60		$	0.56
Comprehensive Income:
Net income		$	40,501		$	37,403
Other comprehensive income (loss):
Net unrealized investment gain (loss)		11,329			(9,197		)
Net unrealized derivative instrument (loss) gain		(2,577		)	2,691
Cumulative translation adjustment		62			129
Other comprehensive income (loss)		8,814			(6,377		)
Comprehensive income		$	49,315		$	31,026

 

See Notes to Unaudited Consolidated Financial Statements.

4

 

Investors Financial Services Corp.
Unaudited Consolidated Statements of Stockholders’ Equity
Three Months Ended March 31, 2007 and 2006 (Dollars in thousands, except share data)

		March 31,			March 31,
		2007			2006
Common shares
Balance, beginning of period		68,523,129			67,177,306
Exercise of stock options		863,175			478,635
Restricted stock issuance		273,804			—
Balance, end of period		69,660,108			67,655,941
Treasury shares
Balance, beginning of period		2,895,021			2,124,669
Balance, end of period		2,895,021			2,124,669
Common stock
Balance, beginning of period		$	685		$	672
Exercise of stock options		12			5
Balance, end of period		697			677
Surplus
Balance, beginning of period		334,929			286,265
Share-based awards and exercise of stock options		31,326			15,314
Tax benefit from exercise of stock options		6,518			2,361
Transfer of deferred compensation to surplus		—			(311		)
Amortization of deferred compensation		—			104
Balance, end of period		372,773			303,733
Deferred compensation
Balance, beginning of period		—			(311		)
Transfer of deferred compensation to surplus		—			311
Balance, end of period		—			—
Retained earnings
Balance, beginning of period		720,433			572,549
Net income		40,501			37,403
Cash dividend, $0.0250 and $0.0225 per share in the three-month periods ended March 31, 2007 and 2006, respectively		(1,650		)	(1,469		)
Balance, end of period		759,284			608,483
Accumulated other comprehensive (loss) income, net
Balance, beginning of period		(14,514		)	(13,369		)
Net unrealized investment gain (loss)		11,329			(9,197		)
Net unrealized derivative instrument (loss) gain		(2,436		)	3,164
Amortization of terminated interest rate swap agreements		(141		)	(473		)
Cumulative translation adjustment		62			129
Balance, end of period		(5,700		)	(19,746		)
Treasury stock
Balance, beginning of period		(102,795		)	(72,948		)
Balance, end of period		(102,795		)	(72,948		)
Total Stockholders’ Equity		$	1,024,259		$	820,199

 

See Notes to Unaudited Consolidated Financial Statements.

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Investors Financial Services Corp.
Unaudited Consolidated Statements of Cash Flows
Three Months Ended March 31, 2007 and 2006 (Dollars in thousands)

		March 31,		March 31,
		2007		2006
Cash Flows From Operating Activities:
Net income		$40,501		$37,403
Adjustments to reconcile net income to net cash provided by operating activities:
Equity in undistributed loss of unconsolidated subsidiary		7		7
Depreciation and amortization		9,691		7,806
Share-based compensation		2,096		1,155
Amortization of premiums on securities, net of accretion of discounts		12,119		10,267
Excess tax benefit related to share-based compensation		(7,826	)	(1,633	)
Changes in assets and liabilities:
Accrued interest and fees receivable		(7,358	)	(4,187	)
Other assets		31,591		5,509
Accrued taxes and other expenses		(1,754	)	16,271
Other liabilities		5,518		29,895
Net cash provided by operating activities		84,585		102,493
Cash Flows From Investing Activities:
Proceeds from maturities and paydowns of securities available for sale		638,958		251,050
Proceeds from maturities and paydowns of securities held to maturity		273,459		302,247
Proceeds from the redemption of non-marketable equity securities		1,092		—
Purchases of securities available for sale		(871,332	)	(392,764	)
Purchases of securities held to maturity		(970	)	(48,363	)
Purchases of non-marketable equity securities		—		(750	)
Net decrease in due to brokers for open trades payable		(26,359	)	(9,344	)
Net increase in Federal funds sold and securities purchased under resale agreements		(2,650,000	)	(525,000	)
Net decrease (increase) in other short-term investments		837		(6,089	)
Net decrease in loans		11,738		94,449
Purchases of equipment, software and leasehold improvements		(28,165	)	(17,704	)
Net cash used for investing activities		(2,650,742	)	(352,268	)
Cash Flows From Financing Activities:
Net increase in demand deposits		657,323		107,326
Net increase in time and savings deposits		1,680,765		324,775
Net increase (decrease) in securities sold under repurchase agreements		696,273		(5,857	)
Net decrease in short-term and other borrowings		(454,554	)	(169,446	)
Proceeds from exercise of stock options		29,461		14,164
Excess tax benefit related to share-based compensation		7,826		1,633
Dividends paid to stockholders		(1,650	)	(1,469	)
Net cash provided by financing activities		2,615,444		271,126
Effect of exchange rates on cash		35		450
Net Increase in Cash and Due From Banks		49,322		21,801
Cash and Due From Banks, Beginning of Period		113,994		79,637
Cash and Due From Banks, End of Period		$163,316		$101,438

See Notes to Unaudited Consolidated Financial Statements.

6

 

Investors Financial Services Corp.
Notes to Unaudited Consolidated Financial Statements

1.     Description of Business

Investors Financial Services Corp. (‘IFSC’) provides asset administration services for the financial services industry through its wholly-owned subsidiary, Investors Bank & Trust Company (‘the Bank’).  As used herein, the defined term “the Company” shall mean IFSC together with the Bank and its domestic and foreign subsidiaries.  The Company provides core services and value-added services to a variety of financial asset managers, including mutual fund complexes, investment advisors, family offices, hedge funds, banks and insurance companies.  Core services include global custody, multicurrency accounting, fund administration and middle office outsourcing.  Value-added services include foreign exchange, cash management, securities lending, investment advisory, performance measurement, institutional transfer agency, lines of credit and brokerage and transition management services.  The Company is subject to regulation by the Federal Reserve Board of Governors (‘FRB’), the Federal Deposit Insurance Corporation (‘FDIC’), the Office of the Commissioner of Banks of the Commonwealth of Massachusetts (‘Commissioner’), the Securities and Exchange Commission (‘SEC’), the National Association of Securities Dealers, Inc. (‘NASD’), the State of Vermont Department of Banking, Insurance, Securities & Health Care Administration (‘BISHCA’), the Office of the Superintendent of Financial Institutions in Canada (‘OSFI’), the Irish Financial Services Regulatory Authority (‘IFSRA’), the Cayman Islands Monetary Authority (‘CIMA’), the Financial Services Authority in the United Kingdom (‘FSA’) and the Commission de Surveillance du Secteur Financier in Luxembourg (‘CSSF’).

On February 4, 2007, the Company entered into an Agreement and Plan of Merger (the ‘Merger Agreement’) with State Street Corporation (‘State Street’).  At the closing of the transaction contemplated by the Merger Agreement, the Company will merge into State Street and the Company’s shareholders will receive 0.906 shares of State Street common stock for each share of the Company’s common stock.  Each company’s Board of Directors has approved the Merger Agreement.  The Company expects to complete the transaction in the third quarter of 2007, subject to customary closing conditions, including regulatory and shareholder approval.

2.     Interim Financial Statements

The unaudited consolidated interim financial statements of the Company as of March 31, 2007 and December 31, 2006, and for the three-month periods ended March 31, 2007 and 2006 have been prepared by the Company pursuant to the rules and regulations of the SEC.  Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America (‘GAAP’) have been omitted as permitted by such rules and regulations.  All adjustments, consisting of normal recurring adjustments, necessary for their fair presentation in conformity with GAAP are included.  All significant intercompany accounts and transactions have been eliminated.  The Company’s 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.  The preparation of the financial statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes.  Actual results may differ from those estimates.  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 in prior years’ financial statements have been reclassified to conform to the current years’ presentation.

Cash and Cash Equivalents — For purposes of reporting cash flows and amounts on the consolidated balance sheets, the Company defines cash and cash equivalents to include cash, due from banks, and interest-bearing deposits with other banks that have original maturities of 90 days or less.

Securities — The Company classifies all equity securities that have readily determinable fair values and all investments in debt securities into one of three categories.  Debt securities that the Company has the positive intent and ability to hold to maturity are classified as held to maturity and carried at amortized cost.  Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and carried at fair value, with unrealized gains and losses included in earnings.  All other debt and equity securities not classified as either held to maturity or trading are classified as available for sale and carried at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income.

Non-marketable securities primarily consist of stock of the Federal Home Loan Bank of Boston (‘FHLBB’) and stock of the Federal Reserve Bank of Boston (‘FRBB’).  The FHLBB stock is carried at cost and redeemable at par value.  The Company is required to hold this stock under its borrowing arrangement with the FHLBB.  The Company was required to purchase stock of the FRBB in connection with its membership with the FRBB.

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An investment is considered impaired if the fair value of the investment is less than its cost.  The Company recognizes an impairment charge if, based on the facts and circumstances, management determines the impairment to be other than temporary.  For example, the Company will record an other than temporary impairment charge on a debt security if it is determined that it is probable that the Company will be unable to recover all amounts due under the contractual obligations of the security.

Amortization and accretion of debt securities purchased at a premium or discount are amortized or accreted into income using a method which approximates the constant effective yield method.  The Company applies Statement of Financial Accounting Standards No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases (‘SFAS 91’) for the amortization of premiums and accretion of discounts.  In calculating the effective yield for securities that represent holdings of large numbers of similar loans for which prepayments are probable and the timing and amount of prepayments can be reasonably estimated, prepayments are anticipated using the Company’s actual three-month prepayment experience.

The amount of amortization or accretion to recognize in income is driven by the calculation of the constant effective yield.  When calculating this yield, the Company assumes that prepayments will continue from the analysis date to the date of the security’s expected maturity at its most recent three-month prepayment rate.  The prepayment rate is updated monthly based on the Company’s previous three-month actual prepayment experience.

The Company utilizes three-month prepayment rates to anticipate prepayments because such rates are based on its own actual prepayment experience and because the Company believes three-month rates are a better estimate of future experience than either one-month or six-month or longer rates.  In the opinion of management, a one-month rate does not capture enough experience to predict future prepayment behavior and may create undue volatility in interest income due to one-time fluctuations in prepayment activity.  Conversely, in the opinion of management, a six-month or longer rate would not capture enough volatility to predict future prepayment behavior.

If a difference arises between the Company’s estimated prepayments and its actual prepayments received, the constant effective yield is recalculated based on the Company’s actual payments to date and anticipated future payments.  This monthly recalculation results in the carrying value of the security being adjusted to the amount that would have existed had the new effective yield been applied since the purchase date, and a corresponding charge or credit is recognized to interest income.

For securities that do not represent holdings of large numbers of similar loans for which prepayments are probable and the timing and amount of prepayments can be reasonably estimated, the associated premiums and discounts are amortized or accreted over their contractual term using the constant effective yield.  Actual prepayment experience for such securities is reviewed monthly and a proportionate amount of premium or discount is recognized in income at that time such that the effective yield on the remaining portion of the securities continues unchanged.

As of and for the periods ended March 31, 2007 and 2006, the Company anticipated prepayments on its residential mortgage-backed securities.  All other securities do not meet the SFAS 91 criteria for anticipating prepayments.  Accordingly, no prepayments were anticipated for these securities.

Income Taxes — Income tax expense is based on estimated taxes payable or refundable on a tax return basis for the current year and the changes in deferred tax assets and liabilities during the year.  Deferred tax assets and liabilities are established for temporary differences between the accounting bases and the tax bases of the Company’s assets and liabilities at enacted tax rates expected to be in effect when the amounts related to such temporary differences are realized or settled.  If the Company determines that it is “more likely than not” that some portion or all of a deferred tax asset will not be realized, the Company records a valuation allowance in accordance with the provisions of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (‘SFAS 109’).

The Company presents taxes collected from customers and remitted to government authorities (such as sales and value added taxes) on a net basis in the consolidated statement of income and comprehensive income.

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In accordance with Accounting Principles Board Opinion No. 23, Accounting for Income Taxes — Special Areas (‘APB 23’), the Company presumes the undistributed earnings of its foreign subsidiaries will be distributed to its parent company unless the Company adopts the indefinite reversal provisions of APB 23, which would require the Company to provide sufficient evidence to support that the subsidiary has invested or will invest the undistributed earnings indefinitely.  The Company recognizes the indefinite reversal provision of APB 23 for its Irish and Cayman Islands subsidiaries due to the projected capital needs necessary to support the continued growth of these entities.  As such, the Company does not record U.S. income taxes on the undistributed earnings of its Irish and Cayman Island subsidiaries.

On January 1, 2007, the Company adopted Statement of Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109 (‘FIN 48’).  FIN 48 establishes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  Pursuant to FIN 48, the effects of a tax position are recognized in the financial statements when it is more likely than not, based on the technical merits, that the position will be sustained upon examination by the taxing authority.  Conversely, previously recognized tax positions are derecognized when it is no longer more likely than not that the tax position would be sustained upon examination.  FIN 48 also requires certain disclosures regarding unrecognized tax benefits and the amounts and classification of the related interest and penalties.  There was no material impact to the financial condition or results of operations of the Company upon adoption of FIN 48.

As of January 1, 2007, the Company’s unrecognized tax benefit totaled $2.1 million.  The amount of unrecognized tax benefit which, if recognized, would affect the effective tax rate was $1.4 million, of which $0.4 million related to interest and penalties.  The Company does not anticipate recognizing any unrecognized tax benefits during the next twelve months.  In accordance with the Company’s policy, any tax-related interest and/or penalties are classified as a component of income taxes in the consolidated statement of financial position.  The tax years ended December 31, 2003, 2004 and 2005 remain subject to examination by various state jurisdictions.

Share-Based Compensation — On January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (‘SFAS 123R’).  SFAS 123R requires that compensation cost relating to share-based payment transactions be recognized in the financial statements, with measurement based upon the fair value of the equity or liability instruments issued.  The Company adopted SFAS 123R using the modified prospective application method.  Under that method, compensation cost for equity awards granted after January 1, 2006 is recognized over the service period based on the grant date fair value.  In addition, compensation cost for the portion of awards for which the requisite service has not been rendered that are outstanding as of January 1, 2006 is recognized prospectively as the requisite service is rendered.  The compensation cost for that portion of awards is based on the grant date fair value of those awards as calculated under the pro forma disclosures of Statement of Financial Accounting Standards No. 123, Accounting for Stock-based Compensation (‘SFAS 123’).  In accordance with the modified prospective application method, the financial statements of interim periods prior to the adoption of SFAS 123R have not been restated.

The following table sets forth share-based compensation cost and the related tax benefit recognized in the income statement for all of the Company’s share-based compensation plans (Dollars in thousands):

		For the Three Months Ended March 31,
		2007			2006
Share-based compensation cost		$	2,096		$	1,155
Income tax benefit		$	660		$	230

 

Certain of the Company’s share-based awards contain terms that provide for a graded vesting schedule whereby portions of the awards vest in increments over the requisite service period.  As provided for under SFAS 123R, the Company has elected to recognize compensation cost for awards granted on or after January 1, 2006 with graded vesting schedules on a straight-line basis over the requisite service period for the entire award.

The fair value of each option grant under the Director Plan, the Stock Plan, and the 2005 Plan (as described further in Note 8) was estimated on the date of grant using the Black-Scholes valuation model with the following weighted-average assumptions for the three months ended March 31, 2007 and 2006, respectively:  an average assumed risk-free interest rate of 4.67% and 4.52%, an average expected term of seven years and five years, an expected volatility of 50.42% and 42.82%, and an average dividend yield of 0.20% and 0.21%.

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The Company bases its estimate of expected term on the historical exercise and post-vesting employment termination behavior for similar grants. The Company’s volatility assumption is based on the historical volatility of the Company’s stock over a period equating to the expected term of the employee share option, using weekly price observations and looking backward from the date of grant.

The fair value of the option feature of grants under the 1997 Employee Stock Purchase Plan (‘ESPP’) (as described further in Note 8) was estimated on the grant date using the Black-Scholes valuation model with the following weighted-average assumptions for the three months ended March 31, 2007 and 2006, respectively:  an average assumed risk-free rate of 4.95% and 4.40%, an expected term of 0.5 years, an expected volatility of 28.84% and 36.96%, and an average dividend yield of 0.21% and 0.25%.

The expected term for the ESPP is equal to the six-month payment period.  The Company estimates expected volatility for the ESPP in the same manner as for employee stock options, except that daily volatility is used instead of weekly volatility.  The Company uses daily volatility for the ESPP because weekly volatility over six months does not result in a statistically significant number of data points upon which to base the volatility calculation.

Earnings Per Share — Basic earnings per share (‘EPS’) is computed by dividing net income by the weighted-average number of common shares outstanding during the quarter.  Diluted EPS reflects the potential dilution that could occur if contracts to issue common stock were exercised into common stock that then shared in the earnings of the Company.  The reconciliation from Basic EPS to Diluted EPS is as follows (Dollars in thousands, except per share data):

 

There were 843,717 and 91,737 options which were not considered dilutive for purposes of EPS calculations for the three-month periods ended March 31, 2007 and 2006, respectively.

Recently Issued Accounting Pronouncements — In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (‘SFAS 157’).  SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands upon existing disclosures about fair value measurements.  SFAS 157 does not require any new fair value measurements.  Rather, the guidance contained in SFAS 157 applies to assets, liabilities, and certain equity instruments that are already measured at fair value under existing accounting pronouncements.  SFAS 157 is effective for fiscal years beginning after November 15, 2007.  We do not anticipate any material impact to our financial condition or results of operations as a result of the adoption of SFAS 157.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (‘SFAS 159’).  SFAS 159 permits entities to elect to measure certain financial instruments and other items at fair value through earnings.  The fair value option may be applied on an instrument by instrument basis, is irrevocable and is applied only to entire instruments.  SFAS 159 requires additional financial statement presentation and disclosure requirements for those entities that elect to adopt the standard and is effective for fiscal years beginning after November 15, 2007.  We do not anticipate any material impact to our financial condition or results of operations as a result of the adoption of SFAS 159.

10

 

3.     Securities

Amortized cost amounts and fair values of securities are summarized as follows as of March 31, 2007 (Dollars in thousands):

		Amortized			Unrealized			Unrealized			Fair
Held to Maturity		Cost			Gains			(Losses)			Value
Mortgage-backed securities		$	3,611,327		$	9,784		$	(20,895	)	$	3,600,216
Federal agency securities		1,542,336			1,551			(19,971		)	1,523,916
State and political subdivisions		94,817			3,972			(56		)	98,733
Total		$	5,248,480		$	15,307		$	(40,922	)	$	5,222,865

 

		Amortized			Unrealized			Unrealized			Fair
Available for Sale		Cost			Gains			(Losses)			Value
Mortgage-backed securities		$	4,137,289		$	11,880		$	(21,522	)	$	4,127,647
Federal agency securities		398,954			42			(46		)	398,950
State and political subdivisions		343,905			2,539			(453		)	345,991
Corporate debt		168,404			127			(818		)	167,713
Foreign government securities		10,556			—			(21		)	10,535
Total		$	5,059,108		$	14,588		$	(22,860	)	$	5,050,836

 

Amortized cost amounts and fair values of securities are summarized as follows as of December 31, 2006 (Dollars in thousands):

		Amortized			Unrealized			Unrealized
Held to Maturity		Cost			Gains			(Losses)			Fair Value
Mortgage-backed securities		$	3,753,497		$	7,271		$	(25,584	)	$	3,735,184
Federal agency securities		1,680,458			2,956			(12,328		)	1,671,086
State and political subdivisions		98,375			4,206			(63		)	102,518
Total		$	5,532,330		$	14,433		$	(37,975	)	$	5,508,788

 

		Amortized			Unrealized			Unrealized
Available for Sale		Cost			Gains			(Losses)			Fair Value
Mortgage-backed securities		$	4,302,932		$	7,400		$	(35,281	)	$	4,275,051
State and political subdivisions		343,204			2,090			(990		)	344,304
Corporate debt		170,797			226			(1,173		)	169,850
Foreign government securities		10,559			—			(24		)	10,535
Total		$	4,827,492		$	9,716		$	(37,468	)	$	4,799,740

 

Excluded from the above tables are nonmarketable equity securities, which consisted primarily of stock of the FRBB and FHLBB at March 31, 2007 and December 31, 2006.  The Company’s capital stock investment in the FHLBB totaled $28.4 million as of March 31, 2007, which represents a $1.0 million decrease from December 31, 2006.  The $28.4 million capital stock investment includes both a $25.0 million membership component and a $3.4 million activity-based component.  The membership component of the FHLBB capital stock investment requires a five-year advance notice of withdrawal.  The Company’s $28.4 million capital stock investment in the FHLBB provides an overnight borrowing capacity of up to $114.5 million.  There was no outstanding balance under this arrangement as of March 31, 2007.  The Company currently has the ability to purchase up to $25.0 million of activity-based capital, which would provide a total overnight borrowing capacity of $833.3 million.

The Company had no sales of securities during the three-month periods ended March 31, 2007 and March 31, 2006.

The carrying value of securities pledged amounted to approximately $7.9 billion and $7.2 billion at March 31, 2007 and December 31, 2006, respectively.  Securities are pledged primarily to secure clearings with other depository institutions, to secure repurchase agreements and to secure outstanding FHLBB and Federal Reserve Discount Window borrowings.

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On a quarterly basis the Company reviews its investment portfolio on a security by security basis for any investment that may be other than temporarily impaired.  In its evaluation, the Company considers the length of time the security has been impaired, the severity of the impairment, the financial condition and future prospects of the issuer and the Company’s ability and intent to hold the security to maturity or until it recovers in value.  At March 31, 2007, no securities were considered to be other-than-temporarily impaired.

4.     Loans

Loans consist of demand loans to custody clients of the Company, including individuals, not-for-profit institutions and mutual fund clients.  The loans to mutual funds and other pooled product clients include lines of credit and advances pursuant to the terms of the custody agreements between the Company and those clients to facilitate securities transactions and redemptions.  Almost all of the Company’s commitments to fund loans are at variable rates.  The credit risk associated with these loans is considered low since the loans are, or may be, in the event of default, collateralized with marketable securities held by the Company as custodian.  However, management recognizes some credit risk inherent in the portfolio, and therefore the Company has recorded an allowance for loan losses of $0.1 million at March 31, 2007, a level which has remained consistent for the past five years.  This allowance is not allocated to any particular loan, but is intended to absorb any risk of loss inherent in the loan portfolio at the balance sheet date that is not captured in the Company’s historical loss rates.  Management actively monitors the loan portfolio and the underlying collateral and regularly assesses the adequacy of the allowance for loan losses.  There were no impaired loans, nonperforming loans or loans on nonaccrual status at March 31, 2007 or December 31, 2006.  In addition, there were no loan charge-offs or recoveries during the three months ended March 31, 2007 or 2006.  Loans are summarized as follows (Dollars in thousands):

 

5.     Deposits

The following is a summary of deposit balances by type (Dollars in thousands):

 

Time deposits with balances greater than $100,000 totaled $630.3 million and $524.4 million at March 31, 2007 and December 31, 2006, respectively.  All time deposits had a maturity of less than three months at March 31, 2007 and December 31, 2006.  The aggregate amounts of overdraft deposits that have been reclassified as loan balances were $131.3 million and $86.2 million at March 31, 2007 and December 31, 2006, respectively.

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6.     Securities Sold Under Repurchase Agreements

The components of securities sold under repurchase agreements are as follows (Dollars in thousands):

 

Approximately $4.6 billion and $3.9 billion of securities were pledged to collateralize repurchase agreements as of March 31, 2007 and December 31, 2006, respectively.

7.     Short-term and Other Borrowings

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

 

The Company has borrowing arrangements with the Federal Reserve Discount Window and the FHLBB, which have been utilized on an overnight and short-term basis to satisfy funding requirements.  A summary of the borrowing arrangements are as follows (Dollars in thousands):

 

8.     Stockholders’ Equity

As of March 31, 2007, the Company’s capital stock consisted of 1,000,000 authorized shares of preferred stock, of which no shares were issued, and 175,000,000 authorized shares of common stock, of which 69,660,108 shares were issued.  All shares have a par value of $0.01 per share.

The Company has four equity incentive plans:  the Amended and Restated 1995 Stock Plan (‘Stock Plan’), the Amended and Restated 1995 Non-Employee Director Stock Option Plan (‘Director Plan’), the 1997 Employee Stock Purchase Plan (‘ESPP’) and the 2005 Equity Incentive Plan (the ‘2005 Plan’).  The 2005 Plan supersedes both the Stock Plan and the Director Plan, both of which continue in effect only with regard to options outstanding under those plans.  Options awarded under the Stock Plan, the Director Plan and the 2005 Plan generally vest over zero to nine years of continuous service and generally have ten-year contractual terms.  The exercise prices of these awards are generally equal to the fair market value of the Company’s common stock on the date the awards are granted.  There were no amendments to any plans during the three months ended March 31, 2007.

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Cash received from options exercised under all share-based payment arrangements for the three months ended March 31, 2007 was $29.5 million.  The actual tax benefit realized for the tax deductions related to these exercises amounted to $6.6 million for the three months ended March 31, 2007.

In June 2006, the Company announced that its Board of Directors authorized a repurchase plan of up to $150.0 million of the Company’s common stock over the twelve months following the announcement.  As of March 31, 2007, the Company has repurchased $29.3 million of its common stock.  The plan expires in June 2007.

The Stock Plan, the Director Plan, and the 2005 Plan

Effective with the start of the 2005 Plan, 45,703 shares of the Director Plan and 3,439,197 shares of the Stock Plan were transferred to the 2005 Plan.  On April 14, 2005, the shareholders authorized an additional 2,000,000 shares of common stock for issuance under the 2005 Plan.

A summary of option activity under the Stock Plan, the Director Plan and the 2005 Plan for the three months ended March 31, 2007 is as follows:

 

The weighted-average grant-date fair values per option of options granted during the three months ended March 31, 2007 and 2006 were $26.37 and $19.24, respectively.  The total intrinsic values of options exercised during the three months ended March 31, 2007 and 2006 were $22.1 million and $7.1 million, respectively.

As of March 31, 2007, there was $21.5 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Stock Plan, the Director Plan and the 2005 Plan.  That cost is expected to be recognized over a weighted-average period of 4.2 years.

A summary of the status of the Company’s nonvested shares for the three months ended March 31, 2007 is presented below:

 

As of March 31, 2007, there was $12.7 million of total unrecognized compensation cost related to nonvested shares granted under the Stock Plan, the Director Plan and the 2005 Plan.  That cost is expected to be recognized over a weighted-average period of 4.6 years.

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ESPP

Under the terms of the ESPP, the Company may issue up to 1,620,000 shares of common stock pursuant to the exercise of nontransferable options granted to participating employees.  The ESPP permits eligible employees to purchase up to 8,000 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 market value of the Company’s common stock on the first business day of the payment period or (ii) 90% of the market value of the Company’s 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.  The NASDAQ Stock Market became a registered national securities exchange with the SEC in August 2006.  In accordance with the terms of the plan, because the Company is now traded on a national securities exchange, the Company will calculate the market value on a measurement day to be the average of the high and low prices of the Company’s common stock on that day.  This calculation method applies to all purchases made during and after the six-month period ended December 31, 2006.

A summary of activity under the ESPP is as follows:

 

For the first payment period in the year ended December 31, 2006, the purchase price of the stock was $33.52, or 90% of the market value of the Company’s common stock on the first business day of the payment period ending June 30, 2006.  For the second payment period in the year ended December 31, 2006, the purchase price of the stock was $38.45, or 90% of the market value of the average of the high and low price of the Company’s common stock on the last business day of the payment  period ending December 31, 2006.

Prior to the adoption of SFAS 123R, the ESPP was considered a non-compensatory plan and, therefore, no compensation cost was recognized.  However, pursuant to SFAS 123R, the ESPP is considered a compensatory plan, effective January 1, 2006.  Accordingly, compensation cost is computed as the sum of:  (a) 10% of the fair market value of the Company’s common stock on the first day of the purchase period and (b) the fair value of the option features, calculated using the Black-Scholes valuation model.  Compensation cost is recognized ratably over the payment period based on the components of fair value in the preceding sentence and the number of shares that could be purchased at grant date based on the estimated total withholdings and the discounted market price of the stock on grant date.  The weighted-average grant-date fair value of awards granted under the ESPP was $8.17 per share for the three months ended March 31, 2007.

Compensation cost related to the ESPP was $0.3 million and $0.2 million for the three months ended March 31, 2007 and 2006, respectively.  As of March 31, 2007, there was $0.3 million of total unrecognized compensation cost related to the nonvested awards granted under the ESPP.

9.     Employee Benefit Plans

Pension Plan — The Company has a trusteed, noncontributory, qualified defined benefit pension plan (‘Pension Plan’) covering substantially all of its employees who were hired before January 1, 1997.  The benefits are based on years of service and the employee’s compensation during employment.  Generally, the Company’s funding policy is to contribute annually the maximum amount that can be deducted for federal income tax purposes.  Contributions are intended to provide not only for benefits attributed to service to date, but also for benefits expected to be earned in the future.  The plan document was amended in December 2001 and December 2004 to freeze benefit accruals for certain highly compensated participants.  Effective December 31, 2005, all Pension Plan participant’s accounts were frozen and effective January 1, 2006, no further Pension Plan benefit will accrue on behalf of any Pension Plan participant.   The Company uses a December 31 measurement date for this plan.

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Net periodic pension benefit for the Company’s Pension Plan included the following components (Dollars in thousands):

 

The Company does not expect to contribute to its Pension Plan during 2007, and no contributions were made during the three-month period ended March 31, 2007.

Supplemental Retirement Plan — The Company also has a nonqualified, unfunded, supplemental retirement plan (‘SERP’) which was established in 1994 and covers certain employees and pays benefits that supplement any benefits paid under the Pension Plan.  Benefits under the SERP are generally based on compensation not includable in the calculation of benefits to be paid under the Pension Plan.  The plan document was amended in April 2000 to eliminate the compensation cap and include bonuses and commissions of certain employees.  The Company uses a December 31 measurement date for this plan.

Net periodic pension cost for the Company’s SERP included the following components (Dollars in thousands):

 

During the three-month period ended, March 31, 2007, the Company contributed $0.03 million to the SERP, and the SERP distributed $0.03 million to its plan participants.  The Company does not anticipate making any contributions during the remainder of 2007.

Effective December 31, 2006, the Company adopted the provisions of FASB Statement No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (‘SFAS 158’).  SFAS 158 changes current practice by requiring employers to recognize the overfunded or underfunded positions of defined benefit postretirement plans, including pension plans, on the balance sheet.  The funded status is defined as the difference between the projected benefit obligation and the fair value of plan assets.  SFAS 158 also requires employers to recognize the change in funded status in other comprehensive income (a component of shareholders’ equity).  Upon adopting SFAS 158, the Company recognized the funded status of its SERP and pension plans on its consolidated balance sheet.

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