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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [NO FEE REQUIRED]
For the fiscal year ended December 31, 1996
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [NO FEE REQUIRED]
For the transition period from _______ to _______
COMMISSION FILE NUMBER 0-26996
INVESTORS FINANCIAL
SERVICES CORP.
(Exact name of registrant as specified in its charter)
DELAWARE 04-3279817
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
89 SOUTH STREET
P.O. BOX 1537 02205
BOSTON, MASSACHUSETTS (Zip Code)
(Address of principal executive offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (617) 330-6700
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $.01 PAR VALUE
CLASS A COMMON STOCK, $.01 PAR VALUE
SERIES A JUNIOR PREFERRED STOCK PURCHASE RIGHTS
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No_____
-----
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of Common Stock held by non-affiliates of the
registrant was $189,006,707 based on the last reported sale price of $34.25 on
The Nasdaq National Market on February 18, 1997 as reported by Nasdaq.
As of February 18, 1997, there were 6,101,636 shares of Common Stock
outstanding and 342,676 shares of Class A Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The registrant intends to file a definitive proxy statement pursuant to
regulation 14A within 120 days of the end of the fiscal year ended December 31,
1996. Portions of such proxy statement are incorporated by reference into Part
III of this report.
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ITEM 1. BUSINESS
GENERAL
Investors Financial Services Corp. (the "Company"), based in Boston,
Massachusetts, provides asset administration services for the financial services
industry through its wholly-owned subsidiary, Investors Bank & Trust Company(R).
The Company provides domestic and global custody, multicurrency accounting,
institutional transfer agency, performance measurement, foreign exchange,
securities lending, mutual fund administration and investment advisory services
to a variety of financial asset managers, including mutual fund complexes,
investment advisors, banks and insurance companies. The Company provides
financial asset administration services for assets that totaled approximately
$122 billion at December 31, 1996, including assets managed by 51 mutual fund
complexes and insurance companies and approximately $9 billion of foreign
assets. The Company also engages in private banking transactions, including
secured lending and deposit accounts.
The Company operated as a subsidiary of Eaton Vance Corp. ("Eaton Vance"),
an investment management firm conducting business through subsidiaries, from its
formation in 1969 through November 1995. In 1995, the boards of directors of
the Company and Eaton Vance determined to separate the business operations of
the Company from those of Eaton Vance by means of a tax free, pro rata
distribution of Eaton Vance's ownership interest in the Company to the
stockholders of Eaton Vance (the "Spin-Off Transaction"). The principal reasons
for the Spin-Off Transaction were to eliminate certain regulatory restrictions
to which the Company was subject under the Competitive Equality Banking Act of
1987 ("CEBA"), and to enable the Company to pursue its business goals
independent of Eaton Vance. In order to avoid being regulated as a bank holding
company under the Bank Holding Company Act of 1956, Eaton Vance had operated
Investors Bank & Trust Company under certain growth and activity restrictions.
The elimination of the CEBA growth and activity restrictions enabled the Company
to expand its current business activities and participate in certain additional
business activities. The Spin-Off Transaction was completed on November 10,
1995, prior to the completion of an initial public offering of 2,300,000 shares
of the Company's Common Stock, $.01 par value, (the "Common Stock") on November
14, 1995 (the "Offering"). As used herein, the defined term "Company" shall
mean Investors Financial Services Corp. from and after June 29, 1995, the date
of organization of Investors Financial Services Corp., and shall mean Investors
Bank & Trust Company prior to that date, unless the context otherwise indicates.
Investors Bank & Trust Company is sometimes referred to herein as the "Bank."
Prior to the completion of the Spin-Off Transaction, the Company's fiscal
year end was October 31, the fiscal year end observed by Eaton Vance and the
Company filed an annual report on Form 10-K with the Securities and Exchange
Commission for the year ended October 31, 1995. In December 1995, the Company
elected to change its fiscal year end from October 31 to December 31 in order to
align its fiscal year end with its regulatory, tax and budget reporting period.
The Company filed a Transition Report on Form 10-K for the two-month period from
November 1, 1995 through December 31, 1995 (the "Transition Period").
Accordingly, this report contains certain financial information and operating
results for the years ended October 31, 1994 and 1995, for the Transition Period
and for the year ended December 31, 1996. The operating results for the
Transition Period are not necessarily indicative of annualized results.
OVERVIEW OF THE FINANCIAL SERVICES INDUSTRY
In the financial services industry, asset managers, whether independent or
affiliated with investment management companies, banks or insurance companies,
manage and invest financial assets entrusted to them. Asset managers utilize a
broad range of pooled investment products such as mutual funds, unit investment
trusts, separate accounts and variable annuities to achieve their clients'
investment goals. Asset administration companies, such as the Company, perform
various services for the asset managers and the pooled products they sponsor,
including domestic and global custody, multicurrency accounting, transfer
agency, portfolio performance measurement, foreign exchange, securities lending,
administration and advisory services.
The Company believes that the rapid pace of financial asset creation
through the flow of assets into pooled products and other investment products
and the related asset administration of those products is the key to revenue
growth for asset administration companies. As shown in the chart below, total
financial assets managed by mutual fund companies, insurance companies, private
pension funds and banks have grown at an average annual rate of over 12% since
1990. Mutual funds, such as those serviced by the Company, make up a large part
of the financial assets in pooled investment vehicles and have grown at the most
rapid pace. The U.S. mutual fund market has grown at an average annual rate of
19.32% since 1990, with over $3.0 trillion in assets at September 30, 1996.
According to Bank Securities Journal, worldwide fund assets were over $5.4
trillion in June 1996, an increase of $3.0 trillion in approximately five years.
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TOTAL U.S. FINANCIAL ASSETS
(in billions) DECEMBER 31, 1990 SEPTEMBER 30, 1996 GROWTH RATE
Mutual Funds 1,154.6 3,197.7 19.32%
Life Insurance Companies 1,367.4 2,199.0 8.60
Private Pension Funds 1,610.9 2,873.1 10.57
Bank Personal Trusts and Estates 522.1 773.5 7.07
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Total 4,655.0 9,043.3 12.22%
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Source: Federal Reserve Bank
The asset administration environment differs by asset management
organization and operational philosophy. Most asset managers outsource custody
services. In many cases, they use multiple custodians to foster cost reduction
through competition. Large asset managers may have the critical mass necessary
to justify the cost of in-house facilities to handle accounting, administration
and transfer agency services, while smaller asset managers outsource these
services as well. The Company believes that asset administration companies such
as the Company operate most efficiently when bundling services such as custody
and accounting with value-added services such as securities lending and foreign
exchange. The Fund Accounting and Custody Tracking System ("FACTS"), the
software system developed and owned by the Company, with its integrated
functionality, supports these services, so that information is input once and is
entered into various administrative subsystems without manual intervention.
Providing asset administration services offshore is a growing activity in
the financial services industry. Non-U.S. investors in certain pooled
investment vehicles are subject to U.S. income tax if their income is
effectively connected with the conduct of a trade or business in the U.S.
Operating an investment fund from an offshore location is a requirement for
sheltering an investment fund from U.S. taxation. In July 1993, the Company
opened a subsidiary in Toronto, Canada to service the growing offshore mutual
fund market. In July 1994, the Company opened an office in Dublin, Ireland to
service European clients. In February 1996, the Company opened a small
administration site in the Cayman Islands to service Caribbean-based funds.
Another driving force in the financial services industry is information
technology. Asset managers are able to create innovative investment products
using data from world markets as a result of more powerful and affordable
information processing power, coupled with the ability to send large volumes of
information instantly through widely dispersed communication networks. Timely
on-line access to electronic information on security positions, prices and price
shifts facilitate on-line currency trading, indexation of assets, real time
arbitrage, and hedging through the use of derivative securities. Asset
administration providers use technology as a competitive tool to deliver precise
and functional information to the asset managers, and to increase value-added
services. Value-added services include performance measurement and analytical
tools for asset managers, such as reports showing time-weighted return,
performance by sector, and time-weighted return by sector. Other factors, such
as the reduction in settlement times in world markets, have created greater
demand for asset administration service providers to have on-line, real-time
systems. The Company believes that the integrated nature of FACTS, compared
with the disparate systems used for different tasks by many other financial
service providers, provides the Company with a competitive advantage and
positions the Company well to respond to the changing technological demands of
the financial services industry.
Competition in the asset administration industry has reduced pricing in
almost all business segments, particularly with respect to custody services and
trustee services. Partially offsetting this trend is the development of new
services that have higher margins. The Company's continuous investment in
technology has permitted it to offer new value-added services to clients, such
as offshore custody and fund accounting, securities lending and foreign exchange
at competitive prices around the globe. Technological evolution and new service
innovation enable the Company to generate additional revenues to offset price
pressure in maturing service lines.
Asset managers create different investment structures in an effort to
capture the efficiencies of larger pools of assets. One example of this
innovation is the master-feeder structure. In the master-feeder structure, one
or more investment vehicles (the "feeder funds") with identical investment
objectives pool their assets in a common portfolio held by a separate investment
vehicle (the "master fund"). This structure permits each of the feeder funds to
be sold to a separate target market and through a different distribution channel
even if the feeder fund, on a stand alone basis, would not be large enough to
support its operating costs. The feeder funds benefit from economies of scale
available to the larger pool of funds invested in the master fund. A
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patented variation of the master-feeder structure, Hub and Spoke(R), is marketed
by Signature Financial Group, Inc. ("SFG"). At December 31, 1996, the Company
processed over $30 billion of assets in the master-feeder structures, including
$27 billion of assets processed in the Hub and Spoke structure. See "The
Company - Company Strategy."
In addition, a growing number of mutual funds have been structured as
multiple class funds in order to address the differing requirements and
preferences of potential investors. In the typical multiple class environment,
investors have the option of purchasing fund shares with the sales load
structure that best meets their short-term and long-term investment strategy.
Multiple class arrangements allow an investment company to sell interests in a
single investment portfolio to separate classes of stockholders. Multiple class
funds, due to the increased complexity of their structure, present new
opportunities for asset administration companies.
The financial asset service industry has recently experienced a
consolidation among service providers. The Company believes that its size and
its responsiveness to client needs provide the financial services industry with
an asset administration alternative to superregional and money center banks and
other administration providers. In addition, consolidation within the industry
creates opportunity for the Company as prospective clients review their
relationships with existing service providers. The Company's sales and
marketing group actively monitors these situations as they develop.
COMPANY STRATEGY
Global and domestic custody and multicurrency accounting are the principal
asset administration services provided to the Company's clients. The Company's
securities lending, foreign exchange, transfer agency and mutual fund
administration and investment advisory services are value-added services
utilized by clients based on their particular needs. The Company's objective is
to provide a broad range of services to all clients, maximize the use of its
value-added services and increase the size of its client base. To achieve this
objective, the Company has adopted the following strategy:
. Deliver superior service and expand client relationships. Service
quality in asset administration relationships is a key to maintaining
existing business and attracting new clients. The Company takes an
integrated approach to asset administration rather than the functional
approach of some of its competitors. Instead of separate departments
managing components of the custody and accounting task (e.g., trade
settlement, income collection, corporate actions, general ledger
accounting, portfolio accounting and pricing), the Company has
integrated these custody and accounting functions and dedicates a
single operations team to handle all work for a particular account or
fund. In addition, each client is assigned a Client Manager,
independent of the operations team, to anticipate the client's needs,
to coordinate service delivery, and to provide consulting support.
The Company believes that its strong client relationships create
continuing opportunities to provide additional services to existing
customers. Financial assets processed by the Company for existing
clients increased by $21.6 billion during the year ended December 31,
1996.
. Maintain technological expertise. The asset administration industry
requires the technological capability to support a wide range of
global security types and complex portfolio structures in both local
and base currencies, as well as the telecommunications flexibility to
support the diversity of global communications standards. FACTS was
developed in the mid-1980s to support the Company's integrated
approach to the provision of services to its clients. From a systems
standpoint, FACTS is an integrated computerized information system
that provides custody, securities movement and control, portfolio
accounting, general ledger accounting, pricing, net asset value
calculation, and Hub and Spoke or master-feeder processing into a
single information system. By consolidating these functions, the
Company has eliminated redundancy in data capture and reduced the
opportunity for clerical error. The FACTS architecture enables the
Company to modify the system quickly, resulting in increased
processing quality and efficiency for its clients. The Company
believes that this integrated architecture helps differentiate the
Company from its competitors.
System enhancements and upgrades are an ongoing part of asset
administration, both to remain competitive and to create information
delivery mechanisms that add value to the information available as
part of clearing and settling transactions. During the past two
years, the Company has developed standardized data extracts and
automated interfaces that allow its clients to connect electronically
with the Company's host computer and access data collected from
clearance and settlement transactions in multiple currencies on a
real-time basis. Through these information-sharing tools, the Company
is better equipped to expand its custody and accounting services with
4
foreign exchange services and asset and transaction reporting and
monitoring services. This electronic linkage also positions the
Company to respond quickly to client requests.
The Company's 75 systems professionals have developed expertise
in various advanced technologies, including graphical user interfaces,
relational database management systems, distributed processing and
imaging technology. The Company intends to continue to utilize these
technologies to provide the responsiveness necessary to keep pace with
the rapidly changing requirements of the industry and the needs of its
clients.
. Expand the range of value-added service offerings. Asset
administration companies gain competitive advantage by offering a
range of value-added services to their financial services clients. The
Company operates most efficiently when bundling basic services such as
custody and accounting with value-added services such as performance
measurement, securities lending and foreign exchange. Since the Spin-
Off Transaction, the Company has not been subject to the activity
restrictions imposed by CEBA and now is able to participate in
additional business activities.
The Company's clients, which consist mainly of managers of mutual
funds, unit investment trusts and other pooled asset products,
typically generate large cash balances from securities sales and other
transactions which they wish to invest on a short-term basis. Because
the Company was subject to a 7% annual asset growth cap under CEBA, it
was not able to accept those deposits and directed those deposits to
other financial institutions, foregoing a potential source of revenue.
The Company directed client deposits averaging almost $1.2 billion
daily to other financial institutions in fiscal year 1995. Similarly,
many of the Company's clients use credit lines to leverage their
portfolios or to handle overnight cash shortfalls; however, CEBA rules
restricted the Company from making commercial loans of this type. As a
result of the Spin-Off Transaction, the Company may now offer these
deposit and lending services directly to existing and potential
clients.
In November 1996, the Bank executed agreements with the Merrimac
Master Portfolio and the Merrimac Funds, newly formed master-feeder
investment companies (the "Funds"), pursuant to which the Company has
agreed to act as investment advisor to the Funds. At the same time,
the Company engaged The Bank of New York to act as sub-advisor to
manage the investments of the Funds. Currently, the Funds have one
operating master fund, the Merrimac Cash Portfolio, and one operating
feeder fund, the Merrimac Cash Fund.
. Expand offshore processing capabilities. Non-U.S. investors in certain
pooled investment vehicles are subject to U.S. income tax if their
income is effectively connected with the conduct of a trade or
business in the U.S. To shelter effectively an investment fund from
U.S. taxation, the fund's operations, including asset administration
functions, must be conducted outside the U.S. In July 1993, the
Company opened a subsidiary in Toronto, Canada to service the growing
offshore mutual fund market. As of December 31, 1996, the Canadian
subsidiary processed over $12 billion in assets requiring the
calculation of 84 daily net asset values. In July 1994, the Company
opened an office in Dublin, Ireland to service European clients. In
February 1996, the Company opened a small administration site in the
Cayman Islands to service Caribbean based funds. The technology
requirements of the offshore fund accounting operations are
facilitated by the architecture of FACTS. FACTS allows microcomputers
located at offshore processing centers to use the FACTS software
system to perform the components of processing on-site in compliance
with local jurisdiction and Internal Revenue Service requirements for
off-shore investment funds, while utilizing the Company's existing
U.S. based mainframe processing, storage and archive capabilities. In
contrast, other fund accounting providers typically utilize entirely
separate systems for domestic and offshore processing.
. Build expertise in the employee base. The Company believes that in
order to compete successfully for new business and obtain additional
business from existing clients, a qualified employee base is required
together with a commitment to ongoing training to keep employees
abreast of technological advances and industry developments in the
financial services industry. Successful completion of a Professional
Development Training Program is required of all newly hired employees.
Topics covered during the training program include an overview of the
financial services industry and pooled asset vehicles, principles of
mutual fund accounting and custody, instruction in control procedures,
manual performance of fund accounting tasks and intensive training on
FACTS. This training program is supplemented by continuing education
to keep employees informed of industry or client base changes.
5
. Seek strategic alliances. The Company intends to continue to pursue
strategic marketing and other alliances with participants in the
financial services industry. In May 1993, the Company signed a Hub
and Spoke license agreement with Signature Financial Group, Inc. the
developer of the Hub and Spoke structure. Hub and Spoke is an
investment structure that makes it possible for investment advisers to
reach new markets and avoid the inefficiencies of maintaining separate
portfolios that have common investment objectives. The Company
processes assets in Hub and Spoke products that totaled approximately
$27 billion as of December 31, 1996. See "The Company - Overview of
Financial Services Industry."
SERVICE OFFERINGS
The Company provides a broad range of asset administration services to the
financial services industry, including domestic and global custody,
multicurrency accounting, securities lending, foreign exchange, mutual fund
administration, institutional transfer agency, performance measurement, private
banking and investment advisory services. Global and domestic custody and
multicurrency accounting are the principal asset administration services
provided to the Company's clients. Fees charged for these services reflect the
highly competitive nature and price-sensitivity of the market for custody and
multicurrency accounting services. Securities lending and foreign exchange
services provide a more favorable pricing environment for the Company and
increased activity by the Company in these areas would not involve a
proportionate increase in personnel or other resources. Mutual fund
administration and institutional transfer agency services provide additional
revenue generating opportunities, but require a corresponding increase in
personnel and processing resources.
Client fees vary from client to client based on the volume of assets under
custody, the number of securities held and portfolio transactions, income
collected and whether other value-added services such as foreign exchange and
performance measurement are needed. Fees are generally billed to the client
monthly in arrears, and upon their approval, charged directly to their account.
The Company takes an integrated approach to asset administration rather
than the functional approach of some of its competitors. The Company has
integrated the components of the custody and accounting task (e.g., trade
settlement, income collection, corporate actions, general ledger accounting,
portfolio accounting and pricing) and dedicates a single operations team to
handle all work for a particular account or fund, instead of using separate
departments to manage these custody and accounting functions. In addition, each
client is assigned a Client Manager, independent of the operations team, to
anticipate the client's needs, to coordinate service delivery, and to provide
consulting support. The Company's accounting control group independently checks
and verifies transfer agency, custody and administrative operations each day.
The following is a description of the various services offered by the
Company.
Domestic Custody. Custody entails overseeing the safekeeping of client
securities and settlement of portfolio transactions. The Company's domestic
assets under custody have grown from $22 billion at October 31, 1990 to $102
billion at December 31, 1996. Custody functions are fully integrated with
security movement and control, portfolio accounting, general ledger accounting,
and pricing and evaluation through FACTS. Custody functions include:
. Settlement of purchases and sales of securities.
. Safekeeping of securities and cash.
. Tracking and collection of income and receivables, such as dividends
and distributions.
. Reconciliation of cash and security positions.
. Disbursement of expenses.
. Calculation and reporting of cash availability to asset managers.
. Reporting and processing of corporate actions, such as stock splits
and bond calls.
. Initiation of settlement inquiries, including reclaims for foreign tax
withholding.
. Periodic reporting of holdings, transactions, income, corporate
actions and cash flow.
Foreign Custody. Foreign custody includes the safekeeping of cross-border
securities for clients, such as the safekeeping of Hong Kong stocks for a Dutch
mutual fund or German bonds held for a U.S. bank-sponsored mutual fund. The
Company entered the foreign custody marketplace in 1988, when the nature of
foreign custody began to change dramatically. In the 1970s, foreign custody was
a series of manual, labor intensive exchanges; settlement was a slow process
where most securities were re-registered and vaulted in the U.S. and the volume
of assets was relatively small. Major developed countries
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throughout the world have evolved to highly automated environments, and the
transition in developing countries is proceeding rapidly. At December 31, 1996,
the Company's foreign assets under custody totaled approximately $9 billion.
Given the evolution of information technology and the industry's acceptance
of computer technology as the preferred vehicle to support foreign custody, the
Company established a worldwide network of global subcustodians. In countries
with centralized clearing houses such as Euroclear, the Company establishes a
subcustodian relationship with the clearing house and is able to receive
information from the subcustodian in electronic format directly onto FACTS. In
nations without automated environments, subcustodians hold physical securities
in their own vaults and provide reporting in hard copy format to the Company for
input onto FACTS. Today, the Company has custody agreements in 72 countries,
typically with regional providers of custody services. Since the Company does
not have its own branches in these countries, it is able to operate in the
foreign custody arena with minimal fixed costs, while the Company's clients
benefit from the ability to use only one custodian, the Company, for their
international investment needs.
Multicurrency Accounting. Multicurrency accounting entails the daily
recordkeeping for each account or investment vehicle, including calculations of
net asset value per share, dividend rates per share, and the maintenance of all
books, records and financial reports required by the Securities and Exchange
Commission and other regulatory agencies. Due to the growth in international
investments by asset managers, traditional fund accounting tasks must be
reconciled across multiple currencies. The primary approach of the Company is
to bundle the sale of fund accounting and custody services in order to work
within the natural efficiencies and control mechanisms of its integrated
custody/fund accounting system and operational philosophy. Multicurrency
accounting functions include:
. Maintenance of the books and records of a fund in accordance with the
Investment Company Act of 1940.
. Tracking of investment transactions for use in the calculation of tax
gains and losses.
. Calculation and accrual of expenses.
. Booking of purchases, redemptions and transfers of fund shares as
directed by the transfer agent.
. Calculation of gains and losses by security and currency.
. Determination of net income.
. Calculation of daily yield in accordance with Securities and Exchange
Commission formula requirements.
. Preparation of statements of assets and liabilities and statements of
operations.
. Computation of the market value of the account.
. Calculation of the daily Net Asset Value of the account and reporting
of this value to National Association of Securities Dealers for
publication in newspapers.
In addition to providing the above services to domestic-based accounts and
investment vehicles, the Company also provides offshore fund accounting. The
Company views the offshore market as a significant business opportunity and will
continue to invest in expansion to support client demand. The Company's Toronto
operations, conducted by the Company's wholly-owned Canadian subsidiary,
currently provide offshore services to 39 portfolios. As of December 31, 1996,
the Canadian subsidiary processed over $12 billion in assets requiring the
calculation of 84 daily net asset values. In 1994, the Company opened a
processing site in Dublin to service European clients and in February 1996, it
opened a small administration site in the Cayman Islands for Caribbean-based
funds.
The technology requirements of the offshore fund accounting operations are
facilitated by the architecture of FACTS. FACTS allows microcomputers located
at offshore processing centers to use the FACTS software system to perform the
components of account processing on-site in compliance with local jurisdiction
and Internal Revenue Service requirements for off-shore investment funds, while
utilizing the Company's mainframe processing, storage and archive capabilities.
In contrast, other fund accounting providers typically utilize entirely separate
systems for domestic and offshore processing.
Mutual Fund Administration. The Company provides mutual fund
administration services, including management reporting, regulatory reporting,
and tax and accounting reporting. Management reporting consists of information
and reporting which is of primary interest to the fund's asset managers and its
board of trustees and includes:
. Preparation of detailed quarterly financial information for
presentation to fund management and its board of trustees.
. Monitoring the reporting of net asset value, settlement of trades, and
processing of stockholder transactions.
. Monitoring compliance with investment portfolio restrictions.
. Calculation of fund dividends to be declared in accordance with
management guidelines.
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. Preparation and monitoring of a fund's expense budget.
Regulatory reporting is the reporting and accumulation of information
required of the fund by the Securities and Exchange Commission and state
securities regulators and includes:
. Coordination of preparation and filing of Securities and Exchange
Commission reports.
. Maintenance of effective "blue sky" registrations in jurisdictions
selected for fund sales.
. Coordination of the preparation and printing of stockholder reports.
. Preparation of prospectus update and proxy material.
. Coordination of on-going "blue sky" compliance.
Tax and accounting reporting is required either by the fund's auditors or
by Internal Revenue Service rules and regulations and includes:
. Performing portfolio compliance testing to establish qualification as
a regulated investment company.
. Preparation of income and excise tax returns.
. Preparation of audit package for use by independent public
accountants.
. Coordination of review of income, capital gains, and distribution
information.
The Company also provides mutual fund start-up services in addition to
ongoing services. The Company has worked with a number of investment advisors
to assist them in the development of new mutual funds. Its services typically
include assistance with product definition, service provider selection, and fund
structuring and registration. The Company's Administration Group is staffed by
48 accounting and legal professionals who have prior experience in either mutual
fund complexes or mutual fund servicing organizations.
Investment Advisory. In November 1996, the Bank executed agreements with
the Merrimac Master Portfolio and the Merrimac Funds, newly formed master-feeder
investment companies, pursuant to which the Company has agreed to act as
investment adviser to the Funds. At the same time, the Company engaged The Bank
of New York to act as sub-adviser to manage the investments of the Funds.
Currently, the Funds have one operating master fund, the Merrimac Cash
Portfolio, and one operating feeder fund, the Merrimac Cash Fund, with assets
totaling over $1 billion at December 31, 1996. The Merrimac Cash Fund offers
its shares only to institutions and other "accredited investors" (as that term
is defined in Rule 501(a) under the Securities Act of 1933) and invests all of
its assets in the Merrimac Cash Portfolio. The Merrimac Cash Portfolio invests
its assets in high quality money market instruments. The Funds may add
additional feeder funds and/or master funds in the future.
Foreign Exchange. The Company offers foreign exchange services to
facilitate settlement of international securities transactions for U.S. dollar
denominated mutual funds and other accounts and to convert income payments
denominated in a non-U.S. currency to U.S. dollars. By using the Company rather
than a third party foreign exchange bank to perform these functions, clients
reduce the amount of time spent coordinating currency delivery and monitoring
delivery failures and claims. The Company, as principal, enters into a foreign
exchange contract with a client and simultaneously enters into a matched trade
with another financial institution. The current volume of trades processed by
the Company is approximately 20,000 trades per year, which vary in size. The
Company initiates foreign exchange transactions only in response to a client's
request and engages in no foreign exchange trading transactions for its own
account. Foreign exchange fee revenue totaled $536,000, $1,044,000, $237,000,
and $2,106,000 for the years ended October 31, 1994 and 1995, for the Transition
Period, and for the year ended December 31, 1996, respectively.
Securities lending. Securities lending involves the lending of clients'
securities to brokers and other institutions for a fee, which improves a
client's return on the underlying securities. The Company acts as agent for its
clients for both international and domestic securities lending services.
Currently, lending services are provided to seven clients, and the current loan
portfolio aggregates approximately $1.1 billion. The Company retains as
compensation a portion of the lending fee due to the client as owner of the
borrowed asset. Securities lending fee revenue totaled $1,181,000, $1,142,000,
$157,000 and $1,947,000 for the years ended October 31, 1994 and 1995, for the
Transition Period, and for the year ended December 31, 1996, respectively.
Through a network of broker/dealers, the Company places the securities out
on loan pursuant to client instruction, delivers the subject securities and
performs the necessary loan accounting. Accounting entails monitoring each
security out on loan by broker, allocating the loans to each fund, tracking the
fixed or variable rebate due the broker, updating the daily
8
investments, applying the earnings to each security loan and preparing daily and
monthly earnings statements for each fund and all the brokers.
All loans are fully collateralized with cash, government securities or a
letter of credit. This collateral is reinvested according to each client's
instructions. The Company monitors all outstanding loans on a daily basis by
reviewing exposure by broker, performing asset reconciliations, and marking each
security to market to ensure that proper collateral levels are maintained.
Institutional Transfer Agency. Transfer agency encompasses mutual fund
shareholder recordkeeping and communications. Services include tracking capital
shares, fulfilling purchase, transfer, and redemption requests, and sending
account statements, tax reporting information and distributions to shareholders.
The Company provides mutual fund shareholder servicing and recordkeeping for
clients representing approximately 26,000 shareholder accounts. These services
are generally provided only to institutional clients with smaller numbers of
outstanding shareholders or omnibus positions of retail shareholders.
Performance Measurement. Performance measurement services involve the
creation of systems and databases that enable asset managers to construct,
manage and analyze their portfolios. Services include portfolio profile
analysis, portfolio return analysis, and customized benchmark construction.
Performance measurement uses data already captured by FACTS to calculate
statistics and report them to asset managers. The Company provides this service
for an aggregate of over $16 billion in assets managed by 49 investment
advisors.
Private Banking Services. The Company offers private banking services to
individuals, family groups, trusts, endowments and foundations, and retirement
plans. The Company develops this client base by forming relationships with
investment advisors and working with the advisors to service mutual clients.
The Company services individually managed trust and custody accounts that
numbered approximately 6,100 at December 31, 1996. The Company does not conduct
consumer banking operations.
Acting as a fiduciary, the Company provides trust administration and estate
settlement services. These services include on-going fiduciary review of the
trust instrument, collection and safekeeping of assets, distribution of income,
appropriate reporting for court and tax purposes, preparation of tax returns,
and distribution of assets as required. The Company does not provide investment
advice, but works closely with third-party investment advisors chosen by each
client to carry out the investment of assets. Custody services, such as the
safekeeping of securities and the settlement of securities transactions, are
also provided to these clients. Custody service fees are determined based on
assets under custody and number of transactions in each account.
Because it was a subsidiary of Eaton Vance, prior to the Spin-Off
Transaction the Company was restricted by CEBA from making commercial loans or
from writing residential mortgages. As a result, the Company has traditionally
specialized in lending to individuals and non-profit institutions on a secured
basis.
At December 31, 1996, the Company had gross loans outstanding to
individuals and non-profit institutions of approximately $66 million, which
represented 7% of the Company's total assets. The interest rates charged on the
Bank's loans are indexed to either the prime rate or the rate paid on 90-day
Treasury bills. The Company has never had a loan loss, and has no delinquent
loans. Other than a loan made to a non-profit association for purposes of the
Community Reinvestment Act, all loans are secured by marketable securities and
are due on demand.
Commercial Banking Services. As a result of the Spin-Off Transaction, the
Company is now able to offer commercial banking services. The Company offers
credit lines to its clients for the purpose of leveraging portfolios and
covering overnight cash shortfalls. Since the Spin-Off Transaction, the Company
has entered into agreements to provide up to an aggregate of $40 million under
secured lines of credit to mutual fund clients. Additionally, the Company's
clients, which consist mainly of managers of mutual funds, unit investment
trusts and other pooled asset products, typically generate large cash balances
from securities sales and other transactions which they wish to invest on a
short-term basis. Because the Company was subject to a 7% annual asset growth
cap under CEBA, it was not able to accept those deposits and directed those
deposits to other financial institutions. The Company directed an average of
approximately $1.2 billion of such deposits daily to other financial
institutions in fiscal year 1995. Since the completion of the Spin-Off
Transaction and the Offering, the Company has redirected an average of
approximately $734 million daily of these balances into its own deposit products
and may now offer these deposit services directly to existing and potential
clients.
9
SALES, MARKETING AND CLIENT SUPPORT
The Company employs a direct sales staff of five employees that targets
potential market areas, including investment management companies, insurance
companies, banks and investment advisors. Sales personnel are primarily based
at the Company's headquarters in Boston and are given geographic area sales
responsibility. Additionally, the Company provides the sales staff with market
data and presentation materials. Senior managers from all functional areas are
directly involved in obtaining new clients, frequently working as a team with a
sales professional.
New client contacts are generated by a variety of methods, including client
referrals, personal sales calls, attendance at trade shows and seminars,
advertising in trade publications, and direct mailing to targeted clients.
In order to service existing clients, a client management staff of
approximately 12 professionals based in the Company's Boston office provides
client support. Each client is assigned a Client Manager responsible for the
overall satisfaction of the client. The Client Manager is usually a senior
professional with extensive industry experience and works with the client on
contracts, new products and specific systems requirements.
SIGNIFICANT CLIENTS
The Company presently provides services to approximately 51 mutual fund
complexes and insurance companies. The Company's current largest client, Eaton
Vance, accounted for 18%, 14%, 11% and 10% of the Company's net operating
revenues for the years ended October 31, 1994 and 1995, for the Transition
Period, and for the year ended December 31, 1996, respectively. A former client
of the Company, Merrill Lynch, accounted for 16% and 5% of the Company's net
operating revenues for the years ended October 31, 1994 and 1995, respectively.
Merrill Lynch paid the Company to assign the Company's servicing rights to The
Bank of New York effective March 1, 1995 and therefore accounted for no net
operating revenue in the Transition Period or in the year ended December 31,
1996. The percentages of consolidated revenues attributable to Eaton Vance and
Merrill Lynch for the periods referenced above were substantially the same as
the percentages of net operating revenues described above. Eaton Vance
accounted for 10% of the Company's consolidated revenues for the Transition
Period. No single client represented more than 10% of the Company's
consolidated revenues for the year ended December 31, 1996. No other single
client of the Company represented more than 10% of net operating revenues or
consolidated revenues for the periods discussed above. Eaton Vance has been a
client of the Company since 1975. The Company's agreements with mutual funds
managed by Eaton Vance, pursuant to which the Company provides custody and fund
accounting services, extend through August 2000 and continue thereafter until
terminated by either party upon sixty days prior notice. If a majority of non-
interested trustees of a fund determines that the performance of the Company
under any such agreement has been unsatisfactory or adverse to the interests of
the fund's shareholders, or that the terms of the agreement are no longer
consistent with publicly available industry standards, the Company shall have 60
days after receipt of written notice to such effect to (i) correct its
performance or (ii) renegotiate such terms. If such corrective action or
renegotiation is not satisfactory to such trustees, such agreement may be
terminated on sixty days prior notice. The Company has long-term contracts with
15 other clients with terms ranging from two to five years. Total assets
processed under long-term contracts at December 31, 1996 were over $45 billion.
All other client engagements are, and in the future may be, terminable upon 60
days notice.
SOFTWARE SYSTEMS AND DATA CENTER
The Company's asset administration operations are supported by
sophisticated computer technology. The Company receives vast amounts of
information across a world-wide computer network. That information, which
covers a wide range of global security types and complex portfolio structures in
various currencies, must then be processed, resulting in system-wide updating
and reporting. The Company must have the capability to provide not only daily
and periodic reports of asset accounting and performance, but also to provide
measurement and analytical data to asset managers on-line on a real time basis.
These technology requirements call for powerful and sophisticated computer
hardware and software systems operated in a cost effective manner.
The primary software system used by the Company is FACTS. The system was
developed over a four-year period by the Bank of New England, and was put into
operation in 1986. It was acquired by the Company in 1990 in connection with
the acquisition by the Company of the Financial Products Services Division of
the Bank of New England.
10
FACTS utilizes microcomputers networked to a mainframe computer system.
The microcomputers can be located in any location with the requisite
telecommunications network for the automated interface to the mainframe,
enabling the Company to provide geographically dispersed processing services
effectively and efficiently. The microcomputer to mainframe configuration also
provides redundant processing capability; if the mainframe fails, FACTS is able
to process independently on the microcomputers.
FACTS emphasizes efficiency and accuracy because it integrates custody,
securities movement and control, portfolio accounting, general ledger
accounting, pricing, net asset value calculation, and Hub and Spoke processing
into a single system. The traditional industry approach is to have separate
applications for each of these functions and to interconnect the component
applications with manual intervention at various points in the process.
The integrated and automated nature of FACTS is best reflected in following
a transaction through the system. For example, a purchase of a security is
entered on a client trading system and the transaction information is
electronically transmitted to FACTS. The receipt of the trade information by
FACTS will trigger the following activities with no manual intervention by the
Company:
. Creation of a Securities Movement and Control transaction to track and
control the trade for the entire settlement cycle (e.g., confirmation,
affirmation, settlement).
. Updating of the portfolio position for the security being purchased.
. Immediate updating of all required general ledger accounts.
. Creation of a pricing record to enable pricing of the security and
inclusion in the total market value and net asset value determination.
. Affirmation and settlement of the trade upon notification from the
counterparty with associated transaction and general ledger updates
occurring simultaneously.
. Accounting for all income for the holding period of the security.
FACTS also complies with current industry standards such as the requirement
that mandates a three business day settlement cycle for public securities
transactions rather than the traditional five business day cycle. The
enhancements made to FACTS to address this change included enabling FACTS to
interact with the Depository Trust Company via its new Interactive Institutional
Delivery System, which allows institutions to confirm trades earlier in the
trade life cycle.
The integrated nature of FACTS architecture allows the Company to affect
modifications and enhancements quickly, resulting in increased processing
quality and efficiency for the Company's clients. This integrated architecture
helps differentiate the Company from its competitors. System enhancements and
upgrades are an ongoing part of asset administration, both to keep ahead of the
competition and to create information delivery mechanisms that add value to the
information available as part of clearing and settling transactions. During the
past two years, the Company has developed standardized data extracts and
automated interfaces that allow its clients to connect electronically with the
Company's host computer and access data collected from clearance and settlement
transactions in multiple currencies on a real-time basis. This electronic
linkage also positions the Company to respond quickly to client requests.
A substantial portion of the Company's electronic transaction processing
services depends upon a mainframe computer system, owned and operated by
Electronic Data Systems ("EDS"), contained in the EDS Information Processing
Center ("IPC") in Camp Hill, Pennsylvania. Processing and networking functions
and equipment are located at the IPC, and in the Boston and Detroit metropolitan
areas. The Company has outsourced its mainframe data processing to EDS since
December 1990. By outsourcing data processing, the Company can focus its
resources on its core line of business and minimize its capital investment in
computer equipment. EDS is able to offer the Company up to date computer
products and services to which it would not otherwise have access, while
removing the risk of product obsolescence. Due to its diverse customer base,
EDS can invest in the latest computer technology and spread the costs over
multiple users. In addition, the defined pricing provided by EDS for products
and services allows the Company to match its data processing cost with the
related revenue stream. The use of EDS as a hardware provider allows the
Company to dedicate its efforts to the ongoing enhancement of its software
systems while receiving the benefit of the continuing investment by EDS in its
computer hardware.
EDS provides mainframe disaster recovery services. EDS maintains
additional processing equipment at the Camp Hill IPC and at a designated
alternate IPC which may be used in the event of equipment failure. The Camp
Hill facility is also supported by an uninterruptable power supply and diesel
generators which can supply power to continue operations for an extended period
of time. Critical software and data files are backed-up daily and stored off-
site. Disaster recovery plans are
11
tested through simulations conducted by the Company twice a year.
Notwithstanding these precautions, there can be no assurance that a fire or
other natural disaster affecting the data center would not disable the host
computer system.
The current agreement between the Company and EDS obligates EDS to provide
the Company with comprehensive data processing services and obligates the
Company to utilize EDS's services for substantially all of its data processing
requirements. The Company is billed for these services monthly on an as-used
basis as determined by a pricing schedule for specific products and services.
EDS began providing services to the Company in December 1990 and the current
agreement is scheduled to expire on December 31, 2000.
COMPETITION
The market for asset administration services is highly competitive. The
Company's most significant competitors are State Street Boston Company, The Bank
of New York, Chase Manhattan Corp., Brown Brothers Harriman & Co., and PNC Bank.
These competitors possess substantially greater financial, sales and marketing
resources than the Company and process a greater amount of financial assets than
the Company. In addition, the Company also encounters competition in the sale
of fund accounting services from large in-house accounting departments of mutual
fund complexes, insurance companies and banks offering proprietary mutual funds.
Competitive factors include technological advancement and flexibility, breadth
of services provided and quality of service. The Company believes that it
competes favorably in these categories.
INTELLECTUAL PROPERTY
The Company's success is dependent upon its software development
methodology and other intellectual property rights developed and owned by the
Company, including FACTS. The Company relies on a combination of trade secret,
nondisclosure and other contractual arrangements and technical measures, and
copyright and trademark laws to protect its proprietary rights. The Company
generally enters into confidentiality agreements with its employees and
consultants, and limits access to and distribution of its proprietary
information. There can be no assurance that the steps taken by the Company in
this regard will be adequate to deter misappropriation of its proprietary
information or that the Company will be able to detect unauthorized use and take
appropriate steps to enforce its intellectual property rights. Furthermore,
such protections may not preclude competitors from developing products and
services with functionality or features similar to those of the Company. In
addition, effective copyright, trademark and other trade protection may not be
available in certain international markets serviced by the Company. Finally,
there can be no assurance that intellectual property protection will be
available in certain foreign countries. The registration of the service mark
Investors Bank & Trust Company will remain in force until 2006, at which time it
may be renewed.
Although the Company believes that its services do not infringe on the
intellectual property rights of others, there can be no assurance that such a
claim will not be asserted against the Company in the future.
EMPLOYEES AND TRAINING
As of December 31, 1996, the Company had 792 full-time employees, including
seven in senior management, 19 in marketing and client management, 662 in
operations and 104 in general and administration. None of the Company's
employees are represented by a union. The Company believes that its relations
with its employees are good.
The Company has developed a five-week professional development program for
entry level staff. Successful completion of the program is required of all
newly hired employees. Topics covered during the program include an overview of
the financial services industry and pooled asset vehicles, principles of mutual
fund accounting and custody, instruction in control procedures, manual
performance of fund accounting tasks and intensive training on FACTS. This
training program is supplemented by ongoing education on the industry and client
base.
The Company's business is labor-intensive, and its success depends to a
significant extent upon a number of key management employees and skilled
technical, managerial and marketing personnel, few of which are bound by
employment agreements. From October 31, 1990 to December 31, 1996, the
Company's staff increased from 463 to 792 employees.
12
REGULATION AND SUPERVISION
In addition to the generally applicable state and federal laws governing
businesses and employers, the Company and the Bank are further regulated by
federal and state laws and regulations applicable only to financial institutions
and their parent companies. Virtually all aspects of the Company's and the
Bank's operations are subject to specific requirements or restrictions and
general regulatory oversight. State and federal banking laws have as their
principal objective either the maintenance of the safety and soundness of
financial institutions and the federal deposit insurance system or the
protection of consumers or classes of consumers, rather than the specific
protection of stockholders of a bank or its parent company. To the extent the
following material describes statutory or regulatory provisions, it is qualified
in its entirety by reference to the particular statute or regulation.
The Company
General. The Company, as a bank holding company, is subject to regulation
and supervision by the Federal Reserve Board (the "FRB") and by the
Massachusetts Commissioner of Banks (the "Commissioner"). The Company is
required to file annually a report of its operations with, and is subject to
examination by, the FRB and the Commissioner. The FRB has the authority to
issue orders to bank holding companies to cease and desist from unsound banking
practices and violations of conditions imposed by, or violations of agreements
with, the FRB. The FRB is also empowered to assess civil monetary penalties
against companies or individuals who violate the Bank Holding Company Act of
1956, as amended, (the "BHCA") or orders or regulations thereunder, to order
termination of non-banking activities of non-banking subsidiaries of bank
holding companies, and to order termination of ownership and control of a non-
banking subsidiary by a bank holding company.
BHCA -Activities and Other Limitations. The BHCA prohibits a bank holding
company from acquiring substantially all the assets of a bank or acquiring
direct or indirect ownership or control of more than 5% of the voting shares of
any bank, or increasing such ownership or control of any bank, or merging or
consolidating with any bank holding company without prior approval of the FRB.
No approval under the BHCA is required, however, for a bank holding company
already owning or controlling 50% or more of the voting shares of a bank to
acquire additional shares of such bank. The Riegle-Neal Interstate Banking and
Branching Efficiency Act of 1994 (the "Interstate Act") generally authorizes
bank holding companies to acquire banks located in any state. In addition, the
Interstate Act generally authorizes national and state chartered banks to merge
across state lines (and thereby create interstate branches) commencing June 1,
1997. Under the provisions of the Interstate Act, states are permitted to "opt
out" of this latter interstate branching authority by taking action prior to the
commencement date. States may also "opt in" early (i.e., prior to June 1, 1997)
to the interstate merger provisions.
The BHCA also prohibits a bank holding company from acquiring a direct or
indirect interest in or control of more than 5% of the voting shares of any
company which is not a bank or bank holding company and from engaging directly
or indirectly in activities other than those of banking, managing or controlling
banks or furnishing services to its subsidiary banks, except that it may engage
in and may own shares of companies engaged in certain activities the FRB has
determined to be so closely related to banking or managing and controlling banks
as to be a proper incident thereto. In making such determinations, the FRB is
required to weigh the expected benefit to the public, such as greater
convenience, increased competition or gains in efficiency, against the possible
adverse effects, such as undue concentration of resources, decreased or unfair
competition, conflicts of interests or unsound banking practices.
The FRB has by regulation determined that certain activities are closely
related to banking within the meaning of the BHCA. Should the Company desire to
expand its activities beyond its current financial services activities, it would
generally be limited to the following activities: operating a mortgage company,
finance company, credit card company, factoring company, trust company or
savings association; performing certain data processing operations; providing
limited securities brokerage services; acting as an investment or financial
advisor; acting as an insurance agent for certain types of credit-related
insurance; leasing personal property on a full-payout, non-operating basis;
providing tax planning and preparation services; operating a collection agency;
and providing certain courier services. The FRB also has determined that
certain other activities, including real estate brokerage and syndication, land
development, property management and underwriting of life insurance not related
to credit transactions, are not closely related to banking and a proper incident
thereto.
Commitments to Affiliated Institutions. Under FRB policy, the Company is
expected to act as a source of financial strength to the Bank and to commit
resources to support the Bank in circumstances when it might not do so absent
such policy and is expected to maintain the financial flexibility and capital-
raising capacity to obtain additional resources for assisting the Bank. The
legality and precise scope of this policy is unclear, however, in light of
federal judicial precedent. Additionally, the
13
Federal Deposit Insurance Act (the "FDIA") requires the holding company parent
of an undercapitalized bank to guarantee, up to certain limits, the bank's
compliance with a capital restoration plan approved by the bank's primary
federal supervisory agency. Because Investors Financial Services Corp., as a
holding company for the Bank, has no assets other than its ownership interest in
the Bank, its ability to serve as a source of strength to the Bank through the
contribution of capital is, presently, limited to contributing proceeds from the
sale of securities such as the Capital Securities discussed under "Market for
Registrant's Common Equity and Related Stockholder Matters - Recent Sales of
Unregistered Securities."
Capital Requirements. The FRB has adopted capital adequacy guidelines
pursuant to which it assesses the adequacy of capital in examining and
supervising a bank holding company and in analyzing applications to it under the
BHCA. These capital adequacy guidelines generally require bank holding
companies to maintain total capital equal to 8% of total risk-adjusted assets
and off-balance sheet items, with at least one-half of that amount consisting of
Tier I or core capital and the remaining amount consisting of Tier II or
supplementary capital. Tier I capital for bank holding companies generally
consists of the sum of common stockholders' equity and perpetual preferred stock
(subject in the case of the latter to limitations on the kind and amount of such
stocks which may be included as Tier I capital), less goodwill. Tier II capital
generally consists of hybrid capital instruments; perpetual preferred stock
which is not eligible to be included as Tier I capital; term subordinated debt
and intermediate-term preferred stock; and, subject to limitations, general
allowances for loan losses. Assets are adjusted under the risk-based guidelines
to take into account different risk characteristics, with the categories ranging
from 0% (requiring no additional capital) for assets such as cash to 100% for
such assets as premises, plant and equipment and traditional consumer loans.
Claims on, or guaranteed by, U.S. government agencies, as well as the portion of
claims that are collateralized by securities issued or guaranteed by the U.S.
Treasury are assigned a 20% level in the risk-weighting system. Off-balance
sheet items also are adjusted to take into account certain risk characteristics.
In addition to the risk-based capital requirements, the FRB requires bank
holding companies to maintain a minimum leverage capital ratio of Tier I capital
(defined by reference to the risk-based capital guidelines) to total assets of
3.0%. Total assets for this purpose does not include goodwill and any other
intangible assets and investments that the FRB determines should be deducted
from Tier I capital. The FRB has announced that the 3.0% Tier I Leverage
Capital Ratio requirement is the minimum for the top-rated bank holding
companies without any supervisory, financial or operational weaknesses or
deficiencies or those which are not experiencing or anticipating significant
growth. Because the Bank, and consequently, the Company, anticipates
significant future growth, the Company will be required to maintain Tier I
Leverage Capital Ratios of at least 4.0% to 5.0% or more. Management currently
intends to maintain Tier I Leverage Capital Ratios of 6.0%.
The Company currently is in compliance with both the Risk Based Capital
Ratios and the Leverage Capital Ratio requirements. At December 31, 1996, the
Company had Tier I Risk Based Capital Ratio and Total Risk Based Capital Ratio
equal to 24.67% and 24.71%, respectively and Tier I Leverage Capital Ratio equal
to 6.30%.
Limitations of Acquisitions of Common Stock. The Federal Change in Bank
Control Act prohibits a person or group of persons from acquiring "control" of a
bank holding company unless the FRB has been given 60 days prior written notice
of such proposed acquisition and within that time period the FRB has not issued
a notice disapproving the proposed acquisition or extending for up to another 30
days the period during which such a disapproval may be issued. An acquisition
may be made prior to expiration of the disapproval period if the FRB issues
written notice of its intent not to disapprove the action. Under a rebuttable
presumption established by the FRB, the acquisition of 10% or more of a class of
voting stock of a bank holding company with a class of securities registered
under Section 12 of the Securities Exchange Act of 1934, as amended (the
"Exchange Act") would, under the circumstances set forth in the presumption,
constitute the acquisition of control.
In addition, any company, as that term is defined in the statute, would be
required to obtain the approval of the FRB under the BHCA before acquiring 25%
(5% in the case of an acquirer that is a bank holding company) or more, or such
lesser percentage as the FRB deems to constitute control over the Company, of
the outstanding Common Stock of the Company. Such approval would be contingent
upon, among other things, the acquirer registering as a bank holding company,
divesting all impermissible holdings and ceasing any activities not permissible
for a bank holding company.
Massachusetts Law. Massachusetts law generally defines a bank holding
company as a company which owns or controls two or more financial institutions.
Although the Company owns or controls only one financial institution, it is
deemed a bank holding company for purposes of Massachusetts law due to the
manner in which it acquired the Bank. Accordingly, the Company has registered
with the Commissioner and is obligated to make reports to the Commissioner.
Further, as a Massachusetts bank holding company, the Company may not acquire
all or substantially all of the assets of a banking institution or merge or
consolidate with another bank holding company without the prior consent of the
Board of Bank Incorporation (the
14
"BBI"). As a condition of such consent, the BBI must receive notice from the
Massachusetts Housing Partnership Fund (the "Fund") that arrangements
satisfactory to the Fund have been made by the Company to make 0.9% of its
assets available for financing, down payment assistance, share loans, closing
costs and other costs related to programs promoted by the Fund, including those
related to creating affordable rental housing, limited equity cooperatives, and
tenant management programs.
The Bank
General. The Bank is subject to extensive regulation and examination by
the Commissioner and by the FDIC, which insures its deposits to the maximum
extent permitted by law, and to certain requirements established by the FRB.
The federal and state laws and regulations which are applicable to banks
regulate among other things, the scope of their business, their investments,
their reserves against deposits, the timing of the availability of deposited
funds and the nature and amount of and collateral for certain loans.
FDIC Insurance Premiums. The Bank pays deposit insurance premiums to the
FDIC based on an assessment rate established by the FDIC for Bank Insurance
Fund-member institutions. The FDIC has established a risk-based assessment
system under which institutions are assigned to one of three capital groups -
"well capitalized," "adequately capitalized" and "undercapitalized" - which are
defined in substantially the same manner as under the regulations establishing
the prompt corrective action system pursuant to Section 38 of the FDIA, as
discussed below. These three capital groups are then each divided into three
subgroups which reflect varying levels of supervisory concern, from those which
are considered to be healthy to those which are considered to be of substantial
supervisory concern. The matrix so created results in nine assessment risk
classifications, with corresponding assessment rates ranging from .04% for well
capitalized, healthy institutions to .31% for undercapitalized institutions with
substantial supervisory concerns. There is a statutory minimum assessment of
$1,000 per semi-annual period. The Bank is currently subject to the statutory
minimum assessment.
Capital Requirements. The FDIC has promulgated regulations and adopted a
statement of policy regarding the capital adequacy of state-chartered banks
which, like the Bank, are not members of the Federal Reserve System. These
requirements are substantially similar to those adopted by the FRB regarding
bank holding companies, as described above.
The FDIC's capital regulation establishes a minimum 3.0% Tier I Leverage
Capital Ratio requirement for the most highly-rated state-chartered, non-member
banks, with an additional cushion of at least 100 to 200 basis points for all
other state-chartered, non-member banks, which effectively will increase the
minimum Tier I Leverage Capital Ratio for such other banks to 4.0% to 5.0% or
more. Under the FDIC's regulation, highest-rated banks are those that the FDIC
determines are not anticipating or experiencing significant growth and have well
diversified risk, including no undue interest rate risk exposure, excellent
asset quality, high liquidity, good earnings and, in general, which are
considered a strong banking organization, rated composite 1 under the Uniform
Financial Institutions Rating System. A bank having less than the minimum Tier
I Leverage Capital Ratio shall, within 60 days of the date as of which it fails
to comply with such requirement, submit to its FDIC regional director for review
and approval a reasonable plan describing the means and timing by which the bank
shall achieve its minimum leverage capital requirement. A bank which fails to
file such plan with the FDIC is deemed to be operating in an unsafe and unsound
manner, and could be subject to a cease-and-desist order from the FDIC. The
FDIC's amended regulation also provides that any insured depository institution
with a Tier 1 Leverage Capital Ratio less than 2.0% is deemed to be operating in
an unsafe or unsound manner pursuant to Section 8(a) of the FDIA and is subject
to potential termination of deposit insurance. Such an institution, however,
will not be subject to an enforcement proceeding thereunder, solely on account
of its capital ratios if it has entered into and is in compliance with a written
agreement with the FDIC to increase its Tier I Leverage Capital Ratio to such
level as the FDIC deems appropriate and to take such other action as may be
necessary for the institution to be operated in a safe and sound manner. The
FDIC capital regulation also provides, among other things, for the issuance by
the FDIC or its designee(s) of a capital directive, which is a final order
issued to a bank that fails to maintain minimum capital to restore its capital
to the minimum leverage capital requirement within a specified time period.
Such directive is enforceable in the same manner as a final cease-and-desist
order.
The FDIC has augmented the capital leverage ratios described above with a
risk-based capital framework which is more explicitly and systematically
sensitive to the risk profiles of individual banks. Under the risk-based
capital framework, the assets of the Bank are weighted pursuant to the risk
category in which each asset falls. These risk categories are substantially the
same as those described in the discussion of FRB capital requirements above.
Banks generally will be expected to maintain a minimum Tier I Risk Based Capital
Ratio of 4.0% and a Total Risk Based Capital Ratio of 8.0%. Any bank that does
not meet the minimum requirements, or whose capital is otherwise considered
inadequate, generally will be expected to develop and
15
implement a capital plan for achieving an adequate level of capital, consistent
with the provisions of the risk-based capital framework.
At December 31, 1996, the Bank was in compliance with all minimum Federal
regulatory capital requirements which are generally applicable to FDIC insured
banks. As of such date, the Bank had Tier I Risk Based Capital Ratio and Total
Risk Based Capital Ratio equal to 24.67% and 24.71%, respectively, and Tier I
Leverage Capital Ratio equal to 6.30%.
Prompt Corrective Action. Under Section 38 of the FDIA, each federal
banking agency is required to implement a system of prompt corrective action for
institutions which it regulates. The federal banking agencies have promulgated
substantially similar regulations to implement the system of prompt corrective
action established by Section 38 of the FDIA. Under the regulations, a bank
shall be deemed to be (i) "well capitalized" if it has Total Risk Based Capital
Ratio of 10.0% or more, has a Tier I Risk Based Capital Ratio of 6.0% or more,
has a Tier I Leverage Capital Ratio of 5.0% or more and is not subject to any
written capital order or directive; (ii) "adequately capitalized" if it has a
total Risk Based Capital Ratio of 8.0% or more, a Tier I Risk Based Capital
Ratio of 4.0% or more (3.0% under certain circumstances) and does not meet the
definition of "well capitalized," (iii) "undercapitalized" if it has a Total
Risk Based Capital Ratio that is less than 8.0%, a Tier I Risk Based Capital
Ratio that is less than 4.0% or a Tier I Leverage Capital Ratio that is less
than 4.0% (3.0% under certain circumstances), (iv) "significantly
undercapitalized" if it has a Total Risk Based Capital Ratio that is less than
6.0%, a Tier I Risk Based Capital Ratio that is less than 3.0% or a Tier I
Leverage Capital Ratio that is less than 3.0%, and (v) "critically
undercapitalized" if it has a ratio of tangible equity to total assets that is
equal to or less than 2.0%. Section 38 of the FDIA and the regulations also
specify circumstances under which a federal banking agency may reclassify a well
capitalized institution as adequately capitalized and may require an adequately
capitalized institution or an undercapitalized institution to comply with
supervisory actions as if it were in the next lower category, except that the
FDIC may not reclassify a significantly undercapitalized institution as
critically undercapitalized.
An institution generally must file a written capital restoration plan which
meets specified requirements with an appropriate federal banking agency within
45 days of the date that the institution receives notice or is deemed to have
notice that it is undercapitalized, significantly undercapitalized or critically
undercapitalized. A federal banking agency must provide the institution with
written notice of approval or disapproval with 60 days after receiving a capital
restoration plan, subject to extensions by the agency.
An institution which is required to submit a capital restoration plan must
concurrently submit a performance guaranty by each company that controls the
institution. Such guaranty shall be limited to the lesser of (i) an amount
equal to 5.0% of the institution's total assets at the time the institution was
notified or deemed to have notice that it was undercapitalized or (ii) the
amount necessary at such time to restore the relevant capital measure of the
institution to the levels required for the institution to be classified as
adequately capitalized. Such a guarantee shall expire after the federal banking
agency notifies the institution that it has remained adequately capitalized for
each of four consecutive calendar quarters. An institution which fails to
submit a written capital restoration plan within the requisite period, including
any required performance guarantee, or fails in any material respect to
implement a capital restoration plan, shall be subject to the restrictions in
Section 38 of the FDIA which are applicable to significantly undercapitalized
institutions.
A critically undercapitalized institution is to be placed in
conservatorship or receivership with 90 days unless the FDIC formally determines
that forbearance from such action would better protect the deposit insurance
fund. Unless the FDIC or other appropriate federal banking regulatory agency
makes specific further findings and certifies that the institution is viable and
is not expected to fail, an institution that remains critically undercapitalized
on average during the fourth calendar quarter after the date it becomes
critically undercapitalized must be placed in receivership.
Immediately upon becoming undercapitalized, an institution becomes subject
to the provisions of Section 38 of the FDIA (i) restricting payment of capital
distributions and management fees, (ii) requiring that the appropriate federal
banking agency monitor the condition of the institution and its efforts to
restore its capital, (iii) requiring submission of a capital restoration plan,
(iv) restricting the growth of the institution's assets and (v) requiring prior
approval of certain expansion proposals. The appropriate federal banking agency
for an undercapitalized institution also may take any of a number of
discretionary supervisory actions if the agency determines that any of these
actions is necessary to resolve the problems of the institution at the least
possible long-term cost to the deposit insurance fund, subject in certain cases
to specified procedures. These discretionary supervisory actions include
requiring the institution to raise additional capital; restricting transactions
with affiliates; restricting interest rates paid by the institution on deposits;
requiring replacement of senior executive officers and directors; restricting
the activities of the institution and its affiliates; requiring divestiture of
the institution or the sale of the
16
institution to a willing purchaser; and any other supervisory action that the
agency deems appropriate. These and additional mandatory and permissive
supervisory actions may be taken with respect to significantly undercapitalized
and critically undercapitalized institutions.
At December 31, 1996, the Bank was deemed to be a well capitalized
institution for the above purposes. Bank regulators may raise capital
requirements applicable to banking organizations beyond current levels. Because
the Company is unable to predict whether higher capital requirements will be
imposed and, if so, at what levels and on what schedules, it therefore cannot
predict what effect such higher requirements may have on the Company and the
Bank.
Brokered Deposits. The FDIA restricts the use of brokered deposits by
certain depository institutions. Under the FDIA and applicable regulations, (i)
a well capitalized institution may solicit and accept, renew or roll over any
brokered deposit without restriction, (ii) an adequately capitalized institution
may not accept, renew or roll over any brokered deposit unless it has applied
for and been granted a waiver of this prohibition by the FDIC and (iii) an
undercapitalized institution may not (x) accept, renew or roll over any brokered
deposits or (y) solicit deposits by offering an effective yield that exceeds by
more than 75 basis points the prevailing effective yields on insured deposits of
comparable maturity in such institution's normal market area or in the market
area in which such deposits are being solicited. The term "undercapitalized
insured depository institution" is defined to mean any insured depository
institution that fails to meet the minimum regulatory capital requirement
prescribed by its appropriate federal banking agency. The FDIC may, on a case-
by-case basis and upon application by an adequately capitalized insured
depository institution, waive the restriction on brokered deposits upon a
finding that the acceptance of brokered deposits does not constitute an unsafe
or unsound practice with respect to such institution. Currently, the Bank is
deemed to be a well capitalized insured depository institution for purposes of
the restriction on the use of brokered deposits by such institutions. The bank
historically has not relied upon brokered deposits as a source of funding and,
at December 31, 1996, the Bank did not have any brokered deposits.
Transactions with Affiliates. The FDIA restricts the range of permissible
transactions between a member bank and an affiliated company. The Bank is
subject to certain restrictions on loans to the Company, on investment in the
stock or securities thereof, on the taking of such stock or securities as
collateral for loans to any borrower, and on the issuance of a guarantee or
letter of credit on behalf of the Company. The Bank also is subject to certain
restrictions on most types of transactions with the Company, requiring that the
terms of such transactions be substantially equivalent to terms to similar
transactions with non-affiliates.
Activities and Investments of Insured State-Chartered Banks. Section 24 of
the FDIA generally limits the activities and equity investments of FDIC-insured,
state-chartered banks to those that are permissible for national banks. Under
the FDIC's regulations dealing with equity investments, an insured state bank
generally may not directly or indirectly acquire or retain any equity investment
of a type, or in an amount, that is not permissible for a national bank. An
insured state bank is not prohibited from, among other things, (i) acquiring or
retaining a majority interest in a subsidiary, (ii) investing as a limited
partner in a partnership the sole purpose of which is direct or indirect
investment in the acquisition, rehabilitation or new construction of a qualified
housing project, provided that such limited partnership investments may not
exceed 2% of the Bank's total assets, (iii) acquiring up to 10% of the voting
stock of a company that solely provides or reinsures directors', trustees', and
officers' liability insurance coverage or bankers' blanket bond group insurance
coverage for insured depository institutions, and (iv) acquiring or retaining
the voting shares of a depository institution if certain requirements are met.
Community Reinvestment Act. The Federal Community Reinvestment Act ("CRA")
requires the FDIC and the Commissioner to evaluate the Bank's performance in
helping to meet the credit needs of the community. The Bank has been designated
as a "wholesale institution" for CRA purposes by the Commissioner and has an
application for similar treatment pending with the FDIC. This designation
reflects the nature of the Company's business as other than a retail financial
institution and proscribes CRA review criteria applicable to the Bank's
particular type of business. As a part of the CRA program, the Bank is subject
to periodic examinations by the FDIC and the Commissioner, and maintains
comprehensive records of its CRA activities for this purpose. The Bank is
currently in compliance with all CRA requirements.
Massachusetts Law - Dividends. Under Massachusetts law trust companies
such as the Bank may pay dividends only out of "net profits" and only to the
extent that such payments will not impair the Bank's capital stock and surplus
account. If, prior to declaration of a dividend, the Bank's capital stock and
surplus accounts do not equal at least 10.0% of its deposit liabilities, then
prior to the payment of the dividend the Bank must transfer from net profits to
its surplus account the amount required to make its surplus account equal to
either (i) together with capital stock, 10.0% of deposit liabilities or, (ii)
subject to
17
certain adjustments, 100% of capital stock. These restrictions on the ability of
the Bank to pay dividends to the Company may restrict the ability of the Company
to pay dividends to its stockholders.
Regulatory Enforcement Authority. The enforcement powers available to
federal banking regulators include, among other things, the ability to assess
civil money penalties, to issue cease-and-desist or removal orders and to
initiate injunctive actions against banking organizations and institution-
affiliated parties, as defined. In general, these enforcement actions may be
initiated for violations of law and regulations and unsafe or unsound practices.
Other actions or inactions may provide the basis for enforcement action,
including misleading or untimely reports filed with regulatory authorities.
Federal law requires, except under certain circumstances, public disclosure of
final enforcement actions by the federal banking agencies.
Transfer Agency. In order to serve as transfer agent to its clients that
execute transactions in publicly traded securities, the Company must register as
a transfer agent under the Exchange Act. As a registered transfer agent, the
Company is subject to certain reporting and recordkeeping requirements.
Currently, the Company is in compliance with these registration, reporting and
recordkeeping requirements.
Regulation of Investment Companies. Certain of the Company's mutual fund
and unit investment trust clients are regulated as "investment companies" as
that term is defined under the Investment Company Act of 1940, as amended (the
"ICA"), and are subject to examination and reporting requirements applicable to
the services provided by the Company.
The provisions of the ICA and the regulations promulgated thereunder
prescribe the type of institution which may act as a custodian of investment
company assets, as well as the manner in which a custodian administers the
assets in its custody. Because the Company serves as custodian for a number of
its investment company clients, these regulations require, among other things,
that the Company maintain certain minimum aggregate capital, surplus, and
undivided profits. Additionally, arrangements between the Company and clearing
agencies or other securities depositories must meet ICA requirements for
segregation of assets, identification of assets and client approval. Future
legislative and regulatory changes in the existing laws and regulations
governing custody of investment company assets, particularly with respect to
custodian qualifications, may have a material and adverse impact on the Company.
Currently, the Company is in compliance with all minimum capital and securities
depository requirements. Further, the Company is not aware of any proposed or
pending regulatory developments, which, if approved, would adversely affect the
ability of the Company to act as custodian to an investment company.
Investment companies are also subject to extensive recordkeeping and
reporting requirements. These requirements dictate the type, volume and
duration of the record-keeping undertaken by the Company, either in its role as
custodian for an investment company or as a provider of administrative services
to an investment company. Further, the Company must follow specific ICA
guidelines when calculating the net asset value of a client mutual fund.
Consequently, changes in the statutes or regulations governing recordkeeping and
reporting or valuation calculations will affect the manner in which the Company
conducts its operations.
New legislation or regulatory requirements could have a significant impact
on the information reporting requirements applicable to the Company's clients
and may in the short term adversely affect the Company's ability to service
those clients at a reasonable cost. Any failure by the Company to provide such
support could cause the loss of customers and have a material adverse effect on
the Company's financial results. Additionally, legislation or regulations may
be proposed or enacted to regulate the Company in a manner which may adversely
affect the Company's financial results.
18
ITEM 2. PROPERTIES.
As of December 31, 1996, the Company leased four offices located in Boston,
as well as foreign offices in Toronto, Canada and Dublin, Ireland for its
offshore funds processing business.
The following table provides certain summary information with respect to
the principal properties that the Company leases:
Location Function Sq. Ft. Expiration Date
- -------- -------- ------ ---------------
89 South St., Boston, MA Principal Executive Offices 115,504 1997
and Operations Center
200 Clarendon St., Boston, MA Operations Center 25,300 2007
1 Exeter Plaza, Boston, MA Training Center 11,375 2001
24 Federal Street, Boston, MA Operations Center 3,658 Tenant at will
1 First Canadian Place, Toronto Offshore Processing Center 13,674 1997
Earlsfort Terrace, Dublin Offshore Processing Center 3,400 1997
In November 1995, the Company entered into an agreement to lease 158,656
square feet at the 200 Clarendon Street location for a ten-year term to commence
in 1997 in order to consolidate its Boston operations. See Note 14 of Notes to
Consolidated Financial Statements. In December 1996, the Company exercised an
option under this ten-year lease to activate an additional 24,834 square feet at
this location.
ITEM 3. LEGAL PROCEEDINGS.
The Company is from time to time subject to claims arising in the ordinary
course of business. While the outcome of any claim cannot be predicted with
certainty, management does not expect these matters to have a material adverse
effect on the results of operations and financial condition of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of the Company's security holders
during the quarter ended December 31, 1996.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.
PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY
The Company's Common Stock is currently included in The Nasdaq National Market
under the symbol IFIN. The Company's Common Stock began trading on November 8,
1995 in connection with the Company's initial public offering priced at $16.50
per share. The following table sets forth, on a per share basis for the periods
shown, the range of high and low sales prices of the Company's Common Stock as
reported by Nasdaq.
_____________________
HIGH LOW
---- ---
First Quarter $23.125 $20.500
Second Quarter $23.500 $21.000
Third Quarter $26.000 $20.875
Fourth Quarter $28.000 $25.750
As of February 18, 1997, there were approximately 2,045 stockholders of record.
19
DIVIDENDS
The Company currently intends to retain the majority of future earnings to
fund the development and growth of its business. The Company's ability to pay
dividends on the Common Stock and Class A Common Stock depends on the receipt of
dividends from Investors Bank & Trust Company. In addition, the Company may not
pay dividends on its Common Stock or Class A Common Stock if it is in default
under certain agreements which the Company entered into in connection with the
sale of the 9.77% Capital Securities described below. Any dividend payments by
Investors Bank & Trust Company are subject to certain restrictions imposed by
the Massachusetts Commissioner of Banks. See "Business -Regulation and
Supervision." Subject to regulatory requirements, Investors Bank & Trust
Company expects to pay an annual dividend to the Company, which the Company
expects to pay to its stockholders, currently estimated to be in an amount equal
to $.08 per share of outstanding Common Stock and Class A Stock (approximately
$515,545 based upon 6,444,312 shares outstanding as of December 31, 1996). The
Company expects to declare and pay such dividend ratably on a quarterly basis.
RECENT SALES OF UNREGISTERED SECURITIES
On January 31, 1997, the Company completed the issuance and sale of
$25,000,000 in 9.77% Capital Securities (the "Capital Securities"). The Capital
Securities were issued by Investors Capital Trust I, a Delaware statutory
business trust sponsored by the Company. The sale of the Capital Securities was
underwritten by Keefe, Bruyette & Woods, Inc. ("Keefe"), pursuant to which Keefe
received compensation in the amount of $562,500. The Capital Securities were
sold only to "Qualified Institutional Buyers" (as defined in Rule 144A under the
Securities Act of 1933 (the "Act") and institutional "accredited investors" (as
defined in Rule 501(a)(1), (2), (3) or (7) under the Act) pursuant to the
exemption provided by Section 4(2) of the Act. See Exhibits 10.19 through 10.24
to this Report.
20
ITEM 6. SELECTED FINANCIAL DATA.
Except as discussed below, the selected financial data presented below have
been derived from the Company's audited financial statements. This data should
be read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations," the Company's Consolidated Financial
Statements, and other financial information appearing elsewhere in this Report.
For the Two Months For the Year
For the Year Ended October 31, Ended December 31, Ended December 31,
----------------------------------------------------------------------------------------------
1992 1993 1994 1995(1) 1995 1996
-------------- ----------- ----------- ---------- ----------- -------------
(Dollars in thousands, except per share data)
STATEMENT OF INCOME DATA:
Net interest income $ 3,659 $ 4,494 $ 4,778 $ 5,870 $ 1,966 $ 17,944
Noninterest income 29,664 32,967 43,049 51,562 8,085 56,632
Gain on sale of investment securities - 48 - - - -
-------------- ----------- ----------- ---------- ----------- ------------
Net operating revenues 33,323 37,509 47,827 57,432 10,051 74,576
Operating expenses 30,589 33,939 42,503 50,224 8,481 61,935
-------------- ----------- ----------- ---------- ----------- ------------
Income before income taxes 2,734 3,570 5,324 7,208 1,570 12,641
Income taxes 1,163 1,211 1,863 2,800 670 4,867
-------------- ----------- ----------- ---------- ----------- ------------
Net income $ 1,571 $ 2,359 $ 3,461 $ 4,408 $ 900 $ 7,774
============== =========== =========== ========== =========== ============
PER SHARE DATA
Earnings per share $ 0.14 $ 1.20
=========== ============
Average number of shares outstanding 6,467 6,504
=========== ============
AVERAGE BALANCE SHEET DATA:
Interest earning assets $ 81,148 $ 87,965 $ 94,351 $ 106,130 $ 219,775 $ 575,662
Total assets 99,609 109,477 116,810 128,174 249,064 628,893
Total deposits 88,684 99,523 102,664 106,446 197,013 377,219
Stockholders'equity 7,053 9,022 11,779 16,119 34,000 56,137
SELECTED FINANCIAL RATIOS:
Return on equity (2) 22.27% 26.15% 29.38% 27.35% 15.11% 13.85%
Return on assets (2) 1.58% 2.15% 2.96% 3.44% 2.12% 1.24%
Equity as % of total assets 6.52% 8.24% 10.08% 12.58% 16.57% 6.41%
Dividend payout ratio (3) 3.82% 2.54% 1.73% 1.36% 0.00% 2.49%
Tier 1 capital ratio (4) 37.78% 37.08% 42.53% 37.62% 62.10% 24.67%
Noninterest income as % of net
operating income 89.02% 87.89% 90.01% 89.78% 80.44% 75.94%
Nonperforming assets as % of
total assets 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
Allowance for loan losses as %
of total loans 0.59% 0.34% 0.26% 0.26% 0.15% 0.15%
OTHER STATISTICAL DATA:
Assets processed at end of period (5) $43,348,597 $61,239,242 $72,418,449 $91,099,976 $94,208,228 $122,563,401
Employees at end of period 460 522 678 671 674 792
_______________
(1) Noninterest income for the year ended October 31, 1995 includes the
recognition of net proceeds of $2,572,000 from the assignment to a third
party of asset administration rights associated with $5 billion of unit
investment trust assets. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
(2) Ratios for the two months ended December 31, 1995 have been annualized. The
ratios for the year ended October 31, 1995 include the effect of the unit
investment trust transaction described in (1) above. Without the earnings
associated with this transaction, return on equity and return on assets for
the year ended October 31, 1995 would have been 18.10% and 2.28%,
respectively.
(3) The Company intends to retain the majority of future earnings to fund
development and growth of its business but the Company currently expects to
pay cash dividends at an annualized rate of $.08 per share, subject to
receipt of a like dividend from the Bank and further subject to regulatory
requirements and the terms of certain documents entered into in connection
with the sale of the Capital Securities described under "Market for
Registrant's Common Equity and Related Stockholder Matters - Recent Sales of
Unregistered Securities. "
(4) Tier I capital consists of the sum of common stockholders' equity and non-
cumulative perpetual preferred stock minus all intangible assets (other than
certain qualifying goodwill) and excess deferred tax assets.
(5) Assets processed is the total dollar value of financial assets on the
reported date for which the Company provides one or more of the following
services: custody, multicurrency accounting, institutional transfer agency,
performance measurement, foreign exchange, securities lending and mutual
fund administration and investment advisory services.
21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The following discussion and analysis of the financial condition and
results of operations of the Company should be read in conjunction with the
Company's Consolidated Financial Statements and related notes, which are
included elsewhere in this Report. The Company, through its wholly owned
subsidiary, Investors Bank & Trust Company, provides domestic and global
custody, multicurrency accounting, institutional transfer agency, performance
measurement, foreign exchange, securities lending and mutual fund administration
and investment advisory services to a variety of financial asset managers,
including mutual fund complexes, investment advisors, banks and insurance
companies. The Company provides financial asset administration services for
assets that totaled approximately $122 billion at December 31, 1996, including
approximately $9 billion of assets based outside the United States. The Company
also engages in private banking transactions, including secured lending and
deposit accounts.
The Company's historical business and financial results have been
significantly influenced by the restrictions imposed under CEBA. Under the CEBA
restrictions, the Company could not: (a) engage in any activity in which it was
not engaged as of March 5, 1987; (b) increase its assets by more than 7% during
any 12-month period beginning after August 10, 1988; (c) engage in certain
cross-marketing activities with affiliates; or (d) permit overdrafts by or incur
overdrafts on behalf of affiliates at a Federal Reserve Bank. As a result of
the Offering and the Spin-Off Transaction, the Company is no longer subject to
such restrictions. Accordingly, the Company's historical operating results may
not necessarily be indicative of either the full scope of the future conduct of
the Company's business or its future operating results.
The Company is now able to expand current business activities and
participate in certain additional business activities which may result in
increased revenues generated by a possible increase in client deposits and
lending opportunities. The Company's clients typically generate cash balances
from securities sales and other transactions which they seek to invest on a
short-term basis. Because the Company had been subject to the CEBA 7% annual
asset growth cap, it was not able to accept those deposits prior to the
completion of the Spin-Off Transaction and directed them to other financial
institutions, foregoing a potential source of revenue. The Company directed
client deposits averaging approximately $1.2 billion daily to other financial
institutions in fiscal year 1995. Since the completion of the Spin-Off
Transaction and the Offering, the Company has redirected an average of
approximately $734 million daily of these balances into its own deposit
products. Similarly, many of the Company's clients use credit lines to leverage
their portfolios or to handle overnight cash shortfalls. CEBA requirements
restricted the Company from making commercial loans of this type. As a result
of the removal of CEBA limitations, the Company is now able to make commercial
loans. Additionally, since the Spin-Off Transaction, the Company has entered
into agreements to provide up to an aggregate of $40 million in secured lines of
credit to mutual fund clients.
In November 1996, the Bank executed agreements with the Merrimac Master
Portfolio and the Merrimac Funds, newly formed master-feeder investment
companies (the "Funds"), pursuant to which the Company has agreed to act as
investment adviser to the Funds. At the same time, the Company engaged the Bank
of New York to act as sub-adviser to manage the investments of the Funds. In
addition to acting as adviser to the Funds, the Bank has entered into agreements
to provide custody, fund accounting, administration, transfer agency and certain
other related services to the Funds. Currently, the Funds have one operating
master fund, the Merrimac Cash Portfolio, and one operating feeder fund, the
Merrimac Cash Fund, with assets totaling over $1 billion at December 31, 1996.
The Merrimac Cash Fund offers its shares only to institutions and other
"accredited investors" (as that term is defined in Rule 501(a) under the
Securities Act of 1933) and invests all of its assets in the Merrimac Cash
Portfolio. The Merrimac Cash Portfolio invests its assets in high quality money
market instruments. The Funds may add additional feeder funds and master funds
in the future.
The Company's current largest client, Eaton Vance, accounted for 18%, 14%,
11% and 10% of the Company's net operating revenues for the years ended October
31, 1994 and 1995, for the Transition Period, and for the year ended December
31, 1996, respectively. The Company believes its relationship with Eaton Vance
is good and expects it to continue. The Company's agreements with mutual funds
managed by Eaton Vance, pursuant to which the Company provides custody and fund
accounting services, extend through August 2000 and continue thereafter until
terminated by either party upon sixty days prior notice. If a majority of
noninterested trustees of a fund determines that the performance of the Company
under any such agreement has been unsatisfactory or adverse to the interests of
the fund's shareholders, or that the terms of the agreement are no longer
consistent with publicly available industry standards, the Company shall have 60
days after receipt of written notice to
22
such effect to (i) correct its performance or (ii) renegotiate such terms. If
such corrective action or renegotiation is not satisfactory to such trustees,
such agreement may be terminated on sixty days prior notice. There have been no
requests for corrective action or renegotiation to date pursuant to these
contract clauses.
The Company derives its revenues from financial asset administration
services and private banking transactions. Although interest income and
noninterest income are reported separately for financial statement presentation
purposes, the Company's clients view the pricing of the Company's asset
administration and banking service offerings on a bundled basis. In
establishing a fee structure for a specific client, management analyzes the
expected revenue and related expenses, as opposed to separately analyzing fee
income and interest income and related expenses for each from such relationship.
Accordingly, management believes net operating revenue (net interest income plus
noninterest income) and net income are meaningful measures of financial results.
Noninterest income consists primarily of fees for financial asset
administration and is principally derived from custody, multicurrency
accounting, transfer agency and administration services for financial asset
managers and the assets they control. The Company's clients pay fees based on
the volume of assets under custody, the number of securities held and portfolio
transactions, income collected and whether other value-added services such as
foreign exchange, securities lending and performance measurement are needed.
Asset-based fees are usually-charged on a sliding scale. As such, when the
assets in a portfolio under custody grow as a result of changes in market values
or cash inflows, the Company's fees may be a smaller percentage of those assets.
Fees for individually managed accounts, such as custodial, trust and portfolio
accounting services for individuals, investment advisors, private trustees,
financial planners, other banks and fiduciaries, and other institutions are also
included in noninterest income.
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.
The Company, because it is no longer subject to the CEBA balance sheet
growth restrictions, is able to accept client deposits it had historically
directed to other financial institutions. As compensation for directing these
deposits to other financial institutions, the Company had retained a portion of
the earnings on the deposits; this amount was recognized as fee income.
Generally, the Company invests these deposits in various interest-earning assets
and pays its clients interest expense. As a result, the mix of fee income and
interest income that comprise the total compensation package from clients is
shifting as the relative amount of fee income decreases while the relative
amount of interest income increases.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
From time to time, information provided by the Company, statements made by
its employees or information included in its filings with the Securities and
Exchange Commission (including this Form 10-K) may contain statements which are
not historical facts, so-called "forward-looking statements," which involve
risks and uncertainties. The Company's actual future results may differ
significantly from those stated in any forward-looking statements. Factors that
may cause such differences include, but are not limited to, the factors
discussed below. Each of these factors, and others, are discussed from time to
time in the Company's filings with the Securities and Exchange Commission.
The Company's future results may be subject to substantial risks and
uncertainties. Because certain fees charged by the Company for its services are
based on the market values of assets processed, such fees and the Company's
quarterly and annual operating results are sensitive to changes in interest
rates, declines in stock market values, and investors seeking alternatives to
investment offerings of the Company's clients. Also, the Company's interest-
related services, along with the market value of the Company's investments, may
be adversely affected by rapid changes in interest rates. In addition, many of
the Company's client engagements are, and in the future are likely to continue
to be, terminable upon 60 days notice. Also, a substantial portion of the
assets held in the Merrimac Cash Fund are contributed by accounts managed by the
fund's sub-advisor, The Bank of New York. Because the Company's fee income from
its investment advisory services is based on a percentage of assets invested in
the Merrimac Cash Fund, withdrawal from the fund by the accounts managed by The
Bank of New York could have an adverse affect on the Company's revenues. Also,
the Company relies on certain intellectual property protections to preserve its
intellectual property rights. Any invalidation of the Company's intellectual
property rights or lengthy and expensive defense of
23
those rights could have a material adverse affect on the Company. The segment of
the financial services industry in which the Company is engaged is extremely
competitive. Certain current and potential competitors of the Company are more
established and benefit from greater market recognition and have substantially
greater financial, development and marketing resources than the Company.
The Company's quarterly and annual operating results are affected by a wide
variety of factors that could materially adversely affect revenues and
profitability, including: the timing of the commencement or termination of
client engagements, the rate of net inflows and outflows of investor funds in
the debt and equity-based investment vehicles offered by the Company's clients,
the introduction and market acceptance of new services by the Company and
changes or anticipated changes in economic conditions. Because the Company's
operating expenses are relatively fixed, any unanticipated shortfall in revenues
in a specified period may have an adverse impact on the Company's results of
operations for that period. As a result of the foregoing and other factors,
the Company may experience material fluctuations in future operating results on
a quarterly or annual basis which could materially and adversely affect its
business, financial condition, operating results and stock price.
STATEMENT OF OPERATIONS
Comparison of Operating Results for the Years Ended December 31, 1996 and 1995
Noninterest Income
Noninterest income increased $4,705,000 to $56,632,000 for the year ended
December 31, 1996 from $51,927,000 for the year ended December 31, 1995.
Noninterest income consists of the following items:
For the Year Ended December 31,
----------------------------------- -----------
1995 1996 Change
---------------- -------------- -----------
(Dollars in thousands)
Asset administration fees $48,779 $56,076 15%
Proceeds from assignment of
UIT servicing, net 2,572 0 -
Computer service fees 501 482 (4)
Other operating income 75 76 1
Net loss on sale of securities - (2) -
------------ ------------
Total Noninterest Income $51,927 $56,632 9%
============ ============
Asset administration fees increased due principally to higher levels of
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, multicurrency accounting, institutional transfer
agency, performance measurement, foreign exchange, securities lending and mutual
fund administration. Total assets processed increased to $122 billion at
December 31, 1996 from $94 billion at December 31, 1995. Of the $28 billion net
increase in assets processed from December 31, 1995 to December 31, 1996,
approximately 24% of the increase reflects assets processed for new clients, and
the remainder of the increase reflects growth of assets processed for existing
clients and improved methods for tracking the amount of assets processed, offset
in part by the assets of clients no longer serviced by the Company. The
remainder of the growth in asset administration fees was due to the net
expansion of relationships with existing clients and increased use of the
Company's cash management and foreign exchange services. In addition, because
the Company is now able to accept deposits that had been historically directed
to other financial institutions due to CEBA asset growth restrictions, the
Company has experienced a shift in the mix of compensation received from its
clients. See "Overview" in this Item 7. A larger portion of the Company's
compensation from clients is now in the form of interest income generated from
client deposits, resulting in a decrease to asset administration fees and a
related increase in net interest income. The growth in asset administration
fees was also offset by the transfer of unit investment trust assets discussed
below. The administration of these assets accounted for approximately
$1,491,000 in asset administration fees in the year ended December 31, 1995.
Unit investment trust ("UIT") assets processed by the Company have
decreased over the last five years, a reflection of declining investor demand
for this type of unmanaged investment product. Declining asset levels led one
client, Merrill, Lynch, to consolidate its asset administration service
providers, and it agreed, effective March 1, 1995, to pay the Company to assign
the Company's servicing rights to The Bank of New York. The Company recognized
proceeds of $2,572,000, net of expenses, resulting from the assignment of the
rights to service approximately $5.0 billion of the client's unit investment
trust assets. The
24
Company has made the strategic decision to focus its marketing and processing
efforts on mutual funds and other pooled investments which typically experience
higher growth in asset levels and can utilize a wider variety of services
provided by the Company, as compared to unit investment trusts. See Note 10 of
Notes to Consolidated Financial Statements.
Computer service fees consist of amounts charged by the Company to Eaton
Vance for data processing services related to individual accounts managed by
Eaton Vance. Other operating income consists of miscellaneous private banking
fees for safe deposit and checking account services.
Operating Expenses
Total operating expenses increased by $10,672,000 to $61,935,000 for the
year ended December 31, 1996 compared to $51,263,000 for the year ended December
31, 1995. The components of operating expenses were as follows:
Compensation of officers and employees increased by $4,013,000 or 14% from
period to period due to several factors. The number of employees increased 18%
to 792 at December 31, 1996 from 674 at December 31, 1995. In addition,
compensation expense related to the Company's management incentive plan
increased because of the increase in earnings subject to incentive in 1996
compared to 1995. The remainder of the increase in compensation expense
resulted from salary increases.
For the year ended December 31,
--------------------------------- ---------
1995 1996 Change
---------------------------------- ---------
(Dollars in thousands)
Compensation $ 28,135 $ 32,148 14%
Pension and other employee
benefits 4,764 5,354 12
Occupancy 4,163 4,283 3
Equipment 4,833 5,586 16
Insurance 1,078 853 (21)
Subcustodian Fees 1,698 4,151 144
Depreciation and amortization 1,388 1,502 8
Professional Fees 1,506 2,363 57
Travel and sales promotion 785 1,158 48
Other operating expenses 2,913 4,537 56
---------------- -----------
Total Noninterest Expenses $ 51,263 $ 61,935 21%
================ ===========
Pension and other employee benefits, including payroll taxes, group
insurance plans, retirement plan contributions and tuition reimbursement,
increased to $5,354,000 for the year ended December 31, 1996 from $4,764,000 for
the same period in 1995. The 12% increase was due to increased payroll taxes
attributable to the increase in compensation expense and a decrease in the
discount rate used to calculate the expense associated with the defined benefit
retirement plan.
Equipment expenses vary with the level of assets processed by the Company.
The $753,000 increase between periods was due principally to the growth in
assets processed by the Company.
Insurance expense decreased by $225,000 or 21% between the periods due to
the renegotiation of the Company's coverage for errors and omissions liability,
directors and officers liability and blanket bond.
Subcustodian expense consists of fees paid to centralized clearinghouses
and depositories for settling and holding securities on the Company's behalf.
This expense increased $2,453,000 to $4,151,000 for the year ended December 31,
1996 from $1,698,000 for the year ended December 31, 1995. This increase
results from the increase in foreign assets processed, which are subject to
higher subcustodian fees, from $6.4 billion at December 31, 1995 to $9.3 billion
at December 31, 1996, and from the movement by clients into emerging markets
which have higher costs due to structural inefficiencies. These costs are
passed through to clients and contribute to the increase in asset administration
fees.
Professional fees increased $857,000 to $2,363,000 for the year ended
December 31, 1996 from $1,506,000 for the year ended December 31, 1995. This
57% increase resulted primarily from the Company's increased use of independent
contractors to perform certain information systems development projects, rather
than adding permanent staff. Additionally, legal
25
fees incurred in connection with the Company's initial compliance with year-end
related filings with the Securities and Exchange Commission and the change of
the Company's fiscal year contributed to this increase. The Company has hired
general counsel to, among other things, assist with these reporting requirements
in the future.
Travel and sales promotion expense consists of expenses incurred by the
sales force, client management staff and other employees in connection with
making sales calls on potential clients, traveling to existing client sites and
the Company's foreign subsidiaries, and attending industry conferences. This
expense increased $373,000 to $1,158,000 for the year ended December 31, 1996
from $785,000 for the year ended December 31, 1995 due primarily to increased
travel to the foreign subsidiaries.
Other operating expenses increased $1,624,000 to $4,537,000 for the year
ended December 31, 1996 from $2,913,000 for the year ended December 31, 1995.
Other operating expenses include fees for daily market pricing data, telephone,
photocopy service outsourcing, office supplies, and Delaware excise tax. Fees
for daily market pricing data vary with the level of assets processed. Other
expenses such as telephone and office supplies vary with staffing levels. The
outsourcing of photocopy service commenced in 1996 and accounted for
approximately $240,000 of the increase between periods. The Delaware excise tax
is based on the number of shares authorized for issuance by the Company. This
tax was imposed on the Company after its formation as a Delaware Corporation in
June 1995 and accounts for $180,000 of the increase between periods. The
remainder of the increase relates to the increases in assets processed and
staffing levels.
Net Interest Income
Net interest income is affected by the volume and mix of assets and
liabilities, and the movement and level of interest rates. The table below
presents the changes in net interest income resulting from changes in the volume
of interest-earning assets or interest-bearing liabilities and changes in
interest rates for the year ended December 31, 1996 compared to the same period
in 1995.
Change Change
Due to Due to
Volume Rate Net
--------- -------- --------
(Dollars in thousands)
INTEREST-EARNING ASSETS
Fed funds sold and
interest-earning deposits $ 1,256 $ (45) $ 1,211
Investment securities 25,876 491 26,367
Loans 1,341 (250) 1,091
--------- -------- --------
Total interest-earning assets 28,473 196 28,669
--------- -------- --------
INTEREST-BEARING LIABILITIES
Deposits 8,249 180 8,429
Borrowings 9,236 (41) 9,195
--------- ------ -------
Total interest-bearing liabilities 17,485 139 17,624
--------- ------ -------
Change in net interest income $10,988 $ 57 $11,045
========= ====== =======
Net interest income increased $11,045,000 or 159% to $18,009,000 for the
year ended December 31, 1996 from $6,964,000 for the 1995 period. This net
increase resulted from an increase in interest income of $28,669,000 offset by
an increase in interest expense of $17,624,000. The net impact of the above
changes was a 240 basis point decrease in net interest margin.
The increase in interest income resulted primarily from a higher level of
interest earning assets. Prior to the Spin-Off Transaction, the Company was
subject to a 7% annual asset growth cap under CEBA. The elimination of the CEBA
growth restriction has allowed the Company to accept deposits from clients which
it had historically directed to other financial institutions. The Company's
average assets for the year ended December 31, 1996 increased $483,710,000 or
333% compared to the 1995 period. This growth primarily resulted from an
increase in average interest earning assets of $449,720,000.
Interest expense increased $17,624,000 due primarily to the higher level of
deposits and borrowings and to a lesser extent to an increase in the interest
rate paid by the Company. Prior to the Spin-Off Transaction, the Company was
not trying to
26
attract deposits to its balance sheet and therefore did not pay a competitive
interest rate. The average rate paid on deposits and short-term borrowings
increased from 4.12 % to 4.83% between periods.
Income Taxes
The Company's earnings were taxed on the federal level at 34% for the 1995
period and 35% for the 1996 period. State taxes on the gross earnings from the
Company's portfolio of investment securities, held by a wholly-owned subsidiary,
were assessed at the tax rate for Massachusetts securities corporations of
1.32%. State taxes on the remainder of the Company's taxable income were
assessed at the tax rate for Massachusetts banks of 11.72%. The provision for
income taxes for the year ended December 31, 1996 increased by $1,856,000 over
the 1995 provision. The overall effective tax rate decreased to 38.5% for the
year ended December 31, 1996, from 39.5% for the year ended December 31, 1995.
The decrease in the effective tax rate was due to a decrease in the income of
the Company's Canadian subsidiary, which was taxed at the Canadian effective
rate of 45.37%, and the related increase in the income of the Company's
subsidiaries in Dublin and the Cayman Islands, which are lower tax
jurisdictions. The reduction of the income in the Company's Canadian subsidiary
resulted as the Company transferred certain offshore processing activities from
Toronto to Dublin and the Cayman Islands.
Comparison of Operating Results for the Two Months Ended December 31, 1995 and
1994
Noninterest Income
Noninterest income increased $204,000 to $8,085,000 for the two months
ended December 31, 1995 from $7,881,000 for the prior period. Noninterest
income consists of the following items:
For the Two Months Ended December 31,
------------------------------------- ---------
1994 1995 Change
--------------- ------------- ---------
(Dollars in thousands)
Asset administration fees $7,782 $7,988 3%
Computer service fees 88 83 (6)
Other operating income 11 14 27
------------ -----------
Total Noninterest Income $7,881 $8,085 3%
============ ===========
An increase in asset administration fees, due principally to higher levels
of assets processed, represented a significant part of the increase. Assets
processed is the total dollar value of financial assets on the reported date for
which the Company provides one or more of the following services: custody,
multicurrency accounting, institutional transfer agency, performance
measurement, foreign exchange, securities lending and mutual fund
administration. Total assets processed grew to $94 billion at December 31, 1995
compared to $71 billion at December 31, 1994, a 32% net increase. Approximately
20% of this growth resulted from assets processed for new clients. The
remainder of the growth was due to the net expansion of relationships with
existing clients, including growth in assets processed and increased use of the
Company's foreign exchange services. In addition, because the Company is now
able to accept deposits that had been historically directed to other financial
institutions due to CEBA asset growth restrictions, the Company has experienced
a shift in the mix of compensation received from its clients. See "Overview" in
this Item 7. A larger portion of the Company's compensation from clients is now
in the form of interest income generated from client deposits, resulting in a
decrease to asset administration fees and a related increase in net interest
income. The growth in asset administration fees was also offset by the transfer
of $5 billion of unit investment trust assets to another financial institution
on March 1, 1995; the administration of these assets accounted for approximately
$1,148,000 in asset administration fees in the two months ended December 31,
1994.
Computer service fees consist of amounts charged by the Company to Eaton
Vance for data processing services related to individual accounts managed by
Eaton Vance. Other operating income consists of miscellaneous private banking
fees for safe deposit and checking account services.
27
Operating Expenses
Total operating expenses increased by $879,000 to $8,481,000 for the two
months ended December 31, 1995 compared to $7,602,000 for the two months ended
December 31, 1994. The components of operating expenses were as follows:
For the two months ended December 31,
---------------------------------------- ------------
1994 1995 Change
------------------- ------------------ ------------
(Dollars in thousands)
Compensation $ 4,197 $ 4,957 18%
Pension and other employee benefits 761 840 10
Occupancy 677 625 (8)
Equipment 804 808 1
Insurance 176 194 10
Subcustodian Fees 363 217 (40)
Depreciation and amortization 19 186 879
Professional Fees 213 202 5
Travel and sales promotion 175 123 (30)
Other operating expenses 217 329 52
------------------- ------------------
Total Noninterest Expenses $ 7,602 $ 8,481 12%
=================== ==================
Compensation of officers and employees increased by $761,000 or 18% from
period to period due to several factors. The number of employees decreased 1%
to 674 at December 31, 1995 from 681 at December 31, 1994. During the two
months ended December 31, 1994, the Company deferred approximately $200,000 of
personnel-related start-up costs associated with serving a new client for whom
services were not provided until calendar year 1995. These costs were amortized
during 1995. Compensation expense for the two months ended December 31, 1995
included an increase of $152,000 related to the Company's management incentive
plan, which is based on calendar year pre-tax operating income. The total
expense of this plan for the 1995 calendar year was lower than the total expense
for the 1994 calendar year, but because of the timing of various income and
expense items, the expense for the two months ended December 31, 1994 and 1995
increased. The remainder of the increase in compensation expense resulted from
salary increases.
Pension and other employee benefits, including payroll taxes, group
insurance plans, retirement plan contributions and tuition reimbursement,
increased to $840,000 for the two months ended December 31, 1995 from $761,000
for the same period in 1994. The 10% increase was due to increased payroll
taxes attributable to the increase in compensation expense and increased
participation by employees in the retirement plans and the tuition reimbursement
plan.
Subcustodian expense consists of fees paid to centralized clearinghouses
and depositories for settling and holding securities on the Company's behalf.
This expense decreased $146,000 to $217,000 for the two months ended December
31, 1995 from $363,000 for the two months ended December 31, 1994. This
decrease resulted from abnormally high compensating deposit balances held by one
client at a Hong Kong subcustodian, which reduced the fees charged by that
subcustodian.
Depreciation and amortization expense increased $167,000 between periods
due to a nonrecurring adjustment to the useful life of capitalized software
development costs related to the SEI Trust 3000 system used for individually
managed accounts. The Company leases this system from SEI and software
development costs were amortized over the original term of the lease, which
expired on December 31, 1994. At that time, the Company exercised a renewal
option to extend the lease for two additional years, and the accumulated
amortization of the software developments costs was adjusted for the change in
the lease term.
Travel and sales promotion consists of expenses incurred by the sales force
and client management staff in connection with making sales calls on potential
clients, traveling to existing client sites and attending industry conferences.
This expense decreased $52,000 to $123,000 for the two months ended December 31,
1995 from $175,000 for the prior period due to the timing of various conferences
and sales trips.
Other operating expenses increased $112,000 to $329,000 for the two months
ended December 31, 1995 from $217,000 for the two months ended December 31,
1994. Other operating expenses include fees for daily market pricing data,
telephone, office supplies, and the FDIC assessment on deposits. Fees for daily
market pricing data vary with the level of assets processed.
28
Other expenses such as telephone and office supplies vary with staffing levels.
The FDIC assessment is based on deposit balances as of four annual measurement
dates. A majority of the increase in other operating expenses resulted from a
decrease in client reimbursement of charges for telephone, office supplies, and
fees for daily market pricing. The Company was reimbursed for a portion of these
charges by the Merrill Lynch unit investment trust accounts prior to the
transfer of these accounts in March 1995.
Net Interest Income
Net interest income is affected by the volume and mix of assets and
liabilities, and the movement and level of interest rates. The table below
presents the changes in net interest income resulting from changes in the volume
of interest-earning assets or interest-bearing liabilities or changes in
interest rates for the two months ended December 31, 1995 compared to the same
period in 1994.
Change Change
Due to Due to
Volume Rate Net
-------- ------- -------
(Dollars in thousands)
INTEREST-EARNING ASSETS
Fed funds sold and
interest-earning deposits $ 280 $ 1 $ 281
Investment securities 901 105 1,006
Loans 28 1 29
-------- ------- -------
Total interest-earning assets 1,209 107 1,316
-------- ------- -------
INTEREST-BEARING LIABILITIES
Deposits 28 83 111
Borrowings 111 0 111
-------- ------- -------
Total interest-bearing liabilities 139 83 222
-------- ------- -------
Change in net interest income $1,070 $ 24 $1,094
======== ======= =======
Net interest income increased $1,094,000 or 125% to $1,966,000 for the two
months ended December 31, 1995 from $872,000 for the same period in 1994. This
net increase resulted from an increase in interest income of $1,316,000 offset
by an increase in interest expense of $222,000. The net impact of the above
changes was a 30 basis point increase in net interest margin.
The increase in interest income resulted primarily from a higher level of
interest earning assets. Prior to the Spin-Off Transaction, the Company was
subject to a 7% annual asset growth cap under CEBA. The elimination of the CEBA
growth restriction has allowed the Company to accept deposits from clients which
it had historically directed to other financial institutions. The Company's
average assets for the two months ended December 31, 1995 increased $118,744,000
or 91% compared to the same period in 1994. This growth primarily resulted from
an increase in average interest earning assets of $116,607,000.
Interest expense increased $222,000 due to the higher level of deposits and
an increase in the interest rate paid by the Company. Prior to the Spin-Off
Transaction, the Company was not trying to attract deposits and therefore did
not pay a competitive interest rate. The average rate paid on deposits
increased from 2.23% to 4.20% during the period.
29
Income Taxes
The Company's earnings were taxed on the federal level at 34% for the 1995
and 1994 periods. State taxes on the gross earnings from the Company's
portfolio of investment securities, held by a wholly-owned subsidiary, were
assessed at the tax rate for Massachusetts securities corporations of 1.32%.
State taxes on the remainder of the Company's taxable income were assessed at
the tax rate for Massachusetts banks of 12.54%. The provision for income taxes
for the two months ended December 31, 1995 increased by $253,000 over the same
period in 1994. The overall effective tax rate increased to 43% for the two
months ended December 31, 1995, from 36% for the same period in 1994. The
Company files its tax return on a calendar year basis and thus the effective tax
was affected for the entire 1995 calendar year by the net proceeds from the
assignment of servicing rights for unit investment trust assets which were taxed
at the higher state tax rate and the profits of the Company's Canadian
subsidiary which were taxed at the Canadian effective rate of 45.37%.
Comparison of Operating Results for the Years Ended October 31, 1995 and 1994
Noninterest Income
Noninterest income increased $8,513,000 to $51,562,000 for the year ended
October 31, 1995 from $43,049,000 for the prior fiscal year. Noninterest income
consists of the following items:
For the Year Ended October 31,
--------------------------------- ---------
1994 1995 Change
--------------- --------------- ---------
(Dollars in thousands)
Asset administration fees $42,423 $48,413 14%
Proceeds from assignment of
UIT servicing, net 0 2,572 -
Computer service fees 552 505 (9)
Other operating income 74 72 (3)
--------------- ---------------
Total Noninterest Income $43,049 $51,562 20%
=============== ===============
An increase in asset administration fees, due principally to higher levels
of assets processed, represented a significant part of the increase. Total
assets processed grew to $91 billion at October 31, 1995 compared to $72 billion
at October 31, 1994, a 26% increase, despite the transfer of $5 billion of unit
investment trust assets discussed below. Approximately 25% of this growth
resulted from assets processed for new clients. The remainder of the growth was
due to the net expansion of relationships with existing clients, including
growth in assets processed and increased use of the Company's securities lending
and foreign exchange services.
Unit investment trust ("UIT") assets processed by the Company decreased
over the last five years, a reflection of declining investor demand for this
type of unmanaged investment product. Declining asset levels led one client,
Merrill, Lynch, to consolidate its asset administration service providers, and
it agreed, effective March 1, 1995, to pay the Company to assign the Company's
servicing rights to The Bank of New York. The Company recognized proceeds of
$2,572,000, net of expenses, resulting from the assignment of the rights to
service approximately $5.0 billion of the client's unit investment trust assets.
The administration of these assets accounted for $5,954,000 in asset
administration fees for the year ended October 31, 1994 and $2,570,000 in such
fees for the 1995 fiscal year in addition to the assignment fee. The Company
has made the strategic decision to focus its marketing and processing efforts on
mutual funds and other pooled investments which typically experience higher
growth in asset levels and can utilize a wider variety of services provided by
the Company, as compared to unit investment trusts. See Note 10 of Notes to
Consolidated Financial Statements.
Computer service fees decreased $47,000 to $505,000 for the year ended
October 31, 1995 from $552,000 for fiscal year 1994 due to fewer special
processing requests for those accounts. Other operating income consists of
miscellaneous private banking fees for safe deposit and checking account
services.
30
Operating Expenses
Total operating expenses increased by $7,721,000 to $50,224,000 for the
year ended October 31, 1995 compared to $42,503,000 for the year ended October
31, 1994. The components of operating expenses were as follows:
For the year ended October 31,
--------------------------------- ----------
1994 1995 Change
--------------- -------------- ---------
(Dollars in thousands)
Compensation $ 23,163 $ 27,214 17%
Pension and other employee benefits 4,136 4,685 13
Occupancy 3,736 4,215 13
Equipment 4,292 4,829 13
Insurance 1,070 1,060 (1)
Subcustodian Fees 1,327 1,844 39
Depreciation and amortization 1,376 1,221 (11)
Professional Fees 955 1,517 59
Travel and sales promotion 735 837 14
Other operating expenses 1,713 2,802 64
--------------- --------------
Total Noninterest Expenses $ 42,503 $ 50,224 18%
=============== ===============
Compensation of officers and employees increased by $4,051,000 or 17% from
period to period due to higher staffing levels throughout 1995 compared to the
prior fiscal year. The number of employees decreased 1% to 671 at October 31,
1995 from 678 at October 31,1994. However, the principal portion of headcount
growth for the 1994 fiscal year occurred in the last four months of the period
and, as a result, the compensation expense associated with this growth is not
reflected in the full 1994 fiscal year. Approximately 40 employees staffed the
unit investment trust accounts which were transferred on March 1, 1995. These
employees were retained to support future business growth. The average
annualized salary increase for Company employees during the 1995 fiscal year was
approximately 5%.
Pension and other employee benefits, including payroll taxes, group
insurance plans, retirement plan contributions and tuition reimbursement,
increased to $4,685,000 for the year ended October 31, 1995 from $4,136,000 for
the same period in 1994. The increase was due to increased payroll taxes
attributable to the increase in compensation expense and increased participation
by employees in the tuition reimbursement plan.
Occupancy expense increased $479,000 between periods, as additional office
space was leased in Boston and Toronto and a new office was opened in Dublin
during the 1995 fiscal year. The additional space was needed due to the growth
in assets processed and the corresponding client base.
Equipment expenses vary with the level of assets processed by the Company.
The $537,000 increase between periods was due principally to the growth in
assets processed by the Company. In addition, the Company increased its usage
of EDS services during the year ended October 31, 1995 during implementation of
new functionality in FACTS to support shorter settlement periods for securities
transactions.
Subcustodian expense increased $517,000 to $1,844,000 for the year ended
October 31, 1995 from $1,327,000 for the year ended October 31, 1994. This
increase was due to two factors: the growth in assets processed, and the
movement by clients into emerging markets with higher cost structures and where
subcustodians are required.
Depreciation and amortization expense decreased $155,000 between periods as
certain assets purchased in 1990, 1991 and 1992 were fully depreciated.
Professional fees increased $562,000 to $1,517,000 for the year ended
October 31, 1995 from $955,000 for the year ended October 31, 1994. This
increase was primarily due to the Company's increased use of independent
contractors to perform certain information systems development projects, rather
than adding permanent staff.
31
Travel and sales promotion expense increased $102,000 to $837,000 for the
year ended October 31, 1995 from $735,000 for the prior year due to the
strategic decision to increase the Company's visibility at industry conferences
in the U.S. and abroad.
Other operating expenses increased $1,089,000 to $2,802,000 for the year
ended October 31, 1995 from $1,713,000 for the year ended October 31, 1994. Fees
for daily market pricing data vary with the level of assets processed. Other
expenses such as telephone and office supplies vary with staffing levels. The
FDIC assessment is based on deposit balances as of four annual measurement
dates. A majority of the increase in other operating expenses resulted from a
decrease in client reimbursement of charges for telephone, office supplies, and
fees for daily market pricing. The Company was reimbursed for a portion of
these charges by the Merrill Lynch unit investment trust accounts prior to the
transfer of these accounts in March 1995.
Net Interest Income
Net interest income is affected by the volume and mix of assets and
liabilities, and the movement and level of interest rates. The table below
presents the changes in net interest income resulting from changes in the volume
of interest-earning assets or interest-bearing liabilities or changes in
interest rates for the year ended October 31, 1995 compared to the same period
in fiscal 1994.
Change Change
Due to Due to
Volume Rate Net
-------- ------- -------
(Dollars in thousands)
INTEREST-EARNING ASSETS
Fed funds sold and
interest-earning deposits $291 $ 24 $ 315
Investment securities 353 33 386
Loans 63 280 343
-------- ------- -------
Total interest-earning assets 707 337 1,044
-------- ------- -------
INTEREST-BEARING LIABILITIES
Deposits 453 (578) (125)
Borrowings 76 1 77
-------- ------- -------
Total interest-bearing liabilities 529 (577) (48)
-------- ------- -------
Change in net interest income $178 $ 914 $1,092
======== ======= =======
Net interest income increased $1,092,000 or 23% to $5,870,000 for the year
ended October 31, 1995 from $4,778,000 for the same period in 1994. This net
increase resulted from an increase in interest income of $1,044,000 and a
decrease in interest expense of $48,000. The net impact of the above changes
was a 47 basis point increase in net interest margin.
The increase in interest income resulted from both a higher level of
interest earning assets and higher interest rates. The Company's average assets
for the year ended October 31, 1995 increased $11,364,000 or 10% compared to the
same period in 1994. This growth was significantly affected by an increase in
average interest earning assets of $11,779,000. The prime rate increased 100
basis points between October 31, 1994 and October 31, 1995, improving the yield
on the Company's prime-based loan portfolio.
Interest expense decreased $48,000 due largely to the shift from interest-
bearing deposits to noninterest-bearing deposits. The average rate paid on
deposits increased from 2.01% to 2.85% during the period.
Income Taxes
The Company's earnings were taxed on the federal level at 34% for the 1995
and 1994 periods. State taxes on the gross earnings from the Company's
portfolio of investment securities, held by a wholly-owned subsidiary, were
assessed at the tax rate for Massachusetts securities corporations of 1.32%.
State taxes on the remainder of the Company's taxable income were assessed at
the tax rate for Massachusetts banks of 12.54%. The provision for income taxes
for the year ended October 31, 1995 increased by $937,000 over the same period
in 1994. The overall effective tax rate increased to 39% for the year ended
October 31, 1995,
32
from 35% for the same period in 1994 as the net proceeds from the assignment of
servicing rights for unit investment trust assets were taxed at the higher state
tax rate.
FINANCIAL CONDITION
Investment Portfolio
The following table summarizes the Company's investment portfolio for the dates
indicated:
October 31, December 31,
-------------------------- ----------------------------
1994 1995 1995 1996
------------ ------------ ------------ -----------
(Dollars in thousands)
INVESTMENT SECURITIES:
U.S. Treasury securities $ 76,158
Mortgage-backed securities 12,120
----------
Total investment securities $ 88,278
==========
SECURITIES HELD TO MATURITY:
U.S. Treasury securities $ 60,408 $ 0 $ 0
Mortgage-backed securities 49,609 144,124 414,665
Federal Agency securities 10,000 37,517
Foreign Government Securities - 7,828
----------- --------- ---------
Total securities held to maturity $ 110,017 $ 154,124 $ 460,010
=========== ========= =========
SECURITIES AVAILABLE FOR RESALE:
U.S. Treasury securities $ 50,652 $ 40,259
Mortgage-backed securities 40,167 230,862
---------- ---------
Total securities held to maturity $ 90,819 $ 271,121
========== =========
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 banks in
connection with its custody services. The portfolio is composed of U.S.
Treasury securities, mortgage-backed securities issued by the Federal National
Mortgage Association ("FNMA" or "Fannie Mae") and the Federal Home Loan Mortgage
Corporation ("FHLMC" or "Freddie Mac"), and Federal Agency callable bonds issued
by FHLMC and the Federal Home Loan Bank ("FHLB").
The Company invests in mortgage-backed securities and Federal Agency
securities to supplement its portfolio of U.S. Treasury securities and increase
the total return of the investment portfolio. Mortgage-backed securities
generally have a higher yield than U.S. Treasury securities due to credit risk
and prepayment risk. Federal Agency callable bonds generally have a higher yield
than U.S. Treasury securities due to credit risk and call risk. Mortgage-backed
securities and Federal Agency callable bonds have credit risk, even though
payment guarantees and credit enhancements substantially reduce it. Mortgage-
backed securities are also subject to the risk that fluctuating interest rates
and other factors may alter the prepayment rate of the loans underlying the
mortgage-backed securities, and so affect both the prepayment speed and the
value of such securities, while Federal Agency callable bonds are subject to the
risk that fluctuating interest rates and other factors may result in the
exercise of the call option by the Federal Agency.
Effective November 1, 1994, the Company classified its investment portfolio
as held-to-maturity. Management had the intent and the Company had the ability
to hold these securities until maturity. In connection with the initial
adoption of the Financial Accounting Standards Board's Special Report, A Guide
to Implementation of Statement 115 on Accounting for Certain Investments in Debt
and Equity Securities, the Company reassessed the appropriateness of the
classifications of all securities held as of December 31, 1995. As a result of
this reassessment, the Company reclassified debt securities with a carrying
value of $90 million from held-to-maturity to available for sale. The held-to-
maturity portfolio is carried at cost, adjusted for amortization of premiums and
accretion of discounts. The available-for-sale portfolio is carried at fair
value, with the net unrealized gains and losses recognized as an adjustment to
capital until final disposition or recovery.
33
The book value and weighted average yield of the Company's securities held
to maturity at December 31, 1996, by effective maturity, are reflected in the
following table.
Weighted
Average
Book Value Yield
---------- ---------
Due within one year $ 19,052 6.25%
Due from one to five years 114,459 6.90%
Due after five years up to ten years 240,621 6.93%
Due after ten years 85,878 6.73%
----------
Total securities $ 460,010
==========
The book value and weighted average yield of the Company's securities
available for sale at December 31, 1996, by effective maturity, are reflected in
the following table.
Weighted
Average
Book Value Yield
---------- ----------
Due within one year $ 20,047 6.19%
Due from one to five years 214,526 6.69%
Due after five years up to ten years 36,548 6.84%
----------
Total securities $ 271,121
==========
Loan Portfolio
The following table summarizes the Company's loan portfolio for the dates
indicated:
October 31, December 31,
--------------------------------------------------------------------
1992 1993 1994 1995 1995 1996
------------- --------- --------- -------- -------- ---------
(Dollars in thousands)
Loans to individuals $5,103 $ 8,435 $12,085 $13,446 $12,610 $23,449
Loans to not-for-profit
organizations 814 1,821 1,520 289 289 13
Loans to mutual funds 0 0 0 0 10,000 42,875
------------- --------- -------- -------- -------- ---------
5,917 10,256 13,605 13,735 22,899 66,337
Less: allowance for loan losses (35) (35) (35) (35) (35) (100)
------------- --------- -------- -------- -------- ---------
Net loans $5,882 $10,221 $13,570 $13,700 $22,864 $66,237
============= ========= ======== ======== ======== =========
Floating Rate $5,892 $10,231 $13,580 $13,675 $22,839 $66,224
Fixed Rate 25 25 25 25 25 13
------------- --------- -------- -------- -------- ---------
$5,917 $10,256 $13,605 $13,700 $22,864 $66,237
============= ========= ======== ======== ======== =========
Historically, the Company's loan portfolio has been composed primarily of
loans to individually managed account customers. Although many of its clients
with pooled investment vehicles such as mutual funds use credit lines to
leverage their portfolios or to handle overnight cash shortfalls, CEBA
requirements restricted the Company from making commercial loans of this type.
As a result of the removal of CEBA limitations due to the Spin-Off Transaction,
the Company may now offer lending services directly to all clients and made its
first commercial loan in December 1995.
Virtually all loans to individually managed account customers are written
on a demand basis, bear variable interest rates tied to the prime rate and are
fully secured by liquid collateral, primarily freely tradeable securities held
in custody by the Company for the borrower. Since December 1995, the Company
has entered into agreements to provide up to an aggregate of $40 million under
secured lines of credit to mutual fund clients. Loans to mutual funds also
include advances by the Company to certain mutual fund clients pursuant to the
terms of the custody agreements between the Company and those clients. The
advances facilitate securities transactions and redemptions involving those
mutual funds and are fully secured by liquid collateral, primarily freely
tradable securities held in custody by the Company for those mutual funds.
34
At December 31, 1996, the Company's only lending concentrations which
exceeded 10% of total loans were the revolving lines of credit to mutual fund
clients discussed above. These loans were made in the ordinary course of
business on the same terms and conditions prevailing at the time for comparable
transactions. The Company also had a lending relationship at December 31, 1996
with Landon T. Clay, a principal stockholder of the Company and an officer of
Eaton Vance, representing two loans aggregating $1,200,000 in principal amount
These loans to Mr. Clay were made in the ordinary course of business on the same
terms and conditions prevailing at the time for comparable transactions with
unrelated third parties. Each of these loans was secured with non-voting common
stock of Eaton Vance.
The Company's credit loss experience has been excellent. There have been
no loan chargeoffs or adverse credit actions in the history of the Company. It
is the Company's policy to place a loan on non-accrual status when either
principal or interest becomes 60 days past due and the loan's collateral is not
sufficient to cover both principal and accrued interest. As of December 31,
1996, there were no past due loans, troubled debt restructurings, or any loans
on nonaccrual status. Although virtually all of the Company's loans are fully
collateralized with freely tradeable securities, management recognizes some
credit risk inherent in the loan portfolio, and has recorded an allowance for
loan losses of $100,000 at December 31, 1996. This amount is not allocated to
any particular loan, but is intended to absorb any risk of loss inherent in the
loan portfolio. Management actively monitors the loan portfolio and the
underlying collateral and regularly assesses the adequacy of the allowance for
loan losses.
As a result of the removal of CEBA limitations, the Company is now able to
make commercial loans such as the credit lines and advances to mutual fund
clients discussed above. The Company hopes to increase its lending activities
with clients in 1997.
INTEREST RATE SENSITIVITY
The Company, like all financial intermediaries, is subject to interest rate
risk. Rapid changes in interest rates could adversely affect the profitability
of the Company by causing changes in the market value of the Company's assets
and its net interest income. Interest rate risk arises when an earning asset
matures or when its rate of interest changes in a time frame different from that
of the supporting interest-bearing liability. By seeking to minimize the
difference between the amounts of earning assets and interest-bearing
liabilities subject to interest rates changes in the same time frame, the
Company attempts to reduce the risk of significant adverse effects on net
interest income caused by interest rate changes. The Company does not attempt
to match each earning asset with a specific interest-bearing liability.
Instead, as shown in the table below, it aggregates all of its earning assets
and interest-bearing liabilities to determine the difference between these in
specific time frames. This difference is known as the rate-sensitivity gap. A
positive gap indicates that more earning assets than interest-bearing
liabilities mature in a time frame, and a negative gap indicates the opposite.
Maintaining a balanced position will reduce risk associated with interest rate
changes, but it will not guarantee a stable interest rate spread because the
various rates within a time frame may change by differing amounts and change in
different directions.
In addition to structuring the balance sheet to minimize interest rate
risk, the Company seeks to manage interest rate risk by investment portfolio
actions designed to address the interest rate sensitivity of asset cash flows in
relation to liability cash flows. Portfolio actions used to manage interest
rate risk include managing the effective duration of the portfolio securities
and utilizing interest rate contracts. Interest rate contracts are used to
hedge against large rate swings and changes in the shape of the yield curve. It
is the Company's policy to limit the annual variability in net interest income
to plus or minus 10% for a 200 basis point interest rate movement. The
Company's simulation model currently projects that a gradual 200 basis point
increase in interest rates, over a one year period, would reduce net interest
income by 9%.
Interest rate contracts involve elements of credit and market risk which
are not reflected in the Company's consolidated financial statements. Such
instruments are entered into for hedging (as opposed to investment or
speculative) purposes. See Note 13 to the Consolidated Financial Statements.
The Company periodically monitors the financial stability of its counterparties
according to prudent investment guidelines and established procedures. There
can be no assurance that such portfolio actions will adequately limit interest
rate risk.
35
The following table presents the repricing schedule for the Company's
interest earning assets and interest bearing liabilities at December 31, 1996
Within Over Three Over Six Over One
Three to Six to Twelve Year to Over Five
Months Months Months Five Years Years Total
----------- ---------- ---------- ---------- --------- ---------
(Dollars in thousands)
Interest earning assets (1):
Federal funds sold $ 120,000 $ 120,000
Investment securities (2) 262,024 $131,157 $143,422 $119,334 $ 75,194 731,131
Loans - fixed rate 0 13 13
Loans - variable rate 66,324 66,324
----------- ---------- ---------- ---------- --------- ---------
Total interest earning assets 448,348 131,157 143,422 119,347 75,194 917,468
Interest bearing liabilities
Demand deposit accounts 116,193 116,193
Savings accounts 276,602 276,602
Treasury, tax and loan account 4 4
Interest rate contracts (150,000) 20,000 80,000 50,000 0
Repurchase Agreements 296,421 296,421
----------- ---------- ---------- ---------- --------- ---------
Total interest bearing
liabilities 539,220 20,000 80,000 50,000 0 689,220
----------- ---------- ---------- ---------- --------- ---------
Net interest sensitivity gap
during the period ($90,872) $117,157 $ 63,422 $ 69,347 $ 75,194 $ 228,248
=========== ========== ========== ========== ========= =========
Cumulative gap ($90,872) $ 20,285 $ 83,707 $153,054 $228,248
=========== ========== ========== ========== =========
Interest sensitive assets as a
percent of interest sensitive
liabilities (cumulative) 83.15% 103.63% 113.10% 122.21% 133.12%
Interest sensitive assets as a
percent of total assets
(cumulative) 46.49% 60.09% 74.96% 87.33% 95.13%
Net interest sensitivity gap as a
percent of total asets -9.42% 11.53% 6.58% 7.19% 7.80%
Cumulative gap as a percent
of total asets -9.42% 2.10% 8.68% 15.87% 23.67%
________________________
(1) ADJUSTABLE RATE ASSETS ARE INCLUDED IN THE PERIOD IN WHICH INTEREST RATES
ARE NEXT SCHEDULED TO ADJUST RATHER THAN IN THE PERIOD IN WHICH THEY ARE
DUE. FIXED RATE LOANS ARE INCLUDED IN THE PERIOD IN WHICH THEY ARE
SCHEDULED TO BE REPAID.
(2) MORTGAGE-BACKED SECURITIES ARE INCLUDED IN THE PRICING CATEGORY THAT
CORRESPONDS WITH THEIR CONTRACTUAL MATURITY.
LIQUIDITY
Liquidity represents the ability of an institution to meet present and
future financial obligations through either the sale or maturity of existing
assets or the acquisition of additional funds through liability management. For
a financial institution such as the Company, these obligations arise from the
withdrawals of deposits and the payment of operating expenses.
The Company's primary sources of liquidity include cash and cash
equivalents, federal funds sold, demand loans to individuals, new deposits,
federal funds purchased, interest payments on securities held to maturity, fees
collected from asset administration clients, and the capital raised from the
Offering. Asset liquidity is also provided by managing the duration of the
investment portfolio. As a result of the Company's management of liquid assets
and the ability to generate liquidity through liability funds, management
believes that the Company maintains overall liquidity sufficient to meet its
depositors' needs, to satisfy its operating requirements and to fund the payment
of an anticipated annual cash dividend of approximately $.08 per share.
The Company's ability to pay dividends on the Common Stock and Class A
Common Stock depends on the receipt of dividends from Investors Bank & Trust
Company. In addition, the Company may not pay dividends on its Common Stock or
Class A Common Stock if it is in default under certain agreements entered into
in connection with the sale of the Capital Securities described under "Market
for Registrant's Common Equity and Related Stockholder Matters - Recent Sales of
Unregistered Securities." Any dividend payments by Investors Bank & Trust
Company are subject to certain restrictions imposed by the Massachusetts
Commissioner of Banks. Subject to regulatory requirements, Investors Bank &
Trust Company
36
expects to pay an annual dividend to the Company, which the Company expects to
pay to its stockholders, currently estimated to be in an amount equal to $.08
per share of outstanding Common Stock and Class A Stock (approximately $515,545
based upon 6,444,312 shares outstanding as of December 31, 1996).
At December 31, 1996, cash and cash equivalents were 2% of total assets,
compared to 7% of total assets at December 31, 1995. At December 31, 1996,
approximately $723 million or 75% of total assets mature within a one year
period.
The Company has informal borrowing arrangements with various counterparties
whereby each counterparty has agreed to make funds available to the Company at
the Federal funds overnight rate. The aggregate amount of these borrowing
arrangements as of December 31, 1996 was $72 million. Each bank may terminate
its arrangement at any time and is under no contractual obligation to provide
requested funding to the Company. The Company's borrowings under these
arrangements are typically on an overnight basis. The Company believes that if
these banks were unable to provide funding as described above, a satisfactory
alternative source of funding would be available to the Company.
The Company also has Master Repurchase Agreements in place with various
counterparties whereby each broker has agreed to make funds available to the
Company at various rates in exchange for collateral consisting of marketable
securities. The aggregate amount of these borrowing arrangements at December
31, 1996 was $425 million.
The Company also has a borrowing arrangement with the Federal Home Loan
Bank (the "FHLB") whereby the Company may borrow amounts determined by
prescribed collateral levels and the amount of FHLB stock held by the Company.
The minimum amount of FHLB stock held by the Company is required to be 1% of its
outstanding residential mortgage loans or .3% of total assets, whichever is
higher. If the Company borrows under this arrangement, the Company is required
to hold FHLB stock equal to 5% of such outstanding advances. The aggregate
amount of borrowing available to the Company under this arrangement at December
31, 1996 was $313 million.
The Company's cash flows are comprised of three primary classifications:
cash flows from operating activities, investing activities, and financing
activities. Cash flows provided by operating activities were $7,644,000 for the
year ended December 31, 1996. Net cash used in investing activities,
consisting primarily of purchases of investment securities and proceeds from
maturities of investment securities, was $639,707,000 for the year ended
December 31, 1996. Net cash provided by financing activities, consisting
primarily of net activity in deposits, was $629,391,000 for the year ended
December 31, 1996.
CAPITAL RESOURCES
Historically, the Company has financed its operations primarily through
internally generated cash flows. The Company incurs capital expenditures for
furniture, fixtures and miscellaneous equipment needs. The Company leases
microcomputers through operating leases. Such capital expenditures have been
incurred and such leases entered into on an as-required basis, primarily to meet
the growing operating needs of the Company. As a result, the Company's capital
expenditures for fiscal 1994 and 1995 were $1,616,000 and $1,564,000,
respectively, $118,000 for the two months ended December 31, 1995, and
$3,236,000 for the year ended December 31, 1996.
Stockholders' equity at December 31, 1996 was $61,859,000, an increase of
$8,438,000 or 16%, from $53,421,000 at December 31, 1995. The growth in
stockholders' equity is attributable to current period net income. The ratio
of stockholders' equity to assets decreased to 6.41% at December 31, 1996 from
16.57% at December 31, 1995 due to the significant growth in assets.
The Federal Reserve Board has adopted a system using internationally
consistent risk-based capital adequacy guidelines to evaluate the capital
adequacy of banks and bank holding companies. Under the risk-based capital
guidelines, different categories of assets are assigned different risk weights,
based generally upon the perceived credit risk of the asset. These risk weights
are multiplied by corresponding asset balances to determine a "risk-weighted"
asset base. Certain off-balance sheet items, which previously were not
expressly considered in capital adequacy computations, are added to the risk-
weighted asset base by converting them to a balance sheet equivalent and
assigning them the appropriate risk weight.
Federal Reserve Board and FDIC guidelines require that banking
organizations have a minimum ratio of total capital to risk-adjusted assets and
off balance sheet items of 8.0%. Total capital is defined as the sum of "Tier I"
and "Tier II" capital elements, with at least half of the total capital required
to be Tier I. Tier I capital includes, with certain restrictions, the sum of
common stockholders' equity, noncumulative perpetual preferred stock, a limited
amount of cumulative perpetual preferred
37
stock, and minority interests in consolidated subsidiaries, less certain
intangible assets. Tier II capital includes, with certain limitations,
subordinated debt meeting certain requirements, intermediate-term preferred
stock, certain hybrid capital instruments, certain forms of perpetual preferred
stock, as well as maturing capital instruments and general allowances for loan
losses.
The following table summarizes the Company's Tier I and total capital
ratios at December 31, 1996:
December 31, 1996
-----------------
Amount Ratio
---------- ----------
(Dollars in thousands)
Tier I capital $ 60,718 24.7%
Tier I capital minimum requirement 9,846 4.0%
---------- ----------
Excess Tier I capital $ 50,872 20.7%
========== ==========
Total capital $ 60,818 24.7%
Total capital minimum requirement 19,692 8.0%
---------- ----------
Excess total capital $ 41,126 16.7%
========== ==========
Risk adjusted assets, net of intangible assets $ 246,144
==========
In addition to the risk-based capital guidelines, the Federal Reserve Board
and the FDIC use a "Leverage Capital Ratio" as an additional tool to evaluate
capital adequacy. The Leverage Capital Ratio is defined to be a Company's Tier I
capital divided by its adjusted total assets. The Leverage Capital Ratio adopted
by the federal banking agencies requires a ratio of 3.0% Tier I capital to
adjusted average total assets for top rated banking institutions. All other
banking institutions will be expected to maintain a Leverage Capital Ratio of
4.0% to 5.0%. The computation of the risk-based capital ratios and the Leverage
Capital Ratio requires the capital of the Company to be reduced by most
intangible assets. The Company's Leverage Capital Ratio at December 31, 1996 was
6.30%, which is in excess of regulatory requirements. See "Business -Regulation
and Supervision."
38
The following tables present average balances, interest income and expense,
and yields earned or paid on the major categories of assets and liabilities for
the periods indicated.
Year Ended December 31, Year Ended December 31,
1995 1996
------------------------------------------ -----------------------------------------
Average Average Average Average
Balance Interest Yield/Cost Balance Interest Yield/Cost
---------- ---------- ------------ ---------- ---------- ------------
INTEREST-EARNING ASSETS
Fed funds sold $ 10,218 $ 595 5.82% $ 33,989 $ 1,859 5.47%
Interest-earning deposits 1,000 59 5.90% 126 6 4.76%
Investment securities 100,861 6,123 6.07% 497,965 32,490 6.52%
Demand Loans 13,863 1,231 8.88% 43,582 2,322 5.33%
---------- ---------- ------------ ---------- ---------- ------------
Total interest-earning assets 125,942 8,008 6.36% 575,662 36,677 6.37%
========== ============ ========== ============
Allowance for loan losses (35) (74)
Noninterest-earning assets 9,276 53,305
---------- ----------
Total assets $145,183 $628,893
========== ==========
INTEREST-BEARING LIABILITIES
Deposits:
Demand $ 11,995 610 5.09% $142,059 6,944 4.89%
Savings 10,742 245 2.28% 56,775 2,302 4.05%
Time - - - 721 38 5.27%
Short Term Borrowings 2,575 189 7.34% 186,952 9,384 5.02%
---------- ---------- ------------ ---------- ---------- ------------
Total interest-bearing liabilities 25,312 1,044 4.12% 386,507 18,668 4.83%
---------- ------------ ---------- ------------
Noninterest-bearing liabilities:
Demand deposits 46,568 132,063
Noninterest bearing time deposits 46,368 45,601
Other liabilities 7,442 8,585
---------- ----------
Total liabilities 125,690 572,756
Equity 19,493 56,137
---------- ----------
Total liabilities and equity $145,183 $628,893
========== ==========
Net interest income $ 6,964 $ 18,009
========== ==========
Net interest margin (1) 5.53% 3.13%
Average interest rate spread (2) 224% 1.54%
Ratio of interest-earning assets
to interest-bearing liabilities 497.6% 148.9%
_________________________
(1) Net interest income divided by total interest-earning assets.
(2) Yield on interest-earning assets less rate paid on interest-bearing
liabilities.
39
Two Months Ended December 31, 1994 Two Months Ended December 31, 1995
-------------------------------------- --------------------------------------
Average Average Average Average
Balance Interest Yield/Cost Balance Interest Yield/Cost
--------- ---------- ------------ --------- ---------- ------------
INTEREST-EARNING ASSETS
Fed funds sold $ - $ - 0.00% $ 28,702 $ 280 5.85%
Interest-earning deposits 1,000 9 5.40% 1,000 10 6.00%
Investment securities 88,125 837 5.70% 174,122 1,844 6.35%
Demand Loans 14,043 201 8.59% 15,951 230 8.65%
--------- ---------- ------------ --------- ---------- ------------
Total interest-earning assets 103,168 1,047 6.09% 219,775 2,364 6.45%
---------- ------------ ---------- ------------
Allowance for loan losses (35) (35)
Noninterest-earning assets 27,187 29,324
--------- ---------
Total assets $130,320 $249,064
========= =========
INTEREST-BEARING LIABILITIES
Deposits:
Savings $ 23,726 127 3.21% $ 33,919 241 4.26%
Time 23,412 48 1.23% 11,658 46 2.37%
Short Term Borrowings - - 0.00% 11,321 111 5.88%
--------- ---------- ------------ --------- ---------- ------------
Total interest-bearing liabilities 47,138 175 2.23% 56,898 398 4.20%
---------- ------------ ---------- ------------
Noninterest-bearing liabilities:
Demand deposits 36,110 95,115
Noninterest bearing time deposits 30,000 45,000
Other liabilities 3,028 18,051
--------- ---------
Total liabilities 116,276 215,064
Equity 14,044 34,000
--------- ---------
Total liabilities and equity $130,320 $249,064
========= =========
Net interest income $ 872 $1,966
========== ==========
Net interest margin (1) 5.07% 5.37%
Average interest rate spread (2) 3.86% 2.26%
Ratio of interest-earning assets to
interest-bearing liabilities 218.9% 386.3%
___________________
(1) Net interest income divided by total interest-earning assets.
(2) Yield on interest-earning assets less rate paid on interest-bearing
liabilities.
40
Year Ended October 31, Year Ended October 31,
1994 1995
---------------------------------------- --------------------------------------
Average Average Average Average
Balance Interest Yield/Cost Balance Interest Yield/Cost
------------ ------------ -------------- ----------- -------- ------------
INTEREST-EARNING ASSETS
Fed funds sold $ 393 $ 20 5.20% $ 5,376 $ 315 5.86%
Interest-earning deposits 1,000 38 3.80% 1,000 58 5.80%
Investment securities 80,462 4,731 5.88% 86,393 5,117 5.92%
Demand Loans 12,497 859 6.87% 13,361 1,202 9.00%
----------- ----------- ----------- ---------- --------- ----------
Total interest-earning assets 94,351 5,648 5.99% 106,130 6,692 6.31%
----------- ----------- --------- ----------
Allowance for loan losses (35) (35)
Noninterest-earning assets 22,494 22,079
----------- ----------
Total assets $116,810 $128,174
=========== ==========
INTEREST-BEARING LIABILITIES
Deposits:
Savings $ 12,898 256 1.98% $ 14,388 367 2.55%
Time 30,212 609 2.01% 11,568 373 3.22%
Short Term Borrowings 220 6 2.79% 2,603 82 3.15%
----------- ----------- ----------- ---------- --------- ----------
Total interest-bearing liabilities 43,330 870 2.01% 28,559 822 2.88%
----------- ----------- --------- ----------
Noninterest-bearing liabilities:
Demand deposits 37,535 34,678
Noninterest bearing time deposits 22,019 43,869
Other liabilities 2,147 4,949
----------- ----------
Total liabilities 105,031 112,055
Equity 11,779 16,119
----------- ----------
Total liabilities and equity $116,810 $128,174
=========== ==========
Net interest income $4,778 $5,870
=========== =========
Net interest margin (1) 5.06% 5.53%
Average interest rate spread (2) 3.98% 3.43%
Ratio of interest-earning assets to
interest-bearing liabilities 217.8%
________________________________
(1) Net interest income divided by total interest-earning assets.
(2) Yield on interest-earning assets less rate paid on interest-bearing
liabilities.
41
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The information required under this item is contained in the financial
statements and schedules set forth in Item 14(a) under the captions
"Consolidated Financial Statements" and "Financial Statement Schedules" as a
part of this Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.
There have been no changes in or disagreements with accountants on
accounting or financial disclosure matters during the Company's two most recent
fiscal years.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required under this item is incorporated herein by
reference to the information in the sections entitled "Occupations of Directors
and Executive Officers," "Election of Directors" and "Compensation and Other
Information Concerning Directors and Officers" continued in the Company's
definitive proxy statement pursuant to Regulation 14A, which proxy statement
will be filed with the Securities and Exchange Commission not later than 120
days after the close of the Company's fiscal year ended December 31, 1996.
ITEM 11. EXECUTIVE COMPENSATION.
The information required under this item is incorporated herein by
reference to the information in the section entitled "Compensation and Other
Information Concerning Directors and Officers" contained in the Company's
definitive proxy statement pursuant to Regulation 14A, which proxy statement
will be filed with the Securities and Exchange Commission not later than 120
days after the close of the Company's fiscal year ended December 31, 1996.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required under this item is incorporated herein by
reference to the information in the section entitled "Management and Principal
Holders of Voting Securities" contained in the Company's definitive proxy
statement pursuant to Regulation 14A, which proxy statement will be filed with
the Securities and Exchange Commission not later than 120 days after the close
of the Company's fiscal year ended December 31, 1996.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required under this item is incorporated herein by
reference to the information in the section entitled "Certain Relationships and
Related Transactions" contained in the Company's definitive proxy statement
pursuant to Regulation 14A, which proxy statement will be filed with the
Securities and Exchange Commission not later than 120 days after the close of
the Company's fiscal year ended December 31, 1996.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) 1. CONSOLIDATED FINANCIAL STATEMENTS.
For the following consolidated financial information included herein,
see Index on Page F-1:
Report of Independent Accountants.
Consolidated Balance Sheets as of December 31, 1995 and December 31,
1996.
Consolidated Statements of Income for the Years Ended October 31, 1994
and 1995, for the Two-Month Period Ended December 31, 1995, and for
the year ended December 31, 1996.
42
Statements of Stockholders' Equity for the Years Ended October 31,
1994 and 1995, for the Two-Month Period Ended December 31, 1995, and
for the Year Ended December 31, 1996.
Consolidated Statements of Cash Flows for the Years Ended October 31,
1994 and 1995, for the Two-Month Period Ended December 31, 1995, and
for the year ended December 31, 1996.
Notes to Consolidated Financial Statements.
2. FINANCIAL STATEMENT SCHEDULES.
None.
3. LIST OF EXHIBITS.
EXHIBIT NO. DESCRIPTION
2.1(1) Plan of Exchange of Common and Class A Stock of the Company for all
outstanding stock of the Bank
3.1(1) Certificate of Incorporation of the Company
3.2(1) By-laws of the Company
4.1(1) Specimen certificate representing the Common Stock
4.2(1) Stockholder Rights Plan
5.1(1) Opinion of Testa, Hurwitz & Thibeault, LLP
10.1(1) * 1995 Stock Plan
10.2(1) Custodian Agreement among and between the Company, Eaton Vance
Corp. and each investment company advised by Eaton Vance Corp.
which adopted the Agreement dated December 17, 1990
10.3(1) Transfer and Assumption Agreement between the Company and Bank of
New York dated January 27, 1995 regarding the assignment of Merrill
Lynch Unit Investment Trust administration service
10.4(1) Information Technology Services Contract between the Company and
Electronic Data Systems, Inc. dated September 24, 1990
10.5(1) Third Party Hub and Spoke Processing License Agreement between the
Company and Signature Financial Group, Inc. dated May 21, 1993
10.6(1) Hub and Spoke Facilities Management Agreement between the Company
and Signature Financial Group, Inc. dated May 21, 1993
10.7(1) Loan Agreements with Landon Clay dated May 10, 1993 and October 6,
1994
10.8(1) * Description of the executive bonus arrangement
10.9(1) * Employment contract between the Company and Kevin Sheehan
10.10(1) * Employment contract between the Company and Michael Rogers
10.11(1) * Employment contract between the Company and Edmund Maroney
10.12(1) * Employment contract between the Company and Robert Mancuso
10.13(1) Sublease Agreement, as amended, between the Company and the Bank of
New England, N.A. dated May 25, 1990, for premises located at 89
South Street, Boston, Massachusetts
10.14 * 1995 Non-Employee Director Stock Option Plan
10.15(2) Information Technology Services Contract between the Company and
Electronic Data Systems, Inc. dated September 20,1995,
10.16(2) Lease Agreement between the Company and John Hancock Mutual Life
Insurance Company, dated November 13, 1995, for the premises
located at 200 Clarendon Street, Boston, Massachusetts.
10.17 * Employment contract between the Company and Karen C. Keenan
10.18 * 1995 Employee Stock Purchase Plan
10.19 Amended and Restated Declaration of Trust among the Company and the
Trustees named therein, dated January 31, 1997
10.20 Purchase Agreement among the Company, Investors Capital Trust I and
Keefe, Bruyette & Woods, Inc., dated January 30, 1997 (Included in
Exhibit 10.19)
43
EXHIBIT NO. DESCRIPTION
10.21 Indenture between the Company and The Bank of New York, dated
January 31, 1997
10.22 Registration Rights Agreement, among the Company, Investors Capital
Trust I and Keefe, Bruyette & Woods, Inc., dated January 31, 1997
10.23 Common Securities Guarantee Agreement by the Company as Guarantor,
dated January 31, 1997
10.24 Capital Securities Guarantee Agreement between the Company as
Guarantor and The Bank of New York as Capital Securities Guarantee
Trustee, dated January 31, 1997
21.1 Subsidiaries of the Company
24.1 ** Power of Attorney (See Page 56 of this Report)
(1) Incorporated herein by reference to the exhibits to the Company's
Registration Statement on Form S-1 (File No. 33-95980).
(2) Previously filed as an exhibit to Form 10-K for the fiscal year ended
October 31, 1995.
* Indicates a management contract or any compensatory plan, contract or
arrangement.
(b) REPORTS ON FORM 8-K.
On January 27, 1997, the Company filed a Current Report on Form 8-K
reporting the Company's financial results for the quarter and year ended
December 31, 1996 and reporting the sale of capital securities described in
Item 5 of this Report.
(c) EXHIBITS.
The Company hereby files as part of this Form 10-K the exhibits listed in
Item 14(a)(3) above. Exhibits which are incorporated herein by reference
can be inspected and copied at the public reference facilities maintained
by the Securities and Exchange Commission, 450 Fifth Street, N.W., Room
1024, Washington, D.C., and at the Securities and Exchange Commission's
regional offices at CitiCorp Center, 500 West Madison Street, Suite 1400,
Chicago, IL 60661-2511 and Seven World Trade Center, Suite 1300, New York,
NY 10048. Copies of such material can also be obtained from the Public
Reference Section of the Securities and Exchange Commission, 450 Fifth
Street, N.W., Washington, D.C. 29549, at prescribed rates.
(d) FINANCIAL STATEMENT SCHEDULES
None.
44
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in Boston,
Massachusetts on the 18th day of February, 1997.
INVESTORS FINANCIAL SERVICES CORP.
By: /s/ Kevin J. Sheehan
----------------------------------
Kevin J. Sheehan
President, Chief Executive Officer and Chairman of
the Board
POWER OF ATTORNEY AND SIGNATURES
We, the undersigned officers and directors of Investors Financial Services
Corp., hereby severally constitute and appoint Kevin J. Sheehan and Michael F.
Rogers, and each of them singly, our true and lawful attorneys, with full power
to them and each of them singly, to sign for us in our names in the capacities
indicated below, all amendments to this report, and generally to do all things
in our names and on our behalf in such capacities to enable Investors Financial
Services Corp. to comply with the provisions of the Securities Exchange Act of
1934, as amended, and all requirements of the Securities and Exchange
Commission.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons in the capacities indicated and
on the 18th day of February, 1997.
Signature Title(s)
- --------- --------
/s/ Kevin J. Sheehan President, Chief Executive Officer and
- ---------------------------
Kevin J. Sheehan Chairman of the Board (Principal Executive
Officer); Director
/s/ Michael F. Rogers Executive Vice President
- ---------------------------
Michael F. Rogers
/s/ Karen C. Keenan Chief Financial Officer (Principal Financial
- ---------------------------
Karen C. Keenan Officer and Principal Accounting Officer)
/s/ Robert B. Fraser Director
- ---------------------------
Robert B. Fraser
/s/ Donald G. Friedl Director
- ---------------------------
Donald G. Friedl
/s/ James M. Oates Director
- ---------------------------
James M. Oates
/s/ Phyllis S. Swersky Director
- ---------------------------
Phyllis S. Swersky
/s/ Thomas P. McDermott Director
- ---------------------------
Thomas P. McDermott
/s/ Frank B. Condon, Jr. Director
- ---------------------------
Frank B. Condon, Jr.
45
INVESTORS FINANCIAL SERVICES CORP.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Report of Independent Accountants............................................................. F-2
Consolidated Balance Sheets as of December 31, 1995 and December 31, 1996.................... F-3
Consolidated Statements of Income for the Years Ended October 31, 1994 and 1995, for the
Two-Month Period ended December 31, 1995 and for the Year Ended December 31, 1996........ F-4
Consolidated Statements of Stockholders' Equity for the Year Ended October 31, 1995, for the
Two-Month Period ended December 31, 1995 and for the Year Ended December 31, 1996........ F-5
Consolidated Statements of Cash Flows for the Years Ended October 31, 1994 and 1995, for the
Two-Month Period Ended December 31, 1995, and for the Year Ended December 31, 1996....... F-6
Notes to Consolidated Financial Statements.................................................... F-7
F-1
INDEPENDENT AUDITORS' REPORT
To the Stockholders and the Board of Directors of
Investors Financial Services Corp.:
We have audited the accompanying consolidated balance sheets of Investors
Financial Services Corp., including its predecessor, Investors Bank & Trust
Company and its subsidiaries (collectively, the "Company"), as of December 31,
1995 and December 31, 1996 and the related consolidated statements of income,
stockholders' equity, and cash flows for each of the two years in the period
ended October 31, 1995, for the two-month period ended December 31, 1995 and for
the year ended December 31, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company at December 31, 1995
and December 31, 1996, and the results of their operations and their cash flows
for each of the two years in the period ended October 31, 1995, for the two-
month period ended December 31, 1995 and for the year ended December 31, 1996 in
conformity with generally accepted accounting principles.
As described in Note 1 to the consolidated financial statements, in November
1995 Investors Bank & Trust Company became a wholly owned subsidiary of
Investors Financial Services Corp. as a result of the share exchange between
Investors Financial Services Corp. and shareholders of Investors Bank & Trust
Company.
Deloitte & Touche LLP
February 14, 1997
F-2
INVESTORS FINANCIAL SERVICES CORP.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1995 AND 1996
- --------------------------------------------------------------------------------
ASSETS DECEMBER 31, DECEMBER 31,
1995 1996
Cash and due from banks $ 21,898,903 $ 19,226,453
Time deposits due from banks 1,000,000 -
Federal funds sold 15,000,000 120,000,000
Securities held to maturity (approximate market values of
$155,685,959 and $460,182,579 at December 31, 1995
and December 31, 1996, respectively) 154,123,901 460,009,923
Securities available for sale 90,819,293 271,120,964
Nonmarketable equity securities - 967,400
Loans, less allowance for loan losses of $35,000 and $100,000
at December 31, 1995 and December 31, 1996, respectively 22,864,216 66,236,889
Accrued interest and fees receivable 10,440,758 16,366,171
Equipment and leasehold improvements, net 3,525,581 5,243,974
Other assets 2,763,661 5,289,873
-------------- -------------
TOTAL ASSETS $322,436,313 $964,461,647
============== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits:
Demand $122,907,489 $264,914,614
Savings 21,085,503 276,602,295
Time 45,000,000 55,000,000
-------------- -------------
Total deposits 188,992,992 596,516,909
Securities sold under repurchase agreements 74,401,454 296,421,201
Other liabilities 5,620,936 9,664,227
-------------- -------------
Total liabilities 269,015,382 902,602,337
-------------- -------------
STOCKHOLDERS' EQUITY:
Preferred stock - -
Class A common stock 5,935 3,595
Common stock 58,505 60,848
Surplus 54,312,474 54,352,812
Deferred compensation (2,117,787) (1,687,675)
Retained earnings 899,794 8,480,431
Net unrealized gain on securities available for sale 262,010 649,299
-------------- -------------
Total stockholders' equity 53,420,931 61,859,310
-------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $322,436,313 $964,461,647
============== =============
See notes to consolidated financial statements.
F-3
INVESTORS FINANCIAL SERVICES CORP.
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED OCTOBER 31, 1994 AND 1995, THE TWO-MONTH PERIOD
ENDED DECEMBER 31, 1995, AND THE YEAR ENDED DECEMBER 31, 1996
- --------------------------------------------------------------------------------
TWO MONTHS ENDED
DECEMBER 31, DECEMBER 31,
1994 1995 1995 1996
OPERATING REVENUE:
Interest income:
Federal funds sold $ 20,430 $ 315,270 $ 279,741 $ 1,858,541
Other short-term investments 37,993 58,114 10,102 6,448
Securities held to maturity
and available for sale 4,730,824 5,116,155 1,844,222 32,490,280
Loans 859,005 1,202,029 229,690 2,322,158
------------------- -------------------- -------------------- ------------------
Total interest income 5,648,252 6,691,568 2,363,755 36,677,427
------------------- -------------------- -------------------- ------------------
Interest expense:
Deposits 864,148 720,395 286,945 9,271,675
Securities sold under
repurchase agreements - - 98,248 9,016,792
Federal funds purchased - 81,957 8,483 367,103
Treasury, tax and loan
account 6,143 19,241 4,423 12,464
------------------- -------------------- -------------------- ------------------
Total interest expense 870,291 821,593 398,099 18,668,034
------------------- -------------------- -------------------- ------------------
Net interest income 4,777,961 5,869,975 1,965,656 18,009,393
Provision for loan losses - - - 65,000
------------------- -------------------- -------------------- ------------------
Net interest income after
provision for loan losses 4,777,961 5,869,975 1,965,656 17,944,393
Noninterest income:
Asset administration fees 42,422,555 48,412,551 7,988,056 56,075,625
Proceeds from assignment of UIT
servicing, net - 2,572,298 - -
Computer service fees 552,407 505,534 83,424 482,275
Other operating income 74,163 72,029 13,772 76,305
Net loss on securities
available for sale - - - (2,488)
------------------- -------------------- -------------------- ------------------
Net operating revenue 47,827,086 57,432,387 10,050,908 74,576,110
OPERATING EXPENSES
Compensation of officers
and employees 23,162,729 27,213,593 4,957,575 32,148,445
Pension and other employee
benefits 4,136,066 4,685,100 839,888 5,353,770
Occupancy 3,735,820 4,215,472 624,816 4,283,008
Equipment 4,292,523 4,828,811 807,931 5,585,704
Insurance 1,069,996 1,060,468 194,016 852,638
Subcustodian fees 1,326,783 1,844,214 216,899 4,151,500
Depreciation and amortization 1,375,850 1,220,988 185,791 1,502,196
Professional fees 955,341 1,516,720 202,006 2,362,909
Travel and sales promotion 735,385 837,136 122,682 1,157,718
Other operating expenses 1,712,950 2,801,451 329,212 4,537,689
------------------- -------------------- -------------------- ------------------
Total operating expenses 42,503,443 50,223,953 8,480,816 61,935,577
------------------- -------------------- -------------------- ------------------
INCOME BEFORE INCOME TAXES 5,323,643 7,208,434 1,570,092 12,640,533
INCOME TAXES 1,863,000 2,800,000 670,298 4,866,571
------------------- -------------------- -------------------- ------------------
NET INCOME $ 3,460,643 $ 4,408,434 $ 899,794 $ 7,773,962
=================== ==================== =================== ==================
WEIGHTED AVERAGE SHARES OUTSTANDING 6,504,382
==================
EARNINGS PER SHARE $1.20
==================
See notes to consolidated financial statements.
F-4
INVESTORS FINANCIAL SERVICES CORP.
STATEMENTS OF STOCKHOLDERS' EQUITY
YEAR ENDED OCTOBER 31, 1995, THE TWO-MONTH PERIOD
ENDED DECEMBER 31, 1995 AND THE YEAR ENDED DECEMBER 31, 1996.
- -------------------------------------------------------------------------------
CLASS A
COMMON COMMON DEFERRED
STOCK STOCK SURPLUS COMPENSATION
BALANCE, NOVEMBER 1, 1994 $ - $ 10,000,000 $ - $ -
Net income
Cash dividend, $0.06 share
------------ ------------- --------------- -------------
BALANCE, OCTOBER 31, 1995 $ - $ 10,000,000 $ - $ -
============ ============= =============== =============
Effect of share exchange (Note 1) $ 6,114 $ 34,186 $ 18,021,176 $ -
Common stock issuance, net of costs of $3,829,062 - 23,000 34,097,938 -
Issuance of restricted stock - 1,140 2,193,360 (2,194,500)
Conversion of Class A common stock (179) 179 - -
Amortization of deferred compensation - - - 76,713
Net income - - - -
Net unrealized gain on securities available for sale - - - -
------------ ------------- --------------- -------------
BALANCE, DECEMBER 31, 1995 5,935 58,505 54,312,474 (2,117,787)
Adjustment to costs of stock issuance - - 35,193 -
Conversion of class A to common stock (2,340) 2,340 - -
Amortization of deferred compensation - - - 430,112
Exercise of stock options - 3 5,145 -
Net income - - - -
Cash dividend, $0.03 per share - - - -
Change in net unrealized gain on - - - -
securities available for sale
------------ ------------- --------------- -------------
BALANCE, DECEMBER 31, 1996 $ 3,595 $ 60,848 $ 54,352,812 $ (1,687,675)
============ ============= =============== =============
NET
UNREALIZED
GAIN ON
INVESTMENT
SECURITIES
RETAINED AVAILABLE
EARNINGS FOR SALE TOTAL
BALANCE, NOVEMBER 1, 1994 $ 3,713,042 $ - $ 13,713,042
Net income 4,408,434 4,408,434
Cash dividend, $0.06 share (60,000) (60,000)
------------- -------------- --------------
BALANCE, OCTOBER 31, 1995 $ 8,061,476 $ - $ 18,061,476
============= ============== ==============
Effect of share exchange (Note 1) $ - $ - $ 18,061,476
Common stock issuance, net of costs of $3,829,062 - - 34,120,938
Issuance of restricted stock - - -
Conversion of Class A common stock - - -
Amortization of deferred compensation - - 76,713
Net income 899,794 - 899,794
Net unrealized gain on securities available for sale - 262,010 262,010
------------- -------------- --------------
BALANCE, DECEMBER 31, 1995 899,794 262,010 53,420,931
Adjustment to costs of stock issuance - - 35,193
Conversion of class A to common stock - - -
Amortization of deferred compensation - - 430,112
Exercise of stock options - - 5,148
Net income 7,773,962 - 7,773,962
Cash dividend, $0.03 per share (193,325) - (193,325)
Change in net unrealized gain on
securities available for sale - 387,289 387,289
------------- -------------- --------------
BALANCE, DECEMBER 31, 1996 $ 8,480,431 $ 649,299 $ 61,859,310
============= ============== ==============
See notes to consolidated financial statements
F-5
INVESTORS FINANCIAL SERVICES CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED OCTOBER 31, 1994, AND 1995, THE TWO MONTH PERIOD ENDED DECEMBER 31,
1995 AND THE YEAR ENDED DECEMBER 31, 1996.
- --------------------------------------------------------------------------------
OCTOBER 31, OCTOBER 31 DECEMBER 31 DECEMBER
1994 1995 1995 1996
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 3,460,643 $ 4,408,434 $ 899,794 $ 7,773,962
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,375,850 1,220,988 185,791 1,502,196
Amortization of deferred compensation - - 76,713 430,112
Provision for loan losses - - - 65,000
Amortization of premiums on securities, net of
accretion of discounts 1,300,037 792,574 205,071 2,521,119
Loss on sale of securities available for sale - - - 2,488
Loss on disposal of fixed assets - - - 15,211
Deferred income taxes (127,000) (469,000) 78,377 1,156,706
Adjustment to carrying value of interest rate
floor contracts - 1,057,700 - -
Changes in assets and liabilities:
Accrued interest and fees receivable (3,714,212) (189,689) (868,478) (5,925,413)
Other assets 1,185,210 (639,592) 814,394 (3,568,354)
Other liabilities 1,589,835 1,074,563 (667,218) 3,670,535
-------------- ------------- ---------------- ---------------
Total adjustments 1,609,720 2,847,544 (175,350) (130,400)
-------------- ------------- ---------------- ---------------
Net cash provided by operating activities 5,070,363 7,255,978 724,444 7,643,562
-------------- ------------- ---------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities of securities
available for sale - - - 48,406,151
Proceeds from maturities of securities held
to maturity 16,264,293 18,404,529 12,865,343 39,691,309
Proceeds from sale of securities available
for sale - - - 26,904,258
Purchases of securities available for sale - - - (243,550,740)
Purchases of securities held to maturity (25,636,094) (40,936,504) (147,559,658) (359,516,797)
Purchase of nonmarketable equity securities - - - (967,400)
Net (increase) decrease in time deposits due
from banks - (24,345) 24,345 1,000,000
Net (increase) decrease in federal funds sold - (36,000,000) 21,000,000 (105,000,000)
Net (increase) decrease in loans (3,349,620) (129,487) (9,164,520) (43,437,672)
Purchases of equipment (1,616,307) (1,563,538) (118,205) (3,235,800)
-------------- ------------- ---------------- ---------------
Net cash used for investing activities (14,337,728) (60,249,345) (122,952,695) (639,706,691)
-------------- ------------- ---------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in demand deposits (32,657,559) 53,411,987 (39,453,616) 142,007,125
Net increase in time and savings deposits 35,088,220 332,489 66,023,363 265,516,792
Net increase in securities sold under
repurchase agreements - - 74,401,454 222,019,746
Proceeds from common stock - - 37,950,000 -
Costs of stock issuance - - (3,829,062) 35,193
Proceeds from exercise of stock options - - - 5,148
Dividends paid (60,000) (60,000) - (193,325)
-------------- ------------- ---------------- ---------------
Net cash provided by financing activities 2,370,661 53,684,476 135,092,139 629,390,679
-------------- ------------- ---------------- ---------------
INCREASE (DECREASE) IN CASH AND DUE FROM BANKS (6,896,704) 691,109 12,863,888 (2,672,450)
CASH AND DUE FROM BANKS, BEGINNING OF PERIOD 15,240,610 8,343,906 9,035,015 21,898,903
-------------- ------------- ---------------- ---------------
CASH AND DUE FROM BANKS, END OF PERIOD $ 8,343,906 $ 9,035,015 $ 21,898,903 $ 19,226,453
============== ============= ================ ===============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 807,000 $ 898,000 $ 197,750 $ 17,253,000
============== ============= ================ ===============
Cash paid for income taxes $ 2,136,000 $ 2,919,000 $ 885,000 $ 4,220,000
============== ============= ================ ===============
See notes to consolidated financial statements.
F-6
INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED OCTOBER 31, 1994 AND 1995, THE TWO MONTH PERIOD ENDED DECEMBER 31,
1995 AND THE YEAR ENDED DECEMBER 31, 1996
- --------------------------------------------------------------------------------
1. DESCRIPTION OF BUSINESS
Investors Financial Services Corp. ("IFSC") provides asset administration
services for the financial services industry through its wholly owned
subsidiary, Investors Bank & Trust Company (the "Bank"). The Bank provides
domestic and global custody, multicurrency accounting, institutional
transfer agency, performance measurement, foreign exchange, securities
lending, and mutual fund administration services to a variety of financial
asset managers, including mutual fund complexes, investment advisors, banks
and insurance companies. IFSC and the Bank are subject to regulation by the
Federal Reserve Board of Governors, the Office of the Commissioner of Banks
of the Commonwealth of Massachusetts and the Federal Deposit Insurance
Corporation.
As used herein, the defined term "the Company" shall mean IFSC together
with the Bank from the date of the share exchange discussed below and shall
mean the Bank prior to that date.
On November 8, 1995, the business operations of the Company were separated
from its former parent, Eaton Vance Corp. ("EVC"), by means of a tax-free,
pro rata distribution of EVC's ownership interest in the Company to the EVC
stockholders (the "Spin-off Transaction"). Immediately prior to the Spin-
off Transaction, all of the stockholders of the Bank exchanged their
1,000,000 shares of the Bank's common stock for a combination of 3,418,573
shares of Common Stock and 611,427 shares of Class A Common Stock ("Class A
Stock") of a newly formed bank holding company formed for the purpose of
facilitating the Spin-off Transaction. For financial reporting purposes,
the exchange has been accounted for as if it occurred on November 1, 1995.
Subsequent to the completion of the Spin-off Transaction, IFSC sold
2,300,000 additional shares of its Common Stock in an initial public
offering at an offering price of $16.50 per share. The net effect of this
transaction was an increase in the Company's consolidated capital of
approximately $34,000,000.
In December 1995, the Company changed its fiscal year end from October 31
to December 31.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION - The consolidated financial statements include the
accounts of the Company and its domestic and foreign subsidiaries. All
significant intercompany accounts and transactions have been eliminated.
CUSTODY AND TRUST ASSETS - Asset administration fees, including securities
lending and foreign exchange services and computer services fees, are
composed primarily of fee and fee-related income and are recorded on the
accrual basis.
ACCOUNTING ESTIMATES - The preparation of the financial statements in
conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
F-7
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SECURITIES - Effective November 1, 1994, the Company adopted Statement of
Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." SFAS No. 115 requires
investments in equity securities that have readily determinable fair values
and all investments in debt securities to be classified into three
categories as follows:
. Debt securities that the Company has the positive intent and ability
to hold to maturity are classified as held to maturity and reported at
amortized cost.
. Debt and equity securities that are bought and held principally for
the purpose of selling them in the near term are classified as trading
securities and reported at fair value, with unrealized gains and
losses included in earnings.
. All other debt and equity securities are classified as available for
sale and reported at fair value, with unrealized gains and losses
excluded from earnings and reported in a separate component of
stockholders' equity.
At the adoption of SFAS No. 115, the Company classified its entire
portfolio of securities as held-to-maturity based upon the Company's
positive intent and ability to hold such securities to maturity. Factors
considered in determining the Company's ability to hold such securities to
maturity include the Company's historical experience, the maturity
distribution of securities and the Company's access to additional deposits
from custody and trust clients. The effect of adopting SFAS No. 115 was not
significant.
In connection with the initial adoption of the Financial Accounting
Standards Board's ("FASB") Special Report, A Guide to Implementation of
Statement 115 on Accounting for Certain Investments in Debt and Equity
Securities, the Company reassessed the appropriateness of the
classifications of all securities held as of December 31, 1995. As a result
of this reassessment, the Company reclassified debt securities with a
carrying value of $90,382,610 from Held to Maturity to Available for Sale
on December 31, 1995. The net effect of this transfer was a $262,010
increase to stockholders' equity, net of taxes.
FAIR VALUE OF FINANCIAL INSTRUMENTS - SFAS No. 107, "Disclosures About
Fair Value of Financial Instruments," requires the disclosure of the
estimated fair value of financial instruments, whether or not recognized in
the Company's consolidated balance sheets, estimated using available market
information or other appropriate valuation methodologies.
The carrying amounts of cash and due from banks are a reasonable estimate
of their fair value. The fair value of the Company's securities is
estimated based on quoted market prices. Both loans (including commitments
to lend) and deposits (including time deposits) bear interest at variable
rates and are subject to periodic repricing. As such, the carrying amount
of loans and deposits is a reasonable estimate of fair value. The fair
value of the Company's interest rate contracts is estimated based on quoted
market prices. The Company does not have any other significant financial
instruments.
LOANS - Interest income on loans is recorded on the accrual basis. Losses
on loans are provided for under the allowance method of accounting. The
allowance is increased by provisions charged to operating expenses based on
amounts management considers necessary to meet reasonably foreseeable
losses on loans.
EQUIPMENT AND LEASEHOLD IMPROVEMENTS - Equipment and leasehold
improvements are stated at cost, less accumulated depreciation and
amortization. Depreciation and amortization are provided on the straight-
line method over the estimated useful lives of the assets which range from
three to seven years.
F-8
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES - Income tax expense is based on estimated taxes payable or
refundable on a tax return basis for the current year and the changes in
deferred tax assets and liabilities during the year in accordance with SFAS
No. 109, "Accounting for Income Taxes." Deferred tax assets and liabilities
are established for temporary differences between the accounting basis and
the tax basis of the Company's assets and liabilities at enacted tax rates
expected to be in effect when the amounts related to such temporary
differences are realized or settled.
TRANSLATION OF FOREIGN CURRENCIES - The functional currency of the
Company's foreign subsidiaries is the U.S. dollar. Accordingly, gains and
losses realized from the settlement of foreign currency transactions, which
were not significant in the years ended October 31, 1994 and 1995, the two
month period ended December 31, 1995, or the year ended December 31, 1996,
are included in other operating expenses in the consolidated statements of
income.
DERIVATIVE FINANCIAL INSTRUMENTS - Prior to the assignment of the unit
investment trust servicing more fully described in Note 10, the Bank used
derivative financial instruments in the form of interest rate floor
contracts ("Floors"). These instruments were matched with fees on trust and
custody assets that were based on current interest rates. Periodic cash
payments were accrued on a settlement basis. The premiums associated with
the instruments were amortized over their term until they were adjusted to
market value in March 1995 in connection with the sale of the hedged assets
as more fully described in Note 10.
The Company also enters into interest rate swap agreements as discussed in
Note 13 and foreign exchange contracts as discussed in Note 16. The Company
implemented SFAS 119, "Disclosure About Derivative Financial Investments
and Fair Value of Financial Instruments," in fiscal 1996. This standard
requires expanded disclosure about amounts, nature and terms associated
with the derivative financial instruments held. The adoption of SFAS 119
did not have a significant impact on the Company's consolidated financial
statements.
The Company does not purchase derivative financial instruments for trading
purposes. Interest rate swap agreements are matched with specific financial
instruments reported on the balance sheet and periodic cash payments are
accrued on a settlement basis.
The Company enters into foreign exchange contracts with clients and
simultaneously enters into a matched position with another bank. These
contracts are subject to market value fluctuations in foreign currencies.
Gains and losses from such fluctuations are netted and recorded as an
adjustment of asset administration fees.
STOCK-BASED COMPENSATION - The Company accounts for stock-based
compensation using the intrinsic value-based method of Accounting
Principles Board Opinion No. 25, as allowed under SFAS No. 123, "Accounting
for Stock-Based Compensation."
EARNINGS PER SHARE - Earnings per share are based on the weighted average
number of shares outstanding during the period.
NEW ACCOUNTING PRONOUNCEMENTS - "Extinguishments of Liabilities," SFAS No.
125 establishes consistent accounting standards for transfers and servicing
of financial assets and extinguishments of liabilities. SFAS No. 125
provides consistent standards for distinguishing transfers of financial
assets that are sales from transfers of financial assets that are secured
borrowings based upon the existence of control. SFAS No. 125 is required to
be adopted by the Company in 1997 and is not expected to have a material
effect upon the Company's consolidated financial statements.
RECLASSIFICATIONS - Certain amounts in the prior periods' financial
statements have been reclassified to conform to the current year's
presentation.
F-9
3. SECURITIES
Carrying amounts and approximate market values of securities are summarized
as follows as of December 31, 1995:
CARRYING UNREALIZED UNREALIZED APPROXIMATE
HELD TO MATURITY VALUE GAINS LOSSES MARKET VALUE
Mortgage-backed securities $144,123,901 $1,562,732 $117,924 $145,568,709
Federal Agency securities 10,000,000 117,250 - 10,117,250
------------ ---------- -------- ------------
Total $154,123,901 $1,679,982 $117,924 $155,685,959
============ ========== ======== ============
AMORTIZED UNREALIZED UNREALIZED CARRYING
AVAILABLE FOR SALE COST GAINS LOSSES VALUE
U.S. Treasury securities $ 50,312,501 $ 346,672 $ 6,673 $ 50,652,500
Mortgage-backed securities 40,070,111 117,667 20,985 40,166,793
------------ ---------- -------- ------------
Total $ 90,382,612 $ 464,339 $ 27,658 $ 90,819,293
============ ========== ======== ============
Carrying amounts and approximate market values of securities are summarized
as follows as of December 31, 1996:
CARRYING UNREALIZED UNREALIZED APPROXIMATE
HELD TO MATURITY VALUE GAINS LOSSES MARKET VALUE
Mortgage-backed securities $414,664,590 $1,973,263 $1,750,168 $414,887,685
Federal Agency securities 37,517,495 49,546 224,972 37,342,069
Foreign government
securities 7,827,838 124,987 - 7,952,825
------------ ---------- ---------- ------------
Total $460,009,923 $2,147,796 $1,975,140 $460,182,579
============ ========== ========== ============
AMORTIZED UNREALIZED UNREALIZED CARRYING
AVAILABLE FOR SALE COST GAINS LOSSES VALUE
U.S. Treasury securities $ 40,107,999 $ 151,304 $ 3 $ 40,259,300
Mortgage-backed securities 229,930,801 1,086,092 155,229 230,861,664
--------------- ---------- ---------- ------------
Total $270,038,800 $1,237,396 $ 155,232 $271,120,964
=============== ========== ========== ============
F-10
3. SECURITIES (CONTINUED)
Nonmarketable equity securities at December 31, 1996 consisted of $967,400
of stock of the Federal Home Loan Bank of Boston (the "FHLBB"). As a member
of the FHLBB, the Company is required to invest in $100 par value stock of
the FHLBB in an amount equal to 1% of its outstanding residential mortgage
loans or .3% of total assets, whichever is higher. If the Company borrows
under this arrangement, the Company is required to hold FHLBB stock equal
to 5% of such outstanding advances. If and when such stock is redeemed, the
Company will receive an amount equal to the par value of the stock.
The carrying amounts and approximate market values of securities by
effective maturity are as follows:
DECEMBER 31, 1995 DECEMBER 31, 1996
CARRYING APPROXIMATE CARRYING APPROXIMATE
HELD TO MATURITY VALUE MARKET VALUE VALUE MARKET VALUE
Due within one year $ - $ - $ 19,052,213 $ 18,873,837
Due from one to five years 79,803,891 80,885,330 114,459,070 113,819,081
Due five years up to ten
years 68,228,986 68,639,409 240,620,332 241,016,881
Due after ten years 6,091,024 6,161,220 85,878,308 86,472,780
-------------- -------------- ------------ ---------------
Total $154,123,901 $155,685,959 $460,009,923 $460,182,579
============== ============== ============ ===============
DECEMBER 31, 1995 DECEMBER 31, 1996
AMORTIZED CARRYING AMORTIZED CARRYING
AVAILABLE FOR SALE COST VALUE COST VALUE
Due within one year $ 25,240,028 $ 25,263,000 $ 19,964,080 $ 20,046,800
Due from one to five years 58,395,211 58,791,503 213,758,992 214,525,641
Due five years up to ten
years 6,747,373 6,764,790 36,315,728 36,548,523
-------------- -------------- ------------ ---------------
Total $ 90,382,612 $ 90,819,293 $270,038,800 $271,120,964
============== ============== ============ ===============
The maturity distributions of mortgage-backed securities have been allocated
over maturity groupings based upon actual pre-payments to date and anticipated
pre-payments based upon historical experience.
Five securities available for sale were sold during the year ended December 31,
1996 resulting in losses totaling $19,178 and gains totaling $16,690.
The carrying value of securities pledged amounted to approximately $206,000,000
and $362,000,000 at December 31, 1995 and December 31, 1996, respectively.
Securities are pledged primarily to secure public funds and clearings with other
depository institutions.
F-11
4. LOANS
Loans consist of demand loans with individuals and not-for-profit
institutions located in the greater Boston, Massachusetts metropolitan area
and loans to mutual fund clients. The loans to mutual funds include
advances pursuant to the terms of the custody agreements between the
Company and those mutual fund clients to facilitate securities transactions
and redemptions. The loans are generally collateralized with marketable
securities. There were no impaired or nonperforming loans at December 31,
1995 or December 31, 1996. In addition, there have been no loan charge-offs
or recoveries during the years ended October 31, 1994 and 1995, the two
months ended December 31, 1995 or the year ended December 31, 1996. Loans
consisted of the following at December 31, 1995 and December 31, 1996:
DECEMBER 31, DECEMBER 31,
1995 1996
Loans to individuals $12,610,018 $23,448,999
Loans to not-for-profit institutions 289,198 12,500
Loans to mutual funds 10,000,000 42,875,390
----------- -----------
22,899,216 66,336,889
Less allowance for loan losses 35,000 100,000
----------- -----------
Total $22,864,216 $66,236,889
=========== ===========
The Company had commitments to lend of approximately $1,708,000 and
$37,127,518 at December 31, 1995 and December 31, 1996, respectively. The
terms of these commitments are similar to the terms of outstanding loans.
During 1996, the Company increased the allowance for loan losses by $65,000
due to the overall increase in lending activities.
5. EQUIPMENT AND LEASEHOLD IMPROVEMENTS
The major components of equipment and leasehold improvements are as follows
at December 31, 1995 and December 31, 1996:
DECEMBER 31, DECEMBER 31,
1995 1996
Furniture, fixtures and equipment $6,281,172 $8,516,450
Leasehold improvements 761,929 744,395
------------ ------------
Total 7,043,101 9,260,845
Less accumulated depreciation and
amortization 3,517,520 4,016,871
------------ ------------
Equipment and leasehold improvements, net $3,525,581 $5,243,974
============ ============
F-12
6. DEPOSITS
Time deposits at December 31, 1995 and December 31, 1996 include
noninterest-bearing amounts of approximately $45,000,000 and $55,000,000,
respectively.
All time deposits had a minimum balance of $100,000 and a maturity of less
than three months at December 31, 1995 and December 31, 1996.
7. REPURCHASE AGREEMENTS
The Company enters into repurchase agreements whereby securities are sold
by the Company under agreements to repurchase. The Company had liabilities
under these agreements of $74,401,454 and $ 296,421,201 at December 31,
1995 and December 31, 1996 respectively. The interest rate on the
outstanding agreements at December 31, 1995 ranged from 5.5% to 6.0% and
all agreements matured on January 2, 1996. The interest rate on the
outstanding agreements at December 31, 1996 was 5.91% and all agreements
matured by January 2, 1997. The following securities were pledged under
these agreements at December 31, 1995 and December 31, 1996:
DECEMBER 31, 1995 DECEMBER 31, 1996
CARRYING APPROXIMATE CARRYING APPROXIMATE
VALUE MARKET VALUE VALUE MARKET VALUE
U.S. Treasury securities $29,345,800 $29,345,800 $ 37,249,940 $ 37,249,940
Federal Agency securities - - 25,000,000 24,803,950
Mortgage-backed
securities 47,211,518 47,254,137 245,689,672 246,777,873
------------ ----------- ------------ ------------
Total $76,557,318 $76,599,937 $307,939,612 $308,831,763
============ =========== ============ ============
The amount outstanding at December 31, 1996 was the highest amount
outstanding at any month end during the year ended December 31, 1996. The
average balance during the year ended December 31, 1996 was $180,181,000.
8. INCOME TAXES
The components of income tax expenses are as follows for the years ended
October 31, 1994 and 1995, the two-month period ended December 31, 1995,
and the year ended December 31, 1996:
OCTOBER 31, OCTOBER 31, DECEMBER 31, DECEMBER 31,
1994 1995 1995 1996
Current:
Federal $1,829,000 $2,781,000 $445,480 $3,593,391
State 161,000 484,000 139,429 181,416
Foreign - 4,000 7,012 193,251
---------- ---------- -------- ----------
1,990,000 3,269,000 591,921 3,968,058
========== ========== ======== ==========
Deferred:
Federal (7,000) (391,000) 50,538 619,357
State (3,000) (154,000) 17,580 240,861
Foreign (117,000) 76,000 10,259 38,295
---------- ---------- -------- ----------
(127,000) (469,000) 78,377 898,513
========== ========== ======== ==========
Total income
taxes $1,863,000 $2,800,000 $670,298 $4,866,571
========== ========== ======== ==========
F-13
8. INCOME TAXES (CONTINUED)
Differences between the effective income tax rate and the federal statutory
rates are as follows for the years ended October 31, 1994 and 1995, the
two-month period ended December 31, 1995, and the year ended December 31,
1996:
OCTOBER 31, OCTOBER 31, DECEMBER 31, DECEMBER 31,
1994 1995 1995 1996
Federal statutory rate 34.0% 34.0% 34.0% 35.0%
State income tax rate, net of federal benefit 2.0 3.0 6.6 2.2
Foreign income taxes with different rates (1.5) 0.7 1.1 1.2
Other 0.5 1.1 1.0 0.1
-------- -------- --------- ----------
Effective tax rate 35.0% 38.8% 42.7% 38.5%
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets and liabilities consist of the following at
October 31, 1994, December 31, 1995, and December 31, 1996:
OCTOBER 31, DECEMBER 31, DECEMBER 31,
1995 1995 1996
Deferred tax assets:
Employee benefit plans $1,060,000 $1,012,922 $ 933,216
Foreign operating losses 54,000 38,295 -
Other 18,000 9,810 37,562
---------- ----------- -----------
1,132,000 1,061,027 970,778
Deferred tax liabilities:
Prepaid insurance - - (620,979)
Securities available for sale - (174,673) (432,866)
Unearned compensation - - (183,175)
Depreciation and amortization (95,000) (102,404) (106,514)
---------- ----------- -----------
Net deferred tax asset (liability) $1,037,000 $ 783,950 $(372,756)
========== =========== ===========
Net deferred tax assets are reported as a component of other assets in the
1995 consolidated balance sheets. Net deferred tax liabilities are reported
as a component of other liabilities in the 1996 consolidated balance sheet.
F-14
9. STOCKHOLDERS' EQUITY
COMMON STOCK - On May 27, 1994, the Bank's Board of Directors approved a
reduction in the par value of the Company's common stock from $100 per
share to $10 per share, and a 100-for-1 stock split which caused the number
of shares of common stock authorized, issued and outstanding to increase
from 10,000 shares to 1,000,000 shares. The stock split resulted in a
$9,000,000 increase in common stock, a $1,000,000 decrease in surplus and
an $8,000,000 decrease in retained earnings. There were no other changes in
authorized, issued or outstanding common stock for any period presented
prior to the Spin-off Transaction.
IFSC has authorized 1,000,000 shares of Preferred Stock, 650,000 shares of
Class A Common Stock and 20,000,000 shares of Common Stock, all with a par
value of $.01 per share. At December 31, 1995 and December 31, 1996, there
were no preferred shares issued or outstanding. There were 593,500 and
359,545 shares of Class A Common Stock and 5,850,500 and 6,084,767 Common
Stock issued and outstanding at December 31, 1995 and December 31, 1996,
respectively. The Common Stock and Class A Common Stock are identical
except that the Class A Common Stock has ten votes per share and
automatically converts into Common Stock upon transfer and under certain
other circumstances.
STOCK OPTIONS - The Company has two stock option plans, the 1995 Stock Plan
and the 1995 Non-Employee Director Stock Option Plan.
Under the terms of the 1995 Stock Plan, the Company may grant options to
purchase up to a maximum of 560,000 shares of Common Stock to certain
employees, consultants, directors and officers. The options may be awarded
as incentive stock options (employees only), nonqualified stock options,
stock awards or opportunities to make direct purchases of stock.
Under the terms of the 1995 Non-Employee Director Stock Option Plan, the
Company may grant options to non-employee directors to purchase up to a
maximum of 40,000 shares of Common Stock. Options to purchase 2,500 shares
of Common Stock were awarded at the date of initial public offering to each
director. Subsequently, any director elected or appointed after such date
will receive an automatic initial grant of options to purchase 2,500 shares
upon becoming a director. Thereafter, each director will receive an
automatic grant of options to purchase 2,500 shares effective upon each
one-year anniversary of the date of such director's original grant.
Additionally, in April 1996 the Company's stockholders approved an
amendment to the 1995 Non-Employee Director Plan that will allow non-
employee directors to elect to receive options to acquire shares of the
Company's Common Stock in lieu of such director's cash retainer. Any
election is subject to certain restrictions under the 1995 Non-Employee
Director Stock Option Plan. The number of shares of stock underlying the
option is equal to the quotient obtained by dividing the cash retainer by
the value of an option on the date of grant as determined using the Black-
Scholes model.
The exercise price of options under the 1995 Non-Employee Director Stock
Option Plan and the incentive options under the 1995 Stock Plan may not be
less than fair market value at the date of the grant. The exercise price of
the nonqualified options from the 1995 Stock Plan is determined by the
compensation committee of the Board of Directors. All options become
exercisable as specified at the date of the grant.
In November 1995, the Company granted 114,000 shares to certain officers of
the Company under the 1995 Stock Plan. Of these grants, 105,000 shares vest
in sixty equal monthly installments, and the remainder vest in five equal
annual installments. Upon termination of employment, the Company has the
right to repurchase all unvested shares at a price equal to the fair market
value at the date of the grant. The Company has recorded deferred
compensation of $2,117,787 and $1,687,675 at December 31, 1995 and December
31, 1996, respectively, pursuant to these grants.
F-15
9. STOCKHOLDERS' EQUITY (CONTINUED)
A summary of option activity under all plans is as follows:
NUMBER OF EXERCISE PRICE
SHARES PER SHARE
Outstanding at December 31, 1995 211,500 $ 16.50
Granted 141,150 $22.375 - $26.125
Exercised (312) $ 16.50
Expired (7,188) $ 16.50
-----------
Outstanding at December 31, 1996 345,150 $ 16.50 - $26.125
-----------
Exercisable at December 31, 1996 60,489
-----------
EMPLOYEE STOCK-BASED COMPENSATION - With respect to employee stock-based
compensation, the Company has adopted the disclosure-only requirements of
SFAS No. 123. Accordingly, no compensation cost has been recognized in the
accompanying consolidated financial statements for employee stock-based
compensation awarded under employee stock option plans. If compensation
cost had been determined for awards granted commencing November 8, 1995
under the Company's employee stock option plans based on the fair value of
the awards at the date of grant in accordance with the provisions of SFAS
No. 123, the Company's net income and earnings per share for the year ended
December 31, 1996 would have decreased to the pro forma amounts indicated
below:
Net income - as reported $7,773,962
Net income - pro forma 7,502,714
Earnings per share - as reported 1.20
Earnings per share - pro forma 1.16
The pro forma amounts do not include any adjustment for compensation
expense that would have been recorded in the current fiscal year for
nonemployee stock-based awards made on or prior to December 15, 1995.
Accordingly, the pro forma disclosures are not likely to be representative
of the effects on reported net income for future years.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with an assumed risk-free interest
rate of 6.25%, an expected life of five years, an expected volatility of
20%, and assumes nominal dividends will be paid.
F-16
10. PROCEEDS FROM ASSIGNMENT OF UNIT INVESTMENT TRUST SERVICING, NET
On March 1, 1995, the Company recognized a net gain of $2,572,298 of
noninterest income resulting from the assignment to another company of the
rights to service approximately $5.0 billion of unit investment trust
assets. In connection with the assignment, the Company adjusted to market
value interest rate floors with a notional amount of $80,000,000, and the
resulting loss of $1,057,700 is reported net of the cash proceeds from the
assignment of unit investment trust servicing. These interest rate floors
had previously been designated as hedges of fees from the unit investment
trusts (see Note 13).
11. EMPLOYEE BENEFIT PLANS
PENSION PLAN - The Company has a trusteed, noncontributory, qualified
defined benefit pension plan covering substantially all of its employees
who were hired before January 1, 1997. The benefits are based on years of
service and the employee's compensation during employment. The Company's
funding policy is to contribute annually the maximum amount which can be
deducted for federal income tax purposes. Contributions are intended to
provide not only for benefits attributed to service to date but also for
benefits expected to be earned in the future.
The Company established a supplemental retirement plan in 1994 that covers
certain employees and pays benefits that supplements any benefits paid
under the qualified plan. Benefits under the supplemental plan are
generally based on compensation not includable in the calculation of
benefits to be paid under the qualified plan. The total cost of this plan
to the Company was $41,148, $86,563, $6,827 and $36,960 in the years ended
October 31, 1994 and 1995, the two-month period ended December 31, 1995,
and the year ended December 31, 1996, respectively.
The following table sets forth the funded status and accrued pension cost
for the Company's pension and supplemental retirement plans.
DECEMBER 31, DECEMBER 31,
1995 1996
Actuarial present value of benefit obligations:
Accumulated benefit obligations, including vested benefits
of $4,600,000 and $3,746,000 for December 31, 1995 and
1996, respectively $ 4,918,000 $ 4,109,000
=============== ==============
Projected benefit obligations for services rendered to date $ 7,995,000 $ 6,885,000
Plan assets at fair value, primarily listed stocks and U.S.
government obligations 5,625,000 6,213,000
--------------- --------------
Projected benefit obligations in excess of assets (2,370,000) (672,000)
Unrecognized net gain from past experience different from
that assumed and effects of changes in assumptions (358,000) (1,075,000)
Prior service cost not yet recognized in periodic pension cost 267,000 238,000
Unrecognized net (asset) liability 562,000 (378,000)
--------------- --------------
Accrued pension cost $(1,899,000) $(1,887,000)
=============== ==============
F-17
11. EMPLOYEE BENEFIT PLANS (CONTINUED)
Net pension cost included the following components for the years ended
October 31, 1994 and 1995, the two-month period ended December 31, 1995 and
the year ended December 31, 1996:
OCTOBER 31, OCTOBER 31, DECEMBER 31, DECEMBER 31,
1994 1995 1995 1996
Service cost - benefits earned during the $ 559,000 $ 618,000 $123,000 $ 848,000
period
Interest cost on projected benefit obligations 400,000 425,000 86,000 520,000
Return on plan assets (389,000) (420,000) (73,000) (1,013,000)
Net amortization and deferral (5,000) (5,000) 1,000 508,000
------------- ------------- ------------ -----------
Net periodic pension cost $ 565,000 $ 618,000 $137,000 $ 863,000
============= ============= ============ ===========
The weighted average discount rate and the rate of increase in future
compensation levels used in determining the actuarial present value of the
projected benefit obligations were as follows:
DECEMBER 31, DECEMBER 31,
1995 1996
Weighted average discount rate 7.5% 7.5%
Rate of increase in future compensation levels 5.0 5.0
Long-term rate of return on plan assets 8.5 8.5
EMPLOYEE SAVINGS PLAN - The Company sponsors a qualified defined
contribution employee savings plan covering substantially all employees who
elect to participate. The Company matches employee contributions to the
plan up to specified amounts. The total cost of this plan to the Company
was $164,000, $222,000, $36,000 and $208,000 in the years ended October 31,
1994 and 1995, the two-month period ended December 31, 1995, and the year
ended December 31, 1996, respectively.
12. RELATED-PARTY TRANSACTIONS
As a result of the Spin-off Transaction described in Note 1, transactions
between the Company and EVC are no longer considered related-party
transactions. However, prior to the Spin-off Transaction, the Company
entered into various transactions with EVC and a group of mutual funds
sponsored by EVC. The following is a summary of such related-party
transactions for the years ended October 31, 1994 and 1995:
OCTOBER 31, OCTOBER 31,
1994 1995
Asset administration fee income $8,565,000 $8,355,000
Computer service fee income 552,000 506,000
Occupancy expense 344,000 260,000
The aggregate of the above fees exceeds 10% of interest income and non-
interest income.
F-18
12. RELATED-PARTY TRANSACTIONS (CONTINUED)
In addition, EVC and its group of mutual funds had the following amounts
outstanding with the Company at October 31, 1995:
Fees receivable $ 308,000
Deposits 102,869,000
The Company also makes loans to officers of EVC and other related parties.
Such loans are made in the ordinary course of business and on the same
terms and conditions prevailing at the time for comparable transactions.
The following is a summary of loans to related parties during the years
ended October 31, 1994 and 1995.
Balance at October 31, 1993 $1,261,000
Loans made/advanced 507,000
Repayments (135,000)
-----------
Balance at October 31, 1994 1,633,000
Loans made/advanced 55,000
Repayments (55,000)
-----------
Balance at October 31, 1995 $1,633,000
===========
13. OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
LINES OF CREDIT - At December 31, 1996, the Company had commitments to
individuals under collateralized open lines of credit totaling $74,743,700,
against which $37,616,182 in loans were drawn. The credit risk involved in
issuing lines of credit is essentially the same as that involved in
extending loan facilities. The Company does not anticipate any loss as a
result of these lines of credit.
INTEREST-RATE CONTRACTS - The following table summarizes the contractual or
notional amounts of derivative financial instruments held by the Company at
December 31, 1996:
DECEMBER 31, DECEMBER 31,
1996 1995
Interest Rate Contracts:
Swap agreements $180,000,000 -
Floor contracts 30,000,000 80,000,000
Interest rate contracts involve an agreement with a counterparty to
exchange cash flows based on an underlying interest rate index. An interest
rate floor is a contract purchased from a counterparty which specifies a
minimum interest rate for the specified period of time. A swap agreement
involves the exchange of a series of interest payments, either at a fixed
or variable rate, based upon the notional amount without the exchange of
the underlying principal amount. The Company's exposure from these interest
rate contracts results from the possibility that one party may default on
its contractual obligation. Credit risk is limited to the posititve market
value of the derivative financial instrument, which is significantly less
than the notional value. During 1996, 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 18 months.
The weighted-average fixed-payment rates were 5.74 percent at December 31,
1996. Variable-interest payments received are indexed to 1 month LIBOR. At
December 31, 1996, the weighted-average rate of variable market-indexed
interest payment obligations to the Bank was 5.61 percent. The effect of
these agreements was to lengthen short-term variable-rate liabilities into
longer-term fixed-rate liabilities. These contracts had no carrying value
and the market value was approximately ($112,000) at December 31, 1996.
F-19
14. COMMITMENTS AND CONTINGENCIES
RESTRICTIONS ON CASH BALANCES - The Company is required to maintain certain
average cash reserve balances with the Federal Reserve Bank. The reserve
balance requirement as of December 31, 1996 was $22,170,000. In addition,
other cash balances in the amount of $1,391,679 were pledged to secure
clearings with a depository institution as of December 31, 1996.
LEASE COMMITMENTS - Minimum future commitments on noncancelable operating
leases at December 31, 1996 were as follows:
Bank
Fiscal Year Ending Premises Equipment
1997 $ 4,014,746 $1,043,538
1998 4,252,481 751,090
1999 4,252,481 416,208
2000 4,252,481 -
2001 and beyond 26,963,921 -
Total rent expense was $4,604,000, $5,511,000, $843,000 and $4,129,000 for
the years ended October 31, 1994 and 1995, the two months ended December
31, 1995, and the year ended December 31, 1996, respectively.
On February 1, 1996, the Company entered into a five year facility
management agreement with a third party provider of duplicating and
delivery services. Under the terms of the agreement, the Company agrees to
pay minimum annual charges of $368,970, $387,214, $406,788, $427,119, and
$35,735 in the years ended December 31, 1997, 1998, 1999, 2000, and 2001,
respectively. These minimum charges can increase due to certain usage
thresholds. Service expense under this contract was $239,597 for the year
ended December 31, 1996.
CONTINGENCIES - The Company provides domestic and global custody,
multicurrency accounting, institutional transfer agency, performance
measurement, foreign exchange, securities lending and mutual fund
administration services to a variety of financial asset managers, including
mutual fund complexes, investment advisors, banks and insurance companies.
Assets under custody and management, held by the Company in a fiduciary
capacity, are not included in the consolidated balance sheets since such
items are not assets of the Company. Management conducts regular reviews of
its fiduciary responsibilities and considers the results in preparing its
consolidated financial statements. In the opinion of management, there are
no contingent liabilities at December 31, 1996 that are material to the
consolidated financial position or results of operations of the Company.
F-20
15. FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value and estimated fair value of financial instruments are as
follows at December 31, 1995 and 1996 (in thousands):
DECEMBER 31, 1995 DECEMBER 31, 1996
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
On-balance sheet amounts:
Cash and due from banks $ 21,899 $ 21,899 $ 19,226 $ 19,226
Time deposits due from banks 1,000 1,000 - -
Federal funds sold 15,000 15,000 120,000 120,000
Securities held to maturity 154,124 155,686 460,010 460,183
Securities available for sale 90,819 90,819 271,121 271,121
Loans 22,864 22,864 66,237 66,237
Deposits 188,993 188,993 596,517 596,517
Off-balance sheet amounts:
Commitments to lend ($1,708 and
$37,127 at December 31, 1995 and 1996) - 1,708 - 37,127
Interest rate floor contracts
(notional amounts of $80,000 and
$30,000 at December 31, 1995 and 1996) - - - -
Interest rate swap agreements
(notional amounts of $0 and $180,000
at December 31, 1995 and 1996) - - - (112,160)
Foreign exchange contracts
(notional amounts of $108,372 and
$114,302 at December 31, 1995 and 1996) - - - -
The fair value estimates presented herein are based on pertinent
information available to management as of December 31, 1995 and 1996.
Although management is not aware of any factors that would significantly
affect the estimated fair value amounts, such amounts have not been
significantly revalued for purposes of these consolidated financial
statements since those dates and therefore, current estimates of fair value
may differ significantly from the amounts presented herein.
F-21
16. FOREIGN EXCHANGE CONTRACTS
A summary of foreign exchange contracts outstanding at December 31, 1995
and December 31, 1996 is as follows (in thousands):
DECEMBER 31, 1995 DECEMBER 31, 1996
--------------------------------- -------------------------------
UNREALIZED UNREALIZED
CURRENCY PURCHASES SALES GAIN/LOSS PURCHASES SALES GAIN/LOSS
Japan (Yen) $46,211 $46,211 - $40,828 $40,828 -
Malaysia (Ringgit) 505 505 - 6,009 6,009 -
Germany (Mark) 955 955 - 2,118 2,118 -
United Kingdom (Pound) 111 111 - 1,873 1,873 -
Hong Kong (Dollar) 1,991 1,991 - 1,807 1,807 -
France (Franc) 859 859 - 1,093 1,093 -
Netherlands (Guilder) 1,797 1,797 - 918 918 -
Belgium (Franc) 715 715 - 450 450 -
Thailand (Baht) - - - 382 382 -
Singapore (Dollar) - - - 331 331 -
Other currencies 1,042 1,042 - 1,337 1,337 -
---------------------------------- --------------------------------
$54,186 $54,186 - $57,146 $57,146 -
================================== ================================
The maturity of contracts outstanding as of December 31, 1996 is as
follows:
Maturity Purchases Sales
January 1997 $51,246 $51,246
February 1997 5,770 5,770
March 1997 130 130
17. REGULATORY MATTERS
The Company and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory - and possibly
additional discretionary - actions by regulators that, if undertaken, could
have a direct material effect on the Company's consolidated financial
statements. Under capital adequacy guidelines and the regulatory framework
for prompt corrective action, the Bank must meet specific capital
guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance sheet items as calculated under
regulatory accounting practices. The Bank's capital amounts and
classification are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the
table below) of total and Tier 1 capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier 1 capital (as defined) to
average assets (as defined). Management believes, as of December 31, 1996,
that the Bank meets all capital adequacy requirements to which it is
subject.
F-22
As of December 21, 1996, the most recent notification from the Federal
Deposit Insurance Corporation categorized the Bank as well capitalized
under the regulatory framework for prompt corrective action. To be
categorized as well capitalized the Bank must maintain minimum total risk-
based, Tier I risk based, and Tier I leverage ratios as set forth in the
table. There are no conditions or events since that notification that
management believes have changed the institution's category. The following
table presents the capital ratios for the Bank. The capital ratios for the
Company are the same as the capital ratios for the Bank.
To Be Well
Minimum Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes: Action Provisions:
------------------------ ------------------------- --------------------------
Amount Ratio Amount Ratio Amount Ratio
------------- --------- ---------- --------- ------------ -----------
As of December 31, 1996:
Total Capital
(to Risk Weighted Assets) $60,818,485 24.71% $19,691,528 8.00% $24,614,410 10.00%
Tier I Capital
(to Risk Weighted Assets) $60,718,485 24.67% $ 9,845,764 4.00% $14,768,646 6.00%
Tier I Capital
(to Average Assets) $60,718,485 9.65% $25,155,710 4.00% $31,444,637 5.00%
As of December 31, 1995
Total Capital
(to Risk Weighted Assets) $53,422,219 44.58% $ 9,587,613 8.00% $11,984,516 10.00%
Tier 1 Capital
(to Risk Weighted Assets) $53,387,219 44.55% $ 4,793,806 4.00% $ 7,190,710 6.00%
Tier I Capital
(to Average Assets) $53,387,219 36.59% $ 5,836,684 4.00% $ 7,295,855 5.00%
Under Massachusetts law, trust companies such as the Bank may only pay
dividends out of "net profits" and only to the extent that such payments
will not impair the Bank's capital stock and surplus account. If, prior to
declaration of a dividend, the Bank's capital stock and surplus accounts do
not equal at least 10% of its deposit liabilities, then prior to the
payment of the dividend, the Bank must transfer from net profits to its
surplus account the amount required to make its surplus account equal to
either (i) together with capital stock, 10% of deposit liabilities, or (ii)
subject to certain adjustments, 100% of capital stock.
18. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
YEAR ENDED DECEMBER 31, 1996 FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
Interest income $ 5,964,713 $ 7,966,327 $10,360,380 $12,386,007
Interest expense 2,022,877 3,904,330 5,662,451 7,078,376
Noninterest income 12,944,198 14,097,339 14,034,278 15,555,902
Operating expenses 14,517,448 14,912,163 15,377,305 17,128,661
Income before income taxes 2,347,539 3,219,106 3,354,903 3,718,985
Income taxes 927,277 1,215,814 1,289,905 1,433,575
Net income 1,420,262 2,003,292 2,064,998 2,285,410
Earnings Per Share 0.22 0.31 0.32 0.35
F-23
19. FINANCIAL STATEMENTS OF INVESTORS FINANCIAL SECURITIES CORP. (PARENT ONLY)
The following represents the separate condensed financial statements of
IFSC as of December 31, 1995 and 1996, and for the two-month period ended
December 31, 1995 and the year ended December 31, 1996.
STATEMENT OF INCOME TWO MONTHS ENDED YEAR ENDED
DECEMBER 31, 1995 DECEMBER 31, 1996
Equity in undistributed income of subsidiary $ 899,794 $ 7,601,082
Dividend income from subsidiary - 478,546
Operating expenses - (305,666)
---------------------- ---------------
Net income $ 899,794 $ 7,773,962
====================== ===============
BALANCE SHEET
DECEMBER 31, 1995 DECEMBER 31, 1996
Assets:
Investments in subsidiary $53,344,218 $61,367,783
Receivable due from subsidiary 76,713 493,089
Other assets - 3,438
---------------------- ---------------
Total Assets $53,420,931 $61,864,310
====================== ===============
Liabilities and Stockholders' Equity
Total Liabilities $ - $ 5,000
---------------------- ---------------
Stockholders' Equity
Common stock 64,440 64,443
Surplus 54,312,474 54,352,812
Deferred compensation (2,117,787) (1,687,675)
Retained earnings 899,794 8,480,431
Net unrealized gains on available for sale securities 262,010 649,299
---------------------- ---------------
Total Stockholders' Equity 53,420,931 61,859,310
---------------------- ---------------
Total Liabilities and Stockholders' Equity $53,420,931 $61,864,310
====================== ===============
F-24
19. FINANCIAL STATEMENTS OF INVESTORS FINANCIAL SECURITIES CORP. (PARENT ONLY)
(CONTINUED)
TWO MONTHS ENDED YEAR ENDED
STATEMENT OF CASH FLOWS DECEMBER 31, 1995 DECEMBER 31, 1996
Cash flows from operating activities:
Net income $ 899,794 $ 7,773,962
--------------------- -----------------
Adjustments to reconcile net income to net cash provided by operating
activities:
Amortization of deferred compensation 76,713 430,112
Change in assets and liabilities:
Receivable due from subsidiary (416,376)
Other Assets (3,438)
Other Liabilities 5,000
Equity in undistributed earnings of subsidiary (976,507) (7,601,082)
-------------------- ----------------
Total adjustments (899,794) (7,585,784)
-------------------- ----------------
Net cash provided by operating activities - 188,178
---------------------- ----------------
Cash flows from investing activities:
Payments for investments in and advances to subsidiary (34,120,938) (35,193)
---------------------- ----------------
Net cash used by investing activities (34,120,938) (35,193)
---------------------- ----------------
Cash flows from financing activities:
Proceeds from common stock 37,950,000 -
Costs of stock issuance (3,829,062) 35,193
Proceeds from exercise of stock options - 5,148
Dividends paid (193,326)
---------------------- ----------------
Net cash provided by financing activities 34,120,938 (152,985)
---------------------- ----------------
Net increase in cash and due from banks $ - $ -
Cash and Due from Banks, beginning of period $ - $ -
---------------------- ---------------
Cash and Due from Banks, end of period $ - $ -
====================== ===============
F-25